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Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 5th Annual African Development Finance...
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T T Mboweni: African economic integration Keynote address by Mr TT Mboweni, Governor of the South African Reserve Bank, at the 5th Annual African Development Finance Conference, Johannesburg, 9 October 2003. * 1. * * Introduction Esteemed guests, ladies and gentlemen. Africa is the poorest region in the world, with real per capita incomes averaging one-third less than those in South Asia, the next poorest region. Sub-Saharan Africa's per-capita GNP is only one tenth that of Latin America. Therefore, the promotion of economic development remains the major challenge confronting the continent today. However, it is widely accepted that economic development goes beyond the mere maximisation of economic growth. The distributional consequences of economic growth are of paramount importance. Given their potential to address both the growth and distributional concerns of economic policy, it is imperative that appropriate attention is given to the promotion of SMEs. The presentations and deliberations at this conference cover many important aspects pertinent to the development of SMEs. It is widely accepted that macroeconomic stability is a pre-requisite for sustainable economic growth. If this is the case, then what has been the African experience to date? 2. Recent macroeconomic developments in Africa In the past three years, real GDP growth in sub-Saharan African countries remained surprisingly resilient in spite of the slowdown in advanced economies. GDP growth in the sub-Saharan African region (excluding South Africa) was 3,1 percent in 2002, compared to 3,8 percent in 2001. Subdued economic activity in 2002 was due to the weak global economy, the slower-than-expected rebound in world trade, droughts, and political and armed conflicts in some parts of the continent. The latest IMF forecast released in September 2003 projects that GDP growth in sub-Saharan Africa (excluding South Africa) will rise to 3,6 percent in 2003, mainly as a result of the expected global recovery, improved macroeconomic policies, rising commodity prices and the debt relief under the Heavily Indebted Poor Countries (HIPC) initiative. While the economic growth rate in Africa compares quite favourably with those of developed countries, it is significantly less than those in other emerging countries, most notably in Asia. A reasonable benchmark for the evaluation of Africa's economic development, is the progress being made towards the achievement of the Millennium Development goals. The world's leaders adopted the UN Millennium Declaration in September 2002, committing their countries to reduce poverty, improve health and promote peace, human rights and environmental sustainability. Eight Millennium Development Goals, with specific targets to be achieved by 2015, dealing with key development challenges emerged from the Declaration. According to the 2003 Human Development Report, sub-Saharan Africa will not meet any of the goals by 2015 at the current rate of progress – the only region for which this is the case. In order to meet the Millennium Development Goal of halving poverty between 1990 and 2015, the IMF has estimated that growth in sub-Saharan Africa should be around 7 percent a year. IMF. 2003. World Economic Outlook: 51 2003: 51. Only six African countries achieved growth rates above 7 percent in 2002. There is little doubt that monetary policy has been successful in bringing down inflation in Africa. The rate of increase in prices has declined from an average of 14,3 percent in 2000 to 9,3 percent in 2002. Contributing to the low inflation environment has been the fiscal prudence apparent in the macroeconomic policies of a number of African countries since the late 1990s. The development challenges that confront the continent today, demand that both the quantity and efficiency of government expenditures are kept in check. While global FDI inflows declined 21 percent between 2001 and 2002, the inflow of FDI to Africa declined dramatically by more than 40 percent, according to the 2003 World Investment Report. In addition, Africa's share of foreign direct investment into developing countries has dropped from 25 percent in the early 1970s to just 5 percent in 2000. To compound matters further, an estimated 40 percent of Africa's own private savings are invested outside the continent. The more effective pursuit of political and macroeconomic stability, the implementation of structural reforms, greater geopolitical stability and a more supportive stance by the international community to addressing the concerns of Africa, would go a long way towards making Africa a preferred destination for FDI inflows. 3. International trade International trade has been an important engine of growth, and will continue to play a vital role, in promoting economic development and alleviating poverty in Africa. According to the United Nations Economic Commission for Africa (UNECA), Africa's share of world exports has fallen from 4,6 percent in 1980 to 1,8 percent in 2000. The international community has recognised the importance of closer economic co-operation as an impetus for economic growth in the world economy. The Fourth Ministerial Conference of the World Trade Organization held at Doha in November 2001, the International Conference on Financing for Development held in Monterrey, Mexico in March 2002, and the World Summit on Sustainable Development, held in Johannesburg in September 2002, collectively defined a new global partnership for development between developed and developing countries. Many analysts and policymakers, particularly those in developing countries, had hoped that the commitment of the developed countries would be operationalised at the WTO talks in Cancun, Mexico. However, as you are aware, this did not materialise. It is therefore not surprising that great disappointment followed the failure of the recent World Trade Organisation talks at Cancun to reach agreement on the lowering of agricultural subsidies in developed countries. While, there is little doubt that increased trade between Africa and the developed world will increase Africa's chances of achieving it's economic and social objectives, it is imperative that attention is also given to the promotion of intra-Africa trade. Despite four decades of integration efforts, intra-African trade as a percentage of total trade remains low. For example, the United Nations Economic Commission for Africa (UNECA) estimates that intra-African trade has increased only marginally from 8 percent in 1989 to 12 percent in 2002. It is therefore not surprising that current account deficits in many countries remain relatively high. The low level of African exports can be partly explained in terms of issues related to market access, inadequate infrastructure and other structural impediments to economic diversification in the various economies. In addition, low productivity and high costs of doing business have been often cited as the main factors undermining Africa's competitiveness. 4. Initiatives promoting African economic development Many initiatives have been undertaken to promote economic development in Africa. Article 44 of the Abuja Treaty calls for the harmonisation of economic policies across the African continent. The Treaty emphasises two important pillars of economic integration across the African continent: the promotion of intra-Africa trade and the enhancement of monetary co-operation. The African Monetary Co-operation Programme (AMCP) seeks to operationalise the monetary co-operation mandate of the Abuja Treaty. In the main, this involves a single monetary area, encompassing a common currency and a common central bank by the year 2021. The SADC countries have already undertaken many initiatives which are aligned with the objectives of the AMCP. For example, the harmonising of payment, clearing and settlement systems has already begun. Some SADC central banks are successfully implementing real time gross settlement systems (RTGS). And the strengthening of banking supervision has already begun in the region. A Memorandum of Understanding (MOU) on Macroeconomic Convergence has also been agreed to by SADC member states. This MOU forces members to pursue economic policies that would ensure macroeconomic stability. For example, by 2008, SADC member states are required to have single digit CPI inflation rates; ensure that the nominal value of public and publicly guaranteed debt, as a ratio of GDP, does not exceed 60 percent; ensure that the public budget deficit as a ratio of GDP does not exceed 5 percent; and have sustainable current account deficits – meaning 3 percent of GDP or less. In addition, Africa has embraced the New Partnership for Africa's Development (NEPAD) to confront the challenges facing the continent. It is a strategic development plan that addresses the economic, political and dimensions of Africa's future development. NEPAD is a clear demonstration of the willingness of the continent to take responsibility for its own actions and for its future. It is a new start for Africa to meet the Millennium Development Goals and targets. Crucially, the vision and way forward include, building political consensus and the necessary institutions as well as determining the pace of implementation of the programme. NEPAD aims to reduce poverty by significantly increasing economic growth throughout the continent. It is within this context that small and medium enterprises can emerge and flourish and support African economic development, employment creation and poverty reduction. However, we must remember that the global environment of the 21st century is an important determinant of industrial and economic success. Globalisation demands improved competitiveness. Increased competition presents new challenges and opportunities for African enterprises. As the world economy is being deregulated and liberalised, enterprises that are competitive in national markets have to be competitive in world markets as well. A pre-requisite for survival and success requires a winning combination of competitive strengths. 5. Conclusion There is little doubt, then, that there have been major changes in economic policy in many African countries in the recent past. Many of these changes have been advocated in support of the African Renaissance. These changes have entailed a transition towards more open, market-oriented regimes. On the political front, there has been a move towards multi-party democracy, and high priority being given to issues of governance and transparency in the policymaking process. The foundation is being laid. We now have to ensure that the policy intentions are realised. While the road to success may not guarantee a smooth ride, it is imperative that we ensure that it is not a long one. The increasingly important role of SMEs in this process should not be underestimated. The awards that will be presented at this conference are evidence of that. SMEs can play a vital role in job creation and in strengthening competition in domestic market. The challenge is however to ensure that individual success at the level of the firm, contributes towards the competitiveness of the national economy. I congratulate all the award-winners. Thank you.
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the dinner for Heads of Foreign Missions, Pretoria, 1 December 2003.
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T T Mboweni: Recent economic developments Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the dinner for Heads of Foreign Missions, Pretoria, 1 December 2003. * 1. * * Introduction Dean of Diplomatic Corps - Ambassador Alzubeidi Members of the Diplomatic Corps, Ambassadors and High Commissioners Representatives of: the United Nations System - Mr Ohiorhenuan The European Union - Ambassador Lake The International Labour Organisation - Dr Andoh The World Bank - Mr Omar Foreign Affairs - DDG: Africa, Ambassador Mamabolo Management & Staff of the South African Reserve Bank Ladies & Gentlemen As a relatively open developing economy, South Africa was again affected considerably by world economic conditions during the past year. The weak and fragile global economic recovery impacted on domestic economic growth, low world inflation contributed to a decline in domestic inflation and substantial financial inflows led to a further recovery in the external value of the rand. 2. International economic developments Global economic activity suffered a setback in the second half of 2002 when business confidence was detrimentally affected by revelations of corporate accounting malpractices, a further decline in stock exchange prices and a threat of war against Iraq. In the first half of 2003 equity prices began to rise somewhat and the war in Iraq was concluded without severely impacting on oil production. Yet the international economy continued to move at a sluggish pace, with the result that most analysts downgraded their initial forecasts for world growth in 2003. More recently there have been encouraging signs that the macroeconomic environment has improved somewhat. Production growth in the United States of 8,2 per cent in the third quarter of 2003 seems to confirm that the much-anticipated economic recovery is gaining momentum. This acceleration in the pace of growth impacted favourably on the demand for labour, causing the US unemployment rate to edge lower to 6 per cent in October 2003. The real gross domestic product of Japan also increased at stronger-than-expected rates during 2003, while growth in China remained high. A strong domestic demand, improved export performance and fiscal and monetary policies in the rest of Asia are expected to support growth in the rest of this continent. In contrast economic activity in the euro area was weaker than expected in the second quarter of 2003, but indicators for this region indicate that economic activity could firm somewhat in the coming months. Rising net exports and real exchange rate developments are expected to lead to a modest recovery in Latin America. Global inflation remains low and monetary and fiscal policies were eased in most advanced economies during the past two years. However, with the recent acceleration in economic growth, some authorities have begun with a less lenient policy stance. The Reserve Bank of Australia and the Bank of England have both recently increased their official central bank rates by 25 basis points. Both central banks cited the pickup in economic activity and increasing household borrowing as the main reasons for the tightening in their monetary policy. An important further characteristic of the global economic environment in the past two years has been a considerable weakening in the external value of the United States dollar. In particular during the current year this has affected the currencies of most developing countries because of substantial financial inflows into these countries. 3. Domestic production and expenditure Although domestic growth is expected to benefit from the improvement in the global economic environment in the coming months, the weakness in international economic growth impacted severely on domestic production. Having recorded a high rate of 5 per cent in the second quarter of 2002, real output growth in the South African economy slowed down progressively in the next four quarters to a mere ½ per cent in the second quarter of 2003. In the third quarter of 2003 the growth in production rose somewhat to an annualised rate of 1 per cent. This brought the increase in real gross domestic product to only 2 per cent in the first nine months of 2003 compared with the same period in the preceding year, i.e. to a considerably lower rate than the 3½ per cent attained in 2002 as a whole. As could be expected if world economic conditions are taken into consideration, this decline in domestic production was mainly the result of a decrease in the volume of net exports. The growth in South African exports has always been closely correlated with world demand for our goods, especially the demand for our minerals and metals. The recovery in the exchange rate of the rand also had a significant price effect on manufacturing exports to the rest of the world. At the same time it was accompanied by a rise in real imports to South Africa. Fortunately a considerable improvement in the terms of trade of the country related to a substantial increase in international commodity prices, softened the effect of a deterioration in the volume of net exports. As a consequence, the surplus on the current account of the balance of payments in 2002, changed to a deficit of approximately 1 per cent of gross domestic product in the first nine months of 2003. This relatively small deficit poses no threat for a recovery in domestic economic growth. Growth in domestic production during 2003 continued to be supported by domestic demand. Domestic final demand increased at a rate of 4 per cent in the first nine months of 2003 compared with the same period in the preceding year. This continued high growth in domestic final demand was the result of increases in consumption as well as fixed capital formation. The growth in real final consumption expenditure by households also remained strong throughout 2003. The sustained high growth in private consumption expenditure was underscored by a rise in real personal disposable income owing to recent salary and wage increases, a reduction in income tax rates and more recently the decrease in interest rates. To supplement the growth in their disposable income, households became more willing to incur debt. Consequently, households debt as a percentage of disposable income rose somewhat from 51 per cent in the fourth quarter of 2002 to 53 per cent in the third quarter of 2003. This level is still low compared to those of many other countries. The strong domestic demand was also supported by growth in real final consumption expenditure by general government at an annualised rate of about 4 per cent in the first three quarters of 2003. This was mainly due to government purchases of goods and services, while real spending on salary and wages of government employees was rather restrained. Expenditure on real gross fixed investment continued to be buoyant throughout the first nine months of 2003. Private business enterprises as well as the public sector increased their fixed capital outlays. The government and public corporations increased their capital expenditure on infrastructure expansion aimed at service delivery, while private business appeared to be making the most of conditions that favour expenditure on capital goods. Such conditions included an exchange rate conducive to importing goods, a lowering in the cost of borrowing, rising prices in international commodity markets and considerably more stability on the inflation front. The strong domestic final demand was unable to prevent a decline in manufacturing output. Having increased robustly in the first half of 2002, real manufacturing output started to grow at a slower rate in the second half of that year and then declined in the first nine months of 2003. This was mainly a reflection of lacklustre global growth trends and the recovery in the exchange rate of the rand. Most of the subsectors of manufacturing were affected by a low demand for exports and increased imports as a greater proportion of domestic demand was met by competitively priced imports. As could be expected, this had a marked effect on employment. 4. Inflation and monetary policy The inflation outlook improved significantly during 2003. The twelve-month CPIX inflation fell from a peak of 11,3 per cent in October 2002 to below the upper boundary of the inflation target from September 2003. In October 2003 it even receded to below the mid-point of the target range when it reached 4,4 per cent. This achievement was underpinned by the sustained maintenance of prudent monetary and fiscal policies together with the recovery in the international exchange value of the rand and a moderation in food price increases. As the inflation outlook improved, the monetary policy stance was adjusted on four occasions in 2003. The first reduction in the repo rate was only made in June 2003, but there were already clear signs that the inflation rate was moving towards the inflation target at the March meeting of the Monetary Policy Committee. At the time of that meeting it was felt that upside risks limited any possible actions that the MPC could take. In particular, the commencement of the war in Iraq on the first day of the meeting had an important effect on the Committee's decision. As the uncertainties about the inflation outlook dissipated and it became increasingly apparent that most factors favoured the attainment of the inflation target in the next two years, the MPC started to lower interest rates. The repo rate was cut by 150 basis points in June, by 100 basis points in August and September, and again by 150 basis points in October. All in all, a total reduction of 500 basis points in a period of only five months. This was indeed an aggressive lowering of interest rates. Nominal rates are at levels last seen in the 1980s, but the difference is that the current and expected inflation rates are significantly lower than those observed in the 1980s. Although international and domestic economic conditions have allowed the MPC to reduce short-term interest rates in an aggressive manner, the overriding objective of the Reserve Bank remains the attainment of the inflation target. Achieving low inflation is not an end in itself. It is important because it is a prerequisite for sustainable high economic growth and employment creation. The current and more importantly the expected state of the domestic economy will always carry weight in the determination of monetary policy. 5. The exchange rate of the rand Of all the recent economic developments, the behaviour of the external value of the rand has attracted the most attention. The exchange rate of the rand has been very volatile during the past few years. After the nominal effective exchange rate of the rand had declined by 13 per cent in 2000 and 34 per cent in 2001, it increased by 24 per cent in 2002 and by nearly 25 per cent in the first eleven months of 2003. Such volatility in exchange rates seems to be a fact of life in most economies these days. Fluctuations in the external value of currencies are unavoidable in the current international monetary system of generally floating exchange rates. Even when currencies are pegged to another currency or to a basket of currencies, they still float against other currencies and fluctuate widely at times. Large fluctuations in the exchange rate of the rand are clearly not healthy for the economy. The uncertainty caused by these fluctuations makes investment and export planning extremely difficult. What may seem to be a profitable venture can turn out completely different with a substantial swing in the external value of the rand. The Reserve Bank would obviously prefer to have greater exchange rate stability, but as already indicated fluctuations in the exchange rate of the rand seems unavoidable. The Bank can only create an environment that favours exchange rate stability. One of the most important recent developments in this regard has been the improvement in the net open foreign currency position of the Reserve Bank. The oversold foreign currency position of the Bank has always been perceived as a source of exchange rate weakness and instability. The Bank's objective was therefore to eliminate this oversold position, which stood at US$23,2 billion at the end of September 1998. During the past year this objective was finally achieved in May. At the end of October a positive net open foreign currency position of US$2,7 billion was recorded. Having removed this perceived vulnerability, the price discovery process in the market for foreign exchange should now display a better two-way trading pattern. In an attempt to further improve the functioning of the South African market for foreign exchange, the Bank has shifted its focus to reducing its oversold forward book and to strengthening the official foreign exchange reserve position. Considerable success has been achieved in bringing the oversold forward book down to lower levels. The balance on the oversold forward book stood at US$2,3 billion at the end of October 2003, compared with US$6,9 billion at the end of December 2002. In the mean time, the official foreign exchange reserve position was also increased to a level of US$7,8 billion at the end of October 2003. 6. Conclusion These improvements in the functioning of the foreign exchange market and the lower inflation rate should at least provide a basis for more stability in the value of the rand. However, the South African economy will always be affected considerably by developments in the rest of the world. Any weakness in the US dollar or any of the other major currencies will affect the exchange rate of the rand. Our focus can therefore only be to develop an environment favouring greater stability. Monetary policy will continue to focus on the objective of price stability. Fortunately the world economic outlook has recently improved considerably, which should assist in attaining higher domestic economic growth. In addition, the outlook for inflation looks good. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Mercury/Safmarine Business Breakfast, Durban, 14 May 2004.
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T T Mboweni: Recent economic developments and monetary policy in South Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Mercury/Safmarine Business Breakfast, Durban, 14 May 2004. * 1. * * Introduction Ladies and Gentlemen. Since September of 2003, monetary policy in South Africa has succeeded in maintaining CPIX inflation within the specified 3-6 per cent target range. This was achieved less than a year after inflation had peaked at over 11 per cent in November of 2002. This success was a result of the monetary policy reaction to the inflation surge in 2002 following the depreciation of the rand in late 2001, as well as other favourable developments, both domestically and internationally. This morning I will review some of the recent economic developments, both positive and negative, that have contributed to the favourable inflation outcomes of the recent past. However monetary policy should not dwell on the past. Monetary policy should be, and in fact has been, forward looking, and I will, therefore, highlight some of the risks and challenges to monetary policy in the future. 2. International economic developments After a number of false starts, the world economic recovery was well under way in the latter half of 2003, particularly in the United States and Asia. Real growth in the US had risen to 3,1 per cent in 2003, and the latest IMF World Economic Outlook forecast is for 4,6 per cent growth in 2004. The recovery has been accompanied by high levels of productivity growth, and more recently by increases in employment. The Japanese economy appears to have emerged from a protracted period of low or negative growth, and this has provided an additional stimulus to the Asian region. Recent suggestions of a possible slowdown in China have raised fears that the generalised recovery is under threat. This has had a negative impact on commodity prices in recent weeks. These fears are likely to be exaggerated, as China still has enormous growth potential. Although Chinese growth may decline from its unsustainably high levels, the country is likely to remain an important and dynamic engine of economic growth internationally. Of greater concern to South Africa is the low growth in the euro area, South Africa’s largest trading partner. Growth in the euro area was 0,4 per cent in 2003 and although there are encouraging signs that some of the countries in the region are beginning to recover, growth is only expected to reach 1,7 per cent in 2004. The United Kingdom, Latin America, Australasia and Africa have also been part of the global recovery to varying degrees. Behind the euphoria, there are a number of factors that have been identified as posing a risk to the sustainability of the turnaround. Firstly there are the imbalances in the US economy. The US trade and current account deficits may require an adjustment in US macroeconomic policies, if the required adjustment is not achieved through movements in the dollar exchange rate. Some adjustment is inevitable as economic growth in the US accelerates. The challenge for the US will be to reverse its policies in such a way that does not undermine the global recovery and also achieves the desired effects with respect to the imbalances. The lenient macroeconomic policies of the United States in particular were an important element in bringing about the global recovery, and the challenge is to prevent the inevitable reversal of these policies from undermining the recovery. The recent positive employment figures emanating from the US have fuelled expectations that the tightening of the US policy stance will begin sooner rather than later. This will follow the lead of central banks in the UK, Australia and New Zealand which have already increased interest rates. Secondly, a further risk to the global recovery is posed by the recent developments in the international oil market, where oil prices are moving inexorably towards the US$40 per barrel mark. This is a result of a combination of low inventory levels in the United States, the reduction in OPEC production quotas, tensions in the Middle East, and political problems in a number of oil-producing countries. As recently as February it appeared that the pressure on prices would be short-lived as the OPEC basket price moved from around US$30 per barrel down to the US$28 per barrel level, the upper limit of the OPEC target range. Unfortunately this turned out to be a temporary reprieve. The average price of the OPEC basket was US$32,05 in April and US$35,23 in the first week of May. Although at this point it appears that this threat is more short term in nature, there have been warnings that excessively high prices could undermine the sustainability of the global upswing. Despite the upswing in the global economy, there is no widespread expectation of a revival of generalised world inflation. The IMF World Economic Outlook projects a decline in world inflation from 3,7 per cent in 2003 to 3,2 per cent in 2005. Although a handful of countries are expected to have higher inflation, the forecast is for all regions of the world to have single digit inflation by 2005. The expected upturn in the international interest rate cycle is likely to reinforce this positive inflation outlook, although the oil price developments could pose some risk. Domestic economic developments 3. Output, expenditure and monetary conditions Domestic growth has not been synchronised with world developments. Following the 3,6 per cent recorded in 2002, growth declined to an annual rate of 1,9 per cent in 2003, as a result of a significant contraction in the value added by agriculture and manufacturing. The poor performance in agriculture was a result of poor weather conditions that had an impact on both livestock and field crop production. In the case of manufacturing output, the contraction was largely a result of the initially slow world recovery and the impact of the recovery of the exchange rate of the rand. Capacity utilisation in manufacturing had declined in the fourth quarter of 2003 to 79,6 per cent. There are, however, indications that South Africa’s growth prospects are improving. Although still at low levels, growth in the second half of 2003 exceeded that recorded during the previous six months and the recent good rains have improved the outlook for agriculture in many areas. The delay in the release of manufacturing sector statistics makes it difficult to know with certainty how the manufacturing sector has been performing in the recent past, but there are indications that there has been an overall improvement in this sector. Recent reports have pointed to strong domestic demand impacting positively on manufacturing, and various confidence indices as well as the Investec Purchasing Managers Index (PMI) are indicative of an improvement. There are also signs that the growth in world demand is beginning to have a positive impact on manufactured exports. Domestic expenditure has continued to grow at a robust pace, increasing by 7,2 per cent in the fourth quarter on a quarterly annualised basis, and 4,2 per cent for 2003 as a whole, slightly lower than that recorded in the previous year. Gross fixed capital formation grew by 8,4 during the year, reflecting in part increased infrastructure spending by government, while government consumption expenditure and household consumption expenditure increased by 4,6 per cent and 3 per cent respectively. The latter was underpinned by declining prices of various consumer items, tax reductions, interest rate reductions, a declining ratio of debt servicing costs to disposable income and fairly high real wage settlements. This excess of expenditure over output is reflected in a smaller trade surplus and higher current account deficit of around 1,8 per cent of GDP. Import volumes increased by 3,3 per cent in the final quarter of 2003 while the physical volume of exports of goods and services increased by 2,2 per cent. However, the trade surplus in February and March of this year improved as a result of an increase in exports with the 3-month moving average (seasonally adjusted and annualised) of the trade surplus increasing from R17,6 billion in January to R20,5 billion in February. The moderate deficit on the current account is not an immediate cause for concern. At these levels the deficit is sustainable and has been comfortably financed through significant inflows on the financial account, which showed healthy surpluses in the final three quarters of 2003. The surplus in the final quarter amounted to R34,6 billion. However, there is no room for complacency. It is well known that financial account reversals can occur very quickly, and if expenditure growth proceeds unchecked, the current account developments could prove to be unsustainable. The higher levels of domestic expenditure have been reflected in more buoyant money market conditions. Most of the money supply aggregates have grown at a relatively robust pace. The average twelve-month growth rate for M3 in 2003 was 13,0 per cent, and grew by 14,9 per cent and 14,0 per cent in February and March respectively. Twelve-month growth in banks’ total loans and advances to the private sector has remained at levels of around 12,5 per cent since early 2003. Growth in mortgage, instalment sale and leasing finance has been particularly strong over the past year. 4. Recent labour market developments The unemployment situation in South Africa remains a major source of concern. Fortunately, quarter-to-quarter increases in employment were recorded on both the public and private sectors during the final two quarters of 2003, reversing the trend of the previous two quarters. From a monetary policy perspective, a concern of the Bank has been the trend in wage settlements, which play an important role in the inflation process in South Africa. Central to the Bank’s concern is the fact that wage settlements often tend to be set in a backward-looking manner. This acts as a constraint of the downward movement of inflation. The Bank would like to see wages and prices being set on the basis of the inflation rate that is expected to prevail over the period for which wages are being set. Although wage demands are still trying to compensate for the high inflation of 2002, there are indications that nominal wage settlements, although still high, are moderating. According to Andrew Levy Employment Publications, the average rate of settlements in collective bargaining agreements declined from 8,9 per cent in 2003 to 7,6 per cent in the first quarter of 2004. Of greater significance perhaps is the fact that the average unit labour cost increases amounted to 5,2 per cent in the fourth quarter of 2003 and an average of 5,0 per cent for the year. Although the trends are promising, the Monetary Policy Committee will be watching these developments carefully. 5. Exchange rate and foreign exchange reserves The exchange rate continues to play a critical, albeit unpredictable role in the inflation process. During 2003 the rand continued its recovery and from the end of December 2002 to the end of April 2004 the nominal effective rand exchange rate appreciated by 16,4 per cent, and by 26,4 per cent bilaterally against the US dollar. There are a number of factors that explain the recovery of the rand during the past two years. Besides the correction of the overshooting that occurred during 2001, other factors include US dollar weakness, rising commodity prices, positive interest rate differentials, improved perceptions of the strength of South Africa’s economic fundamentals as evidenced by narrowing spreads on South African international bonds and improved credit ratings by the international credit-rating agencies. Furthermore, the conversion first of the net open foreign-currency position (NOFP) in May 2003 into a positive position, and the closing out of the Reserve Bank’s oversold forward book during 2004 not only contributed to the rand’s recovery, but is also expected to contribute to greater stability in the rand exchange rate, as the perception that the rand is a one-way bet has now disappeared. In the past few weeks the rand has moved from the levels of around R6,50 to the US dollar to around US$7,00 to the dollar, a result of increased dollar strength, the recent moderation in commodity prices and an expectation of an early increase in US interest rates. In the past such a move would have sparked fears of a continuous depreciation of the currency, leading to a large sell-off. There is however a broader acceptance in the market that although the rand may still be subject to some volatility, a weakening of the currency will not inevitably lead to further weakening. The emerging view is that the rand will respond to changing fundamentals in an orderly manner, and the direction of change will not be one way. This change in perception is to a large extent a result of the improvement in the overall international liquidity position. Although the Bank has been engaging in limited purchases of foreign exchange reserves for the purpose of bolstering foreign exchange reserves, this should not be misinterpreted as intervention in the market in order to target a specific level of the exchange rate. South Africa’s foreign exchange reserves are low by comparison with other emerging market economies, and this perception makes the rand vulnerable to speculative attacks. The Bank’s objective is to build up foreign exchange reserves in a prudent manner, and in such a way that has a minimum impact on the exchange rate. The Bank does not have a target for the exchange rate, and at this stage the Bank does not have a target for foreign exchange reserves or a target for the rate of accumulation of reserves. As at the end of April 2004, gross reserves stood at US$10,1 billion while the net reserves or international liquidity position was US$6,4 billion. This can be compared, for example, to the position at the end of December 2002 when gross reserves amounted to US$7,8 billion and international liquidity position was minus US$1,6 billion. 6. Inflation developments Developments on the inflation front continue to be positive. CPIX inflation slowed down from a peak of 11,3 per cent in October and November of 2002 to move to within the target range of 3-6 per cent by September of 2003 and has remained there since. It reached a low of 4,0 per cent in December 2003 before increasing to 4,8 per cent in February and then fell back to 4,4 per cent in March 2004. The achievement of bringing inflation down to within the target range can be attributed to a number of factors including the monetary policy response to the inflation shock of late 2001, positive base effects and the sustained recovery in the exchange rate of the rand. The decline in food price inflation, which had been a major factor driving inflation up in 2002, was also an important contributor to the decline in the inflation rate. The upturn in the inflation trend in the early months of this year was not unexpected and in line with the Bank’s inflation forecast. The Bank’s inflation forecast which is published in the latest Monetary Policy Review, shows that CPIX inflation is expected to rise gradually towards the upper limit of the inflation target range before moderating again. There are a number of factors underlying this inflation outlook. On the positive side is the low world inflation, the relatively low levels of manufacturing capacity utilisation resulting in output below potential, continued fiscal prudence, and the impact of production price inflation, which is a short term indicator of future consumer inflation. Production price inflation has been negative since September 2003, with the rate of decline in the production price index slowing from minus 2,5 per cent in November 2003 to minus 1,0 per cent in February 2004 and minus 1,2 per cent in March. The main factor driving this trend has been imported prices, influenced by the recovery in the rand and the low global inflation. Imported price inflation has been negative since April 2003. However, domestic producer price inflation has also declined, reaching 0,2 per cent in November of last year, and 1,5 per cent in March 2004. On a quarter-on-quarter basis, producer price inflation showed no growth in the first quarter of 2004. A further positive development has been the evolution of inflation expectations. The Bureau for Economic Research (BER) at the University of Stellenbosch conducts a survey of inflation expectations on behalf of the Bank. The latest survey released in April 2003 shows a continuation of the downward trend in CPIX inflation expectations. Most significantly, the expectations of business executives and trade union officials have fallen sharply. Unfortunately there are a number of risks to the inflation outlook. A factor constraining the continued downward movement in the inflation rate was the fact that services inflation had remained relatively sticky. Services inflation did moderate from 8,6 per cent in September 2003 to 7,8 per cent in March, but this is still significantly above the upper limit of the target. A significant portion of services comprise administered prices which for long have been singled out as a threat to the inflation target. Fortunately some administered prices have shown signs of moderating, particularly in the light of low tariff increases granted by the relevant regulators to the Post Office, Eskom and Telkom. A further concern is the trend in international oil prices discussed earlier. The higher international oil price translates itself quickly into higher pump prices and the effects have already been felt in the inflation numbers. The pump price of 93 octane petrol in Gauteng, for example, rose from R3,78 in January 2004 to its current level of R4,39 per litre, although this includes the 10 cents per litre increase in the fuel tax and the 5 cents per litre increase in the Road Accident Fund levy announced in the recent budget. A lesser risk is posed by food prices which threatened to create problems as the maize price began to rise considerably in late 2003 as a result of the drought in large parts of the country. Fortunately this threat has dissipated somewhat with the good rains that were experienced in many parts of the country recently. The SAFEX futures price for white maize for delivery in 2004 increased sharply from around R1000 per ton in October-November 2003 to R1578 per ton early in February 2004. However prices have subsided to around R1100 per ton since March as rainfall figures improved late in the season and higher crop estimates were published. 7. Monetary policy Recent monetary policy should be seen against the backdrop of the developments outlined above. Between June and December of 2003, the repo rate was reduced by 550 basis points, bringing the repo rate to 8,0 per cent, the lowest nominal level for this interest rate or its predecessor, the Bank rate, since 1980. However, historical comparisons of nominal rates can be misleading. In 1980 the inflation rate was around 14 per cent, implying a strongly negative real interest rate. Currently, although real interest rates have come down with the successive reductions in nominal rates, they are still significantly positive. In December the repo rate was reduced by 50 basis points, despite the fact that the market consensus was that the reduction would be 100 basis points or more, with further reductions forecast for the subsequent meeting. It is perhaps important to explain why the MPC decision was not in line with market expectations. The expectation that the MPC would continue to lower interest rates aggressively in December was probably based on the incorrect assumption that monetary policy decisions are based on current inflation. At that time, CPIX inflation was within the target and was still trending downwards. However policy decisions are made not on the basis of the current inflation rate but on the basis of the expected trend of inflation over the control horizon, which is the lag between a change in monetary policy and its full impact on inflation. This transmission lag in South Africa is estimated to be between 18 and 24 months. Monetary policy cannot impact on current inflation, rather it has to focus on future inflation. The current inflation rate is the basis for assessing the success or otherwise of past monetary policy. To assess the appropriateness of the current monetary policy stance, on the other hand, we need to look at how the expected trend of inflation over the next 18 to 24 months or so compares to the target. In the same way that the decisions to lower interest rates during the course of 2003 were determined by the outlook for inflation rather than the actual inflation at the time, so the recent decisions of the Monetary Policy Committee to keep rates unchanged were based on forward-looking assessments of the factors that affect the inflation rate, and were informed by the forecasting model of the Bank. It should be stressed however that although the forecast is an important guide to policy, policy is not determined by the forecast in a mechanical way. Although the current inflation rate was well within target at the time of the December meeting, the focus of the MPC was on the future trend of inflation. By then it was clear that a further lowering of interest rates, combined with the assessment of the factors that are likely to affect inflation in the future, would threaten the inflation target. These factors are likely to change over time, which is why there is a reassessment of monetary policy at regular intervals. 8. Conclusion Over the past few months monetary policy has achieved the objective of keeping the CPIX inflation rate within the inflation target band of 3-6 per cent. Monetary policy was assisted in this through favourable developments that were outlined earlier. On the other hand, there are risks to inflation, and the Monetary Policy Committee will have to monitor these carefully. These risks include the uncertain trend in wage settlements, domestic demand conditions, and developments with respect to administered prices. Perhaps a more immediate threat is that posed by developments in international oil markets. Since the adoption of inflation targeting in South Africa, the economy has been hit by a number of shocks including food price shocks, exchange rate shocks and oil price shocks. Whilst the general policy prescription is to respond only to the second-round effects of such shocks, the challenge for monetary policy is to recognise when the impacts are becoming more generalised, and to act at the appropriate time to avoid undermining the integrity of the inflation targeting framework. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the South Africa ten years on - empowerment, finance, trade and investment conference, Cape Town, 20 May 2004.
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T T Mboweni: The restructured South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the South Africa ten years on - empowerment, finance, trade and investment conference, Cape Town, 20 May 2004. * 1. * * Introduction Ladies and Gentleman, thank you for the invitation to speak at this conference. After ten years of democracy in South Africa, I think it is useful to consider what we have achieved and what challenges we will still have to face. My address this morning is a summary of a more detailed chapter that I wrote on this same subject for a book to be published by the World Economic Forum entitled “South Africa, The Miracle Continues”. This may be a book of interest to many of you. I believe it will be launched at the Africa Economic Summit 2004, which will be held from 2 to 4 June in Maputo, Mozambique. 2. The South African economy in 1994 When the first democratically elected South African government came to power in 1994, the country was to a large extent economically isolated from the rest of the world. Trade boycotts, economic sanctions, disinvestment, the withdrawal of other capital and the declaration of a partial debt standstill from September 1985, forced the authorities to pursue an inward-oriented policy that had a severe impact on domestic economic performance. At the time of the standstill, the affected debt amounted to US$13,6 billion and the total debt amounted to US$23,7 billion. As a consequence living standards deteriorated, economic growth was constrained, unemployment rose, productivity growth slowed down and economic management became less effective. The refusal of foreign creditors to roll over the short-term credit facilities of domestic borrowers led to a shortage of foreign exchange and a confidence crisis in 1985. Despite the debt standstill on the repayment of foreign debt, capital continued to flow out of the country. At first this consisted mainly of short-term capital that was not affected by the standstill arrangements. Blocking this capital would have jeopardised trade flows. Later these capital outflows also included amounts which became payable in terms of the various standstill agreements. From the beginning of 1985 to 1993 the net financial outflow from South Africa amounted to about R45 billion, or to 11 per cent of gross domestic fixed investment. As a result of this outflow, the South African authorities were forced to generate current account surpluses. The gold and other foreign reserves of the country remained at low levels and domestic savings had to be used to finance the withdrawal of capital. The balance of payments constraint effectively limited the policy options the authorities had at their disposal. Although the forced repayment of loans improved the overall foreign debt position of the country, the policy of constrained domestic expansion called for huge sacrifices by the South African population and continued to affect the domestic economy for a long time after 1994. 3. Global integration Even before the new government came to power, many countries started to normalise trade relations with South Africa when it became apparent that the political transition would be negotiated in a peaceful manner. Trade boycotts, economic sanctions and the disinvestment campaign were suspended. However, debtors in South Africa had to continue making repayments on debt affected by the standstill arrangements for a number of years. The standstill only ended on 15 August 2001 when the final repayment on the affected debt was made. In the meantime, the South African government started raising funds again on international capital markets from 1995 and non-residents resumed investing in private entities in the country. This normalisation of international relations allowed the newly-elected democratic government to gradually reintegrate the domestic economy into the global environment. High priority was given to the reform of trade policy in this process. The trade regime at the beginning of the 1990s was characterised by three interrelated strategies, namely the promotion of domestic industries through import substitution, the development of specific industries to attain self-sufficiency and the promotion of mineral beneficiation. South Africa’s industries therefore became heavily protected by formulae, specific and ad valorem duties and surcharges. High tariff levels were complemented by quotas that limited the quantity of imports. The tariff structure was extremely complicated. Overall the strategies pursued by the authorities resulted in a complex discretionary regime with an anti-export bias. After the transition in 1994, government became committed to a policy of import liberalisation, and agreed to import tariff reductions to levels even lower than that required by GATT, i.e. the predecessor of the World Trade Organisation. Key aspects of the trade reform included a five-year tariff reduction and tariff rationalisation programme; a decrease in tariffs and subsidies on agricultural products and the conversion of all quantitative restrictions on agricultural imports to ad valorem rates; an increase in the number of binding rates applicable on industries as well as in the percentage of zero tariff lines to total tariff lines; a phasing out of the export subsidy scheme applicable at that time, which was called the “General Export Incentive Scheme (GEIS)”. As a result of these changes to the tariff regime, the number of tariff categories was reduced from over 100 to only six and the average weighted import duties on manufactured goods to the total value of manufacturing imports decreased from 14,0 per cent in 1994 to 4,7 per cent in 2002. Several free trade agreements were also signed to dismantle trade barriers and to gain increased market access. In addition to these measures undertaken to promote competition, industrial policy was adjusted to enhance the competitiveness of manufacturing enterprises in export markets. In particular more emphasis was placed on supply-side measures, rather than demand-side measures such as expensive export support programmes. These measures included investment incentives for large investments of a strategic nature and for small and medium enterprise development; training grants to firms investing in the promotion of skills; the development of industrial development zones; improved access to finance; and support for investments in economic infrastructure. A new Competition Act was passed in Parliament in 1998 to, among other things, create a greater spread of ownership in enterprises, to expand opportunities for South African participation in world markets and to provide consumers with competitive prices and product choices. The Act further focuses on preventing any form of anti-competitive conduct by a firm or a group of firms arising from agreements. Institutions were established in terms of the Act to ensure that these objectives are achieved and to monitor implementation and adherence to the law. A further step to reintegrate the South African economy into the world economy was the gradual dismantling of exchange controls. The financial rand system was already abolished in 1995 and considerable success has been achieved in relaxing all the other controls. Limits are still applicable on the amounts that residents and emigrants may repatriate from South Africa, but these limits have been increased progressively over the past ten years. Moreover a foreign exchange control amnesty and accommodating tax dispensation were announced in February 2003 to allow individuals to bring funds back that are held illegally offshore or to pay a 10 per cent charge on funds remaining offshore. The amnesty offers individuals an opportunity to regularise their affairs. The period for filing for amnesty relief ran up to 29 February 2004. 4. Fiscal policy The liberalisation of South Africa’s trade relations with the rest of the world was accompanied by considerable changes in the management of public finances. At the beginning of the 1990s an unsustainable fiscal situation had started to develop, and the deficit before borrowing and debt repayment of the government reached 7,3 per cent of gross domestic product in the fiscal year 1992/93. Government expenditure continued to rise relative to domestic production, the tax burden increased, the public sector made increasing demands on the domestic capital market, the ratio of government’s interest payments to gross domestic product rose steeply and government dissaving increased to unacceptably high levels. The post-apartheid South African government therefore placed considerable emphasis on restoring fiscal stability. The economic strategy at first was to create stable macroeconomic conditions as a necessary precondition for sustained growth and employment creation. It was believed that by improving fiscal sustainability, poverty reduction and income redistribution would become attainable objectives over the medium term. The expenditure restraint applied by the national and provincial governments reduced the fiscal deficit before borrowing and debt repayment to 1,5 per cent of gross domestic product in fiscal 2001/02. This successful fiscal consolidation allowed the government to adopt a more expansionary fiscal policy stance from fiscal 2001/02. More emphasis was placed on infrastructural development and social upliftment than in the previous years. The government, however, continued to apply fiscal discipline and despite a decline in the growth of tax revenue, was able to contain the main budget deficit to an estimated 2,4 per cent of gross domestic product in fiscal 2003/04. Economic growth was primarily promoted by microeconomic reforms to boost the supply side of the economy, rather than by stimulating demand through rapid increases in expenditure and the lowering of taxes. An important aspect of the budget reform was the adoption of the Medium-Term Expenditure Framework in the fiscal year 1998/99 and the Public Finance Management Act of 1999. The MediumTerm Expenditure Framework consists of three-year rolling expenditure and revenue projections for the national and the provincial governments. This creates greater certainty and transparency to the budgetary process. The Public Finance Management Act has enhanced the accountability of public sector managers by emphasising disciplines such as regular financial reporting, sound internal expenditure controls, improved accounting standards, performance monitoring and independent audit and supervision systems. The asset and liability management of government has also changed considerably over the past ten years. After years of isolation, the South African government established itself again as a credible borrower in the international capital markets. This is reflected in the upgraded credit ratings received from international rating agencies since 1994 and the continued interest in investing in bond issues of the national government. However the government has maintained its foreign debt well within appropriate levels. At the end of December 2003 the foreign debt of the national government amounted to only 6,0 per cent of gross domestic product. In the domestic market the government’s strategy has been aimed at reducing borrowing costs and risk, managing maturity profiles, diversifying funding instruments, increasing transparency and building credibility. The marketing of government debt through primary dealers was introduced in 1998, followed by a debt consolidation programme in 2002. The funding instruments were also diversified from fixed income bonds and treasury bills to inflation-linked bonds, variable rate bonds and retail bonds. Moreover, considerable progress has been made in improving cash management through investments in interest-bearing deposits. As a result of all these measures the government has been able to reduce its net loan debt from a peak of 48,1 per cent of gross domestic product in fiscal 1996/97 to 36,8 per cent in 2003/04. This not only contributed to lower interest payments on total public debt, but also to generally lower long-term yields in the South African capital market. The prudent measures applied by government have brought about a decline in government net dissaving from the high level of 7,3 per cent of gross domestic product in 1992 to 1,1 per cent in 2003. 5. Monetary policy The more normalised relations with the rest of the world made it possible for the authorities to focus monetary policy on the creation of a financial environment that would be conducive to the attainment of the growth potential of the country. The objectives of monetary policy at the beginning of the 1990s were to reduce the rate of inflation to the average rate of inflation in trading partner and competitor countries; to manage the money creation process in such a way that an adequate, but not an excessive amount of new money would be supplied to the system; to maintain positive real interest rates; to increase the gold and other foreign reserves to a comfortable level and to develop a sound financial infrastructure consisting of healthy financial institutions and financial markets. In the 1990s the Reserve Bank also intervened heavily on its own initiative in the spot and forward market to influence supply and demand in the foreign exchange market. These operations were undertaken to smooth out large short-term fluctuations in the exchange rate, but it was explicitly stated by the Bank that it did not target the level of the exchange rate. The extent to which the Bank intervened in the foreign exchange market was clearly reflected in the changes in the net open position in foreign reserves (NOFP), i.e. the net gold and other foreign reserves of the Bank less the balance on its net oversold forward book. For example, on 30 September 1998 the NOFP reached a peak of US$23,2 billion. Despite this active intervention, large fluctuations occurred in the weighted average external value of the rand, particularly during the second half of the 1990s in an environment of more liberalised exchange controls. The monetary policy measures, however, achieved considerable success in bringing the rate of inflation down. After inflation in the consumer price index had generally fluctuated around a level of about 15 per cent in the late 1980s and the beginning of the 1990s it moved below double digits in 1993 and declined to 5,2 per cent in 1999. In February 2000 the government announced that South Africa had formally adopted an inflationtargeting monetary policy framework to make monetary policy more transparent and accountable and to promote a more co-ordinated approach with other policy measures. In the application of inflation targeting in South Africa, it was decided to leave the external value of the rand to the market and not to intervene in the foreign-exchange market to influence the exchange rate. It was realised that this could lead to volatility in the exchange rate of the rand. Although the Bank would have preferred to operate in an environment characterised by exchange rate stability, cognisance is taken of the fact that fluctuations in the external value of the rand are unavoidable in the current international monetary system of generally floating exchange rates. In these circumstances the authorities can only aim at creating underlying economic conditions that are conducive to exchange rate stability. Fluctuations in the exchange rate of the rand have nevertheless complicated the implementation of monetary policy. For example in 2002 monetary policy was dominated by inflationary pressures arising from a substantial depreciation in the external value of the rand in late 2001, combined with a sharp rise in international oil prices as well as in domestic food prices. These external shocks were responsible for a surge in the twelve-month rate of increase in the CPIX from a low of 5,8 per cent in September 2001 to a peak of 11,3 per cent in October 2002. Restrictive monetary policy measures and the subsequent recovery in the exchange rate of the rand then brought the rate of increase over twelve months in the CPIX down to 4,4 per cent in March 2004. With the adoption of the inflation targeting framework, it also became the stated objective of the Reserve Bank to reduce the NOFP because of the negative effect that this position had on foreign investments into South Africa and the assessment of domestic economic conditions of international rating agencies. The NOFP was accordingly reduced from the peak oversold position of US$23,2 billion at the end of September 1998 to an overbought position of US$0,9 billion at the end of July 2003. The Reserve Bank then shifted its focus to reducing its oversold forward book and to gradually strengthen the official foreign exchange reserve position. As a result of the appreciation in the exchange rate of the rand, the oversold forward book of the Reserve Bank amounting to US$4,1 billion at the end of July 2003 and was quickly turned around to an overbought position of US$38 million at the end of February 2004. The official foreign exchange reserves of the country was also increased from US$7,6 billion at the end of December 2002 to US$10,0 billion at the end of April 2004. It is now the objective of the Reserve Bank to increase its foreign reserves further in a gradual manner whenever the underlying circumstances allow it to do so. 6. The financial sector In the period of political and economic isolation during the 1980s the domestic financial sector continued to grow rapidly. Many improvements were made to the regulatory framework such as the creation of a uniform legal framework for all deposit-taking institutions; the establishment of appropriate structures for the markets in new financial instruments; and the revision to rules governing the marketing of equities, bonds and derivatives. Moreover, the authorities endeavoured to promote proper risk management procedures and internationally accepted principles with the objective to preserve the soundness of financial institutions. The efforts made to maintain an effective and efficient financial sector were hampered by the lack of co-operation with foreign regulators due to the political circumstances at that time. As a consequence, some regulations and practices started to deviate from international best practices. With the re-establishment of normal relations with the rest of the world in the 1990s, great efforts were made to bring the rules and regulations on the activities of financial institutions in line with international norms and standards. From 1994 South African financial institutions started operating on an increasing scale in major international financial centers as well as opening branches or subsidiaries in other African countries. As part of this process, five large domestic companies transferred the primary listing of their stock to foreign bourses. This change gave them greater access to capital resources at lower cost and provided them with opportunities to promote their core business into other countries and regions. All these companies maintained secondary listings on the JSE Securities Exchange South Africa (JSE), and their market capitalisation on the JSE actually increased from R126 billion in 1997 to R471 billion in 2003. Over this same period foreign financial institutions were encouraged to conduct business in South Africa by the creation of a level playing field between local and foreign service providers. The regulatory authorities also actively encouraged the development of appropriate clearing, settlement, ownership-transfer and market information systems and insisted on proper intra-market and crossmarket risk management systems, including capital adequacy requirements for market participants. The operations of the financial markets in South Africa were improved considerably to bring them in line with international standards. In 1996 bond trading was shifted from the JSE to the Bond Exchange of South Africa. This led to a substantial rise in the turnover in the secondary bond market from R2 trillion in 1995 to nearly R12 trillion in 2003. Improvements to the JSE included the electronic clearing and rolling contractual settlement, the dematerialisation of equity scrip and the implementation of an electronic trading system. The value of shares traded on the JSE increased from R62 billion in 1994 to R752 billion in 2003. An important further development since 1994 has been the importance attached to the provision of access to finance and banking activities to small, medium and micro enterprises and underbanked communities. This challenge has been accepted with due recognition of the regulatory objective of achieving a high degree of economic efficiency and consumer protection in the economy. This requires an approach that introduces changes to achieve greater participation in banking while financial stability is maintained at the same time. Developments in the regulatory framework of South Africa’s financial markets during the past years have been aimed at addressing empowerment issues. For this purpose, the financial sector has developed a Financial Sector Black Economic Empowerment Charter to promote increased black ownership of and access to financial institutions. This Charter, which was made public on 17 October 2003, sets out targets that will be pursued up to December 2014 regarding, among other things, investment in human resource development; a procurement policy that favours accredited black economic empowerment companies; improved delivery of and access to financial services to a greater segment of the low-income population; the mobilisation of resources for empowerment financing; increased direct black ownership at the holding company level; the encouragement of shareholder activism in promoting the objectives of the charter; and directing a percentage of after-tax operating profits to corporate social investment aimed at education, training and job creation. 7. Conclusion The normalisation of relations with the rest of the world made it unnecessary to follow relatively restrictive fiscal and monetary policies to maintain a surplus on the current account of South Africa’s balance of payments and created leeway for the promotion of economic growth. In the past ten years a deficit was therefore recorded on the current account, but this deficit as a ratio of gross domestic product remained low and averaged only 1 per cent per year. Over the same period a net financial inflow was recorded from the rest of the world amounting to nearly R204 billion, compared with the net financial outflow of about R45 billion from 1985 to 1993. As a result, the level of foreign investment in South Africa amounted to R736 billion at the end of 2002. These developments allowed the authorities to pursue more liberal policies while maintaining financial stability, which contributed materially to a better growth performance of the domestic economy and the improvement in the living standards of the population. South Africa’s real economic growth doubled from an average annual rate of 1½ per cent during the 1980s to about 3 per cent between 1994 and 2003. In addition, the average growth in real gross national income per capita, an indicator of living standards, improved from a negative figure of 1,1 per cent per annum during the 1980s to a positive figure of 0,8 per cent between 1994 and 2003. Moreover, between 2000 and 2003 the average growth in real gross national income per capita amounted to about 1,5 per cent. The challenge is to further increase the growth performance of the domestic economy. The foundation has been provided over the past ten years to make this achievable. So the future looks promising. List of references Calitz, Estian and Krige, Siebrits, Changes in the role of government in the South African economy, Economic Perspective, Absa Group Limited, Second Quarter 2002. Cassim, Rashad, et al, The state of Trade Policy in South Africa, Trade and Industrial Policy Strategies, Department of Trade and Industry, December 2002. Cross, James, Global integration and capital liberalisation in South Africa, Bank for International Settlements, Paper No 15, 2001. De Kock, G.P.C., The Monetary System and Monetary Policy in South Africa, Final Report to the Commission of Enquiry into the Monetary System and Monetary Policy in South Africa, Government Printers, Pretoria, 1985. Falkena, H.B. et al, Financial Regulation in South Africa, S.A. Financial Sector Forum, Johannesburg 2001. Republic of South Africa, National Treasury, Budget Review 2004, RP18/2004, Pretoria, 18 February 2004. Republic of South Africa, National Treasury, Medium-Term Budget Policy Statement, October 2003, RP201/2003, Pretoria, 2003. South African Reserve Bank, Governor’s Address, 1994 to 2003. South African Reserve Bank, Bank Supervision Department, Annual Reports, 1994 to 2003.
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the BMF Corporate Update Gala Dinner, Gallagher Estate, 18 June 2004.
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T T Mboweni: The foundation has been laid1 Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the BMF Corporate Update Gala Dinner, Gallagher Estate, 18 June 2004. * * * One of the institutional arrangements arising out of the political negotiations process at the World Trade Centre in Kempton Park was the creation of the Transitional Executive Council (TEC), a sort of “provisional government”. The TEC as many will recall, established a number of sub-councils. I served on the sub-council on finance. Effectively, the then government could not take any major economic decisions without the concurrence of the TEC sub-council on finance. Those were nice days when we had power without the stress of responsibility! One of the problems/constraints facing the economy at that time, was that the country only had foreign reserves to cover for plus/minus three weeks of imports. This was indeed a crisis for an economy as big as ours. At that time, South Africa’s gross domestic product at market prices was around R480 billion. For the sake of perspective, today’s GDP at market prices is R1.2 trillion. The then Minister of Finance, Mr Derick Keys, approached the TEC to negotiate an agreement with us for a joint approach to the International Monetary Fund (IMF) for assistance. This was a difficult request since there were so many strategic and tactical questions to consider. An example in this regard was the question of whether the apartheid government was trying to lock us into an IMF structural adjustment programme via the back door, thereby tying the hands of the future democratic government. The end result was that we agreed to that request by the then government to approach the IMF for the required balance of payments support called the Compensatory and Contingency Financing Facility (CCFF). There were no conditionalities attached since this was a soft loan as it were. However, we had to provide the IMF with a “Statement on Economic Policy”. The statement was fairly simple: assure the IMF that the future government will pursue prudent macroeconomic policies. This was something that the ANC in particular had adopted as an approach as early as 1992 in a document entitled - Ready to Govern. We did not sell out! However, this “Statement on Economic Policy” has been described by some as the beginning of neo-liberal economic policies that were to be pursued by the future government. Recently, Prof Sampie Terreblanche, of the University of Stellenbosch has said in a book entitled: A history of lnequality in South Africa, 1652 - 2002, that “in 1993 the corporate sector and some ANC leaders reached a hugely important elite compromise. This happened before the Transitional Executive Council (TEC) accepted a secret $850 million loan from the IMF to help tide the country over balance of payments difficulties in November 1993” (p96). He continues to say that “before the TEC signed the loan agreement, the corporate sector and the NP government on the one hand and ANC leaders on the other signed a secret protocol on economic policy … (they) agreed with the IMF, the TEC committed itself to a neo-liberal, export-oriented economic policy and a ‘redistribution through growth’ strategy”. I was one of the people involved and I can say with confidence that Prof Sampie Terreblanche is totally and completely wrong. There was no secret meeting of the corporate sector and the core leaders of the ANC that I am aware of to agree on a secret document. This was a TEC matter handled through the sub-council on finance. Naturally, the delegates to the subcouncil consulted their principals. But I emphasize that any careful reading of the statement will find no contradiction with Ready to Govern. But that is a matter for political economists to sort out in due course. It is fair to say that the balance of payments constraint that we grappled with at the TEC was only the tip of a large iceberg. Here are some of the indicators of an economic crisis that we went through. The pre-1994 period is contrasted below with what has happened in ten years. Firstly, in 1985, on the back of the sanctions campaign, the government of the day declared a partial debt standstill. The affected debt was $13,6 billion and the total debt was $23,7 billion. From 1985 to 1993, the net financial outflow Adapted from the chapter appearing under my name in a book by the World Economic Forum entitled South Africa: The Miracle Continues. June 2004. from South Africa was some R45 billion or 11 per cent of gross domestic fixed investment. That forced the authorities at the time to implement stringent policies to generate current account surpluses. The cost to the economy was immense. In August 2001 the final repayment was made. The international capital markets were opened to South Africa effectively in 1995 when the first post-apartheid sovereign bond issues of $750 million was launched. Secondly, the trade regime at the beginning of the 1990s was characterised by three interrelated strategies, namely the promotion of domestic industries through import substitution, the development of specific industries to attain self-sufficiency and the promotion of mineral beneficiation. South Africa’s industries therefore became heavily protected by formulae, specific and ad valorem duties and surcharges. High tariff levels were complemented by quotas that limited the quantity of imports. The tariff structure was extremely complicated. Overall the strategies pursued by the authorities resulted in a complex discretionary regime fraught with corruption and bureaucratic mismanagement. As a result changes to the tariff regime became a fundamental imperative for the new government in 1994. The number of tariff categories was reduced from over 100 to only six and the average weighted import duties on manufactured goods to the total value of manufacturing imports decreased from 14,0 per cent in 1994 to 4,7 per cent in 2002. Several free trade agreements were also signed to dismantle trade barriers and to gain increased market access. The process continues today and many global trade doors have been opened. In addition to these, measures were undertaken to promote competition, industrial policy was adjusted to enhance the competitiveness of manufacturing enterprises in export markets. In particular more emphasis was placed on supply-side measures, rather than demand-side measures such as expensive export support programmes. These measures included investment incentives for large investments of a strategic nature and for small and medium enterprise development; training grants to firms investing in the promotion of skills; the development of industrial development zones; improved access to finance; and support for investments in economic infrastructure. A new Competition Act was passed in Parliament in 1998 to, among other things, create a greater spread of ownership in enterprises, to expand opportunities for South African participation in world markets and to provide consumers with competitive prices and product choices. Thirdly, at the beginning of the 1990s an unsustainable fiscal situation had started to develop, and the deficit before borrowing and debt repayment of the government reached 7,3 per cent of gross domestic product in the fiscal year 1992/93. The internationally acceptable rule of thumb is that the fiscal deficit should ideally not be more that 3% of the GDP. Government expenditure continued to rise relative to domestic production, the tax burden increased, the public sector made increasing demands on the domestic capital market, the ratio of government’s interest payments to gross domestic product rose steeply and government dissaving increased to unacceptably high levels. The post-apartheid South African government therefore placed considerable emphasis on restoring fiscal consolidation and stability. The economic strategy at first was to create stable macroeconomic conditions as a necessary precondition for economic growth and employment creation. The basic logic of the approach followed was that by improving fiscal sustainability, poverty reduction and income redistribution would become attainable objectives over the medium term. The expenditure restraint applied by the national and provincial governments reduced the fiscal deficit before borrowing and debt repayment to 1,5 per cent of gross domestic product in fiscal 2001/02. This by any measure represented a major milestone by a government which was suspected of being macroeconomic populist. This successful fiscal consolidation allowed the government to adopt a more expansionary fiscal policy stance from fiscal 2001/02. More emphasis is now placed on infrastructural development and social upliftment. The government, however, continues to apply fiscal prudence and despite a decline in the growth of tax revenue, was able to contain the main budget deficit to an estimated 2,4 per cent of gross domestic product in fiscal 2003/04. An important aspect of the budget reform was the adoption of the Medium-Term Expenditure Framework in the fiscal year 1998/99 and the Public Finance Management Act of 1999. The Medium-Term Expenditure Framework consists of three-year rolling expenditure and revenue projections for the national and the provincial governments. This creates greater certainty and transparency to the budgetary process. The Public Finance Management Act has enhanced the accountability of public sector managers by emphasising disciplines such as regular financial reporting, sound internal expenditure controls, improved accounting standards, performance monitoring and independent audit and supervision systems. The government has reduced its net loan debt from a peak of 48,1 per cent of gross domestic product in fiscal 1996/97 to 36,8 per cent in 2003/04. This not only contributed to lower interest payments on total public debt, but also to generally lower long-term yields in the South African capital market. The prudent measures applied by government have brought about a decline in government net dissaving from the high level of 7,3 per cent of gross domestic product in 1992 to 1,1 per cent in 2003. This is absolutely superb and provides an excellent support pillar for lower inflation. Fourthly, monetary policy has also seen many changes. The objectives of monetary policy at the beginning of the 1990s were to reduce the rate of inflation to the average rate of inflation in trading partner and competitor countries; to manage the money creation process in such a way that an adequate, but not an excessive amount of new money would be supplied to the system; to maintain positive real interest rates; to increase the gold and other foreign reserves to a comfortable level and to develop a sound financial infrastructure consisting of healthy financial institutions and financial markets. This was a reasonable approach in the circumstances, but the achievement of these goals was hampered by the overall political and economic environment. In the 1990s the SA Reserve Bank also intervened heavily on its own initiative in the spot and forward market to influence supply and demand in the foreign exchange market. These operations were undertaken supposedly with the intention of smoothing out large short-term fluctuations in the exchange rate. An impression was created that the SA Reserve Bank had some preferred exchange rate level. This naturally was an open invitation to speculators. Despite this active intervention, large fluctuations occurred in the weighted average external value of the rand, particularly during the second half of the 1990s. The monetary policy measures, however, achieved considerable success in bringing the rate of inflation down. After inflation in the consumer price index had generally fluctuated around a level of about 15 per cent in the late 1980s and the beginning of the 1990s it moved below double digits in 1993 and declined to 5,2 per cent in 1999. In February 2000 the government announced that South Africa had formally adopted an inflation-targeting monetary policy framework to make monetary policy more transparent and accountable and to promote an ex ante co-ordination of economic policy. Fluctuations in the exchange rate of the rand have nevertheless complicated the implementation of monetary policy even under inflation targeting. For example in 2002 monetary policy was dominated by inflationary pressures arising from the substantial depreciation in the external value of the rand in late 2001, combined with a sharp rise in international oil prices as well as in domestic food prices. These external shocks were responsible for a surge in the twelve-month rate of increase in the CPIX from a low of 5,8 per cent in September 2001 to a peak of 11,3 per cent in October 2002. Restrictive monetary policy measures undertaken and the subsequent recovery in the exchange rate of the rand then brought the rate of increase over twelve months in the CPIX down to 4,4 per cent in April 2004. Fifthly, a large forward book was built over the years as the country faced sanctions and could not access the international capital markets. The SA Reserve Bank entered into forward forex contracts in order to gain access to foreign currency. It was a very expensive exercise. In 1994, the forward book stood at $26,9 billion. Unfortunately, in the post-1994 environment, the central bank continued to intervene heavily in the forex market. In September 1998, the forward book stood at $24,9 billion and the Net Open Foreign Currency Position was $23,2 billion. In mid February 2004, the forward book was expunged and the foreign reserves position improved impressively. The country now has gross gold and foreign reserves of some $26 billion, with plus/minus $10 billion of the international liquidity position currently in ‘the bag’. Sixthly, clearly, the financial sector suffered tremendously before 1994. Efforts to maintain an effective and efficient financial sector were hampered by the lack of co-operation with international regulators due to the political circumstances at that time. As a consequence, some regulations and practices deviated from international best practices. With the reestablishment of normal relations with the rest of the world in the 1990s, great efforts were made to bring the rules and regulations on the activities of financial institutions in line with international best practices. From 1994 South African financial institutions started operating on an increasing scale in major international financial centres such as London New York and Hong Kong as well as opening branches or subsidiaries on the African continent. As part of the globalisation process, five large domestic companies transferred their primary listings to international bourses. This change gave them greater access to capital at lower cost and provided them with opportunities to become truly global South African giants. But more significantly, all these companies maintained their secondary listings on the JSE Securities Exchange South Africa, and their market capitalisation on the JSE actually increased from R126 billion in 1997 to R471 billion in 2003. So they have kept the home fires burning too! Over this same period international financial institutions began to conduct business in South Africa. The creation of a level playing field between local and foreign service providers was entirely pursued by the authorities. The regulatory authorities also actively encouraged the development of appropriate clearing, settlement, ownership-transfer and market information systems and insisted on proper intramarket and cross-market risk management systems, including capital adequacy requirements for market participants. The operations of the financial markets in South Africa were improved considerably to bring them in line with international best practice. In 1996 bond trading was shifted from the JSE to the Bond Exchange of South Africa. This led to a substantial rise in the turnover in the secondary bond market from R2 trillion in 1995 to nearly R12 trillion in 2003. Improvements to the JSE included the electronic clearing and rolling contractual settlement, the dematerialisation of equity scrip and the implementation of an electronic trading system. The value of shares traded on the JSE increased from R62 billion in 1994 to R752 billion in 2003. Seventhly, the normalisation of relations with the rest of the world made it unnecessary to follow restrictive fiscal and monetary policies to maintain a surplus on the current account of South Africa’s balance of payments and created a leeway for the promotion of economic growth. In the past ten years a deficit was therefore recorded on the current account, but this deficit as a ratio of gross domestic product remained low and averaged only 1 per cent per year. Over the same period there was a net financial inflow recorded from the rest of the world amounting to nearly R204 billion, compared with the net financial outflow of about R45 billion from 1985 to 1993. As a result, the level of foreign investment in South Africa amounted to R736 billion at the end of 2002. This is a very significant post-apartheid dividend for country. South Africa’s real economic growth doubled from an average annual rate of 1½ per cent during the 1980s to about 3 per cent between 1994 and 2003. In addition, the average growth in real gross national income per capita, an indicator of living standards, improved from a negative figure of 1,1 per cent per annum during the 1980s to a positive figure of 0,8 per cent between 1994 and 2003. Moreover, between 2000 and 2003 the average growth in real gross national income per capita amounted to about 1,5 per cent. The big challenge is to further increase the growth performance of the domestic economy. The foundation has been laid over the past ten years to make this achievable. To make life better for all our people. So we can indeed claim, without fear of contradiction that the post-1994 period has seen some remarkable improvements in the macroeconomic and financial position of our country. A good foundation has been laid. Greater efforts have now to be directed at micro-economic reforms and job creation as the President has directed. My own personal journey has been a momentous one. In 1980, as a twenty one- year-old kid, I adventurously and illegally crossed the South Africa/Lesotho border at Ladybrand into Lesotho whilst the border guarding soldiers were changing guard. A long story on its own in an autobiography perhaps. My parents were utterly shocked when I skipped the country. They could not comprehend it at all. My father died whilst I was in exile and I could not attend his funeral. So traumatic. His younger brother died last month at the age of sixty-nine (69) and we buried him next to my Dad at our family burial grounds. I gave the funeral oration. It was like burying my own father. I cried so badly. I grew up in foreign lands, in exile I received good university education abroad, learnt how to shoot using all sorts of guns and make bombs, studied military combat work (mcw), learned how to speak some Portuguese and Sesotho sa Moshoeshoe, drafted and edited radical economic policies. And now after being a minister of labour between 1994 and 1998, I hold one of the most coverted jobs in the world, Governor of a central bank. The greatest honour a country can bestow on any of it’s children, is to make them Governor of their central bank. The journeys of so many South Africans have been remarkable too. From having no electricity and pipe water, schooling under a tree, to what we have today. This country of ours has moved on. So much still needs to be done. So little time. Life is not about economic statistics, it is about people. Myself, yourself, all of us, we have made progress. We have moved on. I suppose that you can call me an exile kid, an international kid born in South Africa, but my home is in South Africa, Lesotho, Mozambique, the United Kingdom, Zambia, Angola, Tanzania, Swaziland, the USA, Switzerland and everywhere I stayed in my youth. I hate narrow nationalism, cannot stand it. I hate xenophobia. But now my country is free and ten years old. Only ten years! Still too young. It has been a long walk from the beautiful and dusty village of Bordeaux in Tzaneen. But as President Manadela says “I have walked that long road to freedom. I have tried not to falter, I have made missteps along the way. But I have discovered the secret that after climbing a great hill, one only finds that there are many more hills to climb. I have taken a moment here to rest, to steal a view of the glorious vista that surrounds me, to look back on the distance I have come. But I can rest only for a moment, for with freedom come responsibilities, and I dare not linger, for my long walk is not yet ended.” I love Freedom!!!!! Even central bank governors love freedom!!!! Tonight, I salute our country! I salute our people! Poor as they might be, they have political power in their hands. Hold on to that dear people, don’t let that slip away no matter how hard things might be. You are my boss, for which I am eternally grateful. And so, here is to TEN YEARS OF FREEDOM!!! May we have many, many more years of FREEDOM!!! Thank you very much BMF for what you are doing for us all. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the School of Economics Awards Evening, University of Pretoria, Pretoria, 8 July 2004.
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T T Mboweni: The South African economy: an overview Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the School of Economics Awards Evening, University of Pretoria, Pretoria, 8 July 2004. * * * World economic growth has gained momentum since the middle of last year and amounted to 3,9 per cent for 2003 as a whole. Early indications are that activity remained brisk in the first half of 2004, with China and India recording sparkling performances. The global economic recovery has created favourable conditions for higher commodity prices. However, consumer price inflation remained subdued in most parts of the world. Global inflation concerns has, however, arisen due to the relatively high price of crude oil. A number of central banks already pre-emptively raised interest rates moderately to contain future inflation, but on balance the level of short-term interest rates remains relatively low. Favourable export prices, low interest rates and growth-supportive fiscal policy assisted domestic economic activity and South Africa has now experienced eighteen consecutive quarters of economic expansion. Growth in South Africa’s real gross domestic product picked up decisively in the first quarter of 2004 to a seasonally adjusted annualised rate of 3 per cent - more than double the pace attained in any of the four quarters of 2003. The acceleration in real output in the first quarter of 2004 was broad-based. Real output in important sectors of the economy such as manufacturing and agriculture, which had contracted throughout 2003, increased markedly in the first quarter of 2004. Platinum producers brought about an increase in the production of the mining sector, while construction activity expanded briskly and the tertiary sector again recorded a solid growth performance. Preliminary indications for the second quarter of 2004 are that real manufacturing and mining production continued to increase. In contrast to the acceleration in domestic production growth, the pace of expansion in real gross domestic expenditure lost some of its earlier momentum in the first quarter of 2004. This was largely due to a much slower pace of inventory accumulation than in the fourth quarter of 2003. The pace of growth in real expenditure nevertheless continued to exceed the pace of growth in real production. Real fixed capital formation recorded an exceptionally high rate of increase in the first quarter of 2004 as private business enterprises stepped up fixed capital outlays and as the South African Airways acquired several aircraft. The increased production capacity flowing from investment expenditure gives good reason for optimism about future growth. Growth in real household consumption expenditure also gained further momentum in the first quarter of 2004, supported by solid increases in households’ real disposable income and lower interest rates. Tax reductions and relatively high wage settlements supported growth in real disposable income. Expenditure on durable and semi-durable goods increased at a brisk rate. Real government consumption expenditure also rose further mainly on account of the acquisition of another corvette. Preliminary indications for the second quarter of 2004 are that growth in real gross domestic expenditure probably remained fairly strong. Solid consumer confidence and buoyant retail trade sales point towards this conclusion, as well as a quarter-on-quarter rate of increase of 3,6 per cent in new vehicle sales. Formal non-agricultural employment declined at an annualised rate of 1,7 per cent in the first quarter of 2004. Both the public and private sectors experienced declines. Nominal remuneration per worker rose at a year-on-year rate of 9,4 per cent over the same period. Overall labour productivity increased at a year-on-year rate of 3,3 per cent in the first quarter of 2004 containing unit labour cost to a yearon-year rate of increase of 5,9 per cent. Notwithstanding the recovery in world economic growth, the volume of South African exports contracted further in the first quarter of 2004. However, the value of exports increased on account of the marked improvement in the prices of South African export commodities. Import volumes also declined somewhat in the first quarter of 2004 because of a decrease in crude oil imported. Accordingly, the deficit on the current account of South Africa’s balance of payments receded slightly to 1,6 per cent of gross domestic product. At this level it was easily financed by inflows of direct and portfolio investment. Preliminary information for April and May 2004 indicates a possibly slightly weaker trade balance in the second quarter of 2004. However, in the second quarter of 2004 the proceeds from the Republic of South Africa’s global bond issue of $1 billion supported investment flows into South Africa. In the first half of 2004, the Reserve Bank continued its accumulation of foreign exchange reserves and the strengthening of its international liquidity position. The potential impact of these transactions on domestic money-market liquidity was sterilised by means of open-market operations. The exchange rate of the rand against a basket of currencies strengthened by 16 per cent in the year ending December 2003 and, on balance, appreciated by a further 8,2 per cent in the six months to the end of June 2004. This appreciation occurred despite the setback to international prices of commodity exports in the second quarter of 2004 in response to indications that steps would be taken to cool down buoyant economic growth in China. While these movements of the exchange rate of the rand reduced the international competitiveness of South African producers, it resulted in a decline in the year-on-year change of imported goods over the past 14 months, notwithstanding a significant increase in the international price of crude oil over this period. Goods price inflation therefore moderated further both at the production and consumer level. By May 2004, CPIX inflation had been maintained within the 3 to 6 per cent target range for nine months in succession and the year-on-year rate of increase amounted to 4,4 per cent in each of the three months to May. Twelve-month growth in M3 remained brisk though it decelerated from 12,6 per cent in April 2004 to 11,9 per cent in May. Credit extended by banks by means of mortgages, instalment sale and leasing advances to the domestic private sector recorded strong growth in 2004 under conditions of lower interest rates, rapidly increasing domestic expenditure and rising house prices. Growth in total loans and advances to the private sector nevertheless decelerated from 10 per cent in April 2004 to 9,1 per cent in May owing to a decline in overdrafts. Yields on long-term South African government bonds increased sharply from 8,87 per cent on 17 January 2004 to 10,26 per cent on 15 June in response to the weaker exchange value of the rand and inflation concerns arising from strong real economic activity and the higher price of oil. Subsequently, bond yields fell back by about 50 basis points as the recovery in the external value of the rand scaled down inflation concerns. On balance, the trend in domestic yields closely followed that of US government bond yields from the beginning of March 2004. In the share market, prices on the JSE Securities Exchange SA fell back by 9,7 per cent from a recent peak in March 2004, in contrast to the bull rally in the preceding ten months. The real-estate market remained buoyant and house prices continued to increase at a brisk pace, recording nominal year-on-year rates of increase of around 24 per cent in the first half of 2004. However, month-on-month rates of increase in nominal house prices indicate that the prolonged boom in this sector could be losing some momentum in 2004. The authorities continued to pursue a cautiously expansionary fiscal policy, recording a public-sector borrowing requirement of 3,2 per cent of gross domestic product in fiscal 2003/2004 - higher than before, but nevertheless in accordance with widely accepted principles of fiscal prudence. It is envisaged that this ratio will decline to 2,7 per cent in fiscal 2006/07. Rising capital expenditure by the public sector not only contributes to a more efficient functioning economy but public works programmes also enhance skills and create employment. From this brief description of recent economic developments, it can be concluded that domestic growth prospects seem positive. The exchange value of the rand remains firm, and the improved foreign exchange reserve position could contribute to rand strength and stability. In general most factors favour a containment of inflation within the target range, and market participants also seem to be scaling down inflation expectations. However, in the short-term, developments in international oil prices, through their impact on domestic fuel costs, are likely to be a source of upward pressure on inflation and it is conceivable that the rate of increase in CPIX could temporarily breach the upper level of the target range towards the end of 2004 and the early part of 2005. Forward-looking monetary policy remains focussed on the expected trend of inflation; policy decisions will be guided by the mandate to maintain CPIX inflation within the target range. Collaboration between the Reserve Bank and universities In conclusion I want to emphasise that the South African Reserve Bank has a vision of responsible and effective monetary policy formulation and continually strives to be an institution of excellence and innovation. In this regard, the Bank remains committed to capacity building and enhancing its skilled human resources, providing high-quality and relevant research, and facilitating and stimulating debate on pertinent monetary policy issues. I therefore wish to make use of this opportunity to emphasise the Bank’s commitment to continuous interaction and involvement with the academic world on both theoretical and empirical aspects of economic research, monetary policy formulation and implementation. As you are well aware, the Bank’s professional staff members embark on a career at the Reserve Bank after obtaining formal qualifications from a university or other tertiary institution. Many of our staff members are encouraged to develop further skills and continue with postgraduate studies by utilising the bursary scheme of the Bank which is available to all our staff members. In fact, it makes me proud to see that tonight we are honouring no fewer than three of our employees who received their PhDs at the fall 2004 graduation ceremony of the University of Pretoria. They are joining the ranks of many other highly reputable senior bank officials who also obtained their postgraduate training at this illustrious university. I would furthermore like to add that the Bank supports human resources development in general and has now developed a new bursary system to support deserving students pursuing studies in economics, finance and ICT. These areas are central to our work at the Bank. The collaboration between the Bank and the University of Pretoria has a proud history. I am therefore very keen that this close relationship be expanded further. This can be particularly beneficial for both our institutions in the field of monetary economics, which does not seem to receive enough attention in South Africa. Such a collaboration will be in line with developments elsewhere in the world. Internationally, establishing strategic partnerships between central banks and universities has become a norm. There is collaboration between the European Central Bank and the Goethe University in Frankfort and the Board of Governors of the Federal Reserve System and Georgetown University, to name just two. I realise that the University of Pretoria, and particularly the Department of Economics, is already making a substantial contribution to training, research and policy analysis through the activities of the Bureau of Economic Policy and Analysis (BEPA), the Investment and Trade Policy Centre (ITPC), the Southern African Tax Institute (SATI) and the African Institute for Economic Modelling (Afrinem). Monetary economics, however, is perhaps not receiving the attention it deserves. This can perhaps be rectified in collaboration with the Reserve Bank. Apart from the fact that the University of Pretoria is ideally situated in close proximity to the Bank, it stands to reason that formalising a partnership between the Bank and the University of Pretoria will create economies of scale to the benefit of both institutions. The interactions between the Reserve Bank and the University of Pretoria could play an important role in advancing our intellectual capabilities and the deepening of our knowledge regarding the intricacies of monetary economics in general and central banking in particular. The collaboration between the two institutions is therefore fundamental for the fulfilment of our commitment to excellence, not only in terms of training but also in terms of economic analysis and research. I hope that our respective officials will finalise the proposal they are considering in this regard. I am absolutely excited about the potential for this. Now, let me congratulate the Award winners tonight. Well done. We depend on you to research, write and publish on economic theory, empirical issues and inform on policy development. Thank you.
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at a dinner of The South African Institute of Electrical Engineers, Rand Club, Johannesburg, 22 July 2004.
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T T Mboweni: Economic developments and monetary policy Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at a dinner of The South African Institute of Electrical Engineers, Rand Club, Johannesburg, 22 July 2004. * 1. * * Introduction Ladies and gentlemen, I thank you for the invitation to attend your dinner in these illustrious surroundings. It is indeed always an honour to attend a function at one of the oldest clubs in South Africa, and even more so because of the role that it played in the history of our country. I appreciate having the opportunity to talk to your Institute on this occasion because of your role in the development of our economy. As a topic for discussion I thought it may be useful to briefly look at recent economic developments in the world and in South Africa and conclude my address with a few remarks on monetary policy and exchange rates. 2. Global economic developments The global economy started to recover at an accelerated pace during the course of 2003 and the first quarter of 2004 and then growth seems to have slowed down somewhat in the second quarter of this year. This was mainly due to slower growth in the United States and China. The softening in the economic growth of the United States' economy is probably a temporary phenomenon related to the spike in the international price of oil, which affects consumer expenditure. It is, however generally expected that business investment in the United States will pick up strongly in the second half of 2004 and give further impetus to the world economic recovery. The slowdown in the Chinese economy was the result of deliberate policy actions taken by the Chinese authorities to cool down the rapid growth that they have experienced over the past years. Although the slower growth in China will occur from a very high level, it could have a significant impact on other Asian economies. A slowdown in China's energy, steel and chemical production could also affect demand in international commodity markets, resulting in a decline in international prices. China has become a major player in the world economy and is also now the fifth largest trading partner of South Africa. However, it seems unlikely that this slower growth will be a lasting feature of the world economy and most international organisations such as the International Monetary Fund and the Bank for International Settlements are still projecting a marked recovery in the global economy in the rest of this year and in 2005. Another important risk that the world economy is facing is the substantial increase in international oil prices. Brent crude oil prices have increased from levels around US$24 per barrel in May 2003 to almost US$40 per barrel in May 2004. This rise in international oil prices was mainly related to ongoing geopolitical tensions in the Middle East, together with a strong demand for oil in the United States and China. Although oil prices started to decline somewhat in June 2004 to levels of around US$34 per barrel when the OPEC countries indicated that they would increase their production, this did not last long and at present Brent crude oil prices are fluctuating again at around US$38 per barrel. As one would expect with such a rise in oil prices, consumer price inflation increased in most of the major industrialised economies. For example, overall inflation in the United States accelerated from 1,7 percent in March 2004 to 3,3 percent in June 2004. These increases are, however, coming from low levels. A significant rise in global inflation is therefore not foreseen, particularly in view of continued strong productivity growth in some of these countries combined with a tightening in monetary policy stance. After keeping the federal funds rate unchanged since the middle of 2003, the US Federal Open Market Committee raised this rate by 25 basis points to 1,25 percent on 30 June 2004. As underlying inflation is expected to remain low, the FOMC is of the view that “policy accommodation can be removed at a pace that is likely to be measured”. Such a tightening should therefore not be expected to have a marked impact on global economic growth. Several other central banks, including the Bank of England, the Reserve Bank of Australia and the Reserve Bank of New Zealand have also been increasing interest rates. By contrast the European Central Bank has kept rates unchanged, while monetary policy has been eased in Japan. 3. Domestic economic developments An important side effect of the acceleration in the global economic recovery has been a strong growth in world trade and a sharp rise in international commodity prices. These factors have led to an acceleration in the export prices of South Africa, which together with the decline in domestic interest rates and a growth-supportive fiscal policy stance assisted the economy in maintaining a period of economic expansion that has now already lasted for eighteen consecutive quarters. During the course of 2003, economic growth in most of the main domestic economic sectors became a little hesitant, but it then picked up again decisively in the first quarter of 2004 when the real gross domestic product increased at a seasonally adjusted annualised rate of 3 percent - more than double the pace attained in any of the four quarters of 2003. Preliminary indications show a continuation of this relatively high overall growth in the second quarter of the year. What made the strong growth in the first quarter of 2004 even more remarkable was that it was registered in all the main sectors of the economy. Real manufacturing and agricultural output, which had contracted throughout 2003, both rose at a seasonally adjusted and annualised rate of 2½ percent. Strong growth was also recorded in the value added by mining and electricity. Perhaps more important from the perspective of your Institute is that the real output of the construction sector continued to increase strongly. Its annualised quarter-to-quarter growth rate amounted to 6½ percent in the first quarter of 2004, the same rate as that attained in the fourth quarter of 2003. The growth in real gross domestic expenditure continued to exceed the growth in real gross domestic product throughout 2003 and the first quarter of 2004 and probably remained strong in the second quarter. This strong growth in domestic expenditure contributed to the rise in domestic output and to a marked increase in the volume of imports. The demand for goods and services remained buoyant as a result of the significant reductions in the repo rate, decreases in income tax rates, high salary and wage settlements and the infrastructural expenditure of government and public corporations. In particular, growth in real fixed capital formation accelerated considerably from the beginning of 2004. This follows on a good performance in 2003. The rate of increase in real fixed investment rose from 8½ percent in the fourth quarter of 2003 to no less than 21 percent in the first quarter of 2004. This exceptionally high growth was registered as a result of the fact that private business enterprises stepped up fixed capital outlays and the South African Airways purchased several aircraft. Growth in real private consumption expenditure rose from an annualised rate of 4 percent in the fourth quarter of 2003 to 5 percent in the first quarter of 2004. The solid expansion in the consumption expenditure of households was discernible in all the main categories of expenditure, but was especially apparent in the expenditure on durable goods such as transport equipment, furniture and household appliances. The expenditure of households was influenced mainly by the continued growth in real disposable income, the reduced cost of credit, and an improvement in the net wealth of households related to the rise in house prices. The real outlays on consumer goods and services by general government remained at a high level, particularly on account of the purchases of two corvettes for the South African Navy, while the pace of real inventory growth slowed down sharply in the first quarter of 2004 as the rebound in manufacturing production made inroads into stocks. The continued expansion in economic activity at first seemed to have had the desired effect on employment creation and from 2002 onwards there were some quarters in which increases were recorded in the formal non-agricultural employment in the economy. On balance, employment creation in the non-agricultural sectors of the economy continued to be disappointing and it seems that the total number of persons employed declined in the current upward phase of the business cycle. The creation of employment opportunities will be crucial if we are to improve people's lives in the years ahead. Considerably more success was achieved on the inflation front during the past year. The twelve month rate of increase in the CPIX declined from a recent peak of 11,3 percent in November 2002 to 4,0 percent in December 2003 and then rose to a still low 4,4 percent in May 2004. A number of factors have been identified in our Monetary Policy Statements explaining this favourable inflation outcome, which I won't repeat again this evening. It is generally expected that the high petrol and diesel price increases at the beginning of June 2004 and increases in the prices of medical products would have caused inflation to rise in that month. This should only be a temporary upward movement, which will probably again be reversed in the subsequent month. Projections using the SA Reserve Bank's econometric models indicate, however, that CPIX inflation could move above the upper boundary of the inflation target range towards the end of the year. Fortunately, this is also expected to be reversed relatively quickly and is not a significant cause for concern. As already indicated, the increase in domestic expenditure led to a marked rise in the volume of imports during 2003. In the first quarter of 2004 the volume of imports contracted owing to a decline in the imports of oil. The volume of South African exports has fluctuated around a more or less horizontal trend since the second half of 2001, which brought about a substantial deterioration in the real trade balance over this period. This was accompanied by an improvement in the average terms of trade of 2½ percent in 2002, 4½ percent in 2003 and by a further 2½ percent in the first quarter of 2004 in comparison with the fourth quarter of 2003. These favourable price developments were unable to prevent the current account of the balance of payments from moving into a deficit. The improving terms of trade nevertheless kept the deficit on the current account of the balance of payments at a level of about 1½ percent of gross domestic product. At this level the current account was easily financed by net inflows of direct and portfolio investment. As these inflows of capital exceeded the current account deficit, they led to a sharp increase in the gold and other foreign reserves of the country. The favourable overall balance of payments position also allowed the SA Reserve Bank to build up our official reserves to a higher level in a gradual manner while taking into account the limitations of our own balance sheet. As a consequence, the official gold and foreign exchange reserves of the Bank rose from US$7,8 billion at the end of 2002 to US$11,4 billion at the end of June 2004. The authorities continued to pursue a moderately expansionary fiscal policy. The non-financial publicsector borrowing requirement as a ratio of gross domestic product accordingly rose from 1,4 percent in the fiscal year 2002/03 to a budgeted 3,1 percent in the fiscal year 2003/04. At this level this borrowing requirement is still in line with widely accepted principles of fiscal prudence. Moreover, it is envisaged that this ratio will decline in the coming years, despite the positive emphasis on infrastructural development. On the monetary and financial fronts, the domestic economy was characterised by a few developments. Firstly, the twelve-month growth rate in the broadly defined money supply (M3) remained brisk throughout the last twelve months and fluctuated around a level of 12 percent. Secondly, credit extended by banks by means of mortgages, installment sale and leasing advances to the domestic private sector recorded strong growth in 2003 and the first half of 2004 under conditions of lower interest rates, rapidly increasing domestic expenditure and rising housing prices. Thirdly, money-market interest rates followed the repo rate downwards during 2003 and fluctuated around a horizontal trend in the first six months of 2004. Fourthly, yields on long-term government bonds, which had declined during 2003 to a low of 8,78 percent on 12 January 2004, rose to 10,26 percent on 15 June 2004 in response to rising inflation concerns. With the increase in the external value of the rand, yields fell again to below 10 percent in July. Fifthly, the JSE all-share index declined from an index value of 10387 at the end of December 2003 to 10131 on 21 July 2004 after having risen quite sharply from May 2003. Lastly, the real estate market remained buoyant and house prices continued to increase at a brisk pace, recording a year-on-year rate of increase of about 24 percent in the first half of 2004. 4. Monetary policy As already indicated considerable success was achieved with the monetary policy measures during the past year and CPIX inflation has been within the target range since September 2003. This has allowed the SA Reserve Bank to keep the repo rate at an unchanged level of 8 percent per annum in 2004. The major threats to the inflation target in this year have come mainly from exogenous factors. At first the drought experienced in the country was regarded as an important risk because of the negative implications that it could have had on food prices in general. Fortunately, this threat dissipated when widespread rains in February and March improved the outlook for the maize crop, leading to a fall in maize prices. Increases in international oil prices then increasingly became the major negative factor for the inflation outlook. At the MPC meeting in April 2004, developments in nominal unit labour cost were also singled out as a risk to the inflation projection. The rate of increase of these costs declined from 6 percent in 2002 to 5 percent in 2003, but the salaries and wages per worker still increased at a rate of 8,7 percent. Other threats to the inflation outlook that were identified included the stronger trend in monetary growth, the rapid rise in domestic demand, and the threat of increased international instability. These threats to the inflation outlook still exist today. However there are also many positive factors which should assist us in containing inflation in the coming months. The most important of these is perhaps the decline in inflation expectations. Other factors supporting a favourable inflation outcome are the strength in the external value of the rand, the decline in production prices, low expected world inflation, low levels of capacity utilisation and the fiscal discipline of government. Against this background, our projections of inflation showed that the year-on-year rates of increase in the CPIX could temporarily breach the upper level of the target band towards the end of 2004 and early part of 2005. Any such breach is nevertheless expected to be short-lived, with the stronger likelihood that CPIX inflation would return to within the range shortly thereafter. The inflation outlook in general is still regarded as favourable. This view is supported by inflation expectations of business, labour, analysts and households. In view of the success achieved with an inflation-targeting monetary policy framework, I find it surprising that so many people still seem to be very critical of this framework. This is probably related to the recent strength of the rand. Monetary policy and more particularly the inflation-targeting policy framework seems to have been singled out as being mainly responsible for this development. The rand's strength is, of course, not only dependant on monetary policy. In the current circumstances the weakness of the dollar and a substantial increase in international commodity prices contributed significantly to the strength in the external value of the rand. In addition, exporters have been selling their foreign exchange proceeds in an aggressive manner and South Africa has attracted considerable financial inflows owing to the improved macroeconomic fundamentals and confidence in our country. The criticism against the monetary policy framework is even more surprising because the number of countries with floating exchange rates has increased dramatically since the early 1990s. This is partly due to the currency crises experienced under fixed exchange rate systems and a growing consensus on the disadvantages of conventional currency pegs. Floating exchange rates in combination with the inflation targeting regime have become the norm in a large number of countries, i.e. monetary policy has become more forward-looking while the determination of the exchange rate has been left to the currency markets. Inflation targeting requires assessing all the available information, including real economic developments, monetary analysis and the external balance of the economy. This is done in a systematic and complex way. It is hence more demanding from this point of view than the alternative monetary strategies. Inflation targeting has placed the forecasting process at the heart of monetary policy decision-making. The inflation forecast has become not only an important internal decisionmaking tool, but also a crucial communication device. However, in line with best international practice, even our highly developed, technically advanced and well-organised forecasting procedure is certainly not an automatic pilot for monetary policy decision-making. The forecast is an important input into the monetary policy process and like other central banks we continue to try our best to continuously improve our macroeconomic forecasting capability. However, eventually the decision is always still based not only on the central forecast itself, but also on the assessment of all the associated risks. We now have more than four years of experience with inflation targeting and although the new monetary policy framework was introduced in February 2000 in a challenging situation of not having all the required supporting systems properly in place at the time, the economy urgently needed a new and more reliable nominal anchor to ensure a sustained disinflation path. The first years of the new regime have certainly not been easy, and have been characterised by unfavourable currency developments that contributed to numerical inflation target misses. South Africa has nevertheless for some time now been experiencing inflation within the target range and surveys indicate clearly that inflation expectations are more firmly anchored at lower levels. It is now more important than ever for us to stay the course as continued price stability is the most crucial pre-requisite for sustained economic growth and development in the years ahead. 5. Exchange rate developments The exchange rate of the rand against a basket of currencies recovered by 16 percent in the year to the end of December 2003 and, on balance, appreciated by a further 12 percent in the six-and-a-half-month period to the middle of July 2004, despite the temporary setback to the international prices of commodity exports in the second quarter. While these movements of the exchange rate of the rand reduced the international competitiveness of South African producers, it also caused the prices of imported goods to record twelve-month declines over the past 14 months, notwithstanding a significant increase in the international price of crude oil over this period. Goods price inflation was accordingly moderated, both at the production and consumer level, contributing to a reduction in twelve-month CPIX inflation. Despite the fact that the rand is at a five-year peak to the dollar, prospects for the economy have continued to improve. Tourism has fared better than expected and manufacturing output has improved significantly. The trade sector in particular is thriving, consumer confidence is at record levels and the world growth outlook remains favourable, with the result that some analysts have announced upward revisions to their real growth forecasts for the South African economy for 2004 and 2005. This, together with indications of a possibly more favourable credit rating for the country, flies in the face of the projections of most doomsayers. The process of dealing with a strong currency has most certainly been painful but also beneficial as it has forced productivity improvements and increased competition in the economy. Although business leaders continue warning of eroding profits and impending cuts in investment and jobs, the local economy has been adjusting well to a stronger, more stable currency. Significant problems have certainly been experienced by many mining and manufacturing enterprises as a result of the strength of the rand. This has had serious repercussions for the profitability of these enterprises, as well as their investment planning and employment. The recovery in the exchange rate of the rand has, however, forced companies to restructure their firms to cushion the impact of the strengthening rand. The restructuring has contributed to increasing resilience of the South African economy. Besides restructuring, the manufacturing sector has been taking advantage of buoyant domestic demand sparked by the sharp fall in interest rates last year to the lowest levels in almost two decades. Manufacturing enterprises have been taking advantage of strong local demand and are now doing this on a more productive basis as a result of restructuring. This has led to a rebound in manufacturing output from the first quarter of this year, and some analysts say this illustrates clearly that there were also benefits associated with the strengthening of the rand. Benefits that could last for a long time, rather than the short-lived relief of external price adjustments. 6. Conclusion Critics of our current policy seem to forget these positive developments associated with the recovery in the exchange rate of the rand. I realise, of course, that there have been serious disadvantages, but I must emphasise that the strength of our currency is not directly related to the monetary policy framework that we apply. We accordingly still belief that an inflation-targeting monetary policy framework allows an independent central bank to commit credibly to its long-term goal of price stability. In such a framework supply and demand in the foreign exchange market must inevitably determine the level of the exchange rate of the rand. The role of the SA Reserve Bank in this framework is to gradually build up the official foreign reserves of the country to a respectable level in an orderly fashion in accordance with our balance sheet whenever circumstances allow us to do this. So the state of the economy looks promising. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a conference to commemorate the Bank of Zambia¿s 40th Anniversary, Lusaka, Zambia, 5 August 2004.
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T T Mboweni: Challenges of central banking in Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a conference to commemorate the Bank of Zambia’s 40th Anniversary, Lusaka, Zambia, 5 August 2004. * 1. * * Introduction Your Excellency, the President of the Republic of Zambia, Dear Colleague, the Governor of the Bank of Zambia, Excellencies, Management and staff of the Bank of Zambia, Retired former Governors of the Bank of Zambia, ladies and gentlemen. It is indeed an honour and privilege to make this presentation on the occasion of the celebrations marking the 40th anniversary of the Bank of Zambia. Indeed, the Government, the management and staff of the Bank of Zambia and the people of Zambia as a whole have every justification to be proud on reaching this historic milestone. I am truly overwhelmed by your invitation, not only to say a word or two today on the challenges of central banking in Africa, but also for providing me the opportunity to return to Lusaka which was my home in the late 1980s and early 1990s. Zambia’s contribution to the freedom struggle in Southern Africa is firmly embedded in our memories. So I have returned, this time in a central banker’s suit and tie, to my home here in Lusaka. Mr President, may I express our gratitude on behalf of my contemporaries who found a home here. As will be evident from my address, the challenges facing central banks are generally the same all over the world, but in some instances they are more pronounced in emerging markets than is the case in developed countries. 2. Price stability In a paper delivered at the Jackson Hole1 conference in 2003, Professor Kenneth Rogoff, who was at the time the Economic Counsellor and Director of the Research Department of the International Monetary Fund (IMF), describes how over the last ten years global inflation has dropped from about 30% per annum to below 4 per cent per annum. This is indeed a remarkable achievement. In the economically advanced countries, inflation averaged 9 per cent in the first half of the 1980s and 2 per cent since the beginning of this decade. Following on this success, the developing world has performed even better. While inflation averaged around 30 per cent in the developing countries in the first half of the 1980s, it was on average below 6 per cent in the first few years of this decade. Recent estimates and forecasts by the IMF indicate that for the year 2003, inflation in Africa averaged 10,3 per cent and for 2004 it is expected to decline to 8,6 per cent. Bearing in mind that average inflation in Africa was around 40% in the early 1990s, this is quite an achievement. The African success in containing inflation is in reality even better. The higher inflation rate is occasioned by the impact of a few countries that still have very high inflation. Examples in this regard are Angola, Zimbabwe and the Democratic Republic of Congo. Nonetheless, if the average inflation rate of 10,3 per cent for Africa in 2003 is compared to 2,7 per cent for developing countries in Asia, it is clear that there is still room for improvement. Consequently, the pursuit of price stability is a major challenge for governments and central banks in Africa. The worldwide success in bringing inflation down to more acceptable levels cannot be ascribed to monetary policy alone. It is certainly also a consequence of other important factors such as more prudent fiscal policy, the easing of trade barriers, greater competition, productivity improvements and changing public expectations of inflation. While the causality regarding inflationary expectations is not totally clear, it does appear plausible that success in the quest for price stability is rewarded with Jackson Hole, Wyoming, is the venue for the Annual Meetings of Central Bank Governors, academics, and financial editors, organised by the Federal Reserve Bank of Kansas City. further success as inflationary expectations adjust downwards, influencing the overall price setting mechanism or chain. These expectations also depend on the credibility of the central bank. Whatever other factors influence the inflation rate, one can hardly deny that the execution of monetary policy in pursuit of price stability is a core function of central banks in all modern economies. The credibility of central banks depends to a large extent on whether they are perceived as either consistently applying monetary policy in a fair, dynamic, flexible and socially responsible manner or whether they are perceived as institutions staffed by arrogant, narrow-minded unelected bureaucrats. Almost in passing, one would like to refer to the phenomenon of “dollarisation”. In some countries foreign currency, usually the US dollar, is preferred to domestic currency. One is not convinced that this would happen if the central bank has earned its stripes as a consistent inflation fighter. There are of course other reasons beyond “dollarisation” why central banks should pursue price stability. There has been a growing consensus that high and variable inflation distorts decision making in the economy, leading to a misallocation of resources and ultimately to bad economic performance. Inflation also tends to lead to an unequal redistribution of wealth to the benefit of the wealthy who can hedge themselves against inflation and to the detriment of the poor who have neither the resources nor the skills to protect themselves. In a real sense, central banks are there to protect those who cannot protect themselves against the vagaries of inflation. An emphasis on the pursuit of low inflation as an important challenge facing central banks in Africa would be incomplete without at least a reference to inflation targeting. Following the successful example set by New Zealand, a growing number of countries have in recent years adopted inflation targeting as a framework or anchor for monetary policy. While it should be acknowledged that not all countries in Africa might be ready to adopt inflation targeting, it follows quite logically from the pursuit of price stability. Many African countries could probably benefit from working towards adopting an inflation targeting monetary policy framework. It is important to emphasise that governments and not central banks should ideally decide on the target and the central bank should implement such a framework. After using different monetary policy frameworks over time, an official inflation target was specified for the South African Reserve Bank for the first time in February 2000 by the government. Notwithstanding the impact of considerable exchange rate volatility, this monetary policy framework is serving South Africa well. In deciding on monetary policy, the SA Reserve Bank emphasises the inflation rate. Despite acting with due regard to the short-term impact of monetary policy on production and employment, the SA Reserve Bank keeps its focus firmly on inflation. This steadfast approach has been rewarded with success and since September 2003, the twelve-month percentage change in CPIX, the official measure for inflation targeting purposes, has been inside the 3 per cent to 6 per cent official target range. 3. Autonomy While low inflation cannot be the responsibility of the central bank and monetary policy alone, there can be no doubt that the central bank has a special role to play in combating inflation. In order to do that, the central bank needs to be properly empowered. This implies that the central bank has to be autonomous or independent enough to take the monetary policy decisions that are required to pursue price stability. The central bank must have total instrument independence which it must pursue without fear or favour. Pursuing the requisite autonomy is the next challenge facing central banks in Africa. This autonomy must be explained as one could ask why an institution of unelected officials making such critically important policy decisions in a country that has a democratically elected government should be independent. In the words of Mr B Gaolathe, Minister of Finance and Development Planning in Botswana: “However, there is need to reflect deeply on the issue of independence of the Central Banks. While we all agree that there should be autonomy of Central Banks, those institutions are created by the State [or legislators] to serve an important public purpose, and cannot completely be de-linked from the policies and laws of the nation, especially those pertaining to promotion of economic development”. It should be borne in mind that being independent does not imply not being accountable. No central bank can be totally independent in the sense that it 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 has the ultimate power to change the laws governing the central bank. Independence also does not mean that there is a lack of dialogue between the government and the legislature as the political authorities on the one hand and the central bank on the other. It has become customary to distinguish between goal independence and instrument independence for central banks. Once again, I would like to explain the difference by referring to South Africa. Our inflation target is set by Government after consultations between the Bank and the National Treasury have taken place. Thus the Bank does not have autonomy in choosing the inflation target and as such does not have goal independence. The Bank, however, has complete independence in making monetary policy decisions aimed at achieving the target. This is instrument independence par excellence. The autonomy entrusted to the Bank in the use of monetary policy instruments implies that the Bank has to be accountable for these decisions, and it should therefore ensure transparency. To this end, the Bank publishes Monetary Policy Reviews on a bi-annual basis, while regular regional Monetary Policy Forums are arranged to provide a platform for discussions of monetary policy with a broader range of stakeholders in the country. More importantly, the Bank’s annual report, which is submitted to Parliament by the Minister of Finance, combined with the Governor’s regular testimonies before Parliament’s Portfolio Committee on Finance, ensure that there is a democratic structure to enforce accountability and transparency. The explanation above should hopefully clarify the concept of central bank autonomy. It is a difficult paradigm shift for the political leadership. One of the major reasons for this autonomy was explained as follows by President Mbeki in 2001 at a meeting of the Association of African Central Bank Governors: “In our case this commitment is borne of the understanding that monetary policy should not be subjected to the vicissitudes that necessarily confront ruling political parties.” Monetary policy decisions, which impact on the economy with a lag and over extended periods of time, should be insulated from the short-term pressures that accompany party politics and elections. There is one other aspect of central bank autonomy which deserves mention, namely the potential impact of fiscal policy on monetary policy. Without fiscal discipline, the ability of even the most independent central bank to combat inflation successfully is severely curtailed. This is particularly true when the government has significant recourse to the central bank to finance its budget deficit. A central bank can hardly be autonomous if it is obliged to finance unsustainable government deficits. In the central banking literature, this is referred to as “fiscal dominance”. 4. Uncertainty It might sound strange to observers who are not central bankers or economists, to indicate that uncertainty is one of the difficult challenges facing central banks. How, after all, can central banks ask for operational autonomy if they are uncertain about major issues such as, for instance, the monetary policy transmission mechanism? One might hasten to add that the theory and practice of central banking and monetary policy have developed a great deal in recent decades. Nonetheless, monetary policy decisions are still taken against a background of considerable uncertainty. As will be indicated, this is even more true in the developing world. A few examples could illustrate the uncertainties confronting central banks. The first would be the impact of unexpected exogenous shocks or disturbances on the economy and inflation. In this regard, one can refer to developments in the oil price. Earlier this year, the SA Reserve Bank’s Monetary Policy Committee was still convinced that the higher oil prices would be transitory and as such would only be a short term risk to inflation. Unfortunately, the oil price has remained higher for longer, implying a greater risk for inflation. In general, monetary policy in South Africa does not react to exogenous shocks like the oil price, exchange rate or drought. If, however, these exogenous shocks result in a more generalised impact on inflation, some monetary policy reaction might be called for. Any response to these exogenous factors would depend on how the Monetary Policy Committee viewed their second round effects. This often calls for judgement beyond any econometric forecast as the second round effects can be very uncertain. It is also virtually impossible to judge with any accuracy whether an exogenous shock like the oil price increase is transitory or whether it will continue for a prolonged period of time. A further example of uncertainty facing central banks would be structural changes in the economy. This is a challenge facing not only emerging market economies, but also developed economies. While the emphasis might differ somewhat among countries, the causes of structural changes could be productivity increases, flexible labour markets, technological innovation, the spread of information technology, globalisation and increasing competition. These structural changes all affect micro and macroeconomic relationships, making it very challenging to forecast the future. Zambia is currently contemplating a Financial Sector Development Plan. While this plan could potentially deliver considerable benefits, it will certainly alter the structure of the Zambian financial system and economy. Beneficial as this will be, successful implementation of the plan will change established relationships between interest rates, output, employment and inflation, making the task of monetary policy even more uncertain than in the past. In essence, structural changes impact on the monetary policy transmission mechanism. At the best of times, it is difficult to judge whether monetary policy, through interest changes, affects the economy mostly via domestic demand, asset prices, the exchange rate, credit extension or inflation expectations. When economies change rapidly, as many African countries are trying to do, a further layer of uncertainty is added. The additional uncertainty facing African central banks extends further. Monetary policy decisions inevitably depend on a host of economic developments. Determining the appropriate stance of monetary policy requires that the current state of the economy should be correctly reflected in the available economic statistics. The relevant statistics should also be available timeously and be reliable and credible. Therefore adequate resource allocation to the statistics offices is of paramount significance for central banks and monetary policy. In the absence of correct and timeous economic statistics, it is impossible to determine the current state of the economy, let alone forecast future developments. In this regard, it seems appropriate to once again refer to South Africa, although this time as an example of how things should preferably not be done. In 2003, a relatively small distortion in the compilation of the CPI caused, when it was discovered, a downward revision of some 2 percentage points in the inflation rate. The consumer price index in South Africa covers approximately 1500 goods and services. A mistake in one component, housing rental, soon compounded to a sizeable deviation. For March 2003, the CPIX inflation measure targeted by the South African Reserve Bank was revised to 9,3 per cent, compared to the 11,2 per cent published originally. This example amply illustrates the potential consequences of incorrect information on monetary policy decisions. The appropriate stance of monetary policy is often judged by considering developments in indicators such as the real interest rate, the slope of the yield curve, the output gap, the natural rate of interest and the natural rate of unemployment. To determine some of these measures is difficult enough at the best of times. In the absence of correct information it is impossible. 5. The development of the financial system As was indicated earlier, there is no denying that price stability has become a core objective of central banks all over the world. It is also becoming increasingly apparent that well-functioning financial systems require financial stability as well. This could be described as the presence of soundly managed financial institutions and robust financial markets. Central banks in emerging markets typically face a more fundamental challenge in the sense that their financial systems are under-developed. Today some developing countries experience low rates of economic growth, partly because of under-developed financial systems and a concomitant lack of financial intermediation. Financial markets, including the institutions involved such as banks, through the process of financial intermediation, serve as a conduit for the efficient and optimal allocation of financial resources and can accelerate the rate of economic growth. In essence, financial intermediation tends to raise the level of saving and investment as it reduces the costs associated with bringing lenders and borrowers together. As in the case with price stability, the central bank cannot accept sole responsibility for the development of banks and financial markets, but is well placed to shoulder a major portion of the burden. The scope of the central bank’s role in developing the financial system is far too broad for an exhaustive discussion in one address and a few related comments will have to suffice. The first comment is an example of what a central bank can do in practice to help markets develop. Some years ago, as part of the development of the market in government bonds in South Africa and prior to the appointment of primary dealers, the SA Reserve Bank acted as a market maker in the market for government bonds. This was an interim phase in the development of the market. The Bank contributed to the market’s development by managing liquidity. While the Bank is still involved in the primary market as the issuer of government bonds, we have no role left as a market maker. The government bond market has matured with a group of primary dealers having to act as market makers. The Bank also played an active role in the early stages of the development of the spot and forward foreign exchange market involving the Rand. As we know only too well this participation by a central bank in the market can be fraught with risk. As such, it should be planned carefully and managed diligently. It can, however, expedite the development of a market if the central bank acts as market maker while other participants develop the capacity to fully participate. The central bank’s participation should be purely to provide and manage liquidity for a defined period and should not degenerate into intervention to influence market trends. A second comment relates to financial stability. Central banks and Finance Ministers in Africa have an important role to play to ensure that a proper regulatory infrastructure for supervising banks and other financial institutions and financial markets is established. An effective regulatory infrastructure, efficient financial markets and sound financial institutions are essential for financial stability. At a micro-prudential level, central banks have a real interest in banking supervision while at a macroprudential level, central banks should focus on promoting overall financial system soundness. The debate about the most appropriate location of banking supervision is, in the final analysis, dependent on country specific factors. There is no ready-made case study or example. A third comment relating to the development of the financial system is to point out that central banks have a pivotal role to play in the development of clearing and payment systems. An efficient and reliable clearing and payment system is an important component of overall financial stability. The central bank has to be involved in various aspects of the payment system, such as the establishment of the appropriate legal framework and the oversight of the payment system. 6. The role of markets Having reviewed the pursuit of price stability, autonomy, uncertainty and the development of financial systems as important challenges facing central banks in Africa, the next challenge, namely the role of markets, seems to fit in quite logically. In an address in 2001, reviewing changes that have transformed the economic and financial landscape as well as the way that monetary policy is conducted over the last two to three decades, Mr Jozef Van’t dack, Adviser to the General Manager, Bank for International Settlements, stated that: “No doubt the first and most fundamental change has been the almost universal reliance on market forces and the competitive price mechanism in organising real and financial activity”. A decrease in government’s role in the economy, fiscal discipline, financial liberalisation and reliance on market forces have also spread to Africa. In many African countries, however, further progress is still possible. Concomitant with this process, central banks have to develop market oriented instruments of monetary policy such as repurchase agreements and other open market operations. In a financial environment characterised by liberalisation and markets, the so-called direct instruments of monetary policy such as credit ceilings and directed lending are less effective. 7. Monetary cooperation In recent years, important initiatives have been taken with a view to the sustainable development of Africa. Key amongst these would be the Constitutive Act of the African Union and the New Partnership for Africa’s Development (NEPAD). Central banks in Africa will have to face the implicit challenges in these initiatives. The political will to pursue monetary union, a single currency and an African central bank should not be under-estimated. Article 44 of the Abuja Treaty calls for the harmonisation of economic policies across the African continent. The Treaty emphasises two important pillars of economic integration: the promotion of intraAfrica trade and the enhancement of monetary cooperation. The African Monetary Co-operation Programme (AMCP) seeks to operationalise the monetary cooperation mandate of the Abuja Treaty and the Constitutive Act of the African Union. In the main, this involves a single monetary area, encompassing a common currency and a common central bank by the year 2021. In terms of the AMCP monetary union in Africa is to be achieved in six stages starting in 2002/2003 and culminating in stage VI in 2021 with the introduction and circulation of the common African currency. During these six stages, African governments and central banks will have to work towards harmonisation and coordination of macroeconomic and monetary policies, the harmonising of interconnected payment and clearing systems, the strengthening and harmonisation of banking and financial supervision and the observance of increasingly strict macroeconomic convergence criteria. At the continental level, the Association of African Central Bank Governors subscribes to the AMCP. At the level of the Southern African region, the Committee of Central Bank Governors in SADC (CCBG) has become more involved in the various initiatives taken at the continental level. The CCBG has pledged support for the AMCP and the various projects that fall under NEPAD. The CCBG was established in 1995 with the specific purpose of achieving closer cooperation and integration in the area of monetary policy among SADC central banks. The work of the CCBG has contributed to major developments towards regional monetary cooperation such as significant progress in the harmonisation of the payment and clearing systems, the approval of Memoranda of Understanding on Cooperation, Coordination of Exchange Control Policies in SADC, and Cooperation in the area of Information and Communication Technology. The CCBG has also contributed to the coordination of training for central bank officials in SADC and the creation of a Training and Development Forum. The economies of our Southern African region are closely intertwined. Whilst it is evident that our countries experience differences in levels of GDP, inflation, employment or unemployment, exchange rate regimes, etc. we are nonetheless, one of the promising regions in our continent. Most SADC countries experienced higher growth rates in real GDP in 2002. Indications are that this continued in 2003. Notwithstanding this improvement, the aggregate growth in the SADC region still falls below the 7 per cent as recommended by international financial institutions to impact positively on poverty. In 2002 Angola, Mozambique and Tanzania reached commendable growth rates in excess of 6.0 per cent. The average rate of inflation for the region slowed down from 2001 to 2002. Figures for 2003 indicate that most SADC countries are making progress to achieving single digit inflation rates as proposed in the stage of implementation of the African Monetary Co-operation Programme (AMCP) for the period 2004 - 2008. A budget deficit/GDP ratio target of less than 5 per cent for the medium term (2004 - 2008) and a ratio of not exceeding 3 per cent by 2012 is proposed in the AMCP. Seven SADC countries recorded deficit/GDP ratios of 5 per cent or less in 2002. Most SADC countries have made progress in implementing economic reform policies, resulting in moderate inflation rates and reduced levels of Government deficit as percentage of GDP. However, the region still faces the challenge of generating higher rates of sustainable growth that will satisfy regional and global policy objectives of significant poverty and unemployment reduction and other aspects of social development. According to the IMF World Economic Outlook, April 2004, economic activity in sub-Saharan Africa is expected to increase to 4.25 per cent in 2004 and 5.75 per cent in 2005. It is expected that various large-scale development projects in manufacturing and infrastructure in the region by South Africa will provide economic stimulus to several countries. One of the projects is the expansion of the Mozal aluminium plant in Mozambique, construction of a gas export pipeline from Mozambique to South Africa and the Inga Dam project in the Democratic Republic of Congo. Achieving macro-economic stability and convergence in key macro-economic aggregates are important pre-requisites for the eventual achievement of monetary union. This does not all fall in the ambit of central bank responsibility. Nonetheless, central banks play a key role in pursuing macroeconomic stability. If central banks successfully pursue price stability, that is low inflation, they will be making a fundamental contribution to macroeconomic stability, which is a prerequisite for monetary union. 8. Conclusion In reflecting on the challenges facing central banks in Africa, one cannot but notice the overarching need for capacity building. To face all these challenges and others that have not been touched upon in this address will place significant demands on the staff of central banks. The training and development of staff is in reality a further important challenge facing our central banks. It is my pleasure to wish the Bank of Zambia well for the future. You have an important role to play in Zambia, SADC and Africa. You can count on us as your ally, friend and colleague. Happy birthday! Thank you very much References 1. Gaolathe, B (2004): “Official Opening Speech for the SADC Committee of Central Bank Governors’ Meeting”, Gaborone, 30 April 2. Mbeki, T (2001): “Address at the 25th meeting of the Association of African Central Bank Governors”, Johannesburg 3. Rogoff, K (2003): “Globalisation and Global Disinflation”, Paper prepared for the Federal Reserve Bank of Kansas City conference on “Monetary Policy and Uncertainty: Adapting to a Changing Economy”, Jackson Hole, WY, 28-30 August 4. Van’t dack, J (2001): “The Framework of Monetary Policy: An Overview of Issues”, Presentation to the Conference on Monetary Policy Frameworks in Africa, Pretoria, 17-18 September. 5. Mboweni, TT(2000): Address at the Reuters Forum Lecture, 11 October, Johannesburg. South Africa.
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Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, to the Association of Collective Investments Conference, Cape Town, 17 August 2004.
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Ian Plenderleith: Always something normal from South Africa Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, to the Association of Collective Investments Conference, Cape Town, 17 August 2004. * * * It is not very often that a central banker gets to comment on his country’s economy in Latin. As someone whose undergraduate studies were ancient Greek and Latin, I am delighted to seize the chance. The Latin I have in mind is Pliny’s often-quoted phrase, “ex Africa semper aliquid novi” - always something new out of Africa, by which I think Pliny meant that Africa could always be relied on to spring surprises, by astonishing the world with some bizarre new novelty. I want today to suggest some reasons why, if Pliny were with us now looking back on the remarkable progress South Africa has made over the past ten years, he would say the opposite. Much of the effort that has been applied to leading South Africa forward over the past decade has been directed to achieving what might be called “normalisation” - the steady process of building the stable political and social and economic structures that are normal for a modern, well-governed country in the 21st century. This is true of our political system, as was evident to all the world earlier this year as, with pride and style, we celebrated 10 years of democracy and held standard normal democratic elections, which were conducted with exemplary calm and good order. It is true, too, of the immense progress that has been in building a genuinely open multi-racial society and progressively alleviating the legacy of social neglect in areas such as education, health and basic living standards. It is true also, very visibly, in the economic sphere, in the huge strides that have been made in bringing South Africa into the frame as a normal, modern, open, competitive, market-based economy. It is this commitment to normalisation that has won the admiration of the world. I think it would win Pliny’s admiration, too, and that he would see that it is not frivolous novelty, but stable and sensible normality that is South Africa’s great achievement. So I think he would re-write his quotable phrase, to suggest that the key ingredient in the immense progress we have made in the past ten years has been, not “semper aliquid novi”, but “semper aliquid normalis” - always something normal out of South Africa. In the economic sphere, the extent to which the country has been put on the track of normalcy, running as a standard, normal, modern economy, is something of which everyone can be immensely proud. It is a priceless gain, achieved by hard work, dedication and intelligent policy-making. But it is not just something to look back on with satisfaction. It is even more important to look forward, to recognise that the stable framework for a normal, well-run economy that has been achieved to date provides the foundation for improved economic performance in the years ahead. That means the prospect, if we stick to the task, of faster sustainable growth, better public services, higher living standards for all our citizens and growing and competitive businesses that will generate lasting jobs for the future. But we need to recognise, too, that it is only now, after some years of laying the foundations, that we are beginning to see these benefits come through in substantive, concrete form. Sensible policies, aimed at generating benefits that are sustainable over the long term, take time to deliver dividends. But commitment to good government, in the economics sphere as elsewhere, really does produce results, and I want to highlight three areas where I believe we are now seeing the benefits come through strongly. First, South Africa has for ten years steadily pursued a stable, disciplined macroeconomic framework. The rewards for macroeconomic discipline, however, build up over time and it is important to recognise where we are now beginning to see the real benefits come through. On the fiscal side, the National Treasury’s commitment to maintaining budgetary control and strengthening the public finances is now providing the base for significantly increased expenditure on key public services without in anyway jeopardising fiscal discipline. On the monetary side, the inflation-targeting framework and the independent responsibility given the South African Reserve Bank for managing monetary policy has enabled us to bring down inflation to within the target range of 3 - 6 percent and, in the process, reduce interest rates very substantially during the past year or so. With the exchange rate recovering from its temporary and irrational plunge in 2001, increased public confidence in the inflation targeting framework has delivered a steady decline in inflation expectations. The benefits of this steady commitment to a stable macroeconomic framework have now begun to come through in a quickening in economic growth over the past year, with every prospect that the economy can continue to pick up speed in the year ahead and beyond helped by the recovery in the global economy. The economy has in fact achieved the remarkable record of registering continuous positive growth every quarter for the past 22 quarters. With inflation remaining under control, we are set to extend that record, as can be seen just last week by the further step we were able to take in reducing interest rates. A second feature of particular relevance has been the strengthening of the micro structure of financial markets in South Africa, again designed to ensure that our markets meet normal established international standards. The well-constructed framework the National Treasury has pursued in its debt management activities, the quality of the markets administered by the JSE Securities Exchange, the Bond Exchange of South Africa and the clearing and settlement agencies, and the oversight exercised by the regulatory authorities have all greatly improved the quality and liquidity of our markets and generated substantial international interest and participation in South African financial instruments. Well-functioning markets encourage savings and, by matching savings with productive investment opportunities, help to bring down the cost of capital. We have seen the evidence of this in the diversification of issuers in the bond markets: alongside the Government’s bond issues, corporate issues are growing rapidly, securitization is increasing and recently the municipal bond market has returned to life. This process undoubtedly has further to go and will help to provide the efficient structure of financial markets that are an essential support as our economy continues to grow. A notable further step in strengthening our financial infrastructure was implemented only last week, when our real-time wholesale payment system - SAMOS - moved to same-day final settlement. This is an excellent example of how the steady and persistent commitment to normalising the structure and functioning of our economy can produce real gains that are often overlooked or under-recognised. SAMOS, our real-time payments system, lies deep in the plumbing of our financial system. Its functioning is a fascinating piece of advanced IT engineering - at least for central bankers like myself and my colleagues at the National Payment System Department at the South African Reserve Bank, though I have to confess we have noticed that other people’s eyes tend to glaze over when we wax lyrical about the elegance of the system! What this seemingly technical step does is to remove a significant element of overnight risk for the financial system as a whole: we can go to bed, however late, knowing that all the day’s millions of individual payments have definitively been delivered and that all the resultant inter-bank olbigations have been settled finally and irrevocably. As importantly, that step in turn paves the way for South Africa later this year to join the international CLS system providing for real-time settlement of foreign exchange transactions between the rand and other currencies. In all these ways, the structure of our markets has steadily been strengthened so that they meet international standards. A third area I want to highlight where normalisation is now bringing real benefits is in the South African Reserve Bank’s own financial operations. There are two aspects here - external and domestic. In our external operations, in foreign exchange, a particular feature of the South African economy that has often attracted attention as an area of weakness has been our relatively low foreign exchange reserves position. Here too, normalisation has been pursued - to build up the official foreign exchange reserves towards a level normal for countries at our stage of development. At worst, in September 1998, we had a negative foreign exchange reserves position of $23 billion - the legacy of accumulated losses on foreign exchange operations in earlier years. The progressive closing-out of this negative net open foreign currency position has been a major challenge in the recent years. The negative position was finally closed out only last year, in May 2003. We then set to the task of squaring-off the negative forward book which had been financing part of our gross reserves. This in turn was achieved in February this year. Since then our reserves have continued to rise, to a level currently of gross reserves of $11.8 billion and net reserves (net of the Reserve Bank’s use of committed medium-term facilities) of $8.4 billion. This means that the structure of our foreign exchange reserves now looks, and is, normal by international standards. We shall continue to build the reserves gradually over time, as opportunity presents, but the positive reserves levels we now enjoy should make a material contribution to lessening rand volatility and strengthening our credit standing. Indeed, that is already evident, in the ratings upgrades South Africa has received in recent years and in the substantial narrowing in the spreads on South African international bonds. This in turn helps to reduce the cost of international borrowing by South African companies across the spectrum. This increase in official foreign exchange reserves is a very positive development, and has been widely welcomed as such. But as we have moved steadily forward, the markets, rather like spectators at the Olympics now underway, have begun to enter into the spirit of the occasion and cheer us on to yet more heroic efforts. Some urge us to run faster and faster and, if not exactly go for gold, at least aim for seriously higher levels of foreign exchange reserves. Others argue that we should run in more than one event, pursuing not only higher reserves but also more active management of the exchange rate. So it is worth being clear exactly what we can hope to achieve in this area of our operations, and equally what we cannot. We can, and will, continue gradually to build up our official foreign exchange reserves to a respectable level in an orderly fashion in accordance with our balance sheet whenever circumstances allow us to do this. This will bring benefits, as I have indicated, in terms of lessening rand volatility and strengthening our international credit standing. The scale of our operations is, in fact, cumulatively more substantial than is sometimes recognised: over the six years I have described above, we have acquired, directly by purchases in the market, or indirectly, of the order of $30 billion. Around $10 billion of this has been acquired in the past eighteen months. These are not negligible sums, particularly in relation to the size of foreign exchange activity in the rand. In the process, our operations have undoubtedly provided some moderation to the rise of the rand we have experienced over the period. This has in degree helped to alleviate some of the strains exporters and our manufacturers have faced from the rise of the rand. We fully recognise the difficulty businesses face in adjusting to those strains, and it is useful that our operations can help in this way. But our operations have to remain focused on rebuilding our reserves. It would not be sensible for us to switch to a different focus, of seeking more actively to manage the exchange rate, principally for two reasons. First, neither we nor anyone can claim with any confidence to know what would be an appropriate equilibrium exchange rate. It is much more sensible for us to pursue a stable monetary framework aimed at delivering low inflation and thereby help the market find a stable trading range for the rand - as indeed it has managed to do for extended periods over the past year. Secondly, endeavouring to manage the exchange rate would jeopardise our success in delivering low inflation: countless episodes in the past around the world demonstrate that attempting to switch focus to the exchange rate means that the central bank loses control of inflation, with seriously damaging results to the prospects for sustaining growth in the economy on a continuing basis. So we can, through our continuing operations designed to rebuild the reserves, help in the process to moderate the pace of adjustments in the exchange rate. That we are doing and it is entirely consistent with our inflation targeting framework. But a more activist approach to try to manage the exchange rate would risk undermining the inflation target. In our domestic market operations, in the rand money markets, we have also achieved over the past two years a major streamlining of our activities aimed, here too, essentially at normalisation - to bring our operations back within the frame of normal central bank management of money market liquidity. We were out of this frame because the accumulated foreign exchange losses, described earlier, had two major distorting effects in our domestic markets. First, the losses accumulated on an account - the Gold and Foreign Exchange Contingency Reserve Account (GFECRA) - which falls to be settled by the National Treasury, but in the meantime stands as a claim on the assets side of the SARB balance sheet. We needed to find a way to fund that asset. Secondly, the losses generated as their counterpart a large structural surplus of rand liquidity in the market. These two distortions - the asset on our balance sheet that needed funding and the excess liquidity held by the market - are essentially two sides of the same coin. We had to bring the two sides together, so to speak, by draining the surplus, in order to ensure that short-term money market rates remained in line with the policy repo rate set by the Monetary Policy Committee; and in doing so, we obtained temporary funding for the GFECRA asset. At peak, in August 2002, the structural surplus we had to drain amounted to the huge sum of close to R70 billion. We drained this by the use of variety of instruments - some normal in character, e.g. bond repos, but some innovative or unusual, such as the sale of SARB debentures and, on a very large scale, so-called special money market swaps with deposits, which were foreign exchange swaps with the foreign exchange we gave on the swap redeposited with us. Rolling over this diverse funding operation was a technically demanding task and I would like to pay tribute to my colleagues at the SARB who, long before my arrival, handled this task with skill, expertise and high professionalism. This was clearly not a sustainable situation. Not only did it impair the central bank’s balance sheet, but it also had seriously distorting effects on the domestic money markets, hampering their development; and at times it risked undermining the implementation of monetary policy. We have therefore over the past two years set ourselves to find ways of draining this liquidity on a permanent basis. The key to doing so was the steps taken by the National Treasury, starting in September 2002, to pay off the balance on the GFECRA, principally by issuing the SARB with bonds. We were then able to sell these bonds, either directly or by switching into forthcoming maturing issues, and so drain the excess liquidity on a permanent basis. At the same time, other factors helped us along the way - notably, the steady increase in notes and coins in circulation, and the recovery in the rand, which enabled us to start generating profits on our oversold forward book. The result is that, by the end of last year, we were able to pension off the use of special money market swaps with deposits - which had amounted to over R50 billion at peak - and had effectively completed the task of draining the liquidity surplus on a permanent basis. This episode is a fascinating story of bringing liquidity management back from a distorted position to normalcy. Thus here, too, there has been a steady process of bringing our structures and process back to normalcy. The process of normalisation is a feature of many areas of our efforts over recent years. I hope I have been able to show that it has been worth the effort, for the benefits it brings in terms of better and more sustainable economic performance for the country as a whole. I hope I have also been able to show that these benefits are now beginning to come through in substantive form, but that there is much more yet to be gained from the heavy lifting that has been done in recent years. That is why we will stick to the task.
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the cocktail function in honour of the ACI South Africa, Pretoria, 20 September 2004.
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T T Mboweni: Developments in the foreign exchange markets during the last couple of years Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the cocktail function in honour of the ACI South Africa, Pretoria, 20 September 2004. * * * Ladies and gentlemen, welcome to the South African Reserve Bank. We thank you for being here this evening, and we feel honoured that you should have accepted our invitation. As most of you are engaged in the foreign exchange markets, we thought that it might be useful to make a few remarks on our involvement in the markets and refer to recent developments in this regard. We think that you are an important and critical constituency as far as our work is concerned, and it is only correct and proper that from time to time we should come together to exchange views and interact with one another. Allow me to congratulate ACI South Africa for being selected to host the ACI Council Meeting in Sandton from the 23rd to 27th November this year. It will be the first time that this prestigious event will be held in South Africa. We wish you good luck with the organisation of that event and we are certain that you will do us proud! We have also noted from your website that you are also taking this opportunity to draw attention to the "sights and sounds" of our beautiful country. We are also aware of the important role, which the ACI is playing in actively promoting the educational and professional interests of the financial markets. In particular, the active role in the education of dealers with a view to establishing an accreditation standard and developing the technical skills and knowledge of financial market dealers in South Africa and Africa as a whole is to be appreciated. It is assumed here that as an organisation you are also an active participant in the financial services charter process. We also admire your efforts in compelling your members to maintain the professional level of competence and the ethical best practices of loyalty as set out in your Model Code. We strongly support all your attempts to promote professional and ethical behaviour in South Africa as these are essential in building credible international trading relations, and in establishing, maintaining and enhancing the reputation of our financial markets. Our remarks this evening will focus on developments in the foreign exchange markets during the last couple of years. A good starting point appears to be the last time we met with you as an organisation here at the central bank. What were the big issues at the time of the last ACI cocktail? Just to touch on a few issues: If my memory serves me well, we met in May 2001, at a time when the currency markets were dominated by a strong US$ on the back of strong flows into the USA, although at the time the strong economic growth seen in 2000 was already giving way to a somewhat less favourable growth prospect in the USA. We were all surprised that the US$ was still showing some resilience and continued to be generally strong. As we all now know, things did not stay that way. In the year 2000, the Rand lost 22% of its value against the US$ and during the first five months of 2001 the Rand lost about 5.5% against the US$, which did not seem too strange based on economic fundamentals at the time. Little did we know, of course, that at the end of the year 2001 we would be talking about a 37% depreciation and that there would have been the attacks on the United States, which would precipitate more conflicts and wars, and change risk perceptions in financial markets. We talked then about volatility in the financial markets and acknowledged that it was becoming a constant feature as the processes of deregulation, liberalisation and globalisation continued to gather momentum. Trading in our foreign exchange markets and in the Rand was very much influenced by the existence of the NOFP and the Forward Book, with the NOFP still registering a negative balance of US$9bn, in spite of significant progress that had been made in reducing it from the precarious levels of over US$23bn in 1998. This was seen as a negative factor by rating agencies and investors, and we were constantly called upon to explain how we were going to deal with that situation. Where did the journey take us after that? As you all know, the period after our last meeting brought with it some major challenges for the world economy, which South Africa as a small open economy got its fair share of. However, we also had to face serious challenges that were more related to our own situation. The second half of 2001, especially the fourth quarter saw a steep depreciation of the Rand, not only against the US$, but on a broad base. The situation got to a point where the two-way risk inherent in trading the currency was temporarily dislodged, and a perception existed in the market that the Rand was a one-way downward bet. Our observation of the existence of large speculative positions at the time compelled us to issue the now famous statement of October 16, 2001, in which we reminded market participants to adhere to existing rules and regulations covering currency trading. It is worth noting at this stage that we very much valued the cooperation we received from the ACI when we attempted to clarify certain issues to market players at the time. Whilst many reasons have been advanced, and even a commission of enquiry established, to some extent those developments still remain unexplained. That massive depreciation in the exchange rate of the rand led to a deterioration in inflation, which represented a serious setback for us in the early stages of South Africa's implementation of a formal inflation targeting monetary policy framework. Having registered some success since the introduction of formal inflation targeting, and even managing to steer CPIX into the target range in September and October 2001, the knock-on effects of the currency depreciation resulted in a sharp increase in inflation during 2002, with CPIX peaking at 11.3% in November 2002. These developments necessitated a tighter monetary policy stance, which was delivered by way of repo rate increases totalling 400 basis points during 2002. But we are now back on track… We are, however, pleased to say that the pressures that we faced then were relatively short-lived. Our policy responses, whilst admittedly painful at the time, together with global and domestic developments allowed us to resume the positive path we had been travelling on before the interruption of 2001. The currency has recovered very well, and contributed to better inflation outcomes as well as a much improved inflation outlook. This in turn has allowed the Monetary Policy Committee to reduce the repo rate by as much as 600 basis points between June 2003 and August 2004. It is indeed pleasing to note that the CPIX inflation measure, which is the one that our policy is judged against, has now been within the specified target range of 6 - 3 % for almost a year. As you are well aware, owing to the combined efforts of the SA Reserve Bank and the National Treasury (NT), the net open foreign currency position (NOFP) was finally eliminated in May 2003, and the oversold forward book of the Bank was closed out, in February 2004. We are glad to say that these developments, resulted in fully transferring the function of forward cover provision back from the Bank to the authorised dealers. Those positions also had major consequences for liquidity management in the money market. In fact they complicated our lives very badly! Whereas previously the huge losses from the forward book led to a structural liquidity surplus in the money markets, which had to be mopped up by using expensive instruments such as the so called special money markets swaps, our operations in the money markets now follow what one may refer to as normal central banking patterns. Moreover, all these achievements also enabled the Bank to focus more on increasing the official reserves to more internationally acceptable levels. What that level is, is rather difficult to say, and there appears to be no universally agreed upon international benchmark in this regard. The appropriate level may need to be evaluated against a country's specific circumstances such as the size of its economy and degree of openness, its exchange rate regime, credit rating, risk of capital flight, and many other factors. Extensive research on the subject continues to be undertaken here and internationally. As stated previously, whilst not working toward a specific target for reserves within a specific time frame, the Bank is strengthening its reserves mainly by means of purchasing, in a reponsible manner, moderate amounts of foreign exchange in the market, as and when, in our opinion, market conditions permit such purchases without unduly influencing the exchange rate and introducing unnecessary volatility in the market. We continue to accept that the exchange rate is set in the market. From time to time the Bank was also supported by the National Treasury in the process of accumulating reserves, when the proceeds of foreign bond issuances were sold to the Bank in exchange for Rand. In addition to "creaming-off" and foreign borrowing by government, the Bank also borrows foreign currency in its own name mainly through the syndicated loan market, which increases the level of gross reserves. The international liquidity position has increased to $8,6 billion as at 31 August 2004 and the gross reserves (including gold reserves of approximately 4 million fine ounces) increased to slightly more than $12 billion at the end of last month. This is indeed a remarkable achievement, when one considers that at the time of our meeting in 2001, the negative NOFP stood at US$9bn, as indicated earlier. Some observers at times blame the Bank for not increasing the pace at which it is accumulating foreign exchange reserves. These well 'educated and informed' folks sometimes forget that converting a negative NOFP position of $23,2 billion in September 1998 into a positive net reserve position of $8,6 billion in August 2004, implies that over this six-year period, the Bank has acquired a staggering amount of almost $32 billion, most of which was obtained from the forex markets. After a steady appreciation in the exchange rate of the Rand since 2003, the currency depreciated moderately after the reduction in the repo rate on 12 August this year and appears to have settled between R6,50 and R6,70 per dollar - approximately the same level as at the end of 2003. Various factors are in one way or the other responsible for the Rand's general appreciation so far this year. Firstly, the US dollar has depreciated against major currencies, benefiting the currencies of many emerging-market countries. Secondly, high commodity prices in international markets supported commodity-based currencies like the Rand. Thirdly, accommodative policy stances in some developed countries resulted in positive interest-rate differentials for emerging market countries compared with their counterparties within the industrialised countries. This is still the case with respect to South Africa despite the overall reduction of 600 basis points in the repo rate since June 2003. Fourthly, a number of significant corporate transactions resulted in an increased supply of foreign exchange and fifthly, momentum and technical trading may also have contributed to some of the Rand strengthening in recent months. Another important factor generally supporting the above mentioned has to do with the fact that the overall perception, or sentiment as you like to call it in the markets, of South Africa has been improving, with international investors making positive assessments of the political, fiscal and monetary management process in the country over recent years. It is also interesting to note that the volatility conditions in the domestic foreign exchange market seem to have normalised during the course of 2004. For example, the one-month historical volatility of the Rand declined from a most recent high of 28,4 percent in January 2004 to 12,2 per cent in June 2004, before picking up again to just below 20 per cent. Another measure of volatility, namely the difference between the highest and lowest exchange rate recorded during a month, declined from R1,36 in January 2004 to around 50 cents during the last few months. Although by some standards this still represents a fair degree of volatility, one should see this in the context that South Africa is an open economy exposed to international foreign exchange markets that have been fairly volatile recently. Our efforts with regard to strengthening our reserves level should over time contribute to a less volatile exchange rate. The average daily turnover against the Rand in the domestic foreign exchange market declined to just below US$6 billion in 2002, and remained fairly subdued at US$7,7 billion in 2003. In 2004 to the end of September, the average daily turnover against the Rand increased to above US$8 billion, and reached levels last recorded in 1999. We continue to see active participation by non-residents in our forex markets, especially in the swap market, where the share of non-residents currently amounts to around 65%. Non-residents accounted for about 60% of total turnover in the foreign exchange market. Higher turnover generally correlates positively with market activity and also provides a good measure of market liquidity. Liquidity in the Rand market usually increases when the currency behaves in a predictable manner. However, in an uncertain trading environment, bid-offer spreads widen and the market loses its depth as market participants become reluctant to quote prices, which was the case in 2001. During the latter part of 2001, bid-offer spreads widened to approximately ten cents (from only three cents earlier in that year) on regular trading amounts. Conditions have improved drastically since then and spreads have narrowed back to approximately three cents currently. The price discovery mechanism in our forex markets now follows a much more normal pattern of two-way-risk. Given that you are forex dealers, there is no need to elaborate. Many of you have lived to be able to tell the story of the Rand much better. One thing seems to be confirmed now: the Rand is no longer a one-way downward bet. Hopefully some of the lessons learnt in this regard, in the dealing rooms, were not too expensive! Conclusion As you can deduct from the above, there are many areas where the Bank has daily contact with yourselves in the market place. We value these relationships dearly. It is through yourselves, the banking industry and financial markets in South Africa, that the Bank is able to implement monetary policy. You are an essential pillar in our monetary policy transmission mechanism. We wish you well as an organisation. We hope that you may grow from strength to strength. Once again thank you for the role you play in enhancing the reputation of our financial markets. Enjoy the evening with us and have a safe journey home. Thank you.
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Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, to the London Bullion Market Association Biennial Dinner, London, 26 October 2004.
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Plenderleith: Developments in the gold market Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, to the London Bullion Market Association Biennial Dinner, London, 26 October 2004. * * * I want first to thank you very warmly for the chance to join you this evening. It is a particular pleasure for me because, having spent the main part of my career in the City of London at the global centre for gold trading, I now find myself back up the supply chain working in the country that is the leading global gold producer. So it is a great privilege for me to join this notable gathering of the glitterati of both camps, so gracefully hosted by the London Bullion Market Association. Arriving this morning from South Africa, where summer on the highveld is now in full bloom, to the cold, damp, gloom of an English October dawn was a salutary reminder of the realities of globalisation. But, as evidenced by the attendance here this evening, globalisation is no new phenomenon for the gold market. Gold has been a global monetary asset since at least the days of King Croesus of Lydia whose habit of sprinkling gold dust on his food made me look rather carefully at the salt and pepper on the table this evening; and gold has been a store of value and a source of beauty in artefacts for a lot longer. It is by recognizing the global nature of the gold market that the LBMA has been able to raise its act in promoting and serving the gold market around the world, and in the process help strengthen London’s position as the pre-eminent international financial centre. That LBMA membership has this year exceeded the 100 mark reflects the value it is delivering, and I want therefore to pay tribute to the excellent work lead by Simon Weeks, your Chairman, Jeremy Charles, your Deputy Chairman, Stewart Murray, your Chief Executive, Martin Stokes, your immediate past Chairman, and their team of dedicated committees and staff. Their efforts have, for example, helped the Good Delivery List remain the world standard of bar quality: the procedures the LBMA have put in place for pro-actively monitoring the List are a welcome and successful initiative in ensuring that technical standards are maintained. The LBMA’s contribution to strengthening the regulatory framework, and the steps it has taken to improve the transparency of market data, are also welcome progress towards meeting modern market standards. Alongside these initiatives, the LBMA’s information and educational programme, through its conferences and seminars, has been well-focused and continues to provide valuable opportunities for industry issues to be debated. We in South Africa are particularly delighted that next year’s conference is to be held in our country and we look forward to welcoming you to a decent climate and outstanding wines. We regard your visit as good practice for hosting the soccer World Cup in 2010 - though we hope it will be a somewhat less intimidating experience. Looking back over the past year or so, there have been some notable developments in the gold market. I want to touch on just two. First, the news in April that NM Rothschild were withdrawing from gold trading marked a sad moment in the long history of the London market. That they chaired the London Gold Fixing for 85 years, continuously from its inception from 1919, may not, I suppose, be entirely in line with modern-day precepts of corporate governance, but it represents a long-running commitment to promoting the quality and international reach of the London market which has played an important part in maintaining its pre-eminence. We all owe a great debt of gratitude to the House of Rothschild and I want tonight to pay unreserved tribute to the contribution they have made over the years. The market, nonetheless, will continue, and I was delighted to see the decision to move to conducting the fixing by telephone, which I believe was the means by which it was originally conducted in 1919 before moving to more gracious surroundings at Rothschilds. This is a delicious illustration of the paradox, of which I have become increasingly aware, that part of the process by which we edge our way into the future is by inadvertently re-inventing the past. The other notable event to which I want to allude is the renewal from last month of the Central Bank Gold Agreement. Though widely expected, this is welcome evidence of the continuing ability of central banks to work together to align their interests and those of the markets in a sensible arrangement for orderly marketing. The LBMA’s input to this process, through its survey of the views of market participants, was well-timed and helpful. There are, of course, plenty of other fields where we, as central banks, and our governments need to show a similar dedication to international good order in addressing potential imbalances. Elsewhere, of course, the market has continued to digest significant shifts in the trading environment. Earlier this year, prices reached a 15-year high, and are now again close to that level. On the producer front, the process of consolidation amongst mining companies has continued, though not all of them, as recent events have shown, entirely in harmony. De-hedging has also continued. That process - in either direction - is of course a perfectly normal commercial activity, but I strongly advise you to find a better term than “de-hedging’, because friends of the countryside - never very well disposed to mining operations - might be inclined to take ‘de-hedging’ as an environmentally-unfriendly activity designed to flatten the landscape. It has, of course, had much that effect on leasing rates. I assume that is why much is written these days about the contango - which, again, the uninitiated might be forgiven for supposing was the gold market’s distinctive contribution to resolving the Argentinian debt crisis. Before leaving the past year, I want to recognize one other notable personal contribution to the standing of gold - Kelly Holmes’ outstanding achievement in winning two of the most thrilling Olympic gold medals any of us can ever wish to see. I mention this particularly because it gave rise to my own personal golden moment of the past year. As you may know, Kelly Holmes trains in South Africa, and, by chance, my wife and I found ourselves alongside her at the security check at Johannesburg airport a few weeks ago. She was carrying her gold medals, and so had to produce them for inspection. While we were admiring them, we were interrupted by the public announcement that our flight was ready for boarding and we were warned that it would take 15 minutes to get to the gate, whereupon I found myself, to my horror, saying “Well, if we stick with Kelly, it should take us only 47 seconds” - a remark so crass that my wife quite rightly refused to speak to me for most of the rest of the flight. With these and other challenges, or in my case bloopers, behind us, what now are the prospects looking forward? Here, I think the prospects for the gold market can best be described in much the words that tended to be used in my own personal career performance assessments by my superiors over the years: in the medium term, the fundamentals look quite promising, but in the short run, performance has been erratic and the outlook is uncertain. If one looks at the fundamentals, I think a good reason for being positive about the medium term - and a factor that is sometimes not given sufficient attention - is that gold has the benefit, uniquely so far as I am aware, of enjoying demand from four separate markets: it is a core ingredient in high-quality artistic artefacts, notably jewellery; it has applications in industrial production; it is a universal and long-standing outlet for private financial investment; and it is a monetary asset. Other commodities or artefacts share some of these sources of demand, but none covers the field so comprehensively. I do not, for example, think that my wife would be too thrilled if I have her a lump of coal, or even a can of petrol, for Christmas. Of these four markets, a striking feature - and again, a feature that I do not think gets enough attention - is that over the years demand for fabrication, notably jewellery, has consistently outrun current mining production. Current production, on the supply side, and fabrication, on the demand side, are not of course the whole picture. The stockpile held by central banks can be, and has at times been, an important influence on price expectations; but the Central Bank Gold Agreement has helped to provide stability in this area in recent years. Equally, supply can fluctuate depending on scrap sales and producer hedging or de-hedging activity. But the underling balance of demand and supply, viewed over the longer run, strikes me as a good deal more healthy than in sometimes suggested. Jewellery fabrication remains the major source of demand, and here prospects seem to me to be generally encouraging. As the global economy extends its recovery, and as emerging market economies make further progress in raising living standards for their large populations, higher continuing levels of consumer spending should bring increased demand for high-value artefacts, as indeed luxury good retailers around the world are already noticing. There should be increasing opportunities here for the gold industry to expand jewellery sales. But, to reap the full benefits, it will be important that efforts are put into design quality, product innovation and plain, straightforward marketing. LBMA members might wish to reflect whether enough emphasis is placed on these key industry-support elements - particularly marketing. Industrial use of gold is smaller scale, but nonetheless not insignificant, and may also benefit from continuing global economic growth. But the other main source of demand is for gold as a personal financial investment. Here, as with jewellery, there should be excellent opportunities for broadening the market as rising personal wealth stimulates wider interest in gold-related investments. But here, too, I wonder whether we do not sometimes not so much undersell the product as approach it from the wrong angle. Economists, of course, have always struggled to rationalize the merits of gold as a financial investment. But economists, as I have learnt from personal experience, can all too often fall into the trap of being presented with something that works in practice, and objecting, “That’s all very well, but you’ll never make it work in theory!” Perhaps for this reason, we tend too often to promote gold as some kind of exotic alternative investment - as asset that best gains in value when everything else is collapsing. Gold is thus presented as a hedge against disaster. But its value concept should perhaps be put more constructively, as an asset with distinctive characteristics that offers its own prospects of long-run return, based on a rational analysis of supply and demand dynamics; and one that, as such, has a part to play, less at some times, greater at other times, in a diversified financial portfolio. Financial investment in gold also seems to me to be an area where, in degree, as with jewellery demand, the gold industry can help to shape its own future. Products designed to attract broader private investment demand have been with us for some time. Initially the focus was mainly on bullion coins - led by the British sovereign and the South African krugerrand, which seem to me to set the standard for solid reliability, though maybe I am biased, and followed by a galaxy of imitators, of which my favourite is the golden nugget, which seems to me to border on the indecent and can only have come out of Australia. More recently, financial engineering has entered the field and is producing a range of outlets to reach a wider investing public. The London Stock Exchange’s initiative in listing Gold Bullion Securities is welcome in this field. But as rising personal wealth, particularly in the newly-emerged economies, seeks outlets for its savings, there must be much that the gold industry can do to maximize investment interest in gold. In this vein, I want to leave you with a vision. Earlier this year - a year in which we have been celebrating ten years of democracy in South Africa - the South African National Assembly took delivery of a new mace, the symbol of the sovereignty of Parliament and a tangible manifestation of the strength of the democratic process that has taken root in South Africa in the past decade. The head of the mace is an 18-carat gold book inscribed with the preamble to the Constitution in all the national languages. There are, I believe, currently around 185 sovereign nations in the world. All of them, and their regional and municipal governments, and their state bodies, not to speak of their commercial and social institutions, have emblems of their authority and gold will in most cases be the natural choice for such prominent instruments. With gold occupying such a powerful place in our emotions, I am confident that, provided we take advantage of the opportunities, the gold market has a long and fruitful role to play in the future, and I commend the work of the LBMA in pursuing that goal. It is with great pleasure therefore that I ask you all to join me in wishing continuing success and good fortune to the London Bullion Market Association.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the National Bank of Belgium, Brussels, 9 November 2004.
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T T Mboweni: The global economy and central banking in Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the National Bank of Belgium, Brussels, 9 November 2004. * 1. * * Introduction The global economy changed considerably in recent years with important consequences for central banking. During the last half of the previous century the world economy was characterised by a process of liberalisation, deregulation and eventually globalisation, i.e. a process through which an increasingly free flow of ideas, people, goods, services and capital leads to the integration of economies and societies. Globalisation brought increasing prosperity to the countries that became involved in it. The free flow of goods, capital and people boosted incomes and raised living standards in many parts of the world. In addition, new technological advances reduced transportation, telecommunication and computation costs. These developments did not only lead to greater operational effectiveness, but also increased the ease with which national markets could be integrated globally. The more integrated world economy did not benefit all economies and all the inhabitants of the globe. Mr Horst Köhler, the past Managing Director of the International Monetary Fund recently stated that: “nearly 1,2 billion people - one fifth of humankind - continue to live in absolute poverty, with incomes less than $1 a day. In many countries, durable economic and social progress remains elusive. In most of these countries, trade has decreased in the last 20 years and on average, economic growth has not kept pace with population growth. The situation in Africa is particularly dramatic because it is aggravated by the AIDS pandemic. I believe that the fight against global poverty is the greatest challenge for stability and peace in the 21st century.” It is true that disease, unemployment and poverty reduction remain the major challenges confronting policymakers in Africa. For this reason it is encouraging that African leaders have embraced the New Partnership for Africa’s Development (NEPAD) to confront the challenges facing the continent. NEPAD is a strategic development plan that addresses the economic, social and political dimensions of Africa’s future development. It is a clear demonstration of the willingness of the leaders in Africa to take responsibility for actions needed to advance development. The vision and way forward basically consist of creating the policy environment and institutions that are necessary to translate the political commitment into economic benefits. It is further encouraging that there has been some improvement in Africa’s growth performance since the mid-1990s, albeit from a low level. The average growth rate in Africa amounted to 3,7 per cent in the period from 1995 to 2004, compared with 1,9 per cent in the preceding 10 years. This improvement was underpinned by some reduction in conflict on the continent and the achievement of greater macroeconomic stability. According to the International Monetary Fund, African economic growth is expected to rise even further to 4,5 per cent this year and to 5,4 per cent next year. While this improvement can be acclaimed, the progress needs to be accelerated. Only seven African countries achieved economic growth rates above 7 per cent during 2003 - the level required to attain the United Nations Millennium Development Goals. A continued concerted effort is therefore still required to raise living standards in Africa. 2. Price stability An important spin-off of globalisation to the world and to some extent also to Africa has been the contribution that this process has made to the attainment of price stability. In a paper delivered at the Jackson Hole Conference of 2003, Professor Kenneth Rogoff, who was at the time the Economic Councillor and Director of Research of the International Monetary Fund, describes how globalisation has contributed to the drop of global inflation from about 30 per cent to below 4 per cent per year over the past decade. In this paper Rogoff states that although central banks deserve a lot of credit for today’s low inflation rates, they cannot claim all the credit. The increased level of competition in product and labour markets, arising from the interplay of globalisation, deregulation and a decreased role for governments in many economies, was also an important factor. These developments in the rest of the world probably contributed to the increasing emphasis placed in most African countries on the achievement and maintenance of price stability. At a conference on Monetary Policy Frameworks in Africa held at the South African Reserve Bank in Pretoria in September 2001, most of the central banks that attended the conference stated that price stability was the ultimate objective of monetary policy in their countries. Price stability was generally defined as low inflation or single digit inflation. Most of the countries indicated that they had adopted a pragmatic approach in attaining this objective, i.e. to achieve price stability as soon as possible without making policy measures too stringent. Considerable progress has been made with this approach in bringing inflation down to lower levels. According to estimates made by the International Monetary Fund in the World Economic Outlook in September 2004, consumer price inflation in Africa will average 8,4 per cent this year and 8,1 per cent in 2005. This is a far cry from the upper 40 per cent that was recorded at the beginning of the 1990s. Moreover, the number of countries registering double-digit inflation came down from 32 in 1995 to only 12 in 2003, and 21 countries had inflation rates of less than 5 per cent last year. Monetary policy was assisted considerably by prudent fiscal policy in achieving these more favourable results. The International Monetary Fund calculates that the average budget deficit as a percentage of gross domestic product in Africa has declined from 3,9 per cent in 1995 to 1,5 per cent in 2003. 3. Monetary policy strategy Although price stability is the overarching objective governing monetary policy decisions in almost every African country, different monetary policy strategies are followed depending on circumstances existing in the various countries. Before the 1980s direct monetary policy measures were generally applied in African countries. These measures consisted of interest rate controls, credit ceilings, foreign exchange restrictions and fixed exchange rates. This changed in the last 20 years with deregulation and financial liberalisation in the rest of the world. Since the beginning of the 1980s, African countries have generally moved to more market-based financial systems with greater autonomy and accountability applying to central banks. Broadly there are three monetary policy strategies applied by African countries, namely exchange rate targeting, inflation targeting and monetary targeting. Countries forming part of monetary unions have fixed exchange rate regimes with each other. For example, the currencies of Namibia, Lesotho and Swaziland, as members of the Common Monetary Area, are pegged to the South African rand. Some countries that do not form part of monetary unions also prefer to link their currencies to those of other countries or to a basket of currencies. Botswana has been doing this since 1976. Most African countries still apply monetary targeting. Of the 18 countries represented at the Conference on Monetary Policy Frameworks in Africa that was held in Pretoria, 14 targeted monetary aggregates. The operational variable used by these countries are the management of reserve balances or controlling the balance sheet of the central bank. By managing both the domestic and foreign sources of money, the growth in money supply is controlled. Taking the current financial infrastructure of these countries into consideration, the management of reserve balances to influence monetary aggregates as intermediate targets is probably the most efficient way of conducting monetary policy. Recently, inflation targeting is becoming more popular in Africa. However, in a Working Paper of the International Monetary Fund that was prepared by Mark R. Stone, South Africa was the only African country that was regarded to have a clear commitment to inflation targeting. South Africa shifted away from monetary targeting to informal inflation targeting in the 1990s, and started to apply formal inflation targeting from February 2000. The inflation target is determined by government and at present is specified as an increase measured over twelve months of between 3 and 6 per cent in the overall consumer price index excluding the interest cost on mortgages. The South African Reserve Bank has complete instrumental independence, but is of course accountable to the citizens of South Africa. Considerable success has been achieved in bringing the inflation rate down to its present level of 3.7 per cent as of September 2004. In fact CPIX has been inside the target now for more than a year. The instruments of monetary policy in African countries generally agree with those of other emerging-market economies and industrialised countries. In the main they consist of open market operations, treasury bill auctions, transactions in central banks’ bills, repurchase agreements, foreign exchange market operations and accommodation facilities. Most of the African countries continue to make use of statutory reserve requirements. Moreover, these reserve requirements are quite high in many of the countries. 4. Banking supervision and regulation Another important consequence of the globalisation process for central banking has been the rapid pace of consolidation of financial markets and institutions in the world over the past decade. Banks have been merged to become bigger players in the market. This consolidation was also extended to include other financial institutions. The consolidation process was not confined to domestic enterprises. Many mergers and acquisitions transcended national boundaries to create international players in an endeavour to improve profitability. Large international financial conglomerates are now a common feature of the world economy. Developments in technology, especially the impressive growth of internet banking, have made it possible for banks to use their online operations to expand into international markets, thereby avoiding the costly process of establishing subsidiaries or branches. In this way they have become players in the retail markets of many countries, without having any physical presence. The development of information and communication technology has made it possible for non-bank institutions to obtain funds from and provide credit to the public. Large retailers have become involved in activities closely akin to banking practices. This has blurred the boundaries between a bank and other activities. Like most other things on earth, the globalisation and consolidation of banking activities has advantages and disadvantages. On the positive side, these developments could lead to cost saving, improved profitability to the benefit of clients and shareholders, facilitating risk diversification and contributing to economic development. On the negative side, consolidation, if taken too far, could lead to abuse of dominant market positions and moral hazard issues. Excessive involvement in international markets without sufficient knowledge of local conditions could increase the vulnerability of individual banks. One of the most serious negative consequence of financial liberalisation and globalisation is that it has made emerging market economies more prone to sudden withdrawals or inward movements of financial flows. As a result, a number of financial crises have affected the world severely since the beginning of the 1990s. I think here of the crisis in Mexico in 1994/95, East Asia in 1997/98, Russia in 1998, Brazil in 1998/99 and Turkey and Argentina in 2001. Although countries like Chile and South Africa did not experience a financial crisis, substantial reversals in international financial flows complicated the task of central bankers and had a negative impact on economic activities. For example, the substantial financial outflows in 2000 and 2001 from South Africa caused a large depreciation in the exchange rate of the rand and an increase in the rate of inflation. The subsequent reversal in these flows was accompanied by a recovery in the level of the rand above its previous spike in 2000. This forced domestic manufactures and mining companies to make significant adjustments to their development plans in order to protect profitability. From this brief description of the pros and cons of financial liberalisation and globalisation it should be apparent that these developments have significant implications for prudential and supervisory policy, i.e. for systemic risk and the ability of the appropriate authorities to manage them. Derivatives, off-balance-sheet operations and diversification across countries and sectors have made traditional risk-management techniques obsolete and have increased the scope for and the speed of contagion. A liquidity shortage in a particular market can rapidly spread throughout the global market. Financial regulators responded by focusing on increased transparency and by strengthening prudential regulation and supervision in a way that takes account of the increased risks. The initiatives that have been taken include addressing the deficiencies of the 1998 Basel accord; developing guidelines to consolidate financial statements; achieving better cross-country harmonisation in disclosing information; developing standards for the compilation of statistical data; and closing gaps in regulations in order to avoid regulatory arbitrage. At first glance it seems as if the changed international environment had little impact on Africa, with the notable exception of South Africa. A number of African countries attempted to adjust their financial sectors to the changed circumstances, but achieved only limited success. These attempts were hampered by the then high inflation rates that these countries registered. In addition several banks were still publicly owned and the non-performing loans inherited from direct lending programmes before the reforms became were adopted were still very high. The relevance of globalisation, deregulation and financial liberalisation for central banking in Africa becomes more apparent when three important elements of Africa’s policy agenda are considered. As already indicated, Africa has achieved greater macroeconomic stability, and growth has increased significantly in the past ten years. However, for poverty relief, it is firstly of the utmost importance that economic growth should accelerate considerably. Secondly, gross domestic fixed investment must be increased. At a level of about 17 per cent of gross domestic product, domestic investment falls far short of levels needed for higher economic growth. African countries need to establish the economic environment to create investment opportunities for domestic and international investors. Thirdly, African countries need to strengthen their financial sectors by mobilising savings and allocating credit effectively and efficiently so that financial services are available to more people than in the past. The central banks in Africa must play a major part in this third prerequisite for the attainment of higher sustainable economic growth and poverty alleviation. This task of central banks in Africa is more difficult than in other parts of the world. The number of standards and codes can be overwhelming and highly demanding of human and financial resources, and meeting them may overstretch the capacities of some African countries. Moreover, these standards and codes are formulated mainly for industrialised countries and may not always fully take cognisance of conditions in Africa. It will, for instance, be difficult for banks in Africa to meet international standards for limiting portfolio concentration and exposure to a single client, because in many African countries there is little economic diversification and economies are dominated by a few large enterprises. Constraints on the functioning of markets can also reduce the effectiveness of market discipline and, hence, of transparency. Despite these kinds of problems, there is a need for fundamental reforms to strengthen institutional capacity, reduce government interference and allow markets to operate efficiently. Further financial liberalisation should lead to an increase in the quality of financial intermediation. Reforms should be undertaken to, among other things, restructure bank balance sheets by removing bad debts, privatising publicly owned banks, and introducing measures to promote competition in the banking sector. Strengthening the management and risk evaluation capabilities of bank managers and staff should also form an integral part of the restructuring process. In South Africa we are in the fortunate position that our financial system is highly developed and diversified. We have a large number of financial institutions and sophisticated financial markets which perform the function of financial intermediation in an efficient manner. According to assessments made by the International Monetary Fund and other international organisations the banking regulations of the country and supervision of financial institutions conform to high international best practice. Our financial institutions are well managed and non-performing loans are well within the bounds of sound management. Moreover, South Africa subscribes to the Special Data Dissemination Standard of the International Monetary Fund and meets the specifications for the coverage, periodicity and timeliness of all data categories and for the dissemination of advance release calendars. The timeliness of the accounts of the South African Reserve Bank and the banking sector is even better than the due dates prescribed by the Fund. Other African countries have launched a number of initiatives to implement the new international financial architecture. These initiatives are mainly focused on enhancing transparency and accountability, adhering to international standards and codes and maintaining financial stability. A number of African countries have launched medium-term programmes to restructure weak banks. This included measures to address non-performing loans and accumulated losses of banks. In addition, the authorities have increasingly focused on improving banking regulation and supervision, essentially through greater compliance with the Basel Committee’s Core Principles for Effective Banking Supervision. 5. National payment, clearing and settlement systems The national payment, clearing and settlement systems of central banks in Africa have also been influenced to a considerable extent by the changed global economic environment. Global trade and financial integration have led to substantial increases in cross-border flows, while financial liberalisation, the creation of new financial instruments and the development of financial markets increased the domestic payments which have to be cleared and settled. The resulting increase in the values and volumes that have to be handled by the payment systems increased non-settlement risk exponentially. Developments in information and communication technology have changed the payments structure considerably. Although it is still in its infancy on the African continent, the volume of transactions undertaken by means of debit and credit cards have increased significantly and there are signs appearing in South Africa that this means of payment may overtake cash payments in the near future. In some African countries mobile banking facilities have come into use. This demands increased security measures and higher standards. South Africa has put considerable effort into the revision of national payment, clearing and settlement systems. Reforming the national payment system started to receive attention in 1993. By 1995 a plan had been finalised containing the objectives, strategies, fundamental principles and critical issues for payment system reform. The implementation of this plan started off with the introduction of a large value inter-bank real-time gross settlement system in March 1998. The South African National Payment System Act was then promulgated in October 1998, which provided the central bank with the regulatory powers to oversee the safety and integrity of the national payment system. A number of refinements have since been made to the system. Recently arrangements have been finalised to include the South African rand in the Continuous Linked Settlement process before the end of the year, which will link it to the major currencies of the world and eliminate foreign exchange settlement risk through the simultaneous settlement of both legs of foreign exchange transactions. The South African Reserve Bank not only concentrated on the development of our own domestic payment system, but also encouraged the development of payment and settlement systems in other African countries, particularly countries forming part of the Southern African Development Community. A number of these countries have accordingly modernised their payment systems considerably and many have also reviewed domestic legal frameworks to accommodate these changes. 6. Conclusion In conclusion, it can be stated that the changes in the world economy in recent years have led to large improvements in central banking in Africa. At the same time, globalisation and financial liberalisation have complicated the task of African central bankers and the general management of the economies on the continent. Our economies are generally small open economies dependent on one or only a few export commodities. This makes them particularly vulnerable to developments in international markets affecting the demand for and the prices of their main exports. With the exception of South Africa, most of the financial markets in Africa are still thin and under-developed. They therefore depend to a large extent on foreign financing for their development needs. This, in turn, makes them vulnerable to fluctuations in international financial flows and complicates monetary policy. Even in a country with a relatively advanced financial infrastructure, such as South Africa, international financial outflows have seriously disrupted economic developments. Swings in portfolio capital flows and leads and lags in foreign payments and receipts have at times played havoc with the exchange rate of the rand. Turnarounds in international financial flows have also harmed the efficient functioning of domestic money and capital markets and disrupted the implementation of monetary policy. References 1. Greenspan, Allan: “Remarks on Globalisation”, Bundesbank Lecture 2004, Berlin, 13 January 2004. 2. Köhler, Horst: “Towards a Better Globalisation”, Inaugural Lecture on the Occasion of the Honorary Professorship Award at the Eberhard Karls University, Tübingen, 16 October 2003. 3. Maxwell, J and others: “Central Banking in Developing Countries”, Routledge, London, 1996. 4. Rogoff,K.: “Globalisation and Global Disinflation”, Paper prepared for the Federal Reserve Bank of Kansas City conference on “Monetary Policy and Uncertainty: adapting to a Changing Economy”, Jackson Hole WY, 28-30 August 2003. 5. Stone Mark R.: “Inflation Targeting Lite”, Working Paper WP/03/12, International Monetary Fund, January 2003. 6. South African Reserve Bank, “Conference Proceedings on Monetary Policy in Africa”, Pretoria, 17-19 September 2001. 7. South African Reserve Bank, “Challenges of Central Banking in Africa”, Zambia, 5 August 2004.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Conference of the Bureau for Economic Research, Stellenbosch, 18 November 2004.
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T T Mboweni: Monetary policy and inflation - the next decade Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Conference of the Bureau for Economic Research, Stellenbosch, 18 November 2004. * 1. * * Introduction Chairperson, ladies and gentleman, I have been asked to share my views with you today on what will happen with monetary policy in the next ten years. Looking into the future is always a hazardous undertaking. It requires a careful analysis of what has changed already and what likely changes will occur in the coming years. Such an analysis cannot only concentrate on what has happened in South Africa, but must also take into account the structural changes in the rest of the world and how these developments could perhaps affect South Africa. This is indeed a formidable task. In the next thirty minutes I will do my best to give you my view on these matters. 2. Structural changes in the world’s financial sector World War I and the great depression of the 1930’s left the world with highly regulated capital markets and a disintegrated international financial system. The highest priority was therefore attached to restoring multilateral payments and current account convertibility towards the end of World War II, which led to the Bretton Woods Agreement and the General Agreement on Tariffs and Trade. In the period after the war, the emphasis shifted to the liberalisation of trade and payments. Progress with these reforms was relatively slow and at first concentrated on the currency convertibility of current account transactions. In the 1980’s the authorities of the industrialised countries began liberalising financial systems, which were later followed by a number of emerging-market economies. The convertibility of the capital account of the balance of payments gained further momentum with the negotiations in the World Trade Organisation to liberalise transactions in financial services. This financial liberalisation was accompanied by a process of globalisation, i.e. a growing economic interdependence of countries became discernible through the increasing volume and variety of cross-border transactions and through the rapid and widespread diffusion off technology. New technological advances reduced transportation, telecommunication and computation costs, thus greatly increasing the ease with which national markets may be integrated at the global level. The liberalisation and globalisation resulted in a growing interdependence of national financial markets. Although these markets still do not form a single global market, the degree of interdependence is already strong enough to have altered the environment in which monetary policy is conducted. In particular, it has affected the volume of international financial transactions. International transactions in goods and services have become considerably less important than financial transactions. The closely linked financial markets have changed the monetary transmission mechanism, and shocks that occur in one country can easily have an impact on other countries. As a transition phase of or perhaps as an alternative to globalisation, considerable emphasis has been placed on closer international co-operation, convergence and integration since the end of World War II. Many regional economic co-operation arrangements have been formed or are under consideration. The aim of these regional arrangements is to free international trade and financial transactions between a group of countries. But many of them also want to encourage the movement of labour across domestic frontiers and the eventual attainment of political unions. The establishment of the European Union is, of course, the best example in this regard. This regional arrangement has created the largest government bond market in the world and led to the development of the euro into a major international currency. Another important structural change in the world’s financial market has been the achievement of greater price stability. Over the past twenty years the rate of inflation has declined dramatically in most countries of the world. The disinflation process was at first mainly concentrated in the industrialised countries. According to the International Monetary Fund the average annual inflation rate in the major advanced countries already started to decline from the early 1980s from 12,3 per cent in 1980 to 1,7 per cent in 2003. By contrast, the average inflation in emerging-market and developing countries continued to increase from 25,0 per cent in 1980 to 107,7 per cent in 1992, before declining sharply to 6,1 per cent in 2003. These developments brought the average rate of inflation in the world as a whole down to only 3,7 per cent in 2003. This disinflation process has been so strong that some countries even experienced declines in their average price indices. Consumer prices have actually been declining in Japan and Hong Kong for quite a while, while some other countries such as China recorded decreases for a short period. As could be expected, disinflation to low positive values has been accompanied by a corresponding decrease in short-term interest rates to low levels. Finally the financial sector, just like all other activities in the world, has been severely influenced by the revolution experienced in information technology and telecommunication. In central banking the advances made in information technology and telecommunication have particularly led to a more efficient payment system catering for real-time gross interbank settlement. New developments in commercial banking include automated teller machines, credit and debit cards, telephone and inter-net banking, intelligent cards and card reading devices. In the 1990s a further advance in technology made it possible to store monetary value on a silicon chip embedded in a plastic card or in a personal computer. This was the first step in the development of electronic money or e-money. Initially it was believed that this development would lead to a quick and dramatic change in the way that payments are made. Such a change would have required large investments in infrastructure and the general acceptance of this new payments method by the public. It is thus not surprising that it did not take off in the way predicted by some analysts. However, initial setbacks to new innovations are a common experience and it is quite possible that the public could eventually be more willing to accept this new innovation. 3. Effects on South Africa’s financial structure These changes in the rest of the world did not affect South Africa’s financial sector to any great extent during the 1980s, i.e. in a period in which the country became increasingly isolated from the rest of the world as a result of trade boycotts, embargoes and financial sanctions. The subsequent transition to a new political dispensation and the normalisation of the country’s international relations completely changed this situation. These circumstances forced the South African financial sector to move from a relatively isolated position to a world that had changed in many ways from the time when our financial institutions were still actively involved internationally. To cope with the challenges faced in this new environment it was important to improve the functioning of the domestic financial markets and to reintegrate them in the world economy in an orderly way. Great efforts were accordingly made to bring the rules and regulations applying to financial institutions in line with international norms and standards. The re-entry of South Africa in an integrated financial community also made it important to reconsider the strict exchange control rules applicable at that time. The country’s limited foreign exchange reserves prevented the immediate removal of all exchange control measures, which caused the authorities to opt for a policy of a gradual relaxation of capital account transactions. From 1994 South African financial institutions started operating on an increasing scale in major international financial centres and opened branches or subsidiaries in other African countries. At the same time foreign financial institutions were encouraged to conduct business in South Africa by the creation of a level playing field between local and foreign service providers. In addition, the regulatory authorities actively encouraged the development of appropriate clearing, settlement, ownership-transfer and market information systems, and proper intra-market and cross-market risk management systems. This restructuring led to a sharp increase in the involvement of foreign banks and other non-residents in domestic financial markets. In particular their transactions on the Bond Exchange and the Johannesburg Stock Exchange increased considerably. This participation of non-residents contributed to the increase in the turnover of these two markets. It also caused more volatility in long-term interest rates because investors quickly altered their positions with changes in domestic and international conditions, while prices on the Johannesburg Stock Exchange became even more susceptible to changes in the prices on the stock exchanges of major financial centres. Moreover, the normalisation of relations with the rest of the world led to a turnaround in the international financial flows of South Africa from a net outflow of about R45 billion in the period from 1985 to 1993 to a net inflow of nearly R204 billion since 1994. At the same time the volatility in these financial flows increased. Although the country generally experienced an inflow of capital from the rest of the world, the magnitude of these inflows varied considerably from year to year. For example, a net financial inflow of about R29 billion in 1998 was followed by inflows of just more than R7 billion in each of the next two years, before these inflows increased again to about R30 billion in 2002 and R63 billion in 2003. Most emerging-market economies now seem to experience large and volatile capital movements. Despite considerable efforts to make South Africa a more investor-friendly country, it can safely be assumed that fluctuations in capital movements will continue to be a feature of our economy in the future. This volatility will not only be influenced by domestic developments, but also by events in the rest of the world. The volatile capital movements brought about large swings in the exchange rate of the rand not only against individual currencies but also on a trade weighted basis. For instance, in 2000 and 2001 the nominal effective exchange rate of the rand declined by 13 percent and 39 per cent, respectively, before it increased again by 24 per cent in 2002 and by 44 per cent in 2003. These fluctuations have complicated the implementation of monetary policy. In particular, monetary policy was dominated in 2002 by inflationary pressures arising from the substantial depreciation in the external value of the rand in late 2001, combined with a sharp rise in international oil prices as well as in domestic food prices. These external shocks were responsible for a surge in the twelve-month rate of increase in the CPIX from a low of 5,8 per cent in September 2001 to a peak of 11,3 per cent in October 2002. Subsequently, the appreciation of the rand from the beginning of 2002 again had to be carefully taken into consideration in the formulation of monetary policy. The fluctuations in the exchange rate of the rand clearly illustrated the need for structural adjustments in the foreign exchange market in South Africa. The Reserve Bank accordingly concentrated on eliminating its negative net open foreign reserve position and its oversold forward book. With the success achieved with these objectives, the focus of the Bank has now shifted to a gradual strengthening of the official foreign exchange reserves. Since the end of 2002 the official foreign exchange reserves of the country have increased from US$7,6 billion to US$13,0 billion at the end of October 2004. The higher foreign exchange holdings should help to stabilise the external value of the rand. 4. Implications for monetary policy Taking these changes in the world and more specifically in South Africa into consideration, we now come to the crucial question on how will monetary policy be affected or what will happen to monetary policy in the next ten years. More in particular I want to concentrate on three questions in this regard, namely: Will monetary policy still be effective? What should the primary objective of monetary policy be? What monetary policy framework should be applied? 4.1 The effectiveness of monetary policy As in the rest of the world, e-money has not really taken off in South Africa. Although several potential products have been evaluated by the Reserve Bank, no roll-out on a significant basis has yet occurred. The failure of e-money to meet expectations can possibly be ascribed to the fact that cash remains a trusted and very convenient payment mechanism, debit and credit cards are widely used and e-money products generally do not allow for person-to-person payments. However, it is conceivable that this could change in the future and that e-money could to an increasing extent become a substitute for banknotes and coin. As Benjamin M. Friedman (1999) has pointed out it is possible, albeit at present highly unlikely, that e-money could be used as a means of payment as well as settlement and therefore erode the role of currency and reduce banknotes and coin in circulation. Friedman also stated that the size of base money (currency in circulation plus the balances of banks at the central bank) could decline in future because of the declining role of banks in advancing credit to the non-bank private sector. If bank credit extension to the private sector decreases, less deposits are created. The reserves that banks are required to hold at the central bank are then smaller, which reduces base money. Securitisation and the liberalisation and globalisation of South Africa’s financial markets have led to a declining role of banks in the advancement of credit to the non-bank private sector. As already indicated, South African organisations are now more easily able to obtain financing from abroad than they were before 1994. Many private sector companies have also started to make increasing use of the bond market to raise funds for development purposes. Although this disintermediation has not led to a decline in reserve requirements of banks, it has affected the growth of base money. Friedman further indicated that private bank clearing mechanisms could be developed that would further reduce base money. Mervyn King (1999) also pointed out that there is a possibility that the demand for settlement balances could eventually be eliminated by the development of electronic networks allowing payments to be settled without the involvement of the central bank. These arguments led Friedman to the conclusion that the central bank in the future will become “an army with only a signal corps”. Central banks will only be able to indicate to the private sector how they believe monetary conditions should develop, but will be unable to do anything about this if the private sector has a different view. It nevertheless seems highly unlikely that the effectiveness of monetary policy will decline in South Africa in the next ten years because of the increased use of e-money, the liberalisation and globalisation of our financial markets or the development of private banking clearing mechanisms. At most these factors should only have a limited impact on the effectiveness of monetary policy. As Woodford (2000) stated, the effectiveness of monetary policy is not dependent “upon a mechanical connection between the monetary base and the volume of nominal spending, which is then presumably dependent upon a need to use base money as a means of payment”. In fact, in South Africa the supply of money is endogenously determined. The repo rate is the operational variable of the Reserve Bank and this rate is not affected by the size of base money. 4.2 The primary objective of monetary policy Having determined that monetary policy should remain effective in the coming ten years, what should the primary objective of monetary policy be in South Africa? It is now generally accepted all over the world that the central bank’s responsibility is to ensure price stability. As already indicated, considerable success has been achieved with the attainment of this objective and in the advanced countries of the world price stability has been maintained for a relatively long period. As a consequence, many of the central banks of these countries seem to have become less engrossed with combating inflation and have again moved somewhat in the direction of fine tuning economic growth. Many economists are of the opinion that this is the right approach. For example, in a recent article of Carl Walsh (2003) he states that modern central banks must “recognise that achieving and maintaining low inflation cannot be their only objective. Monetary policy has important short-run effects on real economic activity and there is, therefore, a role for monetary policy to play in conducting stabilisation policy”. The danger of such an approach is, of course, that central banks could concentrate too much on expansionary policies at the cost of maintaining price stability. Despite the fact that South Africa has only been able to maintain low inflation over a relatively short period, it can be argued that the Reserve Bank should now give more attention to the promotion of economic growth. It is true that short-term interest rates do have some affect on long-term interest rates which, in turn, is an important determinant of the growth in investment and production. However, it must be realised that reductions in short-term interest rates do not always lead to a reduction in the cost of capital. If it is generally expected that lower levels of short-term interest rates will lead to higher inflation, long-term interest rates are bound to rise. Monetary policy may therefore be less effective in having the desired impact on real economic activity over the short term than generally believed. At the same time it must be admitted that the actions of central banks do have some affect on the growth of domestic product over the short term. Although monetary policy measures affect real economic activity over the short term, long-term economic growth can only be achieved if production capacity and productivity increases. Besides increases in employment, the expansion in production capacity requires additions to capital stock in the form of net fixed investment. Productivity refers to the efficiency with which labour, capital and other inputs are combined and used to produce goods and services of a specific quality in order to satisfy the needs of the market. Technological progress, improving the quality of the labour force and the more productive utilisation of resources are among the factors needed to increase productivity. Monetary policy measures cannot directly influence the factors on which long-term economic growth depend. Monetary policy has the most control over changes in the overall price level and therefore on the long-run impact of inflation on economic growth. But it should at least not discourage and preferably rather encourage domestic saving, investment and the inflow of foreign capital to promote economic growth. Monetary policy should also not stand in the way of the optimal allocation of resources and the most efficient utilisation of these resources in business enterprises, because this could lower the potential growth in output. All in all, monetary policy should therefore not add to the risks that normally confront private business or dampen technological innovations. The South African Reserve Bank believes that the best way that monetary policy can contribute to the important objective of sustained economic growth is to achieve and maintain price stability. The maintenance of price stability should continue to be a major objective of monetary policy particularly now that we have achieved some success in bringing the inflation rate down within our inflation targets. If we are unable to do this, the credibility of monetary policy will be questioned, which could have a severe affect on the effectiveness of monetary policy measures in the future. As Carl Walsh (2003) has indicated “the three most important ingredients to a successful monetary policy are credibility, credibility and credibility”. There are many convincing arguments why price stability should be regarded as a prerequisite for sustainable economic growth. All modern market-orientated 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 deteriorates in value all the time cannot fulfil these functions effectively. High inflation discourages savings and foreign investment, on which economic growth is highly dependent. Not only is the supply of funds for investment reduced by high inflation, but the flow of existing saving to risk capital is distorted. The finance that do become available is invested in such a manner where they can provide the best protection against inflation, and not necessary where they could be the most productive and lead to employment creation. In the past when we experienced high inflation, large amounts of investment in South Africa were made in the construction of office blocks, shopping centres and expensive housing, which cannot be regarded as the most productive forms of investment and which probably lowered the growth potential of the economy. Inflation accordingly undermines the efficiency of the pricing system and does not lead to the optimum allocation of production resources. 4.3 The monetary policy framework In the pursuit of price stability the South African Reserve Bank and the central banks in many other parts of the world have found that the inflation targeting monetary policy framework has proved to be highly effective. In particular, inflation targeting has led to a better co-ordination between monetary policy and other economic policies than with other monetary measures applied in the past. This is largely owing to the fact that the Government is responsible for the determination of the inflation target in South Africa in co-operation with the Reserve Bank. This target is therefore determined in a structured manner, and taking into consideration the other economic objectives of government. After the determination of the target it is the Reserve Bank’s responsibility to see that it is achieved, i.e. the Reserve Bank has instrumental independence but not goal independence. It is therefore surprising that the Bank is sometimes criticised of being over obsessed with the attainment of the target at the detriment of economic growth. Since the target is established in a co-ordinated way, it should in theory form part of the government’s objectives for economic growth and employment creation. Even more importantly, after the target has been established, it is the Reserve Bank’s task to see that it is achieved. Inflation targeting has the further advantage that it provides a nominal anchor to inflation expectations if monetary policy is perceived to be credible. This facilitates a reduction in inflation and should form the basis for future price and wage setting. It is a transparent policy framework, because the target is publicly announced. This announced target provides the basis of accountability of the central bank. This disciplines the actions of the central bank and leads to a better understanding among the public why monetary policy decisions are made. In view of these advantages of inflation targeting in comparison with other monetary policy frameworks, there seem to be little reason to start applying a new framework. The authorities will accordingly continue to apply inflation targeting as the monetary policy framework of South Africa in the next ten years and at most probably only refine the system further to ensure that it continues to function efficiently. 5. Conclusion My general conclusion is therefore that the recent major structural changes in the world and in South Africa will have little effect on the determination and implementation off monetary policy in the coming years. It is true that vast developments have taken place in information technology and telecommunication and that we could probably expect further significant changes in the next ten years which will have a major impact on our lives. The process of liberalisation, globalisation and integration is also bound to change our lives even further. It seems unlikely however, that these changes will affect the efficiency of monetary policy. In this expected changed world the South African Reserve Bank will continue in its quest for the achievement and maintenance of price stability by applying an inflation targeting monetary policy framework. References Friedman, Benjamin M. 1999. “The Future of Monetary Policy: The Central Bank as an Army with only a Signal Corps”, National Bureau of Economic Research, Working Paper 7420 King, Mervyn, 1999. “Challenges for Monetary Policy; New and Old”, Bank of England Quarterly Bulletin 39 Walsh, Carl. E. 2003. “Modern Central Banking: An Academic’s Perspective”, Central Bank of the Republic of Armenia, Anniversary Celebration Woodford, Michael. 2000. Monetary Policy in a World without Money”, World Bank Conference
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Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 7 December 2004
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T T Mboweni: The state of the South African economy Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 7 December 2004. * * * Your Excellency, the Dean of the Diplomatic Corps Your Excellencies, Ambassadors and High Commissioners Your Excellency, the Chief of State Protocol Your Excellencies, Heads of International Organisations represented in the Republic of South Africa Deputy Governors of the South African Reserve Bank Senior Management of the South African Reserve Bank and their spouses/partners Media representatives Ladies and Gentlemen Welcome once again to this annual dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa. My colleagues and I always look forward with bated breath to this evening at the end of every year. This dinner represents for us the highlight of every year as we gather with you to break bread and discuss issues of common interest and relevance to our various countries. 2004 has indeed been a momentous year for the global economy. One of the distinguishing features of this year has been the oil price. When I joined the central bank in 1998, the north sea brent crude oil price was $9 per barrel. Since then, the oil price has shot up quite considerably. The price of north sea brent crude oil is now around $38 per barrel and indications are that it might not come down to the OPEC target levels of $22 - $28 per barrel in the near future. The futures price also indicates that the oil price will stay near the $40 per barrel level. The behaviour of the oil prices has changed the global economic outlook in a real way. Estimates by the International Monetary Fund researchers is that if the oil price averages $37 per barrel in 2004, global growth will slow down by some ½ percentage point, inflation for the advanced countries will increase by about 0.3 percentage point and the trade balance of advanced countries will deteriorate by some 0.3 per cent of gross domestic product. The estimates for South Africa are that economic growth might decline by some 0.6 percentage point, inflation will increase by some 1.6 percentage point and the trade balance will worsen by some 1.4 per cent of gross domestic product. Clearly there is cause for concern all-round. At the core of these oil price developments seems to be concerns about supply constraints. These arise, in part, as a result of supply problems from Iraq, uncertainties about possible tensions between the United States and Iran, production uncertainties in Nigeria, the continuing problems experienced between the Russian government and the Yukos oil company, management and trade union tensions in Norway and the damage to production which was caused by hurricane Ivan in the Gulf of Mexico. Although some of the developments mentioned above are significant, it would, however, seem to us that the oil market players are running ahead of themselves in terms of pricing. Time and again, the largest producer of oil in the world, the Kingdom of Saudi Arabia, has made it known that there are sufficient reserves and capacity to ensure that global supply meets demand. On many occasions, the Kingdom of Saudi Arabia has actually increased supply by no less than a million barrels per day. They have indicated that there are sufficient reserves for the next 50 years. And as stability returns in any troubled oil-producing country, supply surely should be guaranteed. It is maybe time for the market to pause and reflect on the perceived supply constraints. Certainly, the global economy expects no less from the oil market. Despite these risks for the global economy now and in the recent past, substantial global economic growth has been recorded in 2003 and prospects for the whole of 2004 look promising. The global economy recorded an impressive 3.9% growth in 2003, with the United States, Japan, India, China and many emerging market economies making the most impressive contribution to global growth. 1/5 Growth rates in China and India remained the envy of all countries in 2003. Although the Chinese authorities attempted to slow down growth in their country, at growth rates of around 9%, this country continues to amaze. It is forecast that global growth in 2004 is likely to be in the region of 5%, slowing down somewhat in 2005 to 4,3%. Based on these forecasts, we can safely say, without any fear of contradiction, that the world economy is still in a good state of growth. The oil price notwithstanding, the global economy has shown itself to be resilient in the face of so many other constraints. There remain, however, a number of challenges to be tackled if the world economy is to improve further in the medium to long term. At the most recent G20 meeting in Berlin on 20 and 21 November 2004, the challenges to global growth were summarised as follows: “the United States needed to urgently address its fiscal and current account deficits which are resulting in major negative adjustments in other parts of the world; Latin American countries needed to continue with broad based structural reforms and pursue prudent fiscal policy whilst at the same time continuing with policies to encourage investment; Argentina in particular was urged to continue strengthening its banking sector and reviewing its fiscal system; the European Union member countries were urged to continue with structural reforms, in particular reforming their labour markets, consolidating their fiscal positions and reforming their pension systems; the Russian Federation was urged to “create foundations for more broad based and sustainable growth at a high rate”; the Russian Federation was further urged to introduce “reforms of the banking sector and the judiciary systems”; South Africa was urged to focus on infrastructure investment, increased savings and skills development; Saudi Arabia was urged to diversify its economic structure, support private sector development and improve the business environment for foreign investment; South and Southeast Asia were urged to improve the climate for investment, in particular through regulatory reform; India was encouraged to “reduce the budget deficit while raising sufficient resources (ie reforming the tax system) for infrastructure and rural development”; Australia was urged to improve flexibility in workplace relations to expand employment options, improve the tax and income support systems and make progress more generally with microeconomic reforms; Japan was encouraged to continue with its reform agenda, including measures to promote further reform of the financial system, foster privatisation and address more vigorously the problem of fiscal sustainability; China was encouraged to continue deepening the reforms of the state asset management system and the state owned enterprises, to promote the development of the non-state sector of the economy, to consolidate and strengthen the position of agriculture, to carry forward the reforms of the financial system, the fiscal and taxation systems and the investment climate, to push forward the employment and income distribution system, to improve the social security net and strengthen the reforms of the administration management system and the legal system”. The G20 concluded by committing to “strengthening the above-mentioned framework for the global economy”. The G20 encouraged 'trade ministers to work together in good faith to enable the WTO negotiations to succeed as quickly as possible”. Based on the G20 global economic reform agenda, referred to as the G20 Accord, one is encouraged to observe the serious commitment from these leading countries to ensure that the world economy continues to grow and prosper. It is indeed heart-warming that a common global agenda for growth is beginning to emerge amongst the world’s 20 largest economies outside the traditional Washington consensus. Coming back to developments in South Africa, it is also pleasing to note that the hard work which has been put into policy formulation and planning in the past decade is beginning to bear fruit. I know that you are more than familiar with the economic situation in South Africa and I therefore only wish to highlight some of the key features of the recent economic and financial developments. Statistics SA has recently rebased and revised the economic growth numbers. This is an acceptable international best practice. The South African Reserve Bank endorses this endeavour. As a result of their extensive exercise, the developments mentioned below have been observed. Firstly, the South African economy is larger than was previously thought. Previously, the level of the gross domestic product was estimated at R888 billion (2000), R983 billion (2001), R1 121 trillion (2002) and R1 209 trillion (2003). The revised figures show that the level of GDP was much higher at R922 billion (2000), R1 020 trillion (2001), R1 165 trillion (2002) and R1 251 trillion (2003). These revisions are fairly substantial! The Statistician General commented that “the level of the revised GDP at current prices is between 0.5 and 3.9 percent higher than the previous estimates for the period 2/5 1998 to 2003. The GDP for the year 2003 is 3.5% higher than previously reported”. In summary, this means that the level of economic activity in South Africa is indeed very significant. Secondly, the GDP per capita at current prices has improved significantly based on these revisions and if one makes use of the latest available 2001 population estimates. Previously, it was thought that the GDP per capita was R20,3 thousand (2000), R22,1 thousand (2001), R24,5 thousand (2002) and R26,2 thousand (2003). The revised figures mean that we are much better-off than was thought, R21,1 thousand (2000), R22,9 thousand (2001), R25,5 thousand (2002) and R27,1 thousand (2003). Thirdly, these revisions confirm the observations which many people had made about the South African economy. It was clear to many that this economy was larger and growing much faster than the official data from Stats SA had previously suggested. The challenge ahead is to maintain the momentum by focusing amongst others on what the G20 has urged South Africa to do. Of particular importance here will be the absolute fully dedicated focus on education and skills development in South Africa for a higher growth path. Although employment creation is still at low levels, it is nonetheless encouraging to see that there has been a pick up in the numbers of people employed. According to the latest official data available in March 2004, total employment in South Africa was 11 984 million, which was a marked improvement from the total of 11 652 million in September 2003. The number of unemployed people remains high in South Africa despite this improvement. According to Stats SA, the total unemployed was 4 611 million in March 2004 as compared to the 4 627 million in September 2003. So a lot of work still lies ahead as far as employment creation is concerned. But it is encouraging that the number of people unemployed is coming down. As we have indicated in the past, South Africa introduced inflation targeting in the year 2000. The inflation target was specified as the Consumer Price Index less mortgage cost, the co-called CPIX. The numeral target was for CPIX to remain on average between 6 and 3 percent. Now, there has been a little change to specify that the target must be met on a twelve-month continuous basis. We are happy here at the central bank to report to you this evening that since September 2003, we have been inside the target range. This achievement has also begun to influence inflation expectations in a positive way. The expectations of business, trade unions and households are now well within the target levels. This is important for inflation outcomes going forward. In an inflation targeting monetary policy framework, it is important that we are committed to the inflation target and not target any other intermediate variable. So whilst variables such as the exchange rate, monetary aggregates, unit labour cost and oil prices play an important part in the inflation process, these should not become intermediate targets but must however be watched carefully and systematically by the central bank. The exchange rate of the rand is determined by the supply and demand developments in the foreign exchange market. The central bank does not target any level of the exchange rate but takes the rate as given by the forex market. Due to the importance which attaches to the exchange rate in the inflation process, a competitively priced exchange rate is the preferred outcome for the central bank. We neither prefer a weak rand nor an overvalued exchange rate. We prefer a competitively priced exchange rate. From time to time, exchange rates have a tendency to over- or undershoot in the market. This can be the case if, for instance, global imbalances lead to a depreciation or an appreciation in some of the more significant currencies such as the American dollar. Indeed the current level of the dollar is occasioned in the main by the large American current account deficit on their balance of payments. For as long as the rest of the world is willing to finance this deficit by buying American assets, the current account deficit is easily financed but the market seems to have become somewhat doubtful recently. We do not share the view that the American dollar will collapse. Yes, there will be some gradual adjustment as a result of the current account deficit but our hope is that these adjustments should be measured and orderly and not be disruptive to the global currency markets. Extreme volatilities in the forex markets are not helpful to all of us. One should therefore expect that in the current period and in the near term, the rand will show some strength against the dollar. But the rand is not alone in this. Indeed the Euro, Australian dollar, Japanese Yen and many other significant currencies are showing signs of strengthening against the American dollar. This should be expected. 3/5 But our central bank is not losing focus. And indeed it should never lose focus. We are in the business of targeting inflation and not any other intermediate variable. We have taken advantage of the current conditions in the forex market to purchase significant amounts of foreign currency in the market as part of the process of building up our foreign exchange reserves. You might recall that in 1998 we had a negative net open foreign currency position of some $23 billion. That was a difficult time for us here at the Bank. Through some carefully planned processes, we have eliminated the negative net open foreign currency position and now we have some positive $14,4 billion in our gross gold and foreign exchange reserves account. The building of reserves is seen as fundamental to the stability of the foreign exchange market. We therefore hope to see a much more stable exchange rate going forward. I know that a stable foreign exchange market is also of significant importance to the Diplomatic Corps as it brings about stability and certainty in your budgeting processes. We are glad that by eliminating the negative NOFP we could be of some assistance to you. The competent macro-economic management, including fiscal and monetary discipline, has led to the country’s improved economic outlook as well as to the enhanced sound economic fundamentals. International investors have recognised the progress achieved and have in recent years changed their sentiment towards South Africa. The positive sentiment towards the country and the high level of confidence in its future progress has also been supported by numerous ratings upgrades from major international rating agencies over the last few years. These ratings are supported by a stable and transparent macro-economic policy framework; a record of fiscal prudence resulting in moderate public debt levels; and a much improved external liquidity position after the closure of the forward book. The credit ratings continue on an upward path. Currently Moody’s is reviewing the country for a further upgrade, which could see South Africa’s foreign currency rating move from the current Baa2 (lower investment grade) to Baa1 (higher investment grade). Towards the end of October 2004 Fitch revised their outlook on South Africa’s BBB rating from stable to positive. Inflows into South Africa’s bond and equity markets, which were largely elusive in 2002/2003, witnessed a significant turnaround in 2004. Faster economic growth combined with a low inflation environment and interest rates at multi-decade lows has seen non-residents return to the equity market. For 2004 to date, the equity market has enjoyed inflows to the value of R25,9 billion. While on a net basis, the bond market has experienced outflows, these remain small in comparison with the outflows experienced in 2003 (-R1,7bn when compared to -R8,1bn) . In fact, the bond market registered an inflow of R3,9 billion in November alone, as yields on domestic government bonds continued to move to fresh lows during the month. These capital inflows do not only reflect lower risk perceptions justified by improved credit ratings, but clearly indicate a high level of confidence in South Africa’s macro-economic future. Positive sentiment is also reflected in the spreads of South Africa’s foreign currency denominated bonds in relation to US Treasuries. The spreads on the South African sub-index over US Treasuries narrowed significantly. For the first time since its launch, this sub-index closed below the 100-basis-points level, ie at 94 basis points, on 4 November. The improvement was supported by the country’s positive credit rating outlook, the performance of the rand and other sound economic fundamentals. At these levels, South Africa compares favourably with Poland, Malaysia and Thailand, whose credit ratings are at the upper level of investment grade. On 30 November, the South African sub-index narrowed further to 92 basis points over US Treasuries. The spreads of South Africa’s US-dollar denominated bonds maturing in 2009 and 2012 narrowed to 102 and 72 basis points over US Treasuries respectively between 14 October and 30 November 2004. The 10-year US dollar global bond issued in May this year similarly tightened from 195 basis points over US Treasuries at its launch in May to currently around 103 basis points. A ratings upgrade by Moody’s would put South Africa on the same scale as Thailand whose ten-year US-dollar denominated bond spread is currently trading around 52 basis points over US Treasuries. This suggests that South Africa’s ten-year US dollar denominated bond, which is currently at 85 basis points above US Treasuries, could rally further. Another clear indication of South Africa’s improving creditworthiness can also be seen in increasingly narrower margins paid on our international syndicated loans. Whereas in 2001 we were paying 85 basis points p.a. over LIBOR for a three-year loan, by 2003 the margin had come down to 67.5 basis points p.a., and earlier this year we were able to improve the terms further and negotiate a margin of 47.5 basis points p.a. over LIBOR. 4/5 The relations between South Africa and so many countries in the rest of the global village, evidenced by the number of embassies and high commissions stationed in South Africa, bears testimony to this confidence. My colleagues and the senior management staff at your tables will hopefully clarify and amplify some of the remarks I have made during this evening. Meanwhile, welcome once again and thank you for accepting our invitation to this Annual Dinner in honour of Ambassadors and High Commissioners posted to the Republic of South Africa. Your friendship is not taken for granted, it is highly valued. Thank you very much. 5/5
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Address by Mr T T Mboweni Governor of the South African Reserve Bank at the year-end media cocktail function Johannesburg 14 December 2004
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T T Mboweni: The South African banking sector - an overview of the past 10 years Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the year-end media cocktail function, Johannesburg, 14 December 2004. * 1. * * Introduction Over the past decade, South Africa has established a well-developed banking system which compares favourably with those in many developed countries and which sets South Africa apart from many other emerging market countries. At the end of 2004, we find ourselves with a more mature banking sector, with a moderate level of private-sector indebtedness and a respectable and first-rate regulatory and legal framework. South African banks are well managed and utilise sophisticated risk-management systems and corporate-governance structures in conducting the business of a bank. South Africa’s banks are regulated in accordance with the principles set by the Basel Committee on Banking Supervision. Consequently, our banks comply with international sound practice and offer a sophisticated banking system to the public. Customers have online, real-time, nationwide access to bank accounts 24 hours a day, everyday of the year. South Africa’s political transformation, together with the relaxation of exchange controls and the liberalisation of African economies, has resulted in South Africa becoming an increasingly important financial centre. South Africa is now also well positioned to provide global services through the international offices of our banks and the presence of international banks in South Africa. 2. Structure of the South African banking sector Currently, there are 38 registered banks in South Africa. This number consists of 15 South African controlled banks, 6 non-resident controlled banks (subsidiaries), 15 local branches of international banks, and two mutual banks. In addition, 44 international banks have authorised representative offices in South Africa. Representative offices, however, may not take deposits. Five major groups continue to dominate the South African banking sector. These groups are the Absa group, the Standard Bank group, the FirstRand Bank group, Investec and Nedcor. In 1994, these groups represented 83.8 per cent of the total assets of the banking sector and, currently, they represent 87.4 per cent of the banking sector. The remaining 12.6 per cent of assets in the banking sector are currently held by the other 31 banks, excluding the two mutual banks. Initially, the number of medium to small local banks increased steadily over the past decade. During, the latter part of 1999, however, these banks faced liquidity pressures, which led to many of these medium to small banks exiting from the banking system. This downward trend reached its lowest point with the placement of Saambou Bank into curatorship in February 2002 and the subsequent integration of BOE Bank into Nedbank. From the last quarter of 1999 to the end of March 2003, some 22 banks exited the South African banking system. It can be said, however, that this phenomenon was due more to a consolidation of the broader banking sector than a failure of the medium to small banking sector. Currently, small local banks constitute 3.1 per cent of the total banking sector assets, in comparison to 21.7 per cent in 1994. As a result of the political isolation of South Africa in the mid-1980’s, international banks terminated their operations in South Africa. Immediately prior to the advent of the democratically elected government in 1994, few international banks were doing banking business in South Africa. Amendments to the Banks Act in 1994, however, allowed not only representative offices and subsidiaries of international banks to be established in South Africa, but also branches of international banks. Following the opening of South Africa’s financial system in 1994, international participation in the local banking industry increased significantly, from 3 per cent in 1994 to 9.5 per cent of total banking sector assets by the end of October 2004. 1/7 3. Periods of change in the banking sector Following South Africa’s re-entry into international financial markets in 1994, locally registered banks have increasingly been expanding their operations into other countries. At the same time, international banks have been expanding their operations into South Africa. Besides adding further depth and sophistication to the South African market, these foreign banks began to tap into the South African labour market. Consequently, the arrival of these predominantly resourceful and experienced banks posed formidable challenges to local banks. In a quest to survive and excel, South African banks had to devise means to adapt to the new terrain. As a result of the increased competition, lending margins have been placed under greater pressure, and several banks have had to expand their businesses and enter markets with slightly higher credit-risk profiles. Currently, the major banks offer a wide range of services to both individual and corporate customers. One-stop relationship banking, with an emphasis on universal banking, instead of isolated services, has gained in importance during the past few years. Nevertheless, several banks, especially small local and foreign banks continue to service niche markets, where they hold some form of competitive advantage. 4. Trends in South African banks over the past decade Generally, the South African banking sector remained fairly stable during the past decade. The first part of the past decade was characterised by global financial turbulence and banking crises in many countries. In general, the South African banking sector showed itself to be remarkably resilient during the crises experienced. The latter part of the decade was characterised by a significant depreciation of the South African currency and, in 2002, we experienced our own banking instability. Fortunately, and owing particularly to the solid foundations upon which our banking system is based, 2003 and 2004 were marked by greater stability. (i) Balance-sheet structure The aggregated balance sheet of all banks in the South African banking sector grew from R344.6 billion as at end December 1994 to R724 billion as at end December 1999. By the end of October 2004, total assets had grown to a record high of R1.436 trillion. Loans and advances grew continuously over the past decade, from R270.8 billion as at end Dec 1994 to R 1.104 trillion as at end October 2004. Domestic deposits from the public remained the main source of funding for the banking sector over the past ten years and amounted to R888 billion in October 2004 (as opposed to R241.9 billion as at end December 1994). (ii) Profitability The efficiency of the banking sector can be determined by expressing operating expenses as a percentage of total income. Currently, the international benchmark for efficiency is 60 per cent. In the past, South African banks were able to keep this ratio below or close to the international benchmark. The ratio, however, has increased from 60.2 per cent in 1999 to 67 per cent in 2002. The high volatility in efficiency in 2002 indicates that the South African banking sector was indeed experiencing problems with profitability in the first six months of 2002. This deterioration is confirmed by the return on equity of 5.4 per cent (smoothed over 12-months) and the return on assets of 0.4 per cent (smoothed over 12-months) as at the end of June 2002. Since 2002, however, the efficiency ratio has improved and, as at the end of October 2004, the efficiency of the banking sector was 65.2 per cent. By the end of October 2004, the return on equity and the return on assets of the banking sector had similarly improved. (iii) Capital adequacy The change in focus of the regulatory authorities from direct controls to a more market-based approach has been accompanied by an emphasis on proper capitalisation, sound risk-management procedures and greater disclosure. South Africa adheres to the capital-adequacy guidelines for banks promulgated by the Basel Committee on Banking Supervision. The requirement to maintain capital equal to the full ratio of 8 per cent of risk-weighted assets was changed to a rate of 10 per cent by the 2/7 Registrar of Banks in 2001. By end of October 2004, the banking sector as a whole had a capital-adequacy ratio of 13 per cent (up from 9.5 per cent in December 1994). (iv) Non-performing loans Of great significance was a decrease in the growth of total non-performing loans during the past decade. After reaching a peak of R29.2 billion in March 1999, growth in total non-performing loans declined to R23.8 billion as at end December 2003. During 2004, total non-performing loans continued to decrease to a level of R20.9 billion. Provisioning by banks remained adequate throughout the past decade despite non-performing loans being high in the late nineties, as mentioned earlier. 5. Reaction of the regulator to the small to mid-sized banking crises It is common cause that the South African banking sector experienced certain mini-crises over the past decade. None was more concerning than the instability experienced by small to mid-sized banks during the period of the Saambou problem. Saambou Bank experienced a liquidity crisis, emanating from negative market perceptions, a profit-warning announcement and the sale of Saambou shares by two of the bank’s executive directors. At the time, Saambou was the seventh largest South African bank and had both a large retail deposit base and a well-established branch network. In order to prevent a crisis of confidence in the small to mid-sized banking sector, Saambou was placed under curatorship. Unfortunately, this led to further withdrawals, not only from the smaller banks but also from larger banks. This loss of confidence significantly affected the sixth largest bank at the time, BOE Bank, indicating that the lack of confidence could move up the scale and not only down the scale. Since such a trend could not be supported, the South African Reserve Bank entered into consultations with the National Treasury, which ultimately issued a guarantee to all depositors that the government would fund their withdrawals. This action sent a signal to the market that the authorities were serious about maintaining the stability of the banking sector. Several lessons have been learnt from the small to mid-sized banking crises. First, owing to the special nature of banks, all key players, including, for example, external auditors, analysts, the media and rating agencies, should appreciate the nature of banking and act responsibly when dealing with the banking sector. Second, the regulatory authorities must also be mindful of the fact that all their actions, combined and separately, constitute signals to the market and that greater problems may result if a bank in distress is not handled in a manner that provides certainty. Third, the regulatory authorities have also learnt to treat with circumspect institutions that apply for a banking licence, but which have only the interests of the individual shareholder and not the interests of the depositor base in mind when making business decisions. An institution can no longer be allowed to be registered to conduct the business of a bank and, then, simply to ride on the coat tails of the name “bank”, whilst at the same time not conducting deposit-taking business or not acting responsibly in the interests of the depositor base, but rather in the interests of an unobtainable share price. Fourth, the Registrar of Banks needs to be mindful of “boutique” banks that are not fulfilling the definition of the “acceptance of deposits form the general public” and, on the asset side of their balance sheet, are not acting “in the interest of the general public”. Fifth, as a result of the problems prevalent in the small to mid-sized banking sector during the past decade, and especially towards the latter part of the decade, the South African Reserve Bank adopted a policy framework for dealing with banks in distress. This policy framework serves to provide clarity on the process in place for not only dealing with banks in distress, but also preventing problems in one bank spreading to other banks. It is, however, only a framework to guide the approach taken, and the particular approach has to be decided on a case-by-case basis, depending on the specific circumstances. Sixth, in addition to the policy framework for dealing with banks in distress, the Registrar of Banks emphasised the importance of sound corporate governance in banks. In order to investigate the standard of corporate governance within the South African banking sector, the Registrar appointed Adv J F Myburgh SC to conduct a review of the status of compliance with sound corporategovernance practices within the five largest banking groups in South Africa during 2002. 3/7 Among Adv Myburgh’s findings were that, generally the banks investigated were committed to adherence to and application of high standards of corporate governance; the banks on their own initiative reviewed their corporate-governance principles from time to time; and corporate governance in the banks was generally sound but vigilance was required to ensure continued compliance with the best practice in corporate governance which is evolving in South Africa and internationally. Myburgh’s recommendations were, inter alia, that the board of a bank should consist of no more than about 16 members; a bank’s board should not have more than about four executive directors; the majority of non-executive directors should be independent directors with immediate effect; and banks should aim for the majority of their directors to be independent directors within not more than five years. The Registrar of Banks accepted the recommendations made by Adv Myburgh and is dedicated to reviewing the commitment to sound corporate governance in the banking sector on an ongoing basis and is currently reviewing corporate governance in the remaining “non-big five” banks. It needs to be stressed, however, that the objective of regulatory and supervisory authorities world wide can never be to avoid the failure of financial participants, and, that, in a sound system, there will be failures. Instead, the objective is to strive for an optimal balance between, on the one hand, the cost of controls and intervention in order to address market failures and, on the other hand, the anticipated benefits of regulation and supervision. The need for a sound relationship and proper coordination between the fiscal authorities and the regulator can also not be overemphasised. 6. Emergence of the “four-pillar” policy The four pillar policy relates to having a minimum number of substantial banks (so called “pillars”) on which the domestic banking industry relies and discourages the merger between any of those four banks. The primary reasons for such a policy relate to the maintenance of minimum levels of competition, in the interests of prudential and systemic stability, in order to avoid the spread of risk and to promote reliance on a broader platform of institutions. Currently, Australia relies heavily on the “four-pillar” policy, which originated in 1990 from its previous “six-pillar” policy. New Zealand, which effectively has the same major banks as Australia, is protected by the Australian policy. The Australian “six-pillar” policy discouraged mergers between any of the four major banks and two major life insurance companies. The Australian government determined that it would be anti-competitive for the four big banks and two big insurance companies to merge. In 1997, however, the Australian government scrapped its “six-pillar” policy after the Wallis Inquiry concluded that increased competition would achieve lower costs, better services and higher efficiencies for consumers. Nevertheless, the Australian government determined that there was insufficient competition to allow mergers among the big four banks and thus the “six-pillar” policy became the “four-pillar” policy. According to the South African Minister of Finance, who has responsibility for national financial policy, South Africa also follows a “four-pillar” policy. Recently, the Minister stated that South Africa maintains a “four-pillar” policy of having four big, locally owned banks regulated by the Office for Banks. The “four-pillar” policy in South Africa lay at the heart of considering the Nedcor Bank bid for Stanbic. The arguments advanced and conclusions drawn at the time conformed to that principle. Current indications are that a number of international banks are interested in acquiring one or two of our four pillars. Even if such interested was approved, it seems important to the Reserve Bank that there still remain four pillars upon which our banking system rests. The presence of internationally-owned banks will most certainly introduce more competition which in theory should benefit consumers. The authorities will therefore have to examine each application to buy into one of our four pillars on a case by case basis. The world is changing very fast and the regulatory authorities cannot be seen to be standing in the way of globalisation and rapid changes. These changes should be welcome as they are indicative of the increasingly positive outlook for South Africa. The authorities have therefore to face up to the task of anticipating and keeping abreast of changes to meet the new challenges and opportunities. ‘Nothing is stable except stability’ and progress is measured by ‘constantly changing when circumstances change’, as the great philosophers of old would say. 4/7 7. Current challenges for banking policy, especially in view of international banks’ interest in acquiring local banks Closely related to the consideration of a four-pillar policy in a country is a consideration of whether international ownership of any of those “pillars” should be permitted and, if so, on what conditions. In that regard, the banking system of New Zealand serves as a good example of a country that, whilst having predominantly non-resident owned banks, has maintained a sound financial system for decades. Should international interest in our local banks culminate in international ownership, the supervisory regime would have to follow the internationally agreed framework of “home-host” banking supervision. This is already in operation in that South African-owned banks have a presence abroad and internationally-owned banks have a presence in South Africa. The success of such a system relies largely on both the home-country and the host-country regulator ensuring compliance with the Basel Core Principles for Effective Banking Supervision and the various guidelines flowing therefrom. In that regard, regulators seek to ensure that their requirements do not obstruct home-country requirements and, consistent with meeting their responsibilities, dovetail as much as possible with those requirements. Maintenance of a sound and efficient financial system and an ability to respond to a crisis effectively are crucial prerequisites for a country’s economic and social welfare. Therefore, host-country supervisory arrangements are essential, as are structures for coordinating home and host supervision. Home-country and host-country supervisors should be able to rely on and support one another at all times. When banking groups have international shareholders, it is important for the host-country supervisor to be able to rely on the shareholder of reference in times of need. 8. Challenges going forward Three important challenges face the South African banking system, including bank supervisors, in the forthcoming number of years. These challenges are the implementation of the New Capital Accord, or Basel II, as the Accord is commonly known; the provision of the broader access to banking services; and the full implementation of anti-money laundering measures. (i) Basel II The principles of Basel II are intended to align capital-adequacy requirements more closely with the key elements of banking risks and to provide for banks to enhance their risk-measurement and risk-management capabilities. The revised capital framework is furthermore an attempt to adapt to new developments and instruments and to be neutral towards financial innovation. Although the aim is not to stifle innovation, the framework is also not intended to encourage capital arbitrage. Basel II will evidently bring with it a higher supervisory and compliance burden, because of the Accord’s greater complexity. The Office for Banks has embraced the principles contained within Basel II and is of the opinion that Basel II is suitable for application in both G10 and non-G10 countries, since it provides a menu of approaches suitable for both sophisticated and the least sophisticated banks. Implementation of Basel II will be one of the high-priority strategic focus areas of the Registrar of Banks in the forthcoming number of years. Basel II will be implemented within the South African banking sector on 1 January 2008. Parallel runs will take place during 2007. The Office for Banks has and will continue to direct resources towards developing a supervisory framework involving all approaches offered by the new Accord. Basel II will have a significant impact not only on banks, but also supervisors, who will have to re-engineer their processes and tailor their organisational structures to meet the Basel II standards. In collaboration with other supervisors, the Office for Banks is currently developing its Basel II implementation strategy. This process requires, amongst other things, a thorough understanding of the provisions of Basel II, the design of appropriate supervisory processes and the development of complementary tools to discharge supervisory duties. Ultimately, the new capital-adequacy framework has the potential to improve risk management in banks and to align economic capital more closely with regulatory capital. Co-operation between banks and supervisors, between supervisors of different 5/7 countries and between different banks is therefore essential for the successful implementation of Basel II. The Accord Implementation Forum established by the Registrar of Banks and representing banks and various other stakeholders is functioning well and is assisting the banking sector and the regulator with identifying and addressing the risks that may arise prior to and during the implementation of systems designed to ensure compliance with Basel II. There will be continued amendment of the regulatory framework and the supervisory process and procedures, as well as development of complementary tools, in order to cater for the requirements of Basel II. (ii) Broader access to banking facilities One of the most topical issues in the current South African financial landscape is the need to extend access to banking facilities on a wider basis than is currently the case. In South Africa, the regulation and provision of financial services to the poor has largely been based on exemption notices to the Banks Act. The South African Reserve Bank announced through the Bank Supervision Department’s 2002, Annual Report, that it envisaged amending the regulatory framework in order to allow for the establishment of different classes of banking institutions, such as second-tier and third-tier banks. Draft legislation has been published by the National Treasury in the form of the Dedicated Banks Bill and the Co-operative Banks Bill, as a means of providing access to the banking sector to interested participants and thus ensuring a flow-down of banking services to the wider community. It is essential, however, that the new legislation should ensure that the business of such institutions is conducted in a safe and sound manner, conducive to the orderly growth of the financial sector, whilst contributing to poverty reduction in both rural and urban areas. Comment on the Dedicated Banks Bill and the Co-operative Banks Bill may be provided until the end of January 2005. (iii) Anti-money laundering The Financial Intelligence Centre Act, 2001 (FIC Act), imposes duties on certain institutions to introduce anti-money-laundering measures, to train their employees, to report suspicious transactions to the Financial Intelligence Centre (FIC) and to retain client information. The banking sector has therefore begun a concerted campaign to comply with the FIC Act and to fulfill the sector’s obligations in terms of local legislation and international guidelines. In May 2002, South Africa applied for membership of the Financial Action Task Force (FATF), an intergovernmental body that develops and promotes policies, nationally and internationally, to combat money laundering. South Africa was granted FATF membership in June 2003. As from February 2003, banks and several other institutions have been reporting suspicious transactions that may involve money laundering to the FIC. Banks have to make detailed reports of all unusual and/or suspicious transactions to the FIC. In addition, banks have to report the number of such reports to the Registrar of Banks. Although this has been a challenge for banks, resulting in additional system and resource requirements, banks have shown a commitment to comply with their duties. The Bank Supervision Department has an obligation to monitor compliance by our banks with the FIC Act and other anti-money laundering guidelines. In order to ensure compliance with the requirements of the FIC Act, a circular was issued in December 2002. The circular provided guidelines on the types of measures that banks had to implement in order to prevent them being used to launder the proceeds of crime. In terms of the circular, each bank has to furnish the Bank Supervision Department with a detailed plan, with time frames by which the bank intended to achieve full implementation of and compliance with the FIC Act and the FIC Regulations. The initial deadline of 30 June 2004 by which banks had to verify the identities of some 17 million clients was extended to a range of new deadlines, starting on 31 October 2004 for high-risk clients and ending on 30 September 2006 for the lowest risk clients. The Bank Supervision Department, in its role as a supervisory body, will continue to monitor progress with the implementation of anti-money-laundering measures. It is also the intention of the Registrar of Banks to incorporate anti-money-laundering measures into the planned on-site visits to banks. 6/7 9. Conclusion In summary, therefore, the South African banking sector remains stable, and we are convinced that further growth of the industry may be expected in 2005. Such growth, however, will be accompanied by certain challenges. Besides preparing for the implementation of Basel II, South African banks will continue to be encouraged to follow international sound corporate governance practices. Furthermore, the Office for Banks remains mindful of the need for banks to ensure that the objectives of the Financial Services Black Economic Empowerment Charter are met. For the Charter to succeed, co-operation by all stakeholders is a necessity, and the South African Reserve Bank will continue to support and assist banks in meeting their objectives. Taking into account the strengths of our banking sector, we can look forward to a sector that can continue to establish itself as one of the most sophisticated and integrated banking sectors in the world. 7/7
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the launch of the upgraded banknotes, Pretoria, 17 January 2005.
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T T Mboweni: South African Reserve Bank launches upgraded banknotes Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the launch of the upgraded banknotes, Pretoria, 17 January 2005. * * * Ladies and gentlemen Welcome to the South African Reserve Bank. Today we take great pride and pleasure in unveiling South Africa’s upgraded banknotes. The preparation for the issue of this upgraded series has been a complex and a painstaking one and we are very proud of the result. The South African Reserve Bank has the sole authority to issue banknotes and coin in South Africa. The Bank has a concomitant responsibility to ensure that the public has confidence in the currency. To this end, the Bank will be issuing upgraded banknotes with improved security features and with some aesthetic changes to the design of the banknotes from 1 February 2005. Continuous improvements in currency design and security features protect the economy and your money. Banknotes, which are usually taken for granted, are not only a means of payment. They are pieces of craftsmanship that are a window on the country, its people, heritage and culture, portraying its national character. The big-five theme on our banknotes is a reflection of our African heritage whilst the economic sector themes on the reverse of the banknotes more specifically reflect South Africa. The improved security features and the modified design features ensure that our banknotes remain credible and aesthetically pleasing, while reflecting in very concrete ways how far we have come as a democracy. Our banknotes have always been highly regarded, both nationally and internationally, for their design and security features and one of their strengths has been that the banknotes have withstood any major counterfeiting threat over the years. According to international best practice, the security features on banknotes are upgraded or new banknotes with new design and security features are issued every six to eight years. South Africa’s current banknotes series has been in circulation since 1992. With the advent of improved technology and with heightened security and criminal threats, it has become necessary for the Bank to be proactive and to take the necessary steps to upgrade the security features in our banknotes. We have also utilised the opportunity to change some of the design features to align our banknotes with the changes in our country. Ladies and gentlemen, we wish to use this opportunity to thank the President and Cabinet for their endorsement of the upgraded banknote series. In particular, we would like to express our gratitude to the Minister of Finance and the National Treasury for their support and cooperation. Let me highlight some of the salient events in the extensive process leading up to this significant event. The design and development of the banknotes, even though these are only upgraded banknotes, has been a complex and intricate task. Our team has spent a number of years on this endeavour. We had to obtain the services of international companies in the determination of the changes, both for the design and security features on the banknotes, as well as the supply of banknote paper, inks and security threads. The changes to the banknotes have been widely consulted on with the key stakeholders. Consultations have taken place with the Department of Arts and Culture on the Coat of Arms, with the Pan South African Language Board (PANSALB) on the language changes, with the National Council for the Blind on the changes with regards to the features for the blind or partially sighted and with various international and local service providers and the banking industry on the utilisation of the security features in processing and vending machines that have become part of our daily lives. Today is a momentous day as the Bank unveils the upgraded banknotes to the public. Simultaneously, today we launch the communication campaign to inform and educate the public on the changes to the design and security features of South Africa’s banknotes. The objective of the communication campaign is not only to inform and educate the public on the security features, but also to get the public to habitually examine their banknotes to ensure that they have good money. I trust that our key partners in the private and public sectors will play a significant role in ensuring that their constituencies know about the new features and encourage them to check the features on their banknotes. We trust that the media will also play its rightful role in informing and educating the public and in so doing protecting the public and ensuring that we give no quarter to criminals should they attempt to counterfeit our currency. All five denominations of the upgraded banknotes will go into circulation on 1 February 2005. The new banknotes will be issued gradually over time. We must therefore highlight that the upgraded banknotes and the current banknotes will circulate simultaneously. It is important to note that the SA Reserve Bank has not “demonetised” any of its currency. This means we can all confidently continue to use all South African money, even if it is part of a previous series. We encourage all South Africans to know the security features and make the checking of money second nature. The security features on South African Rands are only useful if people use them. It is every user’s responsibility to get to know the upgraded banknotes and check the security features. May we also take the opportunity to thank the team and their collaborators for their energy and effort in ensuring the success of the project as a whole and ensuring that the banknotes are distributed on time and for the efforts in ensuring public confidence in our banknotes. Thank you for coming here today and for your participation in this process and we wish to encourage all of you to spread the message about these very important changes to our banknotes. Thank you.
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Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, to the ACTSA (Action for Southern Africa) Corporate and Professional Dinner, Johannesburg, 2 June 2005.
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Ian Plenderleith: Five big issues in the economic field Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, to the ACTSA (Action for Southern Africa) Corporate and Professional Dinner, Johannesburg, 2 June 2005. * * * Visitors to South Africa are encouraged to go on safari and see “the Big Five”. The big five are, indeed, awesome in the wild and a memorable sight. But I have always regarded the notion that visitors can see just the big five, and then go home feeling they have covered the ground, as distinctly sub-optimal marketing. Any score card that leaves out, for example, the mute grace of the giraffe, or the sheer brute force of the hippopotamus, or - my personal favourite- the nimble elegance of the warthog, does not begin to do justice to the diversity of wildlife in South Africa; and if we also add a few of the rarer sights, like perhaps wild dogs and cheetah, we would encourage visitors to stay longer and add yet more to our tourist earnings. The big five are not, however, only to be found in the bush. In the economic field, too, we have for the past decade been determinedly and assiduously tracking a different sort of big five, representing the key elements we need to nurture to enable our economy to achieve higher and rising levels of sustainable growth in output and in employment and hence in living standards for all the people of South Africa. I want tonight briefly to point out these economic big five to you and to suggest that, after years of carefully stalking the spoor, we are now on track and in sight of the big five and well placed to enjoy the continuing benefit of their company. What are these big five, in the economic field? First, the economy as a whole continues to demonstrate vigorous and sustained growth. We have in fact achieved continuous positive growth in output for the past 26 consecutive quarters - some six and half years. That is a remarkable track record of cumulative growth. More recently, we have seen growth accelerate, from 3 percent or just over in the past few years to 3.7 percent last year and continuing to run close to that level on the first quarter GDP data released just this week. The economy appears to have moved up in the past two years onto a higher growth trajectory which, if it can be sustained, is extremely good news. Secondly, there are good reasons for believing that this move to a higher growth trajectory is not a passing phase, but is sustainable and can continue. The reasons are that disciplined fiscal policy has kept the public finances strong, with the budget deficit and public debt kept to prudently manageable levels; and that monetary policy - the particularly responsibility of the Reserve Bank - has succeeded in bringing down inflation and holding it down, so that inflation has been within our target range of 3-6 percent continuously since the latter part of 2003. Importantly, this track record of low inflation has helped to bring down inflation expectations, and our projection looking forward is that inflation will remain within our target range. It is this encouraging outlook for inflation that enabled us to reduce interest rates in April, and it is this platform of stability achieved by fiscal and monetary policy working together that gives encouragement that the higher growth trajectory we are experiencing will indeed be sustainable, even though there will inevitably be ups and downs along the way as we experience, for example, vagaries in the global economy and normal business cycle effects. Thirdly, our external position has been strengthened. Helped by the recovery in the rand from a sharp temporary fall in 2001, we have been able to make good progress in rebuilding our foreign exchange reserves, working towards more normal levels. Moreover, although the general weakening in the dollar has at times been a source of strain on externally-competing sectors of our economy, we have over the past 18 months seen the rand tend to trade on a more settled basis within a broad trading range, with less volatility. The signs we are seeing of a stable and competitive exchange rate will help to sustain the higher growth trajectory of the economy as a whole. Fourthly, we have in South Africa a strong economic policy framework that has been exemplary in focusing on the development needs of the country in a considered and co-ordinated way, and as such is widely admired internationally. Alongside the disciplined approach to fiscal policy, and the monetary stability our inflation targeting framework has achieved, well-constructed supply-side policies are directed at increasing the growth capacity of the economy, particularly with the current focus on education, training and skills development and on improving the physical infrastructure. Alongside, truly impressive progress has been made in addressing the backlog of social neglect, as is evident from the impressive statistics and the visible evidence all around the country of low-cost house building, water supply, sanitation, health and education facilities and essential social support. All these elements of economic policy are working together to increase growth in output and employment and living standards on a sustainable basis. Fifthly, there has in the past year or two been a perceptible improvement in international confidence in the South African story. The recent evidence of this can be seen in the upgrade in South Africa’s international rating earlier this year by one of the major rating agencies, and in the decision by a leading international bank that it wishes to enter our domestic retail banking market as a full-service participant. Stalking these big five and staying on track to keep them in sight has been a major effort and a considerable achievement in such a short period of years. Nor are they the only objectives we as a society need to pursue. We cannot, of course, relax and we need to keep on track. As for the wild life in our national parks and game reserves, we need to keep the big economic five in sight and to nurture the right environment for them to flourish. In so doing we will, like any good game ranger, ensure that the benefits are sustainable and that they are enjoyed by the whole community.
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Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at an ANC breakfast meeting, Johannesburg, 22 June 2005.
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T T Mboweni: South Africa - a land of hope and opportunity Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at an ANC breakfast meeting, Johannesburg, 22 June 2005. * * * Ladies and gentlemen Distinguished guests Thank you for inviting me here this morning to say a word or two about the South African economy. When I received this invitation to be here this morning, a number of questions arose in my mind. The primary one being whether a governor of a central bank should speak at occasions such as this which are organised by political organisations. It was a vexing question which required of me a serious answer. Central bank governors have to demonstrate at all times their commitment to the independence of central banks from political influence. In fact central bank independence also means rebutting any attempt by anyone including market participants to influence their decisions or interfere in their operational work. At the same time, central bank governors have to engage in extensive communications with the markets, the general population, governments and parliaments. So any opportunity to communicate should be seriously considered and if time permits, should be entertained whether from a political party, market participants or any other organisation which is reputable. So any political organisations wishing to invite me to their functions are welcome to do so. We just have to negotiate time. It is against this background that I accepted your invitation to be here this morning. South Africa is still very much a country in transition. It is a country of many hopes and opportunities. Firstly, the political system is maturing. Most certainly, the political system is entrenching democratic values and systems. People stand for elections within their parties - sometimes squabbling very badly privately and in the media in their endeavours to be elected, they avail themselves as candidates for local council chambers, provincial legislatures and the national parliament. Debate is generally developing in its robustness. More often than not acrimoniously so. Not a place for the weak! Secondly the media - the fourth estate - is lively and maturing too. Public officials and private executives are closely scrutinised to check on their performances and good corporate governance standing in order to move the country forward. The media questions and exposes. Sometimes their approach is certainly questionable but on the whole they are making a good contribution to our society. There is room for improvement particularly in financial journalism - a matter being attended to by some journalism schools. But an open and democratic society by definition requires a vigorous, investigative and independent media. Thirdly, the judiciary, despite its many weaknesses given where we come from, is independent and is making its contribution towards the respect for the law by all of us. Issues are being attended to as far as the transformation of the judiciary both in terms of form and content is concerned. Progress in this regard is promising as the government and the judiciary are hard at work to achieve this historically fundamental objective. The respect for the judiciary really demands that the authorities must not keep their eyes off the transformation ball. But whatever the outcomes of this process, the end result must be to protect and enhance the independence and respect for the judiciary. Fourthly, we have in South Africa policies and laws that respect, protect and understand the fundamental role of private property rights in the economic development of our society. Those who a couple of years ago doubted the positive role of private property in society and its role in the economy are slowly coming to the conclusion that people’s rights in private property are prerequisites for promoting investment and certainty that one’s investment today can be protected by law, with the courts available to enforce it and thus confident to grow businesses whether industrial or agricultural. There are still many countries on our continent which should still need to improve private property rights in order to give surety and confidence to investors. Fifthly, there is in this land of hope and opportunity a vibrant culture and entertainment industry which is vital in any society. Music, dance, theatre, museums and other places to visit and enjoy. We are even beginning to see the entry by black dancers into the ballet schools and companies. Even I, coming all the way from rural Limpopo, now appreciate La Traviata! So it is not just about soccer and rugby. Sixthly, this is a normalising society where challenging issues are looked straight in the eye, in particular race, gender and the development of a black business class. Finally, the population expects and demands to be heard at every turn. Expectations are justifiably high for housing, clean water, good public schools, good health services, good roads and streets, including traffic lights that work, safety and security, employment opportunities, the fairness of the justice system and the rest. There is demand for delivery everywhere. The public authorities and private companies are kept in check all the time. Our society is moving ahead indeed. Of course with demands for socio-economic needs also come responsibility to care and look after that which has been “delivered”. How are we doing then as far as the economy is concerned? How has globalisation affected the South African economy and society? As we know, the South African economy was primarily dependent on gold and diamond mining together with agriculture for many years. Many African people were driven from the land where they lived as peasants and pastoralists to the mines, emerging factories, agriculture and domestic service through the combination of political repression, land dispossession and yes, taxation. In the 1960s, the South African economy increasingly became industrialised and services oriented. Of course the scourge of the colour bar in our society and the workplace was used as a major instrument to racialise everything. Agriculture and mining together contributed about 20.4% to Gross Domestic Product (GDP). In the 1990s this declined to 11.3%. Today mining contributes about 7.8% and agriculture 3.6%. This is a major change in the structural make up of the economy. The secondary sector contributed about 27.8% to GDP in the 1960s. Although this has declined somewhat to 24% currently, this is nevertheless testimony that our economy remains highly industrialised. Another major change in our economy occurred in the services sector. In the 1960s, this sector contributed about 51.8% to GDP and today it accounts for 64%. Again this is a major structural change in our economy. Clearly, mining and agriculture have been the major “losers” in these developments. But let us not make the mistake of abandoning these sectors for we still have two-thirds of our gold in the ground and there are still many viable mineral deposits in this country and we still have to feed ourselves from agricultural activities. Oh by the way: food does not come from Pick ‘n Pay but from agriculture! Sometimes people forget this. The structural change from mining, agriculture and some extent manufacturing to an economy heavily dominated by the services sector has major implications for the jobs market. It means that the skills required for the services sector are much higher than was the case previously. Many people have made the observation that the consequences of the Bantu education system are being more severely felt now than at any time in the past. There is no doubt that one of the most critical areas of focus in South Africa at the moment and for the foreseeable future is education and broadly human resources development. This has to be strategic in nature. We have to focus and provide resources for training people in those areas of extreme need side by side with general education. We need engineers, accountants, pilots, of course lawyers, actuaries, doctors, nurses, scientists and other specialised technical skills for a an increasingly services sector driven economy. And how can I forget economists! Mathematics education is fundamental to this. Alongside these structural changes in our economy has been the process of global integration of the South African economy. Whilst in the 1960s we were mainly an extractive economy, by the 1990s the South African economy was fairly integrating broadly into the world economy. With sanctions out of the way, imports and exports of goods and services amounted to about 44% of the economy. Currently this has increased to 55.6%. The manufacturing sector, despite its challenges from time to time saw its exports rise to 29.6% in the 1990s to about 37.9% in the period 2000-2004. One of the most notable features about the globalisation of the South African economy is to be found in the banking sector. South African banks as a percentage of GDP averaged 77% during the period 1965-1994. In 2004, this share of GDP by South African banks was 109%. The equity market averaged R2 billion in the period 1970 to 1985., R21 billion per year for the period 1986-1993, the annual turnover in the equity market was R62 billion in 1994 and in 2004, the annual turnover was about a R1 trillion. Market capitalisation on the JSE increased from an annual average of R40 billion for the period 1970-1980 to R2 trillion in 2004. Further more compelling evidence of globalisation is to be found in the performance of the bond market. Between 1970 and 1985, turnover in this market was about R8 billion, in 1995 this had increased to R2.3 trillion and in the year 2004 turnover was R8.4 trillion. Finally the foreign exchange market which interests so many people has also seen some remarkable evidence of globalisation. To cut a long story short, in 1987 the average daily turnover in this market was 1.1 billion US dollars and during the course of 2005 the average daily turnover in this market in some 12 billion US dollars. So there is a lot of activity going on there. The only conclusion I can come to is that we are coping well with globalisation. We have seen some benefits but yes there has also been some costs such as the impact of globalisation on the gold mining sector. Let me conclude by saying that there has been a remarkable achievement in the two areas that I closely focus on as part of my job. This is inflation and budget management in South Africa. Inflation has so far been contained within the inflation target. The government’s budget management is an example to many countries throughout the world recording budget deficits before borrowing of less than three percent of GDP consistently. Progress has indeed been made. The hope and opportunities that characterise South Africa make me happy to be a South African at this historic juncture in the development of humankind. President Mandela remarked somewhere that ‘the sun will never set on such a glorious human achievement’ I agree with that. I thank you.
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Comments by Mr T T Mboweni, Governor of the South African Reserve Bank, on the occasion of the signing of the USD1,5 Billion Dual Tranche Syndicated Term Loan facility, London, 18 July 2005.
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T T Mboweni: Signing of a syndicated loan and comments on the South African economy Comments by Mr T T Mboweni, Governor of the South African Reserve Bank, on the occasion of the signing of the USD1,5 Billion Dual Tranche Syndicated Term Loan facility, London, 18 July 2005. * * * Ladies and Gentlemen, I am delighted to address you once again on an occasion such as this and even more delighted to be back in this great city. With the weather you are having here, we could quite easily be experiencing an African winter … I mean summer. It is a pleasure to welcome you here and to be amongst friends such as yourselves who have shown great confidence in South Africa. As many of you live in this city, and almost certainly all of you have operations in London, I think it is right and proper, as we gather here only 10 days after the attacks on London, that I express our sympathy and condolences, on behalf of the South African Reserve Bank, to those who have been affected. The number of many familiar faces present here today reflects both your commitment to South Africa, as well as the South African Reserve Bank's commitment to building strong relationships with a range of financial institutions. The foreign credit facilities we seek to establish with international institutions such as yourselves are utilised from time to time, or fully drawn down over the period of the loan to supplement our foreign reserves. In this case the US$1,5 billion facility is being used to prepay the US$1 billion Dual Currency Term Loan Facility concluded in June 2003 and tranche B of the Dual Currency Term Loan Facility concluded in July 2002. In the run-up to this syndicated loan, we were very encouraged to discover during our discussions that the market was more than willing to support a dual-tranche transaction, namely a three-year and a five-year tranche, at reasonable pricing. In negotiating the 2005 facility we took into account the maturity profile of the country's foreign debt, our financing strategy, as well as the desirability of re-establishing the five-year benchmark. Whereas not too long ago, a five-year maturity would still have been the subject of debate, today it seems very natural for us to borrow for five years, and thus pave the way for other South African borrowers. It is therefore with great pleasure that we celebrate the successful conclusion of this syndicated loan. The loan was oversubscribed and brought to the table some top names spread over a wide geographic area. As usual, we are delighted by the quality of the participating banks and we will, as is our practice at the South African Reserve Bank, make every effort to share our business with our valued counterparties. Priced at 22.5 basis points per annum and 30 basis points per annum over Libor for the three-year and the five-year tranche respectively, this amounts to a considerable improvement over the last couple of years. (As you know, our 2004 syndicated loan, which matures in 2007, was priced at a margin of 47.5 basis points per annum over Libor. And, going even further back in time, we last raised five-year money in 2002 at a 90-basis-point margin above Libor.) The improvement in the pricing structure bears testimony to South Africa's prudent macro-economic policies and to the social and political stability characterising our democracy, which gave rise to and enhanced South Africa's laudable credit story. The successful conclusion of this syndicated loan also bears testimony to the strength of our relationships. Naturally, we grudgingly admit, the pricing also reflects the very liquid conditions prevailing in the syndicated-loan market. The ratings upgrade afforded us by Moody's in January this year reflects South Africa's improved credit worthiness. As you know, Moody's upgraded South Africa's credit rating from Baa2 to Baa1 with a stable outlook based on the "substantial strengthening" in the country's foreign reserves position. South Africa's gross gold and foreign exchange position stood at US$18,7 billion as at the end of June 2005. We are gratified and hopeful that a ratings grid in the loan documentation will result in lower pricing should South Africa's credit rating improve further. Now that the Net Open Foreign Currency Position or international liquidity position, as we now term it, has turned positive, we are relieved of a structural impediment to our economy and a source of much 1/2 international criticism. We have and continue to concentrate on building our reserves gradually and sensibly to a level that could be regarded as appropriate for a small open economy such as South Africa. Of course, we also have to bear in mind the costs of accumulating reserves. The appropriateness of reserve levels will also change over time. Allow me to touch on a few other salient points of South Africa's economy. As you well know, we conduct monetary policy within an inflation-targeting framework. This forms the basis for all our monetary-policy decisions. Inflation has remained within the target range of 3 to 6 percent for some 21 months now. The latest CPIX figures for May showed a year-on-year growth of 3.9 percent. The inflation-targeting framework has served us well and has enabled us to firmly anchor inflation expectations. The overriding and primary objective of monetary policy remains maintaining inflation within the target band, so as to provide a stable platform for sustainable economic growth. Since the signing ceremony last year, the Monetary Policy Committee has reduced interest rates by 100 basis points. Of course, there are a couple of risk factors going forward, the oil price being one, which could exacerbate inflationary pressures. Nonetheless, the outlook remains favourable, aided to some extent by muted increases in food prices and continued low international inflation. The path of the rand, although volatile during some periods, has remained relatively stable over the past couple of months. As a central bank we would prefer a stable exchange rate to reduce the uncertainty of resource-allocation decisions. Since the signing ceremony last year, the rand has depreciated from a level of around R6.10 to the dollar to a level of around R6.65 to the dollar, in part due to foreign currency fluctuations, in particular, the value of the US dollar. Growth remains robust, with the economy registering its 26th consecutive quarter of positive growth in output. Car sales have reached new peaks, and confidence in the economy is strong as reflected by healthy consumer demand underpinning the growth in money supply and credit extension. The economy grew by an annual real rate of 3,5 percent in the first quarter of 2005 after an increase of 4,0 percent in the fourth quarter of last year. There are now signs that the economy may have entered a new higher and sustainable growth trajectory. Before I conclude, may I once more express my appreciation to each and every institution that has committed to this loan. The confidence each financial institution has displayed in South Africa, by committing to this loan, contributes to enhancing South Africa's international profile. We gratefully acknowledge the faith you have placed in us. Finally, I must extend our thanks to the Bank of Tokyo-Mitsubishi for their efforts in finalising the documentation and driving this process under tight deadlines. We also appreciate Mizuho Corporate Bank's efforts in arranging today's signing ceremony and we look forward to working with Bayerische Landesbank as facility agent going forward. Thank you. 2/2
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Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the cocktail reception for delegates to the G-20 seminar, Pretoria, 3 August 2005.
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T T Mboweni: G-20 seminar on economic growth Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the cocktail reception for delegates to the G-20 seminar, Pretoria, 3 August 2005. * * * Ministers, deputy ministers, governor, deputy governors and esteemed delegates Let me extend a warm welcome to the delegates from the G-20 countries to the G-20 Seminar on Economic Growth, which is jointly hosted by the South African Reserve Bank, the People’s Bank of China and Banco de Mexico. It is indeed an honour for me to welcome representatives from various leading countries for discussions on a topic that is of great importance not only to the members of the G-20 but to every country. Permit me also to briefly remind you of the important principles that are set out in the G-20 Accord for Sustained Growth that was discussed at the sixth meeting of Finance Ministers and Central Bank Governors of the G-20 held in Berlin in November 2004. Our Accord for Sustained Growth is all about mobilising economic forces for satisfactory long-term growth by focusing domestic policy on three tasks in particular: establishing and maintaining monetary and financial stability; enhancing domestic and international competition; and empowering people to participate. While appropriate and credible policies are the basis for economic growth, they need to be backed by high-quality institutions, including ethical standards in corporate governance. However, given the diversity of institutional settings and the success of different economic strategies among G-20 countries, it is acknowledged that there is no single template for strong long-term growth. Policies need to be shaped to the special circumstances in individual countries. The Accord deems price stability as being indispensable for sustainable economic growth as it fosters investment and saving. High inflation is destabilising and has a strong negative impact on the poor, while deflation squeezes profits, discourages investment and leads people to postpone spending. The Accord acknowledges the importance of central bank independence in helping to achieve the goal of price stability in the long run. Fiscal discipline is seen to be equally important by, and fiscal policy should ensure that public expenditures and debt remain at reasonable levels in relation to national aggregates in order to prevent economic growth being restrained by crowding-out, anticipated future tax increases and inflationary pressures. The Accord states that the domestic financial sector must be able to withstand economic shocks without giving rise to systemic problems which impair the allocation of savings to investment opportunities and the processing of payments in the economy. Currency mismatches could be diminished by strengthening domestic banking systems and capital markets. Strong domestic financial sectors can reduce the need for foreign currency borrowing and become an alternative channel of external funding by attracting foreign investors into domestic currency instruments. High priority must be given to implementing the relevant internationally recognised standards and codes. The liberalisation of the capital account yields essential efficiencies and benefits for economic growth but the Accord stresses that the elimination of restrictions on capital movements should be appropriately sequenced and that countries seeking domestic monetary autonomy while substantially liberalising their capital account should increase the degree of exchange rate flexibility accordingly. The Accord regards competition as the driving force of economic growth because it fosters efficiency and is essential for innovation and strong investment activity. Carefully designed policies of deregulation, privatisation, and liberalisation of international transactions are important means of strengthening competition. Policymakers are encouraged to aim at strengthening and enforcing intellectual and other property rights, contract law, bankruptcy procedures and anti-trust regulations. Also, efforts will be required to promote good governance and combat corruption. Global trade liberalisation is deemed an essential instrument to promote growth by channelling resources to their most productive use. Policymakers worldwide are encouraged to move ahead vigorously on the basis of multilateral commitments giving due consideration to adjustment costs. Multilaterally consistent bilateral and regional agreements can also contribute to trade liberalisation. Labour market conditions are also crucial cornerstones in achieving high employment levels and broad participation of the labour force and both wage levels and working hours need to be responsive to market requirements and reflect national circumstances. The Accord also emphasises the importance of policies to provide opportunities and incentives to gain and improve skills, foster labour mobility, strengthen incentives to work in the formal sector and reduce information asymmetries. A favourable overall investment climate, including adequate infrastructure, will support domestic capital accumulation and also be attractive for foreign direct investment. The Accord states clearly that mobilising all productive forces of a society requires empowering individuals and enhancing economic participation. Education and training are key requirements as they improve people’s chances of finding jobs and contribute to higher productivity. The broadly-based provision of high-quality education should be a responsibility of governments. An educated population is better placed to demand the provision of good governance and sound institutions. Broadly-based access to a wide range of financial services and reducing impediments to small businesses, such as the time to start a business, is of crucial importance as it fosters entrepreneurial capacities and facilitates the integration of people into the formal economy. While employment is the first and best safeguard against social exclusion, social safety-nets are needed to cushion the effects of unemployment. Moreover, the elements of social infrastructures such as clean water, sanitation and basic health services are public goods whose provision has a positive impact on welfare and potential growth. It is important to design social policies so as to permit market mechanisms to function effectively. As to the agreed actions to implement the G-20 Accord for Sustained Growth, the Finance Ministers and Central Bank Governors adopted the reform agenda that translates our G-20 Accord for Sustained Growth into concrete policy measures for our countries. Progress in this regard will be reviewed at the meeting in Beijing in October 2005, which this seminar will feed into. As to progress by South Africa, I am particularly pleased to report that the Reserve Bank has been making an important contribution to macroeconomic stability, thereby creating a stable framework for growth. CPIX inflation has remained in the 3-to-6-per-cent target range since September 2003, i.e. for 22 successive months. Gross domestic product growth measured 3,7 per cent in 2004 and is expected to grow at similar levels this year, and the government’s objective is to implement policies to raise the growth rate to even higher levels. To promote growth and employment, the South African government has continued along the path of fiscal discipline and has been focusing on enhancing the efficiency of the public service and on infrastructure investment, increasing savings and skills development. The deliberations of the next two days will help shape the strategies in this regard. I wish to conclude by referring to the often quoted inspirational words from Robert Lucas in 1988 “ Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them it is hard to think about anything else.”1 Clearly the Indian government seems to have met Lucas’s challenge and so there are surely lessons to be learned from each and every country’s experience. We look forward to the presentations by the various delegates as set out in the programme during the course of the next two days and to discussions on economic growth and issues of common interest and relevance to our various countries. Meanwhile, welcome once again and may this important seminar achieve all its objectives. Thank you. Zhou Xiaochuan: Improve corporate governance and develop capital market Speech by Mr Zhou Xiaochuan, Governor of the People’s Bank of China, at the High-level Forum on China’s Reform, Beijing, 13 July 2005. * * * Dear friends, ladies and gentlemen, Lucas, Robert E., Jr. (1988). “On the Mechanics of Economic Development.” Journal of Monetary Economics, 22, July, 3-42. Good morning. It’s my pleasure to attend this High-level Forum on China’s Reform. The theme of this forum, which is “Promoting Institutional Innovation by Emphasizing the Reform of Government Administration System”, implies that discussions will be made on the performance of the government and the steps it needs to take in the future. Having a well-established tradition of criticism and self-criticism, the Chinese government has always attached importance to promoting the reforms by deepening its understanding of various issues. In this context, I would like to speak on the roles of the government in promoting the reform of the financial institutions. First, the government needs to further clarify the objectives of the reform and restructuring of the financial institutions. Why should we spend resources on financial sector reform and restructuring? There are two answers to this question. Some people think that financial sector reform aims at preventing risks, crisis and instability, thereby avoiding causing trouble on the government. People holding such a view believe that since risks are concentrated in the financial sector, some risky financial institutions should be closed to eliminate the risks. While some people think that the sustainable, steady and healthy development of the national economy depends on a robust financial sector that provides good financial services. Therefore, we need to carry out the reforms to make most financial institutions strong and healthy, so that they will be able to operate with lower risks and at the same time provide good services, thus contributing to the development of the national economy. The first view is somewhat narrow and short-term based. Risk is not the only factor we need to consider. Inadequate financial services will hamper economic development. One example is related to the rural financial institutions. After we closed some financial institutions because of their unhealthy development, financial services in the rural area became insufficient, hindering the development of the rural economy. The second view emphasizes the role of the financial sector in the allocation of resources. With inadequate financial services, the savings will not be effectively allocated, resulting in a waste of resources and significant negative impact on the long-term growth efficiency. Although the financial sector will give rise to risks, it can also absorb risks. In fact, the financial sector absorbs some of the risks produced by the real sector, and plays the role of price-discovery for the real economy. If performing well, the financial market can serve to absorb, buffer and resolve risks. If we hold the view that the objective of financial sector reform is to make the financial institutions stronger and healthier, measures need to be taken in many areas. First, the government should properly handle the burden of non-performing assets of the financial institutions left over from the past or during the transition period. Second, sound financial, accounting, loss provisioning and tax systems need to be set up to create a favorable institutional environment to enable the financial institutions to develop soundly and provide good financial services. Third, the government should remove unwarranted controls and establish effective incentives to encourage the financial institutions to improve their services and contribute to better allocation of resources. Fourth, steps need to be taken to promote competition-based market mechanisms and eliminate unnecessary price control to enable prices to play a larger role in the economy. Fifth, measures should be taken to help the financial institutions to improve their ability to properly set the prices, including on the money market and capital market. Sixth, we also need to take active and steady steps to develop various instruments including the financial derivatives that can help form an effective pricing mechanism in the market. Seventh, clear strategies on the intermediate services, including accounting, evaluation and credit rating, need to be formulated taking into account both the current need and long tem development of the market. Second, principles and guidelines of corporate governance need to be further clarified. Many people have realized that improving corporate governance is of crucial importance to the entire reform. Nevertheless, the concept and content of corporate governance have yet to be clarified. The basic requirements of corporate governance are set in the Company Law, which needs further improvement in China. On the other hand, the Company Law does not encompass every aspect of corporate governance. Corporate governance involves the agreements or practices outside the stipulations of laws and regulations and those of the self-disciplinary organizations as well as the cultural traditions. In China, different departments or institutions have different understanding for the requirements of corporate governance. We can see that these requirements have major omissions, and no guidelines have been given to resolve the main practical issues. No official view has been clearly expressed regarding the OECD Principles of Corporate Governance (both the 1999 version and the 2004 revised version). Therefore, the reform of corporate governance is likely to be a reform without clear definitions. I’m going to give several examples in this regard. First, preserving shareholders’ rights is one of the core elements of corporate governance. Nevertheless, violating the rights of the shareholders is not a rare phenomenon in China, and there is explicit solution to this problem. For instance, in the debt-equity-swaps, no effective measures are in place to safeguard the rights and interests of the shareholders, and in many cases, the assets they were holding turned out to be neither a loan nor an equity. Second, the OECD Principles of Corporate Governance emphasizes the role of stakeholders. So far, there has not been an accurate and widely accepted translation in Chinese for the word “stakeholder”, nor do we have principles or guidelines concerning the role of stakeholders in corporate governance. Third, the respective roles of the Party organizations and of the board of directors and the management need to be clarified. This is an issue unique in China. In most cases, the Party organizations play a positive role in supporting the operation of the board of directors and the management. However, there are some occasions where the Party organizations and the board of directors or management hold different opinions on certain issues, calling for principles and guidelines to resolve such issues. Fourth, the relationship between corporate governance and the authority’s regulation and supervision need to be properly handled. In the planned economy and during the early transition period, government acted as both the owner and the supervisory authority of the enterprises. Despite the fact that enterprise management and government supervision have been basically separated, there are often cases where these two become mixed together. Clear principles and guidelines are needed in this area. Improving corporate governance is a reform on which the public has placed great hopes. We must not let the public disappointed because of unclear principles and guidelines in pursuing the reform. The government should play an important role in setting up clear principles and guidelines on corporate governance by drawing upon the international and historical experiences as well as taking into account China’s current specific situation. Third, the operations and policies of asset management companies need to be improved. During the several years of development since they were established in 1999, some problems have emerged, which are reflected in the prices at which the non-performing assets are disposed, the abuse of power for personal gains, and the undue transfer of benefits. Several issues are yet to be clarified. First, if and only if the objective of the reforms is to make the financial institutions stronger so that they can provide better financial services does it make sense to dispose the non-performing assets left over from the past, particularly during the period when the management of the enterprises were not separated from government administration. Otherwise the disposal of non-performing assets would be nothing but transferring the risks from the “left pocket” to the “right pocket” of the government, which will invite criticism from the public. Second, the asset management companies have been established to handle the non-performing assets in a professional way. It should be noted that the assets they are dealing with are not good assets, but those classified as doubtful or loss. In terms of value preservation and enhancement, different methods are required for handling the non-performing assets and the good assets. When seeking to recover the bad assets, we need to strike a proper balance between quantity and speed. Although the value of some assets will go up after they have been held for a considerable period of time, in most cases, the longer the assets have been held, the less their value will become. In this sense, the so-called “ice cream effect” does exist. On the other hand, the asset management companies seeking to dispose the non-performing assets very rapidly will likely face criticism, since people think that more will be recovered if the assets are disposed less rapidly. Third, against the background of market-oriented reform, the disposal of non-performing assets will be done through the market. Therefore, measures should be taken to develop the market and enable the assets to be disposed at the prices formed through market competition. This requires that market participants be under hard budget constraints, having sound financial system, clearly defined ownership and well established incentive structure. Regarding incentives, the government should set a clear baseline for the recovery of the non-performing assets, and establish an effective incentives system that will encourage the asset management companies to make the greatest efforts in recovering the assets. Problems will occur in the market-based disposal of non-performing assets if any of the above-mentioned measures are not taken properly. What can the government do? First, steps should be taken to improve the legal framework. Although we have in place a regulation on asset management companies, there are weaknesses in the formulation, administration and enforcement of laws and regulations governing the disposal of nonperforming assets. International comparison shows that China needs to make improvement in this area. Second, apart from the four state-owned asset management companies, private and foreign participants should be encouraged to enter this market to promote competition. Third, internal reforms should be carried out in the four state-owned asset management companies to enable them to operate on real commercial basis with hard budget constraints. Fourth, when the market has not been fully developed, it is desirable to let the institutions with rich market experiences to make price evaluation so as to avoid soft constraints and set up internal incentives. Fifth, efforts should be made to establish proper incentives. Without incentives or with very weak incentives, it is not possible to preserve and enhance the value of the assets and make maximum recovery. Without effective incentives, people may also tend to seek personal gains from the disposal of assets. Sixth, it is important to have appropriate procedures and prevent any improper practices so that the assets are disposed through market competition. However, if the market is not strong enough – for example, market participants are under soft constraints or there are adverse internal incentives, improper behaviors may arise even with sound procedures, and the procedures themselves may become a shelter disguising those improper activities. Seventh, it is crucial to develop market intermediaries, since the disposal of assets relies importantly on the integrity and services of the intermediaries. Eighth, the objectives of setting up asset management companies are not only to dispose the nonperforming assets in a professional way, but also to make the commercial banks stronger so that they will be able to provide better financial services. So the government needs to consider how to handle the relationship between the asset management companies and the commercial banks. The asset management companies will not operate satisfactorily and there will be much criticism from the public if the above are not handled properly. The State Council attaches great importance to the issues concerning the asset management companies. Premier Wen Jiabao has said that “the asset management companies have had five years’ experiences in disposing the non-performing assets, and it is time for them to carefully review the experiences and lessons and try to resolve the long-term problems”. Apart from promoting more effective internal management of the asset management companies and strengthening external regulation and supervision on them, the government has much more to do. From the longer-term point of view, China will need a well-functioning capital market to enable its economy to develop soundly.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Fedusa Third National Congress, Gold Reef City, 15 and 16 September 2005.
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T T Mboweni: The challenge of stronger economic growth and development in South Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Fedusa Third National Congress, Gold Reef City, 15 and 16 September 2005. * * * Introduction Thank you for your invitation to speak at the Fedusa Third National Congress. A constructive dialogue between labour and the other social partners is crucial for fostering community consensus on those issues that are important for accelerating growth and improving the quality of life of all South Africans. I welcome the opportunity to be part of this dialogue. In speaking about the challenge of stronger economic growth and development I will first briefly review where our economy currently stands, paying due attention to the statutory mandate of the South African Reserve Bank. The second part of the address will be directed at the debate on how much growth is needed for South Africa to absorb the unemployed within a reasonable timeframe, and – perhaps more importantly – what needs to be done to boost our growth and development momentum accordingly. Recent economic developments By this time we all know that South Africa's economic growth rate in the second quarter of 2005 amounted to 4,8 per cent, compared with 3,5 per cent in the first quarter. Most analysts forecast that real gross domestic product will increase by around 4 per cent in the full calendar year 2005, signifying an increase of more than 2½ per cent in real income per capita. What is particularly gratifying about the current growth environment is that our economy has enjoyed twenty-three quarters of uninterrupted economic expansion. This is the longest upswing in the recorded economic history of South Africa. The current recovery has the properties of a well-trained long-distance runner, rather than the characteristics of an unfit sprinter loaded with steroids performing admirably for just a fleeting moment. The improvement in growth in the second quarter of 2005 was mainly brought about by a sharp increase in real value added in manufacturing, which reflected rising domestic final demand and stronger export demand for certain categories of goods, alongside a somewhat more competitive level of the exchange value of the rand. Real output of the agricultural sector was bolstered by a bumper maize crop which was predominantly harvested in the second quarter, while simultaneously almost all the other main sectors of the economy displayed solid growth too. Enterprise-surveyed employment outside the agricultural sector recorded successive increases in each of the five quarters to September 2004. Private-sector job opportunities benefited most from the economic recovery, but there was also a moderate increase in public-sector employment. The pick-up in enterprise-surveyed employment was, however, not sustained in the last quarter of 2004 and the first quarter of 2005. Over the year to March 2005 enterprise-surveyed employment rose, on balance, by 111 000. The strongest increases were recorded in the community, social and personal services and trade sectors, while employment in gold mining, finance and manufacturing shrank over this one-year period. Whereas the enterprise survey measures formal employment in the main non-agricultural sectors of the economy, results from household surveys measures all employment. Household survey data indicate that total employment in South Africa expanded by some 500 000 jobs over the year to March 2005, but roughly half of this increase was in the informal, domestic service and agricultural sectors. 1/5 Returning to the narrower data based on the enterprise surveys, it is estimated that labour productivity rose by 2,6 per cent in the year to the first quarter of 2005. Workers engaged in more strike action in the recent past: Man-days lost to industrial action increased more than three-fold from the first half of 2004 to the first half of 2005. Nevertheless, nominal remuneration per worker rose by 8,7 per cent in the year to March 2005, noticeably slower than previously. Allowing for productivity changes, unit labour cost increased by 5,9 per cent in the year to March 2005, i.e. 1,3 percentage points lower than the average rate of increase in 2004. Wage settlements averaged 6 per cent in the first half of 2005. These wage settlements and remuneration increases are modest compared to the high nominal increases recorded in the 1970s and 1980s. However, those distant increases were eroded by equally high inflation. After allowing for fiscal drag they did little if anything to improve the average worker's real disposable income. Currently inflation is much lower, and as a consequence there is far less money illusion and inflationary distortion which misdirect economic decisions. In July 2005 CPIX-inflation amounted to 4,2 per cent, registering its 23rd successive month within the inflation target range of 3 to 6 per cent. Although one cannot deny that it has been a difficult journey to low inflation, the benefits are apparent: More certainty regarding the future purchasing power of the money in our pockets, better planning, especially of cash-flows for those households and businesses using credit and accordingly having to make interest payments. The cash-flow improvement follows because sustained low inflation creates the scope for nominal interest rates to move to lower levels. The achievement of sustained lower inflation made it possible for the household sector to incur more debt – largely for housing and durable consumption purposes – without a significantly heavier interest burden. Since 1999 the household-debt-to-disposable-income ratio, on balance, rose from 57 per cent to more than 60 per cent, whereas the debt-serviceto-disposable-income ratio decreased from around 10 per cent to about 7 per cent. Revealing as they are, these aggregate numbers do not show that numerous households that are already over-indebted and facing uncomfortable circumstances are included in the totals. Nor do they show that there is a further significant number of people who just make ends meet but who would be in dire straits if a fairly small interest rate increase were to take effect. Nevertheless, with employment and real disposable income rising and the average debtservice ratio well contained, most households are still in a comfortable position and this is likely to persist, provided they continue to live within their means and allow for some cushion to shield them against unforeseen events. The South African Reserve Bank is committed to ensuring that the hard-won gains in the fight against inflation are not forfeited. With international oil prices recently recording recordhigh levels, there is no shortage of factors waiting to fuel the inflation spiral. While the immediate or first-round effects of rising energy prices would have to be accepted, monetary policy will not allow this to develop into an inflationary spiral. The Bank will continue to honour its mandate as enshrined in the Constitution and the South African Reserve Bank Act and given explicit content through the adoption by the Government of a 3-to-6-per-cent target range for CPIX inflation. Towards stronger growth and accelerated development These promising economic conditions are clouded by the high rate of unemployment in South Africa: 26 per cent of the workforce is unemployed. Recently debate intensified regarding ways to enhance the growth capacity of South Africa in order to make meaningful inroads into unemployment, poverty and underdevelopment. A sustained real growth rate of around 6 per cent per annum is often mentioned in this context. It is worthwhile to reflect on 2/5 some of the key strands in this debate and to provide a central banker's perspective on some of these. At a G-20 conference on economic growth which was recently held in South Africa and coorganised by the Bank, it was argued that there is more to sustained and vibrant growth and development than just "good macro". In other words, prudent and consistent monetary and fiscal policies, while necessary in order to achieve sustained strong growth and development, are not sufficient. What is needed beyond a prudent and stable macroeconomic policy arrangement is unfortunately not available in standard recipe format, but depends on the specific circumstances in each country. Allow me to discuss a handful of reforms which are likely to be crucial to enhancing the long-term health and vigour of the South African economy. The maintenance, upgrading and expansion of infrastructure deserve a prominent position among any list of reforms needed to propel growth to a higher plane. The real fixed capital stock of South Africa rose by just 2 per cent in 2004, and by between 1 and 1½ per cent per annum in the preceding four years. A continuation of such low rates of increase in the capital stock is clearly not supportive of a real GDP growth rate of 6 per cent per annum. Assuming that the capital stock would have to increase by 4½ to 5 per cent per year to support a real growth rate of 6 per cent per annum, it would require the ratio of fixed capital formation to gross domestic product to rise from the current 17 per cent to around 22 per cent in order to achieve such growth on a sustainable basis. Government – at all levels – and public corporations have committed themselves to ambitious capital programmes. However, implementation almost invariably seems to take longer than initially planned. Institutional capacity rather than money seems to be the problem in many instances. Much has been said about the inadequate road and rail infrastructure which hinders the efficient movement of workers between their residences and places of work, while also inhibiting the movement of goods between producers and markets. Similar concerns have been voiced regarding certain ports. Unfortunately sweeping statements discrediting all infrastructural installations are not at all helpful. The challenge lies in identifying specific current and future bottlenecks at the microeconomic level, followed by the often thankless processes of budgeting, planning, implementation and maintenance management. In each of these processes dedication, appropriate skills and long-term commitment are required to deliver the goods. Those overseeing these processes should stay committed to each project, infrastructure creation, with lengthy gestation periods, clearly would not benefit from high turnover at management level. Several exciting microeconomic reforms involving South Africa's infrastructure are in the pipeline. The introduction of a second fixed-line telephone operator, for example, seems set to increase competition and reduce communications costs. De-mothballing of power generating plants and the upgrading of power distribution networks, water-supply infrastructure, railway lines and rolling stock are all to be welcomed. While our main airports currently seem to cope well, projected further increases in passenger numbers and freight volumes necessitate further expansion. The cluster of industries linked to infrastructure is evidently going to experience buoyant times in the coming years. The accompanying imports of machinery and equipment might, of course, initially widen the deficit on the current account of our balance of payments. However, foreign finance usually accompanies such imports, and later on the improved infrastructure is likely to boost exports as the supply side of our economy is streamlined. A particularly sensitive area is that of land reform. Patterns of land ownership which have evolved over time are not sustainable, and need to change. However, great care needs to be taken in this process. What South Africa cannot afford is the kind of reform where agricultural land which is being used productively is purchased with taxpayers' money, transferred, and ends up being used far less productively than before, subtracting from the country's output 3/5 and destroying job opportunities. Farming is a modern business requiring specialised skills as well as financial capital. Adequate attention has to be paid to the training of newly empowered farmers, advisory services, and financial support for a limited period. Success in improving growth and creating jobs hinges critically on appropriate skills development. This does not require throwing money at the problem, but aligning the system of education and training to the requirements of a modern economy. Agriculture's share in total value added in the economy has dwindled from 7,7 per cent in 1975 to 3,4 per cent last year, and that of mining from 11,1 per cent to 7,1 per cent over the same period. Construction's share fell from 5,1 per cent in 1975 to 2,4 per cent in 2004 (but this should, of course, rise as infrastructure spending gets underway). At the other extreme, the share of the finance, real-estate and business services sector in the economy grew from 12,5 per cent in 1975 to 20,1 per cent last year, and that of community, social and personal services from 16,1 per cent to 21,0 per cent over the same period. Product lines and production processes within the various sub-sectors have undergone revolutionary change with the introduction of sophisticated information and communications technologies. The skills requirements of a modern services-oriented economy (the tertiary sector currently generates 65 per cent of total value added in South Africa) are dramatically different from the requirements which faced entrants to the labour market 30 years ago. In reflecting on ways to systematically improve prospects for growth, the role of the exchange rate merits some consideration. Firstly, it should be emphasised that the authorities have a target for the inflation rate and not for the exchange rate. The exchange rate is essentially determined by supply and demand in the foreign exchange market, reflecting the decisions of numerous participants – tourists, investors, importers, exporters and the like. But for various reasons the Bank cannot be blind to the exchange rate, and has a clear preference for a relatively stable and competitive level of the exchange value of the rand. The preference for a relatively stable exchange value of the rand originates from the painful adjustment costs which accompany large movements in the exchange rate. Adjustment at the margin is a natural economic phenomenon, but large movements in the exchange rate can render entire sectors uneconomical and others extremely viable within a very short period of time. The preference for a competitive level of the exchange rate reflects the need for sustainability – for exporters to move into foreign markets and to stay there. The preference for a relatively stable and competitive exchange value of the rand is seldom perfectly matched by economic outcomes. The foreign exchange market in South Africa is highly liquid (turnover nowadays exceeds US$13 billion per day) and powerful forces beyond our control, such as the international prices of commodities, have a considerable bearing on price formation in the foreign exchange market. Practical experience in the central bank with large-scale intervention in the foreign exchange market has been sobering. Zealous intervention in a liquid market with numerous financially strong participants can be a costly and largely futile exercise. In practice, the Bank prefers to leave the determination of the exchange rate to market forces. The Bank disseminates data on the balance of payments, foreign exchange reserves and related matters, thereby helping to inform market participants' decisions. On rare occasions the Bank may comment on evidence pointing to possible excesses in price formation in the foreign exchange market. The best medicine for the one-way view regarding the direction of the rand's exchange value which prevailed from the early 1980s up to 2001, however, was the recovery of the rand over the past four years, which bit deeply into the pockets of rand pessimists. The Bank may also build up or reduce its international reserves; in recent years the emphasis has been on accumulating international reserves, which naturally has had some price consequences but did not signify the adoption of a target level for the exchange rate. When abundant amounts of foreign exchange are available in the market (and the rand is comparatively strong) it presents the Bank with a good opportunity to buy more foreign 4/5 exchange from the market, since its holdings of gold and foreign exchange are on the low side. On balance the Bank has increased its gross gold and foreign exchange reserves from US$8 billion at the end of 2003 to just below US$19 billion at present. Conclusion Despite some progress made in recent years, high levels of unemployment necessitate more ambitious steps to strengthen South Africa's growth potential. The Reserve Bank is committed to containing inflation, thereby providing a launching pad for enhanced growth and development. But this is not a sufficient condition for economic success. Enhanced infrastructural development, the implementation of education and training programmes which deliver the skills necessary for a modern economy, and careful land reform are but a handful of the key ingredients necessary for boosting economic performance. And, as with monetary policy, all of these elements need to be nurtured carefully as it takes a while before they bear fruit. They require total dedication and sustained attention to detail if they are to be successful. Success is in our hands. 5/5
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Statement of the Monetary Policy Committee by Mr T T Mboweni, Governor of the South African Reserve Bank, at the South African Reserve Bank, Victoria, 13 October 2005.
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T T Mboweni: Monetary and economic trends in South Africa Statement of the Monetary Policy Committee by Mr T T Mboweni, Governor of the South African Reserve Bank, at the South African Reserve Bank, Victoria, 13 October 2005. * * * Introduction For the past two years, CPIX inflation has been within the inflation target range of 3-6 per cent. In recent months, however, oil price developments have posed an increasing risk to the continued attainment of the inflation target and since the last meeting of the Monetary Policy Committee, CPIX inflation has risen by 1,3 percentage points. These increases were in line with expectations, and our current forecasts show that we should remain within the target range over the forecast period. More recently there has been some respite in the oil market, and prices have moderated from recent peaks caused by hurricanes Katrina and Rita. However, oil prices remain at high levels and continue to be of concern. Despite the petrol price increases, the economy continues to perform at a robust pace, domestic demand remains strong, and formal sector employment has increased. Recent inflation developments Inflation as measured by the consumer price index for metropolitan and other urban areas excluding the interest cost on mortgage bonds (CPIX) reached a low of 3,1 per cent in February and then began to increase, mainly as a result of petrol price movements. After measuring 3,5 per cent in June, CPIX inflation increased to 4,2 per cent and 4,8 per cent in July and August respectively. During these two months, the petrol price increased by a total of R0,56. Excluding petrol and diesel costs, CPIX inflation measured 3,6 per cent in both July and August having averaged 3,4 per cent for the previous 12 months. This indicates that thus far there has been limited pass-through from petrol prices to prices of other goods and services. Other categories of goods and services that have shown significant price increases are tobacco products, domestic workers’ wages, medical costs and education. In contrast, prices of clothing and footwear have continued to fall, while most other categories show very subdued price increases. Despite recent increases in the maize price, food price inflation has remained low, measuring 2,7 per cent in August. Administered prices excluding petrol rose at 5,9 per cent, marginally below the upper limit of the inflation target range. However if the petrol price is included, administered prices increased by 11,2 per cent. Production price inflation has also displayed a marked upward trend, reflecting to a significant degree the higher energy prices. Having measured 2,4 per cent in May 2005, production price inflation increased steadily, reaching 4,2 per cent in August. Imported goods inflation increased from an annual rate of 1,8 per cent in May to 6,2 per cent in August, while domestically produced goods inflation increased from 2,6 per cent to 3,6 per cent over the same period. The outlook for inflation Owing mainly to the adverse oil price developments, the Bank’s inflation forecast has deteriorated somewhat since the last MPC meeting. However CPIX inflation is expected to remain within the target range of 3-6 per cent over the forecast period. The upper turning point is expected to occur in the first two quarters of 2006 at a level just below 6 per cent. Thereafter, CPIX inflation is expected to resume a moderate downward trajectory. Although there are no clear signs of second-round effects, the longer the upward trend and volatility of oil prices persist, the more likely the price increases will continue to impact on expectations and feed through to other prices. Monetary policy has to remain vigilant in anticipating such developments. Since the last meeting of the MPC, the international crude oil prices reached new record levels of almost US$70 per barrel in the wake of the hurricanes in the United States. The price of Brent crude averaged around US$64.50 per barrel in August and US$63 in September, compared to US$58 in July. These developments resulted in further increases in the domestic petrol price of R0,29 and 1/3 R0,12 per litre in September and October respectively, and will contribute to further upward pressure on CPIX in those months. More recently crude oil prices have declined to below US$60 per barrel and if this trend continues, we could see a moderate decline in petrol prices in November. However the volatility of international oil prices means that significant upside risk remains. There are a number of other developments that also pose risks to the inflation outlook. The latest inflation expectations survey conducted by the Bureau for Economic Research at the University of Stellenbosch indicates that there has been a marginal deterioration in inflation expectations which may be a result of the impact of the higher petrol prices. CPIX inflation is now expected to average 5,2 per cent next year, and 5,4 per cent in 2007, up 0,3 per cent and 0,4 per cent respectively. The deterioration in inflation expectations was also reflected in the increase in the breakeven inflation rates, measured by the spreads between the yields on South African CPI inflation-linked bonds and conventional nominal bonds of the same maturity. If the deterioration in inflation expectations were to continue, it would be a cause for concern given the critical role of expectations in the price and wage formation process. The economy has continued to grow at a robust pace, with quarter-on-quarter annualised real GDP growth accelerating from 3,5 per cent in the first quarter of 2005 to 4,8 per cent in the second quarter. This acceleration was attributed in part to the strong increase in the real value added by the manufacturing sector, which appears to have recovered from the contraction in the first quarter. The utilisation of production capacity in manufacturing, having fallen back in the previous two quarters, picked up again in the second quarter of 2005. The physical volume of manufacturing production continued on an upward trend in the third quarter and the most recent value of the Investec/BER Purchasing Manager's Index (PMI) also indicates that the recovery in this sector has continued, although at a more moderate pace. Most other sectors have also remained buoyant and the composite leading business cycle indicator shows a favourable growth outlook. This positive growth performance had a positive effect on employment. According to the Quarterly Employment Statistics survey, formal non-agricultural employment increased at an annualised quarteron-quarter rate of 7,6 per cent in the second quarter of this year. Over the past year this reflects an increase of 84,000 employees. Domestic demand shows few signs of significant moderation and all components of final demand grew at a healthy rate in the second quarter. New motor vehicle sales reached new record highs in September, although there was a moderate slowdown in the growth of motor vehicle sales which increased by 25,3 per cent over the year. The strong domestic demand has been underpinned by low nominal interest rates, higher real incomes and increases in asset prices. Share prices on the JSE Limited, for example, reached new record highs, and since the previous MPC meeting the all-share price index increased by 4 per cent. The vigorous demand was financed in part by increased borrowing, and the household debt ratio continued to rise in the second quarter. Household debt as a percentage of disposable income rose from 60 per cent in the first quarter to 62 per cent in the second quarter of 2005. However, because of the low nominal interest rate environment, debt servicing cost as a percentage of disposable income remained unchanged at a relatively low level of 6½ per cent. The monetary and credit aggregates have also been increasing at rates consistent with strong domestic demand. Year-on-year growth in M3 picked up from 17,1 per cent in June 2005 to 19,9 per cent in July and 19,0 per cent in August. Total domestic credit extension grew by 18,0 per cent in July and 18,3 per cent in August. Twelve-month growth in bank loans and advances to the private sector remained above 20 per cent, with increases in mortgage advances reaching 26 per cent in August. The latter reflects continued buoyancy in the housing market, although the rate of increase in house prices has fallen steadily since September 2004. Strong domestic demand and high international crude oil prices have impacted on the current account of the balance of payments. Although the deficit on the current account of the balance of payments as a percentage of GDP contracted to 3,4 per cent in the second quarter of 2005, data for July and August indicate a possible widening of the trade deficit in the third quarter. The current account however remains financed by capital inflows, and the international liquidity position of the Bank increased to a level of US$16,1 billion at the end of September. World inflation is expected to be negatively affected by higher oil prices. The IMF now predicts that world inflation in 2006 will average 3,7 per cent, compared to the April forecast of 3,1 per cent for the same period. Nevertheless this is lower than the revised 3,9 per cent average expected for 2005 and 2/3 indicates that world inflation appears to be well contained. World growth is expected to be sustained at a robust rate of 4,3 per cent in 2006 although it has moderated somewhat since last year. Not all developments have been negative from an inflation perspective. Although inflation expectations have deteriorated moderately, there is no evidence that this has impacted on wage settlements. Unit labour costs in the first half of this year increased at rates within the inflation target range, measuring 4,6 per cent and 5,3 per cent in the first two quarters of this year. The nominal effective exchange rate of the rand depreciated by 0,3 per cent since the last meeting of the MPC, but it has been relatively stable over the period. The volatility that did occur was to a large extent a reflection of movements between the euro and the US dollar. Positive international perceptions of South Africa were further confirmed with the recent sovereign credit rating upgrade by the Fitch rating agency. Monetary policy stance The deterioration in the inflation outlook cannot be ignored. The increased risk of possible pass-through leading to pronounced second-round effects on CPIX inflation must inform policy going forward. Although there is no conclusive evidence of pass-through at present, and the Monetary Policy Committee has not judged it necessary to change the monetary policy stance at this meeting, these developments will be closely monitored. The Committee stands ready to take the appropriate action in order to ensure that the inflation target mandate continues to be achieved. At this meeting the MPC has decided therefore that the repurchase rate will remain unchanged at 7 per cent per annum. 3/3
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the BER conference on Growing the South African Economy, in Somerset West, Pretoria, 9 November 2005.
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T T Mboweni: Monetary policy and sustainable economic growth Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the BER conference on Growing the South African Economy, in Somerset West, Pretoria, 9 November 2005. * * * Thank you for your invitation to speak at this conference on Growing the South African Economy. Over many years the Bureau for Economic Research (BER) has in numerous ways helped to inform economic analysis and policy in South Africa. It has for instance in recent years been commissioned by the South African Reserve Bank to survey inflation expectations in South Africa. This has been very helpful in the deliberations of the Bank’s Monetary Policy Committee. But apart from this narrower interest which the Bank has developed in the activities of the BER, the Bureau and its respondents provide a wide range of economic indicators which warrant the attention of analysts and policymakers alike. The BER also stirs debate on highly relevant topics, as again demonstrated by today’s conference. The economic situation in and outlook for South Africa have already been covered earlier today, alongside the possible direction of political developments. Industrial policy and fiscal policy have also already been discussed. My remarks on monetary policy and sustainable growth will consist of some thoughts on enhancing the tempo of growth and development in general, before narrowing in on what monetary policy can do and cannot do in this regard and reflecting on some developments which are important in informing current monetary policy decision-making. Sustainable economic growth Vibrant growth, sustained over lengthy periods of time, opens up exciting possibilities. Some of the most dynamic examples in this respect are Korea, where real gross domestic product per capita is now four times its level in 1980, and Botswana, where the same comparison yields an increase to 3.3 times what it was 25 years ago. In South Africa real gross domestic product per capita has been rising steadily since 1993, but this followed a gradual decline during the preceding 13 years, resulting in real per capita production at present being quite close to its level a quarter of a century ago. Stepping up the tempo of per capita gains of the past 11 years is an important focal point, and is currently receiving the attention of government, business, labour and community. A G-20 conference on economic growth, co-organised by the South African Reserve Bank together with the People’s Bank of China and the Banco de Mexico, was hosted in the Bank’s conference centre in August this year. It might be worthwhile recalling some of the points made at that meeting of minds. While it was generally agreed that economic growth is one of the most important challenges facing all countries, it was emphasised that no universal recipe for growth exists since each country faces a different set of constraints. There is more to growth than good macroeconomic policy. To obtain higher growth does not seem to require a large set of very fundamental or deep reforms, but rather a more effective focus on a small set of binding constraints. It is extremely important that appropriate strategies be developed to properly identify such binding constraints. Such action requires an institutional setting that allows for a dynamic process where problems are identified, on the one hand, but also effectively addressed, on the other. In doing so not only government failures have to be dealt with, but also market failures, such as large externalities, that require government action. The list of possible binding constraints is virtually endless. Some studies have suggested that high levels of taxation discourage growth through their effect on incentives to work, save and innovate. Others have pointed to the importance of protecting private property rights if growth is to be dynamic. Still others note the importance of human capital, and highlight the role of education as a determinant of economic growth. Excessive rules and regulations can stifle economic progress, slowing fixed capital formation, undermining flexibility and discouraging productive enterprise. Establishing which of these, and many more candidate constraints, is most relevant and then getting policies right is crucial if trend growth is to be increased. As these examples illustrate, many of the things that impact on the quantity and efficiency of the factors of production are quite broader than monetary policy and the ambit of central bank influence. 1/4 As we all know, economic growth might be a necessary but not a sufficient factor in employment creation. What monetary policy can do Sound monetary policy can provide a stable platform for sustainable economic and employment growth. This is recognised in national economic policy and in the South African Reserve Bank Act, both of which assign to the Bank the objective of achieving and maintaining price stability in the interest of balanced and sustainable economic growth in the Republic. High inflation causes numerous well-documented distortions and frictions in the economy. The higher inflation is, the more variable it also tends to be, adding further uncertainty to economic decisionmaking. Low inflation enhances predictability and planning, reduces the uncertainty premia built into nominal and real interest rates, and thereby supports sustained and balanced economic growth. The view that a monetary policy aimed at keeping inflation low is anti-growth is simply wrong. There is no permanent trade-off between inflation and unemployment, and even the short-run trade-off tends to be elusive in an environment where expectations formation is increasingly sophisticated and forward-looking. That said, getting from high inflation to low inflation requires a sustained tight monetary policy. It cannot be denied that a tightening of policy will tend to hurt short-term growth, just as getting fit invariably requires some sacrifice by the athlete. But South Africa’s experience under formal inflation targeting has been relatively favourable. When in late 2001 and during 2002 the inflation targeting framework was severely tested on account of an extraordinary depreciation of the exchange rate of the rand which fuelled inflation, the Bank had to raise short-term interest rates by a total of 4 percentage points. Alongside a conservative fiscal policy and a recovery in the exchange value of the rand, this was enough to first brake and later on reverse the acceleration in inflation. This was done with quite limited loss of real output, partly because of the stimulation to the tradables sector imparted during 2002 by the over depreciated exchange value of the rand, and partly because policymakers deliberately refrained from raising interest rates excessively, mindful of the lags characteristic of the transmission of monetary policy to the economy. Thorough investigation of the business cycle reveals that the economy remained in an upward phase of the business cycle throughout the period of tighter policy in 2002 and 2003. In fact, the upswing has now been sustained for some six years. Being directed at combating inflation with a medium-term orientation, the other side to the coin of the inflation targeting framework which has been adopted in South Africa is that real interest rates are likely to remain positive under virtually all circumstances. This supports balanced and sound growth, inter alia by ensuring that the relative prices of the factors of production are reasonably aligned with their true scarcities. Previous experimentation with negative real interest rates in the 1970s and 1980s contributed to suboptimal allocation of scarce capital, excessive capital intensity in production and weak growth outcomes. Avoiding this obvious pitfall is a very important contribution which monetary policy can make, at the same time helping to ensure fair returns to savers and combating the deterioration in the national saving rate. What monetary policy cannot do Unrealistic expectations regarding what monetary policy can do abound. While monetary policy can contain inflation, reduce inflation risk and uncertainty premia in the economy, ease the cash flow of borrowers once interest rates have adjusted to the low-inflation environment, and contribute towards sound factor allocation, it cannot do any of these things overnight. Allowance should be made for long and variable lags in the operation of monetary policy. A stable environment of low inflation is no guarantee that the private sector will be willing to take risk and establish enterprises, in the process employing resources and producing more output. Neither can it guarantee that government will produce the public goods and services necessary to support sound growth and development. Efficiency in such production, whether by the private sector or by government, can also not be guaranteed. Nevertheless, the absence of distortions arising from inflation significantly improves prospects that these very deserving things will happen and will be reflected in improved growth and employment outcomes. 2/4 Monetary policy in our case does not simultaneously target inflation and the exchange rate. Once the inflation targeting framework was introduced, the exchange rate has essentially been left to be determined by supply and demand forces in the market. Not that there is no relationship between inflation and the exchange rate: If inflation is kept low as it is in our significantly large trading partner countries, the exchange rate is mostly likely to move sideways over the long run. But this does not constitute exchange rate targeting. To develop this point further, one of the calls frequently made is for deliberate depreciation of the exchange value of the rand in order to retain and expand employment in the tradables sector and to enhance overall growth. To realise such a goal in practice would conceivably require some combination of significant exchange rate interventions by the Bank, a radical lowering of interest rates, abolishing of exchange controls and pronouncements by the Bank that it views the external value of the rand as too strong. Each of these, however, has its own challenges. Foreign exchange interventions of the kind demanded of the Bank involve payment of rand by the Bank to the privatesector banks for such foreign currency. In order not to flood the money market with excessive rand liquidity, the rand created has to be sterilised. This involves an interest cost on the instruments used to sterilise the excess liquidity, such as the Bank’s debentures or government bonds. Having raised the Bank’s gross reserves from US$8 billion two years ago to almost US$20 billion at present, the interest cost of sterilisation – ultimately for the account of the taxpayer – has been considerable. Lower interest rates could lead to exchange rate appreciation if expectations of increased short-term profitability and higher share prices overshadow the conventional mechanism which is based on comparative interest rates on bonds and loans, and these expectations are reflected in substantial share purchases by non-residents. Similarly, further relaxation of exchange control could boost confidence in the rand and prompt inflows rather than outflows of foreign currency, thereby leading to appreciation of the rand. Finally, pronouncements on an appropriate level for the rand’s external value might need to be backed up by currency interventions if they are to be taken seriously by the market. But in any case the desired outcome may not arise. Despite these complications, the Bank has a preference for a relatively stable and competitive level of the external value of the rand. Large movements in the exchange rate disrupt resource allocation and economic growth, while an overvalued exchange rate would disqualify deserving exporters from entering international markets on a sustainable basis. Nevertheless, experience with large-scale intervention in the foreign exchange market has been unfavourable. With 1½ days’ turnover in the South African foreign exchange market equal to the entire US$20 billion gross reserves currently held by the Bank, and with numerous forces outside of the South African authorities’ control having an important bearing on supply and demand in the market for foreign exchange, caution is warranted before entering the market with an exchange rate objective in mind. Accordingly, the Bank prefers to leave the determination of the exchange rate essentially to market forces. The Bank of course helps with price discovery in the market by disseminating data on its foreign exchange reserves and international liquidity position, and on the balance of payments and foreign debt situation. The Bank participates in the market on a moderate scale to cream-off any excess foreign exchange. Since other countries with similar characteristics tend to have more reserve assets relative to imports than South Africa, the Bank has over the past two years, on balance, accumulated an additional US$12 billion in foreign exchange – not without at least some impact on the level of the exchange rate. This is common knowledge in the market. Further constraints and risks Fiscal policy has been prudent over the past decade and has contributed to the stable macroeconomic environment. There is currently no fiscal dominance over monetary policy decision making. Government lowered its debt ratio and debt service ratio, thereby freeing resources for productive service delivery, and the public sector borrowing requirement has been maintained at low levels. However, there is widespread agreement that higher economic and employment growth on a sustained basis would require stronger capital formation. Currently the ratio of fixed capital formation to gross domestic product is around 17 per cent, and the real fixed capital stock is growing by 2 per cent per annum. It is calculated that this ratio should ideally rise to 22 per cent in order to boost the rate of growth in the capital stock to 4½ to 5 per cent per year – as seems necessary in order to sustain a real growth rate of around 6 per cent. Stepping up the investment ratio is set to entail much higher levels of fixed capital formation by government, public corporations and the private sector. 3/4 There are encouraging signs that this is starting to happen, although not without delays and some frustration. In many instances financing seems not to be the binding constraint, but skills - in particular project management and other real-sector implementation capacity issues. Fortunately the public sector’s debt ratio is favourably low. Insofar as capital formation will be import intensive, the country’s level of international indebtedness is also quite low, at around 71 per cent of one year’s export proceeds. This provides latitude on the balance of payments front, alongside the fact that South Africa has a flexible exchange rate which can adjust to changing circumstances. Training, education and productive employment of all the people wishing to work is probably the most crucial factor on which sustained long-term growth depends. The challenges in this area are enormous. Sparkling growth requires utilisation of all those skills that are in short supply, entrepreneurship, adequate and relevant training, and a dedicated workforce using those acquired skills productively and ploughing back whatever has been learnt. Six years of economic expansion have been drawing idle resources into the growth process in South Africa, thereby allowing “learning by doing” to take place and building up considerable momentum. But numerous concerns related to human capital formation remain. With the sustained upswing in the economy and more favourable financial conditions there is of course the risk that South African consumers will get carried away as real household disposable income rises briskly and real estate and share investments yield high returns. The level of household debt relative to annual disposable income has already risen to almost 62 per cent, marginally higher than its previous peak value. While currently debt service ratios are undemanding on account of the reduction in interest rates since mid-2003, households would be well-advised to remember the everpresent risk of a deterioration in inflation prospects, which could result in a tightening of monetary policy and the stresses and strains of servicing that debt at a higher interest rate. And talking of deterioration in inflation prospects, the latest BER inflation expectations survey of course showed higher expected inflation than before. In the wake of oil price trends during the past year, this did not really come as a surprise. However, 25 months of CPIX inflation within the 3-to-6-per-cent target range has demonstrated that low and stable inflation can be achieved and remains a priority of economic policy. The Monetary Policy Committee will not allow price shocks to develop into sustained inflation spirals, but will be vigilant, safeguarding the gains made in combating inflation. Conclusion Central banks combat inflation precisely in order to nurture economic and employment growth – balanced growth of the sustainable types. The South African Reserve Bank will certainly not neglect its duty in this regard. But let the debate continue. Maybe in the process all of us will learn new lessons on how to do things in a nuanced manner. Once again, thank you very much for affording us this opportunity to interact with such an august gathering of people interested in high economic growth and employment creation. Thank you very much. 4/4
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Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the LBMA Precious Metals Conference, Johannesburg, 14 November 2005.
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T T Mboweni: The South African Reserve Bank and gold; recent economic developments in South Africa Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the LBMA Precious Metals Conference, Johannesburg, 14 November 2005. * * * Ladies and gentlemen, honoured guests. 1. Introduction Thank you very much for inviting me to participate in this your annual conference being held here in South Africa this time. It is indeed a privilege and an honour to speak to you today. It is also fitting that a conference such as this one is held in Johannesburg. This city was born in 1886 and built on the gold mining industry which flourished as a result of the great mineral wealth present in the rock below us. The African people refer to this place as Egoli or Gauteng which means the city of gold. The platinum group metals (PGMs) also play an extremely important role in the South African economy with South Africa being the major supplier of precious metals to the international market. Our role in the gold refining industry is also significant. The Rand Refinery is the world’s largest single-site gold refinery and it refines gold from as far afield as East and West Africa and Latin America. Since the Rand Refinery was established in 1920 it has refined approximately 32 per cent of all gold produced globally. This is yet another good reason to hold this prestigious conference here. So welcome, once again, to our 119-year old city. We can guarantee great weather and, to add to the excitement, some volatility in asset prices! Regrettably there is no guarantee as to the precious metals prices, either in dollar or rand terms, but we have certainly appreciated the recent upward trend in their dollar prices. I will leave it to you the experts to ponder the future path of these metals. Once you have done so and once you have sampled the delights that this country has to offer you as business people, we hope that you will return and sample its diverse offerings as a tourist. 2. The precious metals industry in South Africa The precious metals market in South Africa has experienced significant changes in recent times. Exports of gold have receded from 51,0 per cent of total visible exports in 1980 to 9,4 per cent in 2004. Over the same period the platinum group metals exports have risen from 5,0 per cent to 9,0 per cent of total visible exports. The changing fortunes of these sectors were also reflected in employment: the number of jobs in gold mining receded from 476 000 in 1980 to 175 000 in 2004, while in platinum mining it roughly doubled from 77 000 to 151 000 over the same period. Over the past decade, the contribution of gold mining to total gross domestic product declined from 3,2 per cent in 1994 to 1,5 per cent last year. At the same time platinum mining’s contribution rose from 2,0 per cent in 1994 to 2,3 per cent in 2004. For all mining sectorscombined, the share in the total value added to the economy receded from 9,5 per cent in 1994 to 7,3 per cent last year. More recently, Chamber of Mines data indicate that South African gold production in the second quarter of 2005 fell by 2,4 per cent from the first quarter and by 18 per cent year-on-year. These declines reflect the industry’s adjustments to the current economic environment and the restructuring that has occurred over the past three years. Although the substantial increase in restructuring costs has resulted in losses for the industry, given that most of the restructuring has taken place, the Chamber of Mines expects the associated costs to decline going forward. This is a welcome development indeed. The exchange rate is often seen as a source of the mining sector’s difficulties. The necessity to adapt to these new and changing circumstances has impacted not only on the mining sector but on all exporting sectors. Despite the mining sector’s difficult circumstances, South Africa remains the world’s largest producer of gold and platinum. 3. The South African Reserve Bank and gold The South African Reserve Bank has historically been an active participant in the gold market. Originally all newly-mined gold had to be offered for sale to the Bank within 30 days of production. Subsequently the Chamber of Mines negotiated the right to sell South African gold independently of the Bank in beneficiated forms of one kilogram and less. These direct sales were restricted to one-third of the annual production. After lengthy consultation, a sea-change in these arrangements occurred when the Minister of Finance announced on 12 December 1997, in a further relaxation of Exchange Control Regulations, that South African gold producers may elect to sell their total output provided the Bank had given the necessary exemption from the relevant Exchange Control Regulations. This led to a gradual but dramatic decline in the Bank’s transactions in the bullion market. Notwithstanding this, the Bank continues to be keenly interested in the health of the bullion market. This is by virtue of South Africa’s significant gold reserves both in the vaults and underground. The SARB also remains active in the various forums where the issue of central gold reserves management is explored. The most prominent of these forums is organized from time to time during the annual meeting of the World Economic Forum in Davos, Switzerland, where producers and central banks discuss the prospects for gold. The general impression that we have gained from these discussions is that the significant central banks which hold gold are very conscious of the impact that their gold sales programme have on the gold price and as such would not want to disrupt the market or cause unnecessary price volatility. The Swiss central bank for example has handled their gold sales in a transparent, honest and exemplary manner. Their programme was pre-announced and followed to the end accordingly. There is some uncertainty however about what would happen in Germany when the new government starts to function. We can only hope that the current approach adopted by the Bundesbank will continue. So the prospects for gold from a central bank perspective is good. A colleague of mine is participating in one of the panel discussions scheduled for tomorrow and he will enlighten you on the Bank’s management of gold reserves. But, allow me to make the following brief comments. The Bank holds around 4 million fine ounces of gold in its foreign reserves. It has held this net figure stable for the past number of years. Gold is, obviously, an internationally acceptable reserve asset. The Bank is very comfortable holding these gold reserves because of the metal’s war-chest qualities,1 because gold is no-one’s liability, and because it allows prudent diversification in the Bank’s total reserves. Whilst not being a signatory to the Central Bank Gold Agreement, we abide by the spirit of this Agreement in the management of the Bank’s gold reserves. As I have mentioned, we are very satisfied with the level of our gold holdings. Indeed, as part of our reviews on the composition of total reserves, we may even consider increasing our gold holdings. 4. Recent economic developments The South African economy has been in an upswing since September 1999, making it the longest business cycle expansion phase on record. During this upswing growth in real gross domestic product has averaged approximately 3½ per cent per annum. Recent data indicate that the sustained growth in real production is also being reflected in some very welcome gains in employment, although the unemployment rate of 26½ per cent remains very high and its further reduction a strategic imperative. Annualised growth in real gross domestic product accelerated from 3,5 per cent in the first quarter of 2005 to 4,8 per cent in the second quarter, with firm growth recorded in virtually all the main sectors of Alan Greenspan in his testimony to Congress on 3 November 2005 said: “The bottom line is that in periods of extreme chaos, it’s turned out that gold has been the ultimate means by which transactions have been consummated. It occurred, for example, during World War II that you could only negotiate transactions with gold.” the economy. All the final demand components – household consumption, government consumption, and fixed capital formation – have been expanding briskly. As could be expected, the upswing in economic activity and expenditure was accompanied by a strong increase in import volumes. Accordingly, the current account of the balance of payments moved into deficit from 2003. The current-account deficit amounted to approximately 3½ per cent of gross domestic product in the first half of 2005. Information on visible foreign trade suggests a larger trade deficit in the third quarter of 2005 than in the first two quarters of the year, but comprehensive data on services and income flows for the third quarter still need to be finalised before the current-account balance for the third quarter of the year can be determined. Relatively favourable prices for most of South Africa’s export commodities have been helping to contain the trade and current-account deficits. At the same time sizeable inflows of financial capital have been recorded over the past three years, exceeding the current-account deficits and enabling the Bank to increase its foreign exchange reserves. On a trade-weighted basis, the rand appreciated by 11,7 per cent in 2004. During the first 10 months of this year it has depreciated by 9 per cent. The rand’s overall recovery since the lows of late 2001 can be mainly attributed to improved perceptions about South Africa’s economic fundamentals, US dollar weakness, rising commodity prices, positive interest rate differentials, and, of course, a recovery from heavily oversold levels. The emerging view of the rand is that it will respond to changing fundamentals in an orderly manner. Rising income levels, improved confidence and lower interest rates have bolstered credit extension, resulting in banks’ loans and advances to the domestic private sector increasing by 21,5 per cent over the twelve months to September 2005. Mortgage lending has been exceptionally strong, supported by rising property prices. Average house prices rose by more than 15 per cent over the past twelve months. However, this is already significantly slower than the 35-percent peak rate of increase recorded approximately a year ago. As a counterpart to the increases in bank loans and advances, the monetary aggregates have also been rising briskly. Twelve-month growth in the broad money supply, M3, amounted to 16,7 per cent in September 2005. Share prices reached successive new record highs during the course of 2005, and the buoyancy in the share market was also reflected in record turnovers of shares on the JSE Limited in recent months. Non-residents are taking a keen interest in South African shares, and are increasingly involved in sizeable direct investment into South Africa. The operations of the financial markets have continued to grow over the years. The turnover in the equity market has risen from R62 billion in 1994 to R1 031 billion last year. Similarly, the turnover in the bond market has risen from R2 trillion in 1995 to R9,5 trillion last year. Improvements made to the JSE such as electronic clearing and settlement and the dematerialisation of shares and electronic trading has facilitated these developments. South Africa has also made progress in providing access to finance and banking activities to small and micro enterprises and the underbanked communities. Fiscal policy has been disciplined over the past decade, contributing to the stable macroeconomic environment. Latest estimates provide for a national government deficit before borrowing of approximately 1 per cent of gross domestic product in the current fiscal year, while the government debt as percentage of gross domestic product has been brought down to around 36 per cent. The inflation-targeting monetary policy framework adopted in February 2000 has contributed to the reduction of inflation to low levels, and has allowed for nominal interest rates to fall to levels last seen at the beginning of the 1980s. Real interest rates have also fallen and become less variable. For the past 25 months, CPIX inflation (i.e. headline inflation excluding mortgage interest cost) has remained within the target range of 3-6 per cent, despite strong output and expenditure growth in the economy. Although currently we still expect inflation to remain within the target range, the outlook has been clouded by the increased risk posed by the behaviour of international crude oil prices which have more or less doubled in US dollar terms over the past two years. Domestic petrol prices have consequently increased and have recently resulted in a significant upward movement in CPIX inflation, from 3,5 per cent in June, to 4,8 per cent in August, although they fell back to 4,7 per cent the following month. Because monetary policy reacts with a lag, there is little that can be done about these so-called first-round effects. However we have to be vigilant to the possible second-round effects or more broad-based increases in inflation which come about when prices are raised in expectation of a generalised price spiral induced by the higher petrol prices. These expectations are affected to a significant degree by expectations of the Bank's policy reponses to the increases. In other words, the credibility of monetary policy is key. In such a situation, monetary policy is faced with a dilemma, and indeed this is the dilemma faced by the MPC at present. At this point, there are few signs of second-round effects, and CPIX inflation excluding the first-round effects of the petrol prices increases, has remained remarkably stable over the past year. On the one hand, if no second-round effects emanate, monetary tightening could be unnecessary. On the other hand, if these second-round effects are expected to materialise, because of the lags in monetary policy, it would be appropriate to act sooner rather than later, to avoid being behind the curve. The challenge is to identify or anticipate these second-round pressures in advance. Monetary policy therefore has the difficult task of weighing up the risk of taking potentially unnecessary or incorrect action by being too preemptive, against the cost of delaying too long before taking action. This requires fine judgement on the part of the Committee. The Bank will, in general, continue to accumulate foreign exchange reserves at a moderate pace and at opportune times. The gross reserves have already reached a level of nearly USD20 billion at the end of October 2005. While there has been a focus on steadily accumulating reserves, given their relatively low level compared to our peers, it must be remembered that we do not target a specific level of reserves. The improved level of reserves is expected to enhance exchange rate stability and improve the Bank’s credibility. Partly due to the strengthening of our reserves position, South Africa’s credit ratings continue to be upgraded. In January this year, Moody’s upgraded the country’s credit rating from Baa2 to Baa1 with a stable outlook. This upgrade was based on the “substantial strengthening” in the country’s foreign reserves position. Political stability and robust macroeconomic policies also played a role. Just recently, at the beginning of August, Standard & Poor’s upgraded South Africa’s credit rating to BBB+ to match the Moody’s rating of Baa1, awarded in January 2005. Towards the end of August 2005 Fitch, similarly, revised South Africa’s BBB rating to BBB+. These ratings place South Africa at the top of the lower investment grade band and are an endorsement of the country’s economic fundamentals and policies. These upgrades have contributed to the increasingly narrow margins paid on the country’s foreign borrowing. The Bank will continue to encourage foreign direct investment. The advantages of FDI should not primarily be seen in terms of foreign exchange flows but rather for the benefits of technology and skills transfer, employment creation and enhanced international linkages. We must continue to ensure an efficient payments and settlement system. Without this you cannot have an efficiently functioning economy. The National Payment System (NPS) is a vital element of financial stability and the Bank continues to enhance its safety and soundness by developing payment system oversight capacity and by maintaining a high standard in the provision of interbank settlement services. We reached an important milestone in December 2004 when the rand was included in the Continuous Linked Settlement (CLS) system. The rand is now positioned as one of only 15 settlement currencies in the CLS mechanism. CLS is a world-wide industry initiative to reduce the risks associated with foreign exchange transactions by settling the two legs of a foreign exchange transaction simultaneously. As a requirement for the rand to be included in the CLS mechanism, the Bank had to move to a system of same day square-off and an amendment to the National Payment System Act, No 78 of 1998 was necessary. 5. Conclusion In conclusion, may I wish you a successful conference and an abundance of networking opportunities. While commodities as an asset class are in favour at present, it would appear that globally, according to the latest GFMS Gold Survey, the gold sector is poised for an interesting shift in international focus driven by the surge in demand from fabrication; possible pressure on the US dollar; lower world growth boosting the interest in alternative assets; and inflation concerns stemming from the high price of oil. Platinum group metals have been buoyant, in part aided by the rally in the gold price and the continued autocatalyst demand. This is good news for South Africa, the world’s biggest precious metals producer. So you have much to discuss. Work aside, please do take the time to experience some of the more relaxing aspects of South Africa once you are done with the business of precious metals. Finally, let me wish you all a very pleasant stay in South Africa and a safe journey home. Thank you.
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Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at The Economist's Fourth Business Roundtable with the Government of South Africa, Johannesburg, 21 November 2005.
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T T Mboweni: How exposed is the rand to the potential outflow of hot money? Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at The Economist’s Fourth Business Roundtable with the Government of South Africa, Johannesburg, 21 November 2005. * * * It is difficult to quantify the exact potential of “hot money” outflows. Undoubtely there is some of it in South Africa, similar to any other high-yielding emerging-market country with a liquid currency market. Some rough indications of potential “hot money” are the following: • the high turnover in the foreign exchange swaps market, with mainly non-resident clients as counterparties. • some build-up in authorised dealers’ net forward commitments against rand • non-residents have increased their holdings of domestic bonds and equities by some R45 billion in the current year to date. South Africa’s current account deficit is financed by (predominantly) foreign portfolio investments which can be easily reversed, while foreign direct investment is generally regarded as being more stable. However, two observations can be made in this regard: • The IMF in March 2005 published a study entitled “The composition of capital flows: Is South Africa different?” This paper argued that ZAR stability and some changes to government policies could contribute to greater FDI. The paper noted, however, the SA attracted three times more foreign portfolio investment than any emerging-market country, as a percentage of GDP. Equity flows to South Africa remained well above levels in other developing and emerging markets. The composition of capital flows to South Africa appears to be quite the opposite of other emerging markets. Importantly, it is noted that South Africa has attracted portfolio inflows more consistently than other countries. • There are indications that FDI might increase (Absa/ Barclays, Vodafone) as we sustain healthy growth rates, the exchange rate becomes more stable and exchange controls are relaxed further and eventually abolished. The rand has become more stable: ZAR volatility has declined over recent months – historical volatility down from as high as 30 per cent in the middle of 2003 to below 10 per cent in October 2005 Behaviour of importers and exporters has become more rational – Balances in CFC accounts stay fairly constant, whereas during 2001 and 2002, there tended to be build-ups in balances as exporters anticipated the ZAR to depreciate. The average holding period of export proceeds is also healthily within the 180 day limit, and remaining fairly stable. A number of stuctural empediments that contributed to the ZAR’s volatility in the past have been removed or improved. E.g. the closure of the NOFP, and the building of international reserves to USD20 billion. This has improved the fundamental value of the ZAR, and also resulted in upgrades by the international ratings agencies. These factors contribute to the ZAR becoming a longer-term investment destination rather than attracting predominantly “hot money”. “Hot money” often tends to be a reference to speculative flows, which can sometimes negatively affect a country. The best way to protect oneself from detrimental speculative flows is for South Africa to continue on its path of responsible, predictable, consistent and transparent policies. Can the economy pick up speed with such a strong currency? International research on the relationship between the exchange rate and growth remains inconclusive to date, as it is difficult to isolate the effect of the exchange rate from other policies and economic structures that would support or hamper growth. Typically, some sectors gain from a strong exchange rate, while others lose. There are a number of indicators that provide some comfort that the South African economy is coping well with an exchange rate at the current levels, e.g. GDP growth of some 4,8% (quarter on quarter saar) and relatively strong manufacturing growth. The mining sector is usually particularly negatively affected by a strong exchange rate. However, the high commodity prices are providing some cushion in this regard. The global environment has been conducive to South African exports. It is the view of the SARB that a stable currency is more important that a particular exchange rate, and that a particular exchange rate should not be targeted alongside an inflation target. The role of the SARB is to contribute to an environment of financial stability in the interest of sustainable economic growth over the long term, rather than providing short-term growth incentives that, from past experience, can severely damage sentiment and economic growth over the long term. Outlook for key indicators The inflation outlook has deteriorated moderately, with CPIX now seen at the upper end of the 3 – 6 per cent range in the first quarter of 2006. Nonetheless, inflation should remain within target range over the forecast period. This is, among others, dependent on the future path of oil prices, and developments in the exchange rate of the rand and food prices. Inflation expectations, as can be expected, have deteriorated moderately, but on the whole still point to CPIX remaining within target over the next three years. The Bank needs to guard against inflation expectations worsening further and becoming entrenched. Economic growth should remain robust, despite the fact that oil prices will most likely have a dampening effect on growth. The manufacturing sector appears to have weathered a relatively strong rand quite well, while global economic conditions are such that export growth should be maintained at a healthy pace. Both consumer and business confidence should remain high, with the factors supporting consumer confidence in 2005 still effective in 2006 – healthy disposable income, structural changes in the economy, and still low nominal interest rates. Money supply and credit extension should witness a mild moderation, alongside growth in the housing market. We have noted signs of cooling off already. Expectations of interest rate increases are likely to dampen credit demand (mortgage financing) somewhat. However, certain country-specific factors are likely to support still high and positive rates of growth, namely, the participation of nonresident buyers in the local market, the emergence of a new middle class, strong consumer demand, and a general catching up in the local housing market with international developments. International developments point to a moderation but still healthy economic growth rates, and while the inflation outlook internationally has deteriorated, the overall picture remains benign. This should support both economic growth locally and limit inflationary pressures in the local economy. The balance of payments may witness a mild deterioration, however, capital inflows, both portfolio and foreign direct investment, should be sufficient to finance this. Fiscal policy remains supportive of a non-inflationary expansion in economic growth. The Bank will continue to build its foreign exchange reserves, and purchase foreign currency at opportune times in a manner that does not destabilise the financial markets.
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Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa, Pretoria, 24 November 2005.
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T T Mboweni: A financial and economic review of the year Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa, Pretoria, 24 November 2005. * * * Your Excellency, the Dean of the Diplomatic Corps Your Excellencies, Ambassadors and High Commissioners Your Excellency, the Chief of State Protocol Your Excellencies, Heads of International Organisations represented in the Republic of South Africa Deputy Governors of the South African Reserve Bank Senior officers of the South African National Defence Force Senior Management of the South African Reserve Bank and their spouses/partners Editors and other media representatives Ladies and Gentlemen Dear Friends Welcome once again to this annual dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa. It has been yet another challenging year for South Africa on many fronts, and although you are no doubt familiar with many of these issues, I wish to highlight briefly the most noteworthy international and domestic financial and economic developments that have transpired since the Bank was honoured by your presence last year. Economic and financial conditions in the international economy have remained generally benign in recent months although there have been a number of challenges. Led primarily by China, India and the United States, the world economy continued to grow at a solid rate although growth projections for 2005 in most countries have been revised downward slightly – with the important exceptions of key Asian economies. The major global imbalances, such as the difference between the US and Asian propensities to save, show no significant signs of reversal. However, underlying inflationary pressures in most countries generally have remained muted, resulting in little transmission of price pressures to the South African economy. Real gross domestic product growth in the US economy remained strong during the first three quarters of 2005. However, real economic growth in the euro area, South Africa’s largest trading partner, was comparatively disappointing, while growth in most developing countries exceeded expectations. The relatively strong world economy, favourable prices of commodity exports and improved policies contributed to an acceleration in growth on the African continent. Non-oil commodity prices have continued to rise during 2005, with strong demand for metals from the US and China -where the manufacturing and construction sectors are recording robust growth - driving prices higher. Prices of iron ore, copper and uranium in particular have risen significantly in recent months. The gold price in dollar terms has also shown a significant increase over the same period as a result of fears of rising global inflation; concerns about geopolitical security; mounting speculation regarding a possible reversal in central bank gold sales; declining mining supply; and strong fabrication demand for gold. Global real gross domestic product grew by about 5 per cent in 2004 and is projected to increase by 4½ per cent in 2005. Growth in some of the developed economies slowed in the second quarter of 2005 while emerging-market economies continued to record robust growth. However, to date the impact on global growth of higher oil prices has been moderate, reflecting in part the fact that higher oil prices have been largely the result of strong global demand. Even though core inflation rates have remained benign, overall inflation rates in most countries have already increased somewhat in response to the sharp rise in oil prices. The world economic outlook therefore remains somewhat clouded by large global imbalances and rising crude oil prices. Crude oil prices have risen significantly over the past year and have on occasion touched US$70 per barrel. This can mainly be related to robust demand for oil emanating from particularly the economies of China and the US, notable supply side shocks emanating from the hurricane season, and continued geopolitical concerns. The oil price is likely to continue exhibiting considerable volatility and is expected to remain at relatively high levels in the near term mainly due to strong demand and supplyside tightness. The rise in global energy prices will continue to exert downward pressure on the purchasing power of households and international inflation is likely to continue edging upwards in the next few months. World inflation is projected to increase to 3,9 per cent in 2005 from 3,7 per cent in 2004. Fortunately, relatively well-anchored inflationary expectations and declining oil intensity in production have served to soften the blow to the global economy so far. Single-digit inflation – and low single-digits , at that – is the norm for the overwhelming majority of countries represented here tonight. If the oil price continues to escalate, second-round effects of price rises could become more prominent, thus leading to a further acceleration in global inflation. However, the short- to medium term global inflation outlook remains positive, particularly in view of the fact that inflationary expectations remain somewhat well anchored and output gaps in most countries are not subject to undue pressure. Notwithstanding these slightly adverse developments, global economic expansion is expected to remain broadly on track against the background of continued supportive global financial conditions. Turning to developments in South Africa, it is pleasing to note that the record upswing in economic activity continues apace. What is particularly gratifying is that the rapid expansion in economic activity in the second quarter of this year marked the twenty-third consecutive quarter of uninterrupted growth since the economy began the current upswing in 1999. This is the longest upswing in the recorded economic history of our country, and is a truly remarkable achievement given the domestic, regional and international challenges that have confronted South Africa during the course of the upswing. The consolidation of inflation at low levels has enhanced macroeconomic stability and contributed to the strong growth in the South African economy and the record upswing is testimony to an increasingly stable and transparent macro-economic policy framework that has been developed meticulously over the past decade. This has resulted in increasing levels of domestic and international investor confidence in South Africa that augurs well for the domestic economic growth outlook. Allow me to highlight a number of the most important domestic developments since I had the privilege of addressing you last year. A significant milestone was reached at the end of last year when the rand was included in the Continuous Linked Settlement (CLS) system – currently being one of only 15 currencies settling through CLS. It is now possible to make a payment here in South Africa and have it immediately transferred to a beneficiary abroad in one of the other 14 currencies’ areas without the risks attached to delay in settlement. The sustained capital inflows into the country have allowed for a continued build-up of the official foreign reserves and have contributed to increased exchange rate stability. The South African Reserve Bank’s gross reserves now stand at almost US$20 billion - more than US$5 billion higher than a year ago. This was despite a fairly large deficit on the current account of the balance of payments. As you are aware, South Africa currently imports more than it exports. This is to be expected, given the growing economy which requires more capital goods – often imports – and which allows for more consumption, some of which also involves purchases of imported goods. However, the financialaccount inflows have exceeded the current account shortfall. Your Excellencies would know only too well that the exchange rate of the rand has depreciated somewhat, on balance, since the end of last year. Against the US dollar, for instance, the rand depreciated notably: a US dollar cost less than R5,70 towards the end of last year, but currently would put you back about R6,60. Against a basket of currencies, the rand has depreciated by roughly 6 per cent since the end of last year. The relatively moderate amplitude of the exchange rate movements of the rand – against a basket of currencies, at least – should be welcomed. Prices in the financial and real-estate markets have reached new record highs. The financial and realestate markets remained buoyant, but with the changed outlook for mortgage interest cost, the rate of increase in real estate prices, which at times exceeded 35 per cent on a year-on-year basis, tapered off over the course of 2005. Its most recent reading is still a quite strong 16 per cent. So embassy property must have turned out to be well-performing investments indeed. The price stability objective in South Africa continues to be strongly supported by government’s management of its financial affairs with the National Government Budget for fiscal 2005/06 again formulated within a framework of fiscal discipline but with more emphasis on infrastructure development and a budget deficit for 2005/06 now projected to amount to only 1,0 per cent of GDP, compared to the 3,1 per cent of GDP projected in February. The government debt consolidation process has allowed the cost of borrowing to decline markedly. Even though debt issuance has increased since 2003/04, sound debt management has been such that new issuance is spread across the maturity spectrum of the yield curve. The latter normalised somewhat in recent months owing, among other things, to the fact that the National Treasury increased supply at the longer end of the curve. With the cost of borrowing falling as dramatically as it has, the bond market has become a more appealing corporate finance tool and, as such, corporate bond and commercial paper listings have become more popular. The corporate bond market has increased considerably in size – expanding from just under R40 billion in 2002 to over R130 billion today – an increase of over 200 per cent! The improvement in South Africa’s long-term foreign currency debt rating from BB (high risk, speculative grade credit) in 1994 to BBB+ in 2005 (investment grade rating), made South Africa’s debt much more attractive to the international investing community. The most recent upgrades by Fitch and Standard and Poor’s contributed towards tighter spreads on South African debt. The yield spreads on South African foreign-currency denominated bonds continue to remain substantially lower than those of emerging markets in general (the Emerging Market Bond Index), indicating that investors share the confidence expressed by international rating agencies and regard South Africa in an increasingly positive light in comparison to competitors. Non-residents have been very active participants in the domestic bond and equity markets this year. Non-resident participation in trading on the Bond Exchange, measured as the sum of their purchases and sales as a percentage of total purchases and sales of bonds, increased markedly from a level of about 9 per cent in early 2004 to as high as 18,9 per cent in early 2005. Furthermore, non-resident participation in share trading on the JSE averaged approximately 20 per cent in both 2004 and 2005 thus far. The Eurorand bond market witnessed a flurry of activity this year, with a total net issuance size for 2005 of close to R6 billion, the highest net issuance since 1999. The issuance of rand-denominated bonds by non-resident borrowers in the Japanese Uridashi market also continued to grow during 2005. Rand-denominated bonds were first issued in that market in July 2004 and total issues for that year amounted to R2,5 billion, while issuance amounted to R7,5 billion in 2005. The demand for randdenominated bonds issued by highly rated non-resident institutions contributed positively to the value of both the rand and domestic bonds. We also witnessed some secondary listings of foreign companies on the JSE Limited and the first listing of a non-resident bank on the Bond Exchange, again displaying confidence in South Africa (the relations between South Africa and so many countries in the rest of the global village, evidenced by the number of embassies and high commissions stationed in South Africa, bears testimony to this confidence). The South African banking sector benefited greatly from the improved macroeconomic conditions – profitability, efficiency and the asset quality of banks improved despite continued strong growth in the total loan book. An important structural change also occurred in South Africa’s banking sector after an international bank obtained a controlling share of a major local bank by means of the largest single foreign direct investment into South Africa to date – together with other significant foreign direct investment announcements which are also indicative of an increasingly positive investment outlook for South Africa. Broadening access to financial services and targeted investment remain high priorities on the agenda for South Africa and our financial sector, and the Bank continued to monitor and support new initiatives. In terms of a Memorandum of Understanding between the banking sector and the Department of Housing, the banking sector will advance R42 billion in low-income housing finance by 2008. The Bank continued to make a significant contribution to economic co-operation in Africa by for expample liaising closely with the Association of African Central Banks regarding the implementation of the African Monetary Cooperation Programme and participating in an ongoing study outlining the costs and benefits of the creation of a common central bank for Lesotho, Namibia, Swaziland and South Africa (the decisions in this regard will be taken by the political leaders of these countries). In February 2005 the Bank hosted a Seminar with the European Central Bank (ECB), attended by Southern African Development Community (SADC) Central Banks in which views on the road towards a Single Central Bank for SADC were discussed against the background of the ECB experience. The MoU on the Harmonisation of Legal and Operational frameworks of SADC Central Banks was finally approved by Ministers for Finance at their meeting held on 5 August 2005 after extensive consultations. At their September 2005 meeting, the Committee of Central Bank Governors (CCBG) in SADC signed Memoranda of Understating (MoUs) on Exchange Control, Information and Communications Technology and Payment, Clearing and Settlement Systems. In May 2005, the Bank was privileged to host the first Financial Stability Forum (FSF) African Regional Meeting. Participants included ministers of finance, governors of central banks and senior officials from finance ministries, central banks and regulatory authorities from various countries in Africa as well as members of the FSF. In June 2005 the Bank participated in workshops on a SADC cross-border settlement model. The Bank, in conjunction with other central banks in the SADC region, is investigating options to facilitate the settlement of cross-border payments within the region. The Bank contributed significantly to the development and deployment of the Bank Supervision Application solution, a computerised system which was developed on behalf of SADC and some East African countries. This application was deployed in all eleven participating countries and is utilised to supervise commercial banks and other financial institutions. International involvement obviously extends beyond Africa and the Bank continued participating and collaborating in the activities of a number of international organisations, central banks and universities. For example, a highly successful G-20 seminar on economic growth, co-hosted by the Bank along with the People’s Bank of China and the Banco de México, was held in Pretoria in August 2005, and the findings were discussed at the meeting of deputy finance ministers and deputy central bank governors in China in September and ultimately at the meeting of finance ministers and governors in October at the Grand Epoch City, Xianghe, Hebei Province, China. In August I mentioned in my address to shareholders of the Bank that closer economic co-operation in the SADC region and the African continent will increasingly become a key strategic focus area in the years ahead. The Bank has for example during the course of the year once again rendered technical assistance to various other central banks in the region. The pursuit of price stability will nevertheless remain the primary objective of the Bank. The consolidation of inflation at lower levels and with lower variability is by far the most important contribution the Bank can make to the economic development of South Africa and by implication that of the subcontinent. Of particular importance therefore from a monetary policy perspective is that CPIX-inflation remains within the target range of 3 to 6 per cent. Considerable success has been achieved in pursuit of major policy objectives and the South African Reserve Bank remains committed to ensuring that the hardwon gains in the fight against inflation are not forfeited. Inflation has extended its stay within the 3-to6-per-cent target range to 26 months – more recently amid a strongly growing domestic economy and robust domestic demand. The inflation outlook has deteriorated moderately over the past few months, mainly as a result of developments in international crude oil prices. Although domestic demand and output remain buoyant and point to some additional upward pressure on inflation, there is still little evidence of demand pressures or second-round effects of oil price increases impacting on inflation. Oil prices, domestic demand and output developments nevertheless pose significant risks to the inflation outlook and monetary policy will have to remain vigilant. Finally, you would have noticed during the course of the year that increasing prominence is being given by government to investigating all the feasible ways of achieving stronger economic growth. Whereas growth in real gross domestic product amounted to 3,7 per cent in 2004, the October Medium Term Budget Policy Statement provided for real growth of 4,4 per cent in 2005 and approximately the same rate of growth in 2006. Despite some progress made in recent years, continued high levels of unemployment necessitate even more ambitious steps to strengthen South Africa’s growth potential in order to achieve sustainable higher economic growth. The South African Reserve Bank is committed to doing its part by containing inflation, thereby providing a launching pad for enhanced growth, development and employment creation. But as I have mentioned on various occasions during the course of this year, this is not a sufficient condition for stronger growth. Enhanced infrastructural development, the implementation of education and skills development programmes which deliver the skills necessary for a modern economy, and careful land and agriculture reform, greater infusion of technology in the economy, and labour market reforms are some of the most important prerequisites for boosting economic performance and employment creation. The macroeconomic policy setting is appropriate. Going forward, structural reforms will be key to unlocking the economic growth and development potential of South Africa. The authorities are on the correct path. All of these reforms need to be nurtured carefully as it takes a while before they bear fruit. However, it is crucial that they be supported throughout by a stable and transparent macroeconomic policy framework. As always, the senior staff of the Bank present at your tables will be available if required to clarify any of the remarks I have made during this evening. Meanwhile, a hearty welcome once again and thank you for accepting our invitation to this Annual Dinner in honour of Ambassadors and High Commissioners accredited to the Republic of South Africa. Your attendance is much appreciated. Thank you.
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Address by Dr X P Guma, Deputy Govenor of the South African Reserve Bank, at the conference on South Africa: Today and Tomorrow, London, 24 January 2006.
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Dr X P Guma: Economic developments in South Africa during 2005 and prospects for 2006 Address by Dr X P Guma, Deputy Govenor of the South African Reserve Bank, at the conference on South Africa: Today and Tomorrow, London, 24 January 2006. * * * 1. Chairperson, distinguished guests, ladies and gentlemen, it is a great honour for me to address you this morning, not least because the confluence of favourable developments referred to by President Thabo Mbeki in his State of the Nation address early last year has indeed contributed to another banner year for South Africa. Today, I wish to highlight only a few of the most important domestic economic developments that have transpired during 2005 and some of the encouraging prospects for 2006. 2. Growth in real gross domestic product amounted to 4,5 per cent in 2004, and preliminary anecdotal evidence suggests that this performance may have been exceeded somewhat in 2005. The record economic upswing in South Africa continued apace throughout 2005 and the third quarter marked the twenty-fourth consecutive quarter of uninterrupted growth since the economy began the current upswing in 1999. This is the longest upswing in the recorded economic history of the country. 2.1 The performance of the South African economy in recent times has also been more solid and consistent than before. One of the reasons is that the economy is in the process of changing from one driven predominantly by consumption, to one driven to a greater degree by fixed investment. The growth momentum over the past year-and-a-half was sustained by strong domestic expenditure, alongside the stronger world economy and generally favourable terms of trade. 2.2 Growth in real gross domestic expenditure picked up considerably in the third quarter of 2005 as both fixed capital formation and inventory accumulation gained momentum. Growth in real fixed capital formation accelerated mainly on account of higher capital spending by the private sector. 3. With gross domestic expenditure consistently exceeding gross domestic product over the past three years, the current account of the balance of payments has recorded a deficit during ten consecutive quarters. Buoyed by rising imports of capital and consumer goods as well as crude oil, the volume of imports rose faster than the volume of exports over this period. Favourable export prices and the fairly strong external terms of trade nevertheless contributed to the containment of the current-account deficit. Surpluses on the financial account of the balance of payments moreover more than fully covered the deficits on the current account, leading to continued surpluses on the overall balance of payments over the past seven quarters. 4. Apart from significant inflows of capital in the form of portfolio and other capital, large direct investment inflows contributed to stronger gold and other foreign-reserve levels. Foreign direct investment into South Africa was bolstered by the acquisition of a majority interest in a South African bank by an international banking group, as well as by increased shareholding by a nonresident investor in a domestic telecommunications company and other significant foreign direct investment announcements which are indicative of an increasingly positive investment outlook for South Africa. The sustained capital inflows into the country have allowed for the continued build-up of the official foreign reserves and this, in turn, has contributed to the relatively moderate amplitude of the exchange rate movements of the rand. The South African Reserve Bank’s gross reserves now stand at almost US$21 billion – more than US$6 billion higher than a year ago. 5. The responsible economic policies pursued by the authorities and improved prospects for the economy were recognised by three rating agencies that upgraded their rating of South African debt instruments during the course of the past year. The improvement in South Africa’s long-term foreign currency debt rating from BB (high risk, speculative grade credit) in 1994 to BBB+ in 2005 (investment grade rating), made South Africa’s debt much more attractive to the international investing community thereby contributing towards tighter spreads on South African debt. The yield spreads on South African foreign-currency denominated bonds continue to remain substantially lower than those of emerging markets in general (the Emerging Market Bond Index), indicating that investors share the confidence expressed by international rating agencies and regard South Africa in an increasingly positive light in comparison to competitors. 6. The Eurorand bond market witnessed a flurry of activity this year, with a total net issuance size for 2005 of close to R6 billion, the highest net issuance since 1999. The issuance of randdenominated bonds by non-resident borrowers in the Japanese Uridashi market also continued to grow during 2005 and demand for rand-denominated bonds issued by highly rated non-resident institutions contributed positively to the value of both the rand and domestic bonds. 7. Non-residents have also been very active participants in the domestic bond and equity markets this year. Non-resident participation in trading on the Bond Exchange, measured as the sum of their purchases and sales as a percentage of total purchases and sales of bonds, increased markedly from a level of about 9 per cent in early 2004 to as high as 18,9 per cent by early 2005. Furthermore, nonresident participation in share trading on the JSE averaged approximately 20 per cent in both 2004 and 2005. South Africa also attracted some secondary listings of foreign companies on the JSE Securities Exchange as well as the first listing of a non-resident bank on the Bond Exchange, again displaying increased confidence in South Africa. Prices in the financial and real-estate markets have reached new record highs and financial and real-estate markets have remained buoyant, but the rate of increase in real estate prices, which at times exceeded 35 per cent on a year-on-year basis in 2004, tapered off significantly over the course of 2005. 8. Inflation picked up in the second half of 2005 in response to the increase in the prices of crude oil and its derivative products. However, when crude oil and petrol are excluded from the production price index and consumer price index baskets, the inflation in the prices of the remaining items remained quite subdued, suggesting no firm evidence of second-round inflationary effects arising from the oil price increase. Moreover, the targeted twelve-month CPIX inflation rate – which incorporates petrol price inflation – only accelerated to a high point of 4,8 per cent in August 2005 and subsequently receded to 3,7 per cent in November, partly on account of the somewhat lower levels of international oil prices at the time. So far, the high oil price has therefore not prevented CPIX inflation from remaining comfortably within the target range of 3 to 6 per cent – an outcome which has been maintained for 27 successive months, and which has helped to anchor inflation expectations. 9. The exchange rate of the rand appreciated significantly towards the end of 2005 and in the first part of January 2006. From its most recent dip at the end of October to R6,71 against the US dollar, it appreciated by more than 11 per cent to trade below R6,00 level by mid-January 2006. Although much of this appreciation mirrored the recent depreciation in the value of the US dollar, the rand has also gained significant ground against the other major currencies. As a result, the nominal trade-weighted index of the rand increased by a similar percentage over this two-and-a-half-month period of 99.18 on 17 January – stronger than its year-end peak recorded in December 2004. In the year to 20 January, the TWI has increased by almost three per cent. A notable development in the exchange rate of the rand during the last few months has been that it has become less volatile: the rand’s historical volatility – a measure based on an average daily standard deviation calculation – declined from almost 21 per cent in June 2005 to below 10 per cent in October 2005, and has remained there in the subsequent two months. 9.1 It bears repeating the fact that the South African Reserve Bank (the Bank) has been given a target for inflation: it has not been given a target for the exchange rate. Of course, the Bank cannot disregard the exchange rate because the exchange rate can exercise considerable influence on developments in inflation. But the Bank understands that neither it nor anyone else can claim with any confidence to know the equilibrium level or time path of the exchange rate. The Bank also understands that to switch focus to the exchange rate could mean losing control of inflation. 10. Broadening access to financial services, targeted investment and increased economic cooperation remain high priorities on the agenda for South Africa and the Bank continues to monitor and support new initiatives in this regard. The Bank makes a significant contribution to economic co-operation in Africa by liaising closely with the Association of African Central Banks regarding the implementation of the African Monetary Cooperation Programme. 10.1 In February 2005 the Bank hosted a Seminar with the European Central Bank (ECB), attended by Southern African Development Community (SADC) Central Banks in which views on the road towards a Single Central Bank for SADC were discussed against the background of the ECB experience. The MoU on the Harmonisation of Legal and Operational frameworks of SADC Central Banks was finally approved by Ministers for Finance at their meeting held on 5 August 2005 after extensive consultations. At their September 2005 meeting, the Committee of Central Bank Governors (CCBG) in SADC signed Memoranda of Understanding (MoUs) on Exchange Control, Information and Communications Technology and Payment, Clearing and Settlement Systems. 10.2 Looking forward to the future, it is the case that there are promising signs that the targeted inflation rate will remain within the stipulated range. This, as my former colleague Ian Plenderleith noted, is not just something to look back on with satisfaction. Rather, it is important to recognise that the stable framework for a normal, wellrun economy that has been achieved to date provides the foundation for sustained, if not improved economic performance in the years ahead. 10.3 Going forward, further structural reforms will be important prerequisites to unlocking the economic growth and development potential of South Africa. All of theses reforms will need to be nurtured carefully and it is crucial that they be supported throughout by a stable and transparent macroeconomic policy framework. 10.4 In conclusion it is reasonable to look forward to the future with confidence: and this we do. References T. Mbeki (2005) “State of the Nation Address” I. Plenderleith (2004) “Always Something Normal from South Africa”
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Microsoft Senior Information Technology Officer Summit, George, 18 May 2006.
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T T Mboweni: Recent developments in the global and domestic financial markets Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Microsoft Senior Information Technology Officer Summit, George, 18 May 2006. * * * 1. Introduction Ladies and Gentlemen, thank you for the invitation as keynote speaker at this event in one of the most beautiful parts of our country. Please allow me also to congratulate you on the selection of your theme for this year, “Pathways to Growth”, which I think is most appropriate in the light of the current state of the domestic and global economy. Indeed, it is a pleasure to deliver a speech focussing on recent economic and financial market developments in the current environment. In your sector, no one needs to remind you of the painful experience when the Nasdaq Composite Index lost almost 70 per cent of its value between 2000 and 2002. Giving a speech of this nature at that time would have been considerably more difficult. Fortunately, those times are now well past, and the picture today is a much rosier one. 2. Developments in the world economy and financial markets The Ministers of Finance and central bank governors of the Group of Seven industrialised countries issued a statement, after their most recent meeting on 21 April 2006, in which they confirmed that the strong global economic expansion continues into its fourth year and that the outlook remains favourable. Being then on a “pathway to growth”, we should not miss this opportunity to take a step back and assess some of the recent developments in international and domestic financial markets. World output has grown by 5,3 per cent in 2004 and by 4,8 per cent in 2005, and is forecast to remain close to the 5,0 per cent level over the next two years, according to the IMF’s latest World Economic Outlook. Growth in emerging markets has been particularly strong, staying well above 7,0 per cent in 2004 and 2005, and forecast to remain in that region over the next two years. Sub-Saharan Africa, which has historically suffered from low or even negative growth rates, managed to grow by close to 6,0 per cent. Generally, these growth numbers have exceeded expectations. One of the clerks working in the SA Reserve Bank has over the past few years qualified herself through part-time study as an Advocate of the High Court of South Africa under very difficult circumstances, whilst at the same time raising two small children. She quoted Einstein as saying that: “In the middle of difficulty lies opportunity”. To a large extent this wisdom can be applied to the world economy and financial markets. There are numerous examples of how it sometimes takes a disaster or a crisis for a structural improvement to occur. It was only after the Asian crises of the late 1990s that Asian emerging markets started to build foreign exchange reserves and strengthen their macroeconomic fundamentals. Today, emerging markets are the net savers of the world, and reap the good results of their macroeconomic discipline in the form of low risk premiums and borrowing rates, ratings upgrades, increased foreign investment and accelerated growth rates. On a micro level, companies have behaved in much the same way. After having been plagued by accounting scandals, downgrades to “junk” status, section 11 classifications and some verging on the edge of bankruptcy, they have pulled themselves together. Corporations have deleveraged their balance sheets and became net savers, accounting standards have improved and corporate governance has become a major focus area. In an environment of strong economic growth, this should definitely put them on a ‘pathway to higher growth’. Consistent with the strength of corporate profits, improved balance sheets and diminishing excess capacity, investment is expected to be strong, contributing to renewed growth. A positive development in the global economy that tentatively seems to be emerging is that growth is becoming more balanced and broad-based. In 2004, the US growth rate was double that of Europe and Japan. Although the US remains the main engine of growth among the industrialised countries, the gap in growth rates is expected to narrow, with US growth moderating from 4,2 per cent in 2004 to 3,4 per cent in 2006, European growth remaining around 2,0 per cent and Japanese growth accelerating from 2,3 per cent in 2004 to 2,8 per cent in 2006. Developing Asia is also likely to remain an engine of growth, with output expected to increase by 8,2 per cent in 2006, and that of China alone by 9,5 per cent. Another remarkable thing about the current cycle of strong global growth is that it has been taking place whilst oil prices have been hovering between USD60 and USD75 per barrel for some time now – levels that would have been almost unthinkable a few years ago and which would have caused market analysts to significantly revise down their growth forecasts. Perhaps more surprising is that high oil prices do not seem to have filtered through to other prices to the extent that might have been anticipated. The so-called “core inflation”, which excludes energy and other volatile prices, remains subdued in most countries. A third factor that distinguishes growth in the current and next few years from previous years is that, while the period of expansion started in an environment of highly accommodative monetary conditions worldwide, it (growth) is now forecast to continue in an environment of higher interest rates. The US Fed has increased the fed funds target rate to its current level of 5,0 per cent, from 1,0 per cent at the start of the tightening cycle, and the general expectation is that it might be close to its peak. The ECB started to increase rates in December 2005 with further increases expected, and market expectations are that the Bank of Japan would follow suit later in the year, having ended their policy of quantitative easing (pumping liquidity into the banking system) in March 2006. Nevertheless, global financial market conditions remain favourable, characterised by unusually low risk premiums and volatility. Despite monetary policy tightening, long-term rates remain below average. The relatively flat US yield curve is a “conundrum” which even Mr Greenspan could not solve before going into retirement! Given this favourable environment, equity prices have risen significantly. Since the beginning of 2003 until the end of April 2006, the Dow Jones has risen by 35 per cent, the Nasdaq by 77 per cent, the German Dax by no less that 117 per cent and the Japanese Nikkei 225 by 104 per cent. In this bull run, equity markets experienced an unprecedented flurry of activity with regard to mergers and acquisitions, which further boosted investor sentiment. (Some retracement in equity prices occurred in the first part of May 2006 – let us hope that it is temporary and that share prices will continue to be supported by positive economic fundamentals.) Low bond yields in industrial countries caused funds to flow into alternative investment opportunities and into emerging markets. Despite a recent warning by the Bank for International Settlements (BIS) in its quarterly bulletin that emerging-market assets might be becoming overvalued, investors continued to favour these assets. In South Africa, non-residents increased their holdings of domestic bonds and equities by a net amount of R48,4 billion in 2005, and by a further R49 billion in the year to the end of April 2006. Some sell-off in emerging-market assets occurred during May 2006, due partly to three factors: seasonal position squaring ahead of the holidays in the northern hemisphere; developments in specific emerging markets; and higher returns now being possible in developed markets. It is too soon to judge the possible extent and effects of this sell-off – hopefully it would not disrupt financial markets in affected countries. However, having painted such a rosy picture, one cannot help but also highlight the risks and uncertainties that currently face the world economy and financial markets. At the forefront of everyone’s minds is most definitely the behaviour of the oil market. It remains to be seen for how long the general level of inflation can withstand the current high oil prices, and recent comments by prominent central bankers the world over seem to point to increased concern about the impact of oil on inflation, going forward. South Africa is no exception, and in the most recent statement of the Monetary Policy Committee of the SA Reserve Bank, rising international oil prices were once again highlighted as a key risk for inflation. The effects of the very high oil prices are likely to increase if inflationary expectations start to react. Secondly, the world remains plagued by geopolitical uncertainties in the Middle East and other parts of the world. Partly as a result of these tensions, combined with inflationary concerns starting to increase, the gold price has recently surpassed a series of 25-year highs, trading above USD730 per fine ounce early in May 2006 before retracing to just below USD700. There are some in the market whose forecast is that the gold price might test the USD1000 per ounce level in the near term. A third risk to the global economy is substantial further increases in interest rates. Despite various degrees of monetary policy tightening in industrial countries during the past two years, monetary conditions can still be described as relatively accommodative. Any exogenous or endogenous factors that could lead to a sharper increase in rates could well threaten the strength of the global economy. In such circumstances, volatility and risk premiums are likely to pick up. A fourth concern that again surfaced recently was the issue of rising global imbalances, and in particular the widening current account deficit in the US, combined with significant surpluses in most of the Asian countries, in particular China. The fact that the US has to date found it relatively easy to finance the current account deficit through capital inflows has to some extent obscured the risks associated with this imbalance. However, the US current account deficit, which according to the latest numbers amounted to 6,5 per cent of US GDP, cannot keep growing indefinitely. One can only hope that the inevitable adjustments in global imbalances will occur in a controlled and synchronised manner and that it will not lead to increased protectionism. Such an adjustment would require the participation of all regions and countries. The IMF was mandated at the recent April meetings to focus on the issue of resolving these global imbalances (the so-called multilateral survey during the Article IV country consultations). As a necessary step to start addressing global imbalances, the most keenly awaited event in the currency markets finally came to pass in July 2005 - the revaluation of the Chinese renminbi (RMB) when the People's Bank of China (PBoC) finally abandoned its decade long peg of the RMB, placing it under a managed float against an un-specified basket of currencies. Subsequently, more steps were taken by the PboC to liberalise the foreign exchange market, such as: announcing the currencies in the basket, widening the daily band of the renminbi against non-dollar currencies, abandoning quotas of foreign currency for domestic companies to invest abroad and allowing more instruments to be used in the foreign exchange market. 3. Developments in South Africa Let me then briefly turn to developments in our own economy. Against the background of a growing global economy, the South African economy has continued to grow at a healthy pace since 2004, with the GDP growth rate of 4,9 per cent in 2005 exceeding the 4,5 per cent registered the year before. Continued sound fiscal and monetary policies have resulted in good budgetary and inflation outcomes. CPIX inflation has been within the target range of between 3 and 6 per cent for 31 months. The outlook for inflation continues to be generally favourable, with CPIX inflation expected to remain inside the target range until the end of the forecast period in 2008, although risks and challenges remain. Vigilance is, therefore, required as is always the case in these matters. Financial markets have also performed well. Yields on domestic government bonds declined to record lows in February 2006, and have only moderately started to increase since then. The All-share index of the JSE reached record highs in April 2006, and has already gained around 18 per cent in the year to the end of April, before retracing somewhat in May, following trends in the global markets and lower commodity prices. It is particularly encouraging that share prices performed so well despite the resilience of the exchange rate. This is true even for sectors that have historically been very sensitive to exchange rate fluctuations. Part of this buoyancy is, of course, attributable to high commodity prices. However, in the Bank, we like to see this also as a sign that, in general, companies have adapted to a relatively robust exchange rate. As for developments in the South African foreign exchange markets, the exchange rate of the rand remains resilient and liquidity remains high relative to other emerging markets, despite the retracement in recent days. We have seen the average net daily turnover (in respect of transactions involving the rand) increase from around USD8bn in 2004 to just below USD10bn in 2005. In addition, the volatility of the ZAR exchange rate has also subsided. From the most recent peak of around 30 per cent and 25 per cent in January 2004, the one-month historical volatility and one-month implied volatility were at a level around 10 and 12 per cent, respectively, in March 2006. It is this positive environment that has attracted substantial investment flows into South Africa, allowing the central bank to build up the official gross foreign exchange reserves from USD8,0 billion in January 2004 to slightly more than USD23 billion in April 2006. It is partly owing to this increase in the reserves in recent times that the country was awarded credit ratings upgrades by all three rating agencies in 2005, to BBB+ with a stable outlook. This has also contributed to a decline in sovereign risk spreads. A more stable currency is critical to an attractive investment environment. Exchange rate volatility has in the past made the rand vulnerable to speculation and discouraged direct investments. The recent build up in reserves, together with some structural impediments that have now been dealt with (e.g. the Net Open Foreign Currency Position), should over time add to the stability we have already seen and reduce uncertainty for both domestic as well as non-resident long-term investors. The sell-off in emerging-market assets and currencies during the first part of May 2006, and the effect that it had on financial markets and exchange rates, including our own, has once again reminded us of the vulnerability of emerging-market economies to a sudden and sharp change in sentiment by nonresident investors. In the case of South Africa, the effects could be even greater, against the background of a current-account deficit of around 4,5 per cent of GDP. In the past, sell-offs of emerging-market assets had been triggered by a wide array of events, which were infrequently related to actual developments in the domestic economy. Conclusion Despite these risks, let me conclude by reiterating that the world and South Africa seems to be well set on a “pathway to growth”. It is conferences such as this one that are likely to sustain this growth. It is also conferences such as this one that will contribute to overcoming obstacles, reducing uncertainty and managing risks. Let us not be discouraged by those, but use a position of relative strength to plan for the future and be mindful of the risks that undoubtedly exist. Thank you for your attention.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Professional Society for Supply Chain Management (SAPICS) Conference, Sun City, 5 June 2006.
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T T Mboweni: The economic and financial context for supply chain management Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Professional Society for Supply Chain Management (SAPICS) Conference, Sun City, 5 June 2006. * 1. * * Introduction Ladies and Gentlemen, thank you for inviting me to address this conference. I am certain that the efforts of your members in ensuring successful supply chain logistics in many sectors have played a very important supportive role in South Africa’s impressive economic achievements in recent years. Your successes are also evidenced by the moon rock you have secured so successfully for this event! No doubt you will continue to contribute meaningfully to making 2006 yet another year of significant positive growth in our economy. Customers worldwide are demanding ever higher levels of service and efficiency. And your society is to be commended for its sterling work in ensuring that South Africa’s growth potential is enhanced as companies adopt improved supply chain logistics in order to compete more effectively in a global environment that is characterised by increasing competitiveness and just-in-time processing and delivery. Of course, the economic context within which you operate is crucial to your success, too. 2. Recent domestic economic developments The South African economy has been in an upswing since September 1999, making the current business cycle expansion phase the longest on record. The upswing continues apace, with strong growth in the South African economy during the first quarter of 2006 as global growth provided a solid tailwind, inflation pressures were relatively calm and interest rates were steady. This is quite a remarkable achievement, given the domestic, regional and international challenges that have confronted South Africa during the course of this upswing. Real gross domestic product recorded an average annual growth rate of almost 5 per cent for the year 2005, which constitutes the highest annual growth rate since 1984. Although there was a deceleration from 4,1 per cent in the third quarter to 3,2 per cent in the fourth quarter of 2005, growth accelerated once again in the first quarter of 2006 to 4,2 per cent. Despite negative growth being recorded in the primary sector, the acceleration in growth was achieved due to the recovery in manufacturing output and continued buoyancy in other secondary and tertiary sectors. The seasonally adjusted real value added by the agriculture, forestry and fishing industry decreased by an annualised rate of 6,9 per cent during the first quarter of 2006 mainly due to the poor performance in the production of field crops. Following the decrease of 5,4 per cent in the fourth quarter of 2005, real value added by the mining and quarrying industry decreased at an annualised rate of 2,9 per cent during the first quarter of 2006 due mainly to declining gold production. However, growth in the real value added in manufacturing recovered significantly in the first quarter as other sectors such as construction, trade and other services remained extremely buoyant in the first quarter of 2006. The real value added by the nonagricultural industries (excluding the impact of the volatile agriculture industry) for the first quarter of 2006 increased by 4,7 per cent compared with the fourth quarter of 2005. Importantly for our members, the manufacturing sector is in an expansionary phase. The seasonally adjusted PMI for May, released this past week, showed the manufacturing sector expanded for the third consecutive month from a level of 54,3 in April to 57,6 in May. Some of the components that strengthened include the business activity component, new sales orders and suppliers’ performance. However, the PMI indicates that inventories fell from April’s level. And indications are that inventory investments in the manufacturing sector slowed in the fourth quarter of last year partly because of low crude oil imports and problems with the change to unleaded petrol. Many of these areas affect the members of your association but I am sure you are generally satisfied with the economy’s performance, thus far. Growth in real gross domestic product in South Africa is expected to remain above the 4-per-cent level for this year as a whole, driven primarily by the robust trend in domestic expenditure. According to the April 2006 Reuters consensus forecasts, the South African economy is expected to grow at 4,5 per cent in 2006 and 2007, and by 5,0 per cent in 2008. In its Budget Review, the National Treasury expects economic growth of 4,9 and 4,7 per cent for 2006 and 2007, respectively. The strong growth momentum in household consumption expenditure and gross fixed capital formation is expected to continue to be the prime driver of growth over the medium term. Despite the recent increases in the fuel price which may somewhat dampen household spending on other items, growth in consumption expenditure is expected to remain robust as a result of sustained real disposable income growth due to expected continued generation of employment and real salary and wage increases. This, together with the favourable wealth effects of higher asset prices, the lower interest rate environment and the up to now contained inflationary pressures, as well as the government’s personal income tax relief package announced in the February 2006 Budget, should continue to sustain the expected growth momentum in real household spending. Government also remains committed to its objective of generating long-term sustainable economic growth through its planned spending on public-sector infrastructure and deeper micro-economic interventions (structural reforms). Government’s continued commitment to improve key infrastructure and social development programmes was highlighted emphatically in the President’s state-of-the-nation address to Parliament earlier this year, when he announced that the Accelerated and Shared Growth Initiative of South Africa (ASGISA) would serve as catalyst to efforts to halve unemployment by 2014. Under ASGISA, large investments will be made in various sectors to improve infrastructure. The President announced a massive investment initiative and promised that government would tackle the skills shortages and speed up the process of achieving even higher levels of real economic growth. Government intends investing R372 billion within three years in order to push economic growth to higher levels. Business confidence levels generally remain upbeat and private-sector investment sentiment remains strong. This has probably been meaningfully supported by the announced increases in parastatal capital expenditure. The surge in business investment is also expected to translate into higher export volumes. A number of new projects in the mining of iron ore and gold have been identified and should commence in the medium term. Vehicle manufacturers are in the process of expanding capacity and cement companies have also been expanding their capacity in order to meet the construction sector’s demand for cement. Capital formation in the construction and commerce sectors should continue to benefit from robust domestic demand. In the 2006/07 Budget several projects were announced which should boost real fixed investment by the general government in the medium to long term. These include: Infrastructural development to improve the provision of water and sanitation; construction of schools, clinics and provincial roads; the upgrading of informal settlements; the expansion of economic and transport infrastructure; and capital expenditure in preparation for the 2010 FIFA World Cup. The work that is underway at Transnet is absolutely central to the micro-economic story going forward. The comprehensive preparations for the World Cup Soccer tournament in South Africa in 2010 should help to stimulate construction activity significantly i.e. via the anticipated investment in soccer stadiums and the expansion and upgrading of accommodation facilities. Eskom, Transnet and Telkom also have exceptionally large capital projects in the pipeline and state-owned enterprises are projected to invest about R123 billion in capital expenditure over the next three years (with R32 billion of this amount being spent on rail and port infrastructure). As could be expected, the lengthy upswing in economic activity and expenditure has been accompanied by a strong increase in import volumes. Import volumes primarily reflect the strong growth in consumption and investment expenditure and are consequently expected to track the pace of growth in domestic demand closely. Accordingly, the current account of the balance of payments moved into deficit from 2003 and the deficit amounted to approximately 4½ per cent of gross domestic product in 2005. However, relatively favourable prices for most of South Africa’s export commodities have been helping to contain the trade and current-account deficits. At the same time, significant inflows of financial capital have been recorded over the past three years, exceeding the currentaccount deficits and enabling the South African Reserve Bank to increase the gold and other foreign exchange reserves. Export volumes are also expected to continue benefiting from the projected global growth, the African Growth and Opportunity Act, and Government’s Motor Industry Development Programme. 3. International economic developments The international economic environment has also supported domestic economic developments. Although there was a slight slowdown in the latter part of 2005, global economic activity managed to maintain a solid pace of growth throughout the year. This lent further support to the rising trend in the international commodity prices which accelerated strongly in the fourth quarter of 2005 and first quarter of 2006. More recently commodity prices have retraced somewhat, but this may prove to be a temporary correction given consensus forecasts for global demand. Ministers from OECD countries last week expressed optimism about prospects for the world economy, with continued strong growth and moderate inflation, but warned that further rises in energy prices could pose a significant risk. OECD ministers expect the buoyant pace of world growth witnessed in the past few years to be sustained in the near future. Their comments echoed the OECD's twiceyearly Economic Outlook released last week, which painted a broadly positive picture of growth prospects while sounding a warning over future energy price rises and current-account imbalances. OECD ministers observed that inflation was likely to remain under control, despite shrinking spare capacity and higher commodity prices, this being so because heightened international competition would help contain prices. A Wall Street Journal report which was also published last week nevertheless sounded a warning and suggested that if the story of today's international economy were handed down as a fable, recent developments might result in it being called "Global Goldilocks Meets the Three Bears." The reasoning behind this is that “Goldilocks -- a.k.a. the world economy -- has been enjoying a not-too-hot, not-toocold 4-per-cent plus growth rate over the past four years thanks to steady prices”, robust U.S. growth and the new wealth experienced by emerging markets countries. However the Journal goes on to identify the three growling bears that are threatening to spoil the fairy tale. Mama Bear is the “increasing energy insecurity, a beast spawned by rising oil prices but made more dangerous by escalating political risk afflicting almost all the major producers: Iran, Iraq, Nigeria, Venezuela, Russia and Saudi Arabia. Papa Bear comes in the form of deflating housing prices in several countries. The lost wealth effect of inflated property values, whether gradual or sudden, could unsettle not only” American consumers -- but also hit other countries with similar problems of high debt ratios and low savings. “Baby Bear is inflation, whose sudden growth in some countries” has spooked the global market and sparked the recent sell-off on the expectation that higher interest rates could slow corporate growth and consumer spending. The important question is whether recent significant market corrections were short-term in nature or whether they were the “sort of overdue awakening to risk” that many economists have been predicting. Some are even convinced that markets are finally responding to "unsustainable global imbalances" -- symbolised by record U.S. deficits and Asian surpluses. But as we are all, too aware, markets do over-react from time to time. We hope that calm will soon return for there is a lot of value out there. Oil prices, property prices and inflation do not only pose dangers to the US economy but certainly pose significant dangers to many other countries including our own. Although economic doomsayers often have been proven wrong in the past few years by the remarkable resilience and flexibility of the U.S. and other leading economies, the threatening nature of these bears is something to keep a close eye on. Consumers are more likely to reduce their spending the longer energy prices stay high and the more they worry about asset values. Although some may argue that this is not much of a threat given that oil prices have risen to $70 a barrel without slowing global growth or igniting second-round inflation, geopolitical risks unabated and could interrupt oil supplies from a number of important oil producers. Political risks could escalate even as oil supplies remain tight. We can only hope that the collective global political leadership will exercise wisdom in dealing with these geopolitical issues. This time the real-estate-bubble threat is more global than is often realised. It has become the symptom in many countries across the world that, during this long period of low interest rates, they have developed similar problems in real estate. As market pressures on such nations increase, investors begin to worry more about risk exposure. Currencies are trading down in the U.S. and several other such economies, including our own, followed by withdrawals from equity and bond markets. The release of U.S. consumer-price data for April triggered global shock waves as it was the strongest indication yet that prices were rising in a more sustained manner, particularly for services, a large part of the U.S. economy in which higher costs are not quickly reversed. The underlying concern therefore revolves around the sustainability of the U.S.’s five-year expansion if the three bears bring a triple setback for U.S. consumers. Global Goldilocks' safe escape depends on the wisdom and political determination to simultaneously ensure that a benign energy demand/supply equilibrium is restored, that global imbalances unwind in an orderly fashion and that inflation is successfully contained. Global leaders' ability to tame these bears will be severely tested in the months ahead. In the meantime, the South African Reserve Bank will continue to monitor important indicators to ensure that the monetary policy stance remains appropriate. 5. The outlook for inflation The primary role of the South African Reserve Bank in the domestic economy is to target inflation for the benefit of all economic players. CPIX inflation has remained within the target range for the past 32 months and the Monetary Policy Committee has been greatly encouraged by the evolution of some of the components of CPIX. It has become clear that there has been a steady convergence of the inflation rates of many of the categories of goods and services which make up the index to within the target range of 3-6 per cent. In the meantime, domestic monetary policy has continued to emphasise price stability and has succeeded admirably in reducing inflation expectations. According to the Bureau for Economic Research inflation expectations survey, inflation expectations for 2006, 2007 and 2008 of all the categories of respondents (business executives, trade union officials and financial analysts) are below 5 per cent which is nicely within the inflation target range. However there are a number of unfavourable trends and risk factors. These include rising crude oil prices and their impact on global growth and inflation, including the possibility that secondary inflationary pressures may be stimulated; the recent acceleration in domestic producer price inflation; the recent movements in the rand exchange rate; and the possibility of rising domestic capacity constraints. Favourable factors contributing to downside inflation risks include increased competition from Asia that can potentially lower price pressure on a range of internationally traded goods; moderate unit labour costs; encouraging administrative prices trends; and a continued benign global inflationary environment. 6. Conclusion In conclusion, the macroeconomic environment remains extremely favourable for sustained growth. The South African Reserve Bank will continue to play its part in strengthening South Africa’s economic growth potential. This we will do by striving for the appropriate policy setting in containing inflation. This, we are convinced, will provide the supporting factor for enhanced growth, development and employment creation. The significant long-term decline in the inventory to GDP ratio that we have witnessed over the years is testimony to SAPICS’ important role. I wish you every success with this year’s conference and trust that your deliberations and networking during the next few days will lead to your members embracing the latest technologies and supply chain methods to contribute towards higher levels of productivity outcomes in the years ahead. Conferences of this nature are extremely important vehicles for enhancing knowledge transfer and ensuring a greater infusion of expertise in the economy. This is very important for boosting economic performance, competitiveness and employment creation. Let us all do our bit. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the London Capital Club, London, 27 June 2006.
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T T Mboweni: The outlook for the South African Economy in a period of uncertainty Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the London Capital Club, London, 27 June 2006. * * * Ladies and Gentlemen, 1. Introduction I was very pleased to have received this invitation to address the members of the London Capital Club today for two reasons. Firstly, I suspect that this club might contain within its history the first seeds of central banking. I believe this Club builds on the proud foundations of the Gresham Club, named after Sir Thomas Gresham. And I was interested to learn that Sir Thomas was an advisor to King Edward VI in 1551 on the financial difficulties facing the country at the time. Sir Thomas implemented a set of plans to overcome these difficulties, which raised the external value of the pound. In his management of these problems, one can perhaps conclude that Sir Thomas was one of the first-ever central bankers. Indeed, Sir Thomas might have had an easier task if England had already followed a policy of inflation targeting at the time as both South Africa and England do today. The second reason why I am delighted to be here today is that the South African Reserve Bank has a direct association with the London Capital Club. One of our former Deputy Governors, Ian Plenderleith, CBE, serves on the Board of Advisors of the Club. I am therefore indeed honoured today to make a contribution to your deliberations but, more importantly, to enjoy lunch with you. Recent upheavals in the international markets have placed the spotlight again on emerging markets. There is disagreement in the markets as to what this burst of global volatility actually reflects, with answers ranging from inflation concerns, to global liquidity and to the growth outlook. South Africa has in the past few weeks experienced significant movements in the rand exchange rate and stock market prices. These developments may be seen by some as a threat to South Africa’s recent strong growth performance, as well as to the growth strategy of the government. But that should not necessarily be the case. 2. Recent international developments Emerging markets have enjoyed an extended period of investor exuberance and search for higher yield over recent years, which, combined with a generally supportive environment of strong global growth and high commodity prices, have caused their currencies to appreciate, equity prices to increase and bond spreads to narrow. Recently, we have experienced the effects of greater uncertainty about future inflation, interest rates and growth in the major economies. These concerns, combined with a state of general nervousness about the fairly sharp increases recently in the prices of riskier assets such as equities and commodities, caused many investors to pause, take profits, square positions and generally adopt a lower-risk investment strategy. The increased risk aversion of global investors was reflected in a number of indicators: The volatility index of the Chicago Board of Exchange (or the VIX), which gives a general reflection of risk aversion in equity markets, doubled from just below 12 on 10 May to almost 24 on 13 June. Prices of foreigncurrency denominated bonds of emerging markets also fell, contributing to an increase in the spread of these bond yields over US Treasuries. The JPMorgan EMBI Plus spread widened from 176 on 10 May to 232 on 13 June. The widening in spreads occurred across all the sub-indices of the EMBI plus, with Latin America the most affected. South Africa’s spread widened relatively less, from around 80 in mid-May to around 90 in mid June. The initial sell-off of higher-risk assets commenced in the US equity markets on 11 May following increased market uncertainty regarding the outlook for global interest rates. A marked decline in the S&P 500 index was followed by similar trends in the equity markets of Europe, Japan and the UK. By mid-June, all the year-to-date gains in most of the major equity markets had been wiped out. Equity prices in some emerging markets were even more affected. The South African equity market, which is dominated by the resources sector, declined by over 16 per cent from its peak reached in mid-May. A number of emerging-market currencies depreciated markedly. Since 11 May until mid-June, the Turkish lira depreciated by over 16 per cent and the Brazilian real by almost 11 per cent. The rand has not fared any better, having depreciated by almost 13 per cent over the same period. As is normally the case whenever investors cut their emerging-market exposures, the liquid South African market has been more severely affected than most of its peers. The rand exchange rate is strongly influenced by commodity prices, which in turn are dependent on global growth and also by the deteriorated sentiment towards emerging markets. Commodity markets also felt the effects of the sell-off of riskier assets. The price of gold declined from around US$725 per fine ounce in mid-May to around US$570 a month later. Similarly, platinum declined from a high of US$1331 per ounce in May to a low of US$1125 in June. It should be noted however that these changes are exaggerated by particularly strong upward price movements in the previous month. For example, the gold price averaged around US$550 per fine ounce in each of the first three months of this year, whilst the platinum price averaged around US$1040 per ounce in these months. This suggests that there had been some overshooting and that the current trends may be an inevitable correction, rather than a generalised collapse in commodity prices. However, the degree of volatility in commodity markets creates an uneasy environment for commodity-based currencies. Interestingly, despite the “sell-off” in emerging market assets since May, non-residents have remained net buyers of South African financial assets and there have been significant investment flows into South Africa over the past year. Non-resident investors bought a net R13 billion worth of South African equities during May 2006, and R460 million in the first half of June 2006. Despite generally negative sentiment towards emerging-market assets, they continued to buy R768 million worth of bonds in May, and R4,5 billion in June. These purchases brought the net amount of South African bonds and equities bought in the year to mid-June to R68 billion, compared with R41 billion in the whole of last year. Similarly, Britain’s Vodafone Group paid R21 billion earlier this year to take over VenFin’s stake in the local cellular operator, Vodacom. And towards the middle of last year, British bank Barclays bought a majority stake in local bank, Absa, for an amount of about R33 billion, making this most likely the single largest foreign investment in South Africa to date. While the market outlook has become more uncertain against the backdrop of a withdrawal of liquidity as well as geopolitical developments which have impacted on the international oil markets, the macroeconomic landscape still appears to be generally favourable, although not without risks. Inflation pressures seem to be building up across emerging markets whilst trade and industrial production trends look robust. High levels of international reserves and current account surpluses in a number of emerging market countries, together with reductions in external debt, have radically improved solvency ratios so that existing volatility, although very large, is unlikely to precipitate any systemic credit events in emerging markets. This is in contrast to the Asian crisis in 1997/98, which was generated by imbalances originating in emerging markets. These recent trends have also left their mark on the South African financial markets. However, not much has changed fundamentally in the domestic economy, and there still seems to be significant appetite for South African financial assets, albeit with a somewhat higher risk premium being priced in. Although South Africa is not a current account surplus country, our low level of foreign indebtedness, both public and private, and improved international reserves position, in conjunction with upgrades from credit rating agencies in the past two years, means that we are likely to be less vulnerable to balance sheet effects that have characterised previous emerging market crises. 3. The growth outlook From a broader perspective, the above suggests that although a period of heightened volatility and uncertainty may ensue, there should be no undue negative impact on South Africa’s growth prospects. In 2005 and 2005 the South African economy grew at a robust pace of 4,5 per cent and 4,9 per cent respectively. Growth in 2006 is expected to be moderately lower than that achieved last year following the 4,2 per cent measured in the first quarter of this year. This is in sharp contrast to the 3 per cent average annual growth experienced between 1994 and 2003. The recent strong growth performance has been underpinned by strong consumer demand which grew at annual rates of 6,5 per cent in 2004 and 6,9 per cent in 2005. Sustaining growth at higher levels will require significant structural reforms and an increase in investment relative to consumption as a contributor to the growth process. Gross fixed capital formation has been growing at annual rates of over 8 per cent for the past three years, driven mainly by private sector investment. In recent years, however, parastatal and public sector investment growth has been extremely low, which accounts for the relatively modest ratio of gross fixed capital formation to GDP of 16,8 per cent in 2005. This ratio has however been on a rising trend since 2002. As you may be aware, the South African government has embarked on the Accelerated and Shared Growth Initiative of South Africa (ASGISA), with the intention of raising the GDP growth rate to around 4,5 per cent until 2009 and 6 per cent thereafter. Central to this strategy is a strong focus on infrastructural investment. As indicated in the Medium Term Budget Policy Statement in late 2005, government and public enterprise investment expenditure for the period April 2006 to March 2009 is planned to be about R370bn. This investment should not only raise current growth, but will also allow for sustained future growth through improved transport, communication and electricity provision. Estimating potential output of a country is a notoriously difficult thing. The problems of estimation are compounded when a country has been experiencing significant structural changes, as has been the case in South Africa. There is no doubt that over the past few years such changes have raised the efficiency and the potential output of the economy. Previous estimates by the IMF and others had put the potential rate of output growth at around 3 per cent per annum or lower. Preliminary research at the Bank estimates current potential output growth to be in the region of between 4 and 4,5 per cent, assuming no significant changes in the underlying economy. Other scenarios in this study show that if the investment initiatives contained in the government’s strategy come to fruition, a potential output growth rate of over 6 per cent can indeed be achieved and sustained. An important component of the future growth scenario is the availability of finance. South Africa has been running current account deficits in the recent past, and will therefore continue to be reliant on non-resident inflows to finance the investment-savings gap. In the past few years, these deficits have been more than financed by capital inflows which, in turn, are being attracted by the improved growth prospects in the economy. These inflows enabled the Bank to further increase its holdings of foreign exchange reserves. By the end of May, official gross gold and other foreign exchange reserves had increased to US$24,1 billion, while the international liquidity position had increased to US$20,4 billion. This is a significant improvement on the negative average international liquidity position of almost US$10 billion in 2000. The stronger reserves position is expected to contribute to greater stability in the foreign exchange market and reduce South Africa’s vulnerability to external shocks. The recent inflows have been mainly equity or FDI inflows, reflecting the fact that favourable growth prospects have been key, and will be critical for future inflows. The sustainability of these flows will depend in part on the evolution of the current bout of volatility in international markets and investor perceptions towards emerging markets in general, and South Africa in particular. An important element in the growth outlook is macroeconomic stability, which is where monetary policy makes its contribution. 4. The role of monetary policy The mandate of the Bank is to achieve low inflation in the interest of sustainable economic growth and development. A low inflation environment contributes to growth and development by providing a more certain basis for investment decisions in the economy, and lowering overall risk. The inflation-targeting framework adopted in February 2000 has contributed to the reduction of inflation to low levels. For the past 32 months, CPIX inflation (i.e. headline inflation excluding mortgage interest cost) has remained within the target range of 3-6 per cent, despite strong output and expenditure growth in the economy, and significantly higher international oil prices. Furthermore, there is evidence that inflation expectations have become entrenched at levels consistent with the target. These developments have allowed for nominal interest rates to fall to levels last seen in the late 1970s. Between June 2003 and April 2005, the repo rate was reduced by a total of 650 basis points, although at the most recent Monetary Policy Committee meeting earlier this month, the repo rate was raised by 50 basis points to 7,5 per cent per annum. Real interest rates have also come down somewhat and have become less variable. The recent repo rate increase, the first since September 2002, was motivated by the deteriorating risks to the inflation outlook. Apart from adverse oil price developments, the concerns of the Committee also centred around the continuing high levels of consumer demand, which have been reflected in rising levels of credit extension to the private sector and also the larger-than-usual current account deficit on/of the balance of payments. Twelve-month growth in bank loans and advances extended to the private sector measured 23,1 per cent in April compared to 24,3 per cent in March, while asset-backed credit extended to the private sector continued to grow strongly at a year-on-year rate of 27,2 per cent in April. Although there were few signs of inflationary consequences at that stage, the impact was being felt in the deficit on the current account of the balance of payments which had expanded to 6,4 per cent of GDP by the first quarter of this year. As we observed in our latest Monetary Policy Review, current account deficits are a reflection of higher domestic expenditure and are not in themselves inflationary. There is however a possible risk to the exchange rate if the deficits are perceived to be unsustainable, particularly if the deficits reflect higher consumption expenditure. This is particularly the case where the international markets are rerating emerging market risk. Under these circumstances, there is the risk of a significant exchange rate adjustment which could threaten the longer-term attainment of the inflation target. The recent events in international markets, particularly with respect to New Zealand and Iceland, show how sensitive market perceptions can be to large current account deficits. Moderately higher interest rates therefore should not be seen to be undermining growth. Failure to respond to inflation risks could, however, be inimical to growth. 5. Conclusion Despite the recent turbulence in international markets, we are of the view that growth prospects remain sound both in South Africa and in the rest of the world. The inflation threats are likely to subside given the resolute determination of central banks around the world to tighten policy. Although the global interest rate environment may need further tightening and the results of which might be a moderation in global growth, it is unlikely to lead to a significant downturn in global growth. Combined with continued strong growth in China and other Asian countries, this should underpin commodity prices. Nevertheless serious risks remain, particularly those posed by geopolitical events which could have an impact on international oil prices. Domestically, the Bank will continue to play its part by contributing to the favourable growth environment. This we do through ensuring that inflation remains within the target band of 3-6 per cent. Thank you.
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Keynote speech by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Institute of Bankers in South Africa¿s Annual Dinner, Johannesburg, 1 June 2006.
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X P Guma: The Institute of Bankers in South Africa Keynote speech by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Institute of Bankers in South Africa’s Annual Dinner, Johannesburg, 1 June 2006. * * * Mr Chairman, Lawrence Mlotshwa; Mr President, Tom Boardman; Chief Executive Officer, Mr Mnisi; fellows of the Institute of Bankers, ladies and gentlemen, I wish to start my address by thanking the Institute for its invitation to me to be the keynote speaker tonight. Having last been invited to attend, let alone to speak on this occasion, almost ten years ago, I am somewhat anxious: for I am not sure about, I don’t know with any certainty, the reasons for your gracious invitation. That said, I must also indicate that I assume that I have not breached the order of precedence of your organisation and hasten to declare that I proceed on the basis that all protocol has been observed. The Institute of Bankers (IOB) in South Africa (SA) The IOB is, I have been told, a world-wide association of bankers which meets biennially with the objective of providing education to the industry. In South Africa, this association has a history which dates back to 1904 and, through its use of heraldry establishes a link between past and present notions of precedence, excellence, discipline and service. “Finis coronat opus” states the logotype – in free translation, “the end crowns the work”. Two stories may, I think, usefully be told in support of my assertion: the link between past and present. The first goes as follows: Once upon a time, in the 1970’s, a young man secured a holiday job with a branch of a major banking institution in a small country. In that country, most people knew or knew of each other. Being known to be bright, keen and energetic, the young man received neither training nor education from the managers of this branch of the major banking institution. Instead, they directed him to the “Waste Department” of the branch and advised him to “work hard”. On his first day on the job the young man – who was known to bright, keen and energetic – watched in wonder as clients conducted their banking business; deposits, withdrawals, investments. And keenly observed the flow of vouchers and chits: pink or red for debits; green or blue for credits. As the banking day drew to a close, a veritable flood of vouchers descended on the “Waste Department”. And our hero – who was known to be bright, keen and energetic set to work. Shred the red ones he thought; save the green ones. This, after all, is the “Waste Department” of a major banking institution. At approximately 2:45 p.m. that day, Nelly, the mentor arrived to assist our hero: he who was known to be bright, keen and energetic. She said: “We must now balance the total of the debits and the total of the credits in the accounts of the depositors … And the investors ….” He looked, with horror, at the pile of shredded pink chits in the waste-bin: “file 13”; Nelly had said before leaving. He looked again at the sign above him: it still read “Waste Department”; and he left – never to return. Now, had I been trained as a banker, this would never have happened. I would have known what was expected of the “Waste Department”, independently of Nelly who wouldn’t have mattered. But I would not have been able to laugh as loudly as I did when, thirty something years later, I received a letter from the said bank stating that: We must conclude that your account was closed in the ordinary course of business…” They don’t know what I know! The South African banking industry needs an Institute of Bankers to protect its depositors and its young from Nelly – the mentor; and from young people who are bright, keen and energetic but prone to improvisation when bored and unrestrained. The story of John Law: A second story The story about John Law, as told by Professor J.K. Galbraith 1 runs thus: Law, a Scotsman, arrived in France in 1716, in flight from a murder charge in England where he had been unduly successful in a duel. Having run through a considerable inheritance he had for some years made his living from gambling. In France, however, he was able to persuade the authorities to grant him – and his brother – the right to establish a bank with capital of 6 million livres or about 250 000 English pounds: banking being then virtually unknown in France. The bank was authorised to issue notes and did so – granting loans to the state. The government then used the notes to pay its expenses and pay off its creditors, whilst the banker – Law and brother – promised redemption in the currency of the weight of metal it contained at the date of issue of the paper. In other words, a classical fractional reserve bank. All went well for some time. The financial position of the government was eased; prices began to rise; business and business confidence improved. The Banque Royale flourished. Trouble arrived in 1719 when Law decided to found a company, the Mississippi Company, to exploit and bring to France the very large gold deposits which America was said to have in abundance. To this end, he sold stock and shares to the general public, the intention being to use the proceeds to finance gold mining in America. The gold was to be added to the reserves of the Banque Royale to support an increased issue of notes – which notes had by now become a generalised means of exchange. The problem lay with the French authorities. For the proceeds of the sale of stock went to them; not to the fictitious gold mines in America. Only the interest on the loans made to the authorities on the basis of the share issue was available to finance the said gold mines. As Galbraith (p.35) notes: “That the government of France was an even more unappealing investment than gold mining in the Louisiana swamps, or even that it and not Louisiana was the object of the investment went unnoticed – at least initially.” And Law, whose name was converted in French speech to the better-sounding Lass, became the most highly regarded man in France; on 5 January 1720, he was made Comptroller General of France, in recognition, it was said, of his financial genius. Then the bubble burst. One prince, early in 1720, offended by his inability to buy stock at what he considered a fair price sent a pile of notes to the Banque Royale to be redeemed in hard currency. It was quite a pile, needing three donkey-carts for the journey. But, to cut a long story short, there was not enough hard money on hand at Banque Royale to redeem the notes. Chaos ensued. Law’s reputation was ruined; business became depressed; prices fell and a general depression ensued. And what became of our financial genius, the Comptroller General of France? Why – he went to Venice and, having for a decade lived in decent poverty, a quiet and virtuous life, died there in the Catholic faith, piously receiving the Sacraments of the Church. And the moral of this story is this: The miracle of money creation by a bank may stimulate industry and trade – the upward phase of a business cycle in modern language – and give almost everyone a warm feeling of well being. But taken to excess, this miracle may result in a terrible day of reckoning. How to have the wonder without the reckoning? That is the question. Mankind has progressed somewhat from the times of the 1720’s with the creation of modern central banks whose functions typically include an element of oversight over the banking system. But the cupidity of certain people is eternal; and requires eternal vigilance. Beware of financial geniuses. This, I would like to suggest to you, provides the best firm reason for the continued existence of the IOB. It must equip all those who are going to work in the banking system with the requisite set of J.K. Galbraith (1975) Money: Whence it came, where it went, Penguin Books ethics with which to restrain people’s greed and cupidity: and protect bright, keen and energetic young men – and women – from the ways of Nelly, the mentor, by providing them with the requisite training. That done, we will all proudly be able to assert as we look back on our contributions to a safe and sound banking system, “Finis coronat opus”. Thank you for your attention. Ndi gqibile.
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Luncheon address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at Investec, Pretoria, 4 July 2006.
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X P Guma: Low domestic inflation in an environment of high oil prices, vigorous household spending and credit demand and a widening current account deficit; and the outlook for interest rates in South Africa Luncheon address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at Investec, Pretoria, 4 July 2006. * * * Inflation in the world economy has declined significantly in recent years and has remained relatively subdued over the past few years despite a significant rise in commodity prices and strong economic growth. Chart 1, based on World Bank data illustrates the trend in world inflation, clearly showing the peak that occurred at a rate in excess of 35 percent per annum in the early 1990s and the rapid deceleration to rates around 5 per cent per annum thereafter. South Africa’s inflation performance began to improve during the 1990s, as the next chart indicates; and subsequent to the adoption of the inflation targeting framework, inflation as measured by CPIX entered and has remained within the target range since September 2003. Oil prices have risen sharply since 2003 (as the next chart indicates), on account of various determinants. During this year, the spot price of Brent crude oil has increased dramatically from approximately US$59.9 per barrel in February to levels around US$70.5 per barrel towards the end of April and an average of US$68.15 per barrel in June. Continued brisk expansion in final consumption expenditure by households has been underpinned by a steady increase in household disposable income, continued buoyancy in the real estate and securities markets and what some describe as an accommodative interest rate environment. Overall household debt as a percentage of annualised disposable income increased to a record level of 68 percent in the first quarter of 2006. Robust growth in gross domestic expenditure and a concomitant strong increase in the value of merchandise imports resulted in a sizeable deficit on the trade account of the balance of payments in the first quarter of 2006. Given the larger shortfall on the services and income account with the rest of the world and the somewhat subdued performance of South Africa’s exports – notwithstanding the buoyancy of international commodity prices, the current account of the balance of payments registered a deficit equivalent to 6.4 percent in the first quarter of 2006. Interestingly, as others have observed, despite the sell-off in emerging markets since May, nonresidents have remained net buyers of South African financial assets and there have been significant investment flows into South Africa over the past year. Non-resident investors bought a net R13 billion worth of South African equities during May 2006 and R460 million the first half of June 2006. Despite generally negative sentiment towards emerging market-market assets, they continued to buy R768 million worth of bonds in May and R4.5 billion in June. About this there can be little argument, for all that I have done is to summarise the facts. It is also not in dispute that the repo rate, the rate at which the South African Reserve Bank will lend to the banks, was increased recently, primarily on account of deteriorating risks to the outlook for inflation. What we can debate, and what I look forward to hearing your views about, is the nature of the conflict regarding the outlook for interest rates in South Africa. The South African Reserve Bank Monetary Policy Review (May 2006) states it as follows: “On the one hand the inflation outlook, as reflected in the recent inflation forecasts of the Bank, has improved significantly… “on the other hand, there a number of developments that have led the MPC to remain vigilant”. This was before the last meeting of the MPC. Does a dilemma remain and how would you characterise it? Let me have your views.
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Friends of St Mark's fundraising dinner, Rand Club Johannesburg, Johannesburg, 28 July 2006.
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T T Mboweni: Education transforms lives – it changed mine Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Friends of St Mark’s fundraising dinner, Rand Club Johannesburg, Johannesburg, 28 July 2006. * * * Honoured guests, ladies and gentlemen I am honoured to be present here this evening and to be a part of this special annual dinner which has been turned into a very worthwhile cause. The Old Diocesan Union defines its objects as bringing together past students of the Diocesan College and the Diocesan Preparatory and Pre-Preparatory Schools, to keep them in touch with Bishops and the present students, to promote the interests and welfare of Bishops and to administer a fund to provide financial assistance for descendants of present and past members of the Union to be educated at Bishops. The formation of the Friends of St Mark’s and its activities over the years is glowing evidence, if any was required, that the role of Bishops has been redefined to shed its elitist image of the past. Situated in the midst of grinding poverty, in an area with unemployment rates at 80 per cent, the modest fees at the College are still beyond the reach of many locals. Fundraisers provide scholarships to disadvantaged pupils and help improve facilities at the school. Also, St Mark’s boasts a laudable community outreach programme that, among others, includes a Saturday school for children from disadvantaged state schools, a maths and science teachers’ support programme, availing the school’s science laboratories for use by other schools in the neighbourhood, and adult literacy classes. The Archbishop Emeritus Desmond Tutu describes St Mark’s College as being like water in a desert – transforming rural hopelessness into an oasis where young people can bloom. “Without St Mark’s College the chances of even literacy for children in this area are slim. These children could become just another statistic in the cycle of poverty. Education is the key to unlocking their potential – and what potential!” the Archbishop Emeritus, the patron of St Mark’s, exclaims. In the same vein, a Chinese proverb says: “If you are planning for a year, sow rice; if you are planning for a decade, plant trees; if you are planning for a lifetime, educate people.” This is echoed in the motto of St Mark’s: “Thuto ke lesedi”, which, broadly translated, means: “Education is light”. To which I may add that education changes lives – it definitely changed mine! The Strength of St Mark’s is the alumni association of St Mark’s College in Jane Furse. Addressing their 20th anniversary fundraising dinner in December 2005, I was impressed by the effort and remarked that it was indeed rare for former pupils of a black school to honour their school and commit themselves to raising funds for the institution. While education remains primarily a responsibility of government, private financial commitment is indispensable. Strong alumni associations in the US, for example, contribute substantial sums of money to their institutions. In South Africa, especially among blacks, there seems to be little interest among alumni to look back and support their old institutions. I do, however, acknowledge the nascent pockets of alumni associations of former black schools that are emerging in some parts of the country. This is a culture that we should endeavour to nurture. The relationship with a school does not and should not end with matriculation. We must seek to inculcate in learners that when they proceed to higher education, join the world of work or business, they remain representatives of their former schools in the community, country and the world at large. It is therefore heartening to be part of this fundraising drive, particularly because the Friends of St Mark’ s have opened their hearts and wallets to deepen and widen an existing initiative by former pupils of St Mark’s who have taken it upon themselves never to allow their Alma Mater to die. These are alumni who are proud of, and seek to build an everlasting relationship with their Alma Mater – a relationship to be treasured, nurtured and cultivated. These are men and women who value so much what they got out of St Mark’ s that they have developed a sense of community around the ownership of the St Mark’s brand. They have decided that the St Mark’s brand will be preserved and enhanced for current and future generations. The importance of building strong alumni associations cannot be overemphasised. The continued involvement and support of alumni have proved to be the hallmarks of long-term success and sustainability of schools and colleges in many parts of the world. As pressure on education budgets mounts the world over, fundraising events like these are no longer intended to raise supplemental income to fund “extras”, but have become essential components of schools’ budgets. Fundraisers are the financial lifeline for St Mark’s College – a matter of life and death. While alumni associations may be instrumental in generating financial resources for institutions, fundraising is not their raison d’être. We can also think of “fun” raising, i.e. entertaining and exciting ways of building alumni relationships. Various projects, too numerous to mention, can be undertaken. Also, benefits of staying connected to one’s Alma Mater, other alumni and peers are immeasurable. Networking is developed through strong alumni associations. This includes circulating information on internship, employment and other opportunities available in the various areas of enterprise alumni are engaged in. To my mind the benefits seem to outweigh the costs. Your effort as we gather here tonight dovetails with one of the government’s key programmes. As you may be aware, the government has set itself the goals of halving poverty and unemployment by 2014. To meet these challenges, the government seeks an annual average growth rate of 4,5 per cent or higher between 2005 and 2009, and an average growth rate of at least 6 per cent between 2010 and 2014. There are strong indications that the South African economy has reached a higher growth path. The growth rate averaged 3 per cent per annum between 1994 and 2003 as compared to 1 per cent during the decade preceding the country’s advent to democracy. However, growth rates in 2004 and 2005 have averaged 4,5 per cent and 4,9 per cent respectively. While growth is expected to decelerate somewhat this year, it is still expected to exceed 4 per cent. There is thus little doubt that the sustained application of prudent macroeconomic policies is bearing fruits. Monetary policy has played its part by contributing to a low inflationary environment - inflation has been within the target range of 3-6 per cent for CPIX for the past 34 months - which in turn has been supportive of economic growth. The maintenance of price stability, however, is not without its challenges. The globalisation of the South African economy is well documented. There is no escaping the impact of global influences on the SA economy. The recent volatility in our financial markets following the increased risk aversion of global investors towards emerging countries is an example in this regard. In addition, the recent successive monthly increases in the price of petrol as a result of the sustained increase in international oil prices bear further testimony to the sensitivity of the South African economy to global developments. As is the case internationally, the high oil price, if sustained, poses a significant threat to inflation and economic growth in South Africa. There are domestically generated risks to the inflation outlook as well. In particular, the current high levels of consumption expenditure, balance of payments imbalances and higher than expected producer prices pose an even greater threat to the low inflationary environment we have been enjoying in South Africa. These developments demand vigilance on the part of the Bank if the hard-fought economic gains are to be sustained. The Bank’s continued contribution to the growth process, therefore, is to maintain a low inflation environment and contribute towards a sound financial system. Although some maintain that the recent interest rate increase will undermine growth, we are of the considered view essential for the maintenance of the stable framework for growth. But low inflation or macroeconomic stability on its own does not guarantee higher growth. The government’s Accelerated Shared Growth Initiative of South Africa (ASGISA) plans to achieve and sustain a higher growth rate through an ambitious investment programme which focuses on improving and expanding the infrastructure of the economy. The government has highlighted the shortage of skilled labour as one of the binding constraints to achieving the desired levels of economic growth. Both government and the private sector have an important role to play in meeting the skills shortage of the economy. Though it may seem modest, this fundraising dinner furthers empowerment through granting learning opportunities to the disadvantaged, thus adding to the skills base and increasing economic opportunity and upliftment in areas around St Mark’s. Initiatives such as this one, if sustained and replicated across the country, will make a meaningful contribution to the ultimate objective of a better life for all. Ladies and gentlemen, the time, effort and money donated towards making this evening such a resounding success, is an eloquent expression of passion for extending educational benefits to the least well-off and most vulnerable. No cause can be worthier. I thank you all for listening to your hearts and opening your purses to make a difference. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 86th Ordinary General Meeting of shareholders, Pretoria, 23 August 2006.
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T T Mboweni: Overview of the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 86th Ordinary General Meeting of shareholders, Pretoria, 23 August 2006. * * * We live in an ever-changing global environment, an environment that is characterised by opportunities and hope, but also fraught with risks. In this environment the South African Reserve Bank (Bank) must implement its mandate and manage the associated risks to ensure that South Africans benefit from opportunities emanating from a changing world. Today, I am pleased to report on another successful year in the eighty-five-year history of the Bank. The achievement and maintenance of price stability remains the primary objective of the Bank. Indeed, the most significant accomplishment of the Bank has been the containment of inflation within the target range since September 2003. This does not imply that the other functions of the Bank are neglected. On the contrary, these remain crucial in the operations of the Bank. Today we also release our Annual Economic Report which covers the broader aspects of the domestic and international economy that impact on many of the activities of the Bank. This address will highlight, where relevant, some of the salient economic developments which have affected our operations. The focus of this address is on the main operational areas of the Bank including monetary policy, monetary operational procedures, gold and foreign exchange reserve management, the national payment system, banking regulation and supervision, international co-operation and internal administration. Monetary policy Monetary policy during the past year was conducted against the background of a strongly growing international economy and buoyant commodity prices. This strong growth, combined with rising geopolitical tensions and other supply constraints, placed upward pressure on international oil prices, which reached highs of almost US$80 per barrel in recent weeks. Despite the high oil prices, world inflation initially remained subdued, but inflationary pressures have since begun to emerge in a number of countries. This has prompted the tightening of monetary policy by several central banks in the past few months. Domestically, the economy grew by 4,9 per cent in 2005. In the first two quarters of 2006, economic growth remained robust but showed some moderation compared to 2005. An annualised growth rate of 4,2 per cent was recorded in the first quarter of 2006. Inflation remained under control in the period under review, with changes in CPIX (that is the consumer price index for metropolitan and other urban areas excluding mortgage interest cost) remaining within the target range of 3 to 6 per cent. In the twelve months from 1 April 2005 to 31 March 2006, the year-on-year CPIX inflation rate averaged 4,1 per cent, but changes ranged between 3,5 and 4,8 per cent over the period. From March to June 2006, CPIX inflation accelerated from 3,8 per cent to 4,8 per cent. Services price inflation continued to decline and had fallen below goods price inflation by the beginning of 2006. This was partly a reflection of the continued containment of increases in administered prices, other than petrol prices. The higher trend in goods prices was initially mainly due to petrol price increases, and more recently food price increases. During the first nine months of 2005, food price inflation averaged 1,8 per cent and therefore contributed to the downward trend in inflation. Following the strong increase in maize prices towards the end of 2005, food price inflation began to increase and had risen to 7,2 per cent by June 2006. By contrast, the prices of a number of categories of goods fell, particularly clothing and footwear, and furniture. Production price inflation increased over the past year and averaged around 5,5 per cent in the first four months of 2006, compared to 2,3 per cent in June 2005. However, a further acceleration occurred in May and June 2006, when producer inflation reached levels of 5,9 per cent and 7,5 per cent, respectively. Changes in energy and food prices provided much of the impetus to higher production prices. For much of the reporting period the inflation outlook was fairly stable and favourable. This allowed for an unchanged repo rate of 7 per cent for a prolonged period following the reduction by 50 basis points in April 2005. In the past year, there were a number of developments that supported a favourable inflation outcome. Lower inflation expectations appeared to have had an impact on wage settlements which have declined steadily. Unit labour cost increases were also moderate, with an average rate of increase of 3,4 per cent for 2005, significantly down from the rate of 6,5 per cent recorded in 2004. These developments, combined with the increased credibility of monetary policy as indicated by improved inflation expectations, were expected to support sustainable low inflation. The inflation outlook was also supported by continued fiscal discipline, output growth in line with growth potential and low world inflation. The initial impact of the significant increase in international oil prices on world inflation, world growth and domestic inflation was minimal, confounding earlier fears of a repetition of inflation spirals seen during previous oil price shocks. Some of the other determinants of inflation have remained favourable for much of the period, although their associated risk increased over the past year. The exchange rate remained within a fairly stable trading range over much of the period. However, following increased uncertainties in the international markets from May 2006, the rand came under pressure, along with the currencies of a number of other emerging-market economies. The rand exchange rate also reacted further to the publication in June of the first quarter current-account deficit of South Africa. Between the beginning of May 2006 and the beginning of August, the trade-weighted exchange rate of the rand depreciated by approximately 14 per cent. Despite the positive developments in the inflation outcomes during the past year, there was a steady deterioration in the outlook of a number of the fundamental determinants of inflation, increasing the degree of upside risk to the inflation outlook. Of increased concern to the Monetary Policy Committee (MPC) was the continued strength of domestic demand. For the past two years, household consumption expenditure has grown at annual real rates of almost 7 per cent. Retail sales continued to grow strongly and consumer confidence reached an all-time high by the end of 2005. This was fuelled by high rates of credit extension which averaged over 20 per cent during the past year, and resulted in household debt rising to 66 per cent of disposable income in the first quarter of this year. The strong growth in expenditure had little immediate impact on domestic inflation, although the MPC noted at its meeting in February 2006 that adverse price effects would be inevitable if these trends continued unabated. Increases in consumption expenditure, however, contributed to the progressive widening of the deficit on the current account of the balance of payments from 4,2 per cent of gross domestic product in 2005 to 6,4 per cent in the first quarter of 2006. This development was seen by the MPC to pose a potential threat to inflation through its possible impact on the exchange rate, should the deficit be regarded as unsustainable. Nevertheless, these deficits were adequately financed by capital inflows. The sustained strong domestic demand, combined with threats posed by international oil prices, food prices, and exchange rate developments, increased the risk to the inflation outlook. In response to these heightened risks and the deteriorating inflation outlook, the MPC felt that pre-emptive action was required. Accordingly, the repo rate was increased by 50 basis points to 7,5 per cent on 8 June 2006 and by a further 50 basis points on 3 August 2006. However, future monetary policy decisions will depend on changes in the outlook for inflation and economic developments. Monetary operations The Bank uses open-market operations to provide and drain liquidity from the money market in order to maintain the liquidity requirement of banks at a level sufficient for the implementation of monetary policy in line with the stance determined by the MPC. Deposits of banks at the Bank in terms of the minimum statutory cash reserve requirement (2,5 per cent of liabilities, as adjusted) amounted to R28,7 billion for the June/July maintenance period. As at the end of June 2006, total outstanding debentures on issue by the Bank and longer-term reverse repurchase transactions amounted to R5,4 billion and R2,0 billion, respectively. The deposits of the Corporation for Public Deposits with the Bank, which amounted to R11,1 billion at the same date, also contributed to the draining of excess liquidity. Notes and coin in circulation also had a contractionary impact on liquidity, increasing from R49,0 billion on 30 June 2005 to R53,9 billion a year later. Currency in circulation The daily average value of banknotes in circulation in the period 1 April 2005 to 31 March 2006 amounted to R46,3 billion, while the average value of coin in circulation during the same period amounted to approximately R2,7 billion. While banknotes in circulation increased by 10,2 per cent over the previous corresponding period, coin in circulation increased by 9,1 per cent. A seasonal peak for banknotes and coin in circulation of R57,4 billion was reached on 23 December 2005. The demand for coin has shown a substantial increase in the past few months. This is particularly the case in respect of the demand for the 5c coin, which shows an increase of approximately 30 per cent, compared to the corresponding previous reporting period. The Bank has co-operated with commercial banks in the development of a more efficient and effective integrated national cash management system. The improved system has the potential to limit the cash holdings of banks, thereby contributing to a reduction in the cost of cash to the public. Gold and foreign exchange reserves The activities of the Bank in the domestic foreign exchange market are aimed at managing domestic money-market liquidity conditions through foreign exchange swaps, servicing the foreign exchange requirements of clients and increasing foreign exchange reserves in a prudent manner when conditions permit. The Bank does not aim to influence the exchange rate of the rand, but leaves its determination to the forces of demand and supply in the foreign exchange market. The Bank continued to take advantage of favourable market conditions to increase the level of official gold and foreign exchange reserves. Gross reserves increased from US$15,9 billion at the end of March 2005 to US$23,95 billion at the end of June 2006. Over the same period the international liquidity position increased by US$7,79 billion to US$20,19 billion. The increase in the level of official reserves has been well received by market participants and rating agencies and has contributed to the improved perception of South Africa’s fundamentals by international investors. The Bank and the National Treasury co-operate very closely in the process of accumulating reserves. In making rand-denominated deposits with the Bank, the National Treasury assists with absorbing the excess liquidity created by the purchases of foreign exchange. As at the end of June 2006, government deposits at the Bank, the greater part of which related to this sterilisation initiative, amounted to R36,2 billion. The higher level of foreign exchange reserves resulted in an increased focus on the management thereof to ensure safety, liquidity and an adequate return within conservative risk parameters. At the end of June 2006, the internally managed portfolios comprised 81 per cent of gross reserves, with the balance managed externally. Internal reserve management capacity and skills have been strengthened significantly through training and skills transfer agreements with external fund managers. A securities lending programme was implemented in July 2005. In terms of this programme, securities held on behalf of the Bank by a custodian can be used in lending transactions against cash or other high-quality collateral. The income and fees generated by this programme help to defray some of the costs incurred as a result of the external fund management programme. In April 2005 the National Treasury made a final payment in the form of zero-coupon bonds to the Bank as compensation for losses accumulated over many years in the Gold and Foreign Exchange Contingency Reserve Account. Financial stability As you are aware, the Bank is not the sole custodian of financial system stability, but contributes towards a larger effort involving the government, other regulators and selfregulatory agencies, and financial market participants. The activities of the Bank relating to financial stability include the application of policies, instruments, norms and tools to prevent, detect and manage systemic instability of institutions, markets, and the payment and settlement system. The robustness of the financial regulatory system was continually assessed and reported on in the bi-annual Financial Stability Review of the Bank. Confidence in the domestic financial services sector remains high. National payment system The Bank published its new strategic framework and strategy for the National Payment System (NPS), known as Vision 2010, in April 2006. Vision 2010 provides strategic direction for the payment system and its bank and non-bank participants up to 2010, identifying five major challenges for the payment system. These challenges include accessibility; transparency; security; support for payment, clearing and settlement initiatives of the Southern African Development Community (SADC); and keeping abreast of international developments. The monthly value of settlement in the South African Multiple Option Settlement (SAMOS) system amounted to R4,6 trillion in June 2006, or approximately R200 billion per day. This includes the settlement of transactions stemming from the equity and bond markets, as well as the rand leg of domestic foreign exchange transactions. Approximately 90 per cent of settlement through SAMOS is effected on a real-time basis during the day, while the remaining 10 per cent, which emanates from the retail batch environment, is settled in the evening. An upgrade of the SAMOS system, providing for the handling of dematerialised money-market instruments, was successfully implemented in June 2006. The Bank continued to facilitate a low-cost payment solution between the different role players in the low-income collection environment. The first directive for conduct in the payment system for banks participating in the low-income collection environment was issued by the Bank during the period under review. Banking regulation and supervision The South African banking regulatory framework has to be amended to provide for the requirements of the new international Capital Accord (Basel II) for banks. During the period under review, two drafts of amendments to the Banks Act, No 94 of 1990, and the regulations thereto, were circulated for comment to the Accord Implementation Forum (AIF), comprising representatives of the Bank, the National Treasury, the banking sector and The SA Institute of Chartered Accountants. All registered banks, branches of foreign banks and mutual banks in South Africa were requested to perform a gap analysis and self assessment, including an impact study of prescriptions for their capital-adequacy requirements, to determine their readiness for the implementation of Basel II. In order to capture the risks faced by an entire banking group, Basel II will be applied on a consolidated basis to internationally active banks. The Bank participated in a joint project with the National Treasury to investigate the requirements necessary to implement a deposit-insurance scheme for South Africa. Once certain issues have been resolved, a final proposal will be submitted to the Minister of Finance for consideration. A corporate governance review of 14 South African banks (including two mutual banks, but excluding the five biggest banks) was undertaken during the period under review. Its purpose was to assess the compliance of the banks under review with sound corporate governance practices as laid down in the Banks Act or the Mutual Banks Act, No 124 of 1993, the regulations to these acts, the recommendations of the Myburgh Report on the Standard of Corporate Governance in the Five Largest Banks, and the second King Committee on Corporate Governance. International co-operation The Bank continued to play an active role in the international arena. The Bank and the National Treasury will jointly chair the G-20 in 2007 and the Bank has been very active in preparing for this. The Bank has established a G-20 Unit for this purpose, which works closely with the G-20 Secretariat in the National Treasury. Established in 1999, the G-20 is a forum where central bank governors and ministers of finance of developed and systemically important emerging and developing economies deliberate on issues related to global economic and financial stability in support of global growth and development. The Bank and the National Treasury will undertake the preparations necessary for hosting meetings and seminars of the G-20 next year. In August 2005, a G-20 seminar on economic growth was held at the Bank, jointly hosted by the South African Reserve Bank, the Bank of Mexico and the People’s Bank of China. The Bank is an active member of the Bank for International Settlements (BIS) which acts as the central bank for the central banks of member countries. In May 2005 the Bank bought further shares in the BIS which represented a pro rata allocation of the redistribution of a portion of US shares in the organisation. I regularly attend the meetings of the BIS, until recently representing the only African country. I am pleased to say that after many years of persuasion by ourselves for the admission of another African country, Algeria is now a shareholder of the BIS. Our co-operation with the International Monetary Fund (IMF) continues. In May 2006, I was appointed by the Managing Director of the IMF, Mr Rodrigo de Rato, as a member of the Committee of Eminent Persons to study the long-term sustainability of the finances of the IMF. There is little doubt that international organisations such as the IMF should become more accountable to their membership regarding their operations. It is my strong view that the financing of any organisation has an important bearing on its accountability and transparency. It is envisaged that the Committee will meet four or five times over the next six months, and will table its report in early 2007. The Bank continues to improve its international co-operation efforts with global partners. During this year the Bank has signed Memoranda of Understanding (MoUs) with the central banks of Argentina and Ukraine. Discussions on co-operation agreements have advanced significantly with the central banks of China and Peru, and completion and signing off of such agreements are expected in due course. With regard to regional integration activities on the continent, the Bank continues to host the Secretariat of the Committee of Central Bank Governors (CCBG) in SADC. Good relationships with central banks in the region have been boosted this year as three MoUs in the areas of information technology, exchange control and payment systems have been signed by central bank governors. The Bank participated in the annual regional payment conference for countries in SADC, which focused on general payment system developments. In addition, three paymentsystem workshops were hosted for SADC countries during the period under review. The aim of these workshops was to evaluate the payment system of each SADC country in accordance with the Financial Sector Assessment Programme of the IMF and the World Bank. These evaluations and the report to the IMF and the World Bank will form the basis of the annual regional payment conference to be held later this year. The South African Reserve Bank College continued to play a key role in training staff members of central banks and financial institutions in Africa. It also co-organised the IMF Financial Programming and Policies course and a Financial Markets Analysis course presented by the Joint Africa Institute. Internal administration The Annual Report of the Bank was distributed to shareholders before this meeting. The balance sheet totals of the Bank show an increase from R129 billion at the end of March 2005 to R168 billion at the end of March 2006. The increase was mainly the result of the accumulation of official gold and foreign exchange reserves and was financed in the main by an increase in government deposits. The profit before taxation of the Bank increased from R866 million for the previous financial year to R1 038 million for the financial year ending 31 March 2006. Budgeted expenditure of the Bank for the current financial year amounts to R1 615 million, compared to actual expenditure of R1 530 million in the financial year to 31 March 2006. This represents an increase of 5,56 per cent in budgeted expenditure compared to actual expenditure for the previous financial year. The four subsidiary companies of the Bank achieved their objectives during the financial year. After a review of reports by their Boards of Directors, and internal and external auditors, the Bank is satisfied that these companies are managed in accordance with their objectives and best corporate governance practice. The results of the subsidiaries are reported on a consolidated basis with those of the Bank in the financial statements. During the financial year to 31 March 2006, 40 transactions in respect of 123 808 shares of the Bank were concluded. On 31 March 2006, the Bank had 615 shareholders and by the end of June this number had remained unchanged. Improved operational efficiency has been achieved since the introduction of a revised organisational structure of the Bank in August 2005. As was envisaged, this structure allows the Governor and deputy governors to devote more time to policy and strategic planning, while the executive general managers are responsible for the general management, supervision and control of the Bank departments reporting to them. The Bank has embarked on a number of capital projects. The existing infrastructure of the head office building is currently under improvement to ensure maintenance and optimal utilisation. The Bank has also made considerable progress with the practical implementation of its business continuity management and disaster recovery strategies. A dedicated disaster recovery site for head office operations has been completed and will be fully functional towards the last quarter of 2006. Business continuity planning for the seven branch offices and the subsidiaries has also been completed. In the year under review the total staff complement of the Bank declined further to 1 956 as at the end of March 2006 and 1 937 at the end of June 2006. This can be compared to a staff complement of 2 288 in March 2003. Staff turnover in the Bank has increased from 4,3 per cent in the 2002/03 financial year to 7,1 per cent in the financial year ending 31 March 2006. These trends could eventually impact on the employment equity targets of the Bank, as many of the resignations occurred from the designated groups at middle management level. The Bank contracted an external party to conduct an organisational culture and climate survey during February and March 2006. The study achieved a high level of voluntary participation among staff members. Although the study has identified a number of areas where the Bank should focus initiatives to improve staff morale, it has also indicated that staff members are satisfied with many other aspects relating to the Bank as an employer. The Bank has also engaged an external service provider to conduct voluntary HIV/Aids prevalence testing among its staff, after launching its HIV/Aids Response Programme in February 2006. Preparation is currently taking place for the roll-out of the initiatives of this programme on a Bank-wide basis, covering matters such as HIV/Aids awareness and education campaigns, and the training of management and employees in HIV/Aids counselling. The Bank is viewed as an industry leader in complying with the requirements of the Employment Equity Act, No 55 of 1998 (EE Act), and the Skills Development Act, No 97 of 1998. The mandates of the structures created for consulting in terms of the EE Act have been amended during the period under review to encompass consultation on the workplace skills plan before its annual submission to the Bankseta. The Bank has made significant improvements in employment equity in recent years. The employment equity representation at the end of June 2006 was 56 per cent black and 46 per cent female in total. At management level the figures were 43 per cent black and 36 per cent female, respectively. However, we have not entirely achieved the target of 50 per cent black at all levels of seniority as was envisaged in the original Employment Equity Plan submitted six years ago. A draft second employment equity plan has been completed and is currently the subject of consultation with staff. The draft plan, to be submitted to the Department of Labour in October 2006, proposes an increase in the target for female employment from 33 per cent to 50 per cent of the staff complement at all levels of employment. A target of 2 per cent of employment for people with disabilities is also under consideration. A number of training and development interventions were conducted during the 2005/06 financial year. A total of 1 346 employees benefited from these interventions, including 626 staff members who attended courses at the South African Reserve Bank College. In addition, 230 staff members received study aid during the year to 31 March 2006 to improve their formal qualifications. The Bank has concluded an extensive consultation process with staff, the Employment Equity Consultative Body and the finance union SASBO regarding the modernisation of staff-related policies. In this process the original policies proposed by the Bank have been amended to incorporate many of the views expressed by these stakeholders. A process has been embarked upon to familiarise staff with the new policies and it is anticipated that implementation will take place on 1 October 2006. Conclusion Reflecting on another successful year in the long history of the Bank, the preceding review provides ample evidence of the achievement of the various objectives of the Bank. Monetary policy has contributed to the containment of CPIX inflation to within the target range against the background of various risks to the inflation outlook. The MPC will remain vigilant and will not hesitate to adjust the monetary policy stance when necessary. The Bank is committed to the pursuit of low and stable inflation as a major contributing factor to the growth and development of South Africa. The Bank will carefully monitor the progress of South African banks towards ensuring their readiness for the implementation of Basel II on 1 January 2008. As always, the internal management of the Bank will receive the necessary attention. The Bank values its human resources very highly and this is borne out in the new and modernised staff-related policies that will be implemented later this year. The Bank is committed to the training and development of staff which will be done in pursuit of transformation as envisaged in the new employment equity plan. We will continually strive towards creating an organisational culture that makes the Bank an employer of choice. Acknowledgements I want to thank the Presidency, the Government and Parliament for their continued support. The Minister and Deputy Minister of Finance, and the Director General of the National Treasury and his staff also supported the Bank in the conduct of its business. I want to express a hearty word of thanks to the Board members for their commitment and service to the Bank. It is an honour and privilege to work with such a diverse and distinguished group of people. During this year, Ms A M Mokgabudi stepped down from the Board and as Chairperson of the Remuneration Committee because of professional commitments. Her service to the Bank is greatly appreciated. Although I have paid tribute to Mr I Plenderleith at the previous general meeting, he officially retired as Deputy Governor in January 2006. It is accordingly appropriate to thank him again on this occasion for his dedication and service to the Bank. Finally, the Bank cannot achieve its goals without the loyalty, service and dedication of its management and staff. I wish to thank the deputy governors, management and staff of the Bank for their contributions.
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Remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Bank Note Design Gala evening, held at the South African Reserve Bank, Pretoria, 30 August 2006.
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X P Guma: Banknote design Remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Bank Note Design Gala evening, held at the South African Reserve Bank, Pretoria, 30 August 2006. * * * 1. Dr Heinz Wirz, President of the South African Bank Note Society, distinguished guests, competitors, ladies and gentlemen; thank you very much for your kind invitation to me to say a few words on this auspicious occasion. I was delighted to be able to accept the invitation. 2. The South African Reserve Bank is the proud sponsor of the evening and of the prizes which will be awarded tonight – and I address you, therefore, not only in my personal capacity but also as a responsible representative of the Bank. 3. A man who was occasionally given to keen insight once spoke as follows: “… the nice thing about being a celebrity is that if you bore people, they think that it is their fault …”. 1 Now, as my claim to celebrity status is as tenuous as any claim I may have on wisdom, I am going to be extremely brief in my remarks: I don’t want to bore anybody, as I won’t be able to deflect subsequent criticism elsewhere. 4. As Governor Mboweni noted at the launch of the upgraded bank note series last year; “...Banknotes… are not only a means of payment. They are pieces of craftsmanship that are a window on the country, its people, heritage and culture …” 2 This is certainly true of ours – but may be less than an exact description of some others. But that, in a sense, is what this evening’s proceedings are intended to celebrate: Banknotes as art, pieces of craftsmanship, even as they serve as a medium of exchange. 5. Not that long ago, as some elderly people are wont to say, South African bank notes were still being printed overseas. When decimalised currency was introduced on 14 February 1961, those first rand notes were printed by Bradbury Wilkinson and Company in England. It was only with the introduction of the so-called Third Rand Series in 1966 that the bank notes, of a completely new design, were printed locally by the newly established South African Bank Note Company. This company, with its printing works in Pretoria, was jointly owned by the South African Reserve Bank and by Bradbury Wilkinson Limited. That was forty years ago. 6. The South African Bank Note Company is now fully owned by the South African Reserve Bank and continues to print quality bank notes for South Africa and for the export market. In this case, ownership by a legal monopoly has not compromised quality or competitiveness. 7. The symbols of value you have been working on are much sought after. Once a bank note makes it into production the numbers involved are staggering. I will not attempt to give exhaustive statistics regarding the production of bank notes in South Africa. It is enough to say that the value of bank notes in circulation outside the South African Reserve Bank exceeds R50 billion – or about one thousand one hundred rand for every man, woman and child in South Africa. And that thousand rand plus is roughly made up of two R10 notes, three R20 notes, two R50 notes, seven R100 notes and one R200 note. Although in your design competition you worked on a R500 note, we are far from needing it. 8. I am happy to confess that the issuing of bank notes is a monopoly. This sole right was legally granted to the South African Reserve Bank by the South African Parliament. As a quid pro quo, the Bank pays over a substantial portion of its profits to the government. In making sure that potential competitors end up in jail, the Bank co-operates closely with the South African Police Service. It is reassuring to note that this collaboration is successful, and that the incidence of Former US Secretary of State, Henry Kissinger as quoted in Business Day, 30 August 2006. Speech by Mr T.T. Mboweni, Governor of the South African Reserve Bank, at the Launch of the Upgraded Banknote, Pretoria: 17 January 2006. counterfeit notes is very limited thanks to the sterling efforts of the Police, the Reserve Bank and the banks in the private sector. 9. The competition emphasises not only the more artistic, political and symbolic dimensions of bank note design, but also the matter of security features. Changes and improvements in the appearance and security features of a bank note series are crucial in making the lives of counterfeiters miserable, and in maintaining public confidence in our money. Unfortunately, nobody has yet devised a system for legally making counterfeiters’ lives also short and brutish. 10. The design competition correctly recognises the importance of the SADC region to our future, by requiring entrants to also propose designs for bank notes in other SADC countries. A greater degree of monetary integration in the region is being planned, to be implemented over the next decade: and this process may well involve changes in the range of currencies used. For the time being South African rand is often used on our subcontinent, being legal tender in Lesotho, Namibia and Swaziland. The Rand circulates more widely than this by virtue of simply being convenient and appropriate to use for certain types of payment in many other countries. 11. Maintaining confidence in our money is, of course, not merely a matter of having beautiful designs, good security features, and ensuring that counterfeiters end up in jail. Right at the core of our monetary system is the need to protect the purchasing power of our money. The South African Reserve Bank is totally committed to doing so, by maintaining inflation within the target range of 3 to 6 per cent per annum. This commitment has been illustrated by our policy actions since inflation targeting was formally introduced in February 2000. That is why I say that we are a long way from needing a R500 note: inflation is under control. 12. I wish to thank the South African Bank Note Society, the staff of the tertiary institutions involved in this competition, the adjudicators who have had great difficulty in deciding between the excellent entries received, and above all the students who participated so diligently. To all of you, please view your time and effort as an investment to maintain and strengthen the pool of expertise in our country, so as to ensure that our designers and producers of banknotes can compete successfully against the best in the world. 13. Utlwa! Ke qetile. Thank you for your attention.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the XVI meeting of the Central Bank Governors' Club, Irkutsk, Russia, 2 September 2006.
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T T Mboweni: South Africa’s economic policy challenges Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the XVI meeting of the Central Bank Governors’ Club 1 , Irkutsk, Russia, 2 September 2006. * * * Governors, Honoured guests Ladies and gentlemen 1. Introduction I am grateful to the Central Bank of the Russian Federation for inviting me to address the Governors’ Club today. I have been informed that one of the main objectives of the Governors’ Club is to promote co-operation in the sphere of central banking among member countries. In the light of the rapid developments in the global financial system, there is little doubt about the benefits of associations such as the Governors’ Club. I trust that the experience of South Africa and the southern African region that I am going to highlight today will be informative to the objectives and activities of the Governors’ Club. 2. South Africa’s economic growth performance Similar to the many countries participating at this meeting, the South African economy can be described as an economy in transition. It is the largest economy in Africa with gross domestic product in 2005 measuring US$239,4 billion (R1523 billion), compared to US$135,8 billion (R482,1 billion) in 1994. GDP per capita increased from approximately US3,500 in 1994 to approximately US$5000 in 2005, in a country with a population of approximately 47 million people and an annual population growth rate of marginally below 1 per cent. Because of the legacy of the apartheid, there is still a highly skewed distribution of income and wealth in the country. According to recent estimates, the Gini coefficient is approximately 0.65. One of the primary objectives of the current government is to rectify these inequalities. This is a particular challenge given the high levels of unemployment in the country. The most recent unemployment rate for 2005 was approximately 27 per cent, slightly higher than a year earlier. Although South Africa is a major commodity producer, and commodities or commodity-based products make up a significant proportion of our exports, the contribution of mining to GDP is relatively small at 6 per cent. The largest sector in the economy is the finance, real estate and business services sector which accounts for almost 20 per cent of GDP, followed by the manufacturing sector which accounts for just over 16 per cent. The agricultural sector is one of the smallest sector, contributing about 2,4 per cent of GDP. Only twelve years ago the country emerged from apartheid, international isolation and economic and financial sanctions. The new dispensation inherited an economy characterised by low growth and high levels of inflation. Growth averaged 1,0 per cent over the period 1984 to 1993, while inflation averaged 14,3 per cent during the same period. Since then, macroeconomic performance has improved significantly as a result of improved policies. In sharp contrast to the 1,0 per cent GDP growth attained during the decade preceding 1994, South Africa has since experienced twelve years of uninterrupted GDP growth, averaging 3,3 per cent per annum. The economy grew by 4,5 per cent and 4,9 per cent during the last two years and growth this year is also expected to exceed 4 per cent. The Governors` Club is an association of central banks from Central Asia, Black Sea Region and Balkan Countries. It consists of 19 members from the following countries: Azerbaijan, Albania, Armenia, Bulgaria, Bosnia and Herzegovina, Greece, Georgia, Israel, Kazakhstan, Kyrgyz Republic, Macedonia, Montenegro, Moldova, Russia, Romania, Serbia, Tajikistan, Turkey and Ukraine. Prudent fiscal management has seen South Africa's budget deficit reduced from 5,2 per cent of GDP in 1994 to 2,0 per cent of GDP in 2004, and 0,3 per cent of GDP in 2005. Monetary policy also underwent a significant ‘regime change’ during the period, with the adoption of an inflation-targeting framework in February 2000. One of the fundamental objectives behind the adoption of the inflation targeting framework was to enhance policy transparency and accountability and thereby decrease and anchor inflationary expectations over time. The improvement in the performance of the South African economy needs to be maintained if meaningful progress is to be made in meeting the economic and social challenges facing the country, particularly the eradication of poverty and unemployment. The South African government has, therefore, set itself the goals of halving poverty and unemployment by 2014. To meet these challenges, the government seeks an annual GDP growth rate that averages 4,5 per cent or higher between 2005 and 2009, and an average growth rate of at least 6 per cent between 2010 and 2014. Public infrastructure investment to the value of R370 billion is also planned for the next three years. The targeted interventions in public transport, communication and electricity provision should not only contribute to the growth performance over the next couple of years but also go some way towards increasing the growth potential of the economy. 3. Monetary policy It is our firmly held view that the best contribution that monetary policy can make towards the attainment of sustainable higher growth rates is to ensure price stability. The mandate of the South African Reserve Bank is defined in the Constitution of the Republic of South Africa as the protection of the value of the currency in the interest of balanced and sustainable economic growth in the Republic. Deriving from this constitutional mandate, the Bank regards its primary goal in the South African economic system as "the achievement and maintenance of price stability". This is currently interpreted as CPIX inflation – that is headline inflation less mortgage interest costs – being between 3 to 6 per cent. Despite some initial setbacks in late 2001 and during 2002, when inflation increased rapidly in reaction to the significant depreciation of the currency, the inflation targeting framework has served us well. Having averaged 7,9 per cent between 2000 to 2002, inflation has been contained within the target range since September 2003. For the past two years inflation has averaged 4,0 per cent. Without getting into the merits and demerits of inflation targeting, the inflation targeting framework has served as a good anchor for monetary policy in South Africa. It has led to better co-ordination of monetary policy and other economic policies than was the case in the past. The political commitment, as evident in the pursuance of prudent fiscal policies, has been crucial to the containment of inflation within the target band. In addition, the inflation target provides the basis for the accountability of the central bank and it improves public understanding of monetary policy decisions. The inflation targeting framework has also helped to anchor inflation expectations within the target range, thereby further enhancing confidence in monetary policy. This has, however, not been achieved easily. Although it proved to be unpopular in some quarters, a stringent monetary policy stance had to be adopted initially in order to demonstrate the commitment of the Bank to meeting its statutory obligations and ensuring the credibility of monetary policy. The initially painful experience had a positive outcome, given the subsequent favourable impact on price and wage setting behaviour in the economy. 4. South Africa’s financial markets South Africa is a small open economy by international standards. This in itself presents some challenges for the pursuit of price stability, not least of which is the nature of the South African financial markets. South African financial markets are relatively deeper, broader and more sophisticated than those in a number of emerging markets. According to the latest World Competitiveness Yearbook, South Africa is ranked 46th overall but 22nd in Banking and Financial Services, higher than countries such as Ireland, Spain, France and even the United Kingdom. Trading in bonds and equities is fully automated and exchange-driven through the Bond Exchange of South Africa (Besa) and the Johannesburg Securities Exchange Limited (JSE), respectively. Corporates currently account for about 32 per cent of the total debt listed on Besa. The turnover on Besa has increased from R2,1 trillion in 1995 to R8,1 trillion in 2005. As at the end of 2005, 388 companies were listed on the JSE. The JSE has evolved into a truly international bourse, with more than 60 companies listed on at least one other exchange internationally, and non-residents accounting for about 20 per cent of the daily turnover. Turnover on the JSE has also grown sharply over recent years, increasing from an annual turnover of R22 billion in 1992 to R1,279 trillion in 2005. The Allshare index of the JSE reached record highs in April 2006, gaining around 18 per cent in the year to the end of April. The All-share index is currently trading at levels close to those in April, having recouped some of the losses incurred in May 2006 as a result of developments in international financial markets. The foreign exchange market in South Africa is the biggest domestic financial market, with an average daily net turnover of US$14,5 billion in July of this year. This consisted of US$1,9 billion spot transactions against the rand, US$1,0 billion forward contracts against the rand, US$7,5 billion swaps against the rand and the balance of US$4 billion consisting of transactions in third (non-rand) currencies. The foreign exchange market is very liquid which makes it an easy target for portfolio realignment by international investors. Thus, the potential for a direct impact on the exchange rate of the rand emanating from this source is great. As a result, the exchange rate of the rand is generally more volatile than those of most other emerging-market currencies. Since 2005, the rand has traded in a fairly stable range. However, as you are aware, the rand is seen as both a commodity and emerging-market currency. As a result, the volatility of the currency has recently increased due to developments in commodity prices and changes in investors’ risk appetite for emerging-market currencies. The rise in precious metals prices has provided support to the rand while the currency experienced some weakness – particularly in May – due to the repricing of emerging-market risk. The currency depreciated to levels around R6,60 to the dollar in mid-May from levels of around R6,00 to the dollar at the beginning of the year. The weakening of the currency was essentially due to the sell-off in emerging–market assets in May 2006. The rand depreciated further in June in response to concerns about adverse developments in the current account of the balance of payments. Unlike many of the other commodity producing countries, South Africa has a deficit on its current account, which increases the country’s vulnerability to currency movements. I will return to this issue a little later on. Historically the South African Reserve Bank practiced a policy of intervening in the foreign exchange markets in an attempt to smooth the volatility of the exchange rate. With no success, I must mention! These activities resulted in huge losses amounting to almost US$24 billion emanating from the oversold net open forward position of the SARB. The unsuccessful and costly policy of intervening in the foreign exchange market has convinced us that it is better to leave the determination of the exchange level of the rand to the market. The SARB has stuck to this policy even when the rand depreciated to R13,89 to the US dollar in late 2001 from levels around R8,00 to the US dollar at the beginning of 2001. Some analysts believe that this was a test of SARB’s resolve not to intervene in the foreign exchange market. Currently, the Bank’s activities in the domestic foreign exchange market are aimed at building foreign exchange reserves, smoothing money-market liquidity conditions through intra-month foreign exchange swaps and meeting clients’ foreign currency needs. The strategy of accumulating reserves is done in such a way that we “cream off” excess “dollars” in the market without any significant influence on the exchange rate. The accumulated gross gold and other foreign exchange reserves now amount to over US$24 billion and, combined with prudent macro-economic policies, has led to South Africa’s credit rating moving up four notches over the last twelve years - from BB in 1994 to BBB+ in August 2005. As you know, maintaining reserves is an expensive exercise – the challenge is therefore to ascertain and maintain a level of reserves that supports the economic fundamentals of the country. However, the increase in reserves, together with the eradication of the Net Open Foreign Currency Position, should contribute towards the stability of the currency and reduce uncertainty for both domestic and non-resident investors. 5. Monetary policy challenges Let me now turn to some of the monetary policy challenges currently facing South Africa. The favourable inflation trend over the last couple of years has allowed for nominal interest rates to fall to levels last seen some three decades ago. Between June 2003 and April 2005, the repo rate was lowered to 7 per cent, representing a total reduction of 650 basis points over the period. After remaining unchanged for 13 months, the repo rate was increased by 50 basis points at each of the MPC meetings in June and August this year. Given the increase in inflationary pressures and the resultant deterioration in the risks to the inflation outlook, the Monetary Policy Committee considered it necessary to tighten policy at the last two meetings. The main factors that have recently led to the heightening of the risks, namely the high levels of consumer spending, adverse movements in the exchange rate, a larger current account deficit, higher food prices and high oil prices. Consumer spending has been increasing at robust levels for some time now. The low interest rate environment has fuelled rising levels of credit extension to the private sector. Growth in bank loans and advances extended to the private sector measured at annual rates have recently increased to levels exceeding 20 per cent. While the inflationary effects are limited at this stage, the impact is manifesting itself via the deficit on the current account of the balance of payments, which had increased to 6,4 per cent of GDP by the first quarter of this year. While the deficit is currently more than adequately financed by capital inflows, these are mainly portfolio inflows, which increase the risks of adverse movements in the exchange rate, especially if the current account deficit is perceived to be unsustainable. This situation makes the exchange rate particularly vulnerable to changes in investor sentiment and risk tolerance, which can result in a tapering off or even withdrawal of portfolio inflows. This issue is of particular relevance given the way in which international markets have been re-rating emerging market risk recently. In such circumstances, there is an increased risk of a significant exchange rate adjustment which could threaten the longer-term attainment of the inflation target. However, the best way to avoid this happening is by maintaining sound and prudent macroeconomic policies. While we do not target any specific level of the exchange rate, exchange rate developments impact significantly on inflation. For a small and open economy like South Africa, the pass-through effects of exchange rate changes on inflation are significant and rapid. Hence, monetary policy has to take due cognisance of the fluctuations in the exchange rate of the rand insofar as their effect on the inflation forecast is concerned. On the issue of oil prices, these have been at sustained high levels for some time now. Given the prevailing geopolitical tensions, there is little doubt that oil prices pose the single biggest threat to global growth and inflation. However, the challenges for monetary policy emanating from high oil prices are not so straightforward. The textbook recommendation is that monetary policy should not react to first-round oil price effects but rather prevent second-round effects from taking hold. The passthrough effects from oil price increases to the different indicators of inflation have been relatively low, with the result that pre-emptive monetary policy decision-making has not been easy. However, there are indications that secondary inflationary pressures from the oil price increases are starting to occur in South Africa, as is evident in the recent acceleration in domestic producer price inflation. The recent tightening of monetary policy should thus be viewed in the context of the deterioration in the risks to the inflation outlook and the objective of the SARB to ensure the credibility of monetary policy and sustainable economic growth in South Africa. 5. Regional co-operation among central banks in Africa Let me now move to the issue of regional co-operation among central banks in the southern African region. Initiatives such as the Governors’ Club, which promote regional co-operation, are vital for success in our modern world, one that is becoming increasingly globalised. Globalisation has brought many benefits, not least of which have been the disinflationary trends that many of our countries have experienced. However, the painful experience emanating from the adverse developments in international financial markets is also fresh in our memories and hence, one cannot over-emphasise the importance of co-operation, particularly among central banks. I am glad to report that central banks in Africa have been actively co-operating on different initiatives for some time now. As you may be aware, African political leaders have adopted the New Partnership for Africa’s Development (NEPAD). This is a multidimensional development framework encompassing economic, political, security, social and cultural dimensions of development. The African Monetary Co-operation Programme (AMCP) which underpins monetary co-operation between central banks, forms an important part of the economic objectives of NEPAD. In the main, this involves a single monetary union, encompassing a common currency and a common central bank by the year 2021. At the continental level, the Association of African Central Banks subscribes to the AMCP while the Committee of Central Bank Governors in SADC (CCBG) spearheads the various continental initiatives in the southern African region. The South African Reserve Bank (SARB) plays an active role in both these fora. The CCBG was established in 1995 with the specific purpose of achieving closer financial/ monetary co-operation and integration in the SADC area. There are a variety of initiatives that the central banks have been, or are currently involved in, which promote monetary integration within SADC. These have inter alia spanned the areas of national payment systems, bank supervision, human resource development and legal issues. In some instances the co-operation has been formalised through the signing of Memoranda of Understanding (MOU). There is little doubt that all the central banks in the region have benefited from co-operating with one another. We have found that co-operation is not only advisable, but a necessity for efficiency in central bank operations in southern Africa. 6. Conclusion In conclusion, I would once again like to reiterate my sincere appreciation for this invitation to address you today. I wish the Governors’ Club every success in its endeavours and would like to assure you of our co-operation and support. I believe that sharing experiences can provide invaluable lessons going forward. Thank you very much.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Star/Safmarine Breakfast, Johannesburg Country Club, Johannesburg, 7 September 2006.
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T T Mboweni: Monetary policy and the markets – a two-way street Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Star/Safmarine Breakfast, Johannesburg Country Club, Johannesburg, 7 September 2006. * * * Honoured guests Ladies and gentlemen 1. Introduction Central banking has come a long way since the days, not too many years ago, when monetary policy was shrouded in secrecy. Central bank communication was akin to deciphering an obscure biblical tract, and monetary policy very often surprised the markets. It is almost unbelievable that as recently as 1994 the US Federal Open Market Committee (FOMC) did not even announce the monetary policy decision, let alone the justification thereof, and it was left to the market to infer from the Fed’s actions in the market whether or not there had been a change in the monetary policy stance. The monetary economist, Karl Brunner, was most scathing in his criticism and in 1981 argued that the peculiar mystique surrounding central banking thrived on the pervasive impression that central banking was an esoteric art confined to the initiated elite. He further added that “the esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences”. As we know, things are very different today. The pendulum has swung in the opposite direction, prompting Alan Blinder, a former Vice-Chairman of the US Federal Reserve System, to refer to it as the ‘quiet revolution’. Much of the debate about communication now focuses on the issue of whether central banks can be too transparent. Notable economists in the field such as Blinder and Lars Svensson argue for maximum transparency, while others, for example Frederic Mishkin, argue that there are limits to transparency. I will argue today that transparency and communication are a function of the decision-making process and particular institutional features, which in effect means that no single approach can be regarded as ‘best practice’. In looking at issues such as transparency and communication, the point must also be made that communication is a two-way street. Making monetary policy also involves giving attention to signals coming from the market. Indeed, the argument is sometimes made that the central bank should simply follow the market, raising the question of who takes the lead. 2. Communication from the market to the Bank It is generally agreed that there is much market information of a forward-looking nature that is extremely useful for monetary policy. Sometimes central banks will follow market movements which can provide information about the outlook that is independent of policy and that is crucial to monetary policy decisions. Prices and interest rates incorporate all information available to the market, and therefore provide important signals about the future. True, there are times when the central bank may have information that is not in the public domain, but equally, many private sector institutions are privy to certain information, or may have superior information because of specialised research in a particular area. Hence a two-way flow of information does exist in practice. The Bank therefore takes market information very seriously and we look at a number of forwardlooking indicators. These include the forward rate agreements (FRAs), the yield curves and yield spreads, break-even inflation rates, the Reuters consensus forecasts and the implied forward exchange rate curves, to name a few. We are also in the privileged position to receive a wide range of detailed in-house research from domestic and international financial institutions. These give us some indication of market expectations concerning various variables. There is a rich literature on the information content of yield curves. The generally accepted wisdom is that monetary policy determines the very short end of the curve to a significant degree. However monetary policy does not determine the long-term rates. These are determined by a number of variables, including real output growth and the market’s expectation of long-term inflation and expectations of the future monetary policy stance. For this reason there is not usually a close relationship between long-term bond rates and the repo rate, although the yield curve may contain useful information about the stance of monetary policy, and the market’s expectations of future inflation and real activity. Interpreting the information contained in the yield curve or the yield spread is not always straightforward. Standard theory tells us that the long-term nominal rate reflects the real rate and inflation expectations. But neither of these components is observable, and there may be other components as well such as liquidity premia which complicate the story. Also, the extent to which the long-term rates react to central bank actions depend on the credibility of monetary policy. The information content of the yield curve or yield spread is therefore not always clear-cut. I am sure you all remember not too long ago Chairman Greenspan’s long-term interest rate ‘conundrum’ in the United States. Similarly, in South Africa, we were recently told that long-term interest rates were being affected by liquidity considerations, as government’s fiscal prudence had resulted in a shortage of scrip in the market. We would therefore not want to set policy on the basis of a single indicator, and we would look to other indicators as well for corroboration. Inflation expectations are critical to monetary policy decisions. Here we would rely on a number of indicators, including the long-term bond yields, the yield differential between conventional and inflation-linked bonds, the Reuters consensus forecasts, and the inflation expectations survey that we have commissioned the Bureau for Economic Research to conduct on our behalf. All of these measures are imperfect, but they are indicative and, unless they contradict each other, they could contain valuable information for policy purposes. Although there are strong arguments for taking note of market signals, this does not solve all our problems. No matter how well-informed markets are, or central bankers for that matter, they do not have perfect foresight. As we know, the future is inherently unpredictable. Even if we make policy optimally on the basis of all available information, new information becomes available all the time. Behavioural relationships by their very nature are very difficult to predict. For example, we may expect on the basis of our models that if real incomes rise, consumer expenditure will increase in proportion to the estimated parameters. However, certain other unpredictable factors such as natural disasters, or geopolitical influences to name a few, are not easily forecastable. As these events unfold and are absorbed by the markets, current prices adjust, making previous forecasts redundant. This is the nature of asset markets. For this reason forward prices are changing all the time, which makes it difficult to easily use all the market information with total confidence. It also explains why forecasts, including our own, are periodically revised. Take the example of oil prices. As you know, oil prices are an important factor of our inflation rate. The international oil price is an exogenous variable in our inflation forecasting model, but the inflation forecast is critically dependent on our assumptions about the future path of oil prices. We are not oil market experts, but we try to understand the supply and demand factors that impact on the market. We also look at the forecasts of a number of institutions, many of which would have specialised oil price models and therefore presumably have a superior view of the oil price outlook. However, these forecasts can vary significantly. According to the Reuters consensus survey, at the June meeting of the MPC, the forecasts for Brent crude for 2006 ranged from US$56 to US$67 per barrel, and the range for 2007 was US$46 to US$64. According to the latest Reuters consensus survey, the range for 2006 is now between US$63 and US$72 per barrel, and for 2007 the range is between US$53 and US$75 per barrel. This indicates the enormous degree of uncertainty even among institutions that put a lot of effort into forecasting the oil price. We can take advice from the market, but whose advice do we take in this instance? The average or ‘consensus’ is not necessarily superior to any of these individual forecasts. Some central banks simply look at the oil futures prices, rather than trying to predict the impossible. But as we all know, the futures curve shifts continuously as current prices change. All it tells us is what today’s price is, and what the implied price is over the next few months on the basis of a risk-free interest rate and, storage costs. A sudden incident in Nigeria, Iraq or Iran, or a new tropical storm system, for example, will suddenly change both the spot and futures prices. Similar reasoning can be applied to forward rates in the currency and interest rate markets. These change almost continuously as new information is absorbed by the market. The FRAs for example change every time there is a change in the exchange rate, because of the expectation that this could lead to a change in interest rates. As most studies show, even though forward rates, whether currency, commodity or interest rates, are supposed to be unbiased predictors of future spot rates, they are nevertheless not very good predictors. This is the uncertain environment in which we as the central bank have to conduct monetary policy. Clearly, we cannot change monetary policy on a daily basis. We have to take a forward-looking, longer-term perspective on the basis of ever-changing data and events, news and surprises. While we can rely on the market for some information, in the end we have to make the decisions on the basis of our judgement. The collective view of the market helps us to make as informed a judgement as possible. 3. Should the Bank follow the market in setting interest rates? So far I have considered the issue of the flow of forward-looking data from the market to the Bank. As I noted earlier, there is a strong case for the Bank to use such information as part of its data for policy decisions. I do not think that this is particularly controversial. A related, but more complicated issue, is the question of whether the Bank should follow the market when it comes to setting interest rates. In other words, should monetary policy simply set interest rates on the basis of market expectations? Today it is generally accepted that monetary policy should be sufficiently transparent so that the market can discount changes in monetary policy in advance. If the market correctly anticipates monetary policy actions, there will be little reaction to monetary policy announcements. One way of achieving this favourable outcome is to simply follow market expectations. However, if there is effective communication, market expectations of central bank actions will not be independent of Bank actions and signals. Indeed, an important dimension of monetary policy is to influence market expectations. Under such circumstances, interest rate expectations are not formed independently of the view that the market has of central bank actions. In other words, if we signal a change in the monetary policy stance, this will be reflected in current market rates ahead of the actual change in the policy stance. Under such conditions, although it could appear that we are following the market, we are in fact leading it. Blinder, in his book “The Quiet Revolution’, also warns against central banks becoming too respectful of markets. He argues that slavishly following the market could lead to poor policy for a number of reasons. Firstly, there is the problem of herd behaviour, which may or may not be rational, in speculative financial markets. This results in overreactions to stimuli whereas monetary policy makers need to proceed with caution and prudence. Secondly, speculative bubbles are a fact of life. As Blinder graphically puts it, ‘central bankers must steadfastly resist such whimsy and inoculate themselves against the faddish behaviour that so often dominates markets. That may be why central bankers are not much fun at parties’. Finally, he argues that market traders tend to have much shorter time horizons than central bankers. This is even the case where long-term bonds are traded, but are in fact treated as shorter-term instruments. The result is that by following the market, monetary policy could land up having a short time horizon and be prone to overreaction. It is important for monetary policy to maintain a focus on the medium term. We have to see through the short term noise and not be blinded by it. 4. Communication from the Bank to the market As I mentioned at the outset, increased transparency is a feature of modern central banking. Although transparency is an essential part of the inflation targeting framework, it is not unique to this framework. It is also the case that communication strategies of central banks differ widely, implying that there is no single blueprint for central bank communication. In many cases, the nature of the communication is determined by the institutional environment. I think it is safe to say that the record of transparency at the South African Reserve Bank has improved significantly with the introduction of inflation targeting. The adoption of inflation targeting in itself was an important step towards increased transparency as it includes the announcement of a clearly defined overriding monetary policy objective - that is, to maintain CPIX inflation within the target range of 6 to 3 per cent. Other elements of improved transparency include the detailed monetary policy statement released after each MPC meeting, the publication of the Monetary Policy Review, the Monetary Policy Forums as well as the numerous speaking engagements undertaken by myself and my colleagues. Of course transparency is a matter of degree, and there are some areas in which you may feel we fall short, but this is an evolving process. Transparency can also be taken too far and there are also some areas of what I would regard as spurious transparency. Take for example our inflation forecast. In the Monetary Policy Review, we publish the graph of our most recent inflation forecast with the assistance of the fan chart tool. In our monetary policy statements we have taken to giving some idea of our inflation forecast at each meeting. We do not however publish the exact numbers pertaining to each point, although we generally indicate the peak and the end point. Some analysts have criticised the Bank for not publishing every point along the trajectory. I would argue that this is a case of spurious transparency. It will not make any difference to the policy decision if the outcome in three years time is 4,8 or 4,9 per cent. What we focus on is the overall general trajectory and its relationship to the target range. In any event, because of the inherently uncertain nature of the forecast, it is depicted in the form a fan chart which illustrates the uncertainties. There is a more substantive and difficult issue related to transparency. In publishing inflation forecasts, the question arises as to how to communicate the path of interest rates on which the forecasts are conditioned. Three different methods are used in practice, each with its own problems. We have adopted an approach common to a number of central banks, of assuming an unchanged monetary policy stance over the forecast period. In doing so, we are not committing ourselves in advance to a particular interest rate path. At a simplistic level, this approach could tell us that if the forecast is above the target, then the stance should be tightened and vice versa. It does not tell us how the forecast will change if interest rates are changed, although different scenarios on different interest rate assumptions can be run. It also does not tell us what the optimal interest rate path would be to keep inflation within the target range over the forecast period. Thus, interest rates may not remain unchanged over the forecast period if inflation is to be kept within the target range. Nevertheless this approach does illustrate clearly the rationale for changing interest rates or leaving them unchanged. An alternative approach, which has been adopted by a number of central banks, is to look at the market forecasts of future interest rates. It has been pointed out by various analysts that this approach contains a problem of circularity. As noted earlier, market rates are set to some extent on the basis of what the central bank is expected to do, so there is nothing to pin down the system, leading to indeterminacy of inflation. The third option, favoured by a number of academics, is for the Bank to give its forecast of the future path of interest rates. The central banks of New Zealand and Norway follow this route. The difficulty here is that the public has to understand that these paths are not unconditional commitments, but that they can change if the facts change. Unless this is fully understood, it can have an adverse impact on monetary policy credibility. There are other practical problems with this approach. In particular, how do you get a committee of eight people to agree on a path of interest rates over the next three years, when it is sometimes exceedingly difficult enough reaching agreement on the current move! It should be borne in mind that monetary policy in New Zealand is made by the Governor alone and not by committee, which reduces some of the practical difficulties associated with this approach. Even if a full path is not specified, there is also the question of whether or not the monetary policy committee should signal future moves or policy bias. Here again practice varies from country to country, as the ability to signal effectively between meetings is often determined by the nature of the decision-making process in a country. Where the responsibility rests with a committee and decisionmaking is by consensus, as is the case in South Africa, clear signals or commitments between meetings becomes more of a communication challenge. There have been times when we have been criticised for “surprising” the markets. It may well be that in some instances the communication could have been clearer, but it is also the case that the market does not always fully appreciate the conditionality of the signals. Let me give two examples. At the June 2004 MPC meeting, interest rates were left unchanged, but we were concerned about the risks to the inflation outlook. At the press conference following the meeting I warned that the ‘party is over’. This was widely quoted in the press and taken as a signal that we had reached the trough of the interest rate cycle. At the next meeting, we lowered interest rates by 50 basis points, which led to accusations that we had misled the markets. There were a number of significant changes between the two meetings. These included the improvement in inflation expectations and the appreciation of the rand which contributed to a lower inflation forecast. Two lessons come out of this. Firstly, any signal that is given is not an unconditional commitment. These commitments are conditional upon things remaining the same or changing in a particular anticipated direction. Quite clearly, the conditions did not remain the same in this instance. The second related lesson is that markets should not lose sight of the fundamentals. Instead of focusing only on what the Bank says at a particular point in time, we should all keep track of how the fundamentals are evolving. Policy should then be assessed on whether the move was justified on the basis of the new information. A more recent illustration was provided in April this year when we raised the repo rate by 50 basis points, again taking some in the market by surprise. However, the tone of the statement issued at the end of the previous meeting was intentionally ‘hawkish’, in order to signal a possible rate hike at the next meeting. The markets recognised the hawkish nature of the statement and most of the analysts picked up on this. Yet when the increase came at the following meeting, it took some in the market by surprise. Perhaps we did not communicate clearly enough, but perhaps the market was also not listening intently enough. 5. Recent economic developments Before ending, I would like to highlight some recent economic developments. In the past few weeks there have been a number of data releases which are of relevance to the Bank. Unfortunately most of these releases have not contained much news, and these developments underline the risks to the inflation outlook that we have been highlighting in the past few MPC meetings. CPIX inflation for July was 4,9 per cent, slightly up from 4,8 per cent the previous month. The main drivers were food and petrol prices. At these levels, we are still well within the inflation target range of 6 to 3 per cent. Of concern however is the broad-based rise in producer price inflation which measured 8,1 per cent in July, the highest year-on-year rate of increase since January 2003. Of particular concern as well is the 18,3 per cent year-on-year increase in prices of agricultural goods. Credit extension numbers show that consumers are still borrowing at a strong pace and there are no clear indications that demand for credit are being affected by the recent changes to interest rates. We are aware however that there is likely to be a lag before these effects are seen. Twelve-month growth in bank loans and advances to the private sector accelerated from 23,3 per cent in June 2006 to 24,6 per cent in July. Mortgage advances were a major contributor to this. Trade account data also indicate the continued underlying strength of domestic demand. South Africa’s trade deficit which had narrowed in June widened to R53,2 billion in July. In July, exports increased month-on-month by 3,3 per cent while imports increased by 6,6 per cent. It is not all bad news however. Growth in real gross domestic product increased at an annualised rate of 4,9 per cent in the second quarter of this year, compared to a revised rate of 4,0 per cent in the first quarter. Although real value added by the agricultural sector declined significantly, real value added by the mining sector grew by 3 per cent, This followed three successive quarters of negative growth in this sector. The manufacturing sector, which experienced annualised growth of 6,1 per cent show signs of sustained resilience. The construction sector remains the strongest growing sector in the economy. 6. Conclusion Let me conclude by saying that communication between the Bank and the market goes both ways. However, communication can only be effective if we listen to each other. The Bank recognises the importance of effective communication and we will continue to try and improve on this. We should also guard against excessive communication, however, as too much information could also result in excessive noise or confusion. Transparency does not however mean that we will always be telling the markets what our monetary policy decisions will be in advance of our meetings. The essence of transparency is for us to react in a consistent manner in response to changes in the economy which impact on our stated objective. Thank you very much.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to trainee chartered accountants in the Western Cape, at the South African Institute of Chartered Accountants, Cape Town, 2 October 2006.
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T T Mboweni: International regulatory developments and the South African banking sector Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to trainee chartered accountants in the Western Cape, at the South African Institute of Chartered Accountants, Cape Town, 2 October 2006. * * * Honoured guests Ladies and gentlemen 1. Introduction Thank you for the invitation to address you today. Financial markets have become increasingly globalised and our markets are no exception. Within this context, regulation according to international best practice, has a big part to play in ensuring the stability of the financial sector. You may be aware the international community has adopted some measures to harmonise the regulation of banks. Today I will provide a brief overview of two of these initiatives namely, the new Capital Accord and the Basel Core Principles, which have been adopted under the auspices of the Bank for InternationaI Settlements (BIS). I will pay particular attention to how these initiatives impact on the regulation of banks in South Africa. As future chartered accountants, these developments will have an important impact on your working lives. I will conclude by making some observations on the performance of the South African banking sector. 2. The Bank for International Settlements Many industries and businesses have established associations, whose aims are to conduct research, review important issues and promote the development of these industries or businesses. The BIS, established in 1930, could be described as a club or association for central bankers. The BIS was established in the context of the Young Plan, which dealt with the issue of the reparation payments imposed on Germany by the Treaty of Versailles following the First World War. The name of the BIS is derived from this original role, and was also created to promote central bank cooperation in general. The reparations issue quickly faded, focusing the activities of the BIS entirely on world-wide cooperation among central banks and, increasingly, other multi-lateral agencies in pursuit of monetary and financial stability. Today, central banks from 55 countries are members of the BIS. The BIS fulfils its mandate by acting as a forum to promote discussion and policy analysis among central banks and within the international financial community. It is also a centre for economic and monetary research; a prime counterparty for central banks in their financial transactions; and acts as an agent or trustee in connection with international financial operations. The most important meetings held at the BIS are the regular meetings of Governors and senior officials of member central banks. I regularly attend these meetings which are held every two months in Basel. These gatherings provide an opportunity for participants to discuss the world economy and financial markets, and to exchange views on topical issues of central bank interest or concern. Other meetings of senior central bank officials focus on the conduct of monetary policy, the surveillance of international financial markets and central bank governance issues. The growth of international financial markets and cross-border money flows in the 1970s highlighted the lack of efficient banking supervision at an international level. National banking supervisory authorities basically regulated domestic banks and the domestic activities of international banks, while the international activities of these banks were not always closely supervised. The collapse in 1974 of Bankhaus Herstatt in Germany and of the Franklin National Bank in the United States prompted the G10 central bank Governors to set up the Basel Committee on Banking Supervision. This Committee, known as the Basel Committee, concerns itself with guidelines for international co-operation in bank supervision. The Committee, which includes representatives from the major supervisory agencies as well as from central banks, provides a forum for regular cooperation on banking supervisory matters. Over the years, the Committee has developed increasingly into a standard-setting body on all aspects of banking supervision. 3. The Basel Capital Accord No bank can maintain the public’s trust for long if it lacks sufficient capital, so supervisors impose capital requirements to safeguard the banking system. Since capital is the last line of defense against bank insolvency, regulatory capital requirements are one of the fundamental elements of banking supervision. In 1988 the Basel Committee issued the Basel Capital Accord. This introduced a credit risk measurement framework for banks which became a globally accepted standard. South Africa complies with the Basel Capital Accord. A revision of this Capital Accord, known as Basel II, is due to be implemented worldwide from the end of 2006. Such standards aim to achieve a better and more transparent measurement of the various risks incurred by internationally active banks, limiting the possibility of contagion in cases of a crisis and strengthening the global financial infrastructure overall. The new Capital Accord is based on three pillars, namely, minimum capital requirements, a supervisory review process, and effective use of market discipline, through minimum disclosure standards. With regard to the first pillar, a material development was the internal rating-based approach to credit risk. Since the board of directors and management of a bank have, or ought to have, the most complete understanding of the risks that their bank faces, the board and management have primary responsibility for the management of these risks. Internal ratings are intended to become an integral part of a bank's risk-management process and its own assessment of capital adequacy before such ratings may be applied in the determination of the bank's statutory capital requirement. Supervisory review of capital, the second pillar of the new Accord, will be a critical complement to minimum capital requirements. Supervisors will have to evaluate how well banks are assessing their capital needs relative to their risks, including whether banks are appropriately addressing the relationship between different types of risk. Market discipline, the third pillar, performs an essential role in ensuring that the capital of banking institutions is maintained at adequate levels. Since effective public disclosure enhances market discipline and allows market participants to assess a bank's capital adequacy, disclosure can be a strong incentive for banks to conduct their business in a safe, sound and efficient manner. South Africa has made good progress with preparations for the implementation of Basel II on 1 January 2008. The South African Reserve Bank remains committed to providing a regulatory environment that will allow South African banks to adopt international best practice. South Africa’s financial sector is held in high regard, and the introduction of Basel II will enable South African banks to maintain, if not strengthen, their international standing, to the benefit of the economy. 4. The Basel Core Principles Countries use the Basel Core Principles as a benchmark for assessing the quality of their supervisory systems and for identifying future work needed to ensure sound supervisory practices. The Core Principles have also been used by the International Monetary Fund and the World Bank in the context of the Financial Sector Assessment Program. Changes have occurred in banking regulation over the years, however, and much experience has been gained with implementing the Core Principles in individual countries. Subsequently, the Basel Committee established the Core Principles Liaison Group to update the Core Principles to reflect these changes. This is to ensure their continued validity, usefulness and relevance as a flexible, globally applicable standard. The updated Principles remain focused on banking supervision. Issues related to the necessary infrastructure for effective banking supervision are discussed as preconditions and provide background for the assessment. The review also stresses the importance of the independence, accountability and transparency of bank supervisory authorities. Recently, an exercise benchmarking the bank supervisory framework of South Africa against the revised Core Principles was conducted and areas of non-compliance identified. An action plan has been initiated to implement the changes, thereby ensuring that the South African bank supervisory framework meets international standards. 5. The global financial sector According to the 76th Annual Report of the BIS, the main risks confronting the global financial sector are of a macroeconomic nature. These relate to the potential effects of higher interest rates, a turn in the credit cycle and, possibly, associated declines in real estate prices and aggregate expenditure. The current global environment places a premium on system-wide risk management. The report highlights the importance of making available information about risk as well as the interplay, and need for consistency, between financial reporting standards, risk management practices and the overall prudential framework. The South African financial sector is also exposed to these risks and the planned implementation of Basel II by South African banks will strengthen reporting standards and market discipline. 6. The South African banking industry The South African banking system is sound and stable. Banks are well capitalised, and the average risk-weighted capital-adequacy ratio for the banking system as a whole was 12,3 per cent at the end of July 2006. Growth in the total balance sheet of banks remained strong during the past year and by the end of July 2006, the total assets of banks – comprising, amongst other things, money, loans and advances, investment and trading position and non-financial assets – had increased by 20 per cent year-on-year, to a level of R1 939,5 billion. By the end of July 2006, the South African banking sector had recorded year-on-year mortgagelending growth of 30,8 per cent to a level of R608,9 billion. This growth was due to a number of factors including lower mortgage-interest rates, a lower level of inflation, lower income-tax rates and an increase in the real disposable income of households. There was also an increase in speculative buying, known as the ‘buy-to-let’ boom. Real estate prices are currently experiencing a slow-down in growth, which suggests some strong resistance from consumers. Consumer spending through credit card lending has recorded year-on-year growth of 38,6 per cent to a level of R36,9 billion at the end of July 2006, while the growth in installment-sales debtors has also continued unabated, growing by 18,8 per cent, to a level of R201,6 billion over the same period. As the regulator of banks, the Bank Supervision Department of the South African Reserve Bank will continue to ensure that banks’ risk-management processes are appropriate for monitoring these activities in the light of increasing household sector indebtedness and the increasing cost of credit. This high rate of credit extension has become a major cause for concern for the Bank. The high levels of credit extension have resulted in record levels of household debt, which have reached levels of almost 70 per cent of household disposable income. The high levels of consumer expenditure have also contributed to the expanding deficit on the current account of the balance of payments. These developments pose a threat to the inflation outlook, and have prompted the Monetary Policy Committee to raise the repo rate by 50 basis points at each of the past two MPC meetings. 7. Conclusion In conclusion, there are three points which I would like to emphasise. Firstly, the implementation of the new Capital Accord by our banks will result in the adoption of a globally accepted standard, which will lead to a more transparent risk measurement and better corporate governance practices. Secondly, complying with the Basel Core Principles, will ensure that banks are regulated according to international standards. Finally, it will be in consumers’ own interests to take note of local economic trends, such as the recent increases in the repo rate of the Bank, prior to incurring new debt. I thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Namibian Stock Exchange, Windhoek, 7 October 2006.
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T T Mboweni: South Africa's financial markets within the Southern African sub-region Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Namibian Stock Exchange, Windhoek, 7 October 2006. * * * Honoured guests, Finalists of the schools competition, Teachers of finalists of the competition, Sponsors of the competition, and Ladies and gentlemen Introduction It is with great pleasure that I present this address at your annual dinner. The initiative of the Namibian Stock Exchange (NSX) to enhance awareness of its activities in the countryside through the Scholar Investment Challenge is indeed a commendable one. This competition raises awareness of financial markets and investment in listed shares among the many participants drawn from a broad cross-section of the Namibian population. I am sure we have amongst the finalists in our midst today some of the stockbrokers of the future. Common membership of regional initiatives Namibia and South Africa share common membership of a number of regional co-operation initiatives. Three of these that come to mind are the Southern African Development Community (SADC); the Southern African Customs Union (SACU); and the Common Monetary Area (CMA). Moreover, the Bank of Namibia and the South African Reserve Bank are active participants in the Committee of Central Bank Governors in SADC and the Association of African Central Banks. Of these regional co-operation initiatives, the CMA is the smallest in terms of the number of member countries. However, it is the initiative with the most direct bearing on monetary policy and financial market issues. The CMA comprises South Africa, Namibia, Lesotho and Swaziland. Previously it existed as an informal arrangement and included Botswana. In 1976 the arrangement was formalised in a series of bi-lateral agreements. At this point Botswana chose not to join the monetary area and Namibia joined after independence in 1990. Although member countries have their own currencies, these currencies trade at par and are pegged to the South African rand. Member countries also apply broadly similar exchange control measures. This currency arrangement has various implications for the CMA countries and their central banks. I wish to mention three of these today. First, the South African Reserve Bank leads the way in setting monetary policy for the CMA countries. However we do take cognisance of the views of the partner banks in periodic meetings of the CMA governors prior to the meetings of the Monetary Policy Committee. Secondly, South Africa has adopted inflation targeting as its nominal anchor for monetary policy in February 2000. The target is to keep CPIX inflation (that is, headline inflation excluding mortgage interest costs) within a range of 3 to 6 per cent. This policy has served the interests not only of South Africa, but also of its CMA partners, as is evidenced by the fact that the South African rate of inflation used for targeting purposes has remained inside the target range since September 2003. The CMA partner countries have also reaped similar benefits; for example, the inflation rate in Namibia has declined from 9,3 per cent in 2000 to 2,3 per cent in 2005. I will say a bit more about South Africa's monetary policy later on. Lastly, the possibility of establishing a central bank for the CMA countries is raised from time to time. A study was conducted in 2005 under the auspices of the CCBG outlining the costs and benefits of the creation of a common central bank for the CMA countries. However, decisions in this regard will be taken by the political leaders of the CMA countries, rather than by central bankers. This is probably a matter of particular importance for our younger audience, as they might perhaps find employment at this institution one day. Exchange controls and related tax amnesty In view of the high degree of regional co-operation discussed above, it is necessary to make mention of the successful exchange controls and related tax amnesty of South Africa. This amnesty was announced by the South African Minister of Finance, Trevor Manuel, in February 2003. The amnesty was announced against the background of an extensive system of exchange controls that have been in place in South Africa for a considerable period of time. Since democratic elections in South Africa in 1994, considerable progress has been made with the gradual liberalisation of controls. Measures included the abolition of the financial rand and the introduction of liberal foreign investment allowances for South African companies. This was particularly the case for investment in Africa. In addition, the foreign investment allowances for South African individuals have been increased over time to the current level of R2 million per individual. The announcement of the amnesty was a next step in the gradual relaxation of exchange controls. The amnesty had as its four goals the broadening of the domestic tax base; provision of an opportunity to South Africans to regularise their affairs without fear of prosecution; provision of updated information to the South African Reserve Bank and the South African Revenue Service; and facilitation of repatriation of foreign assets to South Africa without fear of recrimination. The amnesty succeeded beyond all expectations of the authorities. More than 42 000 people applied for amnesty and more than 99 per cent of these applicants were granted amnesty. All four stated goals of the amnesty were achieved. First, amnesty applicants disclosed undeclared receipts and accruals amounting to R1,36 billion, which will increase the personal income tax base by an estimated R400 million. Secondly, applicants who disclosed previously unauthorised assets are shielded from prosecution. Moreover, the amnesty legislation also relieved banks and financial advisors from reporting responsibilities in terms of the South African Financial Intelligence Centre Act, thus protecting the applicants. In terms of the third objective, applicants disclosed around R 68,9 billion in foreign assets, of which R 45 billion constituted unauthorised foreign assets. Fourthly, the amnesty process facilitated the repatriation of funds to South Africa. Applicants paid a total of R 2,87 billion in amnesty levies in respect of unauthorised foreign assets. These levies amount to some 0,7 per cent of total tax collections of the central government in the 2005/06 fiscal year, and to some 2,3 per cent of personal income tax for the same period. The successful completion of the amnesty in South Africa is a further step in the direction of complete exchange control liberalisation. The stated objective of the South African government is to proceed with a gradual relaxation of controls. Relatively few controls remain, so much so that when full abolition is announced, it will most likely be a non-event. The South African financial markets Financial market developments in South Africa have significant implications for financial markets in the region. I would therefore like to share with you some key features of the South African financial markets. Starting with the equity market, the JSE is one of the oldest stock exchanges in the world, having been established as far back as 1886. In its 120 years of existence, it has developed into the 17th biggest stock exchange in the world - a remarkable achievement for an emerging market country like South Africa. Over recent years, there have been a number of important developments in the JSE, which contributed to its efficiency and global standing. Trading is fully automated through an electronic clearing and settlement system, the STRATE system (Share TRAnsactions Totally Electronic). The product base of the JSE has also expanded to include not only shares, but also a range of equity, commodity and interest rate derivatives. In 2002, the JSE entered into a strategic alliance with the London Stock Exchange (LSE). This alliance led to a number of further improvements, such as the implementation of a new trading system and an indexing system that is aligned to that of the JSE, as well as the adoption of listing requirements that are in line with international best practice. These developments enhanced the profile of the JSE, in particular to international investors. The latest development in the history of the JSE was its own demutualisation in 2005. It became a public unlisted company on 1 July 2005, and listed on its own exchange a year later. At the end of 2005, the JSE had a market capitalisation of R3,6 trillion, with 388 companies listed on the exchange. Just over 60 of these companies are listed on at least two other stock exchanges. Some have up to seven listings, including listings on the major exchanges of the world. Turnover on the JSE has shown strong growth over recent years, increasing from an annual turnover of R22 billion in 1992 to R1 279 billion in 2005. Alongside the equity market, the South African bond market is also formalised in the form of the Bond Exchange of South Africa (Besa), which was established 10 years ago, in 1996. As at 31 December 2005, Besa had granted a listing to 493 debt securities, issued by 71 borrowers, with a total nominal value of R637 billion - equal to just over 40 per cent of gross domestic product (GDP). All bonds have been dematerialised and trading has been fully automated. Government bonds comprise around 60 per cent of the bonds listed on Besa, with the rest consisting of bonds issued by parastatals and corporates. Corporate bond issuances are currently increasing at a much faster rate than government bond issuances. The annual turnover on Besa has increased from R2,1 trillion in 1995 to R8,1 trillion in 2005. The annual turnover is currently about 38 times the market capitalisation, indicating good overall liquidity. In the current year to date, the turnover on Besa has already exceeded that of the full year of 2005. Developed domestic bond markets not only provide for an additional channel for domestic savings mobilisation, they also provide valuable information to the MPC. Expected monetary policy developments are reflected in bond yields and we, in turn, get a lot of information from the bond market about market expectations concerning future monetary policy, inflation and growth. Non-residents are active participants in the South African capital markets, accounting for around 20 per cent of daily turnover on both the JSE and Besa. In the year to the end of September, nonresidents have bought a net R59 billion worth of South African equities compared to R50 billion in 2005. Net purchases of bonds have amounted to R20 billion, compared to net sales of R11 billion last year. In addition to improving the liquidity of our capital markets, these purchases help to finance South Africa's current account deficit. The participation of non-residents in the domestic financial markets is facilitated by a liquid market for foreign exchange. The average daily turnover against rand in the South African foreign exchange market is around USD10 billion, and non-residents account for around 65 per cent of these transactions. However, one downside of such a liquid market is that it tends to make the rand (and, of course, the Namibian dollar with it) much more volatile than the currencies of other emerging-market currencies with less liquid foreign exchange markets. The NSX and the JSE Limited Compared to the JSE, the NSX is still young, as it was established 14 years ago in 1992. However, the establishment of an exchange represented an important step forward for Namibia in the development of its capital market, and in providing an important avenue for domestic savings mobilisation. The success of the NSX is illustrated by the fact that by 2005 it was the second largest African stock exchange in terms of total market capitalisation and the fifth largest in terms of traded value. Currently, 28 companies are listed on the NSX; a high number of which have a dual listing on the JSE. The NSX was also the first exchange in SADC to start using the JSE's electronic trading system (the Jet system) in November 1998. Share trading on the NSX of dual-listed South African companies is settled through STRATE. The existence of dual-listings improves the liquidity and turnover on the NSX, making these shares more attractive to investors. While benefiting from its close relationship with the JSE, the NSX retains control over its own listing requirements, regulations and supervision over compliance, and can adapt these according to the requirements of the domestic economy. The NSX and the JSE are both founder members of the Committee of SADC Stock Exchanges (COSSE). The Committee of SADC Ministers for Finance and Investment agreed to recognise COSSE as a private sector association at their meeting held on 18 July 1997 in South Africa. In terms of the aims of COSSE, the NSX and the JSE play an important role in the institutional structures of stock exchanges in SADC. Among others, COSSE has set itself the challenging goal of establishing by 2008 an integrated real-time network of the national securities markets within SADC, thus facilitating progress with the process of financial integration within the SADC region. This will pave the way towards cross-border listings and, therefore, trading and investments among the different Member Exchanges of SADC. However, like all successful developments in market infrastructure, this should also be driven by market participants, who will seek the optimum balance between cost and risk. Recent monetary policy developments in South Africa As I indicated earlier, the existence of the CMA implies that South Africa effectively determines monetary policy for the whole CMA. CPIX inflation has been within the inflation target range since September 2003 and averaged 4,3 per cent and 3,9 per cent in 2004 and 2005 respectively. Since March of this year, CPIX inflation has been steadily rising, mainly as a result of rising energy and food prices, and in August inflation increased at a year-on-year rate of 5 per cent. Buoyant consumer demand, which increased at an annualised rate of 8 per cent in the second quarter of this year, has been posing a further risk to the inflation outlook. This demand has been fuelled by credit extension growth in excess of 25 per cent. These developments contributed to the expanding current account deficit which measured in excess of 6 cent of GDP in each of the first two quarters of this year. This is turn has contributed to the recent weakness in the rand, which has depreciated on a trade weighted basis by approximately 23 per cent since early May. This degree of depreciation, in turn, poses a further risk to the inflation outlook. In response to these developments, the Monetary Policy Committee of the South African Reserve Bank has raised the repo rate by 50 basis points at each of the past two meetings of the Monetary Policy Committee. This change in the monetary policy stance has occurred against the backdrop of a strongly growing domestic economy. South Africa's economic growth averaged 4,5 per cent and 4,9 per cent in 2004 and 2005 respectively. Despite the change in the monetary policy stance, we do not anticipate that growth prospects will be significantly undermined. Our focus, however, remains on the inflation target, and we will continue to strive to maintain CPIX inflation within the 3-to-6 per cent target range. Conclusion The NSX Scholar Investment Challenge is similar to the competition introduced 34 years ago by the JSE for South Africa schools. The competition is a major success in South Africa, and it seems to me that the same can be said about the Namibian competition. This competition teaches participants the fundamentals of investment strategies and financial markets and encourages them to develop an interest in the trading of shares on the NSX. I trust that participation in this competition has introduced new possible career choices to the participants. The teachers accompanying the participants also deserve special recognition. Your care and commitment has laid an important foundation in the lives of the finalists. Likewise, the sponsors of the competition have made it possible for the finalists to be here today and they have also assisted in broadening the intellectual horizon of the participants in the competition. We trust that the knowledge gained about financial markets will spur many of them to greater heights in the corporate world in the future. Naturally, only one team can win this competition, but I must stress that all participants attending tonight should really be regarded as winners. To make it to one of the top five positions in this competition is a major accomplishment. My best wishes accompany all of you in your careers ahead of you, as you have already shown your dedication to the achievement of your goals. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the South African Bond Market Conference organised by the Debt Issuers Association, Johannesburg, 5 October 2006.
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T T Mboweni: Monetary policy and South African bond market developments Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the South African Bond Market Conference organised by the Debt Issuers Association, Johannesburg, 5 October 2006. * * * Honoured guests Ladies and gentlemen 1. Introduction Thank you for giving me the opportunity to open this conference on the South African Bond Market. There are several reasons for developing debt markets. The most fundamental reason is to make financial markets more complete by generating market interest rates that reflect the opportunity cost of funds at each maturity. This is essential for efficient investment and financing decisions. If bond markets do not exist, firms may have to finance the acquisition of long-term assets by short-term debt, and investment policies may be biased in favour of short-term projects. Furthermore, debt markets can help the operation of monetary policy as prices in the long-term bond market give valuable information about expectations of likely macroeconomic developments and about market reactions to monetary policy moves. In my opening remarks today I will touch briefly on monetary policy and bond market issues. 2. Monetary policy developments As you are all no doubt aware, monetary policy does not determine bond market yields. Nevertheless, monetary policy and the bond markets do impact on each other in important ways. Expected monetary policy developments are reflected in bond yields and we, in turn, get a lot of information from the bond market about market expectations concerning future monetary policy, inflation and growth. More recently, the development of the inflation-linked bond market has provided us with further insights into longer-term inflation expectations in the market. Not surprisingly, the change in the monetary policy stance in recent months has been felt in the local bond markets. The repo rate had been unchanged for 14 months, but in June of this year, the Monetary Policy Committee decided to raise the repo rate by 50 basis points, and this was followed by a further increase of the same amount in August. Although capital market rates reflect expectations, these expectations are not always correct. At the time of the first increase, these changes were not fully reflected in bond yields, but we have seen a significant adjustment since then. Although our actions took many by surprise, for some time we had been sounding warnings that we perceived the risks to inflation to be on the upside. Our warning remains the same today, as we still see significant upside risk to the inflation outlook. Our major concern remains the growth of household consumer demand which grew at an annualised rate of 8 per cent in the second quarter of this year. This expenditure is still being driven by credit extension growth in excess of 25 per cent, and household debt as a proportion of disposable income has risen to an historically high level of 70 per cent. Despite the obvious dangers of such developments and the recent hikes in interest rates, there are no indications of any meaningful change in consumer behaviour. It is hard to imagine that such trends, if unchecked, will not have inflationary consequences. Another area of concern has been the current account deficit, which although narrowing from the 6,4 per cent of GDP registered in the first quarter of 2006, still stood at a high of 6,1 per cent of GDP in the second quarter. As we have noted in the past, current account deficits are not in themselves inflationary. There is however a possible risk to the exchange rate if the deficits are perceived by the markets to be unsustainable, particularly if the deficits are reflecting higher consumption expenditure. On numerous occasions we have pointed out the possible implications of the deficit for investor sentiment and for the rand. The recent exchange rate reaction to the higher deficit is indicative of this, but it is also part of the adjustment process. Nevertheless the adjustment in the exchange rate has reached levels which may pose a further threat to the inflation outlook. Fortunately it is not all doom and gloom, and there has been at least one significant improvement in the risk factors affecting the inflation outlook. International oil prices have offered some respite and come down from their highs of almost US$80 per barrel in early August, to levels below US$60. We are aware that this positive development can change at any time, given the delicate balance between supply and demand in the oil market, and the acute sensitivity of the oil price to changes in risk perceptions. We are nevertheless fortunate regarding the timing of this respite. Domestic economic growth averaged 4,5 per cent and 4,9 per cent in 2004 and 2005 respectively. Despite the change in the monetary policy stance, we do not anticipate that growth prospects will be significantly undermined. The exchange rate developments are expected to be positive for export growth, and it will not be a bad thing if domestic growth is driven by exports and infrastructural spending, rather than by consumer spending as has been the case in the past two years. Our focus, however, remains on the inflation target, and we will continue to strive to maintain CPIX inflation within the 3-to-6 per cent target range. The credibility of our actions will of course be reflected to some extent in the bond market. 3. Domestic bond market developments The South African bond market has for some time had an important role in the financial system, and it is particularly pleasing to note the significant developments in the corporate bond market. It is also of interest to note the burgeoning literature on bond market development internationally. A recurring theme in the literature is the ability of governments or corporates to borrow from non-residents in their own currency. The inability to borrow in ones own currency, referred to in the literature as ‘original sin’, often leads to currency mismatch, and ultimately to balance sheet vulnerability in the event of significant exchange rate changes. South Africa stands out as one of the few emerging market economies that does not suffer from ‘original sin’, given the long history of resident and non-resident participation in the domestic bond market. The development of the corporate bond market adds a further important dimension to the market. It is common knowledge that the South African bond market is highly developed and very deep. There are continuous innovations as is witnessed by the listed products offered by both the Bond Exchange of South Africa and the Yield-X of the JSE. Whereas in its infant stages the Bond Exchange was dominated by government and parastatals, in the recent past corporate issuances have been increasing. Since the South African bond market has historically been a predominantly government and government-related debt market, the use of credit ratings has been limited. With the introduction of corporate bonds in recent years, this has changed as a need has emerged for a better understanding of credit risk. The corporate bond market is today the fastest-growing segment of the bond market, as new issuances of corporate bonds have overtaken those of government bonds. Government has also been borrowing less because of fiscal discipline and more efficient tax collection by the South African Revenue Services. Securitisation issuances have also picked up considerably, and while the banks are major issuers in this market, there are other active players as well. The number of issuers accessing the debt capital markets has grown from a single issuer in the period prior to 2000 to 14 issuers in 2005. The secondary market for bonds in general is developing very slowly. Contributing to this state of affairs is that buyers tend to buy-and-hold due to the attractiveness of these instruments in their portfolios. However, there are early signs of a more active secondary market beginning to resurface as turnover has increased in the past year. 4. Conclusion The stable inflation environment means that the fixed income structure of bonds has become relatively more attractive to investors with risk profiles that demand a steady real rate of return. Also, economic growth has been more robust in recent years amid heightened investor optimism about the country's future prospects. Improved economic fundamentals translate into enhanced growth prospects for South African corporates and a concomitant need for long-term debt financing. The development of this sector of the bond market offers borrowers in the private sector access to long-term finance from the capital markets. I am aware that some of South Africa’s important corporates are here to participate in this conference. We look forward with keen interest to your contributions to the growth of this sector of the market. I wish you well during your deliberations. Thank you for your attention.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Black Management Forum Annual Conference, Durban, 13 October 2006.
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T T Mboweni: The challenge of employment equity with specific reference to transformation at the South African Reserve Bank Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Black Management Forum Annual Conference, Durban, 13 October 2006. * * * The President of the Black Management Forum, Former Presidents and Executive members of the Black Management Forum, Members of the Black Management Forum Executive, Ordinary members of the BMF, Distinguished Guests, Ladies and Gentlemen, When we were approached by the BMF leadership to address this august gathering on challenges of employment equity with specific reference to the transformation process at the South African Reserve Bank, we were more than pleased to oblige and grabbed the opportunity with both hands primarily because the progress we have made at the Bank since 1999 has been remarkable. This does not in any way imply that our current transformation milestones are a destiny already reached, but we thought that we could share with you how we have embraced transformation as a journey which will hopefully someday help us realise the desired South African end-state 1 . When one takes into consideration that the Bank comprised mainly, but not only, of Afrikaner white males in technical and strategic decision making positions in 1998 at the Bank, we are certain that all might concur that the road to transformation at the Bank was paved with many serious challenges/obstacles and presented an extremely steep gradient of resistance. It is against this opening scene and milieu that we can lay claim that the progress made has been indeed remarkable and to some extent (maybe) exemplary. Allow me to share with you the facts and figures of employment equity and transformation at the Bank. This will entail a little walk back in the history of the Bank’s workforce movements and composition, but the historic walk will serve as empirical support of the Bank’s transformation and equity successes. A historically significant starting point would be the year 1994. In that year the Bank’s total staff comprised 21 per cent Blacks and 38 per cent females. The management levels, however, comprised 1 per cent Blacks and 12 per cent females. When we joined this transformation journey after 1998 2 , we had a workforce that, in total comprised 36 per cent Blacks and 42 per cent females, but the management levels comprised only 13 per cent Blacks and 19 per cent females. The strategic General Management level comprised only 15 per cent Blacks and 7 per cent females. Thus the workforce composition of 1998 will effectively serve as the starting point of numerical transformation in the Bank since then. The question that confronted us was: how, when, by who and what should be done to change the status quo. It was clear that a strategic plan and modalities had to be developed to answer this question. And so the Journey began. Firstly, we developed a strategy driven by the executive level of the Bank. An important element of that strategy was to talk through the issues with ALL management and staff about the imperative of transformation as an optimal human resources allocation issue and also as a contribution to the deracialisation of South Africa. This was not an easy task and still is not an easy one. Numerous strategy planning meetings to achieve a buy-in were and still are the order of the day. Change is continuous though. We are always in a state of change. So the end-state is nothing but a brief moment to reflect. As some philosophers have said “nothing is stable except stability” I say “joined” because I do not want to claim that transformation only began in 1998. Far from it. The fact that by that time there were some black mangers and females in the senior professional and assistant general management level is testimony to the fact that my predecessors had begun the journey. We accelerated the pace. Secondly, management was tasked with the responsibility to indicate to the Executive Team 3 how and by when they could go about implementing a numerical target of 50-50 black/white ratio and a 33% female representation at all occupational levels of the Bank by 2005. This was the basic plan. The process was both fascinating and difficult. Eventually we produced the plan. Thirdly, it was an essential element that transformation was more than about employment equity numbers. It also involved changing the culture and the decision making processes in the Bank. To that extent we sat down to create a committee or syndicate decisionmaking system. This forced people to engage in regular discussions and debates about the work of the Bank around the same table or tables. Examples in this regard are the Monetary Policy Committee (MPC), the Management Committee (MANCO), Financial Stability Committee, etc. These committees or syndicates brought together people from different departments to make collective decisions in order to advance the work of the Bank. Fourthly, the Board of Directors had to change too. In 1998, the Board of Directors was extremely unrepresentative with only four (4) black people out of a total of fourteen (14). The secretary of the Board was also white. There was only one female. It was more than clear that change needed to start at the top for it to have any meaning amongst the staff of the Bank. So where do we stand today in terms of equity representation within the Board of Directors and the Bank as a whole? The following statistics are taken from the Bank’s Annual Report on the Employment Equity Plan to the Department of Labour and has accordingly become a public document and is available for public scrutiny. As of the 31st March 2006, the Board of Directors was composed of ten (10) black directors and four (4) who were white. Of these, five were female. The secretary of the Bank is a black male. The Board has a committee of non-executive directors which is chaired by a female director. The Executive team is made up of five (5) black members out of seven (7). There is a vacancy for a Deputy Governor and hopefully this could be occupied by a female. The Monetary Committee (MPC) has seven members. At the moment five (5) are black and two (2) are white. The secretary of the MPC is a black male. This is quite a nice mix, `me thinks`! The total workforce of the Bank comprised 56 per cent Blacks and 46 per cent women. The management levels of the Bank comprised 43 per cent Blacks and 36 per cent females. The strategic General Management level comprised 51 per cent Blacks and 20 per cent females. The figures speak for themselves. You can draw your own conclusions. So what were the successful strategies that supported these transformation objectives? They focused mainly on the manner in which the Bank aligned its workforce movements with its strategic employment equity objectives. In general the Bank’s staff turnover rate hovers between 5 and 8 per cent. In 2005, the Bank’s Black turnover rate was 6.18 per cent and that of females was 4.51 per cent with the Bank total turnover rate at 5.62 per cent. In 2006, the Bank’s Black turnover rate was 6.64 per cent and that of females was 5.56 per cent with the Bank total turnover rate at 7.07 per cent. The following discussion is focused on the Bank’s workforce movements since its first Employment Equity Plan in 2000. Who has the Bank been recruiting? The following recruitment percentages answer this question: Table 1 Recruitment by race and gender % Blacks % Females The Executive Team at that time was comprised of the Governor, three Deputy Governors and two Advisors. At present, the Executive Team is made up of the Governor, Deputy Governors and four Executive General Managers (EGMs) On average, over the past 7 years, the Bank’s recruitment included about 83 per cent Blacks and about 46 per cent females. These percentages are significantly higher than most of the other players in the Financial Sector. Who has been resigning the Bank? The following termination figures provide this information: Table 2 Termination by race and gender % Blacks % Females On average, over the past 7 years, the Bank’s terminations included about 45 per cent Blacks and about 36 per cent females. We would venture to suggest that the Bank’s experience might very much be similar to that of most business organisations in the country. People resign from organisations for various reasons and the Bank has made a serious attempt to gather information about why people resign. We do this by making use of exit interviews. This method seems unreliable since most of the information gathered during these interviews does not reveal the real or true reasons why people resign from the Bank. One of the reasons for this might be because the Bank avails to staff who have resigned the opportunity to rejoin the Bank should they elect to do so and vacancies exist. As such many who resign try to leave on a “good note” so that doors are not closed behind them. We have had numerous instances where staff have returned to the Bank which calls into question the claim that the “… grass is always greener on the other side”. In the Bank’s recent culture and climate survey, external service providers interviewed some of the Bank’s ex-employees who declared that, “… it has been a privilege to work for the Bank because of its national and international status and because it was a good organisation to work for”. Internal promotions are an important strategy and good practice in any business. This provides existing employees with a career path and rewards good performance as we all know. So how did we go about the promotions process in order to support our strategy at the Bank? The following promotion percentages answer this question: Table 3 Promotion by race and gender % Blacks % Females Managing development and progression at such an institution of specialised skills (and full of intellectuals too!) is as fragile as doing the tango on a frozen lake – if you succeed you are the hero, but if you fall through the ice, you are ridiculed for attempting the impossible. Further, one has to be exceptionally sensitive to managing the extremities of White fears and Black aspirations. The Bank has been able to steer a fairly stable ship through the sometimes turbulent waters of transformation. On average, in the last 7 years, promotions have included about 58 per cent Blacks and about 45 per cent females. The Bank consults with its employees on all its employment equity and skills development issues through our democratically-elected Employment Equity Consultative Body (EECB). The Bank’s first employment equity targets of 50 per cent Blacks and 33 per cent females at all levels of the Bank by 2005 (extended to 2006) received positive support from the EECB. The Bank, in consultation with the staff has adopted new targets of 50 per cent Blacks, 50 per cent females and 2 per cent People with Disabilities by 2011. Special interventions and strategies that address women’s participation at all levels of management and technical skills and development, and the employment of People with Disabilities are currently being discussed and deliberated upon at the Bank. Experience and research have shown that if there is one place to always look out for within business management is the supervisory level. If one does not focus on this, one might experience lots of turbulence going forward. Bad managers and seniors can spoil all the honest efforts being made by any organisation. The executive team has to constantly examine its role vis-à-vis the staff. More often than not that may be where the problem is firmly located. Recently, on learning about my frustrations and complaints about losing skilled black staff from at the Bank and thus weakening our employment equity position, an anonymous Good Samaritan sent me an email saying that “if you are losing people, look to their immediate boss. Immediate boss is the reason people stay and thrive in an organisation. Different managers can stress out employees in different ways – by being too controlling, too suspicious, too pushy, too critical, but they forget that workers are not fixed assets, they are free agents. When this goes on too long, an employee will quit – often over a trivial issue”. 4 Very right too! The Bank submits its draft employment equity progress first to the EECB at least once a quarter where we detail our progress, discusses the barriers that exist and compare our employment equity progress with that of the Financial Sector Charter targets. The Bank is positioned way above the Financial Sector targets in all of the stipulated target levels and categories. In terms of the barriers to employment equity, staff identified 19 in 2000. This number has been significantly reduced to just 3 in 2006. Some officials from the Department of Labour have often cited the consultation mechanism of the Bank as a benchmark that other organisations could emulate. The Bank’s EECB has hosted various organisations that were keen to learn about how the Bank’s consultative mechanism functioned so harmoniously. Further, the Bank’s Change Management Unit was instrumental in establishing the Employment Equity Forum – a platform at which employment equity practitioners from the Bank and various other organisations including Telkom, Escom, SABC and the big-four banks meet to discuss, debate and demystify employment equity issues and prepare for challenges going forward. The Bank is committed to more than just achieving its numerical goals. We are convinced that supporting our staff to develop their skills and proficiencies to their full potential is a more important objective than just pursuing a numbers game. In the last year we have conducted both a skills audit and a bank-wide organisational culture and climate survey primarily because we wanted to establish the developmental needs of our employees and also to determine empirically, what makes employees want to stay in the Bank’s employ and what issues may coerce or indeed induce them to resign. The findings of both audits have resulted in the need for a strategic response from the Bank to mitigate against the issues that have been identified. Over and above these interventions, the Bank has revised all of its policies to ensure that we remove all vestiges of unfair discrimination against the designated group and also to ensure that we kept abreast with best practices both nationally and internationally. The Bank has a generous study aid policy for both employees and their children. We have committed programmes that focus on ABET. Staff is encouraged to attend conferences both as participants and also as delegates in the country and internationally. Maternity benefits have been significantly improved. The Bank has joined the BankSeta in its Letsema project through which we fulfil some of our corporate social responsibilities. We have a dedicated programme that focuses on graduate recruitment (this is our cadet programme). The Bank views the policy revision process as an ongoing endeavour. Our philosophical views on transformation are documented in the Bank’s Vision 2010 which says that “The responsibility to effect change lies not only with management, but also with all staff – every one should be an agent of change.” The operative phrase here is that “everyone should be an agent of change”, not to sit around and whinge and complain, but to do something positive to advance the good of the Bank and society. Our position is that change and transformation are equally accountable partnerships between management and staff. The Bank has walked its talk and the success of transformation within the Bank is testimony of that enshrined philosophy. We have capable black and white staff that have stayed the cause, worked hard, have become internationally respected experts in their fields. I am eternally grateful to all of them for their dedication and loyalty. For more on this issue see the book: First Break All The Rules – What the World’s Greatest Managers Do Differently by Marcus Buckingham and Curt Coffman. Let me conclude by asking some questions. Firstly, when we wake up in the morning we are likely going to do one of the following: go to the loo, flush after our business is done and probably brush our teeth and have a bath as the case might be and whichever comes first. Do we ever ask ourselves the question: why is it that water actually comes out of the toilet, the bath tap? We will all say that it is the job of the technical people? Well which people? What skills do they possess and who are they? Who are these water and toilet engineers? Are they members of the BMF? Secondly, most of us came here to Durban most probably by South African Airways. Who was the pilot? Who were those guys at the Johannesburg Airport who work in the technical division of South African Airways? Are they in the BMF? I am asking these and could ask more questions to draw our attention to the absolute imperative for all of us to look beyond our comfort zones and focus on the strategic human resources issues facing our country. We need to be aware that managerial and technical know-how in a transformed environment is fundamental to our success. The economy is becoming more and more service oriented and this requires a different skills mix than those which might have been applicable to the primary or even secondary sectors in the past. Let us join hands and look on the bright side of these challenges. Ke a Leboga Thank you.
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Welcoming address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the First "Macroeconomic Policy Challenges for South Africa" Conference, held at the South African Reserve Bank, Pretoria, 23 October 2006.
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T T Mboweni: The relationship between the South African Reserve Bank and academia Welcoming address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the First “Macroeconomic Policy Challenges for South Africa” Conference, held at the South African Reserve Bank, Pretoria, 23 October 2006. * * * Honoured guests, Colleagues, Ladies and Gentlemen, 1. Introduction It is with great pleasure that I welcome you to Pretoria on the occasion of the first South African Reserve Bank (Bank) conference entitled “Macroeconomic Policy Challenges for South Africa”. I would like to extend a warm welcome to the keynote speakers and presenters of the papers and to all the discussants who will be participating in our proceedings. All those attending the conference are likewise heartily welcomed and we hope you will participate actively in the series of discussions. This conference is the first in a series of conferences that the Bank plans to hold every second year. It is our contribution to a process of open interaction between economists concerned with macroeconomic and central banking issues. The conference series should further serve as a vehicle for bringing together researchers from academic and financial institutions. The main purpose is to provide a platform where current ideas on macroeconomic issues can be shared. This should signal clearly our commitment to a continuous and active exchange of information between the Bank, academia and private-sector economists. This initiative has been inspired by the examples set by a number of central banks. Other central banks that host similar conferences in collaboration with universities include the Central Bank of Chile, the European Central Bank, the Federal Reserve Banks in the United States, the Swiss National Bank, the Bank of Canada, and the Deutsche Bundesbank. Generally, the aim is to facilitate debate on monetary policy and related issues. Our economists regularly participate in some of these conferences and we are pleased to be able to provide a similar forum. The proceedings of the conference will be published, in order to reach a wider audience. 2. The relationship between the Bank and academia The Bank’s relationship with local universities has been evolving over time. In 1994 the Bank launched a 12-month Cadet Programme providing young graduates with high potential the opportunity to learn more about the operations of a central bank and to gain first-hand practical experience. The programme is managed by the SARB College in collaboration with subject experts from leading local and international academic institutions. To offer life-long learning opportunities to these learners, the College has embarked on a process to develop and register qualifications on the National Qualifications Framework from levels 4 to 6, in collaboration with formal educational institutions. Regular contact is maintained between academics and researchers in the various departments of the Bank and other central banks. A number of conferences and workshops have been organised by the Bank in the past, and an increasing number of academics have been presenting their research findings at seminars in the Bank. During the past two years, a number of collaborative research projects have also been initiated and completed. This latter initiative has become more formalised with the launch this year of the Visiting Research Fellows Programme which will enable leading academics or researchers from other central banks to spend time at our Head Office pursuing their research and interacting with Bank staff. Visitors from the academic world will thus be able to discuss their latest research work and collaborate with Bank staff as co-authors of research papers on a regular basis. The Bank also collaborates formally with tertiary institutions as part of the strategy to enhance central banking skills and knowledge in South Africa. To this end, the Bank is currently sponsoring a Chair in Monetary Economics at the University of Pretoria. This should ensure the development and promotion of research and tuition in the field of monetary economics at the post-graduate level. The incumbent serving as Chair will become a visiting research fellow at the Bank to foster closer collaboration and research synergies between the Bank and the University. In an effort to improve the quality of economic journalism in Africa, the Bank, in partnership with Rhodes University, is in the process of establishing the African Economics Journalism Centre at the School of Journalism and Media Studies at the university. From 2007, the Bank will provide funding and institutional support, as well as funding for scholarships to attract students from previously disadvantaged backgrounds to economics and financial journalism. The SARB College will furthermore assist with the design of the macroeconomics curriculum as part of the programme. Furthermore, from 2008, Rhodes University will offer a dedicated postgraduate diploma in economics journalism, aimed at mid-career journalists and journalism graduates who lack an economics or commerce background. Our contributions to universities are not confined to funding. A number of Bank staff give specialised lectures or courses at various universities. I have the honour of being an honorary professor at Unisa, the University of Pretoria, the University of Stellenbosch and the University of Limpopo. This commits me to present a number of lectures and seminars to staff and students. I particularly value the interaction with students and I often feel comforted by the quality of the training that our future economists are receiving. Overall, the collaboration with universities and research centres plays a key role in the continuous upgrading of our intellectual capabilities and the deepening of our knowledge of relevant subjects. These interactions are fundamental to the fulfilment of our strong commitment to excellence in economic analysis and research at the Bank, which is reflected in our series of working papers and periodic bulletins. The close collaboration between the Bank and the academic world mirrors what is occurring more broadly between academia and the new knowledge-based industries. It facilitates the continuous elaboration and improvement of a large set of tools that are of utmost importance for decision-making at the Bank, ranging from models for forecasting and policy evaluation to analytical frameworks for monitoring monetary developments. 3. The interaction between research and policy-making Macroeconomic policy has attracted a great deal of research in recent years. Much of this research work has concerned issues that are highly relevant to those of us who are engaged in monetary policy decisions. One example is the misconception that there is a permanent trade-off between inflation and unemployment (or output). We are indebted to academic research for proving that the attempts to exploit such trade-offs eventually only lead to higher inflation. It therefore re-established a firm basis for the concept of the long-term neutrality of money. Indeed, this is a perfect example of an academic insight that has become a deep-seated principle of central banking around the world. I have spoken to you about the important input that economic research provides to central banking. Let me briefly touch on the other leg of this exchange, from policy to science. By facing the challenge of decision-making in real time and in the real world, policy-makers continuously uncover a wealth of new intellectual problems that may be unknown to academic researchers. Moreover, economic policymakers have a better knowledge of the institutional constraints affecting policy and are therefore able to transmit a sense of realism to economists who analyse monetary policy issues. An example that springs to mind is that of inflation targeting, which did not originate in any textbook, but at central banks. This widely implemented monetary policy framework has in turn spawned a significant academic literature. An additional, less obvious, but very important aspect of this exchange is that policy-making introduces a form of discipline in the science of monetary economics by placing a premium on analytical results that prove to be robust across different approaches and time horizons. A central bank needs to be very cautious about "jumping on the bandwagon" of any new but untested paradigm that academic researchers, or other observers, may provide. Here I agree with Friedrich Hayek and "confess that I prefer true but imperfect knowledge, even if it leaves much undetermined and unpredictable, to pretence of exact knowledge that is likely to be false." One thing is clear, howeverthe sounder the theoretical foundation for monetary policy, the easier the life of a central bank governor. 4. Macroeconomic policy challenges for SA The theme of the conference is "macroeconomic policy challenges”. I do not want to pre-empt the forthcoming discussions, but I thought it would be appropriate to mention some of the macroeconomic challenges that I see facing South Africa. The fundamental macroeconomic challenge in South Africa is the alleviation of poverty. The best way to alleviate poverty on sustained basis is to generate employment which in turn requires economic growth. Although the economy is growing at its highest rate since the advent of democracy, it is generally accepted that to make sustained and significant inroads into the employment and poverty situation, a higher growth trend is required. This is recognised by the accelerated and shared growth initiative (ASGISA) strategy of government. Some of the questions that need to be considered are the challenges and the risks the strategy faces. We face some monetary policy challenges as well. In recent months the risks to the inflation outlook have increased. Factors leading to this deterioration include high growth in consumer spending, rising levels of credit extension to the private sector and developments in the international oil prices. Although oil prices have moderated recently, upside risks remain, and a challenge we face in the Bank is to keep inflation within the inflation target range in the face of significant exogenous shocks as posed by the oil price movements. Research on the first and second-round inflationary effect of oil price increases is therefore important for making good monetary policy decisions. High levels of domestic expenditure have contributed to the widening deficit on the current account of the balance of payments. While the deficit is currently more than adequately financed by capital inflows, investor fears relating to the sustainability of the deficit increase the risks of exchange rate adjustments which could threaten the longer-term attainment of the inflation target. The policy challenge is to maintain low inflation within the context of a growing economy and a sustainable external balance. There are also challenges facing our financial markets. South Africa is a small open economy by international standards. This in itself presents some challenges for the pursuit of domestic price stability. Our foreign exchange market is very liquid which makes it an easy target for portfolio realignment by international investors. Therefore, there is always a potential threat of a direct impact on the exchange rate of the rand emanating from this source. Finally, there are challenges posed by globalisation and regional co-operation. Regional co-operation is vital for success in our modern world, one that is becoming increasingly globalised. Although globalisation has brought many benefits, the painful experience emanating from the adverse developments in international financial markets is still fresh in our memories, and hence one cannot over-emphasise the importance of co-operation, particularly among central banks. 5. Conclusion It is important that policy-makers assess the current economic situation and establish the areas in which further action will be required. A lot has been achieved, but many economic challenges still remain. I believe that the subjects and the quality of the papers to be presented, the impressive expertise and experience of our speakers, discussants and panelists will provide fertile ground to nurture fruitful debates, enhance our understanding and generate new ideas regarding the challenges facing our economy. Thank you for your willingness to share your knowledge and experience with us. We also trust that you will enjoy the opportunity of meeting with other economists, enjoy the Bank's hospitality, and to those who are from outside our country’s borders, enjoy your visit to our beautiful country. I thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a business breakfast organised by the Graduate School of Business, University of Kwazulu-Natal, Durban, 2 November 2006.
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T T Mboweni: Monetary policy decision making in an uncertain international economic environment Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a business breakfast organised by the Graduate School of Business, University of Kwazulu-Natal, Durban, 2 November 2006. * * * Honoured guests Ladies and Gentlemen 1. Introduction Thank you for the opportunity to address you in Kwazulu-Natal. I should note that my presence here is due to the persistence of Dr Singh who has been berating me for some time for neglecting your province. It is indeed true that it has been some time since I have made a public address in KwazuluNatal but I can assure you that this has not been by design. My address today relates to recent international economic developments and how they impact on our own monetary policy decision making. South Africa is very much part of the global village and as such is heavily influenced by international economic developments. Many of these developments have resulted in increased uncertainty and risks. The emergence of China as an economic powerhouse means that the world is a different place to what it was just a decade ago. Most parts of the world have also been experiencing a period of robust world growth, but while it may be true that every cloud has a silver lining, sometimes a silver lining may have a cloud. In some respects this holds true for the current world growth performance. Some of the current uncertainties relate to the issues of global imbalances, asset price movements, oil prices and tighter conditions in financial markets. These issues add to the uncertainty within which monetary policy has to be conducted. 2. World economic growth In the recent World Economic Outlook published by the International Monetary Fund, the global economic environment is characterised by economic activity that has exceeded expectations, and signs of a build-up of inflationary pressures. These pressures originally emanated from oil and other commodity prices, but more recently have been a result of emerging capacity constraints. Central banks have responded by generally tightening monetary policies. Global imbalances however remain large. The balance of risks to the global outlook is seen to be biased to the downside, and although a benign market-led process of unwinding of global imbalances is seen to be the most likely outcome, the potential for a disorderly unwinding remains. Estimates by the IMF show that world growth has averaged 4,2 per cent since 2000, as compared to 3,2 per cent for the preceding decade. Current projections indicate that the economic expansion is likely to continue with growth rates being very close to 5 per cent in 2006 and 2007. In fact, the global expansion since the turn of the 21st century ranks amongst the highest since the early 1970s. While the global expansion has in general been broad based, the improved growth performance of developing and emerging economies relative to those of developed economies has been most noteworthy. For example, in 2005, emerging economies accounted for more than half of total world gross domestic product (GDP) in purchasing-power parity terms; around 43 per cent of world exports; about 70 per cent of the world’s foreign exchange reserves, half of the world’s energy consumption and around 80 per cent of the growth of oil demand in the past five years. China was the fastest growing economy over the last few years and in 2005 the country became the world’s fourth largest economy (at market exchange rates) after the United States, Japan and Germany. It is the second largest economy in purchasing power parity terms after the United States. China is becoming increasingly important in the world economy by a wide range of measures. The country’s average contribution to global GDP growth in purchasing-power-parity terms, for example, has increased from 9,5 per cent in the 1980s to 18,0 per cent in the 1990s and further to 24,5 per cent in the six years to 2005. The United States’ average contribution to global growth, on the other hand, has decreased from 23,3 per cent in the 1980s to 20,2 per cent in the 1990s and further to 16,3 per cent since 2000. Chinese economic growth has been accompanied by an increase in the demand for raw materials which, in turn, has reinforced the boom in commodity prices. For example, China accounts for 40 per cent and 33 per cent of the world demand for cement and coal respectively. Furthermore Chinese demand accounts for over 20 per cent of steel, copper and aluminium. The emergence of China means that the world economy is probably less dependent on the US for overall global growth. It used to be said that if the United States sneezes, then the rest of the world catches a cold. Although a slowdown in the US will have implications for the world economy, the global economy may not be as susceptible to a US slowdown as it was a decade or so ago when the US cycle was almost synonymous with the global cycle. Today, the outlook for world growth and commodity prices is also dependent on the growth outlook in Asia in general and China in particular. Global growth has implications for our own monetary policy through a number of channels. Higher global growth may, in the absence of productivity growth, result in either higher world inflation or tighter monetary policies in high growth economies. At the same time, strong world growth is generally positive for commodity prices, which may cause the rand to be stronger. Often the implications of world growth developments for monetary policy are far from clear, and this underlines the uncertainties we face. 3. Global imbalances Although the world economy may have achieved a degree of immunity from cyclical downturns in the United States, it is probably still true to say that if the US had to catch a cold, the rest of the world would run the risk of catching a bad case of flu. The possible disorderly unwinding of global imbalances is a case in point. The main manifestations of the global imbalances are the current account deficit in the United States and the current account surpluses in a number of Asian economies and the oil exporting economies. The dominant view in the market appears to be that it is not a question of if, but rather when and how the adjustment will take place. As I noted earlier, the IMF view is that although there is a risk of a disorderly adjustment, a smooth market-led adjustment is the most likely outcome. By contrast, in the 2005 annual report of the Bank for International Settlements it was noted that the unwinding of the imbalances could be uncomfortable, either through profound market turbulence or a protracted period of slow world growth. A number of solutions to the problem of global imbalances have been proposed. In his keynote address to the recent conference on macroeconomic challenges that was organised by the Bank, Professor David Llewellyn argued that none of the proposed solutions would be sufficient on their own, and that unless a number of solutions were implemented concurrently, a negative outcome was more likely. In his view, the required adjustment includes increased savings in the US including a reduction in the fiscal deficit; reduced savings in China, combined with improved social security safety nets in that country; a move away from the dollar peg by Asian economies and a depreciation of the US dollar; and a rise in aggregate demand in Japan and the euro area, accompanied by structural reform in the latter. Unfortunately there does not appear to be a co-ordinating mechanism to bring about the adjustment, and it is also unclear how long these imbalances will persist. The persistence has already confounded a number of analysts who have been predicting a major readjustment of the US dollar for at least the past 4 years. Going forward, there is always the concern that the underlying international imbalances could be resolved through a significant realignment of global exchange rates. Estimates of how much exchange rates would have to adjust vary greatly. In 2005, Obstfeld and Rogoff for example, argued that the dollar adjustment could exceed 30 per cent. An adjustment of this order of magnitude will inevitably impact on the rand, but it is not clear whether under these circumstances the rand would find itself moving with the dollar, or in the opposite direction. Much will depend on how world growth and risk perceptions are affected in such a scenario. Whether or not there will be an orderly or disorderly unwinding of these imbalances, there is very little that some economies such as South Africa can do to pre-empt these effects. The onus is on the large industrialised countries to try and ensure an orderly adjustment or to minimise the negative consequences that may ensue in the wake of a disorderly resolution. 4. International interest rate and inflation developments At the beginning of the 1990s, world inflation averaged around 30 per cent compared to an estimated 3,8 per cent in 2006. In 1992 there were 44 countries with inflation rates in excess of 40 per cent compared to 3 in 2003. At the Jackson Hole conference organised by the Federal Reserve Bank of Kansas City in 2003, one of the issues that was hotly debated was the cause of this decline. Central bankers of course claimed the credit, arguing that it was because of more disciplined monetary policies. Others however argued that it was the forces of globalisation and the emergence of China. As one commentator observed, it reads a bit like an Agatha Christie mystery. The questions are, who killed the victim, how was the victim killed, and is the victim really dead? I think it is true to say that monetary policy has become more disciplined in the 1990s, but globalisation has probably played its part as well. There is no doubt that China has had an impact despite the upward pressure on commodity prices. For example, footwear and clothing prices, which have a weight of just over 4 per cent in our CPIX, have been falling since October 2003. In the year to date, footwear and clothing prices have fallen by 6,6 per cent. There is no doubt that this has had a moderating effect on our domestic inflation. Recently there have been signs that the victim has been showing signs of life, and world inflation has risen somewhat, although the IMF still expects world inflation to remain under control and to average 3,7 per cent next year. Some of the pressures are a result of rising international oil prices, although more recently high levels of capacity utilisation and strong consumer demand have also been observed. Consequently we have seen a general monetary policy tightening cycle globally. In the past year for example, most industrialised and emerging market central banks have raised interest rates at some point. We are often asked if we follow the world interest rate cycle. There is not a simple interest rate cycle. Interest rates in the United States, the United Kingdom and the euro area have not followed exactly the same path. We do not and cannot slavishly follow international interest rate developments. The fact that we have adjusted our monetary policy stance recently is not in response to interest rate developments abroad. Our interest rate decisions are determined by the domestic inflation outlook. Of course, this outlook in turn may be affected in some instances by the same factors that may cause monetary policies to be tightened in general, but this is not necessarily the case. 5. Asset prices and international liquidity Much has been said in the past few years about the impact of increased international liquidity which is in part a consequence of the global imbalances. Stock markets and property markets around the world have reached record highs and emerging market spreads have narrowed significantly. South African equity and property prices have also reached record highs. The question that is often raised in this context is whether the market is correctly pricing risk, and whether the system is vulnerable to a reversal. Our asset markets have a significant degree of participation by non-residents. For example, since the beginning of 2006 to 26 October, non-resident net purchases of South African bonds and equities totaled R20,8 billion and R64,7 billion respectively. However, as an open emerging-market economy we are always vulnerable to changes in international sentiment which may have little to do with domestic economic developments. The appetite for South African financial assets is, to a certain extent, influenced by developments in global bond and equity markets. Asset price developments have important implications for monetary policy although the appropriate response is far from clear. The wealth effects that are generated by high asset prices have an impact on consumer demand and, therefore, potentially on inflation. Various issues emerge here. Firstly, it is not always easy to recognise a bubble. Secondly, there is the question of whether or not monetary policy should try and prick asset price bubbles in order to avoid the consequences of the bubble popping at even higher levels with the attendant risks to financial stability. Generally the response of central banks has been to argue that the best monetary policy can do is to try and anticipate the impacts of asset price movements on inflation, and to react in the same way that we react to any factor that can cause inflation to rise beyond the inflation target. This is in essence our approach as well. However in most countries there is not a full understanding of how these wealth effects affect the inflation process and the transmission mechanism of monetary policy. 6. International oil prices In any discussion of international developments we cannot ignore the oil price. As we all know, international oil prices have increased significantly over the past few years. It is almost unbelievable that the price of Brent crude was around US$11 per barrel in January 1999. By January 2004 Brent crude oil prices had exceeded US$30 per barrel and had subsequently reached a high of around $80 per barrel during August 2006. Since then there has been some moderation and the price has fallen to current levels of below US$60 per barrel. The causes of these increases have been the tight supply and demand conditions in the market, as well as periodic bouts of geopolitical tensions. The increases in oil prices have had a significant impact on domestic petrol prices. During 2006 for example, the price of 95 octane petrol in Gauteng increased from R5,49 per litre in January to peak at R7,04 per litre in August. Fortunately, as a result of falling international prices, we have experienced three successive declines totaling R1,07. The contribution of transport costs to CPIX inflation provides an indication of the direct inflationary impact of petrol price increases. This has averaged around 15 per cent of the overall monthly increase in the CPIX during 2005 and around 17 per cent during the first 9 months of this year. We also saw that for most of 2004 and 2005, most of the volatility observed in CPIX inflation was directly attributable to petrol price movements. More recently, other factors have also been exerting upward pressure on CPIX inflation. We have often emphasised that it is not the first round effects of oil price increases, that is, the direct impact on petrol prices, but rather the second round effects that are of primary concern for monetary policy purposes. While there is little we can do about first round effects, we have to ensure that these effects do not adversely affect inflationary expectations and become more generalised and stimulate inflationary impacts across the economy. If sustained, the recent decline in oil prices augurs well for inflationary developments going forward. Nevertheless, given the underlying market conditions and the vulnerability of oil prices to geopolitical tensions, these lower prices cannot be taken for granted and oil prices continue to pose an upside risk to our inflation outlook. 7. Conclusion Monetary policy has to be formulated against the backdrop of increasingly integrated goods and financial markets. This increases the uncertainty surrounding the workings of the monetary transmission mechanism. Monetary policy making becomes more complicated since the nature and extent of influence of exogenous shocks on the domestic economy is difficult to determine in advance. With highly integrated money and capital markets, changes in sentiment, whether justified or not, can have profound implications for our economy. Similarly, changes in growth prospects in the industrialised countries or emerging Asian economies will also affect us. The exact nature and timing of these developments are always uncertain. As is often said in monetary policy circles, the only certainty is uncertainty. This is highly applicable to the uncertain impact of international developments on domestic monetary policy. I thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 10th Anniversary function of the Payment Association of South Africa, Pretoria, 15 November 2006.
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T T Mboweni: A historical review and a look at the future prospects of the National Payments System in South Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 10th Anniversary function of the Payment Association of South Africa, Pretoria, 15 November 2006. * * * Honoured guests, ladies and gentlemen. 1. Introduction It is with great pleasure that I join you in celebrating the tenth anniversary of the Payment Association of South Africa (PASA). As financial systems have become increasingly complex, stricter regulation, overview and co-ordination of payment systems has been required. South Africa has been no exception, and PASA was born as an integral part of this process. As with most young children, there have been many growing pains, but it is a tribute to all those involved with the organisation that with the passage of time, PASA is developing into a mature adult. For the benefit of those unacquainted with the system, the NPS is a broad concept which not only entails systems to clear payments (cheques, electronic payment and card payments) between banks, but encompasses the total payment process. This includes all the systems, mechanisms, institutions, agreements, procedures, rules, laws etc that come into play from the moment an end-user issues an instruction to pay another person or a business, through to the final settlement between banks at the South African Reserve Bank. The NPS thus enables transacting parties to exchange to do business efficiently. 2. Background to the creation of PASA In the late 1980s, the risks emanating from the settlement of payment-related activities increasingly became of particular concern to central banks. The Bank for International Settlements (BIS) gave this issue further prominence when it started publishing reports highlighting the risks associated with the payment system. These reports highlighted the discomfort of central banks with the level of credit and liquidity risks to which participants in the payment system were exposed. Furthermore, concern was also raised about the regulatory and supervisory responsibilities of central banks in the payment system. In response, central bank Governors agreed to establish an ad hoc committee to investigate the findings of the various reports. Consequently, the Committee on Payment and Settlement Systems (CPSS) at the BIS was established. The Committee is currently convened by Mr Timothy Geithner, President of the Federal Reserve Bank of New York. It has become a trend, especially among the central bank fraternity, for regular attention to be paid to payment systems. This is part of the contribution that central banks make to overall financial system stability. With the reintegration of South Africa into the world economy in the early 1990s, it was clearly evident that this would bring increased obligations in order to ensure that the domestic clearing and settlement systems and risk management procedures conformed to international best practice. In February 1994, the banking industry requested the South African Reserve Bank to take the lead in the modernisation process of the domestic payment system. The NPS project, which was initiated by the Bank in April 1994, was launched as a collaborative effort between the Bank and the banking industry and the initial focus was to formulate a long-term strategy for the modernisation and development of the domestic payment system. This initial work resulted in the development of the South African National Payment System Framework and Strategy document (the so-called Blue Book) which was published by the Bank in 1995. The Blue Book contained the vision and strategy for the NPS up to 2004. An important component of the implementation strategy entailed the establishment of an umbrella body – the Payment Association of South Africa (PASA). It was envisaged that PASA would play a central role in establishing and controlling Payment Stream Associations representing the banks participating in each particular payment stream. It was the view at the time that although the Bank would remain responsible for the overall safety and soundness of the NPS, the clearing environment should be managed by an association made up of participants in that environment. Although the NPS Act, which makes provision for a Payment System Management Body, was only promulgated in October 1998, PASA was already formally established on 26 September 1996. The Act made provision for a Payment System Management Body, not only to manage the affairs of its members in relation to payment instructions, but also to act as a medium of communication with the different stakeholders, namely the Bank, Government, public bodies, the media and even the general public. From what we understand there were some "teething" problems but PASA has over the past ten years matured in terms of both the structural arrangements and its stature. Today PASA has a governing council, an executive office and several strategic, risk and payment clearing house workgroups or committees which has increased its operational efficiency and effectiveness quite significantly. This is good progress for which all of us must take credit. Much of what has been achieved in the development of our NPS over the past ten years has been through consultation, collaboration and co-operation between the members of PASA and the Bank. While the Bank supports the consultative and collaborative approach, we have observed on occasion that competitive issues between the banks themselves, and the banks and other stakeholders, can impede the collaborative process and sometimes cause unnecessary delays in the implementation of certain initiatives. It should be remembered that collegiality, co-operation and inter-operability are vital elements of a world class payment system. To achieve this does sometimes require an above average effort from stakeholders. In this regard, the Bank is committed to ensuring that new developments or any response to problems in the NPS will always be taken in the interest of the system as a whole, and not in the interest of individual participants. 3. Achievements in the NPS over the past 10 years Collaboration between the Bank and the banking industry, particularly with PASA, has resulted in the South African Payment System being recognised as an example or model for development initiatives in the region and internationally. Much has been achieved during the past ten years and although I do not want to go into detail of any particular achievement, there are a few major milestones which are worth highlighting tonight. The first major milestone was reached on 9 March 1998, when the South African Multiple Options Settlement (SAMOS) system was implemented, enabling banks to settle their obligations on a real time gross settlement basis (RTGS). Various changes and upgrades to the SAMOS framework have been implemented since 1998, including facilities for the South African financial markets to conform to international best practice with the introduction of the principle of delivery versus payment (DVP) for settlement of equity, bond and other financial market transactions. The second milestone was reached with the promulgation of the NPS Act in October 1998. The Act provides the SARB with the mandate to oversee and monitor the payment system and provides the objectives and rules for the Payment System Management Body. It also provides for the final and irrevocable settlement in the SAMOS system. The oversight function of the Bank was extended in the amendment of the Act in 2004 when the Bank was given the power to issue directives to any person regarding a payment system or the application of the provisions of the Act. I will return to the role of the Bank in the NPS later on. The third highlight relates to risk-reduction initiatives in the retail payment environment. The Blue Book identified several risk-reduction measures to be implemented in the retail environment. Although risk reduction is an ongoing process in the NPS, two important issues have been dealt with recently. Firstly there was the signing of new contractual agreements between the participants of each payment clearing house in the NPS. Secondly, there was the introduction of item limits for retail payment streams to a maximum of R5 million to reduce the values being settled in these streams and to encourage high value payments to be processed through the SAMOS system. Finally, perhaps one of the most important achievements in the NPS recently was the inclusion of the South African Rand in the CLS Bank settlement system. The Bank and the banking industry were proactive in this regard and the Bank issued a position paper late in 2002 supporting the inclusion of the rand as a settlement currency in the CLS system. South African registered banks were also encouraged to become members of CLS. Following a major collaborative effort, the Rand became a CLS currency in December 2004. 4. The Competition Commission investigation We are all aware of the current Competition Commission investigation into the NPS. This investigation was triggered by the report on The National Payment System and Competition in the Banking Sector. The Bank will most certainly not want to give an opinion on the matter or in any way pre-empt the conclusions or recommendations that the Commission may make. However, I should point out that despite the achievements to date, there is little doubt that there is still a perception that access to the NPS is restricted, and that it operates like a “closed club” or a cartel of the big four banks. This is probably related in part to the lack of transparency in entry criteria. Indeed, if anti-competitive pricing collusion does exist, it is appropriate for the Competition Commission to investigate this and make a ruling so that fairness and competition can be the rule of the day. It is heartening to see a new willingness by the banking industry to open access to the payment system. I should however point out that the Bank as the current overseer of the NPS has an obligation to ensure that restricting or facilitating access to the system does not compromise the overall integrity of the system. Access should be available to any institution qualifying in terms of internationally accepted risk-based criteria, as contained for example in the BIS core principles for systemically important payment systems which are geared at ensuring safety and efficiency of payment systems. 5. The way forward There are new and complex challenges facing the NPS and the different stakeholders operating within the system. As you are aware, the Bank, after consultation with the industry and other stakeholders, published a new Vision and Strategy document (Vision 2010) for the NPS in April this year. The purpose of this document was to provide high-level strategic guidance for the payment system up to 2010. Finally, there appears to be a general misunderstanding that the Bank has a "hands off" approach to the oversight and regulation of the NPS. I would remind all NPS stakeholders that section 10 (i) (c) of the South African Reserve Bank Act states clearly that the Bank, " perform such functions, implement such rules and procedures and, in general take such steps as may be necessary to establish, conduct, monitor, regulate and supervise payment, clearing or settlement systems”. Furthermore, as I noted earlier, the 2004 amendment to the NPS Act makes provision for the Bank to issue directives pertaining to the NPS. We raise this issue as the Bank will soon be issuing directives in terms of the NPS Act which will regulate non-bank participants in the NPS for the first time. We have noticed that the number of nonbank participants has increased to the extent that the risk associated with their operations and the risk that they bring to the clearing and settlement environment requires some formalisation. Of particular relevance in this regard are system operators and third party service providers, who mostly operate in or on behalf of the retail sector. We want to make it clear, particularly to the banking sector, that strict regulation will be applied as far as the NPS is concerned. This should not be perceived negatively, nor do we wish to stifle innovation or competition in the industry. However we need to apply strict supervision and regulation to both bank and non-bank participants in the critical area of the NPS and avoid the risk of turbulence that may emanate from a hands-off approach to regulation. This may require some adjustment to current structures in the NPS and the Bank will have to start playing a far more prominent role in areas such as supervision, regulation and licensing of participants. We also need to ensure that these newly regulated entities have channels to engage with the Bank and other stakeholders, including PASA, in a fair and transparent way. The Bank has already initiated discussions with various international central banks and consulted with NPS stakeholders with a view to adopting a model which will facilitate such engagement. This may take some time but I can assure you that the Bank will continue with the collaborative approach it has used for NPS matters in the past before making any final decisions in this regard. 6. Concluding remarks In conclusion, I would like to congratulate PASA and the industry for the effort, and achievements of the past ten years, not only in the area of systems and infrastructure, but also in the manner in which they have co-operated in the flow of liquidity and the conclusion of commitments in the system on a daily basis. The Bank looks forward to the continued co-operation of PASA and other stakeholders as we tackle the challenges that lie ahead in an effort to ensure that the NPS continues to comply with international best practice. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Variety Club, Water Relief Campaign Launch Banquet, Johannesburg, 14 November 2006.
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T T Mboweni: Joining hands in support of development Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Variety Club, Water Relief Campaign Launch Banquet, Johannesburg, 14 November 2006. * * * Honoured guests Ladies and Gentlemen 1. Introduction I am pleased and honoured that you have accepted our invitation to this banquet whose purpose is to launch the Variety Water Relief Campaign. As has been explained by the organisers, this campaign is an initiative to support the Government’s efforts in reaching out to some of the poorest schools in our country. It is a worthwhile campaign which I am glad that you have decided to join in. The needs out there are many and thanks to your support, the Variety Club can make some contribution towards improving the lives of school children or learners. Our campaign is the Variety Water Relief Campaign. As we all know, water is absolutely essential for the sustenance of human life and maintenance of basic human dignity and should, therefore, be a fundamental human right. Also, there could easily be enough water for everyone if the resource was shared equitably while ensuring the sustainability of natural ecosystems. Yet, globally over a billion people do not have access to clean water supplies and over two billion lack access to adequate sanitation, the primary cause of water-borne diseases. As many of you might know, I grew up in the province of Limpopo in a village just outside the little town of Tzaneen. There was no clean water system there. In fact we depended on water drawn from the nearest Nwaveti River. This task was more often than not assigned to women and young girls. The conditions were not conducive for a healthy life. As a matter of historic fact, in 1969 or thereabout, my two siblings and I fell ill from typhoid and spent three to four weeks in hospital. The environment was just ripe for disease. Boys would be swimming upstream whilst girls and women would be collecting water downstream! I regret to say this evening that many of the people in that area and others still do not have access to clean water. My former cabinet colleagues know of my Mrs Mboweni water story that I told in 1994. Up to today, Mrs Mboweni is still struggling for clean water. 2. Water and the Millennium Development Goals It was against this backdrop that, at the United Nations (UN) Millennium Summit, in September 2000, the leaders of the world adopted the eight Millennium Development Goals (MDGs). The MDGs constitute a developmental framework with time-bound goals and targets for measuring progress, and have since been embraced by all development institutions across the globe. By 2015, the MDGs seek to, among a range of other things, halve poverty, halt the spread of HIV/AIDS, provide universal primary education, reduce by half the proportion of people without sustainable access to safe drinking water and the proportion of people who do not have access to basic sanitation. The UN’s Millennium Development Goals Report (2006) shows significant progress towards the attainment of the MDGs. It also shows that we still have a long way to go. Unfortunately, with half of developing country populations still lacking basic sanitation, the world is unlikely to reach its target. Nevertheless, according to the report, between 1990 and 2004, sanitation coverage in the developing world increased from 35 to 50 per cent. This meant that 1, 2 billion people gained access to sanitation during this period – 300 million less than the requirement to meet the target. The report sees the world as being on track to reach the drinking water target with as many as 81 per cent of people in the developing world having access to improved sources of drinking water in 2004. This can be compared to 71 per cent in 1990. However, issues such as population growth and the urban-rural divide pose challenges going forward. In parts of sub-Saharan Africa, for example, urban dwellers are twice as likely to have safe water as those in the countryside. 3. South Africa and the MDGs And how does South Africa compare? According to the triennial World Water Development Report (2006) of the United Nations, 19 per cent of the South African population still lack access to safe water, and 33 per cent lack basic sanitation services. Public institutions also suffer from a lack of access to safe water and sanitation services: 59 per cent of all schools (over 16 000) and clinics (over 2 500) lack access to acceptable sanitation facilities, while 27 per cent of all schools (over 7 500) and 48 per cent of all clinics (over 2 000) lack access to safe water supplies. The report also cites the occurrence of water-related epidemics and diseases such as diarrhoea, cholera, dysentery, hepatitis and bilharzia. In 2004, there were 2 780 cholera infections with 35 fatalities and 9 503 hepatitis A infections with 49 fatalities. These diseases significantly affect the economic productivity and social activities of affected households. I should, however, hasten to add that it is not all doom and gloom. South Africa is one of a few countries that have made formal legal commitments to acknowledge a right to water and, by one account, is the only country where the right to access to water is embodied in a Constitution. Section 27(1) (b) of the Constitution states that everyone has the right to have access to sufficient water, while Section 27(2) requires the State to take reasonable legislative and other measures, within its available resources, to achieve the progressive realisation of this right. According to South Africa: Millennium Development Goals Country Report (2005), the country has already met some of the MDGs. Since 1994 South Africa has reduced the proportion of people lacking access to safe water from 40 per cent to 19 per cent. This, however, may be related to the fact that in 1994, following the birth of the new dispensation, the government set itself many targets similar to those articulated in the Millennium Declaration. The Five Year Strategic Plan (2006/07 – 2010/11) of the Department of Water Affairs and Forestry seeks to reduce the backlog by a further 1,5 million people in 2006/07, 1,7 million in 2007/08, and 1,8 million per annum in the subsequent three years to 2010/11. These achievements are definitely laudable. But whilst many of us gathered here tonight take clean, safe drinking water for granted and even have a choice between bottled and tap water, there is a child out there who has to wait beyond 2011 to have access to a functioning basic water supply facility. But the children should not wait. One child having to wait one more day is one child too many, and one day too long. 4. The role of the South African Reserve Bank And what is the role of the South African Reserve Bank towards the attainment of the MDGs? The attainment of the MDGs requires high and sustainable rates of economic growth. The International Monetary Fund projects real GDP growth rates of 4, 8 per cent and 5, 9 per cent for sub-Saharan Africa in 2006 and 2007, respectively. However, to attain the poverty MDG to halve the population of people living on less than US$1 a day, the subcontinent will need to accelerate annual GDP growth to at least 7 per cent. The primary mandate of the South African Reserve Bank is the achievement and maintenance of price stability. Indeed, we are of the firm view that the best contribution that the Bank (through monetary policy) can make towards the attainment of high and sustainable rates of economic growth and employment creation is keeping inflation at low levels thus contributing to the achievement and maintenance of overall macroeconomic stability. We target the inflation rate and not any other economic variable and currently our key task is to maintain CPIX inflation – that is headline inflation less mortgage interest costs – within a range of between 6 to 3 per cent. Since September 2003, CPIX inflation has been contained within this range and has averaged 4, 0 per cent for the past two years. Going forward, the South African Reserve Bank remains resolute in the implementation of our mandate and we are keeping a close eye on inflation developments. If, in the view of the Monetary Policy Committee, the inflation target is being threatened by inflationary pressures, then the MPC will have the courage of its conviction to do the correct thing even as we enter the festive period. It is worth stating here that there is no rule that we are aware of which prohibits changes to the monetary policy stance just before Christmas. As the case might be, the MPC will discharge its responsibilities in the event that inflationary pressures persist. Once again our message is that we should all try to tighten our belts no matter how wide or narrow our waistlines might be. 5. Conclusion Let me conclude by posing a rhetorical question: In the face of these enormous socio-economic challenges, should the private sector stay in its comfort zone and focus only on growing shareholder value? Most certainly not. Many South African companies are already involved in large community social investment programmes. These could be expanded and become more focussed, as some do, on facing up to the challenge of improving the lives of ordinary people. According to a recent study 1 for every US$1 invested in water supply and sanitation, the direct and indirect benefits range from US$1 to US$34, depending on the region and level of intervention. Indeed, investments targeting the poor have the highest marginal benefit. Investing in water, we would suggest, is therefore good business. Your support today will go a long way towards contributing to meeting the MDGs, particularly the reduction of poverty. Thank you for your attention. Making Water a Part of Economic Development – The Economic Benefits of Improved Water Management and Services: A report commissioned by the Governments of Norway and Sweden as input to the Commission on Sustainable Development (CSD) and its 2004-2005 focus on water, sanitation and related issues.
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Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Arab-African Investment, Banking and Business Conference, Cape Town, 28 November 2006.
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X P Guma: Investing in Africa Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Arab-African Investment, Banking and Business Conference, Cape Town, 28 November 2006. * 1. * * Introduction Chairperson, Excellencies, distinguished guests, participants, ladies and gentlemen, it is a great honour for me to address you this morning, here in Cape Town. Permit me to add my voice to those which have already welcomed our visitors to South Africa. 1.1. The Victoria and Alfred Waterfront, where we are meeting, is perhaps a uniquely appropriate venue for this meeting of minds, given that this waterfront was recently acquired by the Dubai World and London & Regional Properties consortium. The consortium has in addition, also announced its plans to invest a further US$1 billion plus in the further bricks-and-mortar development of the V & A Waterfront over the next four years. This is, some would say, concrete representation of the nature of the benefits which flow from increased interaction between our respective regions. 1.2. In this address, I intend to outline some salient characteristics of the current conjuncture in Africa – from the perspective of investment. I will then say something about South Africa, again from the perspective of its attributes relative to investment. No claim is made, here, to originality. The object is, by contrast, to re-state those positive aspects of the current conjuncture which bear repetition: for no Arab or African economy is currently included in the list of “advanced economies”. All are typically classified as “emerging-market and developing countries”, equally capable of either retrogression or progression. 2. African emerging 2.1. As is well-known by now, the integrated socio-economic development framework for Africa was adopted in July 2001 in Lusaka by the 37th Summit of the OAU, and was named NEPAD – the New Partnership for Africa’s Development. The four primary objectives of the NEPAD programme are the eradication of poverty, the promotion of sustainable growth and development, the integration of Africa in the world economy, and the accelerated empowerment of women. 2.2 NEPAD has a commitment to good governance, democracy, human rights and conflict resolution as underlying principles. The programme recognises that maintaining these standards is fundamental to the creation of an environment which is conducive to strong investment and long-term economic growth. NEPAD seeks to attract increased investment, capital flows and funding, providing an African-owned framework for development as the foundation for partnership at both the international and regional level. 2.3 NEPAD priority action areas include operationalising the African Peer Review Mechanism, infrastructure, agriculture and food security, the preparation of a coordinated African position on market access, debt relief and official development assistance, and human resource development in the areas of health and education (NEPAD 2006). 2.4 And the current conjuncture is essentially promising. An important indication of the overall soundness of macroeconomic policies can be obtained from the inflation rate. In this connection Africa has made considerable progress. Few policymakers nowadays believe that higher inflation can buy lasting growth and prosperity. In a range of African countries measures have been or are being put in place to legally entrench disciplined financial policies, for instance by providing the central bank with an appropriate mandate and the degree of independence necessary to pursue that mandate successfully. 2.5 A further key indicator of the state of the economy is the real growth rate. Growth in aggregate real gross domestic product in Africa has become more consistent in recent years and has also become stronger, as shown in the slide. Partly this is due to the more sustainable monetary and fiscal policies being pursued in most parts of the continent, replacing earlier stop-go policies. Partly it is also a result of benign global economic conditions and international prices which favour African commodity producers. 2.6 With greater stability and an improved economic performance, Africa has also been able to attract more foreign direct investment in recent years, as shown in the accompanying slide. And this is likely to feed back into stronger growth, helping to create a virtuous circle. 2.7 The benefits of a fair degree of robustness in the face of adverse economic developments are substantial. Accordingly, many developing countries have in recent years strengthened their foreign exchange reserves. Africa is no exception in this regard, as shown in the slide. 2.8 Avoiding excessive levels of foreign debt can be as important as building up foreign exchange reserves in ensuring the ongoing health and robustness of the economy: and Africa has, over the past few years, succeeded in reducing its foreign debt rather dramatically. Part of this reduction is due to the debt write-offs under the Heavily Indebted Poor Countries (HIPC) initiative. 2.9 These developments at the aggregate level for all of Africa are promising. However, further analysis at the regional and country level must clearly be done in coming to terms with any specific investment project or commercial venture. 3. Financial infrastructure – South Africa 3.1 Turning now to the domestic environment; it is the case that the financial sector in South Africa is strong and versatile, offering an extended range of products and services. 3.2 There are currently 18 registered banks, two registered mutual banks and 15 registered branches of international banks in South Africa, with combined assets of just below R2 trillion. As has been pointed out elsewhere 1 - this banking sector is highly integrated with the bond and equity markets – eight of the banks acting as primary dealers in the bond market. The four biggest banks are also settlement agents of the Bond Exchange of South Africa, with the South African Reserve Bank serving also in that capacity. All the banks registered in South Africa are closely supervised by the Bank Supervision Department of the South African Reserve Bank which ensures that they remain well capitalised, have proper corporate governance and risk-management frameworks in place and fulfil all the requirements of the law. 3.3 Both the bond and equity markets are formalised and exchange driven, in the form of the Bond Exchange of South Africa (Besa) and the JSE Limited (JSE). These exchanges have been very successful in fulfilling their function or raising funds and mobilising capital. In 2005, a total net amount of R23,8 billion was raised through the primary issuance of bonds on Besa (after repayments of redemptions), and R82,2 billion of share capital was raised by companies listed on the JSE. Combined, this equals almost seven per cent of GDP. 3.4 During 2005, secondary market turnover on the Besa was equivalent to approximately 38 times the market capitalisation as at the end of December 2005. Moreover, turnover on the JSE amounted to R1,3 trillion, about 35 times the total market capitalisation. Both exchanges continue to enjoy the patronage of nonresidents, who account for approximately 20 per cent of the daily turnover on both exchanges. In short, South Africa’s capital markets are broad, deep, liquid and accessible. 3.5 It is also the case that South Africa has a National Payment System which has been recognised as a model for development initiatives in the region and internationally. The system operates in real time, is governed by an Act of Parliament and is linked to the CLS Bank settlement system ensuring that international transactions are settled with the same efficiency as are domestic ones. T. Mboweni: Deepening Capital Markets: The Case of South Africa – 7 November 2006 3.6 The monetary and fiscal authorities in South Africa pursue sound policies which promote stability and provide a solid platform for growth and development. South Africa has adopted an inflation-targeting framework for monetary policy, and the South African Reserve Bank has maintained inflation within the target range of 3 to 6 per cent over the past 3 years. Furthermore, the maintenance of low and stable inflation is a goal shared by central banks in the Southern African Development Community (SADC). To this end the central banks of SADC are far advanced in developing model legislation which provides for the pursuit of low inflation by central banks, an adequate degree of independence for the central bank, and limits on central bank lending to government. Conclusion Central bankers, and many who work in central banks often hear: they do not always listen. But that should be of little concern to those here present. Those who are here, in the main, are not central bankers. They will likely hear and they may listen. For this reason, I have chosen to say nothing about the problems which, undoubtedly, exist in our respective regions. Hearing and listening are, after all, some of the principal reasons for this dialogue: for it is the honest visitor who will innocently ask about the significance of the tick on your back, it tick there be – when you have chosen to behave as if there is not tick, least of all on your back. And it is the honest host who will respond appropriately. They said, who were wise, “lentswe le tšela noka etletse”. In free translation, “the voice fords fluidly ee’n rivers full”. Let not the rivers or oceans separate us, for voices we have all. We also, unlike the ancients, have the possibility to invest in infrastructure to enhance communication. I thank you for your attention. References • IMF. 2006. September 2006 factsheet on Debt Relief Under the Heavily Indebted Poor Countries (HIPC) Initiative. http://www.imf.org/external/np/exr/facts/hipc.htm. Site accessed on 1 November 2006. • Mboweni “Deepening Capital Markets: the Case of South Africa”, 7 November 2006 • Mboweni: “A Historical Review and a look at the future prospects of the National Payment System in South Africa, 15 November 2006. • NEPAD. 2006. http://www.nepad.org. Site accessed on 1 November 2006 • Wegner, L & Lecomte, H S. 2006. African Economic Outlook 2006 “Moving towards political stability?” Policy Insights No. 20. OECD Development Centre, May 2006.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa, Pretoria, 30 November 2006.
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T T Mboweni: An overview of the economic challenges of 2006 Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa, Pretoria, 30 November 2006. * * * Your Excellency, the Dean of the Diplomatic Corps Your Excellencies, Ambassadors and High Commissioners Your Excellency, the Chief of State Protocol Your Excellencies, Heads of International Organisations represented in the Republic of South Africa Deputy Governors of the South African Reserve Bank Senior officers of the South African National Defence Force Senior Management of the South African Reserve Bank and their spouses/partners Editors and other media representatives Ladies and Gentlemen 1. Introduction It is an honour to welcome you once again to the South African Reserve Bank for what has become an annual event on our calendar. Every year I am humbled by the turnout, and this year is no exception. This past year has been an extremely challenging one from a monetary policy perspective. Some of the challenges have emanated domestically, but external economic and geopolitical events have also provided challenges to us as well as to many other central banks around the world. This evening I will give a brief broad-brush review of some of these developments. Further details can be found in our publications, including our Quarterly Bulletin which will be released next week. I am aware that one of the issues that is close to your hearts in the diplomatic community is the behaviour of the exchange rate of the rand as your purchasing power in this country varies inversely with the fortunes of the rand. I have noticed that many of you are looking a lot happier tonight than you were this time last year! 2. The external environment The recent World Economic Outlook published by the International Monetary Fund (IMF) characterised the global economic environment as robust, with economic activity exceeding expectations. While the global expansion has in general been broad based, the improved growth performance of developing and emerging economies compared to that of developed economies has been most noteworthy. This improvement has taken place across all regions, including sub-Saharan Africa. As a group, developing countries now account for more than half of total world gross domestic product (GDP) in purchasingpower parity terms. This past year has been overshadowed by a high degree of volatility in the international oil markets, which posed a risk to the outlook for world growth and inflation. During the course of the year, the price of Brent crude oil reached new highs of almost US$80 per barrel as a result of tight supply and demand conditions as well as geopolitical developments. Since then the markets have stabilised somewhat and prices are currently around US$60 per barrel. The pressures on world inflation have also been reinforced by high levels of capacity utilisation and strong global consumer demand. Consequently, we have seen the adoption of a general monetary policy tightening cycle in many countries. During the past year, most industrialised and emerging market central banks have raised interest rates at some point. These actions are expected to keep world inflation under control. The global imbalances which have persisted over the past few years have been topical issues in the IMF, World Bank and G20 forums. The anomaly of the current global imbalances is that developing countries, particularly those in Asia are now the financiers of the current account deficits of the United Sates and other industrialised countries. A major concern is whether or not the elimination of these imbalances will take place in an orderly fashion. Although the dominant view is that the process will be orderly, the risk remains that the international economy could be in for turbulent times should a disorderly process emerge. It is probably too early to assess whether the current volatility we are observing in the international currency markets is the beginning of this adjustment process, or to predict how this process will unfold. Until May this year, emerging markets had enjoyed an extended period of investor exuberance and search for higher yield, which, combined with a generally supportive environment of strong global growth and high commodity prices, caused emerging market currencies to appreciate, equity prices to increase and bond spreads to narrow. However, in May, uncertainty regarding future inflation, interest rates and growth in the major economies contributed to some repricing of these assets. Following the anxieties caused to the markets by the widening current account deficits of Iceland and New Zealand earlier in the year, those countries which were perceived to have greater external vulnerability as a result of either high current account deficits or higher levels of external debt, were most affected. South Africa was among these, and as a result the rand depreciated significantly during the second and third quarters of 2006. Fortunately this episode was relatively short-lived and the latest indicators suggest that emerging markets have generally recovered and are enjoying renewed appetite among global investors for higher yielding assets. On the positive side, it seems as if emerging markets have become more resilient to sudden changes in investor sentiment than they were at the time of the Asian crisis in 1997/98. A major disappointment during 2006 was the inability of trade negotiators around the globe to conclude or, at least, continue with discussions in the Doha Round of the World Trade Organisation. There is no doubt that the major reason for the Doha breakdown is to be found in disagreements over agricultural sector protection. The failure of these trade negotiations came as a major disappointment to developing countries in all regions, but the ultimate cost could be borne by both developed and developing nations. Apart from the foregone opportunities for both developed and developing countries that a successful conclusion would have provided, of greater importance are the losses that all will be incurred if the world trading system is allowed to deteriorate with a reversion to protectionism. 3. Domestic economic developments On the domestic front, 2006 has proved to be an eventful and challenging year, which has been influenced to a significant degree by the international developments that I have made mention to above. From a monetary policy perspective, we have continued to achieve our mandate, which is to keep CPIX inflation within the target range of 3-6 per cent. Inflation has been within this range since September 2003 which enabled us to reduce nominal interest rates by a total of 650 basis points between June 2003 and April 2005. In recent months the trend of inflation has been rising, and in October CPIX inflation measured (5% ) per cent compared to 3,7 per cent in April of this year. Furthermore our forecasts suggest that inflation could reach the 6 per cent level by the second quarter of next year. In response to the deteriorating inflation outlook, the monetary policy stance was adjusted in June of this year when we increased the repo rate by 50 basis points. The repo rate was increased further by 50 basis at each of the subsequent meetings in August and October. For much of the year, international oil price developments posed a major risk to inflation. The price of 95 octane petrol increased from R5,49 per litre in January 2006 to peak at R7,04 per litre in August. Fortunately pressures on inflation from this source dissipated somewhat with the decline in the international oil prices and since August domestic petrol prices have declined by a total of R1,07 per litre. Despite this recent moderation, we still see the international oil price being vulnerable to global geo-political tensions, and therefore it continues to pose an upside risk to our inflation outlook. Of concern to us during the year was the persistent rise in domestic consumer demand which in recent times has been increasing at a year-on-year rate of around 8 per cent. This consumer exuberance has been financed by high rates of domestic credit extension and has led to record levels of consumer indebtedness of around 70 per cent of household disposable income. Contributing to these high levels of demand have been rising real incomes, increased employment, lower interest rates and higher asset prices. Both the housing market and equity markets have remained buoyant. The equity market in recent weeks has reached new record highs, having recovered from the reversal it suffered during the international market volatility in May and June when the all-share index declined by as much as 16 per cent. The rand exchange rate was also not spared the fall-out of the emerging market jitters in May and these developments have had an impact on the inflation outlook. Having traded in a relatively narrow trading range for much of the first half of this year, the exchange rate reacted to the global risk aversion, and between 11 May and the middle of June it depreciated from R6,10 to the US dollar to around R6.80. Subsequently, concerns relating to the widening current account deficit on the balance of payments in excess of 6 per cent of GDP caused the exchange rate to depreciate further. At one stage the exchange rate had depreciated to around R7,90 to the US dollar in early October, but more recently it has been trading at levels of around R7,20. In part the depreciation of the rand during 2006 should be seen as an element of the adjustment to the then widening current account deficit. Already the trade account has improved in the third quarter of this year, and a stable rand at current levels will help stabilise the inflation outlook. In addition, the exchange rate adjustments are expected to be positive for export growth, and in conjunction with the adjustment of interest rates should help to ensure that domestic growth is driven by exports and infrastructural investment, rather than by strong consumer spending as has been the case in the past two years. International investor interest in South Africa has nevertheless remained strong. Despite the repricing of emerging-market assets in the middle of 2006, there has not been one month during the year to date in which non-residents had not been net purchasers of South African bonds and equities. In the year to date, the net amount of bonds and equities purchased by non-residents totals a record of more than R100 billion, compared R41 billion in the whole of last year. Consequently, the current account deficit continued to be adequately financed. Although we are hesitant to become too confident too soon, it also appears as if portfolio investments may be becoming a more stable source of financing, as emerging market assets become a more integrated part of global investment mandates, in particular those like South Africa which have investment grade ratings. In 2004 and 2005 the South African economy grew at robust rates of 4.8 and 5.1 per cent respectively. This is in sharp contrast to the 3 per cent average annual growth experienced between 1994 and 2003. In the first two quarters of this year, the economy grew at revised annualised rates in excess of 5 per cent. Although the third quarter growth slowed to 4.7 per cent, this is still a very encouraging picture. According to the National Treasury projections, a growth rate of 4.4 per cent is forecast for next year, rising to 5.3 per cent by 2009. Growth is likely to be underpinned by higher infrastructure expenditure. The impact of this can already be seen in the strongly rising investment ratio. These higher growth rates have also had a positive impact on employment growth. According to the latest Labour Force Survey, approximately 1.2 million jobs were created over the 3-year period to March 2006. This is good news indeed. This positive growth outlook suggests that with an appropriate policy environment, the aims of the Accelerated and Shared Growth Initiative for South Africa (ASGISA) can be achieved, that is, to maintain GDP growth at around 4.5 per cent until 2009 and 6 per cent thereafter. Fiscal policy has remained prudent, to the extent that for the first time ever, provision has been made for a budget surplus in the coming fiscal year. Monetary policy will continue to play its role by providing a low inflation environment. 4. G-20 developments I would like to turn briefly to our role in the G-20 which South Africa will chair in 2007. The G-20 was established in 1999 as a forum where central bank Governors and Ministers of Finance of developed and systemically important emerging and developing economies deliberate on issues relating to global economic and financial stability in support of global growth and development. The Bank and the National Treasury are currently making the necessary preparations for hosting and arranging meetings and seminars of the G-20 next year and three themes for the 2007 work programme have been identified. The first theme relates to the reform of the Bretton Woods Institutions. As I have said in the past, these institutions need to be thoroughly examined and overhauled since their modus operandi no longer serves their diverse membership in today’s dynamic global environment. The second theme of fiscal elements of growth and development, or fiscal space, is envisaged to obtain the perspectives of G-20 member countries on how to create and use this fiscal space in support of economic and social objectives. Finally, the third theme will analyse the effects of commodity price changes on G-20 members from a financial stability perspective. 5. Conclusion As I noted earlier, 2006 has been a challenging year. Going forward, I would venture to guess that 2007 will be no easier. The South African economy should continue on its positive growth path, and the Bank will maintain its focus on keeping inflation under control. We remain committed to our role of providing a stable macro-economic environment which would mitigate the effects of negative international developments if they were to occur. Should you wish to have a further discussion on South African economic issues tonight, I urge you to engage our senior staff members that have been allocated to all the tables. Finally, please enjoy the rest of the evening, and may you have in the period ahead a wonderful festive season and a prosperous New Year. Thank you.
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Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the official launching of the Skills Corporate Centre, Mbabane, Swaziland, 28 February 2007.
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X P Guma: Formation of a Monetary Union – perspective on the Swaziland economy Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the official launching of the Skills Corporate Centre, Mbabane, Swaziland, 28 February 2007. * 1. * * Introduction Your Excellency, Honourable Prime Minister of the Kingdom of Swaziland; Mr A.T. Dlamini: Honourable Minister, L.E. Dlamini M.P. – Minister of Enterprise and Employment and other Ministers here present, Master and Mistress of Ceremonies, fellow speakers, distinguished guests, ladies and gentlemen: it is indeed a rare honour to me to be able to address you this evening on this auspicious occasion. It is also a distinct pleasure to be able to do this at the invitation of Ms Sibongile Mdluli, Deputy Governor of the Central Bank of Swaziland, to whom I extend my congratulations for having been selected as Business Woman of the Year 2006. Congratulations Madam! The Corporate Skills Centre, whose objective, I have been informed, is to build capacity of young professionals on cross-cutting short-term courses to meet the skills gaps which have been identified in the constantly evolving business environment, is a laudable initiative; and I am particularly honoured to be able to offer my support at its inception. With continued support from tonight’s main sponsor and the REDI, success is almost assured. 2. Formation of a Monetary Union I have been asked to speak about the formation of “Monetary Union, Perspective on the Swaziland Economy”: – a matter which I addressed in 1992 in a paper which was presented under the title “Questions regarding Monetary Management: aspects of recorded experience in a quasi-optimal currency area” 1 . In that paper, I argued thus: … Having shed the status of being a protectorate of Great Britain upon obtaining independence in 1968, Swaziland could have refashioned its orientation in a number of ways; including at one extreme complete isolation (pure self reliance) or, at the other extreme, incorporation into a larger unit and management by some authority other than Britain. The nature of the problem, I argued … is to find that institutional framework within which to maximise national, social welfare… subject to the constraints which are imposed by the decisions which all other countries have made: for it is these decisions which define the universe within which choice must be exercised. I also asserted that, … for a small, emergent economy with limited bargaining power, the option of refashioning the global economy in order to maximize national welfare does not exist, whereas such an option does exists for the large, mature economies which created the Bretton Woods institutions and the post-war economic order. Although this was stated in the previous century, I believe it to be true still. In the event, the authorities have made choices: most importantly, in this regard, by participating actively in the institutions of the African Union and the Southern African Development Community, the essence of whose programmes are described below. See X. Guma (1992) “Questions regarding Monetary Management: aspects of recorded experience in a quasi-optimal currency area”, Harare, Zimbabwe : Southern African Foundation for Economic Research 3. Monetary Union in Africa Article 44 of the Abuja Treaty calls for the harmonisation of economic policies across the African continent and emphasises two important pillars of economic integration: the promotion of intra-Africa trade and the enhancement of monetary cooperation. The latter is guided by the African Monetary Cooperation Programme (AMCP) which seeks to operationalise the monetary cooperation mandate of the Abuja Treaty and the Constitutive Act of the African Union. In the main, this involves a single monetary area, encompassing a common currency and a common central bank by the year 2021. In terms of the AMCP monetary union in Africa is to be achieved in six stages starting in 2002/2003 and culminating in stage VI in 2021 with the introduction and circulation of the common African currency. During these six stages, African governments and central banks will have to work towards harmonisation and coordination of macroeconomic and monetary policies, the harmonising of interconnected payment and clearing systems, the strengthening and harmonisation of banking and financial supervision and the observance of increasingly strict macroeconomic convergence criteria. 3.1 The African Monetary Cooperation Programme (AMCP) Stated in point form, the stages of the programme are as follows: Stage I (Year 2002-2003) - Establishment of Sub-regional Committees of the AACB where they do not exist and revitalisation of existing Committees. - Adoption by each Sub-region of formal monetary integration programme. Stage II (Year 2004-2009) - Harmonisation and co-ordination of macroeconomic and monetary policies. - Harmonisation of Concepts and Methodologies including statistical frameworks. - Gradual liberalization of the capital account. - Gradual interconnection of payments and clearing system. - Fostering the development of Banking and Financial Systems, including promotion of African banking networks. - Promotion of sub-regional and regional stock exchanges. - Strengthening and harmonisation of banking and financial supervision and regulation. - Observance of the following macroeconomic indicators by year 2008: • Budget deficit/GDP ratio not exceeding 5 per cent. • Central Bank credit to government not exceeding 10 per cent of previous year's tax revenue. • Single digit Inflation rate. • External reserves/import cover of at least 3 months. • Reduction of Current Account Deficits (excluding grant) as percent of GDP to sustainable level. • Pursuit of Debt reduction initiatives on Public debt as percent of GDP to sustainable level. • Achieving and maintaining High and Sustainable rate of Growth of real GDP. Stage III (Year 2009-2014) Assessment of macroeconomic performance and negotiation for the establishment of a common Central Bank (Year 2015). At this stage, countries would be required to consolidate achievements made at the third stage. The activities under this stage would include: - Continued observance of macroeconomic indicators of convergence including: • Inflation rate of less than 5 per cent. • Overall Budget deficit/GDP ratio (excluding grants) of less than 3 per cent. • Elimination of Central Bank financing of Budget deficits. • External reserves of equal to or more than 6 months of imports of goods and services. • Reduction of Current Account Deficits (excluding grant) as Percent of GDP to sustainable level. • Pursuit of Debt reduction initiatives on Public debt as percent of GDP to sustainable level. • Achieving and maintaining High and Sustainable rate of Growth of real GDP. - Assessing the macroeconomic indicators of each country/sub-region against the convergence criteria. A comparative analysis would be made thereafter to the Convergence Council. - Commissioning of a study on the establishment of an African Exchange Rate Mechanism (2010). - Review of commissioned study on the African Exchange Rate Mechanism (2011). - Observance of the following macroeconomic indicators by year 2012: • Budget deficit / GDP ratio not exceeding 5 per cent by 2012. • Elimination of Central Bank credit to government. • External reserves / imports cover of equal or greater than 6 months. - Finalisation of arrangements required for the launching of the African Monetary Union. - This is the completion stage before the take off of the common Central Bank. The following activities are expected to be undertaken: • Preparation of institutional, administrative and legal framework for setting up the common Central Bank and currency of the African Monetary Union. This includes a) Achieving and maintaining good governance and b) Achieving central bank autonomy, particularly with regard to instrument, personnel and financial independence. • Adoption of the institutional, administrative and legal framework for the setting up of the common Central Bank and currency of the African Monetary Union. • Operationalisation of Exchange Rate Mechanism. • Appointment of key officers of the Common Central Bank. • Preparation for the introduction of a common currency. • Recruitment of staff of the Bank. • Mid-term assessment of country performance. • Final assessment of countries' performance against convergence criteria. Stage IV (Year 2015-2021) - Launching of the African Central Bank (ACB). - Introduction and circulation of the common African currency (2015). A transitional period during which sub-regional currencies would operate alongside the African currency is envisaged. As the programme has progressed, so adjustments have been made, and the current statement of the programme envisages completion by 2015: not 2021 as in the original thinking. 3.2 The SADC region Within the SADC region, the movement towards monetary integration and eventual union is guided by the Committee of Central Bank Governors (CCBG) which has pledged support for the AMCP. The CCBG was established in 1995 with the specific purpose of achieving closer cooperation and integration in the area of monetary policy among SADC central banks. The work of the CCBG has contributed to major developments towards regional monetary cooperation such as significant progress in the harmonisation of the payment and clearing systems, the approval of Memoranda of Understanding on Cooperation, Coordination of Exchange Control Policies in SADC, and Cooperation in the area of Information and Communication Technology. The CCBG has also contributed to the coordination of training for central bank officials in SADC and the creation of a Training and Development Forum. As at April 2005, the integration programme envisaged the establishment of a SADC monetary union by 2016 • Finalise preparation of institutional, administrative and legal framework for setting up a SADC Central Bank by 2016; • Launch a regional currency for the SADC Monetary Union by 2018. 3.3 The Common Monetary Area (CMA) Lastly, the possibility of establishing a central bank for the Common Monetary Area (CMA) countries is raised from time to time: the CMA comprising Lesotho, Namibia, South Africa and Swaziland. A study was conducted in 2005 under the auspices of the CCBG outlining the costs and benefits of the creation of a common central bank for the CMA countries. As is normal, decisions in this regard will be taken by the political leaders of the CMA countries, rather than by central bankers. In short: Programmes intended to achieve monetary union exist at the continental (AU), regional (SADC) and intra-regional levels (CMA): and Swaziland participates in them all. Conclusion The questions which policy makers will have to continue to address are clear. They include the following. Should we continue down this path? Do the programmes have realistic time frames? Are they on target? Fortunately, I don’t have to wrestle with them: and any assessment by me would be not only discourteous but also presumptious. I have sketched the issues in broad outline, and thank you all for your attention.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the National Consumer Forum Conference to celebrate World Consumer Rights Day, Johannesburg, 15 March 2007.
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T T Mboweni: The role of the South African Reserve Bank in the protection of consumers Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the National Consumer Forum Conference to celebrate World Consumer Rights Day, Johannesburg, 15 March 2007. * * * Honoured Guests, Ladies and gentlemen 1. Introduction Thank you for the invitation to address you on the occasion of the celebration of World Consumers Rights Day. As consumers we often forget that we have rights, and it is often said that South African consumers are among the most apathetic when it comes to asserting their rights. Consumers are the reason for the existence of business, and World Consumer Rights Day accordingly deservers our support. The relevance of the theme of this conference; “holding the public and private sectors accountable” is without question. The South African Reserve Bank plays an important role in the South African economy, and our actions impact directly on consumers. It is therefore essential that institutions such as the South African Reserve Bank are fully accountable to consumers for the autonomy they enjoy. In my address to you this afternoon, I will expand on the role of the South African Reserve Bank, particularly with respect to the consumer, and, in line with the theme of the conference, I will highlight our efforts to ensure full accountability. 2. Monetary policy and the consumer The South African Reserve Bank, like central banks in other countries, has a unique position in the economy. The operations of the Bank are governed in terms of the South African Reserve Bank Act, its associated regulations and the Constitution of the Republic of South Africa. The Act and regulations describe the framework and structure of the Bank, the way in which it is managed and the actions it may take. The Constitution prescribes that the objective of the Bank should be the protection of the currency in the interest of sustainable economic growth and development. The Bank interprets this mandate to be the achievement and maintenance of price stability. In February 2000 an inflation targeting framework was adopted in South Africa with the inflation target being set by the Government. The Bank, therefore, in line with most inflation targeting central banks, does not have goal independence. However, in its pursuit of this target, the Bank is guaranteed operational or instrument independence. In other words, we can apply our interest rate policy without interference from government. In terms of our mandate, we have to keep CPIX inflation, (i.e. headline consumer price inflation excluding mortgage interest costs) between 3 to 6 per cent per annum on a continuous basis. In carrying out our mandate, we have a direct impact on the consumer through the impact of monetary policy on inflation and interest rates. The question we are often asked is, why target inflation? Low inflation is in the interest of all South Africans, irrespective of whether they are consumers, business people, or retirees. Inflation, which is a continuous increase in the general price level, implies a continuous decline in the value of money, which implies an erosion of the purchasing power of consumers. The Bank aims to limit such a decline by achieving price stability. However, it is important to note that price stability does not imply that the prices of goods and services do not change at all. Relative prices in a market economy will always change in response to changes in relative scarcities, for example after a drought, food prices are likely to increase. It is also generally the case that those consumers most vulnerable to the ravages of inflation are the poor. The wealthy members of society are in a better position to hedge against inflation for example by borrowing money to buy non-monetary assets. The wealthy often have assets that can more easily be protected against expected inflation. Inflation has other adverse effects such as the distortion of the tax system, and also results in increased uncertainty which makes economic decision-making more difficult. High inflation is usually also accompanied by greater price variability. The confusing price signals make the price system less efficient, and the result is lower levels of investment and growth. We are also often asked why employment or economic growth is not the primary objective of monetary policy. As noted in the Constitution, inflation is not an objective in itself, but is in the interest of sustained growth. It goes without saying that the target of monetary policy should be something that monetary policy can achieve. It is the view of the Bank that although monetary policy can impact on cyclical unemployment and growth, it cannot determine long-run trend real growth. Growth in the long run is determined by real variables and other supply-side factors, including government policies and the general macroeconomic environment that monetary policy contributes to. Monetary policy plays an important role in shaping the macroeconomic environment in which economic agents operate. The best contribution that monetary policy can make is to provide a low and stable inflation environment that is conducive to sustainable long-term growth. The main monetary policy tool at the disposal of the Bank is the interest rate. Essentially the Bank sets the repo rate, which is the rate at which the banks borrow from us, and this in turn affects other interest rates in the economy. It could be seen as somewhat ironical that in order to protect the consumer from inflation, the means to achieve this are likely to impact negatively on consumers through higher interest rates. Unfortunately, on the part of the Bank there is no way to avoid this. At times, the increase in interest rates to keep inflationary pressures in check has drawn some criticism particularly by borrowers who were not expecting such increases. I should note however, that depositors or savers are happy when interest rates increase. Perhaps more publicity is given to the plight of those who are negatively affected by interest rate changes. It should be emphasised that the Bank acts in the interest of all consumers, irrespective of whether they are borrowers or depositors, by setting interest rates at an appropriate level to ensure that the inflation target is achieved. Low inflation allows for generally lower nominal interest rates. Furthermore, as the Bank builds up credibility for its inflation-fighting policies, interest rate cycles are likely to have a lower amplitude. Hopefully the strong interest rate cycles we have seen in the 1980s and 1990s are a thing of the past. By achieving sustained low inflation, we believe that interest rate adjustments can be more moderate and more certainty will result for both consumers and producers. Ultimately we would like to achieve a virtuous circle of low inflation, moderate interest rate cycles and high and sustained economic growth. At times it is possible that the actions of consumers could threaten the inflation target, and it our responsibility to take appropriate action. In the past three years we have seen household consumption expenditure increasing to extremely high levels. Credit extension by banks has been rising at very high rates, and household indebtedness has also increased to record highs. Some of this can be explained by a number of positive developments in the economy apart from lower interest rates. These include stronger household balance sheets, higher real incomes and increased employment. Our monetary policy actions in the second half of last year were in part an attempt to dampen the inflationary potential of this higher consumption expenditure. There are other dangers emanating from excessive borrowing, particularly when interest rates start to rise and consumers find themselves overcommitted. In accepting credit, consumers should understand their rights and not fall prey to aggressive marketing of credit. For this reason we are gratified that the banks have adopted a code of good conduct in the marketing of credit. The National Credit Act, to be implemented in the middle of this year will provide further protection to consumers. There are however always two sides to every transaction, and consumers should also act responsibly when taking on further debt. 3. Accountability of the Bank As noted earlier, our operational mandate is to keep CPIX inflation between 3 to 6 per cent and the Bank has autonomy in the conduct of monetary policy. It is well recognised that autonomy goes hand in hand with accountability. Thus, one of the primary measures of accountability relates to how the bank has performed in relation to its operational mandate. Monetary policy has been successful in achieving the inflation target since September 2003 when CPIX moved to within the target range. This allowed for a reduction in the repo rate by 650 basis points between June 2003 and April 2005. In 2006, in response to perceived risks to the inflation outlook, the Monetary Policy Committee increased the repo rate by 50 basis points at four consecutive meetings from June. Despite this adjustment, economic growth has remained strong and we expect growth rates of around 5 per cent to be sustained. Although monetary policy cannot claim all the credit, its contribution to the economy’s robust growth performance over the last couple of years is well recognised in many circles. Our accountability extends beyond simply achieving the inflation target. Since the announcement of an inflation target in South Africa, any ambiguity about the ultimate goal of monetary policy has been removed. The smooth conduct of an inflation targeting framework implies a great deal of trust and confidence on the part of the public in a central bank’s ability and determination to achieve the target. Without this credibility in the eyes of the public, a central bank’s policy goal is not easily achievable. Since the introduction of an inflation targeting policy framework, the Bank has introduced a number of initiatives to improve transparency and communication with all its stakeholders to enhance the credibility of monetary policy. In fact, communication plays an important role in fulfilling the Bank’s obligation of accountability. For example, decisions of the Monetary Policy Committee (MPC) are announced after each meeting at a televised media conference, where the motivation for the decision is explained. Media representatives also have an opportunity to question the monetary policy decision and the policy stance. The publication of a bi-annual Monetary Policy Review also broadens the understanding of the aims and conduct of monetary policy. The Review analyses developments in and factors influencing inflation, assesses recent policy developments and considers the outlook for inflation. In conjunction with statements after MPC meetings, this publication sheds more light on monetary policy deliberations. Monetary policy and broader economic issues are discussed with stakeholders at Monetary Policy Forums, hosted bi-annually in Bloemfontein, Cape Town, Durban, East London, Gauteng, Kimberley, Mafikeng, Polokwane, Port Elizabeth and Nelspruit. These Forums provide for discussions on monetary policy over a broad geographical spectrum and involve a large cross-section of stakeholders, including trade union representatives, analysts, academics, the media and the general public. The Bank is ultimately accountable to Parliament as the representative body of all the people in South Africa, and an annual report is submitted to Parliament. I also meet periodically with members of the Parliamentary Portfolio Committee on Finance. After the publication of the Bank’s Quarterly Bulletin, a presentation is made to the Committee highlighting the contents of the Bulletin, and I answer questions put by the Committee. In addition to our accountability to Parliament, we also report to our shareholders. The Bank has had shareholders since its inception in 1921, but the legislation is drafted in such a way that no single shareholder can exercise any undue influence over the activities of the Bank. The structure of shareholders adds an additional degree of accountability, in as much as the Bank publishes an Annual Report that is tabled, discussed and approved at the Annual General Meeting of shareholders. The Bank publishes an abridged version of the annual Governor’s Address to shareholders at the Annual General Meeting in six official languages of South Africa in a variety of newspapers and magazines. This ensures that the Address is accessible to all stakeholders in the Bank. The importance of communication within an inflation targeting framework is without question. Communication is a critical part of monetary policy since it can lead to more effective policy by influencing expectations. The challenge for the Bank is to ensure maximum efficiency and consistency of its communication. As I have outlined, it is clear that the communications strategy of the Bank is directed at a broad spectrum of individuals and institutions. From time to time our actions may be misinterpreted or misunderstood but we shall nevertheless endeavour to undertake whatever communication is necessary to ensure that the trust of the general public in the Bank is maintained. 4. Conclusion The Constitution does not deal specifically with the rights of consumers, but deals with the rights of consumers to meet their basic needs which include adequate food, clothing, drinking water, electricity, education, health care and shelter. The National Consumer Forum identifies some important rights of the consumer that supports their endeavours to achieve their basic needs. These range from educational rights to ensure informed decision making on the part of consumers to the rights of individuals to raise views on matters of concern to consumers. The choice of a variety of quality goods and services at competitive prices has also been identified by National Consumer Forum as one of the fundamental rights of consumers. The mandate of the Bank of maintaining price stability, that is keeping inflation at low levels, goes a long way toward ensuring competitive pricing practices in the South African economy. I thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Corporatesport Directors' Dinner, Johannesburg, 20 March 2007.
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T T Mboweni: The benefits of being a good host – the FIFA World Cup and the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Corporatesport Directors’ Dinner, Johannesburg, 20 March 2007. * * * Honoured guests Ladies and Gentlemen: 1. Introduction It is not often that I land up sharing the podium with someone like Mr Jake White, coach of our national rugby team. After all, what does a sports coach and a central bank Governor have in common? This is probably a question that some of you are currently pondering over. Perhaps, one common aspect centres around the target that both of us have. For Mr White it is to win matches and tournaments, while in my case it is to ensure that inflation remains within the target range. There is a subtle difference however. As long as Mr White meets his target, then everyone is happy (apart from the opposition). Meeting the inflation target does not necessarily keep all South Africans happy – this is particularly evident when we have to increase interest rates in order to keep inflationary pressures in check. Consumers, and usually the highly indebted ones, always complain when there are increases in interest rates while pensioners argue that it is a case of too little too late. So the issue of whose job is easier is still very much an open question. However, I am definitely not going to get involved in a scrum or a lineout with Jake in order to answer this question. I have no intention of giving away a penalty, being sin-binned or being cited afterwards. Whatever the case, I do not think that we should swap roles. I don’t know how Mr White would do as a central banker, but I am certain that the national team is better off not having me as their coach. I feel on safer ground sharing a platform with Mr Tim Modise. Both of our jobs involve communication, and he communicates on behalf of a sport that I passionately follow. I am an ardent Kaizer Chiefs supporter, but regrettably we will have to wait till next year for renewed league glory. I am pleased at least that if it is not my team that is leading the pack, it is a team from Tshwane where the Bank is based. I will leave rugby to Mr White, and let me rather use this occasion to highlight some of the economic benefits for South Africa of hosting major international events, in particular sporting events such as the FIFA World Cup. 2. Hosting of mega events The wave of globalisation that has swept across the world for more than two decades has had an impact on communities beyond the economic and financial spheres. It has also impacted on the way in which global communities interact in areas such as education and sport. As the world becomes increasingly integrated, more opportunities have emerged for countries to host and organise what today have become known as mega events. Since 1994, South Africa has become an important venue for hosting such events. Hosting major sporting, cultural and economic events is of significance for many countries since it can provide an important catalyst for growth and development. As a result of this potential, professionals from various disciplines such as marketing, finance, economics and tourism have shown increased interest in understanding the dynamics of hosting mega events. Today, universities in the United States of America, the United Kingdom and Australia offer courses on various aspects of sport education, including sport marketing and sport tourism. This trend is also becoming evident in South African tertiary education and is likely to intensify in the future. South Africa has had its fair share of hosting major sporting events since 1994 such as the African Cup of Nations in 1994, the Rugby World Cup in 1995, and the Cricket World Cup in 2003. In addition, South Africa has also hosted major conferences which have attracted global interest. The most important of these have inter alia included the United Nations Conference on Sustainable Growth in 2002 which attracted more than 60 000 delegates, as well as the United Nations Conference on Racism in 2001, to mention but a few. Major conference and convention centres have been built in most of our major cities and most of them have had a high degree of utilisation. This year, the South African Reserve Bank in collaboration with the South African National Treasury will be hosting the G-20 meeting of Ministers of Finance and Central Bank Governors. Preparations for this meeting will be ongoing for most of the year. Preparatory meetings are held both in South Africa and other member countries. These events will attract high level officials to South Africa from the world’s most important economies. Three major meetings will be held in South Africa during the course of this year. Apart from successfully hosting these events, South Africa has also bid to host the two most important global sporting spectaculars, namely the 2006 FIFA World Cup finals and Cape Town’s bid to host the 2004 Olympic Games. South Africa narrowly failed to win these bids, but fortunately our second attempt to host the FIFA World Cup finals was successful and as you all know, we will be hosting the event in 2010. 3. The economic implications of hosting mega events There has been growing interest in the economic consequences of hosting mega events. The economic advantages of hosting such events do not automatically outweigh the costs. In an environment of scarce resources, the opportunity costs of hosting mega events always attract close scrutiny. Governments are generally required to commit considerable resources to hosting these events; resources that could have been used elsewhere in the economy. In some instances, this may involve an acceleration of spending, an additional allocation or a diversion of expenditure from other uses or regions. For example, a successful bid for the 2004 Olympic Games could have seen resources being diverted from other areas of the country to Cape Town, whereas the World Cup games should see a wider distribution of benefits. A further problem relates to correctly estimating the costs. For example, it was reported last Thursday that the expected cost of the London Olympic Games in 2012 is already more than four times higher than estimated at the time of the successful bid. Finally, these costs have to be weighed up against the expected revenue and other positive spin-offs, which are also difficult to quantify. In many instances, the revenue stream remains long after the event is held, but so does the financing of the costs. Numerous studies have been commissioned in various countries to determine the economic and financial implications of hosting mega events See Bohlmann H R: Predicting the Economic Impact of the 2010 FIFA World Cup on South Africa. May, 2005. University of Pretoria. Working paper 2006-11, for a review of these studies. The Montreal Olympic Games in 1976 are considered by many to have been an economic and financial failure. Hosting the Olympics in Montreal plunged the city into a huge debt burden which was only repaid in full in recent years. Similarly, studies have shown that the benefits to Korea from hosting the FIFA World Cup finals in 2002 fell far short of initial expectations. The country was left with an over-supply of large stadiums, some of which have subsequently been demolished. Notwithstanding these negative outcomes, most countries reap a positive net benefit from hosting these events. The broad conclusion is that proper planning for mega events tends to generate positive spin-offs both in the short and long run. A study conducted by the Los Angeles Sports and Entertainment Commission following the 1984 Los Angeles Olympic Games estimated that income from tourism increased by almost US$9 billion as a result of hosting the games. The study concluded that hosting major events could be beneficial to cities if carefully planned. The Barcelona Olympic Games of 1988 are today considered a model of how to plan for a mega event. The Barcelona Games were integrated into an urban renewal strategy and the economic outcome of Barcelona hosting the Olympic Games was significant. Unemployment in Barcelona was reduced significantly from 18.4 per cent to 9.6 per cent between 1986 and 1992 and from 20.9 per cent to 15.5 per cent in the country as a whole. Overall growth in Barcelona is said to have increased at a pace never seen before, even a decade after hosting the Games. Similarly, the Sydney Olympic Games which took place in 2000 were planned in such a way as to generate positive spin-offs well beyond the actual event. In the case of Sydney, city planners focused on infrastructural development of the venues for the games such that these venues could be used for subsequent sporting events. It has been claimed that the Sydney Olympic Games were beyond a sporting triumph. As we are all aware, South Africa has won the 2010 FIFA World Cup finals bid and preparations to host this event are in progress. There is considerable reputational risk associated with the hosting of the 2010 World Cup finals, and the success of the World Cup finals in Germany puts even more pressure on us to raise the bar. We stand to benefit from the experience and advice of countries that have successfully hosted similar events. As I noted earlier, we have already hosted numerous events, although none perhaps on the scale of the FIFA World Cup finals. Research has shown that South Africa also stands to benefit from hosting the 2010 FIFA World Cup finals. According to a Grant Thornton study conducted in 2003, the event is expected to contribute about R21 billion for the economy as a whole, generate about R7 billion in tax revenue and create about 150 000 jobs. It is not possible to fully and accurately estimate the potential gains to the economy from hosting the World Cup finals ex-ante. However, there is little doubt that with proper planning and interventions by all the relevant stakeholders the potential benefits can be maximised. The spin-offs in terms of tourism, communications and television technology, transport infrastructure to name but a few are significant. Tourism has become an increasingly important source of revenue to the economy and now accounts for about 10 per cent of total export receipts, almost double that of 10 years ago. This number is expected to increase further as a result of the World Cup finals. 4. Growth and investment in South Africa Preparations for the World Cup come at a time when the economy has been experiencing strong economic growth. The persistent adherence to prudent macroeconomic policies by the authorities has resulted in the country’s solid economic performance in recent years. South Africa has experienced the longest upswing in its business cycle lasting almost 7.5 years to date. The average growth rate between 1994 and 2003 measured around 3 per cent, but in the last 3 years, growth has averaged 5 per cent. In the fourth quarter of 2006, annualised growth measured 5,6 per cent. The growth has been spread across all sectors of the economy with the exception of agriculture. Underpinning this strong growth has been a positive trend in investment growth. It is of interest to note that gross fixed capital formation as a ratio to GDP was around 12 per cent at the beginning of the decade. It is now around 19 per cent. This is a significant shift in the economy which we should not lose sight of, and a trend that is likely to continue in the light of the Government’s Asgisa growth strategy. Central to this strategy is a strong focus on infrastructural investment. As indicated in the latest Budget Review, government and public enterprise infrastructure expenditure over the next 3 years is estimated to amount to R416 billion. This investment should not only raise current growth, but will also allow for sustained future growth over the medium to long term through improved transport, communication and electricity provision. These improvements are expected to ease bottlenecks to current and future growth and exports. This is particularly the case when it comes to investment in transport infrastructure, whether rail, air, road or the ports. Government has made special budgetary allocations totaling R8,4 billion for the building of stadiums. This is in addition to what municipalities have committed. Furthermore, over R9 billion will be allocated by national government for municipal transport, roads and precinct upgrades relating to the Word Cup games. Apart from these budget provisions, the investment requirements for the event dovetail well with the planned infrastructural investment over the next few years. The 2010 World Cup finals will help to maintain the focus on infrastructural and investment expenditure projects such as the Gautrain, new stadiums and communications technology, to name a few. Much needed airport expansions are also taking place in anticipation of an influx of tourists for this event. As noted in the latest Budget speech by the Minister of Finance, the impetus provided by the World Cup has resulted in a revolution in municipal planning for public transport and forward thinking about urban development. 5. The World Cup and monetary policy Where does monetary policy fit in to all of this? Of course, when the World Cup finals begin in 2010 we will be keen spectators and supporters of Bafana Bafana, but there is not much we can do to directly impact on the fortunes of the team. I will leave that in the capable hands of Mr Carlos Parreira and his team. We have to keep our eyes on a different ball and a different goal. Through this exciting growth phase that we are experiencing, monetary policy has to ensure that inflation is kept under control. In other words we have to ensure that we maintain inflation within the 3-6 per cent target for CPIX. Excessively high growth brings with it potential inflationary pressures which monetary policy has to be sensitive to. In economic parlance, this refers to the output gap, which is the difference between the potential non-inflationary output of the economy and actual output. From a monetary policy perspective, we have to determine whether the growth we are experiencing is purely cyclical. If this is the case, we are likely to experience inflationary pressures which would require a reaction on our part. However if the current growth trend is structural, that is, if it reflects an increase in the potential output of the economy then these developments are not necessarily inflationary and are sustainable. Unfortunately, estimating potential output is not a simple task and estimates are subject to a high degree of uncertainty. Our view is that in the light of the enormous structural changes and productivity growth in the economy, much of the higher growth we have experienced in recent years is of a structural nature. Current research in the Bank estimates that the potential output of the economy is now at least around 4,5 per cent or more. This can be compared to estimates of around 3 per cent or less during the 1990s. We appear to be well on the way to achieving the 6 per cent sustainable growth that Asgisa is targeting, and the spin-offs from events such as the FIFA games will go a long way towards ensuring that this is a sustainable story. At the same time, monetary policy will have to remain vigilant to ensure that growth occurs in a stable macroeconomic environment of price stability. 6. Growth and the current account of the balance of payments One of the consequences of high growth and investment has been an expanding deficit on the current account of the balance of payments. In recent months, international financial markets have viewed current account deficit countries as being more vulnerable to capital movements and consequently to exchange rate adjustments. Current account deficits in excess of 6 per cent of GDP have appeared in South Africa during the course of last year and caused quite a bit of excitement in the analyst community. In the fourth quarter of last year we experienced a significant widening in the current account deficit, with the deficit on the trade account of the balance of payments having more than doubled from the third to the fourth quarter of 2006. As we noted in the last MPC statement, much of the import momentum in the fourth quarter, however, can be ascribed to the 140 per cent increase in the volume of oil imports compared to the third quarter. It is important to highlight that the related inventory buildup appears to be exceptional and it is unlikely that oil imports will be sustained at these levels. In fact, had there been the normal import volumes of oil during the final quarter of last year, the deficit-to-GDP ratio for that quarter would have been comfortably less than 6 per cent of GDP. South Africa has been able to finance the current account deficit with relative ease precisely because of the positive growth prospects in South Africa. It also needs to be pointed out that the current account deficit also represents the other side of the coin of robust capital expenditure and the growth the country has been experiencing. A substantial part of increased imports have been capital goods and intermediate goods, which will contribute to the increase in the productive capacity of the economy and increased exports going forward. The MPC will continue to monitor the developments around the current account deficit and the potential risk to the inflation outlook stemming from possible currency depreciation. It is, however, important for the market to analyse the drivers of the current account deficit, understand the underlying trends and qualitative dimensions rather than to concentrate on what the mere figure as a percentage of GDP is and possibly draw inappropriate conclusions. 7. Conclusion There is a big difference between winning the bid for the World Cup finals, and adequately preparing for this event. While we cannot afford to be complacent, I am convinced that South Africa has what it takes to successfully host this event and to reap positive benefits for the economy as a whole. We should embrace the opportunities of hosting mega events as part of the process of creating more opportunities for all of our citizens. The World Cup finals attract a huge global audience, apart from the actual visitors, and such exposure can only be positive for the country. Finally, we have a busy sporting year ahead of us, with the current cricket world cup games on the go, and the rugby World Cup finals just around the corner. In monetary policy decision making, we rely somewhat on our forecasts for inflation. My current central forecast is that both the cricket and rugby teams are going to do well this year. As with any forecast, we have to assess the risks to the forecast. In both cases I would venture to say that the risks are firmly on the positive side, and that there is a good probability that we will be showing off two lots of silverware by the end of this year. Allow me to wish Mr White and the Springboks all the best in their endeavours in the rugby World Cup finals in France. We are fully behind you and believe that you have what it takes to bring the cup home. You dare not disappoint the people of South Africa. I thank you.
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Graduation address by Dr X P Guma, Deputy Governor of the South African Reserve Bank and Chairperson of Council, at the Cranefield College of Project and Programme Management, Pretoria, 23 March 2007.
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X P Guma: Higher education in South Africa Graduation address by Dr X P Guma, Deputy Governor of the South African Reserve Bank and Chairperson of Council, at the Cranefield College of Project and Programme Management, Pretoria, 23 March 2007. * * * 1. Introduction • Principal of Cranefield College, Prof P. Steyn; • Distinguished colleagues, members of the Governing Council of Cranefield College; • Graduands; • Parents and relatives of the graduands; • Ladies and gentlemen, It is my pleasure to welcome you to this our 14th graduation Ceremony: the first for 2007. This is worthy of mention if only because 2007 will be the year during which the higher education sector will first admit those school-leavers who have spent their entire school careers in a free and democratic South Africa. Were we to use the American expression “Commencement” rather than graduation – with which many are more familiar – likely, we would note, immediately that the composition of the body of persons entering the higher education sector will be expected now better to reflect the demographics of our society – a path on which Cranefield College commenced from its inception: and which is evident in the evolving composition of its Council and its student’ enrolment. 2. A perspective Before addressing the graduands, it may be appropriate for me to note a few pertinent issues. First, as Vice-Chancellor B. Pityana of UNISA has noted, … In any society, …prosperity presupposes a well-equipped and trained source of human capital, capable of facilitating the required development, and there can be no doubt that in that sense, higher education is a national resource. In South Africa, moreover, … there is now an urgent need for higher education institutions to respond in a more targeted fashion to national growth and development needs. We at Cranefield anticipated this requirement early on, constituting ourselves as a targeted “College of Project and Programme Management”. Second, it does appear to be a justifiable concern, here and abroad that in general, we may be breeding a culture of mediocrity, where excellence and aspiration are no longer “cool” or fashionable: where too many of our young people love the high life but do not wish to work to attain it. What is more worrying still is the fact that many of the young people who emerge from the school system, seem to be the worse for it. As an exasperated Professor Jansen has stated: – … while some schools celebrate “a 100% pass in matric”, their graduates run around Pretoria East, beating up homeless and anonymous black citizens. Young people, who should be in school, run rampant through our society killing and maiming at random. … B. Pityana (2007) “Increasing the Business Viability & Employment Growth in the Country – A Higher Education Perspective”; Keynote address, Skills Development Summit, Sandton, Johannesburg. ibid. Growing numbers of school-age children begin to overpopulate the prison system…. And yet it must be stressed, as Prof Jansen does, that it is not true that all young people suffer from these pathologies. We would point to the enormous drive towards aspiration and achievement of today’s graduands, in counterpoise. Viewed from an historical perspective, it is interesting to recall the views of John Maynard Keynes – one of the towering economists of the twentieth century – regarding “the triple evils of modern society”. The first evil, in Keynes’ view – which has resonance in South Africa today – is the “vast enrichment of individuals out of proportion to any services rendered”. He saw the second and third evils as being “the disappointment of expectations and difficulty of laying plans ahead”; and third “unemployment”. Re-stated in the elegant prose of Mervyn King, “Fat cats, short-termism, and the jobless society”, this in the United Kingdom, in 1923! 4 We at Cranefield earn, honestly, that which is attributed to us; acknowledge the existence of and manage the short and the long-term; and attempt to make our modest contribution to the improvement of the conditions of our modern society through thorough training. Not here mediocrity: rather, the pursuit of excellence. 3. To o the graduands For today’s graduands, this ceremony is the culmination of systematic application to structured learning. Each one of you, no doubt, has had high moments and has suffered, at least occasionally, despair: – moments of absolute clarity and commitment to what you are doing interspersed, perhaps, with moments of confusion. Each of you has a story of personal achievement to tell: and tell it you must. Your achievement is commendable. You graduate from a credible institution and your qualification is recognised here at home and internationally. South Africa has many things for which it could be grateful: today, one of the most important of these is your achievement. Use it wisely: even to confront the evils of modern society. As the Greek poet Constantine Cavafy wrote, in his poem Ithaka; which treats of the ancient evils of the Laistrygonians and Cyclops, angry Poseidon too: – … don’t be afraid of them: you’ll never find things like that on your way as long as you keep your thoughts raised high, as long as a rare excitement stirs your spirit and your body. 4. Conclusion One clown is alleged one day to have said to another: “Considering the cost of tuition, clothing and books, a person today, more than ever, has to be careful, very careful in his/her selection of parents!”. Viewed from the perspective of parents, however, isn’t it true that you age by about 20 years per child – between his/her 18th and 22nd year? Or was I unlucky? To all, the mothers, fathers, children and other relatives of our graduands – however well you chose each other, and whatever have been your relative aging processes – we say, Congratulations indeed! Savour this moment. Cherish it, for yesterday is history, tomorrow is a mystery. Today is reality. Jansen, J (2006) “Teaching the Wrong stuff in a Dangerous World”, Teaching Times. See Mervyn King (1998), Speech at the Employment Policy Institute’s Fourth Annual Lecture: 1 December. C.P. Cavafy (1911) in Edmund Keeley and Philip Sherrard (1992) Collected Poems, Princeton University Press.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Mail and Guardian Business Breakfast, Johannesburg, 4 May 2007.
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T T Mboweni: Risks and challenges facing the global economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Mail and Guardian Business Breakfast, Johannesburg, 4 May 2007. * * * Honoured guests Ladies and gentlemen 1. Introduction Thank you for the invitation to address the Mail and Guardian business breakfast this time round. As you are all aware, South Africa is very much part of the global economy. This is particularly, evident on the economic front, where foreign investment and trade flows have increased quite significantly since the advent of democracy. For example, the ratio of exports and imports as a percentage of GDP increased from 42 per cent in 1994 to 63 per cent in 2006. Thus, it goes without saying that South Africa is not insulated from developments in the rest of the world. On the contrary, we are constantly reminded, almost on a daily basis, of our links with the global community of economies, as developments on world financial markets feed through to our domestic markets. In my remarks to you this morning I will look at recent international economic developments and consider the risks and challenges facing the global economy and their implications for the South African economy. 2. Recent global economic developments and prospects The world economy has been expanding at a strong rate over the past few years. According to estimates by the IMF, the world economy grew by 5,4 per cent last year, following the 4,9 per cent recorded in 2005. In fact, the growth rate during the last five years averaged 4,5 per cent making it the highest in more than three decades. There are some important characteristics of the recent growth performance of the global economy. Firstly, it is clearly evident that world growth is now less dependent on the US economy. This is particularly the case when one considers the economic performance of the developing world. The average growth rate for developing and emerging countries as a group increased to around 7 per cent in the last five years from an average of 4,5 per cent in the preceding period. Growth performance in sub-Saharan Africa has also improved. The region recorded growth of 5.7 per cent in 2006, marking the third consecutive year of growth in excess of 5 per cent. Secondly, despite the pickup in economic activity, inflation trends have been fairly subdued across most countries of the world. Part of the explanation for this development rests with the increased levels of globalisation that currently characterise the global economy. There is little doubt that the integration of countries like China and India into the world economy has not only had a positive effect on overall global growth, but has also had a dampening effect on global inflation. Current projections show that macroeconomic developments in general are expected to remain favourable. For example, world growth is expected to moderate somewhat to 4.9 per cent over the next two years and inflation is expected to remain under control with world inflation approximating 3,5 per cent over the next two years. There are some risks and challenges however, accompanying these favourable projections. Let me now briefly turn to some of these issues. 3. Global inflation risks While the risks to world inflation may have moderated somewhat over the last six months, there are indications that renewed inflationary pressures could stem from capacity constraints in many countries as output gaps narrow. Although productivity growth has helped to dampen inflationary trends in many countries, the significant increases in economic activity over the last couple of years have led to production in many countries being close to, and in some cases exceeding the potential output level. The South African economy has grown by 5 per cent in each of the last three years, a level that we consider to be slightly above potential. In addition, capacity utilisation rates in manufacturing have increased to levels of around 87 per cent. Thus, all indications are that domestic capacity constraints have increased recently and when coupled with the narrowing of the output gaps internationally, the impact of these developments on the domestic inflation outlook requires close monitoring. The price of crude oil has increased quite significantly over recent years. The average price of North Sea Brent crude increased from US$38 in 2004 to US$55 in 2005, reaching US$65 for 2006. Increased global demand and the perceived impact of geopolitical influences on global supply have been the dominant factors influencing oil prices. Geopolitical tensions have renewed in early 2007 thus causing a rebound in the price of brent crude oil from around US$58 per barrel in January to around US$68 per barrel in April thus, underscoring the volatile nature of the market. High and volatile oil prices pose a significant risk as is clearly evident from recent inflation outcomes in South Africa. Petrol price changes over the past few months have mainly reflected the volatility in international oil prices and exchange rates. Petrol price developments are currently playing an important role in the less favourable outlook for domestic inflation. Persistently high and rising oil prices could cause higher inflationary expectations to become more entrenched, thus increasing the probability of a further tightening of monetary policy. While recent surveys indicate that inflation expectations remain relatively well anchored at levels consistent with the inflation target band in South Africa, we cannot afford to become complacent, vigilance is required of a central bank at all times. While oil prices have received much of the attention, the prices of other commodities, most notably metals and minerals have been much stronger over the last year. Last year saw a strong upward shift in the prices of both precious metals (gold, and the platinum group) and base metals (all the others, but especially copper, aluminum, iron, zinc, nickel, tin, and refined products such as steel). The price of base metals continued to increase more significantly in 2007 with copper, aluminum and zinc reaching 7, 11 and 3-month highs respectively, while lead and nickel touched new all-time highs in April this year. Commodities are increasingly being seen as a beneficial addition to traditional diversified investment portfolios. This is due to the fact that it has generally been uncorrelated to other asset classes while healthy growth in China and other developing economies, is expected to keep prices strong. In short, it would appear that commodities have become a much more sought after “new” asset class for many portfolio managers. This has led to robust commodity returns, but has also left commodities prey to herding behaviour, making them more volatile and in fact, more correlated with other asset classes. However, commodity price increases are somewhat of a double edged sword for South Africa. On the export side, it contributes to increased exports and economic growth. On the other hand, rising commodity prices could offset the positive terms of trade effect and lead to an increase in import prices and hence domestic inflation. A further threat to the inflation outlook emanates from buoyant housing markets in many countries which have also served to fuel domestic demand. There have been significant increases in consumption expenditures as a result of increased wealth effects emanating from rising house prices. South Africa is no exception. It is true that the low global interest rate environment has had much to do with these developments. However, the current tightening of monetary policy has given rise to concerns that a decline in residential investment could have wider adverse impacts on the rest of the economy. More specifically, problems related to the sub-prime mortgage market in the US have raised concerns about the probable adverse impacts of developments in the housing market on the rest of the US economy and on the rest of the world. While current indications are that these concerns may have dissipated somewhat, policymakers need to remain vigilant given the impact of asset price movements on macroeconomic developments. 4. Global financial market developments Against the background of favourable global economic developments over the past few years, global financial markets have experienced a sustained rally. Global equity markets in particular have performed strongly, with markets in Japan and Europe outperforming those in the United States. Emerging markets also benefited from continued inflows into their financial markets, and spreads continued to tighten while equity prices rose further. The EMBI+ spread has witnessed a steep decline over the past year, having broken below the record low 160 basis points threshold not too long ago. While the spread has spiked in times of increased risk aversion, it has in all the cases moved back to the pre-volatility levels, even surpassing previous lows. The MSCI emerging market equity index rose by almost 30 per cent in 2006 and by approximately 7 per cent thus far in 2007. Emerging market credit ratings have also improved since the end of 2004, marginally to below BB+, while there were 38 sovereign rating upgrades compared to only two downgrades. Despite this positive view of emerging markets, risks remain as markets have been prone to contagion effects and reversals in response to various developments. There has been a fair amount of turbulence in financial markets over the past year, the causes of which have varied. In May 2006, concerns surrounding inflationary pressures in the US economy caused a sell-off in emerging markets. At that time, the market seemed to be of the view that central banks in general were behind the curve when it came to fighting inflation. As a result, expectations of a more aggressive monetary policy tightening by the major central banks removed some of the allure of emerging market assets. It also resulted in an unwinding of the so-called carry trades. This unwinding of so-called carry trades gained momentum again in February and March 2007. This time it occurred against the background of concerns surrounding a possible recession in the US while the Bank of Japan’s interest rate increase in February 2007 also resulted in investors unwinding their short yen positions. The abrupt decline in the Shanghai stock market, following speculation that China may introduce a capital gains tax on shares and expectations of tighter monetary policy in China propelled the sell-off to gain momentum. Fortunately, these periods of increased risk aversion and sell-offs in riskier assets, including emerging markets, have been relatively brief with markets rebounding soon thereafter. This can most likely be ascribed to the fact that many regions, with the exception perhaps of the US, are experiencing much improved and healthy growth environments, driven to a significant degree by China and India. With the prolonged period of healthy global growth, strong capital inflows, substantial increases in foreign exchange reserves and improving terms of trade, emerging markets have witnessed robust expansion with limited inflationary pressures. Emerging markets have exploited the opportunity to expand their share of the global economy and become less dependent on the US. Nevertheless the bouts of volatility indicate the vulnerabilities and risks to which these countries are exposed. 5. Domestic financial market developments On the domestic front, the equity market has exhibited phenomenal performance over the past few years, with the South African All-share Index (Alsi) increasing from around 10 500 at the start of 2002 to over 28 000 in April 2007. Equity prices were mainly driven by rising commodity prices, especially gold, platinum and copper, which resulted in increases in the resources, gold and platinum indices. However, good economic fundamentals including steady interest rates in a low inflation environment and strong economic growth also played a major role in the demand for equities by nonresidents and contributed to broad-based increases in share price indices across all sectors. In comparing South Africa’s equity market with the MSCI emerging market index, the Alsi follows much the same path as the emerging market index. The domestic bond market has also rallied significantly over the past few years, despite the recent increases in the repo rate. Domestic government bonds have been supported by the exchange rate of the rand, low international bond yields, inflation remaining within the target range and a general lack of supply of government bonds in the market. The yield on the R157 bond declined from 12 per cent in 2002 to under 8 per cent in April 2007. South Africa’s foreign currency denominated debt, as measured by the South African EMBI+ subindex narrowed from over 270 basis points in 2002 to its current level of approximately 70 basis points. South Africa’s individual foreign currency denominated bonds, have all witnessed a significant narrowing in spreads from time of issuance. The 10-year global bond, for example, which was issued at a 195 basis points in May 2005, is currently trading at around 80 basis points. The rand has been influenced positively by the substantial inflows into the bond and equity markets, and the significant improvement in South Africa’s foreign exchange reserves position. However, the combination of being one of the most liquid of the emerging market currencies and having a relatively wide deficit on the current account of the balance of payments has meant that the rand remains vulnerable to changes in international developments and sentiment. Nonetheless, demand for rand remained strong as reflected in the strong increase in turnover in the foreign exchange market. The average daily turnover against rand doubled since 2002 from USD6 billion to over USD12 billion. According to the latest BIS Triennial Survey, the rand’s share of total currency distribution in global currency markets increased from 0,5 per cent in 1998 to almost one per cent in 2004. Volatility in the domestic currency market has been on a declining trend since 2001 – implied volatility declined from almost 50 per cent in 2002 to 13 per cent in March 2007. 6. The outlook for global growth and markets So far, financial market corrections have been relatively well contained and brief, even against the background of a slowing US economy. This can most likely be attributed to what appears to have been a rebalancing of global growth and the adoption of appropriate economic policies. With regards to the latter aspect, there is little doubt that monetary policy has been fairly successful in containing inflationary pressures across the globe. Strong growth elsewhere is expected to partly shelter emerging markets from a US slowdown. The effects are likely to be less severe than have been in the past, as the rest of the world has become more resilient to a US slowdown with reduced dependence on the US consumer. However, adverse developments in the US could affect equity markets, particularly investor sentiments towards emerging market assets. A further risk to global markets is that of the unwinding of yen carry trades. As noted earlier, in February 2007 markets reacted adversely to the Bank of Japan’s decision to raise interest rates by 25 basis points. In particular, the high-yielding currencies suffered the most, as investors unwound their long positions in these currencies and reduced their short positions in the yen. However, at this stage, the market is pricing in a modest scenario of interest rate increases. Similarly, in China, with fixed investment and economic growth exceeding expectations, the authorities have signaled their intentions of cooling down the economy. However, there are market concerns that further policy tightening could adversely impact on Chinese and world economic growth. Given the prominent role of China in the world economy today, investor perceptions about Chinese prospects have implications for global markets. Thus, it is becoming evident that Chinese economic policy is no longer about China but the global economy. This was evident during the third week of April 2007 when global markets came under renewed pressure, albeit briefly, following the fourth increase in China’s banking sector cash reserve requirement this year. The People’s Bank of China increased the cash reserves requirement from 10,5 per cent to 11,0 per cent, in addition to three interest rates increases effected over the past year. Of course, global imbalances remain a key challenge. The April 2007 World Economic Outlook published by the IMF projects that imbalances are unlikely to fall much over the short term, and therefore continued large cross-border net capital flows will be needed to finance the current account imbalances at their present levels. A disorderly adjustment of these imbalances could result in a sharp depreciation in the US dollar, thereby impacting negatively on global economic growth. It is not clear whether under these circumstances the rand would find itself moving with the dollar, or in the opposite direction. Much will depend on how world growth and risk perceptions are affected in such a scenario. However, at this stage a disorderly unwinding of these imbalances appears unlikely. 7. Conclusion Currently the world economy is characterised by generally strong growth and low inflation. This favourable scenario has also benefited emerging markets, which are now starting to play a larger and more crucial role in the global economy. Nonetheless, as we have seen on a number of occasions, markets are susceptible to changes in sentiment. Thus far, negative developments stemming from changes in sentiment has generally been brief. However, sustained market moves could lead to a deterioration of growth prospects. Global imbalances and the unwinding of these remain a key concern. The resilience of markets to these imbalances has continued to confound many analysts, with participants still debating how and when these imbalances will correct and the impact thereof on financial markets and the global economy. From a South African perspective, the sustainability of our current positive growth experience is dependent in part on this positive international environment. Sound macroeconomic policies are essential in ensuring the continued attractiveness of South Africa as an investment destination, and monetary policy will continue to play its role in this respect. While exogenous factors are outside the direct influence of domestic monetary policy, their impact through second round effects cannot be ignored. We have to remain alert to the risks inherent in the international environment and retain the flexibility to react appropriately to global and domestic challenges. I thank you. Are there any questions?
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Remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at a High-level workshop on "Developing Bond Markets in Emerging Economies", Frankfurt am Main, 9-10 May 2007.
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X P Guma: The challenges facing the bond market in South Africa Remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at a High-level workshop on “Developing Bond Markets in Emerging Economies”, Frankfurt am Main, 9-10 May 2007. * 1. * * Introduction Honourable Ministers, distinguished guests, fellow participants, ladies and gentlemen, let me begin by thanking the organisers of this workshop for having invited me to participate. It is always beneficial to interact with persons of the calibre present at this The initial invitation was subsequently upgraded to that of “speaking for about 15 minutes to shed some light on the challenge faced in South Africa”; a task to which I will devote the next 14 minutes. Upgrades are not always without some pain! 2. A brief review of the South African experience There exists at present a relatively sophisticated bond market in South Africa, which market has shown significant growth and development since the 1980s when the government issued bonds only on demand: that is, on an open-ended tap basis. At that time, there were no government (or other) benchmark bonds; nor could any refined yield curve be discerned because it did not exist. Issuance and secondary-market trading were dominated by government and quasigovernment issued debt, the major issuers being the National Treasury, the Landbank and public utilities such as Eskom, Telkom and Transnet. The South African Reserve Bank (SARB) served as the principal underwriter. Following an investigation by a Commission of Inquiry chaired by Dr J. Jacobs 1 , the market opted for self-regulation in the form of the Bond Market Association (BMA), comprising bond issuers, intermediaries, banks, brokers and investors. The SARB was a founding member of (and active participant in) this Association which attempted to formalise the market, achieve greater depth and increase transparency. In 1996, the BMA was granted an exchange license and was transformed into the Bond Exchange of South Africa (BESA), a development that was facilitated, in part, by the decision taken by the government in 1989, to consolidate smaller issuances in order to create benchmark bonds and, thereby, enhance the liquidity and efficiency of this market. In addition, trading on the gilts floors of the Johannesburg Stock Exchange came to an end in November 1995, shifting to the BMA which then operated an informal screen and telephone trading system with the Universal Exchange Corporation Ltd (Unexcor) serving as the clearing house. The Rule Book and the principles underlying the operation of the market were approved in March 1996 and BESA was licensed (and started) to trade on 15 May 1996. Some major developments subsequent to this time include the introduction of electronic trading, matching and settlement; the immobilisation and later, dematerialisation of bonds listed on BESA, the development of a series of total-return indices for government and corporate bonds and the development of a more refined yield curve. Since the late 1990s, the South African bond market has increased in depth and sophistication. Developments include the introduction of inflation-linked bonds, floating rate notes, a strip programme (an acronym for Separate Trading of Registered Interest and Principal), retail bonds and municipal bonds. The corporate bond market has also grown substantially from net issuance of more than R10 billion in 2001 to net issuance of almost R70 billion in 2006. See Jacobs, AJ (1988). The South African Bond Market. Report by the Committee appointed to examine the Market for Public Sector Securities. May. The development of the corporate bond market has been assisted by the decline in issuance of government bonds, a low interest rate environment – at least in relative terms-, mergers and acquisitions, the narrowing of spreads and improved liquidity. Significant also has been the expansion of the regional dimension of this market with the raising, by the Mauritius Commercial Bank, of R350 million – the first inward-listed bond to be raised by a nonresident in South Africa. Regarding sophistication, it is the case that the role of the SARB has changed. In the past, the SARB served as an underwriter and then as a market-maker, quoting two-way prices in the secondary bond market. These activities ended in 1998 when the government adopted a system of regular, weekly, pre-announced auctions. A panel of 12 primary dealers – all being banks – was appointed to participate in the auctions which were, and still are, conducted by the SARB. 2 3. The current conjuncture The introduction of the Global Bond Index Emerging Markets (GBIEM+) by JP Morgan, which tracks changes in emerging-market local-currency bond prices, has been particularly helpful to South Africa, given that most of the country’s debt is denominated in local currency, contrary to the practice in most other emerging markets. In addition, it also implies more dedicated bond inflows into our market, possibly of a more lasting nature. Another area of the bond market, which has seen significant issuance over the years, is that of the Eurorand bond market. The demand for randdenominated bonds issued by highly rated nonresident institutions contributes positively to the value of both the rand and domestic bonds. The government debt consolidation process has allowed the cost of borrowing to decline markedly. Sound debt management has been such that new issuance is spread across the maturity spectrum of the yield curve. The bond market has become a more appealing corporate finance tool and, as such, corporate listings have become more popular. Since the very first listing of a corporate bond (South African Breweries) in 1994, the corporate bond market has increased considerably in size. Innovation in this sector has been impressive – from issuance of vanilla bonds to securitisations and commercial paper. Not only do these innovations offer debt at lower interest rates than vanilla bonds, but also provide lower income groups with access to home mortgage finance. The introduction of inflation-linked government bonds in 2000 was a further significant innovation and is quite helpful in providing monetary policymakers and analysts with important information on inflation expectations through readings of the so-called breakeven inflation rate. Whilst much has been achieved, there are still many opportunities and challenges ahead. Non-government bond issuance has increased sharply; however, banks continue to account for the bulk of this issuance. In addition, the buy-and-hold approach to corporate bonds and inflation-linked bonds, in particular, renders these segments of the bond market relatively illiquid. The municipal bond market is still in a developing stage but can certainly contribute to enhancing the breadth and depth of the domestic bond market. Finally, the significant amount of infrastructure spending planned for the next few years is likely to boost the supply of corporate bonds and therefore increase liquidity in this market. The corporate bond market has increased in size from accounting for 5 per cent of the total bond market at the end of 2001 to almost 30 per cent today. This increase in corporate sector issuance was mainly due to the reduction in the supply of government bonds, lower financing costs and an upbeat corporate sector. In 2006, net issuance in the nongovernment sector amounted to R41,0 billion (excluding securitised assets). Net issuance emanated mainly from the corporate sector, with only R7,2 billion emanating from parastatals and municipalities. Issuance in the corporate market has increased, with both new and old issuers active in the domestic market. For the bond market as a whole the number of issuers has increased, by 38 to 99 while the number of listings increased by 348 The number of primary dealers is currently 9, following some consolidation in the banking sector during the early part of this century. to 725 from 2004 to 2006. Of this, corporate bonds in terms of issuers increased almost twofold and listings threefold to respectively 83 and 563 over the same period. 4. Legal and regulatory framework that supports the development of capital markets According to the Bond Exchange of South Africa the purpose of a legal and regulatory framework is to strengthen and develop the debt capital market, to monitor the debt capital market, and to provide investor protection. The framework is also important for the development of the debt capital market since it provides for an institutional organisation to enforce the rules. Many exchanges across the world have developed as self-regulatory organisations under the supervision of a national regulator. Debt capital market regulation should provide: 1. rules, processes and procedures to deal with listings of bonds, trading, trade capture, matching of trades, clearing and settlement, surveillance, dispute resolution, failed trades, default procedures, appeal processes; 2. sanctions regarding market manipulation and providing misleading information; 3. licensing, monitoring, sanctions and penalties of inter-dealer brokers; 4. licensing powers, duties and responsibilities of self-regulatory organisation and supervisory bodies; 5. ownership, transfer, pledge of securities and security depositories; 6. internationally governance; 7. capital adequacy requirements; 8. legislation to prevent money-laundering, fraud and other white collar crime; 9. legislation to permit institutional investment into debt capital markets. accepted accounting standards, practices and corporate To encourage local and foreign investment into debt capital markets, governments have to ensure that the legislation and regulations that govern the debt capital markets comply with international standards. BESA has ensured that the rules of the exchange are G30compliant. It continuously strives to benchmark its rules according to international best practice. 5. General debt capital market infrastructure Moreover, according to BESA, it is essential to develop an appropriate infrastructure for a debt capital market which inter alia consists of: 1. financial intermediaries or an inter-dealer broker network to support the bond market and promote liquidity; 2. a platform for electronic trade capture and matching; 3. an efficient settlement system that meets the BIS recommendations, e.g. DvP, T+3; 4. a central securities depository to facilitate transfer of ownership of scrip; 5. centralised distribution of market information; 6. a centralised pool of liquidity, e.g. central and transparent price dissemination from a central platform. Whether or not these requirements are supply-leading, demandfollowing or some permutation of these and other determinants remains moot. Conclusion The challenges to which the bond market will have to respond appear, to me, to be principally two. First, the market will have to adopt to the fiscal stance of central government. This stance will reduce the need for government to fund itself through this market, in the near- and medium terms. Second, I suggest, the market will need to address the problem of “original sin” on the sub-continent: that is, the inability of adjacent emerging and developing economies to raise financing in their own currencies beyond their own borders. Resolving this dilemma on a regional basis constitutes a formidable challenge – as does the resolution of most sins! Thank you for your attention.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Country Club Johannesburg Breakfast Meeting, Johannesburg, 8 June 2007.
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T T Mboweni: Making Johannesburg a world-class African city Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Country Club Johannesburg Breakfast Meeting, Johannesburg, 8 June 2007. * * * Honoured guests Ladies and gentlemen 1. Introduction Thank you for the invitation to address one of your series of breakfast meetings, coming as it does only a couple of weeks after the last of a number of memorable and spectacular events marking the Centenary Celebrations of the Country Club Johannesburg. Being only 20 years younger than the city of Johannesburg, the Country Club Johannesburg is indeed an inseparable part of the heritage and history of this magnificent city. 2. History of the city It appears that there is no consensus among the historians about who gave this city the name Johannesburg. There is no dispute, however, that it was named after a man called Johann. Johann was a common Dutch name and remains so to this day. I would not be surprised if it is the most common name in the South African Reserve Bank at the moment. I guess that there could be many Johanns who can lay claim to having given the name. Apparently Johannesburg was proclaimed in a hurry as gold prospectors had begun flooding the place. In fact ten years had passed before anyone sought to enquire about the origin of the name. Many versions have been recorded by historians, including one claiming that the original name was Johannesburg, which was reportedly changed to Johannesburg as it was difficult to pronounce. The history of Johannesburg is very fascinating indeed. Just over 100 years ago, what is today the economic and financial centre of South Africa was an endless untouched savannah. This changed very fast when gold was discovered. This history is littered with many pioneers who suspected that there was gold in the area. After all gold had been found a few hundred kilometres to the east in Barberton. Some prospectors spent years buying up land, digging, trying to find the yellow ore, but nothing substantial was found. George Harrison has to his credit the discovery of gold on the farm Langlaagte in 1886. This marked the beginning of Johannesburg, which was declared a city in 1928. Gold diggers and fortune hunters arrived in droves and soon a tent town sprung up, later to become the city that is now South Africa’s main commercial hub. Gold was the catalyst which brought Johannesburg into being and the city’s identity continues to be closely linked with the yellow ore. The mine dumps that surround the city are a lasting reminder of the city’s origins. This city is appropriately called eGoli, Nguni for gold. The gold rush shantytowns that sprang up were transformed into a modern concrete city, Johannesburg, and the economic boom engulfed the entire country. The revenue generated from gold has enabled the country to develop its impressive industrial, commercial and financial strength. Today Johannesburg is a modern city in every sense – tall skyscrapers, a complex network of freeways, a bustling metropolis of industry and commerce and a hub to which people are drawn. According to the Human Sciences Research Council, the city of Johannesburg has a population which is conservatively estimated to be over three million. 3. A world-class financial centre The discovery of gold led to the establishment of many mining and financial companies, leading to the development of a stock exchange. On November 8, 1887, the Johannesburg Stock Exchange was established and trading was moved around the city several times as the trading halls became too small to accommodate the amount of trading and number of traders. In 1978 the Stock exchange moved to the historic Diagonal Street, before leaving the city centre for its current location in Sandton in 2000. The JSE Limited is the largest stock exchange in Africa and is ranked among the top 20 major equity exchanges in the world. At the end of 2006, the JSE had a market capitalisation of R5,7 trillion, with 388 companies listed on the exchange. Turnover on the JSE has shown strong growth over recent years, increasing from an annual turnover of R1 279 billion in 2005 to R2 100 billion in 2006. One is encouraged to learn of plans by the JSE Limited to construct a Pan-African exchange which will initially allow investors to trade in shares from Ghana, Namibia and Zambia, and later develop to cover the rest of Africa. These are bold steps towards making Johannesburg a financial centre for the continent. The Bond Exchange of South Africa (Besa) also resides in this great city. As at 31 December 2006, Besa had granted a listing to 725 debt securities, issued by 91 borrowers, with a total nominal value of R725 billion – equal to just over 47 per cent of gross domestic product (GDP). Government bonds comprise around 60 per cent of the bonds listed on Besa, with the rest consisting of bonds issued by parastatals and corporates. Corporate bond issuances are currently increasing at a much faster rate than government bond issuances. In fact, on a net basis so far in 2007, government is redeemer of bonds. The annual turnover on Besa has increased from R8,1 trillion in 2005 to R11,6 trillion in 2006. The annual turnover is currently about 38 times the market capitalisation, indicating a very liquid market. In the current year to date, the turnover on Besa is R5,4 trillion. The City of Johannesburg has contributed to the development of the bond market, being the first and only municipality in South Africa to issue a bond. The City of Johannesburg launched several municipal bonds since 2004, the first being a R1-billion bond, which was neither guaranteed by government nor secured by city assets. However, this bond issue had an overwhelmingly positive response from the market, clearing at a spread of 230 basis points above the R153 government bond. This bond is currently trading at a spread of 90. The second bond issued was also a R1-billion bond, partially guaranteed, issued at a spread of 164 basis points above the R157 government bond, was last trading at 120 basis points. Two further bonds were later issued and were also well received by the market as they were issued at spreads of 154 and 120 basis points above the R157 respectively, and are now trading at compressed spreads of 105 and 104 basis points respectively. The city of Johannesburg is at a mature stage to issue paper without any guarantee as the city now has a long-term debt rating of A+. With this improved credit rating and the narrowing of spreads, it is very clear that the city of Johannesburg has a good standing as a borrower in its own right. It is not surprising then that they have undertaken a medium term note programme under which they can issue paper to a total tune of R6-billion. Actually the last bond was issued under this programme. Non-residents are active participants in the South African capital markets, accounting for around 20 per cent of daily turnover on both the JSE and Besa. The participation of non-residents in the domestic financial markets is facilitated by a liquid market for foreign exchange. The average daily turnover against rand in the South African foreign exchange market is around USD10 billion, and non-residents account for around 65 per cent of these transactions. While gold was the initial magnet that attracted and spawned entrepreneurship, today only a few of the mining operations in Johannesburg are still active. Not only have the mining dumps formed a lasting landscape, Johannesburg has developed into a modern financial city. One of the five-year strategic objectives identified in the City’s Integrated Development Programme is improving the profile of Johannesburg, both on the continent and internationally, as a core centre of finance, business and trade. This is to be attained by, among other things, improved liaison with key partners in the business community to define what the City can do over the longer term to help consolidate, protect and enhance Johannesburg’s position in this regard. 4. A globally competitive city-region Although the smallest in size compared to the other provinces, Gauteng is the economic and financial powerhouse of South Africa and the centre of the country’s commerce and industry. The Gauteng province contributes 34,2 per cent of the country’s GDP, 47,2 per cent of all employee remuneration and 51,4 per cent of all institutions’ turnover. Johannesburg accounts for 40 per cent of the economy of Gauteng and enjoys the unchallenged status of being the economic capital of the country and the subcontinent. Johannesburg is the continent’s only world city and a regional motor in the global economy. The city’s share of the national economy constitutes about 16 per cent. It is, therefore, obvious that the economic performance of a city like Johannesburg becomes critical not only to the province in which it resides but to the country as whole. To a very large extent, it is the economic logic stemming out of this reality that informs the growth and development strategies of both the city and the province. Central to both strategies is the strengthening of Gauteng’s position as a global city-region, in recognition of the pivotal role played by cities in modern economies, political, social and environmental trends. City regions are not based on administrative boundaries but rather lay emphasis more on social and economic functional geography. Also, some recent research suggests that strong city-regions are a necessary – even though they may not be a sufficient – condition for ensuring optimal economic growth. Final report of a study entitled: A framework for City-Regions, commissioned in December 2004 by the Office of the Deputy Prime Minister in the United Kingdom. The Gauteng Growth and Development Strategy recognises the advantages of co-operating internally to compete externally. To this end, it advocates the development of a strategy to build Gauteng as an integrated globally competitive region where the economic activities of the different parts of the province complement each other in consolidating Gauteng as an economic hub and an internationally recognised global city region. The City has identified key focus areas for engagement in respect of this vision. 5. Challenges The City’s vision statement visualises Johannesburg in 25-30 years thus: “… a more equitable and spatially integrated city, very different from the divided city of the past. In this world class African city for all, everyone will be able to enjoy decent accommodation, excellent services, the highest standards of health and safety, access to participatory governance, and quality community life in sustainable neighbourhoods and vibrant urban spaces.” On the way towards that vision, however, the City’s 2006-2011 Integrated Development Programme recognises the enormous challenges faced by the city and spells out clear five-year objectives and programmes of action. It identifies Six Mayoral Priorities as: economic growth and job creation; health and community development; housing and services; safe, clean and green city; well-governed and managed city; and the fight HIV/AIDS. Except for economic growth and job creation, I do not think the list is in order of priority. Of course safety is a big issue as far as Johannesburg is concerned and, in particular, the central business district (CBD). This concern has led to many shops and offices moving to the northern suburbs. It is gratifying that measures have been taken by both the business community and the local government to reverse this trend. The installation of the CCTV cameras has led to crime levels in the inner city dropping considerably. The City’s Crime Prevention Programme seeks to focus on crimes that affect business and impact on perceptions of Johannesburg to reduce real and perceived risks to investment. 6. Sporting achievements This city boasts a broad range of sporting achievements. In 1995 it played host to the final of Rugby World Cup final that was won by South Africa. The following year the city hosted the final of the African Cup of Nations which South Africa won. This city also hosted the All-Africa games in athletics in 1999. In 2003 the city also hosted the final of the Cricket World Cup. It is therefore not surprising that Johannesburg looks forward to hosting the FIFA World Cup final in 2010! 7. Conclusion All these lofty plans, programmes and strategies recognise the centrality of economic growth towards the attainment of other policy objectives, particularly the reduction of unemployment and poverty. The primary mandate of the South African Reserve Bank remains the achievement and maintenance of price stability. Maintaining low inflation contributes enormously towards the attainment of high and sustainable rates of economic growth and employment and maintenance of overall macroeconomic stability. Thank you for your attention.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Regional Business Achievers Awards Dinner of the Businesswomen's Association, Pretoria, 27 June 2007.
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T T Mboweni: The commodity price boom and the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Regional Business Achievers Awards Dinner of the Businesswomen’s Association, Pretoria, 27 June 2007. * * * Honoured guests Ladies and gentlemen 1. Introduction Thank you for your invitation to speak at this business achievers awards ceremony. For too long the world of business has been a domain for men only, but in recent years more and more women have been making their mark in this arena. The Businesswomen’s Association has been instrumental in promoting and encouraging women who have entered the business world. The important role that women played in the liberation of our country is without question. Women have also played an important role in various fields which have contributed to the overall development of the country. It is now time for women to be at forefront of the business sector. Women in business are a scarce resource and your efforts deserve support. The economic environment in South Africa has been extremely positive in recent times, with growth averaging around five per cent for the past three years. An important contributing factor to this favourable environment has been the behaviour of commodity prices. As a commodity producer, we should be pleased when commodity prices are performing well. However, as we know from past experience, commodity price booms can be a mixed blessing. Too often in our history we have ignored the fact that commodity prices move in cycles. There had been a tendency to regard price booms as being permanent, only for things to end in tears when the cycle ended. The current boom has persisted for longer than many had predicted, leading to suggestions that we are now in a commodity super-cycle. At the same time, commodities have become a new asset class on their own. In my comments this evening I will highlight some of the recent developments in commodity prices and some of the challenges posed for the economy in general and monetary policy in particular. 2. Commodities and the South African economy As you are aware, commodities have played a central role in South Africa’s economic development. The mining industry, largely supported by gold, diamonds, coal and the platinum group of metals, has for more than a century contributed significantly to the national economy. It has provided the impetus for the development of physical infrastructure, as well as the establishment of the country’s secondary industries. South Africa is a leading supplier of a range of minerals and mineral products. According to the Chamber of Mines, in 2005, approximately 55 different minerals were produced from 1 113 mines and quarries, of which 45 mines produced gold, 29 produced platinum-group minerals, 64 produced coal and 202 produced diamonds. Mining, therefore, remains a key foundation of the South African economy. In 2005 mining made a direct and indirect contribution of approximately 15 per cent to GDP, accounted for around 50 per cent of merchandise exports (including primary and beneficiated mineral exports), 12 per cent of fixed investment, 30 per cent of the market value of the JSE limited and 20 per cent of formal-sector employment. However, it is important to note that an abundance of resources has not always implied a prosperous economy. This is particularly true for many resource-rich African countries, which until recently have not benefited from their resource endowments. Natural resources are also not a prerequisite for growth. Countries such as Japan and Switzerland with few natural resources have at times outperformed countries with a wealth of resource endowments. In fact, having natural resources is sometimes regarded as a curse. As far back as the 1950s, Prebisch and Singer postulated the secular decline of terms of trade of commodity-producing countries. The essence of their argument was that commodity prices had a tendency to decline over the long term. This, until recently, has been largely borne out by empirical evidence. In the last 140 years there have been 18 commodity cycles, with slumps being more persistent than booms. In some instances in sub-Saharan Africa, commodity price slumps have lasted over 30 years. However, since 2001, as commodity prices have boomed, we have witnessed impressive economic growth in many of the resource-rich African countries. Notwithstanding the structural shift from a commodity-based country to a more services-oriented one, South Africa has also experienced a concomitant increase in growth over this period. 3. Commodity price movements over the last five years During 2001, the overall commodity index as measured by the International Monetary Fund began to increase steadily. This increase has continued well into 2007, particularly in the case of energy and metals. Not only have the increases been more persistent, giving rise to the super-cycle hypothesis, but the surge has been larger than in previous cycles. Increases have also differed significantly across commodities. For example the price of North Sea Brent crude oil increased from around $19 per barrel in 2002 to around $72 per barrel in June 2007, having peaked at almost US$80 per barrel in August last year. Metals have also shown a strong increase with gold and platinum prices having increased by approximately 120 per cent over the same period. Agricultural prices, by contrast, have displayed more volatility and less growth when compared to energy and metals. Between 2001 and 2006, the IMF commodity food price index increased by 36 per cent. More narrowly, and perhaps more relevant to South Africa, the cereals price index increased by 48 per cent over the same period. In 2006 alone, the IMF maize and wheat price indices increased by 24 per cent and 26 per cent respectively. Food price inflation is becoming a world-wide concern and South Africa has not been spared. Spot prices of yellow and white maize have increased from levels of around R500 per ton in 2004 to current levels of around R1 800 per ton driven in part by international price developments. In October and November last year, meat prices increased at year-on-year rates of almost 20 per cent, and currently overall food inflation is in excess of 8 per cent per annum. 4. What has driven the recent price increases? It used to be the case that the growth cycle in the United States determined the commodity cycle. More recently, with the emergence of the Asian economies and China in particular, the dominant influence of the US economy on the commodity cycle has waned. Most commentators attribute the recent escalation of commodity prices to the increase in demand for raw materials by China in the wake of this country’s ongoing economic growth and industrialisation. Two factors are frequently mentioned as part of the explanation of China’s impact on global commodity prices. Firstly, China’s large population of over 1,3 billion and the associated large pool of unskilled labour have contributed to increased competitiveness and has led to China being the leading manufacturing production centre of the world. This has in turn kept the demand for commodity inputs in manufacturing high. Secondly, China’s industrialisation comes at a time of ongoing globalisation, which has contributed to overall demand for commodities globally. China’s contribution to global growth in the consumption of base metals in recent years has been considerable. According to the IMF World Economic Outlook, between 2002-2005, China’s contribution to world consumption growth in aluminium, copper and steel was around 50 per cent. Furthermore, China contributed in excess of 80 per cent to increased world demand for nickel and tin. More significantly, over the same period, China accounted for all the consumption growth in lead and zinc, and for 30 per cent of world consumption growth in oil. Due to its rapid growth and rising share in the world economy, China is expected to retain its critical role in driving commodity price movements. The recent increase in food prices has been the result of a number of factors including a weaker US dollar, the impact of higher energy and fertiliser prices, crop-specific supply shortfalls and droughts, and low inventory levels. Some analysts suggest that higher global real incomes have also contributed to the upward pressure on food prices. An increasingly important driver of agricultural prices comes from the strong demand for bio-fuels, which has seen the diversion of agricultural output to energy production. Although a number of countries have made significant strides in bio-fuels production, the United States and Brazil together account for more than 70 per cent of worldwide production of ethanol. 5. The commodity price boom and the markets In recent years, investor interest in commodities has increased in line with the rise in commodity prices and increased global liquidity. Trade in commodity indices, which total approximately US$100 billion has increased by a factor of 20 in the past decade. This is still relatively small compared to other asset classes but there has been a proliferation and diversification of the investor base including hedge funds and asset managers who have seen commodities as a means to diversify portfolio risk and take advantage of the high yields that have been achieved. Significantly, investors are increasingly viewing commodities as a long-term investment. The financialisation of commodities has also been boosted by developments in financial engineering, with strong growth underlying contracts and investment strategies. Expectations of continued and sustained growth in Asia, particularly in India and China, have served to fuel the increased demand for commodity asset classes. A deeper and diversified market can bring benefits in terms of market efficiency. For example the fact that it is easier to hedge future production reduces the risk of new productive investment which may otherwise take some time to come on stream. A related issue concerns the role of speculators who are regarded by some as being responsible for price volatility in the market. Recent evidence, however, suggests that this may not necessarily be the case. A recent study conducted by the Chicago Futures Trading Commission showed that speculative traders were not leading but rather responding to market developments. This suggests that speculators have tended rather to stabilise the market. Developments in the financialisation of commodity markets may, however, raise several financial stability questions for central banks and financial sector regulators. In particular, it is not certain whether regulators have enough information about the exposures of financial institutions to the prices of their export commodity or about how firms’ foreign exchange exposure could compound their commodity exposures. Moreover, a rise in commodity price volatility could make domestic financial assets more volatile. An additional challenge for central banks stems from the credit exposure to the primary production sectors of the banking system and pension funds which have significantly increased their exposure to commodity assets. Furthermore, central banks should always be alert to sudden declines in commodity prices that may bring about deflationary pressures and financial instability in the domestic economy. 6. Economic policy challenges Despite the positive impacts of higher commodity prices on the economy, they also create various problems and challenges for economic management. For commodity-exporting countries, commodity price booms bring with them the concern about the possibility of Dutch Disease, which arises when a booming primary sector causes the real exchange rate to appreciate, and this in turn puts pressure on the manufacturing and other tradable sectors of the economy. The concern is even greater when the cycle turns and the loss of markets by the manufacturing sector is not easily reversible. From a fiscal policy perspective, the challenge that arises relates to the management of windfall revenues. To the extent that tax revenues are boosted by the commodity boom, there may be a need to smooth expenditure and not treat the revenue increase as permanent. A number of primarycommodity exporters, for example Chile and Norway, have created national wealth funds to ensure that expenditure can be maintained when the commodity cycle declines and tax revenues fall. Monetary policy would be concerned with the possible impact of commodity price increases on inflation. Ironically, the strong non-oil commodity price increases have not translated into generalised inflation. In fact the commodity boom has coincided with a long period of low global inflation. Part of the reason may lie again with China and globalisation. High rates of productivity growth in China have allowed for the production of a wide range of goods at low prices despite the increased costs of inputs. In a highly competitive globalised world market and credible monetary policies, product price increases have remained low or prices have even fallen in some instances. Oil and food prices, however, appear to be posing more of a threat to the global inflation outlook than other commodities. Nevertheless, contrary to initial fears, the impact of rising oil prices has had less of an impact on inflation and output than in previous episodes of oil price increases. This may be because of a general decline in oil intensity in many countries and more credible monetary policy frameworks. However, oil and food prices have been the driving forces of recent inflation developments in South Africa and pose the major upside risks to inflation both here and abroad. Monetary responses to terms-of-trade shocks such as oil price increases are not straightforward and depend in part on the magnitude and duration of these shocks. In essence, the issue boils down to distinguishing between permanent and transitory changes in these prices, and how the first- and second-round effects are likely to influence future inflation outcomes. In general, central banks are not likely to change monetary policy in response to commodity price fluctuations. Monetary policy should address the risks emanating from possible second-round effects, i.e. adjustments in expectations triggered by movements in commodity prices which may exert an impact on the inflation process. 7. Conclusion Not surprisingly, in our uncertain world, there are conflicting views on the outlook for commodity prices. Some believe that commodity prices will fall back to their long-term declining trend. Others however, foresee a sustained boom, or at worst a levelling off at higher levels, given the ongoing industrialisation in China and other emerging-market countries. Whatever the future course of commodity prices, there is little doubt that it will have an impact on our economy. In essence, the policy responses will depend on the macroeconomic impact of the price movements. In this regard, the effect of commodity price movements on inter alia the trade balance, aggregate demand, exchange rate and fiscal developments are of paramount importance. From a monetary policy perspective, our key concern is the possible impact on inflation. Food and oil prices are likely to remain an upside risk to the inflation outlook in South Africa. Monetary policy has to be sensitive to the impact of these developments on inflation expectations and we will act appropriately to prevent the emergence of more generalised inflation. The South African Reserve Bank remains committed to its primary mandate of ensuring price stability, that is the maintenance of CPIX inflation between the target range of 3 to 6 per cent. Finally, commodities will retain a central role in the South African economy in the future. A challenge facing our country, and one that is of particular relevance to this audience, is to ensure that women also play their rightful role in this area of economic activity. To this end the recognition of the achievements of women plays a significant role in fostering their interest in all sectors of the domestic economy. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Oxford & Cambridge Business Alumni of South Africa (OCBASA), Johannesburg, 2 August 2007.
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T T Mboweni: Risks to the inflation outlook – looking ahead to the August Monetary Policy Committee meeting Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Oxford & Cambridge Business Alumni of South Africa (OCBASA), Johannesburg, 2 August 2007. * * * Honoured guests Ladies and Gentlemen: 1. Introduction I would like to thank you for the opportunity to address such an illustrious gathering. I was not fortunate enough to attend either the University of Cambridge or the University of Oxford but should state that I followed the rowing competition held annually between the two universities with keen interest. I have always wondered how my Alma Mater – the University of East Anglia – would perform in this competition. I am sure the students at the University of East Anglia would relish such a challenge. Members of the Oxford and Cambridge Business Alumni of South Africa play an important role in the economic and social life of the country. Members of the organisation include Chief Executive Officers of banks, investment bankers, investment analysts, professors, bishops and headmasters, to name a few. My role this evening is to talk about the more mundane issues of monetary policy. I will share with you some of the issues that are of concern to the Bank. These concerns are not new and they have been raised in recent MPC statements, but I thought I would elaborate on some of them in more detail. 2. The inflation target: where do we stand? Before highlighting these issues, let me first remind you where we stand with respect to our monetary policy objective. Our mandate is to keep CPIX inflation within the inflation target range of 3-6 per cent on a continuous basis. This we successfully achieved for 43 consecutive months between September 2003 and March 2007. In April 2007 CPIX inflation breached the upper end of the target at 6,3 per cent, and remained outside the target at 6,4 per cent in May and June. The major drivers of these developments were higher food and petrol prices. In these months, had food and energy prices been excluded, CPIX inflation would have averaged around 4,6 per cent. Nevertheless there is evidence that underlying inflation is becoming more generalised as evidenced by the fact that this narrower measure of inflation has been trending upwards in recent months from a low of 2,5 per cent in June last year. In response to these adverse inflation pressures, monetary policy has been tightened and we have increased the repo rate by a total of 250 basis points since June 2006. It is of concern to the Bank that inflation has breached the target range. However I should emphasise that this should not be seen as a failure of monetary policy. As I noted, the main drivers of the recent surge in inflation were petrol and food price inflation. It is important to emphasise however that monetary policy reacts with a lag, and that it takes approximately 18 months to 2 years for the effects of an interest rate change to be reflected fully in inflation. This implies that there is little monetary policy can do about current inflation, which is an historical number, particularly if it has been caused by unanticipated external shocks. In setting the monetary policy stance we therefore have to focus on the medium to long term. This does not mean that we can be complacent about near-term developments, as inflation expectations and monetary policy credibility are determined in part by these short term considerations. The challenge for monetary policy is to ensure that inflation is brought back to within the target range, and also to convince the markets that we will are serious about this. In this way we will ensure that inflation expectations remain anchored within the target range. I should note that we are not alone in missing our targets. During the past year or so, a number of central banks have temporarily exceeded their targets, the most recent notable example being the Bank of England. Pressures emanating from oil and food prices are a global phenomenon and are posing a challenge to many central banks. 3. Dealing with inflation shocks: International oil prices Rising international oil prices and food prices have been on the top of our list of risk factors for some time. I am often asked what monetary policy can do about oil or food prices? If we tighten monetary policy in the face of higher international oil prices, this will not cause OPEC to raise output or market prices to decline. Similarly with food prices – raising interest rates will not make it rain. Yet these are two variables that are high on our list of concerns. Let us first consider oil prices. At the beginning of 2004, the price of North Sea Brent crude oil was around US$30 per barrel. It is now almost US$80 per barrel. In the first 5 months of this year the domestic petrol price increased by R1,34 per litre, although it has since declined by R0,23. Most of this increase has been due to higher international product prices rather than exchange rate effects. International oil prices are affected by a variety of factors ranging from higher demand in a fast-growing world economy, particularly from China; and risks to supply emanating from OPEC cutbacks, supply disruptions in a number of oil-producing countries, geopolitical tensions and adverse weather conditions. These factors have contributed to the upside risk to the oil price. How should monetary policy react to this? The impact of a change in the international oil price is direct and relatively quick, given that domestic petrol prices are adjusted each month in terms of the formula of the Department of Minerals and Energy. Petrol has a weight of about 5 per cent in CPIX, so a 10 per cent increase in the petrol price would increase CPIX inflation by approximately 0,5 percentage points. This is the impact effect or what we call the first-round effect, and clearly there is nothing we can do about this. Our concern is with the broader impact of this effect, that is, the so-called second-round effects. We have to assess whether or not these increases will be passed on over time in the form of higher transport costs which will increase prices of other commodities, for example food, or through higher production costs. We also have to assess whether there will be an impact on wage and price setting, which will impact broadly on inflation. Over the past two years these second-round effects have been relatively moderate. This could be due to a number of reasons, including increasingly anchored inflation expectations as a result of enhanced monetary policy credibility; increased competitiveness in the economy; and the fact that some of these increases were in fact reversed late last year. The longer the international oil prices are subject to upward pressure, the more likely these second-round effects will feed through to generalised inflation. The challenge for the MPC therefore is predicting not only the future course of volatile international oil prices, but also assessing how these increases will feed through to further inflation pressures over time. In deciding on the appropriate monetary policy response, it is not always easy to differentiate between first and second round effects. Some analysts have argued that we should exclude food and oil from the price index that we target. We do not believe that targeting such an index would be credible. The Economist magazine has appropriately referred to such an index as “the cold-and-hungry index”. 4. Food prices Food prices have also become a cause for concern. Food prices have a weight of almost 26 per cent in the CPIX basket, although this proportion is much higher at around 51 per cent in the consumption basket of the lowest category of income earners. As is the case with oil prices, there is an international dimension to the increase in food prices. Higher food inflation is an international phenomenon. This is partly weather induced, but perhaps more significantly, the increased diversion of maize and sugar to biofuels production has resulted in significant price increases in the international markets. Domestic maize and wheat prices are directly affected by these higher international prices and combined with domestic drought in some areas of the country, have caused the spot price of maize in South Africa to increase almost four-fold over the past two years. Higher maize prices have not only increased the cost of maize products but have also affected meat prices, which last year were increasing at rates of almost 20 per cent. Meat has a weight of around 7 per cent in the CPIX basket, and in 2006 was the single biggest contributor to overall CPIX inflation. Food prices are currently increasing at rates in excess of 9 per cent per annum, and we are still feeling the effects of the maize price increases. One small consolation is that meat price increases have moderated from their peaks last year as more cattle are brought to the market during periods of drought. This trend may not persist as farmers are likely to restock at some stage. 5. Household consumption expenditure Much has been said about the strong growth in household consumption expenditure and the associated increase in domestic credit extension. Household domestic expenditure has been increasing at a year-on-year rate of between 7 and 8 per cent for the past three years, compared to rates of growth of around 3 per cent in the preceding three years. At the same time, credit extension to the private sector has been growing at rates of around 26 per cent despite the tighter monetary policy stance. These are uncomfortably high levels and I have expressed my concern in this regard on various occasions. Excessively high rates of expenditure growth will ultimately impact on domestic inflation, although the timing and extent of these effects are at times uncertain. These developments will remain an important focus of our monetary policy deliberations. My concern, however, extends beyond simple monetary policy considerations. As a result of the high levels of credit extension, household indebtedness has increased to record levels, currently at around 76 per cent of disposable income. Although the debt service ratio reached a low of 6 per cent of disposable income in 2004 and 2005, this has now risen to 9 per cent. Although part of this increased indebtedness is justified on the basis of improved household balance sheets, my concern relates to the socio-economic impact of excessive debt accumulation. As more and more people find employment or better paid employment, the temptation is to rush out and buy a bigger car and a bigger house. Very soon, we see people becoming overextended and repossessions become commonplace. Part of this development is due to excessive exuberance on the part of consumers. There is not a culture of saving in South Africa, as demonstrated by our very low savings rate, and people are happy to borrow excessively against future income in order to finance current consumption. The problem has also been compounded on the supply side with banks and others, including retailers, falling over themselves to extend credit, resulting in a number of questionable lending practices. Perhaps the situation is not as bad as in other countries such as Australia, where it was reported a few months back that a woman successfully applied for a credit card for her cat. But some of the stories we have heard locally are not much better. Fortunately some sanity appears to be returning to the market with the recent adoption by the banks of a voluntary code of good conduct with respect to the marketing of credit. At the same time, further constraints on lending have become evident with the introduction of the National Credit Act in June, when stricter requirements were imposed on lenders to determine the creditworthiness of borrowers. Although this may have a dampening affect on certain categories of credit extension and introduce more careful risk assessment, we do not believe that this will replace the need for monetary policy restraint. 6. Economic growth and inflation Excessively high economic growth brings with it potential inflationary pressures to which monetary policy has to be sensitive. In each of the past three years, the economy has been growing at a rate of 5 per cent, which is high compared to our experience of the past 25 years or so. Capacity utilisation in the manufacturing sector has also reached record high levels. While we in the Bank are pleased by this strong growth performance, we have to ensure that this growth does not affect inflation adversely. In economic terminology this refers to the concept of potential output, which at a simplified level is the rate at which the economy can grow without generating inflationary pressures. From a monetary policy perspective we have to consider whether our current growth experience is inflationary. In other words, are we growing in excess of our potential output? Unfortunately, estimating potential output is not a simple task and the estimates are subject to a high degree of uncertainty. Current research in the Bank estimates that the potential output of the economy is now at least around 4,5 per cent per annum. This can be compared to estimates of around 3 per cent or less during the 1990s. If this estimate is correct, it implies we are currently growing at a rate above potential. This is not necessarily a threat to inflation if this growth entails the necessary microeconomic reforms which will allow for a higher potential growth rate. However if the growth rate does not improve the productive capacity of the economy, there could be inflationary consequences. These considerations are not easily observable, which makes our job that much more difficult. 7. Wage settlements In recent weeks, following the publicity emanating from the public servants strike, much attention has been focused on the risk to inflation from higher wage settlements. From an inflation perspective, higher real wage settlements may increase domestic demand pressures. There also may be a cost-push effect as producers pass on the higher wage costs in terms of higher prices. The latest consolidated data for the economy as a whole are not yet available but there does appear to be a worrying trend towards higher nominal wage settlements. However we should also bear in mind that at this stage real wage settlements do not appear to be significantly higher than in the recent past. In other words, higher nominal wage settlements are simply compensating workers for the higher trend in inflation. It is therefore important that we reverse this inflation trend. Furthermore, we also need to focus on the increases in unit labour costs, that is, the nominal wage increases adjusted for increases in labour productivity. The latest data indicate that in the first quarter of this year unit labour costs in the non-agricultural sector increased by 2,2 per cent compared to the first quarter of last year of 2006. So although wage growth poses an increasing threat to the inflation outlook, it does not appear to be out of control. 8. Administered prices When we initially adopted the inflation targeting framework, one of the constant laments we had at that time was the challenge posed to us by the range of administered or regulated prices in the economy which remained stubbornly high. Administered price setting by the regulators eventually became more market-related, and from around 2003 till recently this category did not feature among the list of our concerns. Unfortunately this situation is changing. The administered price index (excluding petrol) has been increasing steadily in recent months. The API excluding petrol increased at a year-on-year rate of 5,6 per cent in June this year, compared to 4,3 per cent a year ago. Top of our list of concerns are the proposed electricity price increases requested by Eskom. These increases are of the order of 18 per cent for the next two years. While we fully appreciate the need to expand electricity generating capacity in the country as a matter of urgency, it is essential that alternative financing options be carefully considered as these will have significant implications for inflation and monetary policy. A similar argument can be made for other areas where infrastructure expansion will take place. It is accepted that increases in tariffs or indeed excise or fuel taxes should not be regarded as “true” inflation. However if they are a regular annual feature of the economic landscape they become an integral part of the inflation process which we have to take account of. We are mandated to achieve a particular inflation outcome, but to achieve this, government and other regulators need to take account of this in their price setting. 9. Conclusion I have attempted to outline some of the major concerns currently facing the MPC. This does not mean that other issues are not concerning us, or that we see no positive developments. I should also emphasise that we do not have a target for any particular variable – our focus is on the overall inflation outcome, which is the outcome of the interaction of a number of variables. In other words, we cannot say what the appropriate growth of household consumption spending should be, as it would need to be seen in the context of the behaviour of the other factors that determine the inflation rate. Monetary policy-making is not a simple matter of adjusting an interest rate lever in an automatic way. Because monetary policy has to be forward-looking, and because the future is inherently uncertain, we have to make decisions on the basis of our best estimates of the most likely outcomes. Despite these difficulties, we will continue to strive to achieve our mandate and bring inflation back to within the inflation target range. This will be the true test of the success of monetary policy. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Reuters Economist of the Year Award, Johannesburg, 6 September 2007.
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T T Mboweni: Artistic science or scientific art? – The role of forecasting in monetary policy formulation Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Reuters Economist of the Year Award, Johannesburg, 6 September 2007. * * * Honoured Guests, Ladies and Gentlemen 1. Introduction It is said that there are two kinds of economists: those who cannot forecast, and those who don’t know that they cannot forecast. We have to be thick-skinned to be economists as we are often the butt of jokes. Apparently there are more jokes about economists than any other profession, except perhaps lawyers. It would appear that the negative perceptions that are held about economists can be blamed to a large extent on economic forecasters who, we are told, have accurately forecast eight of the last three recessions. But forecasting is not always a joke, and the quality of the contestants of the Reuters Economist of the Year competition is testament to that. Forecasting is a serious and integral part of economic life. Any decision, whether an investment decision or a policy decision, or in fact any decision in life that involves taking a view on the future, has to be made on the basis of some forecast. So if we regard forecasting as a joke, then the joke is on us. Unfortunately we do not have perfect foresight and therefore we will never be able to forecast perfectly. The best we can do is to strive to create forecasting models that are close approximations of reality which in turn provides a coherent and disciplined framework for making decisions. In my comments to you this morning, I will discuss the role of forecasting and how we use forecasts in the monetary policy decision-making process. 2. Models and forecasts There are different ways we can go about generating forecasts. Although there may be some forecasters who engage in pure guesswork or thumb-sucking, most forecasters would be informed by models with varying degrees of sophistication. These could vary from simple extrapolation of the past, to analysing current developments and assessing their implications for the future, to a more complex dynamic stochastic general equilibrium model, which is the latest fad among model builders. Forecasting success, however, is not guaranteed by the level of sophistication of the model. The type of model we use would, to some extent, depend on the time horizon that we are interested in, as different models are better suited to different forecast horizons. In the short run, momentum of data may be more important than longer-term structural and behavioural relationships. We therefore see different types of forecasting strategies in the markets. For example, many traders have time horizons of a few minutes. To them tomorrow is very long term. Those needing short-term forecasts will probably use chartist or bottom-up spreadsheet techniques. These models have little basis in economic theory, and are unlikely to perform well over longer-term horizons. Our structural models in the Bank, for example, use quarterly data, so by definition they cannot be used for predicting one month ahead. For this we would use autoregressive integrated moving average (ARIMA) models, which are also momentum-type models with no underlying economic theory. Predictions based on ARIMA are used for short-term predictions, and since they are based purely on historical trends, they are not very good when it comes to predicting turning points. Some forecasters rely on simple correlations noted in the market. As we all know, correlations do not imply a causal relationship or even any direct relationship. The dangers of spurious correlations are well-known. David Hendry, the renowned Oxford University econometrician, in his appropriately-titled paper: “Forecasting: alchemy or science?” illustrated this perfectly when he showed that there was a better relationship between inflation and the cumulative rainfall in Scotland, than between inflation and monetary aggregates. I don’t know if this means that we should be employing Scottish weather forecasters in the Bank to make our inflation forecasts. I am told, however, that weather forecasters were created in order to make economic forecasters look good. 3. Why are forecasts wrong? Even if we do build sophisticated structural models incorporating good behavioural relationships, the forecasts are still likely to be wrong. There are various types of forecast errors. Firstly, there may be misspecification of the model. This could mean that we have excluded one or more variables, or that we have specified the wrong type of function. Our modelling team is continually developing our models to try and overcome this type of problem. Secondly, there may be structural breaks in the economy which are difficult to take account of when estimating over a long time horizon. This means that there may be a bias to the estimated coefficients of the model. This is particularly relevant to South Africa given the transformation of the economy over the last decade or more. A third problem relates to data. Historical data are subject to measurement error and are also revised after publication. In a number of instances we don’t have a consistent series going back far enough to ensure a more reliable estimate of the parameters. In addition, some variables, such as the wealth or expectations variables, have to be proxied. Inflation expectations are central to the inflation formation process, yet modelling inflation expectations is a major challenge. While misspecified models, bad methods and inaccurate data are often blamed for serious forecast errors, David Hendry argues that they are not the main cause of systematic mistakes. Rather it is the unanticipated large changes or shocks within the forecast period that are the primary source of errors. These are totally unpredictable or idiosyncratic events that we simply cannot predict, and in these instances the fault then lies in not rapidly adjusting the forecasts once they become inconsistent with the exogenous shock. When shocks occur, the best we can do is to adjust our forecasts accordingly. This is why we should be constantly monitoring new developments. There are instances where the risks to the forecast may be known but are unquantifiable. The current round of financial market volatility is a case in point. Although it was not a totally unpredictable shock, the timing was always uncertain and we still don’t know what the ultimate impact will be. Lawrence Meyer, a former Federal Reserve Governor, in commenting on the Federal Reserve’s reactions to the financial market turbulence, said that the recent shift in policy stance “tells us how difficult it is to translate financial turbulence into macroeconomic forecast.” A model-based forecast is only as good as the key assumptions that it is based on. In the forecasting process of the Bank, a lot of time and effort is dedicated to the process of deciding on the exogenous assumptions of the model. Staff at various levels make inputs, but ultimately, about two to three weeks in advance of the MPC meeting, the MPC members meet to finalise the assumptions. Making assumptions about exogenous variables is an important component of the forecasting process. But it is not always easy. Take for example the international oil price for example. It is one of the most important exogenous assumptions in our model and we have to formulate a view of the price over the coming three years. Unpredictable geopolitical events, hurricanes etc., will surprise us over the period and force us to change our views. No matter how well we analyse the underlying market conditions, we are likely to be wrong because of unpredictable events. The difficulty of forecasting the oil price is well illustrated when comparing the oil price forecasts of a number of different forecasters. For the 2008 forecast, the spread between the highest and lowest forecast in the market is almost US$22 per barrel, and for 2009 the spread is slightly wider. If the oil experts are so uncertain, how confident can we be? Yet this variable has a critical bearing on the inflation outcome and the accuracy of our forecasts. One way we try and cope with this uncertainty is to consider various oil price scenarios, so that we can see the sensitivity of the forecast to possible changes in the exogenous variables. We then have to make a judgement call as to which is the most likely scenario. As is the case with policy making, forecasting is very often a science as well as an art. 4. The use of forecasts in monetary policy decision-making The Bank does not rely on a single model for its forecast. In line with most central banks we have a suite of models that can be used for different purposes and various time horizons. As I noted earlier, we use ARIMA models or vector autoregressive (VAR) models for short-term forecasting and for estimating impulse responses. Other models include a disaggregated model which builds up the inflation forecast from the individual components of CPIX independently, which helps us identify the categories where price changes and inflationary pressures have started to emerge. Finally, we have our main quarterly core model which has 18 structural equations. Policy, like investment decisions, has to be made on a forward-looking basis. As inflationtargeters, we need to set interest rates on the basis of our expectations of inflation over the next two years or so. This is particularly the case given the lags in adjustment to interest rate changes. The closer the model represents reality, the better it will be. However, as outlined earlier, no model fully captures all the interrelationships in the economy or captures expectations appropriately. Furthermore, as I outlined earlier, idiosyncratic shocks cannot be forecast. Much is made in the markets every month when new inflation data comes out. To us the latest data point is only important to the extent that it may contain clues to the future and that it gives us a new data point for the longer-term projection. The latest data point is in fact history. We can compare this to driving a car. We do not drive a car by focusing only on the rear-view mirror. That is a sure recipe for disaster. True, we have to look in the rear-view mirror every now and again in case there is a bad driver bearing down on us, but we should be generally looking ahead. Unfortunately, as with policy-making, the road ahead is not always clear. For these reasons, it is not possible to use the forecast in a mechanical way. Although in theory models should incorporate all available information at any given point in time, there is still a certain amount of judgement that must be used. So as policy-makers, we cannot devolve our responsibilities to the outcomes of the model. Much consideration has to be given to a thorough analysis of the risks to the outlook. Even the most sophisticated models need to be supplanted by anecdotal and other off-model information. As Federal Reserve Chairman Ben Bernanke recently remarked, “for all the advances that have been made in modeling and statistical analysis, practical forecasting continues to involve art as well as science.” Our most recent forecast that we reported on in the August MPC statement suggests that we will be outside the target range until the second quarter of next year, and then inflation will gradually decline. However this forecast is only as good as the assumptions we have put in to the model. The sensitivity of the forecast to oil price and exchange rate changes are well known, and any unexpected changes in these or other variables will cause the forecast to change. So there can be no guarantee that the forecast will be the same next time. Forecasts cannot be followed in a mechanical fashion since relevant off-model information has to be accounted for and the risks to the forecasts assessed. 5. Forecasting and transparency The global trend in recent years is towards increased transparency in monetary policy formulation. This helps to make monetary policy more predictable which, in turn, helps reduce volatility in markets and make forward planning easier. We can debate about where to draw the line as to the limits of transparency, but one of the new trends has been for central banks to publish their forecasts as well as their forecasting models. For some time we have been showing our central forecast and the associated fan chart in the Monetary Policy Review (MPR) which we publish twice a year. This is the forecast presented to the MPC at the most recent MPC meeting prior to the publication of the MPR. Furthermore, in our statements which are released after each MPC meeting, we give details of the forecast so that market participants have a good idea of the timing and level at which inflation is expected to change direction. We also indicate where we expect inflation to be at the end of the forecast period. More recently we have also published our core model following numerous requests from private sector analysts and forecasters. We have also provided an assessment of the performance of the model over time which shows that the Bank’s model has performed well, particularly relative to other private sector forecasts. The obvious question to ask is, should these analysts not also be transparent with their models? Would it not improve the quality of debate or assist in the development of better models if we could see how other forecasters generate their forecasts? I have noted a deafening silence when I raise this issue with market economists. 6. Conclusion I will not attempt to forecast the winner of the competition. I congratulate all of the contestants. The winner is the forecaster who has most accurately forecast the month-ahead inflation over the past year. Although forecasting near-term inflation is useful, as the Financial Times columnist, Sir Samuel Brittan argued, this type of forecast tells us more about the present and the recent past than about the future. From a monetary policy perspective, we are primarily concerned with forecasting over a longer time horizon. There is nothing monetary policy can do about the latest inflation numbers. Monetary policy should be judged on whether appropriate actions are being taken today to ensure that inflation will be within the target range in 18-24 months time. For this we need to have a good medium-term forecast to provide us with a coherent framework. Despite all the problems associated with forecasting, they remain integral to policy decisions, and we will continue to use them. The models have become increasingly sophisticated, but the future is inherently uncertain. At the same time the economic and political environment has also become more challenging and difficult to predict. Unfortunately, as is sometimes said, the future is not what it used to be. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 87th ordinary general meeting of shareholders, Pretoria, 20 September 2007.
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T T Mboweni: Overview of the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 87th ordinary general meeting of shareholders, Pretoria, 20 September 2007. * * * Introduction The primary goal of the South African Reserve Bank (the Bank) is the achievement and maintenance of price stability. However, the role of the Bank in the economy goes beyond a narrow monetary policy focus. Low and stable inflation provides an important framework for economic growth, but regulation and supervision of parts of the financial sector, as well as the oversight of the payment system ensure that the wheels of the economy continue to turn efficiently. In the past year we have had to execute our mandate in an increasingly difficult and uncertain environment. The South African financial markets have not been spared the effects of the recent volatility in the financial markets and we have to be increasingly vigilant of the risks posed to the domestic economic landscape. At the same time we have to ensure good governance with respect to the internal workings of the Bank. It is against the backdrop of this volatile economic environment that I report to you today. Today we also release our Annual Economic Report which covers developments in the domestic and international economy over the past year. In particular, we highlight the main economic developments which have affected our operations and policy implementation. The focus of this address is on the main operational areas of the Bank including monetary policy and its implementation, gold and foreign-exchange reserves management, financial stability issues, the national payment system, banking regulation and supervision, international cooperation and internal administration. Monetary policy This past year has been a challenging one for monetary policy. As I reported in August last year, from the middle of 2006 pressures on inflation emerged, and have since intensified. By December 2006, year-on-year CPIX inflation measured 5,0 per cent compared to 3,7 per cent in April of that year. Inflation remained within the target range until April 2007 when it increased to 6,3 per cent from 5,5 per cent in the previous month. Since then it has remained outside the target range. Initially the main drivers of this adverse trend were food and petrol, but more recently there has been evidence of a more generalised upward trend in inflation, including that of services prices. The Monetary Policy Committee (MPC) responded to these developments by raising the repurchase rate by 50 basis points in June 2006, the first increase since 2002. This was followed by successive increases of 50 basis points at each of the subsequent three meetings of the MPC in 2006. By December the repurchase rate had increased to 9,0 per cent per annum. The pressures on inflation emanated from both international and domestic sources. At the global level, the world economy continued its strong performance which contributed to sustained upward pressure on oil and food prices which, in turn, had a direct impact on domestic food and petrol prices. These items were the major contributors to the upward inflation trends during 2006. In August last year international oil prices peaked at levels just below US$80 per barrel. Prices were influenced by strong global demand, supply disruptions in a number of countries and geopolitical uncertainties. Food price pressures have also had a global dimension. Drought conditions in a number of countries as well as the increased diversion of agricultural products, particularly wheat, maize and sugar, to bio-fuels production have contributed to this trend. South Africa was not immune to these developments which, in conjunction with the impact of drought conditions in a number of regions, resulted in an acceleration of food price inflation, in particular meat prices and to a lesser extent maize prices. In October and November 2006 meat prices increased at year-on-year rates of almost 20 per cent, while grain product prices increased by around 6 per cent. Although world inflation remained under control, the pressures emanating from these developments have dictated that monetary policy remains restrictive in many countries. Domestically, the MPC had to contend with the combined threats of high rates of growth of consumption expenditure and credit extension. In the second half of 2006, domestic household consumption demand growth also continued at a robust pace of around 7 per cent per annum, while the various consumer confidence indices indicated sustained optimism on the part of consumers despite the tightening stance of monetary policy. Towards the end of the year, motor vehicle sales, particularly passenger vehicles, showed some signs of moderation. Underpinning this consumer exuberance were strong rates of growth of credit extension, despite an increase in securitisation transactions. Following the 15-per-cent depreciation of the effective exchange rate from May to July 2006, the exchange rate of the rand had an impact on the inflation outlook. However, it then remained in a fairly tight trading range, despite the continued widening of the deficit on the current account of the balance of payments, which continued to be adequately financed by capital inflows. Not all the determinants of the inflation rate posed a threat to the outlook. Nominal unit labour costs were well contained, fiscal policy continued to be supportive of monetary policy and although the economy was growing at a robust pace, it was not deemed to be growing at a rate significantly above potential. Inflation expectations were also anchored within the inflation target range. In the first two months of 2007 international oil prices declined significantly, with the price of North Sea Brent crude oil reaching a low of US$51 per barrel in January. These developments contributed to a general downward revision of oil price and inflation forecasts. At the same time, there were tentative signs of some moderation in household consumption expenditure, particularly with respect to passenger vehicle sales. The MPC was also mindful of the fact that interest rate adjustments take time to impact fully on demand. Although the inflation risks were still perceived to be on the upside, the continued stability of the exchange rate, sustained fiscal restraint and the improved inflation expectations resulted in the committee keeping interest rates on hold at the February and April meetings of the MPC. By the June 2007 meeting of the MPC, the outlook had deteriorated further. Despite the previous adjustments to the monetary policy stance, available data at the time suggested that real household consumption expenditure and credit extension remained strong, growing at year-on-year rates of around 7 per cent and 26 per cent, respectively. International oil prices resumed their upward trend, eventually peaking at around US$78 per barrel in July. The overall impact of the adverse oil-price trend on domestic inflation was moderated somewhat by the relative stability of the rand exchange rate. However, following the breach of the upper end of the inflation target, there were some worrying signs of a deterioration in inflation expectations. Furthermore, partly in response to the higher inflation outcomes, nominal wage settlements began to trend higher, posing a further risk to the inflation outlook. In response to these pressures and the less favourable outlook, the repurchase rate was increased at both the June and August 2007 meetings of the MPC. At the time of the August meeting, the turmoil in the world financial markets had begun. At that stage it was unclear to the MPC whether these developments would be confined to the financial markets, or if they would impact significantly on the growth prospects domestically and abroad. The committee decided that it was appropriate to remain focused on the inflation target, and react to financial market developments insofar as they affected the inflation outlook. The breach of the target can be seen as a setback for monetary policy. Nevertheless, it should be noted that the main cause of inflation exceeding the upper end of the inflation target range was factors beyond the direct influence of monetary policy. We are mindful, however, of the impact of these developments on inflation expectations and the need to act against the emerging broader inflation pressures. The most recent inflation forecasts of the Bank suggest that inflation may return to within the inflation target range during the second half of next year, and the MPC will continue to act accordingly to ensure that this outcome is achieved. Money-market operations To ensure that the implementation of monetary policy was in line with the stance determined by the MPC, the Bank managed the daily liquidity requirement in the money market in a range roughly between R10 billion and R15 billion. The Bank also broadened the list of securities that qualify as eligible collateral in its refinancing operations. With effect from 23 May 2007, two categories of collateral are now accepted. Category 1 securities comprise Government bonds, Land Bank bills, STRIPS, SARB debentures and Treasury bills. The new Category 2 securities comprise all non-bank, non-government securities that are included in the All Bond Index of the Bond Exchange of South Africa. Borrowers using this category have to provide more collateral. In co-operation with various market participants the Bank addressed shortcomings that had been identified in the South African Overnight Interbank Average (Saonia) rate. The Saonia rate was replaced by the South African Benchmark Overnight Rate on deposits (Sabor), which is a more representative and reliable pricing benchmark than its predecessor. Reserves accumulation and management The Bank has continued to increase its level of official reserves. Gross gold and foreign exchange reserves increased from US$23 billion at the end of March 2006 to US$29,8 billion at the end of August 2007. The international liquidity position, which was positively affected by the prepayment by the Bank of the US$1 billion syndicated loan that was raised in 2004, increased from US$19,5 billion to US$27,4 billion over the same period. The prepayment resulted in some cost savings for the Bank, and conveyed a positive signal to counterparties of the Bank and the market. With the recent buy-back of foreign currency-denominated debt by the National Treasury, the prepayment also contributed to the effort to reduce the external vulnerability of the country. A key focus area remained the refinement of the reserves management capabilities of the Bank. In this regard, the Bank worked closely with the World Bank under the auspices of the latter’s Reserves Asset Management Programme for central banks. Capacity building is central to these efforts, and the Bank continued to invest in training and systems for staff involved in the areas of reserves and risk management. In addition, the investment policy of the Bank was reviewed and the governance structure was enhanced by the establishment of a Reserves Management Committee. The Bank and the National Treasury further strengthened their co-operation in the areas of reserves accumulation and liquidity management. The National Treasury assisted in draining a large portion of the liquidity created by the foreign-exchange purchases of the Bank. At the end of July 2007, the special deposit account of the National Treasury with the Bank, which was created for this purpose, totalled R54,5 billion including accrued interest. Agreement has been reached on the settlement of outstanding balances on the Gold and Foreign Exchange Contingency Reserve Account (GFECRA). The Bank and the National Treasury have agreed that, in future, only realised profit or loss positions that have an influence on money-market liquidity would be settled on a regular basis. This arrangement should reduce the amount of funds flowing between the Bank and the National Treasury and moderate the impact on money-market liquidity. Under this new arrangement, the Bank transferred an amount of R319,3 million (including interest) to the National Treasury for settling the outstanding GFECRA balance as at 31 March 2006. Currency distribution Efforts are continuing to combat the counterfeiting of banknotes and to ensure that only banknotes and coin of acceptable quality are in circulation. Minimum standards for the reissue of banknotes have been prescribed. In collaboration with the commercial banks the primary phase of the implementation of the Integrated Cash Management System has been completed. This system has the potential to improve the efficiency and effectiveness of the National Cash Management System in the cash value chain, thereby reducing the cost of cash to the public. The developmental phase of the interactive Cash Risk Identification and Mitigation programme developed by the Bank and the South African Banking Risk Information Centre with the participation of the commercial banks, the cash-in-transit industry and the South African Police Service has been completed. This programme defines the minimum security standards for the cash management industry to reduce incidents of cash-in-transit heists and banking crimes, and is now being consulted on with unions and employee representatives. The minimum standards will also be promulgated into regulations by the Minister of Safety and Security. The national payment system The value of total settlement in the South African Multiple Option Settlement (SAMOS) system amounted to an all-time high of R5,6 trillion in July 2007, which is approximately R280 billion per day. This settlement figure also includes transactions stemming from the equity and bond markets. In 2006 and 2007, approximately 90 per cent of settlement through the SAMOS system was effected on a real-time basis during the day. The remainder, which emanated from the retail environment, was settled in the evening. Directives for conduct in the payment system for system operators and third-party service providers will become effective during 2007. In May 2007 the Bank also commenced with the detailed oversight of non-bank participants in the national payment system. Specific focus is being placed on the operational soundness of payment clearing house operators. Following the promulgation of the National Credit Act, 2007, amendments were made to the National Payment System Act, 1998. These amendments outlawed any non-statutory preferential treatment of a payment instruction in any given payment system and paved the way for the implementation of a specific payment stream to process payment instructions randomly. Financial stability In support of its objective to achieve and maintain price stability, the Bank also seeks to identify inherent weaknesses in the financial system and monitor risks that may result in financial system disturbances. On the basis of an analysis of various financial soundness indicators the financial system was appraised as sound. The Bank also assessed the financial regulatory system in South Africa to be inherently robust in terms of the twelve key financial soundness standards identified by the Financial Stability Forum of the Bank for International Settlements (BIS). Some financial regulatory challenges remain. These include the implications of the recently introduced National Credit Act, the possible introduction of an explicit deposit insurance scheme, the review of South Africa’s membership of the Financial Action Task Force, initiatives to bring the hedge fund industry within the scope of current regulation, and the implementation of a new capital framework (Basel II) for banks on 1 January 2008. In co-operation with other stakeholders in financial stability, the Bank furthered its efforts to prepare and maintain suitable contingency plans and crisis management strategies to respond to systemic distress. In the year under review, a programme of financial sector continuity testing was initiated to help hone the responses of financial sector authorities to systemic threats. The Bank also participated in the Coordinated Compilation Exercise of the International Monetary Fund (IMF), aimed at developing capacities of countries to compile financial soundness indicators for the surveillance of financial systems. Banking regulation and supervision The Bank has the responsibility to ensure that the domestic banking regulatory environment stays abreast of international best practice. A key focus area remains the preparation for the implementation of Basel II. The implementation programme aims to effect the requisite amendments to the legal framework and ensures the successful implementation of Basel II on 1 January 2008. The migration to Basel II has necessitated intensified interaction with the banks. Interaction has included on-site visits by staff of the Bank, requests for and the processing of specific information to assess the impact of Basel II on the capital adequacy of banks, as well as readiness assessment meetings with banks. In accordance with the latest industry requirements and market developments, and with the prescriptions of Basel II in mind, a finalised draft Banks Amendment Bill was approved by the Standing Committee for the Revision of the Banks Act in November 2006. Parliamentary hearings on the draft Bill were held in mid-June 2007. The Bill is expected to be promulgated later this year, with implementation effective from 1 January 2008. The Regulations relating to banks (the Regulations) have been reviewed in totality to comply with the prescriptions of Basel II and to provide banks in South Africa with all the options and approaches offered under Basel II. A compliance assessment with the revised 25 Core Principles for Effective Banking Supervision of the Basel Committee on Banking Supervision was completed in October 2006. Based on this assessment, a gap analysis was completed and supervisors are implementing plans to improve the supervisory process with immediate effect where possible. Where necessary, amendments will be made to the Banks Act, 1990, and Regulations to ensure effective supervision. During the review period the level of compliance of the banking industry with the application of anti-money laundering and the combating of terrorist-financing legislation remained a focus area. About 40 suspect business or investment schemes, which gave the impression of being engaged in banking activity, are under investigation. International co-operation South Africa assumed the chair of the G-20 for 2007 and the Bank and the National Treasury have been jointly co-ordinating activities. The G-20 comprises systemically important developed and emerging-market economies. Two G-20 Deputies meetings, one in Pretoria and the other in Durban, and two African Policy Seminars, which were held on the fringes of the G-20 Deputies meetings, were hosted. Our term as host will culminate in the G-20 Summit of Finance Ministers and Central Bank Governors, which will be held in the Western Cape on 17 and 18 November 2007. Policy topics that will be considered include the reform of the Bretton Woods Institutions, commodity cycles and financial stability, and fiscal elements of growth and development. These topics were also the focus of G-20 seminars hosted in Brazil, the United States and Turkey earlier this year. The international relations of the Bank remain focused on strengthening co-operation with central banks and multilateral organisations. Special attention has been given to the African continent and the Southern African Development Community (SADC) region in particular, where efforts are geared towards the achievement of regional integration. The Bank continues to take a strong leadership role in the Committee of Central Bank Governors (CCBG) in SADC. In its role as leader of the SADC Payment System Project and under the auspices of the CCBG, the Bank has continued to facilitate the modernisation and harmonisation of the SADC regional payment, clearing and settlement systems. To date, the project has focused on the implementation of Real Time Gross Settlement systems, automated clearing and payment system oversight. Significant progress has been achieved in this regard and the current focus of the project is on areas such as remittances, retail payment system risk reduction, the securities settlement project and capacity building for payment system oversight. Further assistance will be provided to the Democratic Republic of the Congo and Madagascar in terms of the planning of their payment system development. The Bank continues to be an active participant in the activities of the BIS. The participation of the Bank in and its contribution to the Foreign Exchange Settlement Risk Subgroup of the BIS Committee on Payment and Settlement Systems ensured that the Bank keeps abreast of international developments in this area and promotes best practice. Closer bilateral relations with other central banks have resulted in the signing of Memoranda of Understanding with the central banks of China and Peru in the past year. In addition, the Bank has received numerous visits from other central banks which have allowed for more exchange of information. The Bank has maintained close relations with multilateral organisations. Our collaboration with the IMF and the World Bank has resulted in a number of joint seminars and courses being presented by the South African Reserve Bank College (College) in 2007. These are open to participants from central banks and finance ministries from the African continent. Internal administration The Annual Report of the Bank was distributed to shareholders before this meeting. The total balance sheet of the Bank shows an increase from R168 billion at the end of March 2006 to R220 billion at the end of March 2007. The increase was mainly the result of the accumulation of official gold and foreign-exchange reserves and was financed in the main by an increase in government deposits, an increase in currency in circulation and the effect of valuation adjustments to the net reserves as a result of exchange rate movements. These adjustments are reflected in the increase in the GFECRA. The profit before taxation of the Bank increased from R1 038 million for the previous financial year to R2 907 million for the financial year ending 31 March 2007. Budgeted expenditure of the Bank for the current financial year amounts to R1 879 million, compared to actual expenditure of R1 658 million in the financial year to 31 March 2007. This represents an increase of 13,3 per cent in budgeted expenditure compared to actual expenditure for the previous financial year. This increase is largely a result of the increased volume and cost of producing new currency. The four subsidiary companies of the Bank achieved their objectives during the financial year. After a review of reports by their Boards of Directors and internal and external auditors, the Bank is satisfied that these companies are managed in accordance with their objectives and best corporate governance practice. The results of the subsidiaries are reported on a consolidated basis with those of the Bank in the financial statements. The Bank continued to operate an over-the-counter market for the trading of its shares. During the financial year ending 31 March 2007, 24 transactions in respect of 94 700 shares of the Bank were concluded at an average price of R1,60 per share. On 31 March 2007, the Bank had 612 registered shareholders and by 31 August this number had increased to 630. The Bank views risk management as an essential element of good corporate governance and has therefore established a Risk Management Committee (RMC) to oversee the risk management process in the Bank. The RMC is chaired by a Deputy Governor and the four executive general managers of the Bank also serve as members. Business continuity planning for the Bank has been completed and extensive adequacy testing is currently being conducted. A consolidated information and communication technology disaster recovery facility was established to enable the successful recovery and continuation of critical business processes in the event of a disaster or serious disruption at the Head Office building. The sourcing of an enterprise resource planning solution for the Bank was approved and a suitable solution selected. This system will replace many of the old and ageing central services software systems in the Bank and also integrate data from disparate information systems into one unified system. The Bank continues to maintain and improve existing buildings and additions not only to enhance the value of its properties, but also to preserve the cultural heritage of the country and support country-wide inner-city development initiatives where possible. Major renovations and refurbishment are being undertaken at Head Office and the branches in Pretoria North, Johannesburg and Cape Town. A new branch is being planned for Bloemfontein and plans are under way to renovate the branches in East London and Port Elizabeth, while preserving the historical character of these buildings. Corporate art collections play a critical role in nurturing artistic talent. In the more than 53 years that the Bank’s art collection has existed, it has supported a wide range of emerging and established artists. A book depicting a selection of the more than 600 works of art, dispersed throughout Head Office, the seven branches and the College was published earlier this month and it is believed that this book will make a valuable contribution to the appreciation of art. The Bank continues to pay close attention to its human resources. The staff complement decreased to 1 934 at the end of March 2007, compared to 1 956 a year earlier. The overall staff turnover for the period was 6,8 per cent. The profile of new appointees was 84 per cent black, with 77 per cent of the management appointees black, and 45 per cent female. The profile of new appointees since 1 April 2007 until the end of July 2007 is 88 per cent black and 40 per cent female, with 80 per cent of the management appointees black, and 60 per cent female. The modernisation process pertaining to the revised Staff Policies was concluded and the policies implemented. The outstanding policies pertaining to outside occupations and directorships, as well as to ethics are being consulted with staff. An emphasis on wellness management continues, with the focus on physical and mental health. Disability management and HIV and Aids prevention continue to receive attention. Other measures taken include the provision of medical and psychological wellness services. The Bank continues to place an emphasis on developing its staff. In addition to students who have recently completed their degrees, the Cadet Graduate Programme will be expanded to also cater for staff members of the Bank. This will double the number of cadets to twenty in 2008. In an effort to guarantee future accreditation for its learnerships, the College has completed a process to ensure that all its learning programmes adhere to the principles of outcomes-based education. To stimulate research in the Bank, a research fellows programme has been introduced in terms of which senior researchers from other central banks and academia are invited to spend time at the Bank and engage in collaborative research. Three research fellows, two of whom are from abroad, have already spent time at the Bank in 2007, and a fourth is expected later in the year. Applications have been invited for the 2008 programme. To contribute further to the economic research effort in the country, a conference on macroeconomic policy challenges for South Africa was organised by the College in 2006. It included papers presented by leading academics from local and international universities, as well as other local economists. Conclusion From a monetary policy perspective this past year has been particularly challenging for the Bank. The international environment has been uncertain, and the recent turmoil in international markets means that further challenges and uncertainties lie ahead. Nevertheless, the Bank will continue to focus on achieving its mandate and will strive to bring inflation to within the target range. Low and stable inflation remains the best contribution the Bank can make to economic growth and development in South Africa. The Bank will continue to make a contribution to financial stability in the country. Apart from oversight and regulation of the national payment system, future challenges are likely to come from the introduction of Basel II at the beginning of next year, the possible implications of the National Credit Act, and the impact of higher interest rates on a highly indebted population. We will not lose sight of the need to give attention to the internal management of the Bank. The Bank remains committed to the training and development of staff in the broader context of its Employment Equity Plan. Acknowledgements I want to thank the Presidency, the Government and Parliament for their continued support. Through the system of bilateral committees, the Bank has maintained a good working relationship with the National Treasury. I wish to thank the Minister and Deputy Minister of Finance, and the Director-General of the National Treasury and his staff for their ongoing support and co-operation. I also wish to express my thanks to the members of the Board for their commitment to the Bank. Their efforts are important in ensuring effective corporate governance and strategic direction for the Bank. Last but by no means least, I wish to thank the deputy governors, management and staff of the Bank for their support and contributions to the successful running of the Bank. An organisation such as ours is only as good as the quality and commitment of its personnel. We are indeed fortunate to be able to attract an excellent group of employees.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the CEPR/ESI 11th Annual Conference on Global Imbalances, Competitiveness and Emerging Markets, Pretoria, 28 September 2007.
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T T Mboweni: Annual conference on global imbalances, competitiveness and emerging markets Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the CEPR/ESI 11th Annual Conference on Global Imbalances, Competitiveness and Emerging Markets, Pretoria, 28 September 2007. * * * Distinguished delegates This is the eleventh year that representatives from the academic world and central banks across the world meet to discuss topics that are very relevant in the prevailing macroeconomic environment. On this occasion, the organisers have selected the issues of global imbalances, competitiveness and emerging markets. From the programme, it is clear that we can look forward to some interesting views and insights into these issues. In my keynote address, I will focus on a few aspects relating to central banks, in particular in emerging-market countries, and the challenges faced in formulating and implementing monetary policy in a globalised financial system characterised by imbalances. When referring to global imbalances, the most obvious ones that spring to mind are the US twin deficits and global trade imbalances, which have probably been the most publicised imbalances over recent years. Yet the world is characterised by many other imbalances. Some of these are embedded in the structure of the world economy as it has developed over the centuries, such as the income gaps between developed, underdeveloped and emergingmarket countries. Others are more cyclical in nature. The current fallout in the US sub-prime market is an example of a reaction to a more cyclical imbalance caused by low interest rates, high liquidity and a general under-pricing of risk over recent years. Cyclical balances are normally restored through a combination of policy adjustments and market forces. However, this can be a painful process, as many financial institutions, investors and sub-prime mortgage lenders and borrowers that were directly affected by the recent events in global credit markets can bear witness to. Another example of a current cyclical imbalance is the extent of carry trades and build-up of long/short investment positions globally, which resulted from loose monetary policy in some countries and tighter policy in other countries, mostly emerging-market countries. This has enticed investors to borrow in the low-interest-rate currencies and invest in the high-yield currencies. Most cyclical imbalances result from the boom and bust characteristics of the global economy and financial markets. In his last speech, read on his behalf at the Jackson Hole Conference on 31 August 2007, the late Edward Gramlich had some interesting things to say about booms and busts. Essentially, he argued, American history showed that boom periods followed a pattern of initial discoveries, breakthroughs, widespread adoption, widespread investment, and then a collapse where prices cannot keep up and many investors lose a lot of money. In the bust that follows the boom, there is generally an overreaction, but after the dust clears investors emerge a little bit wiser and some of the benefits that led to the boom in the first place remain. The challenge to central banks, as well as to academic researchers, is to be able to see through the dust and noise of market talk, commentary, newspaper and television reports, speeches and comments by politicians and trade unions and many others with the interest of particular individuals or groups in mind. Instead, central banks need to make an effort to understand the processes that are underway and to apply the appropriate dose of policy measures, at the right time, for the longer-term benefit of the economy as a whole. This is much easier said than done. When considering the issue of global imbalances, one can imagine the world economy as a giant pendulum swinging to and fro. A stationary state of balance (what economists like to call equilibrium) never exists for very long, if at all. Indeed, Newton’s laws of motion, that for every action there is an equal an opposite reaction, can be equally well applied to the world of economics. A trend or event that pushes the economic pendulum to one side is usually corrected by a counter action, which can be brought about by means of countercyclical policies, or merely through the self-correcting nature of markets. However, while these booms and busts can be fascinating to analyse with the benefit of hindsight, they make the lives of policy makers considerably more difficult. Referring back to the analogy of a pendulum: it is easy to see from the side whether a pendulum is swinging to the left or to the right, but if you sit right on top of it, it becomes much more difficult to know exactly where the balancing point is. Central bankers are part of the global economy as it unfolds day by day, yet they have to judge the balancing point of policies that can affect the global economy and financial markets for many years to come. This is not an easy task, and policies can easily under or overreact to boom and bust cycles. Many of the global imbalances in the world today can be related to the process of globalisation, which facilitated almost unlimited cross-border flows of funds. The wave of financial globalisation and innovation that has flooded over financial markets during the past two decades has also complicated the formulation and implementation of monetary policy. I would like to also make a few comments in this regard. Globalisation has been brought about by a number of factors, including: - the increasing free flow of capital across national borders; - the emergence of global financial institutions; - a technological revolution that made geographical location almost irrelevant; - an explosion of new financial instruments; and - new insights and developments in the areas of asset management and risk management. These developments facilitated the significant cross border flows that emanated from global savings imbalances and a search for higher yields at a time when interest rates in developed markets were low. Emerging markets have been affected by these changes in very particular ways. Emergingmarket assets have increasingly become an acceptable and desired asset class in diversified global portfolios, recognised as both yield-enhancers and risk-reducers through diversification. This is partly attributable to the improved macroeconomic and financial profiles of many emerging markets. On the one hand, this appetite for emerging market assets has contributed to a steadier and more sustainable flow of funds to emerging markets: once accepted as part of an investment mandate, certain portions of portfolios are allocated to these assets for longer periods. On the other hand, large inflows of capital relative to the size of domestic financial markets have a significant impact on domestic asset prices, volatility, liquidity and external vulnerability. Domestic asset prices become very sensitive to changes in sentiment or risk appetite among global investors. Significant foreign investment flows to emerging markets have also to some extent contributed to imbalances between domestic and foreign assets and liabilities. Countries that have received large amounts of inflows, while enjoying the benefits of these, should always keep in mind that they are also building up increasing foreign liabilities, which are likely to affect future outflows of dividends and interest payments. This holds equally true for foreign direct investment and portfolio investment. There is also an ever-present risk that foreign investors could withdraw again if the global environment changes. South Africa is a classic example of a country with such an exposure, and it is precisely for this reason that the South African Reserve Bank has used the opportunity of increased flows to emerging markets to strengthen its foreign reserves position. These developments have complicated the formulation and implementation of monetary policy by central banks, in particular in emerging markets. Globalisation of financial markets has to some extent blurred the conventional ways in which markets react to monetary policy. As a result, the extent and direction of changes in asset prices in response to changes in monetary policy are becoming increasingly uncertain. For example, while conventional unhedged interest-rate parity theory predicts that exchange rates should strengthen when interest rates are increased, the South African experience of late showed that the opposite is just as likely. During the current tightening cycle, the South African rand on more than one occasion weakened when interest rates were increased, and appreciated when interest rates remained on hold. Clearly, in these instances global investors’ views about the impact of rates on the growth trajectory overruled other influences and conventional relationships. The build-up of carry trades globally has been mentioned earlier in this address as a current example of imbalances caused by different monetary policy stances among countries, within the context of globalised financial markets. The extents to which carry trades are conducted globally amplify the effects of relative changes in asset prices – not only for the high-yielding investment destinations, but also for the relatively low-yield origins of funding. Carry trades in their broadest sense comprise any investment made with borrowed funds. Short positions in low-yielding financial markets or instruments are typically used to fund long positions in high yielding markets or instruments. In practice, such funding can take numerous forms in the money, capital and derivatives markets across the world, making it very difficult for an individual government agency or central bank to obtain an exact indication of the extent of these trades in the domestic market. There is also much uncertainty about the triggers that could reverse carry trades, and the speed with which they could be reversed. These are all factors that add to the uncertainty of central bankers about the likely effects of their policies on financial markets and asset prices. A similar “black box” of uncertainty that can have an impact on monetary policy is the activities of hedge funds in global financial markets. We know that hedge funds influence markets in significant ways, but find it very difficult to determine exactly to what extent. Although the term is loosely used, it is not always clear which institutions should be referred to as hedge funds: traditional fund managers and so-called hedge funds seem to be moving closer together in their strategies and activities. Also, the complex structures of some derivative instruments and investment conduits make it almost impossible to determine who is exposed to whom, and to what extent. The current turmoil and illiquidity in the major financial markets is largely attributable to this uncertainty and lack of trust. Emerging markets, in particular, are vulnerable to the contagion effect, which is regularly illustrated. This has affected South Africa on a number of occasions during the past year and contributed to volatility in domestic financial markets. In times where risk aversion increases and investors pull out of riskier assets, the rand tends to be in the basket of currencies that suffers the most. This can be related to some extent to the liquid nature of the rand market. Nevertheless, despite the risks and complexities associated with financial globalisation, there are also clear benefits. Speaking from a South African perspective, the central bank’s inflation targeting framework has been well supported by the benign global inflation outlook over recent years, as well as by conditions in global financial markets that led to increased foreign capital inflows to emerging markets. The combination of global liquidity, combined with favourable conditions in the domestic economy, caused demand for South African equities by non-residents to increase at an exceptional pace, recording net purchases of R33 billion in 2004, R50 billion in 2005, R74 billion in 2006 and a record R66 billion in the year to 20 September 2007. In the bond market, activity has been a little more volatile, with nonresidents purchasing a net R365 million in 2004, selling a net R10,7 billion in 2005 and purchasing a net R34 billion in 2006. Partly supported by these activities, but also in line with global trends, the JSE’s All-share index recorded a succession of record highs, while domestic bonds hardly interrupted their five-year rally, despite a cumulative increase of 300 basis points in the Reserve Bank’s repo rate since June 2006. To date, the significant foreign portfolio inflows, combined with a favourable outlook for the domestic economy, have enabled the country to finance a relatively large current account deficit, which, in turn, was to a large extent driven by investment expenditure and infrastructural developments – hopefully efforts from which the country would benefit in years to come. Capital inflows have also enabled the South African Reserve Bank to increase official reserves to a much healthier level, contributing to a series of upgrades in the sovereign risk ratings, while the exchange rate of the rand has become much more stable compared to a few years ago. My comments have highlighted some of the uncertainties that central banks have to deal with in their policy making. I would like to also focus a bit on how these challenges should be approached. Good central bankers and good academics have a number of unique characteristics in common, which distinguish them from other market participants when faced with uncertainty, volatility and imbalances. Firstly, they both have to take a long-term view, focusing on their primary objectives. Investors and politicians often worry more about their next quarterly results or the outcome of the next election than about the shape of the overall economy in five or ten years’ time. They can exert significant pressure on central banks to apply policies that are likely to benefit their own positions. By contrast, central bankers and academics should try to focus beyond the prevailing noises of volatility, imbalances and uncertainties and focus on long-term objectives and relationships. This requires independence and the ability to resist pressures to succumb to short-term gains rather than long-term benefits. A second commonality between central banks and academics is that they should be impartial and objective, acting without self interest: Monetary policy, like academic research, should be based on sound and consistent principles and methodologies. A third commonality is that, however good a policy or research output may be, it has to be communicated effectively. Even the most brilliant new theory or discovery will be of no value if it cannot be communicated and understood by the target audience. Similarly, monetary policy loses its effectiveness if it is not understood and if the central bank does not have credibility. The uncertainties, complexities and imbalances that exist in the global economy make appropriate communication strategies by central banks all the more important. Clear and regular communication about policy objectives, the policy outlook, risks and objectives becomes an increasingly important policy instrument, in addition to setting interest rates. It is at conferences such as this one that central banks and academic researchers can meet, exchange views and support each other in their commonalities. Policy makers have an opportunity to learn from new theories that emanate from academic research, while academics have an opportunity to apply their minds to current, relevant and complex problems facing the global economy. I look forward to a stimulating programme. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Cape Town Club, Cape Town, 5 October 2007.
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T T Mboweni: What is happening in financial markets? Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Cape Town Club, Cape Town, 5 October 2007. * * * Honoured guests, Ladies and Gentlemen 1. Introduction Thank you for providing me with the opportunity to address you this evening on the recent turmoil experienced in global financial markets which began in July this year. At the time of our last Monetary Policy Committee meeting in August, the turbulence on the international financial markets had intensified and it was unclear how developments would unfold. As we prepare for the MPC meeting next week, the dust appears to have settled. In fact, if one looks at the conditions in the financial and commodity markets today and compares them to the conditions prevailing in mid-July, one would not think there had ever been any disruptions. My remarks to you this evening will focus on the developments in the international and domestic financial markets, potential implications for global growth and the policy implications. 2. The build-up to the turbulence For the past few years now, global financial markets have prospered and seen innovation and integration on an unprecedented scale, leading to more prominent roles being played by investors such as hedge funds, and new derivative instruments and structured products. This boom in financial markets was a result of low interest rates in developed markets, and the financial system being flooded with liquidity. Investors, in an attempt to earn higher returns, invested in riskier assets. As more and more investors jumped on the bandwagon, and demand for riskier assets increased, the excess yield these assets offered diminished. However, this strategy remained beneficial given that the global economy was characterised by low and falling inflation and robust economic growth. This demand for excess yield gave rise to, amongst other things, the boom in the US sub-prime market. The economic and financial environment has almost been a utopia situation in certain respects, displaying a remarkable resilience, even during recent periods of correction. However, this resilience only served to increase the level of complacency about the nature of the risks involved. The central banking community had consistently expressed concern about the level of pricing observed in markets, which did not seem to adequately reflect the level of risk being taken. Now, the sub-prime “bust” has led to a tightening of both liquidity and credit conditions, creating turmoil in financial markets. I am reminded of a comment by Warren Buffet: “It’s only when the tide goes out that you learn who’s been swimming naked.” 3. Recent financial market turbulence A rising wave of risk aversion prompted by increasing foreclosures in the US sub-prime mortgage market resulted in an abrupt deterioration in global financial market conditions in August 2007. Rising foreclosures and delinquencies were linked to sub-prime borrowers who had taken out adjustable rate mortgages. As interest rates reset to higher levels, in line with the rising US interest rate environment, these borrowers found it difficult to pay their mortgage loans. This turbulence was not confined to the US sub-prime market, spreading to the broader mortgage market and financial markets more generally. In mid-June and July, the ratings agencies cut the ratings on a number of securities backed by sub-prime loans and put on review a number of mortgage backed securities for downgrade. Soon after, US foreclosures were reported to be almost 90 per cent higher than the previous years’ level. Two large hedge funds were shut down as a result of exposure to the sub-prime market. Thereafter, some large sub-prime lenders collapsed, while holders of sub-prime residential mortgage backed securities also suffered losses. These events resulted in a tightening in underwriting standards, with fewer households qualifying for subprime loans. Investors reassessed their tolerance for risk, most notably for structured financial products and for securities of highly leveraged firms. All of these events culminated in increasingly impaired short-term and interbank funding markets in August. Many issuers of asset-backed commercial paper programs found rolling over their paper increasingly difficult. This occurred due to a lack of transparency in the financial system, with no-one quite sure of whom owns what and therefore uncertainty regarding the losses faced by financial institutions and their counterparties. Investors started treating all counterparties with suspicion. The exposure to the sub-prime market became all the more pervasive, with banks and hedge funds in the US, UK, and Australia, to name a few, indicating exposure to this market. The global nature of the problem was particularly highlighted when the second largest bank in the Eurozone froze access to certain of its investment funds on 09 August 2007. Risk aversion increased over this period, as clearly witnessed in the almost 200 basis points drop in the US three-month Treasury Bill yield in early August. Banks began to hoard cash to cover their funding needs and as interbank liquidity dried up, banks found it difficult to raise term funding. Surging liquidity demand spilled over into the short-term money market, causing overnight interest rates to soar. Volatility in financial markets, as measured by the VIX 1 index, moved from 14 index points on 17 July to touch a record 31 index points on 16 August. Volatility at levels of around 20, has generally led to a re-pricing of riskier assets. Major equity markets lost between 8 and 12 per cent, with the Japanese equity market worst affected as it was dealt a double blow with the appreciation of the Japanese yen. Emerging market equity markets followed their international counterparts lower as risk aversion increased and investors fled to safe haven assets. The Morgan Stanley Capital International (MSCI) index for emerging markets lost over 16 per cent. The “flight to safety” led to a precipitous fall in developed bond market yields. In the space of a month, the two-year US Treasury yield dropped almost 70 basis points, below 4,00 per cent. The EMBI plus spread above US Treasuries widened by 82 basis points to 250 basis points. Currency markets also experienced increased volatility. The USD appreciated from USD1,38 to USD1,34 against the euro, and appreciated against most major and emerging market currencies. The Japanese yen (JPY) was the exception, as it appreciated by 9,0 per cent against the USD from over JPY122 at the end of July to JPY112 in mid-August, reflecting the role that Japanese interest rates played in supporting risk-taking in recent years. The unwinding of carry trades in particular supported the JPY. The same trend was witnessed in the International Monetary Market data which showed a significant turnaround in speculative forward currency positions from net short JPY positions in July to net long positions in August. VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a measure of the implied volatility of S&P 500 index options. It represents one measure of market's expectation of volatility over the next 30 day period. 4. Central banks react Central banks responded in order to prevent a potential financial crisis caused by neardysfunctional money markets in developed countries. Since 9 August 2007, the Fed and ECB offered three-month term funding, and together with other central banks injected significantly more liquidity into the financial system. The types of securities against which banks could borrow were broadened by the Fed and ECB to include mortgage backed securities – the Fed went a step further and accepted asset-backed commercial paper. The relaxation of key restrictions on lending between banks and broker/dealers also helped to reduce liquidity pressures as it allowed banks to fund their own and other non-bank dealers more easily. On 16 August, the Federal Open Market Committee lowered its discount rate by 50 basis points, returning some calm to markets. In the case of the United Kingdom, it was necessary for the Bank of England to provide emergency liquidity assistance to one financial institution, Northern Rock. As central banks rarely provide this kind of assistance easily to one institution, financial markets will continue to keep a watchful eye on possible subsequent developments in the United Kingdom. The most significant action, however, was the 50 basis points reduction in the target federal funds rate and a further 50 basis points reduction in the discount rate by the FOMC in midSeptember. This had a pronounced impact on financial markets. Risk appetite returned, and the VIX index declined from over 31 index points to 19 index points by 21 September. Stock markets rebounded between 7 and 16 per cent and bond yields increased as investors moved back into riskier assets. The increased risk appetite over this period led to the JPY reassuming its depreciating trend, from JPY112 in mid-August to JPY116 on 21 September. The USD, however, depreciated to over USD1,40 against the EUR, breaching the USD1,40 level for the first time on 20 September, pressured by interest rate expectations. Market expectations of monetary policy have changed markedly since these events from a general environment of tighter monetary policy to easier monetary policy. Commodity prices have reached highs not seen for over 20 years. The gold price has moved above USD740 per fine ounce, but sadly, oil prices have also risen, to over USD80 per barrel. Emerging markets also regained their composure since the Fed lowered its target federal funds rate. The MSCI for emerging markets gained over 25 per cent since mid-August and the EMBI plus spread declined by 56 basis points. It is notable however, that throughout this crisis, there has been limited reaction from emerging markets. One can ascribe this to healthy economic fundamentals. Emerging markets over the past few years have increased their reserve levels significantly, reduced their external balances and debt servicing. Equally important is the fact that debt buybacks have continued and net external debt reduction is still prevalent in many key emerging market countries. Thus, overall, it would appear that emerging markets are far less susceptible to credit events than they may have been in the past. 5. South Africa’s experience South African money markets were relatively unaffected by these events as our banking system had negligible exposure to the subprime market. Liquidity conditions domestically remained healthy, and there was no need for the South African Reserve Bank to provide extra liquidity to markets. However, South African financial markets did not go unaffected. After trading below R6,80 against the USD in July, the rand depreciated to over R7,60 in mid-August. Domestic bond yields increased and the Alsi retreated quickly from the almost 30 000 level reached in July to below 26 000 in August. As calm returned to the markets, so the rand appreciated to below R7,00 against the USD, the Alsi ratcheted up gains above the 30 000 level, surpassing the record highs reached before the crisis, and government bond yields declined. As with many other emerging economies, South Africa’s macroeconomic position places it in good stead. Despite the turmoil in global financial markets, non-resident interest in South African assets remained positive. In fact, for the month of August, South Africa witnessed record purchases of domestic bonds by non-residents. Nonresident purchases of South African shares exceeded R10 billion. Nonetheless, the sustainability of these inflows will depend in part on global liquidity conditions as well as domestic growth prospects. Conditions in the local foreign exchange market also allowed for further accumulation of foreign exchange reserves. There does not appear to be any evidence at this stage that the recent turbulence in the international financial markets will have marked effects on the domestic growth outlook, although this will depend to some extent on the impact of these developments on the US growth performance. 6. Implications for global economic growth Whilst initially the developments in the financial markets appeared to be limited to a liquidity problem, they later transpired to present a credit problem as well. The big question now is to what extent these developments will affect the real economy. It seems logical that the US economy will bear the brunt of the damage of the sub-prime crisis. The tightening of lending standards and therefore the restrictions of credit extension to weaker households could exacerbate the housing downturn in the US even further. Dampened business sentiment and falls in the equity market, combined with the weaker housing market and deterioration in consumer sentiment could mean a more intense negative impact on wealth. The most recent evidence by way of economic data releases seems to suggest that the problems in the housing market may be deeper than initially assumed and harbour real risks for consumption and growth. The recent policy actions from the FOMC very much seem to acknowledge this change in prospects. As the IMF has noted, most of the world will likely emerge relatively unscathed from this crisis. The recent shifts away from the US as being the key driver of global growth, together with the better balance achieved during the last two years represents significant support for the global economy. However, the ramifications of any sharp slowdown in the US always remain and should not be underestimated. As for emerging markets, lower external debt, better reserves levels, more prudent fiscal management, leading to much more improved fundamentals, have undoubtedly already delivered dividends. Whilst the global economy is deemed to be robust enough to shake off US weakness, contagion effects means that the sub-prime problems can contaminate other countries. As noted, emerging markets are better prepared for, but certainly not immune to global financial market risks. A reduction in global risk appetite would curb net capital inflows into emerging markets, placing downward pressure on emerging market currencies and in turn exacerbate inflationary pressures. 7. Policy implications The recent events and actions by central banks around the world have raised an interesting debate on “moral hazard”. It raises the question of whether central bank support of the markets does not amount to a bail-out of careless investors, thereby paving the way for more careless behaviour in future. In a recent speech by Federal Reserve Bank Chairman, Ben Bernanke, he noted that well-functioning financial markets are essential for a prosperous economy. Central banks need to ensure the functioning of financial markets, but in a very difficult balancing act, also need to guard against recreating conditions of careless lending that preceded the market turmoil. In this context it is important to point out that central banks can ill-afford to take any chances with systemic risks. In the process of addressing problems “for the greater good” there could be some by-product of unintentionally providing help to those who do not quite deserve it. This was the dilemma faced by the Bank of England when it eventually had to provide assistance to Northern Rock. But this should never allow financial market participants to work on any assumption of some inbuilt automatic guarantees against failure. As the IMF points out in its September 2007, Global Financial Stability Review, policymakers and market participants need to learn from the present situation and make amendments to the global financial system in order to strengthen it. Key in this is the recognition that there needs to be improvements in a wide range of areas: • Greater transparency between on- and off-balance sheet entities, so that the market is able to properly differentiate and price risk. • better risk monitoring; • improvements by ratings agencies; • better valuations of complex financial instruments and products; and finally • wider risk perimeters that go beyond the accounting and legal perimeters. Policy makers in both mature and emerging markets therefore face considerable challenges going forward, to ensure the stability of the financial system and continued healthy global growth. 8. Conclusion In recent weeks, the present situation has been likened to events in 1998 or 2001. However, what should be borne in mind is that the current situation has occurred against the backdrop of broad-based strength in the global economy. A deeper understanding of what led to the turmoil is required, lessons need to be drawn and where necessary, improvements made. The correction we have observed may have proven painful for many, and I have little doubt that the pain is not yet over. Ultimately, the correction should be seen as positive for the financial sector and the economy overall, especially if spill-over to the real economy can be contained. Hopefully it will allow for more differentiation in pricing of credit and less aggressive mortgage lending and leveraged loan practices, and in so doing, compensate investors and lenders more appropriately for the risks they are taking. I thank you.
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Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 13th Chintaman Deshmukh Memorial Lecture, organised by the Reserve Bank of India, Mumbai, 2 November 2007.
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T T Mboweni: Fasten your seatbelts! Monetary policy challenges in turbulent times Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 13th Chintaman Deshmukh Memorial Lecture, organised by the Reserve Bank of India, Mumbai, 2 November 2007. * * * Governor Reddy, Deputy Governors of the Reserve Bank of India Honoured Guests The Consul General of the Republic of South Africa Members of the India-South Africa Business Forum Ladies and Gentleman 1. Introduction Thank you for your kind invitation. I am delighted to be in India for the first time at this juncture as you celebrate the 60th anniversary of your independence and enjoy the international spotlight as the result of your splendid economic performance. It is a great pleasure and privilege to deliver this address today for two main reasons. Firstly, this lecture is in honour of a truly great person, Mr Chintaman Deshmukh. The contribution of Mr Deshmukh to the Indian economy cannot be exaggerated as is borne out by his long service to this country as Governor of the Reserve Bank of India, member of the Planning Commission of the Government of India, Minister of Finance, Vice-Chancellor of the University of Delhi and as President of the Indian Statistical Institute from 1945 to 1964, amongst others. Secondly, I understand that this lecture series has been graced with the presence of some truly remarkable speakers. I am indeed very grateful to be accorded the privilege to deliver this the 13th lecture in this series. The relationship between South Africa and India is a very strong one today. This relationship, however, goes back a long way in history. President Nelson Mandela, the former President of the Republic of South Africa encapsulated this quite well when he said that “India and South Africa are two countries held so closely by bonds of sentiment, common values and shared experience, by affinity of cultures and traditions and by geography” 1 . The contribution of one of your and our favourite sons, Mohandas Karamchand (Mahatma) Gandhi, and the support received from the Indian authorities during the liberation struggle went a long way towards assisting South Africa to achieve democracy in 1994. The important role that India played in South Africa’s transition to democracy is without question and highly appreciated back home. Currently, strategic relationships on the bilateral and multilateral fronts hold promising opportunities of mutual benefit for both our countries. Already, bilateral trade between India and South Africa has increased by well over 100 per cent in the past four years and a Preferential Trade Agreement between South Africa and India aims to treble trade by 2010. In addition, South Africa has been benefiting from India’s rich entrepreneurial and educational skills base, with many teachers and other skilled personnel being employed in various institutions in our country. India Digest, vol 4, 1996. South Africa is currently India’s biggest investment partner in sub-Saharan Africa, serving as an important entry point into the rest of Africa. Indian investments in our country have grown significantly over the years, and have become more diverse, ranging from vehicles (Tata, Mahindra), steel (Arcelor Mittal), telecommunications (Neotel) and pharmaceutical companies such as Ranbaxy. Investments from South Africa to India are also growing. South African Breweries acquired stakes in various Indian breweries. Other areas in which South African companies have invested include insurance, diamond exploration and infrastructure. In February 2006, Airports Company of South Africa (ACSA) won the contract for upgrading the Mumbai Airport. I also gather that SASOL is interested in a coal-to-synthetic automotive fuel project in India and many other South African companies have signed up marketing contracts with Indian companies in the pharmaceutical sector. On the multilateral front, initiatives such as that involving India, Brazil and South Africa (IBSA) and Brazil, Russia, India, China and South Africa (BRICSA) provide useful platforms for the strengthening of ties between our two countries and the South-South economic relations in general. In addition, over the last few years India, South Africa, Brazil and China have been recognised as systematically important countries to the extent that they have been regularly invited to the G-7 meetings in order to contribute to the discussion on global economic and financial matters. On the one hand, this participation has taken place usually on the fringes of the main G-7 meetings, thus raising the question about the seriousness with which the G-7 countries give to these meetings. On the other hand, these four countries have started to meet on a regular basis in order to strengthen co-operation on issues of common interest. As you may well be aware, one of the burning issues at the moment relates to increasing the “voice” or representation of emerging market economies in the international financial institutions such as the IMF and World Bank. This issue, together with other matters relating to the reform of the Bretton Woods Institutions have also been key agenda items addressed this year during the preparatory meetings for the G-20 meeting of Ministers of Finance and Central Bank Governors. As we know, South Africa currently chairs the G-20 Forum and it will be our pleasure and privilege to welcome the Indian G20 delegation in South Africa during November. There are many issues which are the centre of focus to the G-20 this year, but most prominently are the fiscal elements of growth and development and the impact of commodity prices on member countries. South Africa and India do not only share common policy positions on many of these issues, but have also been very active in advocating the interests of emerging market economies in this new world order. Both countries have benefited from the economic reforms implemented over the last decade or so. However, both countries have similar economic challenges which in the main relate to, inequality, poverty alleviation and the reduction of unemployment. As a central banker, I wish to dwell on some issues and challenges facing monetary policy in emerging markets. 2. The Great Moderation One of the defining characteristics of global economic developments over the last three decades has been termed the “Great Moderation” – the sustained decline in the volatility of output and inflation. This development has been due to the structural changes that many economies have undergone. Some have attributed these changes to the implementation of better policy options and others to simply good luck. Professor Kenneth Rogoff of Harvard University has argued on many occasions that improved competitiveness as a result of increased globalisation coupled with better policies has had a major positive impact on inflationary trends in many countries. The declining trend in inflation since 1990 is clearly evident in India and South Africa. Inflation in India has declined steadily from an average of 10,3 per cent between 1990 – 1994, to 8,9 per cent between 1995-1999 and to 4,3 per cent in this decade. Similarly in South Africa, inflation has declined from an average of 12,5 per cent, to 7,3 per cent and to 5,1 per cent over the same time periods. The economic growth performance of both countries has also been quite impressive. Since 1990, India has experienced average growth rates of around 6 per cent per annum, increasing to an impressive 9 per cent in the last two years. It is now widely expected that the Indian economic growth rate trajectory would be very close to, if not, in double digit territory in the short to medium term. South Africa has not been performing badly either, with an average economic growth rate of about 3,4 per cent per year since the advent of democracy in 1994, compared to an average of below 1 per cent in the previous decade. Over the last three years, however, growth has averaged about 5 per cent and the current trend in the economic growth rate is the longest experienced in the country's recorded history. 3. Improved macroeconomic performance: some side-effects A side-effect of strong economic growth in many emerging market countries is the growing middle class. This has been particularly true for both India and South Africa. The rapid emergence of this middle class brings opportunities that will have a significant impact on future prosperity but also poses a rather unique set of challenges for policymakers. With increasing affluence, there is bound to be a change in consumption levels and patterns. Related policy concerns centre on the implication of these changes on the demand for credit, the level of imports and the effect on asset markets. Then, there is the added concern that the unequal distribution of wealth brings with it a tension between the haves and the have-nots. Under these circumstances, the broadening of access to financial services becomes an important policy objective. It is well recognised that the financial inclusion of the lower echelons of society into the financial sector is a powerful contributory factor to poverty alleviation through, for example, the provision of microfinance. As the demand for consumer finance increases, a greater range of financial instruments are needed and the financial sector will need to adapt. Over the past few decades, alongside financial deepening, household debt levels have been on the rise across a number of countries, both in developing and advanced countries. Rapid increases in household indebtedness have been associated with increases in asset prices, mainly house prices. These developments have indeed increased the probability of defaults, stemming in the main from adverse external shocks and rising interest rates. Whilst household debt ratios in emerging market countries like South Africa are low in comparison to developed countries, the rapid rise in household debt and credit levels has raised some concerns. In addition, high levels of inequality could mean that some groups are more affected than others. Hence, the close monitoring of lending practices and detailed reviews of credit standards can contribute towards the integrity and stability of the financial system. In the case of South Africa, an Act of Parliament (the National Credit Act) was introduced to address this issue. It is still too early to ascertain the impact that this Act has had on borrowing and lending practices in South Africa. There is little doubt that positive outcomes may be realised. 4. The role of monetary policy Central Bankers have more often than not found that the role of monetary policy in the economic growth process is not fully understood or appreciated by all stakeholders. Let me use the South African case to illustrate this difficulty. Monetary policy in South Africa is implemented within an inflation targeting framework – the target range being an inflation rate, namely CPIX (headline inflation less mortgage interest costs) of between 3 and 6 per cent. CPIX inflation in South Africa has been outside the upper end of the target range for the past six months. In addition, there has been a deterioration in the inflation outlook. This has mainly been (initially) as a result of higher international food and fuel prices as well as robust consumer spending. However, underlying pressures have also become more broad-based. Although credit growth has slowed somewhat in response to previous monetary policy tightening, persistently high food and fuel costs have meant that the risks to the outlook are on the upside. Inflation expectations have consequently risen to the top end of the target range, with possible adverse implications for wage and price-setting decisions. These risks to the outlook have necessitated the tightening of monetary policy from 7 per cent in May 2006 to 10,5 per cent currently. The tightening of monetary policy has not gone down well in all parts of society. Not everyone appreciates that sacrifices – albeit short term sacrifices – are sometimes needed to secure medium to long term benefits. In general, due recognition is not always accorded to the role that price stability plays in securing sustainable economic activity. In our modern world where remote controls and microwave ovens are the order of the day, not everyone – market participants included – always comprehend or appreciate that monetary policy operates with a relatively long lag. So in essence, one of our primary challenges as Central Bankers relates to the issue of regular and consistent communication. Communicating monetary policy has become complicated because the transmission channels have become somewhat clouded. Structural changes in the economy have had an impact on functional relationships, with the result that the transmission mechanism of monetary policy has become more complex. Advances in econometrics and economic theory have facilitated the construction of sophisticated structural models incorporating complex behavioural relationships. However, as Professor David Hendry argues, forecast errors are very often the result of unanticipated large changes or shocks within the forecast period 2 . Hence, anecdotal evidence that provides a better understanding of the risks to the inflation outlook is essential to monetary policy-making. As the Chairman of the Federal Reserve Board, Mr Ben Bernanke recently remarked, good economic forecasts “involve art as well as science” 3 . The recent South African experience has shown that some of the conventional observations do not always hold in practice. For example, the South African currency (the Rand) has on more than one occasion weakened when interest rates were increased or appreciated when interest rates were lowered or when they remained unchanged. Furthermore, emerging market currencies in general are subject to extreme volatility resulting from shifts such as was the case with the USD recently, having an impact on domestic monetary conditions. An added challenge relates to the fact that many emerging market countries have a relatively short track record of credible monetary policy. Credibility is earned over time and yet it is central to the anchoring of inflation expectations. Communication is further complicated by the global context in which inflationary pressures occur. On the one hand, there are downward inflationary pressures as a result of lowerpriced goods due to globalisation. On the other hand, increased trade protectionism, coupled with rising commodity prices due to robust world growth, pose risks to price stability. China and India play a significant role in the global economy today. This assertion to many is without question. The disinflationary benefits of globalisation have been manifested in China’s contribution to lower global inflation over the last decade, through lower import prices of manufactured goods, more specifically clothing and footwear. India has also played an important role through the supply of low-cost knowledge based services such as in the field of information and communications technology (ICT). However, the utopia of strong economic growth with low inflation may be reversed as China and India, because of their appetite for commodities, contribute to the surge in commodity prices, notably in base metals Clements, M. P., and Hendry, D. F. (2002). Explaining forecast failure in macroeconomics. In Clements, M. P., and Hendry, D. F. (eds.), A Companion to Economic Forecasting, pp. 539-571. Oxford: Blackwells. Bernanke, B.S (2007). “Inflation expectations and inflation forecasting”. Monetary Economics Workshop of the National Bureau of Economic Research Summer Institute, Cambridge, Massachusetts. and minerals, especially oil prices. China and India have been the world’s fastest growing energy markets with oil demand currently increasing at around 6 per cent for China and 5 per cent for India. As is not foreign to this gathering, oil prices have reached nominal high levels recently, thus placing upward pressure on inflation and complicating the task of monetary policy, specifically in the anchoring of inflation expectations. Regarding the commodity boom, South Africa is faced with a double-edged sword. Whilst the demand for commodities boosts export revenues, surging energy price increases have had a significant upward pressure on import costs and inflation in South Africa. 5. Global financial market integration Global financial market integration has increased significantly in recent years, posing further challenges to the conduct of monetary policy. There are divided opinions on the advantages and disadvantages of global financial market integration, but to a large extent most would agree that globalisation has been positive insofar as it has imposed market discipline on policymakers. There are many who think that globalisation increases economic growth prospects and reduces volatility. In some respects, globalisation and financial market integration also make policymakers aware of the importance of independent central banks. Market participants are more comfortable in situations where central banks are see (and actually are) going about their primary objectives without fear, favour or interference from not only the political executive but all other stakeholders. One of the main challenges of this new global environment relates to the so-called “contagion effect”. The 1997/1998 global financial crisis is one example. Another more recent example relates to developments in the US sub-prime market. To begin with the 1997/1998 crisis, economies with relatively weak macroeconomic fundamentals were punished the most. South Africa, in particular, at the time suffered from capital outflows, a depreciation of the currency and subsequently inflationary pressures. As a result, monetary policy had to flow with the tide, and interest rates were increased by a full 7 percentage points between April and September 1998. However, as painful as the process was, not only for South Africa but most emerging markets, lessons have been learnt and major reform of existing financial structures and adjustment in macroeconomic policies emerged. The 1997/1998 crisis highlighted concerns surrounding debt sustainability. As a consequence, many emerging market countries reduced their domestic and external debt, and in the process, reduced currency mismatches which in some respects rendered these emerging markets less vulnerable to currency depreciation. There have also been efforts to reduce the external vulnerability through debt buybacks, while reserves accumulation has also been gathering pace over the past few years. India’s reserves are the world’s seventh largest at over USD250 billion. While South Africa’s are but a fraction of this, one needs to bear in mind that we have moved from a position of a negative net open forward position of almost USD26 billion at the end of 1998, to positive net reserves of US$28 billion, the result of which means that today the country boasts an investment grade rating. Furthermore, central banks have shifted towards market-based instruments which enhance their ability to respond to shocks. India is one such example, with the increased use of repo and reverse repo operations since the early 2000s, increasing the role of interest rates in the transmission mechanism of monetary policy. In South Africa’s case, we have come a long way in terms of the development of our own bond market, a process in which the South African Reserve Bank played a major role for a very long time. Today, we have a very deep and liquid bond market, if not the most liquid bond market in the emerging market economies. The positive impact of these financial market and macroeconomic developments have been put to the test on numerous occasions since the 1997/1998 crisis. The most recent event has been that of the US sub-prime mortgage market. This episode has been well documented and I shall therefore not spend time on its detail. As you are aware, it was a liquidity and credit crisis, emanating from financial institutions having exposure to the sub-prime market and thereby incurring huge losses as delinquencies and foreclosures increased in the wake of tighter monetary policy. Although the sub-prime mortgage market was an issue related to the US, the adverse developments were transmitted to other developed and emerging markets without much relation to domestic developments. At the height of the crisis, developed and emerging market equities were sold. Foreign exchange markets witnessed a significant increase in volatility as carry trades were rapidly unwound and emerging market spreads rose significantly between late July and mid-August. However, the rise in emerging market debt spreads was not quite as pronounced as that of credit markets in developed economies. Spread movements also reflected higher risk credits moving the market in either direction. Although South African financial markets were affected by the events surrounding the subprime crisis, our money markets were relatively unaffected. Our banking system had very little exposure to the sub-prime market and liquidity conditions domestically remained healthy. As such, there was no need for the South African Reserve Bank to provide extra liquidity to markets. Throughout this turmoil, the principal challenge for the Monetary Policy Committee has been to address inflation concerns. Inflation developments in South Africa have been such that at a time when global monetary policy seems generally to have turned from a tightening bias to an easier or neutral stance, our MPC has had to tighten monetary policy. Since the recent turmoil experienced in financial markets, money market conditions have eased considerably, most notably in the US, following the Fed’s decision to cut interest rates by a cumulative 75 basis points. Money market conditions in Europe, however, remain a little more strained, probably partly due to the fact that a significant amount of the structured investment products were in fact purchased by European and other overseas investors. Up until the end of October, financial markets recovered, with equity markets in particular bouncing back to levels higher than at the time of the turmoil. However, experience has taught us that financial market gains could easily be reversed in times of uncertainty. Emerging markets could still feel the impact of an abrupt and sustained change in global financial conditions and international investor appetite for risk. Such a scenario could play out in the event of a significant slowing in global growth and rapid reversal of capital inflows in spite of better macroeconomic fundamentals. In a more globalised world, emerging market economies may be more vulnerable to shocks originating in developed economies than was the case previously. Under these circumstances, extreme vigilance on the part of policymakers remains the order of the day. The current uncertainties in global financial markets will remain fixed on the radar screens of policymakers for some time to come. 6. Conclusion In an interdependent world, the effects of uncertainties will not only be exaggerated but could also affect innocent third parties. We have to remain vigilant to global and domestic developments in order to ensure that prosperous outcomes are not unduly threatened. Under these circumstances, policymakers have to ensure that strong economic fundamentals are maintained. The role of monetary policy in this process should not be underestimated. For emerging economies, like India and South Africa, the challenge remains to reinforce and build on the achievements of the last decade or so. Thank you very much, once again dear colleagues and Governor Reddy for inviting me to deliver this address. I will leave this remarkable country truly inspired and I am certain that this is not my last visit to this beautiful country. Thank you for your attention.
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Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at a public lecture, Windhoek, Namibia, 4 April 2008.
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T T Mboweni: Origins and causes of recent financial market turbulence and its implications for the CMA Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at a public lecture, Windhoek, Namibia, 4 April 2008. * * * Introduction Thank you for your kind invitation to speak to you about the recent financial market turbulence and its implications for the Common Monetary Area of Lesotho, Namibia, South Africa and Swaziland, or CMA. As you may know, this morning the Governors of the four CMA central banks had a meeting which was hosted by the Bank of Namibia to discuss matters of mutual interest and exchange observations on economic developments in the region. It is always a delight to visit Namibia, renowned for its friendliness, and this lecture gave me an excuse to extend my visit to your beautiful and super-tidy capital. Unfortunately, one should add a footnote to the reference in the topic of my lecture to the “recent financial market turbulence”: As we are all aware, the turbulence is still ongoing. I will first touch upon the build-up to the turbulence in the international financial markets, and use a number of indicators to illustrate the turmoil. This will be followed by some observations regarding international policy reactions to the disturbances. Thereafter I will pinpoint a number of key implications for the CMA, before concluding. The development of the turbulence in the international financial markets Significant developments in the global economy seldom start in isolation. Rather, most episodes are extensions of or reactions to previous episodes. With any analysis, one has to start somewhere – but be mindful that important dimensions may be lost by doing so. We can largely trace the origins of the current turmoil to the United States (US) housing market. I would like to go back to the mid-1990s, when property prices in the US started rising alongside increasing income levels and positive demographic influences on the demand for housing. This upward momentum continued, despite the sharp fall in prices in major share markets early in 2000. Partly in order to stem the negative impact of the share price decline on economic activity, monetary policy became accommodative in the US. This attempt at moderating the slowdown in economic activity seemed to be successful. At the same time, the low interest rates and rising levels of income bolstered the real-estate market, with house prices in the United States going from strength to strength. A long period of rising prices creates an expectation that the trend will persist. Economic agents – and not only unsophisticated ones – may be drawn into this belief, and may adjust their behaviour accordingly. By doing so, they may well reinforce and extend the duration of the trend. Translated to the US housing market, there was a fairly widespread belief that acquiring fixed property was a sure way to make a profit, because rising house prices would cover any cost of borrowing or the opportunity cost of owners’ equity, and still leave a handsome return. This drew numerous borrowers into that market, and caused lenders to happily extend mortgage loans to such borrowers. Many of these borrowers were borrowers in good standing, and their business continues to be good to this day as they continue to repay their mortgage instalments and as the market values of their fixed property continue to exceed their mortgage debt. But there were also home loans extended to very risky borrowers, with little or no income and few, if any, assets. A significant number of these were extended to so-called subprime borrowers – meaning the borrowers were of below-prime quality. (It does not mean that they got an interest rate below the prime rate! Given their riskiness they were usually charged higher-than-average interest rates.) The “security” in this instance was primarily a belief in the continuation of the uptrend in property prices and the ability of homeowners to rent out these dwellings. One of the catchwords of the time says it all: NINJA loans, or loans to borrowers with “No Income, No Job or Assets”. According to the Chairman of the Board of Governors of the US Federal Reserve – the US central bank – advances in technology, the development of credit scoring techniques and the emergence of a large secondary market significantly increased the access to mortgage finance in the US (Bernanke, 2008:1). Consequently, from 1994 to 2006, subprime lending increased from an estimated US$35 billion or 4,5 per cent of originations to US$600 billion or 20 per cent of originations. Although responsible subprime lending was helpful in fostering sustainable homeownership, far too much of the lending was based on abusive, unfair or deceptive lending practices. As mortgage loans were extended, the lender initially extending the loans in many instances securitised the loan. For example, a group or pool of, say, five thousand mortgage advances with an average value of US$100 000 each would be created and sold to a cash-flush investor such as a pension fund for US$500 million. This is nothing new – mortgage advances have been securitised on a substantial scale for many decades. Incidentally, the borrower would usually not even know that his or her mortgage loan had been securitised – the borrowers continue to send their instalments to the institution or “mortgage originator” which initially extended the loan. But the mortgage originator now simply passes on the instalments received to a company created to handle the pool of securitised mortgages, a “special purpose vehicle”, from where it is redistributed to the ultimate owner of the securitised mortgages – the pension fund in this example. Numerous “structured financial products” were developed around the securitised mortgages. For instance, a batch of risky or sub-prime mortgage advances could be lumped together and sold off as a separate “tranche” which would pay a higher rate of interest than a batch of standard mortgages. Furthermore, some institutions provided guarantees or partial guarantees to enhance the risk-return characteristics of some of these products. And all remained well as long as the property boom continued. Loans could be extended quickly and repackaged and securitised speedily. The US housing market eventually ran out of steam around 2006 as supply started to outstrip demand, reinforced by tighter interest rates. This set in motion a chain of events in which subprime borrowers increasingly fell behind on their commitments and certain types of securitised assets and structured products started to show their true colour. As these assets stopped performing (or, at best, paid significantly less than previously projected) investor appetite for structured products and securitised assets diminished rapidly. This interrupted the process in which original lenders (mortgage originators) could so comfortably extend a loan and sell it off to somebody else to carry the credit risk. Liquidity in that market evaporated rather quickly, its previously smooth-running machinery grinding to a halt. More fundamentally, investors and borrowers as well as all those institutions in between discovered that the risk premia which they had priced into a range of financial assets were grossly inadequate. This inadequacy extended beyond sub-prime mortgages, and beyond the USA only: numerous types of securities and derivatives were involved. During the credit boom, investors had struggled to understand complex new securities, so they relied on the credit-rating agencies. The credit-rating agencies labelled the new securities with the same ratings already applied to corporate bonds and this gave investors a handy frame of reference. The ratings methodology for corporate credit risk is, however, fundamentally different from that used for structured credit and yet the ratings that resulted were placed on the same scale, implying similar potential losses. Ratings agencies in their methodologies also assumed adequate liquidity in the trading of structured credit securities – an assumption that did not hold when this market unravelled. Unfortunately, investors placed excessive trust in rating agencies' approach to structured credit as the new securities had little in common with corporate bonds. When the agencies pointed out that they relied on facts presented by issuers, and that due diligence was not conducted on any of the individual mortgages within a pool, investors’ perceptions of ratings on most innovative financial instruments changed. Accordingly, prices of such assets fell considerably as investors became less willing to assume risk. Furthermore, because financial assets are traded in global financial markets, the repricing of assets and drying up of liquidity in trading such assets spread across borders. Consequently, the financial market strains that originated in the U.S. subprime sector began intensifying in the second half of 2007 and led to a sell-off in global equity markets. In a recent speech, the Governor of the Bank of Canada emphasised three underlying causes of the ongoing dislocations in financial markets (Carney, 2008:2). Firstly, overconfidence among market participants that ample liquidity would continue to prevail, providing an outlet for new products and facilitating the rapid growth of the “originate-todistribute” credit model – loans are extended but then repackaged, tiered, securitised and distributed to end investors. Secondly, a lack of transparency and inadequate disclosure in respect of many highly structured financial products, complicating their valuation and reducing secondary market liquidity under conditions of stress. Thirdly, a series of misaligned incentives, which led to the watering down of credit quality standards and encouraged excessive risk-taking. Following the sharp increase in delinquencies, the subprime-related securities were downgraded by rating agencies, causing this market to be impaired significantly. Funding pressures subsequently forced mortgage lenders to scale back or close down, and banks became reluctant to provide liquidity to each other. Uncertainty about who owed how much to whom resulted in overnight interbank lending rates increasing significantly and central banks had to provide additional liquidity to facilitate the orderly functioning of financial markets. Current estimates regarding the scale of losses suffered by mortgage owners in the US range between US$400 billion and US$500 billion, although in a recent article Krugman (2008) states that “ I think there’ll be $1 trillion of losses on mortgage-backed securities...” The turbulence came to the fore in many ways. Probably the most pervasive immediate consequence was the repricing of risk. Global markets generally experienced considerable volatility and illiquidity and borrowers were confronting tighter terms and conditions, spawning fears of a “credit crunch” which could harm economic growth. Credit spreads which had declined to extraordinarily low levels picked up considerably, as illustrated in the accompanying graph. Policy reactions to the turbulence One should point out immediately that some part of the turmoil – an upward adjustment to the risk premia imbedded in the prices of a range of financial assets – should be welcomed as a normalisation of affairs, such premia previously having been unsustainably low. However, authorities had to be mindful of the need to prevent total overshooting behaviour, and had to ensure the continued smooth functioning of the financial system as a whole. At the same time the hard-won gains in the fight against inflation had to be consolidated and protected, keeping inflation low and stable. Fortunately, the deterioration in the global inflation environment due to the rising prices of energy and food was partly offset by the continued impact of globalisation, the pursuit of sound macroeconomic policies and the effect of a long period of low inflation on inflation expectations. When the turmoil struck the financial markets in the United States quite visibly in August 2007, the Federal Reserve responded decisively by loosening monetary policy and adding some liquidity to the money market. This provided some relief to cash-strapped borrowers. Over the subsequent six months the authorities in the US loosened monetary policy further, with the objective among other things to restore the affordability of housing and halt the rising delinquency rate. The Fed also became engaged in match-making and rescuing troubled institutions. A number of prominent financial institutions had to write off huge amounts on account of bad loans, dragging down their share prices and raising concerns regarding their status as creditworthy counterparties. In the past few weeks the Federal Reserve put its balance sheet in harm's way to give assurance to the creditors of Bear Stearns (a mid-size investment bank) and extended that protection to the other primary dealers. In the UK in the meantime, an institution named Northern Rock, which to a significant extent relied on the loan origination-securitisation model, became the first UK banking institution in a long time to experience a bank run as its depositors queued to withdraw their deposits. As the authorities increasingly became mindful of the risks of a widespread crisis developing, Northern Rock was granted emergency liquidity assistance by the Bank of England and eventually nationalised by the British government. Internationally, regulators were given much food for thought by the turbulence in the financial markets. The ability of a problem in one area of the financial system to spread and contaminate other areas was again illustrated rather vividly. The problems attached to innovative financial products were again underlined, including the need for adequate transparency and disclosure of the exact nature of and risks attached to each type of asset. Although regulators certainly had a role to play, the need for investors to ultimately be wary, do their own homework and not assume that others – regulators, credit ratings agencies, sellers of financial products – have already done it for them, was emphasised. To avoid future confusion regarding the risk attached to particular securities, ratings for the different types of obligation should be clearly distinguished and investors should never rely purely on ratings to determine investment policy. Credit-rating agencies will also have to work harder to ensure that users understand the nature of their ratings. Implications for the CMA It is only fair to point out that the countries of the CMA are “in this together”, in dealing with the impact of these disturbances. South Africa and Lesotho, Namibia and Swaziland, through our currency union, have a shared financial market and similar if not identical interest rate policies. In many instances the same banks and financial institutions are active throughout the CMA. The direct CMA exposure to the sub-prime market and to structured products seems to be quite limited. One or two institutions with a strong international presence may have, through companies in their groups, some exposure to the now discredited instruments. However, relative to their overall business and to their capital base, such exposure seems to be small. Fortunately, institutions in the CMA seem to have preferred to focus on more straightforward business and refrained from building up large positions in structured products. Not that banks and other financial institutions in the CMA are not familiar with securitisation; many mortgage and instalment sale contracts have already been securitised, but these have tended to be very straightforward “plain vanilla” securitisations. The international financial market turbulence has resulted in slower global economic growth, and is projected to continue doing so. Recent forecasts suggest a significant slowdown in growth in the US, which is bound to spill over to the rest of the world. Talk of decoupling from the United States is dodgy, at best. Accordingly, CMA exports – and especially those exports destined for the countries most affected by the financial turmoil – are likely to be held back to some extent. As far as the money market in the CMA is concerned, liquidity has remained adequate throughout this episode of international financial market turmoil. The lack of enthusiasm to do business with other private-sector participants in the money market has not emerged in the CMA. Interbank lending, for instance, has continued without any disruption, and the interest rates at which interbank funds are placed have not risen significantly (as would have happened if perceptions of risk had deteriorated). For instance, the margin between the South African Reserve Bank’s repurchase rate and the Sabor, or South African benchmark overnight rate, has not changed much over time. The turbulence prompted investors to demand higher risk premia on a wide variety of securities. Securities issued by emerging-market countries were affected, and the CMA was no exception. Accordingly, the spread of debt instruments issued by CMA governments over “risk-free” US Treasuries have widened. However, as can be seen in the graph, this widening was mostly attributable to declining US Treasury yields, which attracted investors owing to their safe-haven status. While it seems fairly safe to say that the pricing of financial instruments has been influenced by this turmoil, it is more difficult to establish what the impact has been on non-resident capital movements – in other words, the magnitude of capital flows rather than the price thereof. South Africa currently runs a sizable deficit on the current account of the balance of payments, and has since the emergence of the deficit been able throughout to finance the shortfall through capital inflows. Since late 2007 the composition of the flows has changed: portfolio inflows have faltered but at the same time inflows of foreign direct investment and other investment funds have picked up considerably. The turmoil has so far been accompanied by high and often rising international commodity prices. Greater uncertainty for instance tends to be good for the prices of precious metals. Southern Africa has generally benefited from the ongoing boom in commodity prices. However, these gains also imply a number of challenges: These include dealing with the windfall responsibly by not allowing the bulk of it to be translated into consumption; transforming the economy in such a way that the quantities of commodities produced and exported increase in response to favourable prices; and promoting beneficiation. Levels of bad debt in the financial system of the CMA have remained fairly moderate. As indicated previously, there is not much direct exposure to structured financial products among financial institutions in the CMA. The increase in overdue loans which is currently observed is from extremely low initial levels, and is not unexpected, given the increases in interest rates since mid-2006. Bank supervisors and financial supervisors, more generally, in the CMA have again been alerted by the recent events to the forces of globalisation, the significant cross-border activities undertaken by financial institutions in the region, and the accompanying risks. This has underlined the need for continued and effective cooperation and dialogue between supervisory authorities, which are essential for effective cross-border supervision. This legitimate need should, however, not be confused with a need for more comprehensive and intensive financial regulation. The dislocation in certain financial markets has certainly been painful and some of the consequences far-reaching. While a worthy debate can also be entertained regarding possible regulatory changes in the light of the experience gained from the sub-prime fallout, an overambitious extension of regulation could easily be the wrong option. Such extensions often have noble intentions but unintended consequences. A modest and nuanced regulatory response is more likely to succeed than an overambitious attempt to eliminate risk-taking (thereby possibly destroying much of the dynamism and most of the positive gains which have arisen from financial innovation). Conclusion Against a background of volatility in the global financial markets, the CMA seems in some respects to enjoy safe haven status. Very little exposure to the structured asset markets has contributed to maintaining a fairly good level of credit quality and adequate levels of liquidity in the integrated CMA financial system. Our financial institutions are now, it would seem, being rewarded for not being too adventurous and aggressive in conducting their business. But to ascribe the relatively healthy state of affairs in the CMA only to lack of exposure to the structured asset markets would be unfair; the crucial role of CMA financial institutions’ sound internal risk management processes, robust levels of capital and solid supervision should be acknowledged. A general lesson from the recent events is that it is better to assume that trends rarely continue forever. This rings true, whether it involves the prices of houses, shares, gold, platinum or any other asset. Within reason, institutions, regulatory authorities and policymakers should develop feasible contingency plans and take active steps to make systems more robust in the event of significant reversals. In an article presented on behalf of Edward Gramlich at the Federal Reserve Bank of Kansas City's Economic Symposium, legislators were urged to better protect consumers against predatory lenders and to improve regulation of mortgage lenders and banks (Gramlich,2007). Sound institutions, first-class disclosure, sustainable policies, the building up of adequate reserves – being robust in the face of a storm requires that the relevant authorities focus on basics such as these. Prudential oversight and surveillance by regulators and risk assessment by market participants can also be enhanced by filling the gaps in information on global financial flows. International financial institutions such as the International Monetary Fund (IMF) have taken initiatives in this area. Some authorities have already put in place mechanisms to collect information to monitor capital flows by source countries and types of investors. However, the IMF has suggested that, given the severity of the current credit crisis in the US and notwithstanding the comprehensive monetary and fiscal policy steps already announced by their authorities, additional public funds might be needed to rescue the U.S. financial system in this instance. Despite the severe U.S. credit crisis and its palpable spill-over effects on international financial markets, the CMA region's economies have thus far remained buoyant given the greater resilience and flexibility that have resulted from sound macroeconomic policies and structural reforms adopted over the past few years. While one should not underestimate the difficulty in the detail of doing so, the financial system in the CMA has weathered many storms successfully and there is no reason to doubt that it will continue to do so. Central bankers will also have to continue to be vigilant as the United States credit turmoil unfolds, and if confronted by deterioration in local financial-market conditions, stand ready to do what is required to facilitate the continuation of orderly trade. However, inflationary pressures currently pose a greater challenge to the CMA region's economies than the international financial turmoil and equally important therefore, is the assurance that we will continue to protect the purchasing power of the money in your pocket through appropriate monetary policies i.e. the pursuit of price stability. References Bernanke, B.S. 2007. Housing, Housing Finance, and Monetary Policy. Speech at the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole, Wyoming. 31 August. Bernanke, B.S. 2008. Fostering sustainable homeownership. Speech at the National Community reinvestment Coalition Annual Meeting. 14 March. Carney, M. 2008. Addressing financial market turbulence. Remarks presented to the Toronto Board of Trade. 13 March. Toronto: Bank of Canada. Gramlich, E.M. 2007. Booms and Busts, The Case of Subprime Mortgages. Article presented on behalf of Edward Gramlich at the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole, Wyoming. 30 August. Krugman, P. 2008. How bad is the mortgage crisis going to get? Fortune, 31 March. Board of Governors of the Federal Reserve System. 2008. Flow of Funds Accounts of the United States. Flows and outstandings, fourth quarter 2007. Federal Reserve statistical release. 6 March. South African Reserve Bank. 2007. Financial Stability Review. September.
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Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Bank of Tanzania-IMF-East AFRITAC Regional Seminar on Central Bank Communication, Stonetown, Zanzibar, 6-8 May 2008.
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X P Guma: Communicating reserve management and exchange rate policies – a South African perspective Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Bank of Tanzania-IMF-East AFRITAC Regional Seminar on Central Bank Communication, Stonetown, Zanzibar, 6-8 May 2008. * 1. * * Introduction Chairperson, Lila Mkila, Deputy Governor of the Bank of Tanzania, distinguished participants, ladies and gentlemen; I wish to start by thanking the organisers of this seminar for their invitation to me to participate in these proceedings and to proceed on the premise that all protocol has been observed. Having said that, I must especially acknowledge Dr B. Ndulu, Governor of the Bank of Tanzania and my senior in several respects – not least in the context of the Africa Economic Research Consortium from which I benefited as a young(er) economist all those years ago, which he served with characteristic distinction. 2. Communication: of what, how? A story is told, which I think may be appropriate to repeat here. It is said that in 1991 when Mr Mervyn King, the current Governor, joined the Bank of England he visited the former Chairman of the Federal Reserve of the United States of America to seek advice and Mr Paul Volcker obliged with a marvellous word, “mystique”. And that appears to have been the desired practice of senior central bankers of the time, “mystique”. The object of their communication was to create such uncertainty as to ensure that their decisions would be treated with the kind of awe that attends the devotions of the converted. Mr Volcker, it is said, described the central bankers of the Bretton Woods system as “high priests, or perhaps stateless princes”, the process by which they made monetary policy decision resembling the elusive mysteries of papal successions. That perhaps explains the sea change that has occurred in thinking about communication by central banks. Having come of age in central banking at a different time, my purpose today is to be brief, to the point and as clear as possible. In the paragraphs which follow, I will outline the evolution of reserve management in South Africa, indicate the nature of the communication strategy which has been pursued and conclude. The interesting part, our joint deliberations, will be off the record. 2.1 Of what? Reserve management in South Africa has occurred historically in an environment of exchange controls. These were originally introduced in 1939, together with the United Kingdom and other members of the then sterling area, as part of the emergency Finance Regulations applied by that group of countries. The original objective was to retain a free movement of funds between these countries whilst preventing “hard currency” funds from flowing out of the area to non-sterling countries. Whilst the Sterling Area exchange controls were removed gradually after the end of the second World War, liberalisation of controls in South Africa was halted by the declaration of a State of Emergency in March 1960, and the imposition by the authorities in May and June 1961 of comprehensive measures which were intended to strengthen both the current and the capital accounts of the balance of payments. As Roger Gidlow (1995:181 et seq) states then, stricter import controls included restrictions on inheritance, gift and maintenance transfers as well as allowances for tourists and emigrants. Even more significant, capital transfers abroad by residents were disallowed while residents were called upon to declare their foreign assets and liabilities. Furthermore, the transfer of profits earned by foreign controlled companies prior to 31 December 1959 was prohibited. Reviewing developments from the vantage point of 1996, the Governor of the South African Reserve Bank (SARB) wrote as follows (Stals, 1996-06-17): The initial non-economic factors that led to the outflows of capital from South Africa during the more than thirty years, from 1961 until the early 1990’s rapidly disappeared after the announcement of the election of the Government of National Unity towards the end of 1993. Although a large amount of funds still flowed out of the country during the first half of 1994, the situation changed dramatically thereafter. In the second half of 1994, there was a net inflow of more than R9 billion into the country, and during the calendar year 1995 a further net inflow of R21,7 billion, to bring the total net inflow for the 18 months from July 1994 to December 1995 to more than R30 billion. In April 1994, when the Government of National Unity took office, the Reserve Bank held about R7 billion in foreign reserves, but also had about R6 billion outstanding in short-term borrowings. During the years which ensued, the SARB followed a policy of trying to stabilise the exchange rate of the rand by intervening in the domestic foreign exchange market, this being consistent with the provisions of the interim Constitution of the Republic of South Africa which required the Bank to protect the internal and external value of the currency. However, as Mminele (2007) notes, because the level of its gross reserves were fairly low, averaging around USD3,8 billion between 1990 and the end of 1997, the Bank funded its intervention through the forward market, and in the process built up an oversold forward book which, at tits highest level in 1995, amounted to USD29 billion. This exceeded the level of net reserves by a considerable margin, leaving a negative net open foreign currency position (NOFP) which reached a peak of USD23, 2 billion in August 1998; a number which is still mentioned only in hushed tones by those Reserve Bank staff who can recall those momentous times! In 1998, the SARB ceased its intervention in the foreign exchange market, abandoned its attempts to influence the level of the exchange rate and, in addition, made a public commitment to eliminate the negative NOFP and to close out the oversold forward book. And this had the desired result. In September 1998, the level of gross reserves, at US$5,3 billion was still very small in absolute terms and relative to the net oversold forward book of approximately US$18 billion. By May 2003, the NOFP was marginally positive; but by February 2004, the positions in the oversold forward book were balanced and gross reserves had started to increase. At the time of writing, the Template on international reserves and foreign currency liquidity, which is available to all who may be interested at www.reservebank.co.za, indicates that the approximate market value of the official reserve assets as at end of March 2008 was US$34,384 billion. Chart 1, beloved of those SARB directors and staff who speak in public, illustrates these developments. In summary, then: the SARB now has reserves to manage. This was not always the case, for during some periods prior to 1998 what needed to be managed were negative net reserves. Second, the SARB has made a public commitment not to participate in the market for foreign exchange in an attempt to influence or to determine the nominal exchange rate. Third, exchange controls have been liberalised significantly. South Africa does not appear now to be too different from its peers among emerging market economies. 2.2 How? The implications for communication of the afore-going narration were and remain challenging. In a situation of economic vulnerability, such as characterised South Africa at various moments in its past, the need was for the Bank to maintain a sense of calm. Statements had to be circumspect without ever inducing a sense of panic. For nobody would have been prepared to say to all and sundry: “we don’t have sufficient reserves, but are still going to attempt to influence the exchange rate, so there! …” Any student of this period in the economic history of the country will be struck by the subtle nature of the communications of this time. Consider, for example, the difference between the reporting of developments regarding reserves in the Quarterly Bulletin of the SARB. The March 1996 report reads as follows in the section on foreign reserves: “South Africa’s total gross gold and other foreign reserves rose from R14,1 billion at the end of 1994 to R15,2 billion at the end of September 1995 and to R18,2 billion at the end of December 1995. After having increased by R2,2 billion in December 1995, the gross foreign reserves of the Reserve Bank decreased by R229 million in January 1996. Without taking into account the credit facilities of the monetary authority, the total foreign reserves of the country were equal to seven weeks’ imports of goods and services at the end of December 1995.” Billions deflected by casual reference to a few millions: weeks of imports, not months; some numbers refer to the country; others to the Reserve Bank; others still to the monetary authority. All in Rand, not in SDR or dollar values. And these numbers, of course, do not include the credit facilities of the monetary authority, which, if included? Draw your own inference and rest assured that we are not panicking. This may be contrasted with the confident tone of the most recent Quarterly Bulletin (March 2008) which reports on International reserves and liquidity in the following manner: Measured in US dollar, the value of the gross gold and other foreign reserves of the South African Reserve Bank (the Bank) increased from US$ 30,5 billion at the end of September to US$33,0 billion at the end of December 2007 and further to US$34,2 billion at the end of February 2008. The Bank’s international liquidity position increased from US$28,4 billion at the end of September 2007 to US$31,3 billion at the end of December and further to US$32,7 billion at the end of February 2008.” Straight, to the point and, to use the current idiom of some of the young, together! At least two things were done to manage communication during those difficult times. First, in order to ensure consistency, it was the practice for only the Governor of the Bank to address public gatherings on monetary policy. Eschewing the use of speech writers and speaking authentically and unmistakably in his own voice, the Governor, as the public face of the Bank would explain what needed to be explained adopting the tone of wounded indignation to good effect when necessary. For example, commenting on macro-economic adjustment during 1995 and 1996, the Governor (1997-09-08) wry and as caustic as decency allowed wrote, “the South African monetary authorities are indeed, in retrospect (my emphasis), now criticised by the International Monetary Fund for having intervened excessively in the foreign exchange market last year …. This was prompted, however, by an acute shortage of foreign exchange reserves … at the time of the currency crisis”. And then added, diplomatically, “The Reserve Bank agrees with the Fund that the Bank’s role in the foreign exchange market should be reduced.” This strategy had the positive effect of providing consistency in the language of communication, effectively countering the nay-sayers in the market who consistently look for evidence of policy conflict within the Bank. It said, in effect, “one Bank; one policy; one voice”. Secondly, the number of public speaking engagements was kept limited, but unspecified, with the Quarterly Bulletin, the statement on foreign reserves and the annual Governor’s address to shareholders of the Bank being the only documents whose release could be announced in advance. Market participants could, therefore, be assured of a comprehensive set of data, set out in accordance with the highest international standards, in the Quarterly Bulletin and the statement of foreign reserves; and would be guided by the Governor’s address on matters pertaining to exchange rate, reserve management and over-arching monetary policy. Additional information was made available on a discretionary basis. Third, in recognition of the fact that a central bank can only be as independent as the government of the day wants it to be, regular contact was maintained with the Minister of Finance; and the practice of briefings to be relevant Committee of Parliament was maintained. 3. Conclusion The challenge of communicating with the general public, financial analysts, the markets and other interested parties remains. However, at present, the message which needs to be communicated is that of monetary policy in the context of inflation targeting: exchange rate and reserve management issues have lost their centrality, important as they may remain. The tension caused by substantial deviation from the desired outcome, albeit on account of a concatenation of external shocks of unprecedented magnitude, poses an on-going challenge – with regard to time-consistent policy responses and with respect to communication. But these are matters for discussion and debate at another time. Thank you for your attention. References: 1. Asso PF, Kahn GA and Leeson R (December 2007) “The Taylor Rule and the Transformation of Monetary Policy”, Federal Reserve Bank of Kansas City; Research Working Papers. 2. Gidlow, R (1995) “South African Reserve Bank Monetary Policies under Dr T.W. De Jongh 1967-1980”, Pretoria, South African Reserve Bank. 3. King, M (2000) Speech to the joint luncheon of the American Economic Association and the American Finance Association, Boston Marriot Hotel, January. 4. Mminele D (2007) “The Accumulation of reserves by emerging markets and the case of South Africa”, JP Morgan Asset Management Central Bank Reserve Management Seminar, Johannesburg, November. 5. South African Reserve Bank, Quarterly Bulletin, various issues; 1995-2008. 6. Stals, C.L. (1996) “Exchange Control : How critical is it?” Address by Dr Chris Stals, Governor of the South African Reserve Bank, at the Europe-South Africa Business and Finance Forum, Cannes; 17 June. (1997) “Exchange Controls and Monetary Policy.” Address by Dr Chris Stals, Governor of the South African Reserve Bank, at a Roundtable Discussion arranged by Economist Conferences, Johannesburg. (1999) Remarks by Dr Chris Stals, retiring Governor at a Gala Dinner of the South African Reserve Bank; 8 August. 7. Volcker, P (1990) The Triumph of Central Banking; Per Jacobsson Lecture, Per Jacobsson Foundation, Washington DC.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Bureau for Economic Research Annual Conference, Johannesburg, 22 May 2008.
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T T Mboweni: Monetary policy, inflation targeting and inflation pressures Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Bureau for Economic Research Annual Conference, Johannesburg, 22 May 2008. * * * Honoured Guests Ladies and Gentlemen 1. Introduction The monetary policy framework in South Africa is facing its most severe challenge since the inception of inflation targeting in the year 2000. Inflation pressures have been building up strongly, and the most recent CPIX figure of 10,1 per cent is significantly above our inflation target and inconsistent with price stability. These pressures originated primarily from exogenous shocks such as oil, food and electricity price developments. However it is clear that inflation pressures have become more generalised, as evidenced by the continuous upward trajectory in the core indicators. For example, in June 2006 CPIX excluding food and energy measured 2,5 per cent. By April this year it had risen to 5,6 per cent, and indications are that this measure could rise further. Of great concern is the significant deterioration of inflation expectations, which will give further impetus to these inflationary pressures. Over the past year inflation expectations have drifted upwards gradually, but nevertheless appeared to remain anchored within the inflation target range. This picture has changed significantly in the first quarter of this year. We have now observed the biggest increase in inflation expectations since the inception of the inflation expectations survey eight years ago. Reference here is made to the BER inflation expectations survey conducted on behalf of the South African Reserve Bank (SARB). This, together with the possible upward trend in unit labour costs, does not bode well for the inflation outlook going forward. In response to these developments, and to the robust domestic demand that we have been experiencing, the monetary policy stance of the South African Reserve Bank has been tightened since June 2006 by a cumulative 450 basis points. The SARB, more specifically the Monetary Policy Committee (MPC), has been criticised by some commentators now that inflation has breached the upper limit of the target range, and this is interpreted as a sign of lack of determination, commitment, and the will to achieve and maintain price stability. At the same time, others have suggested that the degree to which the SARB has responded to those inflation developments has been excessive, too strict, dogmatic like inflation targeting “nutters”, insensitive to the plight of the poor, that monetary policy is after-all powerless in the face of supply side shocks, and that these actions have demonstrated a lack of concern for growth and employment in South Africa. Nothing can be further from the truth. 2. The inflation targeting framework At this point it may be useful to make a few comments about inflation targeting in general. Some recent statements from many commentators about the appropriateness of inflation targeting often seem to misunderstand what the framework is about. Here we wish to emphasise the word framework, because that is what it is. It is not a policy, and it is not an instrument. It is not a dogma. Take away inflation targeting, and we will still have monetary policy, we will still have the same instruments of monetary policy, and the Bank will still have a constitutional mandate to maintain low inflation. Furthermore, any central bank worth its salt would want in any case to achieve and maintain price stability, meaning low and stable sustainable inflation levels. So even if we did not have an explicit inflation target as set out in the inflation targeting framework, we would still want to pursue price stability. Central banks are in the business of price stability. Our monetary policy objectives would therefore remain the same, and we would face the same challenges as we confront today on how to respond to exogenous shocks and second round effects. It should be noted that it is not only formal inflation targeting central banks that successfully pursue a low inflation objective. The US Fed and the European Central Bank are cases in point. The advantage of an inflation targeting framework is that it provides an anchor for inflation expectations, as it makes explicit the goal of monetary policy. That publicly stated goal is very, very significant in that it also binds politicians to abide by it. This is in our case ex-ante coordination of policy. The more anchored expectations are the more flexibility monetary policy has in responding to exogenous shocks. But announcing a target on its own does not guarantee success. It is not a magic wand. It has to be backed up by appropriate actions to build monetary policy credibility in the eyes of the public. Credibility has to be earned, it is not ordained. Those who criticise inflation targeting often argue that the framework is a straight-jacket which induces procyclical monetary policy particularly in the presence of supply-side shocks. Whether or not this is the case is an empirical question for debate, and is determined in part by the flexibility with which monetary policy is implemented. There is in our view, a distinction between what is referred to as strict and flexible inflation targeting. Strict inflation targeting central banks (or what Governor Mervyn King of the Bank of England has termed “inflation nutters”) would give no weight to short-term output considerations in the conduct of monetary policy. Most central banks, including the SARB, regard themselves as flexible inflation targeting institutions. By this we mean that there is factored into our decision-making systems concern about what the output costs of our monetary policy actions are going to be. In the jargon of economists, there is some weight on output variability in the Bank’s objective function. The inflation objective is not discarded, but rather there is a more pragmatic approach to the speed with which inflation is brought back to within the target range. However there is a trade-off between an excessively long period, which would reduce credibility and raise questions about the commitment of the monetary authorities to low inflation, and an excessively short period in which real costs may be high. The rest is judgement for which a central bank must and shall be held accountable. Inflation targeting has been an increasingly popular framework since it was first adopted by New Zealand in 1990. Most studies have shown that it has been a useful framework for assisting in bringing down and maintaining inflation at low levels. Currently inflation targeting is probably facing its most severe challenge, as international oil prices have quadrupled since the beginning of 2004, and global food and other commodity prices are experiencing persistent strong increases. Whereas a few years ago most countries were within their inflation targets, this unfortunately and regrettably is not the case today. The latest data show that 3 out of 7 industrial countries, and 4 out of 16 emerging market economies are within their targets, although the extent and persistence of the deviation differs somewhat. Does this mean that inflation targeting has failed? The true test of the framework will be whether inflation expectations can be sufficiently anchored to weather the current inflationary pressures, and facilitate a return to within the officially set targets. 3. Dealing with shocks The nature of the original cost pressures that are facing the economy is well known. These pressures – food and energy – do not appear to be cyclical. This might be a debatable assertion. We are facing a significant and probably a permanent change in relative prices globally. We also have to be concerned about pricing and unit labour cost responses to these relative price changes. If producers simply pass on these increases, and if wages increase to compensate labour for these increases without higher levels of productivity growth, and if we allow this process to take effect, inflation expectations will deteriorate and generalised inflation will accelerate. We cannot simply sit back idly, the stakes are too high. However, dealing with supply side shocks always poses difficulties for monetary policy makers. The situation we are facing now differs in important respects from the standard case which sees either a shock which is expected to reverse, in which case not much action is required, or a discrete one-off change in relative prices. In the latter more difficult case, the usual response is to look through the inevitable impact on measured inflation, and once this change is through the system, inflation should ideally return to its normal levels. If inflation expectations are firmly entrenched within the inflation target range, then very little response may be required from the monetary authorities, whose main objective under such circumstances would be to ensure that this process does not feed through to more generalised inflation pressures. The challenge, however, is that we are not being faced by a discrete once-off event. Rather, we are facing what can best be described as a rolling or continuous shock. International oil prices have been on an upward trend since 2004, apart from some moderation in the latter half of 2006. Oil price increases have almost consistently surprised on the upside, requiring a continuous revision of our assumption and thus the forecasts. Indications are that food price inflation is expected to continue to remain high for some considerable time. This is most definitely not seen to be a temporary phenomenon. Similarly, electricity price increases significantly in excess of the average inflation rate are expected to become a multiyear event, as the process of increasing generating capacity is rolled out. These are unusual developments. Unusual responses might be necessary. Things, it seems, might get worse before they become better. We are going through bad times. The magnitude of these inflationary pressures has been such that a breach of the target was inevitable. Whereas we have to accept that we will be unavoidably outside the target range for longer than we would wish, we are determined to bring CPIX inflation back to within the target range within a reasonable time period. If we seem to be abrogating our responsibilities, inflation expectations could get out of hand, price-setting and unit labour costs could become excessive and we could experience an inflation spiral. As noted earlier, we have already seen evidence of second-round effects, deteriorating inflation expectations and elevated wage demands coming through, and these have required a response to prevent inflation getting out of hand. 4. Has the monetary policy response been excessive? This raises the question of whether the SARB has gone for the overkill. There is no doubt that the tighter stance of monetary policy has caused a slowdown in domestic household consumption expenditure. That is good. This is something that we wanted to achieve in order to moderate demand pressures in the economy. There are signs that output growth is also slowing down, but this is not solely due to monetary policy actions alone. The global economic slowdown and electricity supply constraints in South Africa are also important variables influencing this outcome. Nevertheless we are of the view that output growth will decline significantly below the potential growth rate of the economy (4.5 per cent), but economic growth will continue to be underpinned by the massive infrastructure expenditure programme that is currently underway to improve the quality of our transport system, electricity supply and telecommunications networks. These initiatives will not only sustain growth but also increase the potential real GDP growth rate of the South African economy over time. The forecast of the South African National Treasury is for real GDP growth to measure 4.0 per cent this year and to increase over the coming two years. That is not bad at all. Private sector forecasts are slightly less optimistic. The latest consensus forecast is a real GDP growth rate of 3.6 per cent for this year. While lower than in previous years, it is still relatively robust in the context of a weak global economy and overall domestic constraints. From a technical monetary policy perspective, although nominal interest rates have been increased significantly, real rates have not, and in fact may have fallen depending on the deflator used. Interest rates, in other words, have not increased by more than the increase in inflation. Does this mean that we have not been aggressive enough as some would argue? As noted earlier, we have to some extent allowed for first-round effects to happen, and therefore it may have been inappropriate to have responded to those developments, but rather pre-emptively focus on the second-round effects. 5. Changing the target? A number of commentators have suggested that the inflation target range should be changed as a means of avoiding further tightening of the monetary policy stance. We do not support such a course of action. It would be very easy for government to announce tomorrow that our target has been changed from 3-6 per cent, to say 10-15 per cent. We would then be inside the target range, and for a short while no further interest rate action would be required. This would however signal that we are happy with inflation at these levels. But what would be the implication of setting a higher target range? Almost immediately long-term inflation expectations would be adjusted to these levels, and wage and price setting behaviour would be adjusted as well. Our inflation rate would most probably very soon be entrenched around the 15 per cent level, and in order to prevent it from rising further, we would very soon have to raise interest rates further. We cannot escape from the fact that a higher inflation trend requires even higher nominal interest rates. The increased risk premium associated with a higher expected inflation may result in even higher real interest rates. There can be no presumption that real interest rates with a higher target range will be any lower – they may in fact be higher. We cannot simply adjust the target range higher every time we move out of the existing one. The ultimate objective is low inflation, rather than to be within a target range. We would rather be outside a low target range, and focus on getting back to within it, than define ourselves to within a high target range. We accept that we could be outside the target range for longer than we would like as a result of these exogenous shocks. But we are nevertheless determined to maintain a focus on the inflation target range and get back to within it within a reasonable time frame. Having a higher target will not only reduce our credibility and make South Africa a less attractive investment destination for foreign capital, it will also result in a continuously depreciating exchange rate, as our inflation rate will be significantly higher than that of our trading partners. This is turn would translate into further inflation pressures. Alternative proposals seek to redefine the target basket to exclude exogenous items such as food, electricity and petrol. That is a cop-out. In deciding on the appropriate monetary policy stance, we do look at various underlying core measures which do provide us with some idea of the underlying pressures in the economy. But we cannot ignore the headline figures which influence inflation expectation and other pressure points. We cannot run away from the problem and simply exclude a category every time its behaviour does not suit us. This will be a cosmetic change which will not help us get to grips with the underlying problem. We will also, most certainly, lose credibility in the eyes of investors (both domestic and international) as well as amongst global policy makers. This will not be helpful to South Africa’s poor or the South African economy generally. 6. The explanation clause There have been suggestions that we invoke the explanation clause as a means to avoid further monetary policy tightening. There appears to be confusion about the applicability of the explanation clause. There is an assumption that the clause relieves us of the need to react to supply side shocks and that we do not have to worry about the inflation target. This is a misinterpretation of the explanation clause. The clause is worded very carefully and it says that “when the economy is buffeted by a supply side shock similar to those envisaged by the original escape clause that will take CPIX inflation outside the target range (e.g. an oil price shock, a drought, a natural disaster, or financial contagion affecting the currency), at the subsequent meeting of the Monetary Policy Committee, the SARB will fully inform the public of the nature of the “shock”, the anticipated impact on CPIX inflation and the monetary policy response to ensure that inflation returns to the target and the time frame over which this will occur.” There are two important points worth noting. First, the clause clearly allows for us to be outside the target range because of first-round effects of supply side shocks. Second, it does not relieve us of the responsibility of getting inflation back to within the target range. The clause clearly stipulates that if CPIX is out of the target range, we have to explain why, and what we are doing about it. This is something we do after each MPC meeting in any case. But it does not tell us that no effort should be made to ensure a return into the target range. CPIX is currently outside the target range primarily but not only as a result of factors beyond our control, and in line with the explanation clause, we are now taking strong steps to ensure that CPIX returns to within the target range. As we have noted in our most recent MPC statement, we currently expect CPIX to be back within the target range by the end of 2009. However, this is not an unconditional commitment. The outlook may deteriorate further in the light of new developments, and require a reassessment of the monetary policy stance. 7. Conclusion We appear to be going through an extended adjustment in relative prices. The good news is that these relative price adjustments will eventually come to an end. The bad news is that we do not know when and what the long-term levels are going to be. Monetary policy decisions are made under conditions of uncertainty. Unfortunately, some periods are more uncertain than others. Given the extent of these supply-side shocks, no amount of monetary policy tightening could have prevented the first-round effects from emerging and a breach of the upper limit of the target range was unavoidable. However current evidence of more generalised inflation and higher expectations means that we have to be firm in our resolve to contain these pressures. The Monetary Policy Committee will continue to implement inflation targeting in a flexible manner. While at times reducing inflation may lead to some output costs in the short run, achieving the long-term goal of price stability remains our primary objective. A low inflation environment supports growth as evidenced in South Africa’s growth rates in excess of 5 per cent since 2004. There is ample evidence that high inflation does not create jobs on a sustainable basis. Rather, it is simply a tax on the poor. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Gordon Institute of Business Science, conducted in conjunction with the Helen Suzman Foundation, Johannesburg, 28 May 2008.
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T T Mboweni: Central banks in times of turmoil Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Gordon Institute of Business Science, conducted in conjunction with the Helen Suzman Foundation, Johannesburg, 28 May 2008. * 1. * * Introduction The global financial landscape has changed dramatically over the past twelve months, with global financial markets experiencing a financial crisis of note in the history of the world economy. The impact has been severe, with some of the world’s largest and most credible financial institutions reporting large consecutive quarterly losses. By the end of March 2008, the market capitalisation of banks globally had declined by USD720 billion. These developments prompted the former US Fed Chairperson, Mr Alan Greenspan, to remark that “the current financial crisis in the US is likely to be judged as the most wrenching since the end of the Second World War”. Financial market asset prices have also echoed these extremely distressed circumstances and volatile conditions, in some instances requiring unconventional responses by central banks and other international institutions. Recent events again put into full perspective the crucial role of central banks in times of turmoil. In particular, the dual responsibility of central banks to implement monetary policy as well as contributing to financial stability has become much more challenging. 2. Causes of the crisis The financial market turmoil, which started around July 2007, was initially triggered by huge losses on US sub-prime loans, disclosures of delinquencies and foreclosures by households, as well as a number of major hedge funds which reported substantial losses. Exceptionally benign macroeconomic and financial market conditions between 2004 and mid-2007, as reflected by robust economic growth and low inflation and interest rates, however, fostered an underlying search for yield over recent years. At the same time, decades of vigorous financial innovation facilitated a deepening of capital markets, easier access to credit by households and enterprises through a variety of new and complex instruments. In recent years, however, financial innovation has been increasingly associated with complacency in risk management. In particular, the lack of transparency of these complex products may have made it easier for investors to underestimate the risks they take on, as well as the under-pricing of risk in some key asset markets. In addition, with prudential regulation sometimes lagging behind financial innovation, some institutions may not have been sufficiently transparent about their exposures to complex structured financial products on and off their balance sheets. In these circumstances it is not surprising that the most recent Triennial Survey of the BIS showed that the credit derivatives market has witnessed substantial growth, from USD118 billion in 1998 to USD52 trillion in 2007. The main participants in credit derivatives, comprising about 80 per cent of the total market, are banks and hedge funds. The announcement of losses by hedge funds exposed to US sub-prime mortgages in midJuly 2007 triggered the reappraisal of asset prices, and excessive market volatility with a general flight to quality or less riskier assets. Credit risk evolved into liquidity risk and banks struggled to obtain funding as interbank liquidity dried up, causing sharp increases in moneymarket rates in the major financial centres of the world. 3. How deep and widespread? What began as a fairly contained deterioration in portions of the US sub-prime market has evolved into severe dislocations in broader credit and funding markets that now pose risks to the global macroeconomic outlook. In April 2008, the International Monetary Fund (IMF) estimated that declining US house prices and rising delinquencies on mortgage payments could lead to aggregate losses related to the residential mortgage market and related securities of about USD565 billion, including the expected deterioration of prime loans. Adding other categories of loans originated and securities issued in the US related to commercial real estate, consumer credit market and corporations, total losses are estimated at almost USD1,0 trillion. Tighter credit conditions imposed by banks, the erosion of consumers’ spending power due to rising inflation and continuous increases in energy costs have impacted severely on the US economy. According to the IMF, the continuing correction in the US housing market and the unresolved problems in the financial sector have led the US economy to the verge of recession. The IMF has downgraded its forecast for GDP growth in the US in 2008 to 0,5 per cent, while the Fed, in its latest FOMC minutes released on 22 May 2008, expects the US economy to expand by between 0,3 and 1,2 per cent. This has serious implications for global growth, particularly for countries whose economic performance depends heavily on exports to the US. One of the interesting developments I would like to mention is that, whereas previous crises originated from emerging-market economies, developed markets were essentially the epicentre of the crisis. So far emerging markets have also proved relatively resilient to the financial turmoil. Improved fundamentals, abundant reserves and strong growth rates have all helped to sustain flows into emerging market assets. However, there are macroeconomic vulnerabilities in a number of countries that make them susceptible to a deterioration in the external environment – in particular countries with current account deficits financed by private debt or portfolio flows, and countries in which domestic credit has grown rapidly. There is also a risk that banks in developed markets may pare back funding to their subsidiaries in emerging markets, particularly in circumstances where external imbalances are large. Emerging markets are, therefore, by no means isolated from the turmoil in developed markets. 4. The role of central banks Central banks assume a crucial role when market liquidity dries up and funding constraints cast doubt on the solidity and safety of financial institutions. Central banks have to prevent or limit systemic risks. In essence this entails addressing adverse dynamics and preventing the collapse of financial intermediation. During normal times, central banks provide sufficient liquidity to the banking system to keep their policy rates effective. Generally, a reliable relationship links the short-term policy rate and longer-term money-market rates and counterparties effectively distribute liquidity to the wider market. However, in mid-August 2007, the pattern of banks’ liquidity demand in the US changed: the short-term yield curve steepened and became more volatile, the gap between secured and unsecured rates widened, and the broader interbank market that distributed liquidity throughout the system was disrupted. At the immediate onset of the crisis, there was a strong increase in demand for central bank liquidity (i.e., reserves at the central bank), but as the crisis unfolded, commercial banks desired increased liquidity beyond central bank balances. Initially, both the ECB and the Fed provided additional funds, while the Bank of England allowed banks’ increased demand for reserves to be reflected in higher reserve targets. As uncertainty over the financial soundness of counterparties increased, trading of unsecured term interbank funds dwindled because banks – and other clients – wanted to borrow long-term funds but lend only in the short term. Hence, term funding dried up and longer-term yields rose sharply. Central banks were able to increase the volume of longer-term refinancing to the market without expanding their balance sheets by withdrawing liquidity at other maturities or periods. This approach helped to achieve the twin goals of executing monetary operations while addressing financial stability concerns. Central banks had to face a number of challenges in addressing financial system stress. Firstly, they had to deal with the breakdown of standard distribution channels for liquidity, both nationally and internationally. This was because the provision of sufficient liquidity to a small group of intermediaries no longer guaranteed that it would either flow through the system, or to those in need of funding in specific currencies, as stress in money markets spread to foreign exchange swap markets. Secondly, some banks lacked direct access to open market operations (OMOs), either because they did not belong to the list of eligible counterparties, or lacked the eligible collateral. Finally, central banks had to project liquidity demands at different time horizons, as demand patterns changed rapidly and unexpectedly, and the impact of factors such as year-end effects became increasingly unpredictable. The decision by central banks whether or not to provide additional liquidity to markets and to bail out failing banks has its own set of complexities. Clearly central banks have to be concerned about systemic risk. The provision of overall liquidity is probably more clear cut, as such provision is generally done against appropriate collateral, although this requirement was relaxed in a number of instances. With regard to bailing out failing banks, there are more difficult issues. Firstly, there is the issue of moral hazard to consider. Should a central bank under all circumstances bail out a bank – even when it has been mismanaged? How does the central bank ensure that its lender-of-last-resort assistance doesn’t result in excessive risk taking and poor risk management by banks? Secondly, the issue of timing and the degree of intervention required has to be considered. Acting too soon can increase the risk of moral hazard and favour bad firms over good ones. Acting too slowly can exacerbate the consequences. The Bank of England, for example, was accused of delaying too long in attempting to save Northern Rock. In my view, there is no such thing as the perfect handling of a bank failure. A bank failure is a financial disaster, and the most central banks can do is damage control. It is a very difficult call to make whether or not to try and save a failing bank, when to intervene and to what extent to intervene. Whatever decision is taken is normally criticised by some or other group of stakeholders. In addition, central banks can usually not disclose the information upon which their decisions were based. However, even central banks that focus primarily on price stability sometimes face possible conflicts of objectives. The most obvious one is probably the potential conflict between maintaining price stability and financial stability. The issue may be complicated by the fact that there could be a negative feedback loop from financial instability to macroeconomic instability, which in turn feeds back to the financial sector. Central banks potentially have conflicts of interest, being at the same time a participant and regulator of financial markets. Banks that are supervised by the central bank are often also counterparties. This has the potential of complicating decision making, unless properly governed. I am sure that this is not a major issue affecting the role that central banks play in maintaining financial stability: it is generally well managed and control through segregation of duties and firewalls between operational, supervision and policy departments or divisions. However, it is something that central banks should remain sensitive to and manage diligently. 5. Other role players In all of their activities, central banks have to be very sensitive to changes in the structure and functioning of the financial markets. These changes take place on an ongoing basis, and a trend normally becomes visible only after it has progressed fairly significantly. One such change that is occurring is the bigger role played in global financial markets by a number of new players, in particular sovereign wealth funds (SWFs), private equity funds and hedge funds. The role of SWFs in the current crisis is particularly of note, and it is also interesting to see how the activities of these funds occurred complementary to those of central banks. Sovereign wealth funds appear to have played a stabilising role during recent times, alleviating capital constraints and absorbing some of the market volatility. These institutions contributed USD41 billion of the USD105 billion capital injected into major financial institutions since late 2007. There are several factors that facilitate the ability of SWFs to act as a stabiliser in times of market stress. These include the fact that they have a long-term investment horizon and limited liquidity needs and they have a stable funding base and no capital adequacy or prudential regulatory requirements that could force it to liquidate positions. However, the long-term impact and the potentially stabilizing role of SWFs as major institutional investors will require a broader set of data and assessment, and you may well be aware that some SWFs are regarded with quite a bit of suspicion as regards their long-term motives for investment. A number of other institutions also played important roles during the current turmoil, and several initiatives were announced to improve regulations and enforce disclosures, aiming to restore and improve financial stability. At the national level, the US Department of Treasury issued a blueprint for regulatory reform in the US during April, part of which has come into effect, with the US Securities and Exchange Commission announcing its plan to require top Wall Street firms to publicly disclose their liquidity and capital positions. At a broader level, the Bank for International Settlements (BIS) has also been active. From mainly focusing on capital adequacy over past years, the Basel Committee on Banking Supervision is now also devoting more time and resources to the analysis of risk and liquidity management of banks. It will require wisdom and insight to draft and implement the most appropriate regulatory reforms. In addition, the Financial Stability Forum (FSF), an international body under the auspices of the (BIS) has established a Working Group on Market and Institutional Resilience. 6. Concluding comments We have been relatively fortunate in that the Bank did not have to deal with the same financial stability issues that confronted central banks in Europe and the United States. The impact of the current turmoil in global financial markets affected South Africa indirectly, through changes in share prices, bond prices and the exchange rate, rather than directly, as South African banks had almost no direct exposure to the US subprime market. Not surprisingly, given the state of the international banking environment, international credit lines are more difficult to access and the domestic securitisation market is much tighter. Our banks however have not had any interbank or liquidity problems of the type experienced in Europe and the US, and the South African Reserve Bank has not had to intervene with any unusual liquidity provision. The fact that we have not had to be concerned about liquidity and financial stability issues has allowed the Bank to continue focussing on its objective of bringing inflation back to within the target range. As you are aware, our inflation rate is significantly above our target of 3-6 per cent, and we remain committed to bring inflation back to within this range.
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Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the annual symposium of the Cape Pomological Association, Stellenbosch, 3 June 2008.
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T T Mboweni: Perspectives on the economic and financial environment for exporters Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the annual symposium of the Cape Pomological Association, Stellenbosch, 3 June 2008. * * * Ladies and gentleman Thank you for your kind invitation to deliver the keynote address at your annual symposium. The deciduous fruit industry is characterised by participation of numerous small and large entrepreneurs, and ranges from farming activities to the processing, packaging and distribution of deciduous fruit. A significant amount of this output is exported, and therefore it is appropriate to be talking about the economic environment facing exporters. It is probably not necessary to tell this particular audience that exporters are likely to be facing a particularly challenging environment going forward. Contribution of agriculture to the South African economy The Deciduous Fruit Trust estimates that the Western Cape has more than 2 000 deciduous fruit farmers, ranging from very small entrepreneurs to well-known large farming businesses. Farming activities in the Western Cape provide nearly 100 000 employment opportunities, and the employees in turn support nearly 400 000 dependants. Apart from fruit production, the subsequent processing and distribution of deciduous fruit also contributes directly and indirectly to economic activity in the Western Cape. The Trust has also estimated that every increase of R 1 million in final demand for deciduous fruit creates an equivalent of 115 job opportunities through the production and distribution chain. In terms of the overall scale of economic activity in South Africa, the contribution of the agricultural sector is comparatively small. The contribution of agriculture, forestry and fishing to gross domestic product (GDP) was about 2,3 per cent in 2007, down from 2,8 per cent the previous year, with the agriculture sub-sector contributing about 80 per cent of this figure. However, these figures conceal the importance of agriculture in certain regions of our country. In the Western Cape the contribution of agriculture, forestry and fishing to the regional GDP is some 40 per cent larger than the national average, as the Western Cape accounts for nearly one quarter of the contribution of agriculture, forestry and fishing to domestic GDP. Fruit exports currently account for about 2 per cent of our total exports. 1 Despite its relatively small direct contribution to economic activity in the country, the agriculture sub-sector must be gauged against its broader contribution to economic activity. Considering the strong domestic linkages of the agricultural sub-sector with many suppliers and service-related industries in the South African economy, the contribution of this subsector was substantially higher at just over 6 per cent of economic activity in 2006. Global financial markets and global growth Internationally the financial and economic environment has become considerably more uncertain since the advent of the financial system instability in the United States of America, caused in the main, but not only by the sub-prime mortgage crisis. Much has been written about this crisis, which is in essence the lending of money for purchasing residential property Statistics South Africa. to borrowers with marginal or no creditworthiness during a period of low but variable interest rates and rising house values. This business model was clearly unsustainable, and once interest rates increased, delinquencies increased, fuelling a downward spiral of property prices and increased foreclosures. To compound matters, the mortgages were securitised and held by institutions around the world, so the financial market turmoil has not confined to the US. The International Monetary Fund estimates that total potential losses to financial institutions as a result of the sub-prime crisis could be close to USD 1 trillion. However, it would seem that South African financial institutions have no material exposure to the subprime problems. The difficulties in the US housing market has had a significant negative impact on consumer demand in the US, despite significant interest rate reductions by the US Federal Reserve and fiscal policy initiatives. A consequence of these developments has been a significant worsening of global growth outlook, which is not good news for exporters and the global economy. The latest IMF forecasts are for global growth to average 3,7 per cent in 2008, compared to their previous forecast in September 2007 of 4,8 per cent. 2 The advanced economies are expected to grow by 1,3 per cent, and the US by 0,5 per cent. The euro area, which is an important export destination for South African products is now expected to grow by 1,4 per cent, compared to 2,1 per cent in the previous forecast. It is of concern that the risks are seen to be on the downside and growth is only expected to improve marginally in 2009. On the positive side, our trade with emerging markets has been increasing, particularly with Asia, and these economies, while slowing, are still expected to experience relatively robust growth. The IMF expects growth in the emerging-market and developing economies to average 6,7 per cent in 2008, down from the September forecast of 7,4 per cent. Developing Asia is expected to grow by 8,2 per cent, with Chinese growth expected to exceed 9 per cent. It is interesting to note that whereas previous crises have often originated from emergingmarket economies, these economies have so far proven to be relatively resilient in the face of the current financial market turmoil. Improved fundamentals, abundant reserves and strong growth rates have all helped to sustain flows into emerging market assets. However, there are macroeconomic vulnerabilities in a number of countries that make them susceptible to a deterioration in the external environment – in particular countries with current account deficits financed by private debt or portfolio flows, and countries in which domestic credit has grown rapidly. Emerging markets are, therefore, by no means isolated from the turmoil in developed markets. The de-coupling hypo thesis is not supported. Real GDP growth in Africa is expected to be a relatively robust 6,3 per cent. The African continent accounted for some 3,7 per cent of the export value of the deciduous fruit industry in 2007, while the United Kingdom and Northern Europe accounted jointly for some 75 per cent of industry exports. Given the proximity of Africa, also in comparison to our major competitors in the fruit export business, there is no reason why exports to Africa cannot increase considerably in coming years. Increasing such exports is one of the near-term challenges facing the industry, as African countries share the concerns of developed countries about sustained food supply. Global commodity and food price developments In addition to financial market and growth uncertainties in certain parts of the world, we currently also see substantial increases in commodity prices, particularly oil and food. International oil prices have more than quadrupled since the beginning of 2004, and in fact World Economic Outlook, April 2008, Washington. have more than doubled since January 2007 when North Sea Brent Crude averaged a little above US$50 per barrel following a 2006 peak of around US$70 per barrel. This is clearly not good news for anyone except those who are making massive profits. Agriculture is directly affected through the increased costs of diesel and fertilisers (input costs). This relative price increase is not expected to be reversed significantly any time soon, and most analysts expect international oil prices to remain elevated. We in South Africa have the additional impact of movements in the rand exchange rate which has exacerbated the impact. However there is good news for the agricultural sector in that the commodity boom has extended to agricultural prices as well, albeit with a lag. The rising trend in international food prices accelerated in 2008. According to a recent World Bank study, U.S. wheat export prices increased by 18 per cent in the first quarter of 2008, while Thai (Thailand) rice export prices increased by 54 per cent in the same period. 3 This came on top of an 181 per cent increase in global wheat prices over the 36 months to February 2008, and an 83 per cent increase in overall global food prices over the same period. However not all sectors of agriculture have benefited to the same extent as some of the seed crops. While crops such as maize are more homogenous, fruit in particular is subject to other factors such as income changes, quality, taste changes, market access, and more competitive markets. Several factors have contributed to the increase in food prices. As mentioned earlier, farmers have recently been exposed to a whole host of increases in the prices of productive inputs, particularly oil, which also increase the cost of agricultural production. Linked to the level of oil prices has been the increased demand for corn as an input into the biofuels industry. Increasing the capacity for the production of biofuels as a replacement for expensive crude oil is seen as an important alternative source of energy. Increased biofuels production has increased the demand for maize, oilseeds, palm oil and sugar. This increase in demand for alternative usage has reduced the available supply for human consumption. The jury is still out about the potential benefits to be derived from the biolfuels industry. At the same time it would seem that the demand for food has grown in emerging economies such as Brazil, China, India, Russia and South Africa owing to improved standards of living in these and other countries. On the supply side adverse climatic conditions have contributed to lower agricultural output in some parts of the world, with concomitant price increases. In as much as agricultural produce is used in the food production chain, rising feed prices (input costs) resulted in increases in the cost of animal production and, ultimately, meat prices. A number of countries have responded by restricting the export of certain categories of food, which simply compounds the global problem. We are supposed to be promoting and not hindering international trade. That has been the burden of the Doha round (WTO negotiations). This combination of factors has contributed to world-wide concerns about sustained food supply and food security. It is quite ironic that as recently as 2005, a Food and Agricultural Organisation (FAO) report warned that “the long-term downward trend in agricultural commodity prices threatens the food security of hundreds of millions of people in some of the world's poorest developing countries where the sale of commodities is often the only source of cash”. 4 Clearly there has to be a balance between food supply sustainability and affordability. Rising food prices: Policy Options and World Bank responses: Background note for the Development Committee meeting, April 2008. FAO Press Release (15 February 2005) of the FAO Publication: The State of Agricultural Commodity Markets (SOCO 2004), Geneva. Global and domestic inflation Until recently, global inflation appeared to be relatively under control despite the food and energy price developments. According to the IMF, world inflation averaged 4 per cent in 2007 and is expected to increase to 4,8 per cent this year, although many analysts expect this to be higher. However emerging market economies are expected to experience even higher inflation because of the higher weight of food in their consumption baskets. Inflation is therefore expected to increase to average 7.4 per cent in the developing economies. Food price inflation is much higher than overall headline inflation in many countries, including South Africa. World-wide inflation has been accelerating over the past year in the midst of slower global economic growth. In the 1970s similar conditions of slower growth combined with accelerating inflation resulted in stagflation – despite recessionary conditions, many economies suffered inflation. One current challenge facing many economies is to prevent the development of similar unfavourable conditions. For this reason we have seen divergent policy responses. In some countries, such as the US, Canada and the United Kingdom, interest rates have been decreased recent months. However the higher inflation has seen a tighter monetary policy stance in a number of countries including Sweden, China, Russia, Brazil, Iceland, Australia and South Africa. Over the next few months we are likely to see increasing numbers of countries trying to contend with higher inflation pressures and lower growth. The road ahead is going to be bumpy. Domestically, year-on-year CPIX inflation has accelerated during the past few months, and reached 10,4 per cent in April of this year. In response, the Monetary Policy Committee of the Bank has increased interest rates by a cumulative 450 basis points since June 2006. Food and petrol prices are the main contributors to inflation, but in recent months, more generalised price pressures have emerged as well. Food prices increased at a year-on-year rate of 15,9 per cent in April, while petrol prices increased by around 30 per cent. According to our most recent forecast, inflation is expected to persist above the inflation target of 3-6 per cent, and is not expected to return to within the range before the end of 2009. Unfortunately we see the risks to this forecast to be significantly on the upside. So exporters are likely to continue to face an environment of rising costs and high interest rates in the short term. We remain committed, however, to bringing inflation down to within the target range in the medium term. Exchange rate issues South Africa runs a sizeable current account deficit on its balance of payments. This implies that we import more from the rest of the world than we export. For 2007 this deficit amounted to 7,3 per cent of GDP. This deficit has been sustainable because foreign investment attracted to the country has exceeded the deficit on the current account. Given our strong infrastructural expenditure programme and high crude oil prices, our import demand is expected to remain strong. This means that we have to continue to rely on continued capital inflows, or else we need to improve our export performance. Clearly, from a sustainability perspective the latter would be preferable. Unfortunately our export performance has not kept up with imports, despite the significant increase in commodity prices. Over the past few years, when the economy was growing at rates above 5 per cent, the bulk of net capital inflows were into the equity markets. The sustainability of these flows is, however, not only dependent on domestic developments. In the final quarter of 2007 we experienced significant net sales of bonds and equities by non-residents as a result of global risk aversion in response to the turmoil in global credit markets. These sales intensified in January and February as electricity supply constraints contributed to negative perceptions of our growth prospects. These developments impacted on the exchange rate which depreciated by about 20 per cent on a trade weighted basis in the first quarter of 2008. It has since recovered somewhat, but is nevertheless about 12 per cent weaker than at the beginning of this year. Fruit and wine exports are particularly sensitive to exchange rate movements, and one of the consequences of the current financial market turmoil is that there has been a considerable amount of exchange rate volatility in international markets in general. Since the beginning of 2008, for example, the US dollar has depreciated by about 6 per cent against the euro. So even if there were no domestic issues, the rand would still have experienced some volatility. The weaker exchange rate has generally been welcomed by exporters. Of significance perhaps is the fact that while since the beginning of the year the rand has depreciated by about 10 per cent against the US dollar, the Chilean peso has appreciated by around 4 per cent against the dollar. Given that Chile is a major competitor of South Africa in the European fruit market in particular, these developments are seen to give our fruit farmers a significant competitive advantage. It is sometimes argued by some commentators and researchers that a weaker exchange rate is in the long-term interest of the export sector. This is a fallacy. No industry can build a longterm business strategy on a one-way bet on the exchange rate of the currency, or on the basis of short-term nominal exchange rate movements. The immediate benefits of a lower exchange rate for exporters are soon offset by the increased costs of imported productive input such as petrol and chemicals, while cost increases can also feed into higher inflation with all its negative consequences. A weaker exchange rate is usually a sign of high inflation, and unless the inflation problem is addressed, it can set in motion an exchange rate and inflation spiral. In short, a weaker exchange rate can only benefit exporters if the exchange rate change is not offset by cost increases. During times of exchange rate volatility, however, management of exchange rate risk does become a challenge for exporters. Emphasis should however be made here that the South African Reserve Bank does not intervene to try and manage the level of the exchange rate. In an inflation targeting context, the exchange rate must be determined in the market. We would of course prefer to see a stable and competitive currency, but the best we can do is to contribute to this through prudent monetary policy which focuses on achieving and maintaining low inflation which should prevent a continuous depreciation of the currency. Stable macroeconomic policies also contribute to more stable capital inflows, and our higher level of gold and foreign exchange reserves should also make the currency less vulnerable to speculative attacks. The exchange rate is only one aspect of competitiveness in the fruit industry where quality issues are paramount. Other challenges relate to the industry commitment at many levels to ensure compliance with international best practice and commercial guidelines, for instance GlobalGAP. This includes compliance with quality and safety standards, traceability, domestic legislation, and social and ethical conduct. As compliance has a technical and financial impact on emerging farmers, a challenge facing the industry is the rendering of support and assistance to ensure their export readiness and compliance with the strict requirements. Unfortunately compliance costs are very high and it seems that producers have not yet received tangible benefits for compliance in the form of a premium on their products. Concluding comments Internationally, concerns currently focus on the availability and prices of food, and in particular of basic staple commodities such as maize and rice. Although the availability of food domestically may not be a concern at this point, as noted earlier, South African food prices have increased considerably. South Africa is dealing with a problem of food affordability, rather than food availability. This has serious implications for poor people and the unemployed, as their spending on food as percentage of total spending is much larger than is the case with the middle and high income groups. Food accounts for more than 50 per cent of the spending basket of the low income group, compared to some 17 per cent of the spending of the highest income group, and some 20 per cent of the overall CPI basket. Agribusiness can make a contribution to affordability by containing price increases as far as possible, as is indeed also the case for all other productive sectors in the economy in our quest to contain inflation. Cost containment will also help to ensure the international competitiveness of agricultural exports. The deciduous fruit industry is an important contributor to the regional GDP of the Western Cape. It is therefore befitting to wish the industry and its many role players the best wishes for success from all of us at the Bank. Your important role in the domestic economy is never underestimated and we wish you good harvests, a mild climate with sufficient timely rainfall, a healthy crop and international good prices at a level supportive of your business and the South African economy. Thank you very much.
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Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the African Banking Congress 2008, Johannesburg, 8 July 2008.
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X P Guma: Banking in Africa and its future outlook Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the African Banking Congress 2008, Johannesburg, 8 July 2008. * * * 1. Distinguished guests, ladies and gentlemen, I have been asked to speak today on Central Bank perspectives on the outlook for banking in Africa, focusing in particular on the following issues: the role of central banks and major banks in regional integration; latest trends and experiences, and lessons learnt. Having taken note of the formidable array of speakers who are to take to the podium during the course of the day, I have taken the liberty to reduce the scope of my remarks by focusing on the situation in South Africa and the prospects for the Southern African region. Others will, no doubt, enlighten us regarding developments elsewhere. 2. The role of Central Banks and major banks South Africa currently has 20 registered banks, 14 local branches of foreign banks and 46 representative offices of foreign banks, supervision of banks being the responsibility of the Registrar of Banks, a constituent component of the South African Reserve Bank (SARB). The relationship between these two is described in the Banks Act 94 of 1990 in the following terms (Chapter II.S4): “The Reserve Bank shall, subject to the approval of the Minister (of Finance) designate an officer or employee in its service as Registrar of Banks, who shall perform, under the control of the said Bank and in accordance with the directions issued by the Bank from time to time, the functions assigned to the Registrar by or under this Act …” The SARB in turn is defined in Section 223 of the Constitution of the Republic of South Africa 1996 as “… the central bank of the Republic and is regulated in terms of an act of Parliament”, and “the powers and functions of the SARB are those customarily exercised and performed by central banks …” (Section 225). Five of the largest banks account for the greater share of the banking sector assets of R2860.5 billion as at May 2008, a pattern which has been consistent over time. The salient features of this banking sector are summarised in Tables 1 and 2. This outcome may be viewed in contrast to the situation described by Dr A.J. Bruwer in his polemic, South Africa: A Case for a National Gold and Banking Policy (1957), although echoes of the sentiments that he expressed have some resonance in certain sections of contemporary South Africa: “… it becomes abundantly clear that the two British Imperial Banks … have practically a monopolistic hold on the commercial banking of the country and control over 82 per cent of its banking assets. The imperial hold on the banking and currency structure of the country was made practically complete in 1920 with the establishment of the South African Reserve Bank ….” And, he continued: “If South Africa today has a hopeless inferiority complex with regard to her capacity to run her own banking and currency system along national lines, the country cannot be blamed … (Preface) Bruwer’s preferred outcome was stated thus: “What is needed in South Africa more than a central bank (although there is no harm in retaining a bank with independent central banking powers in South Africa) is a powerful extra unit in the field of commercial banking – a unit that will be able within a minimum of time to enter the remotest hamlet in the country in competition with the two all-powerful Imperial banks (p.192). I have quoted Bruwer at length for two reasons; first to indicate the fact that we must expect criticism to be directed at our financial systems from time to time, more so during periods of economic stress. Central Banks, in particular may be deemed to be purveyors of all sorts of undesired policies and actions, some being more fantastic than others. My second reason is to remind this heterogeneous group of eminent persons with direct interest in the financial system that it is important to take into account local concerns when imagining and implementing the architecture of our financial infrastructure, subject always to the need to ensure probity, efficiency and stability in the system as a whole. What works well in one country during a particular period of time may not best be suited to another country and may be less suited to local conditions as time elapses. Stated differently, in the absence of uniform conditions, local improvisations and adjustments are, of course, to be resorted to depending upon factors such as the particular stage of development of a country, the makeup of its banking and credit structure generally, and the degree of organisation of its money market, inter alia. At present, let it be stressed, South Africa has no inferiority complex with regard to her capacity to run her own banking and currency system and the authorities are alive to the need to do better. Let it be said also that the banking system continues to facilitate intermediation between surplus and deficit financial units – not by administrative diktat, as some would prefer. Rather, allocative efficiency is sought through the price mechanism which operates best at arms length. The role of the central bank is then multi-faceted: in particular supervising the banks, large and small alike, implementing monetary policy for the economy as a whole – within a framework of inflation targeting – and maintaining the national payment system. 2.1. Some recent developments Three recent domestic developments warrant mention. The first two have to do with legislation, whilst the third has to do with competition. As noted in the South African Reserve Bank’s Financial Stability Review, March 2008, the Banks Amendment Act, No. 20 of 2007, was promulgated and assented to in 2007 following extensive consultation with relevant stakeholders over a number of years and came into effect on 1 January 2008. The amended legal framework gives effect to current international standards and best practice relating to banking supervision and regulation, and in particular to the new capital framework as envisioned in Basel II. In addition, the financial services industry is currently being subjected to an assessment conducted by the IMF and World Bank under the Financial Sector Assessment Programme, or FSAP. Second, as part of its efforts to improve access to finance, South Africa is moving towards a co-operative banking regulatory framework in order to advance the social and economic welfare of South Africans. Significant progress has been made to date, including the recent promulgation of the Co-operative Banks Act, No. 40 of 2007. The applicable supervisory bodies are in the process of establishing the required developmental and supervisory structures. The Act and the Regulations are likely to be implemented concurrently during 2008. Third, the Competition Commission of South Africa has recently completed an Enquiry into Competition in Banking: at present, only the Executive Overview has been released and is currently being studied. Finally, in this regard, the Bank for International Settlements (BIS) released its Annual Report last week, noting in particular the rapid deterioration in the stability of financial markets during the past year. Most notable, in the view of the BIS, was the “onset of turmoil in the US market for sub-prime mortgages which rapidly affected many other financial markets ….” In the case of South Africa, however, the effects of this turmoil in international financial markets, so far, have been indirect. They have been felt primarily in the form of volatility in the domestic financial markets and in the form of increased pricing for off-shore funding. In theory, international contagion could also be transmitted through the international exposures of the South African financial system. In the event, however, this has not materialised as the financial sector had very little direct exposure to the US sub-prime market. Moreover, as has been indicated earlier, the banking sector in South Africa has capital in excess of the regulatory requirement, operates within a regulatory environment which is fully compliant with the Basel II regulatory framework: and is subject to robust supervision by the Registrar. 3. Regional economic arrangements As is well known, South Africa is a member of three regional organisations in the Southern Africa region, these being the Common Monetary Area (CMA) (with Lesotho, Namibia and Swaziland); the Southern African Customs Union (SACU), with Botswana and the CMA countries; and the Southern Africa Development Community, SADC, whose members include all SACU members as well as Angola, Democratic Republic of Congo, Madagascar, Malawi, Mauritius, Mocambique, Tanzania, Zambia and Zimbabwe. The CMA, at present, allows each member to have its own currency, these being pegged one-to-one to the South African Rand which circulates as legal tender throughout the Area. Each member state, except South Africa, is required to maintain foreign reserves equivalent in value to the total amount of local currency issued. The reciprocal obligation of South Africa is then to pay seignorage to the other countries in proportion to the Rand circulating within their respective regions. For consistency, moreover, exchange controls are harmonised throughout the region. Most of the major South African banks have a presence in each of the member countries of the CMA as indicated in table 3: but, as of now, none of the home-grown banks in Lesotho, Namibia, and Swaziland have yet established a presence in South Africa. Regarding SACU, it is the case that negotiations leading to the current arrangement and reserve-sharing formula were finalised in 2002; ratified in a formal treaty in 2004 and the provisions were first implemented in 2005. Revenue, deriving in essence from the implementation of a common external import tariff structure for the Union and from excise taxes collected, is apportioned among the member states in accordance with a formula which has three components: namely, a customs component, an excise component and a development component. During the three years of operation, South Africa’s contribution to the SACU revenue pool has amounted to approximately 98 per cent whilst South Africa has, in effect, retained the bulk of the excise component – which typically amounts to about 50 per cent of the total; the balance has then been transferred to the other SACU member states, constituting a charge on the services account of South Africa’s balance of payments; an income in the services account of the balance of payments accounts of the other SACU member states. With imports rising rapidly in recent years, import duties collected have also been buoyant and the total amount paid over to the governments of Lesotho, Namibia and Swaziland has risen threefold over the past five years. Within SADC, recent developments have been guided by the Memorandum of Agreement (MOU) on macro-economic convergence, signed in August 2002 on the one hand; and the Regional Indicative Strategy Development Plan (RISDP), on the other. The MOU identifies the following indicators as convergence criteria and proposes the timetable indicated in Table 4 for their achievement, whilst Table 5 adumbrates the timetable for achievement of the quantitative targets for the so-called secondary macro-economic indicators. Stated in words, the SADC convergence criteria require member states to achieve the following by 2018: an inflation rate of less than 3 per cent per annum; a budget-deficit-toGDP ratio of less than 3 per cent; a ratio of public-sector debt to GDP of less than 60 per cent and a ratio of the deficit on the current account of the balance of payments to GDP of less than 5 per cent. Table 5 can be interpreted in similar fashion, mutatis mutandis. The desire for a stable macro-economic environment is one to which most policy-makers would assent. Clearly, though, there will be a need to re-assess the quantitative dimensions of the desired end-state if severe macro-economic dislocation is to be avoided in the period which is to extend beyond 2012, in terms of the SADC timetable. Conclusion To conclude: 1. South Africa has a well regulated banking system, well capitalised, compliant with Basel II and largely unaffected by contagion arising from the financial market turmoil which started in the sub-prime market of the United States of America last year. 2. The relevant South African authorities maintain vigilance with regard to further development of the banking and financial system. Evidence of this is to be found in recent regulatory pronouncements, in particular changes to the regulations under the Banks Act and legislation intended to extend access to finance, or as Dr Bruwer would have it, to “enter the remotest hamlet in the country …” 3. South Africa, today, does not have a hopeless inferiority complex with regard to the capacity to run her own banking and currency system. 4. Regional integration is an objective of the governments of the Southern African region and should provide further impetus for enhanced economic growth and an environment in which existing and new banks, adhering to the dictates of probity, can thrive through competition at arms-length contributing to and being guided by market forces. The current uni-directional flow of investments by banks surely presents a welcome challenge to those entrepreneurs of lofty ambition. 5. In the absence of uniform conditions, monetary authorities in their respective jurisdictions will have to improvise, adapting their practices to local conditions. They must expect to be criticised, sometimes vilified for doing their work, particularly during times of economic adjustment. 6. There is no short cut to development or to sustainable regional integration. These take time, consistent application and nimble adaptation. So too with banking in Africa. Table Table 1: 1: Key Key banking banking sector sector indicators indicators -May May 2008 Jan 2008 Feb 2008 Mar 2008 Apr 2008 May 2008 2 663.2 2 758.1 2 827.4 2 790.8 2 860.5 27.0 27.7 29.9 26.5 28.8 2 103.2 2 175.0 2 209.7 2 194.6 2 241.6 19.2 19.3 19.3 17.4 19.2 Cost-to-income ratio (%) 47.0 54.3 46.7 48.1 50.6 Capital adequacy ratio (%) 11.69 11.94 12.19 12.34 12.39 Impaired advances* (R bn) 44.4 46.2 47.9 49.5 55.7 Impaired advances* as % of total loans and advances 2.0 2.0 2.2 2.3 2.5 Specific credit impairments as % of impaired advances 39.7 40.6 40.7 40.3 37.3 Total assets (R bn) Total assets: year-on-year growth (%) Gross loans and advances (R bn) Gross loans and advances: year-on-year growth (%) Source: Bank Supervision Department * Advances in respect of which a bank raised a specific impairment impairment Table Table 2: 2: Distribution Distribution of of total total banking banking sector sector assets assets –– May May 2008 R bn % Standard Bank 721.8 25.2 Absa 638.9 22.3 FirstRand 552.9 19.3 Nedbank 476.9 16.7 Investec 165.5 5.8 Other 304.5 10.7 2,860.5 100.0 Total banks Source: Bank Supervision Department Table Table 3: 3: South South African African Bank Bank presence presence in in CMA and SACU countries March CMA and SACU countries - March 2008 Bank Standard Bank Absa FirstRand Nedbank As % of bank assets As % of bank assets As % of bank assets As % of bank assets Botswana1 0,99 - 6,8 - Lesotho2 0,42 - 0,09 0,35 Namibia2 1,56 - 2,0 1,07 Swaziland2 0,36 - 0,18 0,26 Country Source: Bank Supervision Department 1 - Southern African Customs Union (SACU) 2 - Southern African Customs Union (SACU) and Common Monetary Area (CMA) Table Table 4: 4: Macroeconomic Macroeconomic convergence convergence targets targets Year Inflation (% p.a.) <10 <5 <3 Deficit1/GDP (%) <5 <3 <3 Debt/GDP (%) <60 <60 <60 <9 <9 <3 Indicator Current account2/GDP (%) Notes: 1. Deficit means the public sector deficit 2. External current account, excluding official transfers Source: SADC Secretariat July 2008 Table Table 5: 5: Other Other macroeconomic macroeconomic targets targets Year Economic growth (% p.a.) External reserves (month of imports) >6 >6 Central bank credit to Government (% of tax revenue) Domestic saving/ GDP (%) Domestic investment/ GDP (%) Indicator Source: SADC Secretariat July 2008 References: Bank for International Settlements (2008) 78th Annual Report. Bruwer, A.J. (1957) South Africa : A Case for a National Gold and Banking Policy, Cape Town, H.A.v.M. South African Reserve Bank (various years), Financial Stability Review South African Reserve Bank (various years), Quarterly Bulletin
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Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the South Africa Economic Conference 'Business Unusual', Johannesburg, 4 September 2008.
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X P Guma: The South African economy and financial markets – outlook, risks and policy responses Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the South Africa Economic Conference ”Business Unusual”, Johannesburg, 4 September 2008. * 1. * * Introduction Our meeting here today occurs during a period of considerable uncertainty: financial turbulence in the major industrialised economies being the proximate cause of international uncertainty; with a variety of factors impacting upon the short-term indicators of domestic economic performance. It is, therefore, appropriate, I think, to attempt to place recent economic developments in some perspective as this may go some way towards piercing the veil of gloom which appears to have descended over this and other economies. And, for this reason, I thank the organisers of this Conference for according to me the opportunity to participate in these discussions. 2. Overview of key economic indicators: South Africa In order to assess the South African economy’s performance over the medium-term, I have chosen to divide the period from 1990 to 2007 broadly into five-year segments, as indicated in Tables 1A and 1B: namely, the periods 1990-1994; 1995-1999; 2000-2004 and finally, the most recent period 2005-2007. As these Tables show, real gross domestic product grew at progressively increasing rates throughout this period: from an average rate of 0.2 per cent during 1990-1994 to an average rate of 5.2 per cent during the most recent period. The strongest sectoral growth occurred in the secondary and tertiary sectors, with growth reaching levels, on average, of 5.8 per cent and 5.7 per cent, respectively, over the period 2005-2007. The economy has become more open with the sum of exports (X) and imports (M) as a percentage of gross domestic product (GDP) increasing progressively, from 40.6 per cent on average, between 1990 and 1994 to 61.6 per cent on average during the period 2005-2007. And inflation, as measured by the Consumer Price Index (CPI), had decreased progressively from an average annual rate of 12.5 per cent in the early period, to an average rate of 5.1 per cent during 2005-2007. 1 Developments in the financial markets have, in general, been consistent with those described above regarding the real sectors of the economy. Stated briefly, the assets of the banking sector have increased substantially; from a nominal value of R281 billion on average, between 1990 and 1994 to an average of R2 100 billion on average between 2005 and 2007. The average market capitalisation of the bond market has increased, in nominal terms, from an average of R374 billion between 1995 and 1999 to an average of R860 billion between 2005 and 2007. And the average market capitalisation on the JSE Limited has increased from an average of R920 billion during the first of our time periods to an average nominal value of R5 697 billion in the last period. Data for CPIX became available only during the year 2000. Moreover, as has been noted elsewhere 2 , growth in South Africa’s securitisation market has remained relatively healthy since its emergence in 2000. However, this market is subject to cyclical variation to a far greater extent than are others. In the fairy tale from which the description “Goldilocks” is derived, experimentation by the heroine leads to temporary bliss: not all the plates of porridge were of a temperature that was just right. But one was. And that plate was licked clean – finished, exhausted of its contents. So too, some would have us believe, with the South African economy: it could, apparently, have been described as approximating a Goldilocks economy, with most of the key ratios being “just right”; neither too strong nor too weak; neither too hot nor too cold. Just right or on the way to being just right. Until March 2007. As explained by Dr M Mnyande 3 , Chief Economist of the South African Reserve Bank (the Bank), the first sign of a possible turning point in the business cycle indicator, which is calculated by the Bank, is usually when the composite leading business cycle indicator changes direction clearly for a period of at least six months. And, in March 2007, the leading indicator reached its most recent peak, whereafter it has been following a downward trend. It was also in March 2007 that CPIX, the measure of the rate of inflation that is of interest to the monetary authorities was last within the target range of 6 to 3 per cent which is specified as being the inflation target. Then, global food and fuel price shocks intensified, employment growth abated, real value added in manufacturing contracted as production was hampered by strike activity in the motor industry and slowing demand, inter alia. Household debt started to edge higher, the deficit on the current account of the balance of payments widened to 8.1 per cent of gross domestic product in the third quarter of 2007 – the highest ratio since the 9.2 per cent registered in the first quarter of 1982. And then in January 2008 power cuts disrupted output and exports, taking the public by surprise. Or stated in such a way as to complete the analogy, at some time during or around March 2007 Goldilocks jumped up and ran away … and has not yet returned. 3. The International financial environment According to the Quarterly Review of the Bank for International Settlements (BIS) issued on 1 September 2008; “… During the period from end-May to late August 2008, global financial markets adjusted to growing signs of a broad-based cyclical deterioration. While markets continued to display signs of fragility, worries about the economic outlook and related uncertainties gained prominence, weighing on valuations across asset classes. Credit markets came under renewed pressure over the period, as spreads widened to reflect the implications of the ongoing cyclical adjustment for loss expectations and financial sector balance sheets. This was despite retreating oil and commodity prices, government action in support of the US housing market and continued recapitalisation efforts by banks and other financial firms. Equity markets reflected similar concerns, as valuations adjusted to reflect disappointing earnings data, including in the financial and other cyclical sectors. Against this background, pressures in interbank money markets persisted, prompting further central bank action to ease financial sector access to funding.” (p.2) A.D. Mminele. (2008) “Benefits and Risks of New Instruments: Derivatives and Securitisation; the case of South Africa”, Berlin, 4 July 2008. Conference on Financial Innovation and Emerging Markets. Dr Monde Mnyande (2008) “Keynote address at the 4th Convention of the South African Institute of Black Property Practitioners (SAIBPP)”, Helderfontein Conference Centre, July 31. The origins of this turbulence, turmoil and distress in the international financial markets are well known and need not detain us unduly. 4 As summarised in the Annual Report 2007 of the Bank Supervision Department of the Bank, the episode began with credit concerns in the United States (US) sub-prime mortgage market, in 2007; and developed into concerns in global credit markets as the extent of exposures and potential losses from the sub-prime market were not known. Then, “… The ongoing boom in the US housing market attracted clients who would not normally have qualified for loans. Loans granted to these clients are commonly known as “sub-prime mortgage loans”. In some instances the sub-prime loans were offered at initial low “teaser” rates, which reset to higher rates after a few years. As these loans began to reset and the housing market began to cool off during 2006 (i.e., growth in house prices decreased), these clients found themselves unable to meet the higher payment obligations and were not able to refinance their loans. It was during this period that non-performing sub-prime mortgage loans increased rapidly.” “Concurrent with the granting of sub-prime mortgage loans, certain institutions securitised their mortgage loans. Numerous methods and instruments were developed to facilitate this process, and the instruments became increasingly complex. Instruments such as mortgage-backed securities and collaterised debt obligations offered tranches of risk, ranging from high-risk equity tranches to low-risk senior tranches. As a result, a wide range of banks and investors faced significant exposure, directly and indirectly, to the US sub-prime mortgage market.” (p.3) At the time of writing, the impact of the US sub-prime crisis on the prospects for the international economy are difficult to assess: not least because of the rate at which the losses which have been incurred by major financial institutions are being reported. However, from media reports, it would appear that Bloomberg’s calculations of write downs by and credit losses of banks related to the sub-prime crisis, at approximately US$400 billion, provide a plausible threshold. These estimates are reproduced in Table 2, below. What is clear is that prolonged financial-market turmoil in the major industrialised economies of the world would impact adversely on economic and financial stability generally, making prospects for a resumption of robust and sustained economic growth in South Africa more uncertain. So too with an attenuation of the processes currently underway to reduce the imbalances which are extant in the global economy through unchanged or increased protectionism, reluctance to permit currencies to appreciate (or depreciate) in accordance with economic fundamentals. In short, prospects for the international economy are served poorly by a generalised failure by policy makers to acknowledge, by praxis, a simple fact: namely, that a globalising economy is, was and will remain a closed system. Its imbalances cannot, as yet, be exported (or transported) elsewhere. See, for example: Bernanke, B.S. (2007) “Housing Finance and Monetary Policy”, Speech at the Federal Reserve Bank of Kansas Economic Symposium, Jackson Hole, Wyoming: 31 August. IMF (2008) Global Financial Stability Report, Washington D.C. 4. Some considerations regarding policy My discussion of policy will be brief for two reasons. First, because the bulk of the effort of this Conference will be devoted to this matter: and second, because the subtitle of the Conference is: “Business Unusual”. According to President Thabo Mbeki, to whom authorship of this phrase is ascribed, “Business Unusual” does not refer “… to any changes in our established policies…”; rather it refers to “… the speedy, efficient and effective implementation of these policies and programmes, so that the lives of our people should change for the better, sooner rather than later.” So, to use the idiom of the contemporary policy analyst, we can assume that the policy thing has been parameterised: in the form of the RDP (1994); GEAR (1996); the Growth and Development Summit (2003) and the Asgisa (2005). My only caution is that in proceeding, sight should not be lost of the fine balance that needs to be maintained between the state and the market as the primary allocator of resources. For, as Schumpeter observed 5 , when the state is pre-eminent and its shortcomings are highly visible, economists and others seem to swoon over the charm of the market. But when the market is in the ascendancy and its drawbacks are evident, then the state may be idealised. Both extremes should be resisted. 5. Conclusion Let me conclude by making the following observations. First, fairy tales have a useful function to perform in entertaining children – but are of dubious value in enhancing discussions of economics. Goldilocks and her kindred spirits should, please, be allowed to go away from the pages of economic analysis. Second, any notion that the South African economy is soon to enter a recession 6 must be rejected, firmly. The current growth rate of the economy may be somewhat lower than had come to be expected but is still strongly positive and will remain so. The so-called “tsunami” of adverse economic outcomes in the period subsequent to March 2007 will lose momentum as inflation abates, the balance between aggregate saving and investment improves, the process of financial deepening intensifies and better use is made of the potential for capture of resource rents in the current commodity cycle. Third, whilst South Africa has been spared, along with many other emerging markets, the worst of the financial market turmoil, the authorities have not become complacent. Adherence to a clearly articulated macro-economic framework, which includes an explicit inflation-target, provides the first line of defence – in particular, against capital flight. A second line is drawn by ensuring adherence to international best standards on laws, regulations, practices and policies in the financial sector; monitoring proven financial soundness indicators for early warning of potential problems. And a third line is drawn by the Financial Sector Contingency Forum – which I currently chair. This is a forum which facilitates inter-agency coordination and preparedness for addressing crises. Finally, I think that South Africa should continue to participate fully in international fora in order to make the case for multi-lateral adjustments in the interests of systemic stability in our closed system. Continued myopia by national governments will, likely, prolong the See Schumpeter, J.A. (1949) “English Economists and the State-Managed Economy”, Journal of Political Economy, 57, no. 5. and also Klitgaard, R. (1991) Adjusting to Reality: Beyond “State versus Market in Economic Development, San Francisco, I CE G. “Recession” here means a classical recession: i.e., a period of economic contraction or negative growth sustained for 2 quarters or more. adjustment process which needs to be completed if the current turbulence in financial markets is to be resolved. And on that note, I end: thank you for your attention. References: 1. Bernanke, B.S. (2007) “Housing Finance and Monetary Policy”, Speech at the Federal Reserve Bank of Kansas Economic Symposium, Jackson Hole, Wyoming: 31 August. 2. BIS (2008) Quarterly Review, Basel. 3. IMF (2008) Global Financial Stability Report, Washington D.C. 4. Klitgaard, R. (1991) Adjusting to Reality: Beyond “State versus Market in Economic Development, San Francisco, I CE G. 5. Mminele, A.D. (2008) “Benefits and Risks of New Instruments: Derivatives and Securitisation; the case of South Africa”, Berlin, 4 July 2008. Conference on Financial Innovation and Emerging Markets. 6. Mnyande, M. (2008) “Keynote address at the 4th Convention of the South African Institute of Black Property Practitioners (SAIBPP), Helderfontein Conference Centre”, July 31. 7. Schumpeter, J.A. (1949) “English Economists and the State-Managed Economy”, Journal of Political Economy, 57, no. 5. 8. South African Reserve Bank (2008) Annual Report 2007: Bank Supervision Department, Pretoria.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 88th ordinary general meeting of shareholders, Pretoria, 18 September 2008.
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T T Mboweni: Overview of the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 88th ordinary general meeting of shareholders, Pretoria, 18 September 2008. * * * Introduction The past year has been a difficult one for both the global and domestic economies. At the time of the previous annual general meeting of the South African Reserve Bank (the Bank), the sub-prime mortgage crisis in the United States (US) was in an early phase, and at that stage the full implications were yet to be seen. A year later we are witnessing the repercussions in terms of pressure on the international financial markets and a slowing global economy. Compounding these developments were sustained increases in the prices of a number of commodities, particularly food and oil, which have fuelled domestic and global inflation. The South African banking sector has been relatively insulated from these financial market uncertainties. Nevertheless, greater vigilance has been required in supervising and regulating the domestic banking sector and payment system, which contributed to an orderly financial market environment. At the same time, monetary policy has faced particular challenges as relative price movements and strong domestic demand caused inflation to exceed the inflation target range. In carrying out its mandate of achieving and maintaining price stability, the Bank has tightened the stance of monetary policy over the past year. However, the Bank has retained its focus on maintaining the efficient internal workings of the Bank. It is in this context that I report to you today. This year a comprehensive economic report is included as part of the Annual Report. In previous years this economic report was published as a separate Annual Economic Report. The economic report provides an analysis of developments in the domestic and international economy during the year under review, with particular emphasis on developments that have had implications for the operations and policy implementation of the Bank. The focus of this address is on the main operational areas of the Bank. Monetary policy The challenges facing monetary policy intensified during the year. Inflation was impacted initially by strong domestic demand pressures, and sustained and significantinternational oil and food price increases. Since April 2007, CPIX inflation has exceeded the upper end of the target range of 3 to 6 per cent and it has risen persistently since then. In July 2008 CPIX inflation had reached a level of 13,0 per cent. The Monetary Policy Committee (MPC) has consistently recognised that there is little that monetary policy can do to avoid the impact or first-round effects of exogenous relative price changes on domestic inflation. Monetary policy needs to focus on preventing these firstround effects from feeding through to a generalised or broad-based increase in inflation. Central to this is the management of inflation expectations. If monetary policy fails to act appropriately, inflation expectations will become less anchored, with implications for price and wage setting. Whereas initially much of the pressure on inflation came from exogenous sources, more recently it has become evident that second-round effects have become more prominent. During the year under review underlying inflation has increased consistently: in July 2007 CPIX inflation excluding food and petrol measured 5,0 per cent, whereas by July 2008 it had increased to 7,4 per cent. There was also some deterioration in inflation expectations. During the second half of 2007 expectations, as reflected in the inflation expectations survey conducted on behalf of the Bank by the Bureau for Economic Research at Stellenbosch University, remained within the target range, although there was a moderate upward drift. This was despite the unfavourable inflation outcomes. However, the picture changed in 2008 when expectations increased significantly above the upper end of the inflation target range for all years in the forecast period. This deterioration is consistent with other market-based measures of inflation expectations. During the past year there have been a number of factors that impacted on inflation and that influenced monetary policy decisions. These included endogenous and exogenous factors. The international oil price continued to put pressure on domestic inflation. Oil prices were affected by strong global demand, particularly from fast-growing emerging-market economies, most notably in Asia. Numerous oil-supply disruptions, mainly a result of geopolitical developments and adverse weather conditions, also affected the oil market. As a result, the price of North Sea Brent crude oil increased from just over US$50 per barrel in January 2007 to reach a high of over US$145 per barrel in July 2008, before moderating in recent weeks. The combined effects of the international oil price and rand exchange rate developments have resulted in a cumulative increase in domestic petrol prices of about R2,75 per litre since September 2007. Despite an improved domestic maize harvest and relatively benign weather conditions, food prices also continued to place upward pressure on inflation. Factors sustaining pressure on international food prices include drought conditions in some regions, export restrictions in a number of countries, the diversion of food crops to biofuels production, and increased global demand fuelled by strong growth and higher incomes in emerging markets in particular. Domestically, between August 2007 and July 2008, food prices contributed on average 4,1 percentage points to average CPIX inflation of 9,3 per cent. Pressures from food and oil prices have also impacted on global inflation. Despite a general downturn in most of the advanced economies, monetary policy in numerous countries has been tightened in recent months in response to heightened inflation pressures. Since early 2008, the exchange rate has also begun to pose a threat to the inflation outlook. The exchange rate reacted to a number of developments including the widening deficit on the current account of the balance of payments, electricity supply constraints, bouts of global risk aversion and movements in the US dollar against other currencies. More recently, the rand exchange rate has appreciated somewhat from its earlier lows. The trend of wage settlements has also become an increasing risk to the inflation outlook. Nominal wage settlements have been increasing over the past year, although they are still on average below the inflation rate, particularly once productivity changes are adjusted for. Most other domestic determinants of inflation remained well contained and have either been neutral or helpful to inflation developments. After a long lag, household consumption expenditure showed a definite response to the tightened monetary policy stance, despite only a moderate slowdown in bank credit extension to households. Demand for durable goods has been particularly responsive to higher nominal interest rates. Asset price developments, in the form of lower equity prices and a subdued housing market, reduced the pressure on inflation emanating from wealth effects. Output growth, which has measured around 5 per cent per annum during the past four years, showed signs of moderating and the economy appears to be growing somewhat below potential output growth. Fiscal policy also remained supportive of monetary policy. In response to the impact of these developments on the inflation outlook, the monetary policy stance has been tightened progressively over the past year. The repurchase rate was increased by 50 basis points after each of four of the six MPC meetings held since the previous annual general meeting. Since the tightening cycle began in June 2006, the repurchase rate has been increased by a cumulative 500 basis points. In January 2008 interest rates were kept on hold despite a mildly deteriorated inflation forecast. At that time, the risks to the outlook were more or less the same, but the MPC assessed that the extent of these risks had moderated somewhat. However, by the next meeting this assessment had changed in the light of new developments, including the risk posed to the outlook by Eskom’s application for a significant further increase in the price of electricity. At its most recent meeting in August 2008 the MPC decided to keep the monetary policy stance unchanged. The committee decided that although upside risks to the inflation outlook remained, the degree of risk had subsided somewhat, particularly in the light of the continued slowdown in household consumption expenditure, the widening output gap and the lower international oil prices. The inflation forecast of the Bank showed that inflation was expected to peak in the third quarter of 2008 and then begin to decline, and to return to within the target range by the second quarter of 2010. The fact that inflation has been outside the target range for some time has been regarded by some as an indication of the failure of the inflation-targeting framework. It is generally accepted that a flexible inflation-targeting regime should allow for a deviation from the target in the event of exogenous shocks, which are beyond the control of the monetary authorities. Our framework also allows for deviations from the target in such instances, to avoid an excessive impact on output variability. However, to prevent second-round effects, it is important that expectations remain well anchored. Failure to respond will inevitably cause expectations to become dislodged and result in a further acceleration of inflation. The Bank remains committed to bringing inflation back to within the target in a reasonable time frame. Money-market operations The Bank manages the daily liquidity requirement in the money market so as to ensure that the implementation of monetary policy is consistent with the stance determined by the MPC. During the past year the daily liquidity requirement has been kept within a range of between R6,6 billion and R14,7 billion. The purchases of foreign exchange from the local foreignexchange market create rand liquidity that has to be drained in order to maintain a liquidity shortage in the money market. Liquidity was drained in a number of ways, including the issuing of SARB debentures, conducting longer-term reverse repurchase transactions and increasing deposits in the sterilisation account that the National Treasury holds with the Bank. In addition, increases in notes and coin in circulation, and in the statutory cash reserves of commercial banks also drained liquidity. Accumulation and management of reserves The Bank continued to increase the level of official gross gold and foreign-exchange reserves, from US$29,8 billion at the end of August 2007 to US$34,3 billion at the end of August 2008. Over the same period, the international liquidity position increased from US$27,4 billion to US$33,5 billion. In addition to accumulating foreign-exchange reserves, the Bank reduced the level of its borrowed reserves from around US$3,2 billion at the end of August 2007 to US$896 million at the end of August 2008. Borrowed reserves were reduced with the repayment of the outstanding portion of the syndicated loan entered into in 2005. South Africa is one of a number of emerging-market countries that have a relatively high current-account deficit, which underlines the need for a healthy level of reserves. The current level of reserves puts South Africa more or less in line with many of its peers in the emerging-market community and it meets the generally accepted reserve-adequacy measures. However, the Bank does not regard the current level as excessive and is likely to continue accumulating reserves at a moderate pace when market conditions permit. Enhancing the reserves management processes of the Bank has been a strategic focus area for a number of years, commensurate with the growing responsibility associated with higher levels of reserves. This improvement continued during the past year. The primary focus during the period under review was the formulation and partial implementation of a strategic asset allocation, which involved the quantification of risk tolerance in the form of a target duration per currency and a risk budget to facilitate the active management of reserves. In line with these developments, the roll-out of the internally managed portfolios was initiated to move closer to the approved strategic asset allocation. Currency distribution In celebration of former President Nelson Mandela’s 90th birthday on 18 July 2008, the Bank issued five million pieces of the bi-metal commemorative R5 coin depicting the former president. Arrangements were made to distribute this special commemorative coin to all provinces prior to 18 July 2008, thereby ensuring that they were available nationally on Mr Mandela’s birthday. The national payment system In March 2008 the Bank celebrated the 10th anniversary of the implementation of the South African Multiple Option Settlement (SAMOS) system. During 2008 an upgrade of the SAMOS system was initiated to facilitate the implementation of delivery-versuspayment in the settlement of money-market securities. Another project was initiated to review the South African settlement system infrastructure and applications, and to benchmark them against those of other central banks. Business continuity management also received special attention during 2008. Interbank clearing and settlement are of systemic importance and the Bank co-operated with stakeholders to minimise potential disruptions in this domain. The Bank continued to develop the oversight of the national payment system (NPS). This included the issuing of directives relating to the conduct of system operators and third-party service providers in the payment system, which became effective in December 2007. The measures contained in these directives are aimed at ensuring the safety and efficiency of the NPS. The Bank also participated in the Continuous Linked Settlement system oversight and served on the foreign-exchange settlement subgroup of the Bank for International Settlements. The Bank, in its role as overseer of the NPS, established the National Payment System Advisory Body (NPSAB), which is representative of all the regulated stakeholders within the NPS. This body allows for regulated bank and non-bank participants to establish associations that can represent the interests of their members at the NPSAB. Financial stability The resilience of financial markets globally has been severely tested during the past year following the widespread impact of negative developments in the US housing and subprime mortgage markets. As a result of the securitisation of sub-prime loans, the effect turned out to be more widespread than anticipated originally. Emerging-market economies, in general, and South Africa, in particular, have proven to be remarkably resilient in the midst of this financial market turmoil. The impact on South Africa has been indirect, mainly through financial market volatility and the resultant economic slowdown in the US and other major industrialised countries. The Bank, in recognising the importance of a stable financial system to support its primary objective, seeks to identify inherent weaknesses in the financial system and monitor risks that may result in financial system disturbances. The domestic financial system was assessed as sound, based on a quantitative analysis of a standard set of financial soundness indicators. The Bank’s qualitative assessment of the inherent robustness of the financial system environment against the 12 key financial soundness standards of the Financial Stability Forum shows a high level of general compliance with international standards and best practice. Bank regulation and supervision As part of its bank supervision function, the Bank focused on the impact of international financial market developments on the banking sector. In mid-2007 the Bank requested a selection of South African banks to provide detailed reports on their exposure to the prevailing risks. It was found that local banks had no direct exposure to the sub-prime mortgage market, while certain of the banks’ international franchises had only limited exposure. However, indirect effects, such as increased funding costs, were observable. In view of the developments in financial markets and specific events in some international banking institutions, the Bank deemed it important to embark on a process to evaluate the appropriateness of South African banks’ incentive schemes during 2008. A major change to the South African banking regulatory and supervisory framework occurred as a result of the implementation of Basel II on 1 January 2008. The process followed in implementing Basel II was characterised by its broad consultative approach; several quantitative impact studies and field tests; amendments to the regulatory and supervisory frameworks; and regular interaction with all South African banking institutions. The amended Banks Act, 1990 and Regulations relating to Banks, as well as the revised supervisory process were implemented at the same time. The Bank, in close co-operation with the Financial Intelligence Centre, continued to monitor the compliance of banking institutions with legislation relating to anti-money laundering and combating the financing of terrorism. Furthermore, in August 2008 the Bank participated in the Financial Action Task Force’s mutual evaluation of South Africa’s anti-money laundering and counter-terrorism financing system. International co-operation The African continent and the Southern African Development Community (SADC) region remain the focal points of the Bank’s international relations efforts as programmes to achieve regional integration gain momentum. The Bank currently hosts the Secretariat of the Committee of Central Bank Governors (CCBG) in SADC and continues to support the implementation of CCBG projects. Significant progress has been made in the committees dealing with payment systems, information technology, macroeconomics, banking supervision and legal issues. This progress has been shared with the finance committees in Parliament where the ratification of the Finance and Investment Protocol, a key instrument to advance regional economic integration in SADC, has been sought. In our relations with multilateral institutions our efforts have been concentrated on increased participation in key forums such as the G-20. The chair of the G-20 passed on to Brazil from South Africa at the beginning of this year. South Africa remains an active participant in this forum of systemically important advanced and emerging-market economies. The focus of the forum this year includes competition in the financial sector, fiscal space for social inclusion and clean energy. In addition, with the active involvement of the forum, progress was made this year with the reform of the Bretton Woods institutions, particularly in relation to quota reform and the finances of the International Monetary Fund (IMF). The Bank, through the SARB College (the College) continued to contribute to training in Africa by co-operating with international training institutions and central banks. The College hosted the residential segment of the IMF Financial Programming and Policies course, and a course for African countries on external vulnerabilities. The College also co-hosted a highlevel seminar on capital flight in sub-Saharan Africa with the World Bank Institute. Internal administration The Annual Report of the Bank was distributed to shareholders before this meeting. The total assets of the Bank show an increase from R220 billion at the end of March 2007 to R300 billion at the end of March 2008. The increase was mainly the result of the accumulation of official gold and foreign-exchange reserves; and was financed, in the main, by an increase in government deposits, the issuing of SARB debentures, an increase in currency in circulation, and the effect of valuation adjustments to the net reserves as a result of exchange rate and gold price movements. These adjustments are reflected in the increase in the Gold and Foreign Exchange Contingency Reserve Account. The Bank’s profit before taxation increased from R2 907 million for the previous financial year to R3 475 million for the financial year ended 31 March 2008. Budgeted expenditure of the Bank for the current financial year amounts to R1,9 billion. The four subsidiary companies of the Bank, namely the South African Mint Company, the South African Bank Note Company, the South African Reserve Bank Captive Insurance Company and the Corporation for Public Deposits achieved their objectives during the financial year. After a review of reports by their Boards of Directors and internal and external auditors, the Bank is satisfied that the subsidiaries are managed in accordance with their objectives and best corporate governance practice. The results of the subsidiaries are reported on a consolidated basis with those of the Bank in the financial statements in the Annual Report. The shares of the Bank continued to trade through the over-the-counter trading facility, implemented on 1 October 2005. During the period 1 April 2007 to 31 March 2008, 42 transactions were successfully concluded, representing 69 516 shares. Human resources remain an important focus of the Bank. As at the end of March 2008 the Bank employed 1 896 permanent and 48 contract staff members. The staff turnover rate was about 7 per cent, which is significantly lower than the banking-sector average of about 11 per cent. In terms of overall racial employment equity, the Bank progressed from 43 per cent black employees in 2000 to 58 per cent in 2008. Accordingly, the Bank’s overall target of 50 per cent black employees has been realised and surpassed. At managerial level, 44 per cent of the positions are filled by black employees compared with 18 per cent in 2000. Overall gender equity improved from 42 per cent female employees in 2000 to 47 per cent in 2008. The Bank aims to have 50 per cent female employees at all levels of employment by 2011. Performance management received special attention during the past year. This issue was identified in the Bank’s Seventh Annual Report on the Employment Equity Plan to the Department of Labour as the only remaining barrier to employment equity. A special task team was commissioned to research, investigate and benchmark best practice relating to performance management. The report was finalised and approved by the Remuneration Committee of the Bank. At the Bank we consider the wellness of employees as one of our primary human capital objectives. In this regard, we have updated and modernised clinic facilities that will cater for the well-being of employees. In the area of HIV/AIDS management we have completed prevalence testing, conducted industrial theatres to sensitise staff, and are implementing Bank-wide peer counsellor and educator training. The Bank has always considered training and development to be of paramount importance. In the past financial year the Bank spent an amount of about R33 million on training, development, study aid, bursaries, skills development levies and educational grants. The Cadet Graduate Programme of the Bank increased its intake from 10 in the previous year to 17 in 2008. The College formed a strategic alliance with the University of South Africa and the Institute of Bankers in South Africa to offer a nationally recognised qualification, namely the Advanced Diploma in Central Banking, which is also prescribed for the Cadet Graduate Programme. A number of high-level workshops and seminars were organised by the College for specific niche markets. The second biennial conference on Challenges for Monetary Policy-makers in Emerging Markets is being organised and is scheduled to take place in October 2008. Business continuity plans have been developed and successfully tested for all critical business processes. The Bank further continues to contribute towards the establishment and maintenance of a resilient business continuity capability within the broader financial sector, including the cash management industry. The upgrading of the back-up uninterrupted power supply for Head Office is in progress. This is being done to prevent interruptions in Bank operations as a result of unplanned power disruptions. The Bank has also embarked on a project to investigate the energy efficiency and environmental friendliness of its buildings. This project should result in a reduction in the consumption of electricity and fuel. Planning is in progress for several projects at the various branches around the country to ensure the efficient distribution of currency. The design for the proposed new Bloemfontein Branch has commenced, and tenders are awaited for extensive additions and alterations to the East London Branch. The new cafeteria at the Pretoria North Branch has been completed. Furthermore, the Cape Town Tower Block will be upgraded and the Johannesburg Branch will undergo major repairs. At Head Office large projects aimed at enhancing the existing infrastructure have been completed. These include the replacement of carpets, modernisation of lifts and maintenance of the air-conditioning system. The upgrading of the fire protection and evacuation systems, and the project to improve accessibility for people with disabilities are under way. Conclusion Global and domestic developments are expected to continue to pose a challenge to monetary policy in the coming year. In the international markets heightened volatility is expected to persist and growth in industrialised countries is expected to moderate further. The outlook for commodity prices is therefore uncertain and this makes for a difficult monetary policy environment. The Bank will continue to focus on bringing inflation down to within the inflation target range. The objective of the Bank remains to achieve and maintain low inflation in the interest of sustainable economic growth. During times of global financial market instability it is even more important to maintain vigilance over the payment system, domestic financial markets and the banking system in particular. After the successful implementation of Basel II, the Bank will continue to monitor closely the domestic banks not only with respect to the possible impact of global developments, but also to the impact of tighter credit conditions on indebted households and firms. Staff development will remain one of our strategic objectives. There will be a continued focus on training and development within the context of our Employment Equity Plan. Appropriate training is a benefit not only to the individual, but more generally to the Bank and the wider economy. Acknowledgements I wish to thank the Presidency, the Government and Parliament for their continued support. The Bank maintained a good working relationship with the National Treasury through the system of bilateral committees. Furthermore, I wish to thank the Minister and Deputy Minister of Finance, and the Director-General of the National Treasury and his staff for their ongoing support and co-operation. Sincere thanks are also due to the members of the Board of the Bank for their tireless efforts in ensuring appropriate corporate governance in the Bank. I welcome Mr Elias Masilela who has been appointed to the Board as a government representative. He takes the place of Prof. Vishnu Padayachee whose term of office expired last year. I wish to take this opportunity to thank Prof. Padayachee for his valuable contributions to the Bank over the past years. The successes achieved in dealing with the challenges of the past year are due to the continued dedication and commitment of the deputy governors, management and staff of the Bank. I wish to thank them all for their contributions and I am confident that these efforts will ensure that the coming year is even more successful.
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Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a charity gala dinner, organised by the University of Pretoria, Pretoria, 15 October 2008.
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T T Mboweni: Lessons to be drawn from the financial crisis for multilateralism and global financial co-operation Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a charity gala dinner, organised by the University of Pretoria, Pretoria, 15 October 2008. * * * Introduction I would like to express my sincere appreciation to the University of Pretoria and the organisers of the Charity Gala dinner for inviting me to address you tonight. I am glad to see that so many representatives of the financial sector are attending this function, notwithstanding the present financial turmoil. There are some encouraging signs that following the concerted commitment shown by various governments and central banks, and backed up by strong action, we may be finally embarking on the road to recovery from one of the worst crises the financial world has had to face. The global financial system has malfunctioned and there appears to be a need to seriously consider what changes and adjustments are required to ensure that the global financial architecture is better equipped to deal with future challenges. Given that the changes will inevitably require certain vested interests to be confronted, the international community will have to commit itself to put the greater good of all of us at the centre of any efforts going forward. The change must, however, be managed and embedded in concrete actions plans to create stronger institutions, with more balanced representation, that will contribute to long term financial stability and sustainable growth. The global economic outlook Presently, we are witnessing a severe financial crisis, a crisis that many commentators view as the worst since the Great Depression. Even before the escalation of the financial crisis, growth in the advanced economies had been faltering, as shown in the recent World Economic Outlook of the IMF. Growth in advanced economies has weakened and is well below potential. Economic activity in developing countries appears to be moderating at a somewhat faster pace than had been anticipated. The danger of a major and protracted slowdown in global growth, with inflationary pressures only likely to react with some time lag, is indeed very real. As most of you are participants in the financial market, I do not intend to go into any great detail about the causes of the global market turmoil. By now we seem to have a general consensus that accommodative monetary policy conditions in developed markets laid the foundation for an aggressive search for yield, which resulted in mispricing of risk on a large scale, coupled with some over-zealous “financial innovation”. The resultant combination of reckless lending and unsophisticated borrowing, which started in the USA ended up engulfing large parts of the financial world. A need for change Against this background I attended the Annual Meetings of the International Monetary Fund (IMF) and the World Bank last week. These institutions were created at the end of the Second World War to fill a much needed gap of providing capital in the global financial system, as well as ensuring the orderly functioning of the system. The IMF was, inter alia, created to provide financial support to countries that may be experiencing short term balance of payments problems, while the World Bank was established to assist countries, in particular European countries, in their post war reconstruction efforts. Over time, the size and the needs of the membership of these institutions have changed. These institutions have, however, not kept pace with the changing conditions in their operating environment. The governance and representation structures have lagged behind the changing global economic realities. The IMF has not fully lived up to one of its core responsibilities, being the conduct of effective surveillance of the global economic environment and that of individual countries. The relevance of the Bretton Woods Institutions, as the IMF and the World Bank have become to be known, has come under severe scrutiny, particularly over that last ten years in the aftermath of the Asian crises. Questioning the relevance of the IMF has intensified in the wake of the current crisis. A key area of criticism has been the failure of the IMF to warn its members of the outbreak of financial crises in a timely manner. The IMF and indeed other global financial institutions are in serious need of change. A need for collective action We need collective global action to overcome the current crisis. The IMF was established to promote coordination and collective action in order to avoid the kind of crisis we are now facing. We all saw the dangers building up over the last few years, particularly with regard to global imbalances. These problems have for many years been discussed within the International Monetary and Financial Committee (IMFC). But this common knowledge was not enough to spur any determined action. Global policy makers were not able to act in unison, and the institutions tasked with facilitating a collective response could not or would not act in accordance with their mandates. This failure on the part of the global economic policymakers needs to be recognised, and as we acknowledge this failure, we must recommit ourselves to deeper multilateral cooperation, mutual accountability and active policy coordination, with adequate representation and participation of developing countries. The weaknesses in addressing these global imbalances are now clearly revealed, as well as the flaws in the regulatory environment of some advanced economies. The current weak global economy has also highlighted the gaps in global economic governance, and the absence of sufficient institutional capacity to manage coordinated global responses to simultaneous global crises. It is incumbent on all countries not only to strengthen their respective policy environments domestically to prevent future meltdowns, but work needs to commence collectively to create a global financial architecture that can respond to crises of this nature in the future. In addition, policy actions are needed for improving the economic infrastructure and creating an environment conducive to investment, and for strengthening the macroeconomic framework and sheltering the poor from the adverse consequences of the crisis. While remaining committed to prudent policies, greater flexibility will be required to soften the impact of exogenous shocks, even as we consolidate the gains of better macro-economic frameworks. A need for change of the Bretton Woods institutions There is a widely held perception that the Bretton Wood Institutions have become instruments in the hands of the major economies to control smaller member countries and indeed sometimes even larger emerging market countries. Over the last ten years the IMF and the World Bank have come under consistent criticism amidst the ever larger calls for them to change. A year ago the Crockett Committee reviewed the income model of the Fund and made some significant recommendations to ensure the sustainability of IMF resources. Some of the recommendations made by the Committee to the IMF board are now being implemented and others will be implemented once endorsed by national legislatures. The IMF has also created a new Committee under the Chairmanship Mr Trevor Manuel, the Minister of Finance in South Africa to review its governance structures and to look at how to improve the effectiveness of the institution. The committee is due to report back to the IMFC at its next meeting in April 2009. The IMF and the World Bank found themselves completely on the sidelines in recent weeks in coming up with recommendations on how to address the current financial meltdown. While it is completely understandable that as countries are expected to come up with their own action plans to get economic conditions on even keel, it should be incumbent upon the Bretton Woods institutions, and in particular the Fund to provide overarching advice on how to stabilise the global economy, as a global public good. However, it would appear that it has been easier for the Fund to give direction to developing countries in times of crises than to provide similar advice to advanced countries. Notwithstanding the weaknesses highlighted and the clear need for improvements, the impression gained at the annual meetings earlier this week suggest that, with the right level of commitment from all stakeholders, the BWIs may adequately reform in the period ahead and regain their relevance. Where do we go from here? With the financial landscape around us under severe stress, we can rightly question, “Is there light at the end of the tunnel?” Given the changing landscape of the world economy and the failure of today’s multi-lateral institutions to provide us with a collective response to the crisis, an ambitious rethink of the global financial system is required. We need to go far beyond incremental changes of the global financial environment and our ambition in the reform of the global architecture of finance and economic policy making must match the gravity of the crisis we currently face, as well as the realities of the global economic environment. The recent financial turmoil has exposed the peripheral nature of the IMF's functions in global finance. Once the crisis struck forcefully, its role was unclear and peripheral. The Fund needs to be strengthened in order to place it on the centre stage, unless we would wish it to become totally irrelevant. On the other hand the crisis presents the IMF with an opportunity to revive itself. With the necessary expertise, its universal membership and the convening power it can play a vital role into the future, especially if it is able to transform its governance structures to meet the challenges of tomorrow’s world. Other institutions such as the Financial Stability Forum, the Bank for International Settlements and the G-20 have also enhanced their claim on providing leadership in the global economic environment. The G-7 has proved itself to be increasingly irrelevant in the changing economic environment of today. Lessons to be learnt from the current crisis It is too early to draw lessons from the crisis that is yet to run its full course. However we must continue to debate the causes of the crisis and contribute to solutions to avoid a similar situation globally and at home. We need stronger institutions that should be lasting, so that the current problems would not recur quickly. However, as the Australian Prime Minister recently said at the United Nations: “The failures that we have seen in recent times do not lie in the institutions alone. The failures lie more in the poverty of our political will to animate these institutions to discharge of the purposes for which they were created”. Is the global governance we are dealing with today still relevant? Clearly it is not. We need to craft a global framework of economic and financial relations that is inclusive and not only serves the needs of a few large economies. The G-7 has for long been acting as the steering committee for global economic governance, The G-7 is an exclusive economic club for rich countries and has outlived its usefulness, since some members in the club are no longer part of the richest members in the global economic environment and their influence will decline even further in the years to come. Countries like China, India, Brazil and Russia are playing an increasingly important role as the engines of growth in the global economy, and none of them are members of the G-7. I am sure that the G-20 will become more relevant in the period ahead, since the G-20 is small enough to allow for meaningful discussions, yet its global influence is broad enough to incorporate all the major players. As a collective the G-20 contributes almost 90 per cent of global Gross Domestic Product and trade. The G-20 as a forum has also already proven its ability to contribute to the global dialogue and providing imputes for new global economic governance. The global crisis of today provides us with a new opportunity to act comprehensively and collectively for the long term – rather than selectively and separately for the short run. We need the necessary resolve to work increasingly in a cooperative fashion with institutions such as the IMF, the BIS and the FSF and the G-20 to come up with action plans which should be implemented urgently and comprehensively. We need new global governance structures that are inclusive for all the stakeholders. Thank you very much.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa, Pretoria, 27 November 2008.
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T T Mboweni: An annus horribilis? Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Dinner in honour of the Ambassadors and High Commissioners accredited to the Republic of South Africa, Pretoria, 27 November 2008. * * * Your Excellency, the Dean of the Diplomatic Corps Your Excellencies, Ambassadors and High Commissioners Your Excellency, the Chief of State Protocol Your Excellencies, Heads of International Organisations represented in the Republic of South Africa Deputy Governors of the South African Reserve Bank Senior officers of the South African National Defence Force Senior Management of the South African Reserve Bank and their spouses/partners Financial Editors and other media representatives Esteemed Ladies and Gentlemen This has been an eventful year. Some might even say it was an Annus Horribilis! The impact of the US subprime crisis, which became evident in August 2007, deepened and spread since then. At the time there was much speculation as to whether or not this crisis was going to remain confined within the financial sector, or spill over into the real sector. Initially, many analysts thought that the crisis would be relatively contained and there was also a view that there would be limited if any impact on the emerging market economies, the so-called decoupling hypothesis. Here again, the initial dominant view was that decoupling would occur and as such emerging or developing economies would emerge relatively unscathed. This view was predicated on the fact that China and India have emerged as new sources of global economic growth. Nothing could have been further from the truth. Maybe we should have thought this out better. Whatever views existed on these decoupling hypotheses has been proven to be horribly wrong. The financial market instability has spilled over into the real economy, and the emerging market economies have not been spared. In fact, it is also probably true to say that many emerging markets are more vulnerable as they are less able to ameliorate the negative consequences of the current crisis. The previously optimistic forecasts for global economic growth have been revised downwards in the most dramatic fashion. More and more developed economies are forecasting imminent and prolonged recessions, with downward growth revisions almost on a weekly basis. These include the UK, the forecasts of the Euro area, Japan and the US economies to name but a few. These are significant trading partners of South Africa. These countries account for more than two thirds of our manufactured exports. Even the previously fastest growing emerging market economies in Asia are expected to experience some significant moderation in economic growth. In the past days, for example, the World Bank has downgraded its forecast for the economic growth rate in China for 2009 to 7,5 per cent, compared to the current economic growth rate of around 9,4 per cent. With regards to the financial sector crisis, South Africa appears to have reasonably weathered the storm, as our financial sector remains broadly robust and stable. The South African Reserve Bank has not been compelled to make any special liquidity provision, and the domestic interbank market remains fully functional. This does not mean that we have been spared the full impact of the fall-out from the slowing global economy. Apart from the direct consequences on our equity market s and the rand exchange rate, we have also witnessed a dramatic decline in commodity prices. It is almost hard to believe that as recently as July this year, the price of North Sea Brent crude oil had reached a level of almost US$150 per barrel, whereas today it is trading at approximately US$50 a barrel, a level last seen in early 2005. The lower fuel costs and significantly lower volumes of world trade have resulted in a major decline of the Baltic Dry Index (an indicator of economic trends which tracks the cost of shipping goods such as coal, iron ore and grain). The index recorded a high of 11,793 points in May this year, but declined to 815 points last week. While these developments are good news for oil-importing countries such as South Africa, particularly in the developing world, it should not be forgotten that the decline in the price of oil is part of a general decline in commodity prices. South Africa, as a commodity exporter is experiencing the negative consequences of these developments. The price of platinum, one of our main export commodities, reached a level in excess of US$2,250 per ounce in early March 2008, but has since declined to the current levels of around US$840 per ounce. Platinum, which is used in the production of catalytic converters in motor vehicles, is highly sensitive to the fortunes of the global automobile industry whose fortunes have changed significantly due to the slowdown. Domestic steel prices have declined by 25 per cent in the past weeks, and at the same time a major South African steel company announced a one third reduction in steel production in South Africa. While the gold price has also moderated somewhat, the extent of the decline has so far been relatively limited. The decline in commodity prices has not been confined to industrial commodities. Global food prices, which along with oil prices were responsible for part of the inflation pressures experienced in the recent period, have also declined in the past few months. Both the Economist Food Price Index and the IMF Food Price Index have declined by about 30 per cent since July of this year. The unfavourable global economic growth and commodity price developments suggest that while South Africa has managed to escape any untoward impact on its banking system, the real economy will not be immune to global developments. The South African economy has experienced positive economic growth since 1999, and growth in excess of 5 per cent per annum was recorded in the four years from 2004 to 2007. However, in 2009 the economy showed signs of slowing down. The year started off in not such a good way, when capacity constraints in electricity provision resulted in the period of load-shedding and electricity supply reductions to the major mining and manufacturing companies. This culminated in a revised annualised economic growth rate of 1,6 per cent in the first quarter of the year. The second quarter saw a rebound to a revised 5,1 per cent, but this was off the low base of the previous quarter. Third quarter annualised GDP growth measured 0,2 per cent, and reflected significant contractions in mining, manufacturing, and wholesale and retail trade. Agriculture and construction on the other han d remained buoyant. The South African Reserve Bank’s leading indicator of economic activity has continued its downward trend, and business and consumer confidence indicators also show that the outlook is not viewed as being particularly favourable. Despite an inevitable slowdown in GDP growth, we do not expect a recession in South Africa at this stage. During the past two years or so, there has been a rebalancing of the sources of economic growth from consumption to investment. The past few years has seen a significant increase in gross domestic fixed investment, from 15 per cent of GDP in 2002 to over 22 per cent of GDP in the second quarter of 2008. This has been a major achievement. The challenge will be to maintain investment at these levels in a world of heightened uncertainty. Part of this impetus has come from the strong infrastructural push from the public sector with respect to transport, telecommunications and electricity infrastructure to name a few. These projects will continue, but no doubt there will be challenges with respect to funding, in terms of both the availability and the cost, given the difficult global financial market conditions we are going through. Private sector investment has played its part as well over the past few years, and the big question that will confront us will be whether or not private sector investment will be able to stay the course during the coming months. We certainly hope so. The higher economic growth rate experienced over the past few years had resulted in some improvements in the employment picture in South African society. According to the official statistics as published by Statistics South Africa, employment growth has averaged almost 3 per cent in 2006 and 2007, and measured 3,9 per cent in the first quarter of 2008. The unemployment rate declined to 23,2 per cent in September 2008, down from over 30 per cent in 2002. While this unemployment rate is still too high, the direction has been pleasing. Financial stability considerations have probably increased over the past year. Monetary policy remains focused on achieving price stability whilst taking full cognisance of the changed global situation. Inflation in South Africa has exceeded the upper limit of the inflation target range since April 2007. In response to this, the monetary policy stance has been tightened, and between June 2006 and June 2008 the repurchase rate was increased by a cumulative 500 basis points. The most recent measure, published yesterday, showed that CPIX inflation declined to 12,4 per cent in October compared to the recent peak of 13,6 per cent seen in August. We are hopeful that this is the start of a consistent downward trend. Currently our forecasts indicate that we should be back in the target range by the second quarter of 2010. The inflation outlook has been improved to some extent by a number of variables that previously were seen as upside risk factors. As mentioned above, the international oil price has declined significantly and global food price inflation appears to be moderating although is yet to feed through to domestic consumer prices. Domestic demand pressures have also subsided as household consumption expenditure has responded to the less accommodative stance of monetary policy. Consumption expenditure has also been influenced by negative wealth effects, as housing and equity markets have weakened. Since the beginning of the year, equity prices on the JSE Limited have declined by 30 per cent, house prices have been flat or negative, and personal disposable incomes have also declined. The lower economic growth rate has meant that supply side cost pressures may also be subsiding. Unfortunately, while there have been improvements on these fronts, we have to contend with some upside risks factors to the inflation outlook. Inflation expectations are an important driver of inflation, and we have seen a successive deterioration of these over the past year in particular. These expectations may feed through to further inflationary pressures. Our hope is that inflation expectations will respond quickly to the expected reversal in the inflation trend. Despite the deterioration however, there is still an expectation that inflation will decline significantly over the next two years. A major risk factor is the exchange rate market which has also been buffeted by global developments. The increased risk aversion in international financial markets has resulted in a reversal of capital flows to emerging market economies in particular. Investors, fund managers and hedge funds are liquidating their positions in emerging markets and moving them to so-called safe havens. Some even call this a flight to quality. This is somewhat ironical, given that capital is moving back to the source of the problems. During the year there has been a significant realignment of exchange rates: the dollar has appreciated against most currencies apart from the yen; sterling has depreciated significantly and most emerging market currencies have also depreciated. Since the end of last year for example, sterling has depreciated by around 23 per cent against the US dollar; the Australian dollar by about 26 per cent; the Brazilian real by 19 per cent; and the Turkish lira by 26 per cent. At the same time the rand has depreciated by about 31 per cent against the dollar and about 24 per cent on a trade-weighted basis. These are significant moves which clearly do not only reflect the underlying fundamentals of these economies. Part of the reason for the poor performance of the rand is related to the decline in commodity prices. Other factors include simple risk aversion, and the concern about the current account deficit on the balance of payments, which to date has been adequately financed through capital inflows. In recent weeks, following the latest round of financial market turbulence, particularly after the demise of Lehman Brothers, there have been significant sales of bonds and equities by non-residents. The ZAR and the domestic bond and equity markets were not the only casualties following the failed attempt by Barclays to acquire Lehman, subsequently resulting in the latter filing for bankruptcy on 15 September 2008. Emerging markets in general came under heavy selling pressure as risk aversion escalated. On 15 September, Romanian shares fell by more than 4 per cent to their lowest levels in over three years while Czech and Hungarian stocks dropped to their lowest levels in over two years, falling by 6 and 4 per cent respectively. Russian stocks also dropped by similar amounts reaching their lowest level in two years, resulting in the authorities in Russia to suspend trading on 17 and 18 September 2008. For that entire week, the stocks of most emerging market countries showed significant declines. Those included Israel (-10,8 per cent); Romania (-7,3 per cent); Thailand (-4.5 per cent); South Africa (-2,9 per cent); Hungary (-2,1 per cent); Czech Republic (-2,0 per cent); Poland and Turkey (-1,9 per cent) and Korea (-1,5 per cent). Emerging Market Bond Indices (EMBI) spreads over US Treasuries widened sharply during the week under review. The widest spreads were recorded in Russia (52 bps); Argentina (42 bps); Venezuela and Ukraine (30 bps) and China (28 bps). South Africa and Poland registered the smallest movements with their spreads over US Treasuries widening by some 5bps. The currencies of most emerging markets weakened considerably against the USD during the week starting on 15 September on the back of major equity and bond selling in these countries. The biggest depreciations were registered by Chile (-3,2 per cent) followed by Brazil (-2,0 per cent) and Iceland (-1,5 per cent). In the year to date, non-residents have been net sellers of equities to the value of around R52 billion, while net bond sales have totalled almost R17 billion. However it is important to note that these sales do not necessarily translate into actual capital outflows. There is little doubt that the traditional source of foreign capital inflows, that is flows into the equity market, may remain under pressure in the coming months as a result of continued risk aversion. Despite the global turmoil, the financial account in South Africa has remained in positive territory. While the deficit on the current account of the balance of payments remains at elevated levels, some pressure on the import side will be taken off by growth, lower oil prices and the poor performance of the rand. Unfortunately, with a rapidly slowing global economy, commodity prices are expected to remain subdued, and the export markets for commodities and manufactured goods in the current climate will remain a challenge. Conclusion Your Excellencies Esteemed Ladies and Gentlemen Colleagues We are living through the most severe economic crisis in our living memory. In response, many governments and central banks have taken extraordinary measures to protect their banking systems and their economies. However the past few months have shown that increased global economic and financial integration has resulted in an increasingly interdependent world. Over the last three years, the focus has increasingly been turned to the G-20 to provide leadership on international financial issues, and this was even more so the case during the current financial turmoil. While the G-20 is still a relatively small grouping, it nevertheless represents almost 90 percent of global trade and GDP respectively. On the other hand, the G-7 has proven itself to be an increasingly necessary albeit insufficient forum in the changing economic environment of today. Hence, the current financial global crisis provides us with a fresh and unique opportunity to review what the role of global institutions and other cooperative arrangements should be. It is clear that the need to act with the necessary resolve and in a cooperative fashion together with institutions such as the IMF, the BIS and the FSF and the G-20 is imperative in order to come up with action plans which should be implemented urgently and comprehensively. New global governance structures that are inclusive of all stakeholders are needed. Recently the G-20 Heads of states met in Washington DC to discuss the global financial crisis. At this G-20 Economic Crisis Summit, the Heads of States resolved that countries should work together to restore financial stability and economic growth. The key issues agreed to at the summit were: the reform of the international financial institutions such as the World Bank and IMF; the conclusion of the global free trade agreement; improvement in financial market transparency; changing incentives so that excessive risk taking is no longer rewarded; drawing up a list of financial institutions that could result in systematic failure; and strengthening financial market regulation. In the meantime, strong and significant actions have been taken in both advanced and emerging market economies to stimulate economies, strengthen the financial sector, provide liquidity and working to ensure that international financial institutions can provide support for the global economy. In addition, the leaders endeavoured at this summit to provide further assistance and to support the global environment by stating the following and I quote: “Against this background of deteriorating economic conditions worldwide, we agreed that a broader policy response is needed, based on closer macroeconomic cooperation, to restore growth, avoid negative spillovers and support emerging market economies and developing countries. As immediate steps to achieve these objectives, as well as to address longerterm challenges, we will: Continue our vigorous efforts and take whatever further actions are necessary to stabilise the financial system. Recognise the importance of monetary policy support, as deemed appropriate to domestic conditions. Use fiscal measures to stimulate domestic demand to rapid effect as appropriate while maintaining a policy framework conducive to fiscal sustainability. Help emerging and developing economies gain access to finance in current difficult financial conditions, including through liquidity facilities and programme support. We stress the International Monetary Fund’s (IMF) important role in crisis response, welcome its new short-term liquidity facility and urge the ongoing review of its instruments and facilities to ensure flexibility. Encourage the World Bank and other multilateral development banks (MDBs) to use their full capacity in support of their development agenda and we welcome the recent introduction of new facilities by the World Bank in the areas of infrastructure and trade finance (and) Ensure that the IMF, World Bank and other MDBs have sufficient resources to continue playing their role in overcoming the crisis.” The next G20 Head of State summit to review progress will be held by 30 April 2009. Hopefully by the time we meet next year, we will be able to report on more promising global and domestic developments. Please enjoy the rest of the evening, and may you have , in the period ahead, a wonderful festive season and a prosperous New Year. ‘Till we meet again! Adios Amigos! Thank you very much.
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Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 48th ACI World Conference, Cape Town, 13 March 2009.
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T T Mboweni: Central banks and financial stability – some lessons for the future Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 48th ACI World Conference, Cape Town, 13 March 2009. * * * Introduction Honoured ACI members, organisers, moderators, guests, ladies and gentlemen. Thank you for the invitation to speak at this illustrious event. It is indeed a privilege and a rare opportunity to share some ideas about the state of the global financial system with market practitioners from across the world. It is difficult in the current circumstances to give an optimistic address. Nevertheless, I will try to avoid to paint too dismal and depressing a picture and instead will focus on things that we can learn from our recent experiences, to contribute towards a better future. The mood in the global economy has changed from almost over-exuberance to the depths of a recession in less than two years. We are certainly experiencing unprecedented events and the actions taken to restore stability and trust in the global financial system are surpassing previous ones. Judging from the programme of your conference, we expect that these issues will be discussed in greater detail over the next two days. This presentation will also make, towards the end, some comments about the state of the South African banking sector. It remains difficult to understand how various role players, including supervisors, central banks, rating agencies, multilateral agencies, governments, risk managers and highly competent private sector participants, failed to fully comprehend these developments that, with hindsight, were bound to bring us at some time to this point. Yet, the important thing is not to apportion blame, but to try and understand how we can avoid repeating the same mistakes. There are many lessons to be learnt, and we are of the view that these lessons can be valuable not only from the point of view of supervisors and policy makers, but also that of traders, bankers and other financial market participants. Clearly, as the situation is still unfolding, one can at best only talk of “preliminary lessons”. Lesson number 1: The sum of perfectly rational individual decisions doesn’t equal a perfectly rational market With hindsight, it is clear that, although individual institutions hedged, transferred and managed their risk exposures in very sophisticated ways, at a systemic level a point is reached at which it becomes impossible to fully diversify or transfer risk. The global financial system is a finite entity, and although risk can be passed around, it does not disappear. We had probably underestimated the inter-linkages of financial systems across the globe, and the extent to which globalisation had created a complicated network of circuits for the contagion of financial risk. The lesson to take forward is that we should never lose sight of the systemic implications of individual institutions, transactions and events. Financial stability is a systemic concept, and it will play a much bigger role in future and should be taken much more seriously than was the case during the exuberant years prior to 2008. Issues such as macro-prudential analysis and supervision, crisis preparedness and stress testing of the financial system are likely to feature much more strongly in our collective endeavours for years to come. Lesson number 2: If something seems too good to last, it probably is The current crisis resulted from a specific combination of a number of causes. For years, liquidity in global financial markets was mispriced, and therefore generally taken for granted. Interest rates were low, and huge profits were locked in through carry trades where funding could be obtained at a minimal cost in overnight markets, and invested in high-yielding longer-term assets, be it emerging-market financial assets, equities, securitised mortgage loans or asset-backed securities. South Africa was a beneficiary of this trend: between 2004 and 2007, net inflows recorded in the financial account of the balance of payments totalled R391 billion. If the inflows that are included under “unrecorded transactions” are added, this figure would be well over R500 billion. Compare this to a combined net outflow of around R23 billion over the prior four years. The advantages of these inflows were significant: they allowed the South African Reserve Bank to restore a fragile foreign exchange reserves position to a more healthy one, they helped the country to finance its current account deficit, to build infrastructure, to boost economic growth and to increase employment. Overall, they made the country slightly more resilient against the adverse developments that we are currently experiencing. However, we have been abruptly reminded that portfolio flows are fickle, and cannot be relied upon as a source of external funding when the tide turns. Even though South Africa still maintained a positive net balance on its financial account for the first three quarters of 2008, there were significant net outflows of portfolio investments as global investors were forced to deleverage. In addition, funding in the international markets has become much more expensive. We have also been reminded that markets move in cycles, and the fallacy of some people who advocated a “decoupling of emerging markets” or that “the business cycle has been conquered” has been proven to have widely missed the point. What is the lesson to be learnt? The lesson is that prolonged periods of high asset growth that are not fully justified by trends in the real sector are bound to correct. For example, how can house prices continue to grow at double-digit rates if economies grow by two to three per cent per year? How can the balance sheets of banks consistently grow four to five times faster than the underlying economy? How can off-balance sheet activities of banks consistently outpace on-balancesheet growth without signalling some sort of distortion? How can profit targets and bonuses keep on rising year after year, while the underlying real economy is still very much the same? It is human nature to be more tolerant of continuous rises in asset prices than of price declines. Perhaps we should be more careful in future: if growth rates and price increases are not justified by developments in the underlying activity in the real economy, asset bubbles develop, and the effects when such bubbles burst can be very serious. Lesson number 3: The seeds of the next crisis are sown in the solutions for the current one Without having much choice, central banks and governments in (mainly) the industrialised world have taken unprecedented actions in their attempts to restore confidence in the financial system. These actions included significant liquidity injections, lowering of collateral requirements, asset swaps, longer-maturity refinancing operations, intervention in foreign exchange markets, co-operation among central banks in their market operations, monetary accommodation, quantitative or credit easing, capital injections into banks and other financial institutions, substantial fiscal stimulus packages and, in some cases, nationalisation of banks. Looking at the instruments available to banks and governments, there really are only a few that have not been used in one way or another during this crisis. Actions being implemented now may be the lifeline for the world financial system, but we are also well aware that they may, inherently, have negative consequences over the long term. The major central banks will have to plan their exit strategies well. Governments will have to manoeuvre themselves out of their heavy indebtedness, the potential crowding out of the private sector would have to be addressed and some reasonable limits to moral hazard will have to be restored. In a recent speech 1 , Jeffrey Lacker, President of the Federal Reserve Bank of Richmond, noted that “the striking feature of central bank lending and other government financial support during the current turmoil is the extent to which it has extended well beyond the boundaries that previously were understood to constrain such lending”, and that “the scope of the financial safety net ultimately must be rolled back”. Although inflation is currently not an issue that many people are worried about, we all know that the measures currently taken are potentially inflationary, and at some point this will have to be attended to. As one of our colleagues has remarked when “the house is on fire, we need all the fire engines on the scene, the mopping up operations will come later”. Lesson number 4: Every good party needs a strong bouncer In financial markets, the bouncers are the supervisors. Looking at previous issues of the IMF’s Global Financial Stability Report, the BIS Quarterly Reports, and various individual central banks’ Financial Stability Reports, it is evident that many of the causes of the financial crisis had been noted, but that they had not been acted upon. As pointed out by our colleague Jean-Claude Trichet 2 in his capacity as chairman of the Global Economy Meetings of central bank governors at the BIS – meetings that we also attend on a regular basis – several policy makers had indicated to market participants that they needed to prepare for a significant correction. With hindsight, there were clear danger signs that supervisors could possibly have countered more decisively. To list but a few of these warnings, excessive leverage through securitisation and re-securitisation, excessive dependence on short-term wholesale funding, a complete under-estimation and under-pricing of risk, in particular liquidity risk, skewed incentive structures, an overreliance on mathematical and statistical risk models without a proper understanding of their assumptions, dynamics and constraints, a blind reliance on credit ratings without properly analysing and understanding their methodologies and caveats, and a proliferation of financial innovation that resulted in complex products that were not well understood by those selling or buying them. However, supervisors and advocates of financial stability seemed powerless to address these issues while the party was still going on. Only weeks before being nationalised, Northern Rock reported record profits and was hailed for its innovative business model and financial strength, including capital adequacy. It is very difficult for supervisors to spoil the fun while everything is going so well. Yet, if supervisors and financial stability functions in central banks have to take on the role of bouncers, they have to have muscle! Much attention is currently given in international forums to strengthening supervisory and regulatory frameworks and to giving more legal powers to financial stability practitioners. For example, some of the recommendations that have been made by the Financial Stability Forum are to strengthen the prudential framework for banks, including with regard to capital, liquidity, risk management and market infrastructure, to strengthen the framework for transparency and valuation, changing the role and uses of credit ratings, and enhancing the responsiveness of authorities to risks and cooperation in dealing with weak banks. 3 Other issues being addressed in various forums are ways in which the pro-cyclicality of financial regulations could be reduced, how areas of regulatory arbitrage could be eliminated, Lacker, J. Financial Conditions and the Economic Outlook. Remarks made at the South Carolina Business and Industry Political Education Committee, 13 January 2009. Trichet, J-C. Undervalued risk and uncertainty – some thoughts on the market turmoil. Speech at the 5th ECB Central Banking Conference, Frankfurt am Main, 13 November 2008. Draghi, M. How to restore financial stability. Lecture at the 5th Bundesbank Lecture, 16 September 2008. and how cross-border supervisory and crisis resolution frameworks could be strengthened, for example through supervisory colleges. Lesson number 5: Common sense should prevail A comment was recently made that perhaps one good thing about the current crisis is that engineering students will in future actually do what they have been trained for: to be engineers. In the past decade or so, the financial world has been taken over by mathematicians, statisticians, engineers and scientists. These professionals have made breakthroughs in the development of sophisticated risk management and valuation techniques, which contributed vastly to financial innovation and the development of new products. But we have probably over-relied on these models. After all, engineering is a different field from banking, finance and business management, and in many instances a great divide was created between the business acumen of boards of directors of banks, and the models on which the banks’ operations were based. While financial and risk modelling should continue to play an important role in future, it should be better balanced by basic business common sense, which should challenge the underlying assumptions of such models and attempt to understand their inherent limitations and constraints. Some comments on the South African banking system We would like to conclude this address as promised earlier, by making some comments on the South African banking system, and why it appears to have weathered the storm relatively well up to now. To date, South Africa’s banking system has remained largely shielded from the direct effects of the global financial market crisis, although our banks have been somewhat affected by the general re-pricing of risk and increases in funding costs. South African banks have very limited direct exposure to the troubled toxic securitised debt market in the US, partly owing to prudential restrictions on the type of assets and on the extent to which domestic banks are allowed to invest offshore. In addition, securitisation activities of our banks have been moderate and prudent. As a result, the high leveraging observed in some other jurisdictions has not been evident in the South African banking sector and our banks have continued to follow a fairly traditional banking model. Even more significantly, South African banks are predominantly funded by domestic deposits, and not through internationally held structured products. As at the end of December 2008, the total foreigncurrency denominated deposits of banks amounted to R78,3 billion, and other foreigncurrency denominated funding to R86,7 billion, together comprising 6,7 per cent of banks’ combined total funding liabilities of R2,4 trillion. Even of this relatively small amount, only a portion is provided by non-residents. South African banks are well capitalised, with an overall capital adequacy ratio of 13,0 per cent of risk-weighted assets under the Basel II measurement, as at the end of December 2008, which is 3,5 percentage points above the minimum requirement of 9,5 per cent. Even on the basis of capital to total un-weighted assets, they are not highly leveraged. Also noteworthy is that Tier 1 capital adequacy stood at 10,2 per cent. This high level of capitalisation makes the banking sector more resilient to economic shocks. Although some deterioration in asset quality has been observed over recent months (for example, impaired advances to gross loans and advances increased to 3,8 per cent by December 2008), this was more attributable to the tightening of domestic monetary policy and slowing growth than to the global financial crisis. These trends are not out of line with what would be expected in the current stage of the domestic economic cycle, and impaired loans are adequately provided for. The foreclosure procedures in South Africa are also different from those in the US, for example, allowing banks to recover a greater portion of their non-performing loans. In this environment, the South African Reserve Bank (SARB) will continue to focus its monetary policy decisions based on the inflation outlook, within the context of its inflationtargeting framework whilst taking full cognisance of the global collective efforts to avoid a deep recession. An improved inflation outlook, against a backdrop of slowing domestic and global growth, allowed the monetary policy committee of the SARB to reduce the policy rate by 150 basis points since December 2008, to 10,5 per cent. The SARB continued to drain significant amounts of liquidity on a net basis in order to maintain a shortage in the money market as part of our monetary policy implementation framework. The domestic interbank market continued to operate, with no anomalies observed in either the volumes or rates of interbank funding. In general, financial market stability continues to be observed in South Africa. Far from being complacent, however, we are monitoring the situation closely. Crisis preparedness is a key consideration for the South African Reserve Bank. In fact, in partnership with the World Bank we are hosting a regional crisis preparedness simulation test for the SADC region next week, to be facilitated by the Toronto Centre. We are also very conscious of the potential impact of the global economic slowdown on our own economy, and are starting to feel the painful effects of this through job losses, rising insolvencies and lower volumes of exports. In this regard, fiscal and monetary policies have to play a much more central role. Conclusion There is a G-20 meeting of ministers of finance and central bank governors taking place in the United Kingdom on Saturday, 14 March 2009. Many issues similar to those you might discuss here are also on the G-20 agenda. Hopefully, the G-20 conclusions will assist in taking us forward. Time is of the essence. I wish you well in your deliberations. Thank you very much.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Road Freight Association Convention, Vanderbijlpark, 19 May 2009.
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T T Mboweni: The implications of the global crisis for South Africa and policy responses Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Road Freight Association Convention, Vanderbijlpark, 19 May 2009. * 1. * * Introduction 1.1 The world is in the midst of the most severe slowdown since the Great Depression of the late 1920s. We have seen negative growth rates in many countries, developing and industrialised, and world trade has declined dramatically. However, there are tentative signs that the global economy may be responding to the co-ordinated monetary and fiscal policy stimuli and that the worst of the contraction may be behind us. Nevertheless the recovery is likely to be slow and protracted. Unfortunately the integrated nature of the global economy means that South Africa has not been spared, and our future growth prospects are dependent to an important degree on global developments. 1.2 The domestic slowdown has had a direct impact on the road freight industry, which moves in excess of 80 per cent of the total load freight in South Africa. The road freight industry has grown in importance over recent years in an environment of relatively high economic growth and static rail freight tonnages. According to a recent CSIR report 1 , in 2007 road transport accounted for 87 per cent of tons transported in South Africa. It goes without saying that if domestic output declines, the impact on the road freight transport sector could be significant. 2. Global economic developments 2.1 Some of the recent developments in the global economy have been quite dramatic. In the fourth quarter of 2008, the so-called advanced economies experienced a contraction of 7,5 per cent in GDP, with the United States economy contracting by 6,2 per cent (quarter-onquarter annualised), and by 6,1 per cent in the first quarter of 2009. The UK economy contracted by 6,1 per cent and 7,4 per cent in the same quarters respectively. Our other major trading partners fared no better. In the fourth quarter of 2008, Japan contracted by 12,1 per cent, the euro area by 6,3 per cent, and within the euro area, Germany contracted by 8,2 per cent. Developing and emerging market economies were also part of the synchronised downturn, contracting by 4 per cent. While China managed to grow by 1,4 per cent in that quarter, the Indian economy experienced zero growth. Taiwan, South Korea and Thailand experienced quarter-on-quarter annualised contractions in excess of 20 per cent, while contractions were also experienced in eastern and central Europe and Latin America. 2.2 The outlook for the global economy in 2009 remains gloomy, with the IMF, the World Bank and the OECD all forecasting negative growth for the year as a whole. The discussions at the recent IMF meetings confirmed a negative outlook, although demand stimuli and natural stabilisers are expected to start having an impact later in the year, and there are tentative signs that this may be the case. 2.3 The pace of the downturn has been confounding the forecasters, and there have been continuous and large downward revisions of growth forecasts during the past few months. According to the latest IMF forecasts, the world economy, which grew by 3,2 per cent in 2008, is now expected to contract by 1,3 per cent in 2009. In January, the forecast for 2009 The Fifth Annual State of Logistics Survey for South Africa, CSIR, 2008. was for the world economy to grow by 0,5 per cent. The so-called advanced economies are expected to contract by 3,8 per cent this year, while emerging market and developing country growth is forecast to be 1,6 per cent. Africa is expected to experience growth of 2 per cent. A modest recovery is forecast for 2010: the advanced economies are expected to experience zero growth compared to emerging market and developing economies growth of 4,0 per cent. 2.4 The impact on world trade from these events has been pronounced, and the World Trade Organisation predicted that the volume of global merchandise trade would contract by 9 per cent this year, compared to an annual average growth rate in trade in excess of 6 per cent since 1990. In an environment of weak demand and lack of trade finance, international trade will continue to suffer. The motor industry has been particularly hard hit as demand continues to decline globally. Japanese motor vehicle exports declined by almost 50 per cent year-onyear in February, while global exports of motor vehicles declined by 64 per cent in that month. Not surprisingly, protectionist tendencies have emerged, with some countries providing subsidies and discriminatory procurement provisions in national stimulus packages. 2.5 Also of relevance to the South African economy has been the sharp decline in commodity prices. Fortunately, gold prices have remained relatively firm. The gold price declined from a high of around US$1000 per ounce in March 2008 to around US$712 in November, but is currently trading above US920 per ounce. However other commodities have not fared as well. From a high of US$2250 per ounce in March 2008, platinum prices declined to US$771 per ounce, before recovering to current levels of around US$1130 per ounce. Aluminium prices reached levels in excess of US$3300 per ton in July 2008, but by February 2009 the price had declined to below US$1300 per ton and currently around levels of US$1540 per ton. Similar trends are evident in the behaviour of other commodity prices. Of course, oil price developments have benefited us. Having reached levels of almost US$150 per barrel in July last year, international oil prices declined to below US$35 per barrel, and are now at levels around US$57 per barrel. Commodity prices in general are likely to remain subdued in line with global growth 2.6 The turmoil on the international financial markets has also impacted on the destination and size of capital flows. Not surprisingly, capital flows to the developing and emerging market economies have declined, with the International Institute of Finance expecting flows to emerging markets to decline from over US$900 billion in 2007 to around US$165 billion in 2009. This has implications for exchange rates and the financing of current account deficits in these countries, at a time when export markets are under pressure. Capital is in fact flowing back to the US, the source of the current crisis. We are told that this is a “flight to quality” or “risk aversion”. An irony indeed. 3. The implications for the South African economy 3.1 Given South Africa’s close trade and financial links with the global economy, it is not surprising that the South African economy would be affected by these adverse developments. After 4 years of GDP growth around or in excess of 5 per cent, the growth rate declined to 3,1 per cent in 2008, with a contraction of 1,8 per cent in the fourth quarter. Current indications are that the negative trend continued in the first quarter of this year. The high frequency data indicate that the manufacturing sector in particular remains under pressure: recent data from Statistics South Africa show that manufacturing output in the first quarter of 2009 declined by 6,8 per cent relative to the previous quarter, while mining production declined by 12,8 per cent over the same period. The utilisation of manufacturing productive capacity declined to its lowest level in ten years. Quarter-on-quarter declines were also seen in retail and wholesale trade sales, while motor vehicle domestic sales and exports also continued to contract significantly. 3.2 The impact on employment was also felt in the final quarter of 2008 when employment levels decreased for the first time in almost four year. Employment declined by 0,7 per cent, with the private sector shedding over 45,000 jobs. Most of the forward-looking confidence indices indicate that a turnaround cannot be expected until at least later in this year. 3.3 These developments are also reflected in the financial markets. In particular, house prices have been stagnant or falling, and the stock exchange has lost about a third of its value since September last year. Although exports have been affected, imports have also declined in the wake of weak demand and lower international oil prices, resulting in a moderation of the current account deficit in the fourth quarter of 2009 to 5,8 per cent of GDP. Despite lower capital inflows, we were still able to finance the deficit on the current account. In line with other emerging economies, the rand exchange rate has been relatively volatile over this turbulent period, although it has recovered significantly since the lows seen in late 2008. 3.4 While it seems clear that the first quarter of this year was also one of negative growth, the general view is that the worst is probably behind us and that things may start to improve slowly in the coming months. The latest consensus surveys indicate that growth is expected to be low but positive in the final two quarters of this year, and to recover to around 2,7 per cent next year. 4. Policy responses 4.1 There has been a multi-faceted global response to the crisis. As was noted in the G-20 London Summit Statement of 2 April 2009, “a global crisis requires a global solution”. The G-20 countries pledged “to do whatever is necessary to restore confidence, growth, and jobs; repair the financial system to restore lending; strengthen financial regulation to rebuild trust; and fund and reform our international financial institutions to overcome this crisis and to prevent future ones” These are noble and correct sentiments, but it is the implementation that counts. A few comments on some of these themes may be in order. 4.2 Firstly, there is no doubt that for the crisis to be resolved, countries with banks exposed to the toxic assets will have to clean up their banking systems. These toxic assets will have to be taken off the balance sheets, the banks recapitalised and sufficient trust built up so that banks can start lending again. There is no easy solution for achieving this, and no simple blueprint. Countries will differ as to how they tackle this problem. But as long as banks are unwilling to lend, and demand remains subdued, the recovery cannot happen. The recent stress-tests conducted on US banks indicated that while banks still remain under pressure and some require further recapitalisation, the worst of the bad news may be behind us. 4.3 Fortunately our banking system is still allowing credit to flow, although much stricter lending criteria are being applied by banks. But unlike in Europe and the US, our interbank market is working normally, the capital adequacy ratios are strong, and no bank has had to approach the South African Reserve Bank for any extraordinary assistance. Although exchange controls irritate many, in this case the existence of these controls, in conjunction with appropriate supervision of the banks, spared us the need to have to find ways to bail out and recapitalise our banks. 4.4 Secondly, there has to be an improvement in banking regulations and supervision. Those elements of the financial system that have been able to avoid regulation must be brought into the regulatory net, and ways must be sought to ensure that regulation does not promote procyclical behaviour on the part of the banks. But we have to be mindful of the danger of over-regulation. There is always the danger that a crisis can spur excessive regulation and stifle the ability of banks to operate normally in the future. A fine balance will have to be achieved between the dangers of over-regulation and allowing banks to undertake normal lending operations. We are likely to see a return to the more traditionally type of banking for some time. 4.5 Third, there have to be appropriate policy responses to restore growth. The G-20 statement underlined the need for continued concerted and exceptional monetary and fiscal policy stimuli. With respect to monetary policy, in many countries, despite the low policy rates, banks are charging much higher spreads over the policy rates because of higher perceived risks. At the same time, households are trying to repair their balance sheets which have been adversely affected by declines in house and equity prices. In other words, the monetary transmission mechanisms are impaired, and what usually works in a relatively predicable way under normal circumstances, may not work in the same way under current abnormal circumstances. The further danger we face is that as the balance sheets of the central banks expand rapidly, down the line there may be inflationary pressures. Central banks will have to be ready to absorb this excess liquidity, but without killing off the recovery. 4.6 The G-20 recognises that even within the framework of a co-ordinated response, local conditions will shape the nature of the response of individual countries. While many countries responded with substantial interest rate reductions, these responses were carried out in the context of very low inflation in many instances, and the need to provide liquidity to ailing banking sectors. While the response of the South African Reserve Bank may appear to be less strong than in many other countries, it should be borne in mind that we started out with a relatively high inflation rate and a relatively healthy banking system. We are seeing a slowdown in the rate of inflation and, although it is relatively sticky, we still expect to be back within the target over the medium term. This has allowed for a 350 basis point reduction in the repurchase rate to date. A continuation of this slowdown of inflation, in part a result of the widening output gap, may allow for further monetary easing. 4.7 As part of stimulus packages, many countries have focused on increasing expenditure on infrastructure. This cannot happen overnight. We have been fortunate that our infrastructural expenditure programme has been accelerating for the past few years, and has therefore come on stream at a time when it is most needed. This has been most fortuitous. Anyone travelling on our national roads will have been frustrated by the inconvenience of the scale of the road upgrades, but we have to remember the positive side: that this infrastructural expenditure is helping to underpin domestic expenditure. Furthermore, such expenditure will help to increase the potential output of the economy over time, and therefore raise the sustainable long term growth rate. According to National Treasury estimates, public sector infrastructure expenditure is expected to average 9,7 percent of GDP over the coming three fiscal years, compared to 4,5 per cent in the 2005/6 fiscal year. During the current fiscal year, total expenditure by the SA National Roads Agency Ltd (SANRAL) on roads is estimated at R19,6 billion, compared to R2,2 billion in 2005/06. I am sure your truck drivers will be pleased when all this construction is completed. 4.8 It is also important to appreciate that monetary and fiscal policies have to be supplemented with other policies and structural reforms. In times of crisis, people tend to forget about longer term structural reforms and focus on the immediate crisis. But it is the structural reforms that will be important to get economies going again. For example industrial policies which can supplement other policy initiatives. 5. Conclusion 5.1 The G-20 proposals contain many important elements that will go a long way to help with the global recovery. However the proof will be in the implementation. Recovery programmes, particularly those which involve coordination between countries can take a while to implement, let alone show results. We also need to ensure that the measures undertaken to ensure the recovery do not sow the seeds of future crises. There are likely to be a number of false dawns on the long road to recovery, but hopefully we are on that road. Thank you very much.
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Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the SAKE24 Economist of the Year Award's Dinner, Johannesburg, 20 May 2009.
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T T Mboweni: Renewed challenges for model builders and forecasters in times of extreme uncertainty Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the SAKE24 Economist of the Year Award’s Dinner, Johannesburg, 20 May 2009. * * * Distinguished guests, ladies and gentlemen 1. Introduction Thank you for the invitation to address you on this important occasion. Since this is a function to recognise the efforts of economic analysts to predict the future, it is fitting to share a few thoughts on the challenges and serious issues that confront both model-builders and forecasters in these most difficult and turbulent times. The current financial crisis has forced us all to make a major re-assessment of the way in which we have generally perceived the economy to work. Previous fundamental relationships and economic correlations we took for granted have come under question and this has caused intense debate in almost all areas of economic discourse. The South Africa Reserve Bank and almost all of us here at this venue make use of various tools in the form of structural models that help us analyse and forecast the future of the economy. The fact that forecasts keep changing in such a dramatic way does not necessarily mean that we are bad modellers or forecasters. But we must be aware of the limitations of models, and the major challenges that face forecasters in this ever-changing economic environment. 2. The use and challenge for models At the heart of any economic model is a perception of how the economy works. This leads to the representation of the structural economic relationships in the economy. This can either be a “guesstimate” or gut feel, based on the modeller’s knowledge of how the economy functions or, alternatively, a well-articulated mathematical representation of the interrelationships in the economy in the form of an econometric model. There are significant differences between models, depending on the different views on how the economy is seen to function, and also the use to which the model is being put. Although the various types of models are structured to capture and replicate the economy by providing for the key channels of the transmission mechanism, the emphasis tends to shift between models. For example, the National Treasury will be interested in a model that is geared to accurately assess the overall economic and financial market impact of the spending patterns of government, while the central bank would be more concerned with having a model specifically aimed at achieving its mandated inflation target and monitoring the economic consequences of its monetary policy actions. There is no unique model or best approach to the forecasting processes and procedures in central banks. This is one reason why the South African Reserve Bank has adopted the socalled suite of models approach. Central banks try to pursue full-information strategies. So, instead of relying on just one model to produce the Monetary Policy Committee (MPC) forecast, we employ a large variety of different models. Also, since the structures of the various models are diverse, each one is capable of telling a different story. The suite-ofmodels approach has the added advantage of taking some degree of model uncertainty into account by taking all relevant and potentially-important information into consideration. There are essentially two different types of models. The first is the structural macroeconomic type of model which includes the traditional multi-equation model, and the second is a shortterm time series forecast model. Each has its own set of benefits and disadvantages. For example, we have the higher frequency autoregressive integrated moving average (ARIMA) models which are useful for short-term forecasts but are incapable of predicting a turning point since they are essentially based on their own historic trends. The structural multiequation models such as the South African Reserve Bank’s core econometric model is more suited for policy analysis and forecasting since it incorporates behavioural relationships between the key variables of the model. Other structural models such as the dynamic stochastic general equilibrium models (DSGE) and quarterly projection models (QPM) are more reliable over the medium to longer term but are extremely sensitive to the initial conditions or data starting points of the forecast. This is also a reason why many central banks that have adopted the DSGE approach spend a lot of time and resources on determining exactly where the economy finds itself currently and how far it is from the steady state. Because of the lags in the response of inflation to changes in the monetary policy stance, any forward-looking monetary policy framework requires a forecast of inflation. However, forecasts should be used with the required degree of caution. Forecasts are, by definition, surrounded by uncertainty, and knowledge about the degree of forecast uncertainty is essential for decision-makers. Basically, we can identify five sources of forecast uncertainty: uncertainty about future shocks to endogenous variables (e.g shocks to consumption and productivity); uncertainty about assumptions concerning exogenous variables (e.g assumptions about oil prices); uncertainty about model parameters (e.g marginal propensity to consume); uncertainty about data (e.g revisions of GDP); and uncertainty about the model structure and specification. Because of these uncertainties, it becomes extremely difficult to assess the balance of the various influences on the central forecast. Mervyn King, Governor of the Bank of England, has therefore argued that we should not focus too much on the central forecast: “The Monetary Policy Committee has always stressed that a projection is a probability distribution for possible outcomes and not a single path for either growth or inflation”.(Mervn King, Bank of England, 2009) Since their impact depends on the variable in question and the forecast horizon under scrutiny, to actually prioritise or rank the source of forecast uncertainty is a difficult task,. However, in any given model, the degree of uncertainty related to future shocks and the assumed trend in the exogenous variables generally pose the greatest threat to aggregated forecast uncertainty, rather than the uncertainty related to the estimated parameters and data. But challenges also relate to the structural specification of the models used by central banks as it is difficult to incorporate everything that really matters in a simplified econometric framework of the real world. For example, the traditional models were not able to capture the current crisis. David Blanchflower of the Bank of England recently commented on the use of misspecified models or models that fail to take crucial financial issues into consideration: “The economic models that provided the rationale for the inflation targeting approach do not describe well the features of the global economy that led to the current crisis; the build up of global imbalances, perceptions of risk in the economy and stresses within the financial sector.” (David Blanchflower, Bank of England, 2009) As these factors are extremely difficult to incorporate into our models, building models that capture these issues will be a challenge to model builders. Apart from specification problems, there is the issue of exogenous assumptions that get fed in to the model. A forecast generated by even the most perfect model will only be as good as the assumptions that are used. Very often these exogenous assumptions are notoriously difficult to predict. For example, in 2007 and 2008 when the international oil prices were increasing, we were continuously surprised on the upside by oil price developments. We were also caught by surprise by the degree to which oil prices declined in the second half of 2008. In the forecasting process our modelling team spends a lot of time analysing the relevant data and forecasts of other institutions to come up with well-informed assumptions. But there is no guarantee that these assumptions will be correct or that they will remain unchanged by the time of the next meeting. By way of illustration, at the April MPC meeting, the assumptions incorporated into the model included an average contractual oil price of US$50 per barrel in 2009 and US$55 in 2010. (The contractual prices are lower than the spot prices). However in August 2008, the oil price assumptions for the same two years were US$115 per barrel and US$107 per barrel respectively. Other assumptions in the previous meeting included: International commodity prices are expected to decline on average by 15 per cent this year and to remain unchanged next year; international wholesale prices are expected to decline by 3¼ per cent this year before increasing by 2 per cent in 2010; while growth in South Africa’s trading partners is expected to contract by 2 per cent in 2009 and expand by 1½ per cent next year. The real effective exchange is expected to depreciate by 4¼ per cent in 2009 and to remain unchanged in 2010. Domestic assumptions include a 4 per cent increase in final consumption expenditure by general government in the next 2 years; administered price inflation of 2 per cent in 2009 and 9¾ per cent in 2010; and an increase in import crude oil volumes of 5 per cent in 2009 and unchanged in 2010. 3. The monetary policy transmission mechanism All central bank models strive to replicate the most important channels of the monetary policy transmission mechanism. In particular this includes the interest rate channel and the exchange rate channel in particular. The exchange rate is possibly one the most difficult variables to estimate in the model and usually includes some sort of interest rate parity measure which allows for the domestic exchange rate to appreciate if the interest rate differential moves in its favour. However, does this relationship necessarily hold at times of global financial market uncertainty? We have seen in these circumstances investors and international banks feel the need to limit their risk exposure by repatriating their funds to “safe-haven” instruments such as USA bonds in particular. Our models are unable to predict reliably the exchange rate during such periods where we have extremely volatile and unpredictable capital movements. The other critical transmission channel is the interest rate channel. Most models generally assume that there is no obstruction to the interest rate pass-through to the rest of the economy. However, at the peak of the financial market crisis towards the latter part of last year, commercial banks started to raise their credit lending standards and criteria. The quarterly Senior Loan Officer survey of the Federal Reserve Board bears testimony to the fact that elevated loan spreads and increased deposit requirements have been self-imposed by the banks to reduce their asset risk in an effort to protect their balance sheets. Although this is probably perfectly rational behaviour by prudent banks struggling to value the extent of their loan exposure, it has the unfortunate effect of reducing the effectiveness of monetary policy initiatives taken by central banks to stimulate the economy. In fact, in most advanced economies, central bank interest rate levels are currently at their lowest levels in decades, but this does not necessarily imply that this intended benefit is passed on directly through to the investor and consumer. The behaviour of commercial banks is quite understandable, given the nature and origins of the current economic situation. However, it also underlines the procyclical nature of their actions: banks are more keen to offer credit when times are good, but become somewhat reluctant to advance credit facilities during times of uncertainty and economic slowdown. This behaviour of commercial banks is not unique to the USA. The BER/ Ernst & Young Financial Services Index has also found evidence that domestic banks also have raised their lending standards and criteria. It also appears that domestic banks are charging higher spreads relative to prime than was previously the case. The above illustrates that we should not rely too heavily on the results of a model to guarantee our policy success, particularly during times of heightened uncertainty. No model can be expected to replicate all these factors in a consistent time-invariant framework, especially since the behavioural patterns of economic agents tend to change so radically from time to time. 4. Conclusion Despite all the problems with the use of models and the challenges related to forecasting in an uncertain environment, models, irrespective of how they are structured, remain integral to the policy decision taken and we will therefore continue to use them. The models themselves have become increasingly sophisticated. But this does not guarantee the success of monetary policy formulation and implementation especially, in an uncertain future. The challenges we are faced with have certainly escalated in recent times. However, with the new challenges we also have new opportunities to get a greater understanding of the dynamic and ever-changing economy we need to deal with. Thank you very much. References Blanchflower, D. 2009. “Macroeconomic policy responses in the UK?”, open lecture by David Blanchflower an external member of the Bank of England Monetary Policy Committee at the University of Nottingham, published by the globalisation and economic policy centre, University of Nottingham, Thursday 29th January, 2009. www.dartmouth.edu/~blnchflr. Ernst & Young, 2009. “The Financial Services Index : 1st Quarter 2009”, the financial services report for the first quarter of 2009, compiled by George Kershoff (BER) and Graham Thompson (E&Y), the survey was conducted between 11 February and 17 March and the results processed on 18 March 2009. The number of responses processed was: retail banks (21), investment banks (17), investment managers (63) and life insurers (17), April 2009. Federal Reserve Board, 2008. “Senior Loan Officer Opinion Survey on Bank Lending Practices”, survey on the state of the USA banking sector provided by the Federal Reserve Board, published January 2009. http://www.federalreserve.gov/boarddocs/snloansurvey/200902/ King, M. 2009. Opening Remarks by the Governor, Inflation Report Press Conference, Bank of England, Wednesday 13 May 2009.
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Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the IPM Annual Business Conference in association with NKR, Durban, 18 May 2009.
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X P Guma: The role of monetary policy Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the IPM Annual Business Conference in association with NKR, Durban, 18 May 2009. * 1. * * Introduction Mr Chairman, ladies and gentlemen, let me begin by thanking you for your invitation to me to participate in this meeting today: for me it is usually better to speak when asked than to ask to speak. The title of my talk today is well known to those who have an interest in and may be well versed in the precepts of that component of public policy which is known as “monetary policy”: that is, the use of monetary instruments to influence macro-economic outcomes. This is so because it was the topic chosen for the Presidential address delivered at the Eightieth Annual Meeting of the American Economic Association on December 29, 1967 1 : an Association which remains one of the foremost scholarly associations of the Economic(s) profession; and has been the scale upon which many nuggets of theoretical insight have been assayed. Theoretical elegance within the confines of the spaces occupied by trained economists is one thing: relevance to, and understanding by, a broader public whose lives are affected by the actions of Central Banks is another. My purpose today is to speak to the latter. 2. The Friedman Statement For my purpose today, the questions to which answers are required are, in the main, those to which the 1967 – address was directed, namely: i) what monetary policy cannot do. ii) what monetary policy can do. A paraphrasing of Friedman would indicate that the course adopted by Central Banks in order to achieve a particular objective, cannot: peg interest rates for more than very limited periods; … peg the rate of unemployment for more than very limited periods. These are, as stated in the address, only two of the limitations of monetary policy which can be drawn from the “infinite world of negation”. To the list could be added many others: for example, easy finance for SMME’s, secure and guaranteed employment for all job seekers including graduates of tertiary institutions, full capacity utilisation for airline companies, unlimited connections for the cellular-less and infinite airtime for the connected 2 . But, monetary policy can: iii) prevent money itself from being a major source of economic disturbance. iv) Provide a stable background for the economy, such policy being the primary responsibility of national central banks. M. Friedman (1967) “The Role of Monetary Policy”; The American Economic Review, Vol. 58, No. 1 (Mar., 1968), pp. 1-17. Those who attend the Monetary Policy Forums of the South African Reserve Bank (SARB) will have heard requests, indeed demands, for such interventions at various times. Logically, therefore, if monetary policy is to provide a stable background for the economy, it must do so by deliberately employing its powers to that end. 3. In all places: at all times? In stating the aforegoing, in free translation, I should not be misunderstood. I do not wish to imply that one monetary policy is always and everywhere appropriate. Such a rendition of this narrative would do injustice not only to the principal author to whom I have referred but also to his antecedents, contemporaries and successors most of whom had and have, respectively, a keen sense of history. For it is the case that the political, economic, social and international environment of central banks is in constant flux. At the same time central banks are quite dissimilar in their constitutions. No two Banks are exactly alike. 3 Nor is it the case that the issues to be addressed are identical at all times in all places. The central proposition remains, however: it is that monetary policy can do certain things; in particular, provide a stable background for the economy. In so doing, this policy will enable producers and consumers, employers and employees to proceed with full confidence that one aspect of an otherwise unknowable future is predictable: namely, the rate of price inflation, or its mathematical inverse, the purchasing power of money. 4 In these conditions, entrepreneurs can plan and act; savers can save without fear that their savings will be wiped out by inflation and borrowers can borrow in orderly markets at interest rates that are not unduly raised by inflation risk premia. Resolution of challenges in the real sector; for example skills shortages or drought – induced agricultural losses requires other policies: stated differently as old people here used to say “nobody can use another person’s teeth to smile”. So to end the analogy, the teeth which will bring a smile to the resolution of those issues cannot be drawn from the mouth of monetary policy. 4. Is price stability enough? But this surely cannot be enough. For we all are aware of the strained circumstances of the international economy in 2009: and are no doubt cognisant of the impact of these developments on the prospects for the domestic economy. So, as William White asked two years ago, “Is Price Stability enough? 5 And, the short response to this could be, in my view, “yes, in normal circumstances. No, in extra-ordinary times”. That, after all, is why policy affords some discretion to the policy-maker. Slave-like adherence to an invariant policy stance is unlikely to yield optimal outcomes when circumstances change dramatically – as they have in recent times. For this reason, principally, many central banks have accepted the distinction that may need to be drawn between price stability and financial stability. That these are not synonyms is evident from the evidence: the worst financial crisis in history has erupted to the detriment of global, real economic activity; and did so in the United States of America despite the low rates of inflation that had been recorded there for some time 6 . Courtney N. Blackman (1999) Central Banking in Theory and Practice Caribbean Cent for Monetary Studies,St. Augistine, Trinidad. In the Address, Friedman discussed the average level of prices; not the rate of price inflation. William R White (2008) in Bank for International Settlements (BIS) Papers No 45, March 2009 For further discussion, see for example, Bernanke, Ben S. (2004) “The Great Moderation”, speech delivered at the meetings of the Eastern Economic Association, Washington, D.C., February 20. On the other hand, the proposition that price stability and financial stability are not mutually exclusive, indeed are linked is intuitively appealing. This is so because the transmission mechanism of monetary policy in contemporary, market-oriented economic systems is based on the assumptions that: 1. credit markets exist and operate efficiently; 2. the policy rate of the central bank is the primary determinant of interest rates in the market for credit; 3. there exist stable, rational and predictable relationships between money and credit, on the one hand; and a host of macro-economic variables on the other; and 4. the demand for and supply of credit are brought into equilibrium, in part, by “the” interest rate. When credit markets cease to operate, or operate inefficiently, one of the channels through which conventional monetary policy operates ceases to be, or becomes increasingly less, effective. There then arises a need to regain financial stability because financial instability has the potential to cause significant macro-economic costs: it interferes negatively with production, consumption and investment and is detrimental to broader goals of sustainable and sustained economic growth, full or rising employment and societal development. It may be necessary, therefore, for some institution, or college of institutions, to validate the often unstated assumptions stated above, in order to avoid or limit financial instability: to enhance the efficiency of monetary policy. Such an authority should be able to, at minimum, • identify systemic threats at an early stage; • promote measures to reduce these threats; • develop and test contingency plans and crisis preparedness; • in extreme cases, implement safety-net measures to support systematically important financial institutions; • maintain confidence in financial markets and resolve the efficient functioning of markets, according to the International Monetary Forum (IMF); the Bank for International Settlements (BIS); and the G-20 – of which South Africa is a member 7 . 5. In South Africa Many countries – which differ in size, structural features and development level – have selected inflation-targeting-with-floating as their preferred framework for pursuing a more independent and effective monetary policy. According to Frederic S. Mishkin and Klaus Schmidt-Hebbel 8 , this choice has been made, typically, by instrument-independent central banks in open economies with a history of inflation, which need to establish a credible monetary anchor to promote price stability. See Mnyande, M. (2009): Remarks at the launch of the Financial Stability Review, South African Reserve Bank (SARB), 6 March. SARB (2009) Financial Stability Review, March. See F.S. Mishkin and K. Schmidt-Hebbel (eds) Monetary Policy Under Inflation Targeting, Central Bank of Chile: 2005. This framework, typically, coincided with the end of experimentation with alternatives: including, in particular, intermediate exchange rate regimes, and monetary aggregates, as an intermediate target. Historically, the most common nominal anchor for policy involved linking the value of the currency to gold (under the gold standard) or to a major currency. There followed a period, in the 1970’s, during which monetary aggregates became the prevalent nominal anchor for policy. When these became an increasingly unreliable anchor, some countries attempted to target the exchange rate – with mixed success 9 . At present, in the case of the South African Reserve Bank (SARB), as is well known, the primary goal of monetary policy is the achievement of price stability. Stated in the words of Section 224(1) of the Constitution of the Republic of South African, 1996, “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”. And South Africa has had experience of most alternatives – including the gold standard, the gold-dollar standard, monetary aggregates and an eclectic approach. To use the intemperate language of the younger generation: been there, done that; got the T-shirt. As has been stated above, it is possible to pursue price stability using alternative approaches: and, many have been tried. As has been observed elsewhere in this regard, “take away inflation targeting and we will still have monetary policy, we will still have the same instruments of monetary policy, and the Bank will still have a constitutional mandate to maintain low inflation” 10 , in the interest of balanced and sustainable economic growth in the Republic. 6. Conclusion In conclusion, permit me to emphasise the following points: – The proposition stated in the Address, to which I have made reference, that our economic system will work best when economic agents can proceed with full confidence that the purchasing power of money will be protected remains central to the role that has to be assigned to monetary policy. In South Africa, this is a constitutional imperative. Recent developments have thrown into sharp relief the importance of financial stability: and some broad guidelines have been suggested, in particular, by the G-20 – of which South Africa is a member – at the Summit held in London early in April 2009. At that Summit, the former Financial Stability Forum was transformed into the Financial Stability Board: and was enjoined, inter alia, to “pursue the maintenance of financial stability, enhance the openness and transparency of the financial sector, implement international financial standards … and agree to undergo periodic peer reviews” 11 . The institutional arrangements for accomplishing this will, clearly, differ from country to country but will certainly not be onerous for South Africa as a great deal has already been done in this regard. Two IMF/World Bank Financial Sector Assessment Program Studies have been concluded; the first in 2000 and the second in 2008. Supervision of banks has been undertaken consistently and the Basle II framework was implemented on the due date. A useful review in this regard may be found in Charles Freedman and Douglas Laxton (2009) “Why Inflation Targeting?”, IMF Working Paper WP/09/86. Mboweni, T.T. (2008) “Monetary Policy, Inflation Targeting and Inflation Pressures”; Address to the Bureau for Economic Research Annual Conference, Johannesburg: 22 May. Declaration on strengthening the financial system. G-20 London Summit, 2 April 2009. Moreover, within the SARB, the Financial Stability Department (FSD) has existed since the year 2000, its task being to identify possible threats to financial stability and suggest ways in which these could be mitigated. Although its existence cannot guarantee that financial stability will be maintained, taken together with the existing framework which exists for the regulation and supervision of financial institutions, its work will assist the authorities to reduce the probability of systemic instability. Finally, financial markets are likely to remain volatile as risk aversion and optimism about growth prospects fluctuate in response to emerging data and conflicting signals, as the most recent Monetary Policy Review of the SARB indicates. Dealing with this will require resolute application of monetary policy in accordance with the mandate to achieve price stability, within an inflation-targeting framework. Thank you for your attention.
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Welcoming remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department's 4th Annual Cocktail Party, South African Reserve Bank, Pretoria, 28 July 2009.
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X P Guma: SARB’s Financial Markets Department Welcoming remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department’s 4th Annual Cocktail Party, South African Reserve Bank, Pretoria, 28 July 2009. * 1. * * Introduction Ladies and gentlemen, it is with much pleasure that I welcome you here this evening to the Financial Market Department’s fourth annual cocktail function. I thank you for taking time out of your busy schedules to be present here this evening. Last year we emphasised the importance of communication between central banks and market participants, highlighting that it was essential for the smooth functioning of markets and in the interest of financial stability. The events of the past twelve months are a good example of the importance of communication. In May 2008, the time of our last gathering, it would have been difficult to imagine that a top US investment institution such as Lehman Brothers would collapse. On 15 September 2008, the unthinkable happened and Lehman Brothers filed for bankruptcy protection. This began a whole chain of events with which all in the financial world have had to deal. South Africa has been in a very fortunate position; the domestic financial system has not been impacted directly. Our banking system remains sound as domestic banks have very limited exposure to so-called “toxic assets”. Being a small and open economy, however, we could not escape the negative effects on the real economy. In the fourth quarter of 2008, the South African economy contracted for the first time in a decade, officially entering a recession in the first quarter of 2009, at the same time recording the worst quarterly economic performance since the 1980s. Domestic financial markets also suffered as investors became increasingly risk averse. Nonetheless, I am not here to discuss economic or financial market developments, as you are all too well aware of this. I would, however, like to briefly comment on the happenings in the Financial Markets Department of the SARB over the past year in the midst of all this turmoil. 2. SARB money market operations Central banks around the world injected significant amounts of liquidity into the money markets as they sought to avoid the worst outcomes of the crises on their respective economies. To avoid a repetition of the Great Depression, central banks acted with much flexibility, speed and urgency. It is perhaps for this reason that we are increasingly hearing about the green shoots of economic recovery. While everyone may breathe a sigh of relief once a recovery is underway, central banks will once again find themselves in a somewhat challenging position, as they now would have to concentrate on appropriate exit strategies such that the growth in their balance sheets do not pose a huge inflationary risk. There are also the “expectations effects”, where these expanding balance sheets may be perceived to signal less commitment to fighting inflation. I am happy to state, however, that in South Africa it has been “business as usual”. The Financial Markets Department has not had to undertake any special liquidity-providing transactions in the market. The domestic banking sector and financial markets, especially the interbank market, continued to operate effectively during the crisis. There was no upward pressure on overnight rates as witnessed in the US and European markets. The spread between the South African Benchmark Overnight Rate on deposits (Sabor) and the Bank’s repo rate remained relatively stable. This spread continued to fluctuate in its usual range, with the Sabor remaining below the repo rate. The liquidity requirement remained in a range of between R8 billion and R13 billion, in line with that prevailing the previous year. Typically, the purchases of foreign exchange for purposes of building reserves would be the single biggest contributor to increased liquidity in the money market and the SARB would have to drain this liquidity through various open market operations. In the 2008/09 financial year, SARB activities in the foreign exchange market were somewhat muted, however, as compared to previous years. This can partly be attributed to the extreme volatility in financial markets. The SARB and National Treasury continue to cooperate in an effort to reduce the country’s external vulnerability and increase the level of reserves. The gross gold and foreign exchange reserves declined marginally from USD34,3 billion in April 2008 to USD34,1 billion in March 2009. Although the SARB purchased over USD1,5 billion in foreign exchange for purposes of increasing the country’s foreign exchange reserves, this was offset by valuation adjustments, given that the country’s reserves are denominated in various currencies. The SARB did not at any time intervene in the currency markets to influence the level of the rand in any way. The international liquidity position increased marginally, owing to the SARB’s decision to reduce its foreign loans. The substantial increase in reserves over recent years, reduced the need to hold significant amounts of borrowed reserves. Foreign loans declined from over USD1,0 billion in April 2008 to approximately USD650 million in March 2009. Over the past few months, gross foreign exchange reserves have increased to levels above USD35 billion, largely due to the successful international bond issue which took place in May this year. As you are aware, the National Treasury placed part of the proceeds of this issue in a foreign deposit account with the SARB which, in future, will be used towards fulfilling government’s foreign currency commitments falling due. Nonetheless, the SARB increased its open market operations during the year, using the traditional sterilisation instruments at its disposal. SARB debentures increased by R9,6 billion to R28,0 billion at the end of April 2009. The longer-term reverse repos were mostly unchanged around R7,6 billion. Government deposits at the SARB increased by R2,7 billion; much of this is related to accrued interest. Liquidity was also drained via an increase in the notes and coin in circulation of R4,3 billion and an increase in the cash reserve account balances of banks of R5,4 billion. To square their end-of-day positions, banks predominantly utilised the cash reserve accounts and only on a few occasions did the SARB have to conduct standing facility operations. These standing facility operations, it must be emphasized, were not in any way linked to stresses in the financial system; rather, they arose due to unexpected increases or decreases in notes and coin flows or because it was the end of the cash reserve maintenance period. The SARB did not effect any changes to the refinancing procedures over the past year, but continues to engage with market participants through the Money Market Liaison Group meetings to discuss issues related to the money markets and SARB operational procedures. As indicated last year, a number of other fine-tuning operational issues, including the coordination of the maturity dates of the SARB’s open market operations with MPC dates, are under consideration but have not yet been finalized. One of the most challenging tasks facing us has been accurately to forecast the quantity of notes banks will need each day. In an attempt to improve the liquidity estimates provided to the market, the SARB plans to use the end-of-day notes and coin figure with a one-day lag in its liquidity calculations. This will assist the SARB in calculating much more accurate liquidity estimates and thereby also allow for the more efficient management of liquidity: There should be less cost and inconvenience to both you and the SARB. The exact details of this arrangement are currently being worked out and will be communicated shortly. The SARB, on behalf of the National Treasury has conducted a number of special Treasury Bill auctions to the value of R8 billion over the past few months. Furthermore, government bond issuance has increased, while R58,6 billion of the R153 bond was switched with market participants. The remainder of the R153 bond will be split into three legs on 31 August. The close relationship which the SARB enjoys with the National Treasury and the market assisted in the smooth implementation of these transactions. We anticipate that we will continue to enjoy the same level of support going forward. 3. SARB reserves management We have heard a lot of talk about the dual responsibility some central banks might have for monetary policy and financial stability. Less remarked upon is the fact that many central banks have become large wealth managers, clearly reflected by the International Monetary Fund (IMF) 1 data which show that global reserves have increased from just over USD1,3 trillion in 1995 to USD7,0 trillion in the second quarter of 2008 (global reserves declined to USD6,5 trillion in the first quarter of 2009). Along with this phenomenal growth in reserves, came the challenge of finding means by which to achieve higher returns. Accordingly, some central banks slowly moved away from traditional asset classes such as Treasury bills and public sector bonds to more sophisticated asset classes. Needless to say, recent market volatility and credit concerns have exposed central banks to the vulnerabilities and risks which attach to such investment decisions. Therefore, the importance of risk management in reserves management has increased exponentially. Managers of foreign exchange reserves within central banks have become much more risk-averse since the global credit squeeze started, with safe assets being back in favour. With just over USD34 billion in net reserves, the management of these remains an important function of the SARB. Being relatively new in the world of reserves management, the SARB has generally been a conservative manager. In line with most other central banks, the SARB tightened its investment guidelines for the management of reserves so as to avoid any potential losses. The greater portion of funds is invested in “AA” and “AAA” rated instruments and with similar-rated counterparties. There were no significant currency allocation shifts in the wake of the crisis. However, because the country’s foreign exchange reserves are diversified, currency fluctuations have impacted on returns as measured in USD. The Strategic Asset Allocation (SAA) was reviewed during 2008/09, while the SARB also embarked on the external fund management review, which is conducted every three years. The revised SAA will be implemented later this year, coinciding with the appointment of new external fund managers and/or reappointment of some existing ones. 4. Other initiatives in the financial markets arena The hard work and determination of the planning committee of the Association Cambiste Internationale (ACI) – now known as ACI The Financial Markets Association – is much in evidence and I am happy to report that the 48th Annual ACI International World Conference held in Cape Town in March 2009 was a resounding success. The South African Reserve Bank is proud to have been associated with an event of this calibre, the first ACI Conference to be hosted on the African continent. The SADC financial markets subcommittee is now operational and has met twice in the past year. At its most recent meeting in May 2009, the Committee of Central Bank Governors approved the work programme of the subcommittee and in fact the Committee holds its third Currency Composition of Foreign Exchange Reserves (COFER), IMF. meeting in Lesotho starting tomorrow. We wish them every success in their efforts at building and developing financial markets in Africa. 5. Conclusion It has certainly been a very trying year for financial market participants and indeed, central banks around the world. We certainly seek evidence of the existence of the “green shoots of recovery”. I wish to thank you all for the close relationship, we as the central bank, enjoy with you. We certainly value the interactions and I trust that the channels of communication will be enhanced further. From our side, we will endeavour to keep you informed of the strategic and operational issues with which we are involved. I also wish to thank the Financial Markets Department, under the leadership of Roelf, for the hard work and determination throughout the year and for making us proud to be associated with the SARB. With them, it is I think appropriate to congratulate your former colleague, Daniel Mminele, upon his appointment as Deputy Governor of the South African Reserve Bank. Please enjoy the rest of your evening!
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 10th Annual Steve Biko Memorial Lecture, University of Cape Town, Cape Town, 10 September 2009.
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T T Mboweni: Reflections on some economic and social developments in South Africa in the past 15 years Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 10th Annual Steve Biko Memorial Lecture, University of Cape Town, Cape Town, 10 September 2009. * * * Introduction I wish to express my gratitude to the Steve Biko Foundation, the Biko family and the University Cape Town for extending this invitation to deliver the 10th Annual Steve Biko Memorial Lecture. I am particularly humbled to belong to the club of those who have previously addressed this august gathering. September 2009 marks the 32nd anniversary of the murder in detention of Bantu Stephen Biko. It is, therefore, a fitting tribute to Steve Biko to hold this event in September, South Africa’s heritage month. This is particularly so because the threat of forgetting who we are, where we come from and how we got to be where we are looms ever larger, particularly for the younger generations. I never met Steve Biko personally, having been a teenager in Limpopo by the time he departed this world. His teachings, though, had a profound influence on me. That was the period historians referred to as a period of political lull. My ultimate involvement in politics stemmed, in part, from some of those efforts of the black consciousness movement to “conscientise” the masses and revive political activism. Indeed, as Archbishop Desmond Tutu writes in his preface to Steve Biko’s I write what I like: “Black Consciousness sought to awaken in us the sense of our infinitive value and worth in the sight of God because we were all created in God’s image, so that our worth is intrinsic to who we are and not dependent on biological irrelevancies such as ethnicity, skin colour or race. Black Consciousness helped to exorcise the horrible demons of self-hatred and selfcontempt that made blacks suck up to whites whilst treating fellow blacks as the scum they thought themselves to be. Black Consciousness aroused in us the knowledge of our share in what St Paul called the glorious liberty of the children of God, urging us to enter into that splendid heritage.” 1 Inflation To break a bit with tradition, the thrust of my address tonight will be on economic issues. In particular, I will share a few observations and thoughts on selected macroeconomic developments in South Africa in the past 15 years. From 9 November 2009 I will no longer be allowed to comment on monetary policy. As the outgoing governor, however, I will take advantage of this platform to remind you of a few truths, one being that no central bank worth its salt can ever tolerate high inflation. Price stability may not be a sufficient condition but I maintain that it is a necessary condition for a solid foundation for sustainable growth and prosperity. I would like to believe that Steve Biko would have been gratified by the fairly contained pace of inflation over the past 15 years, knowing the dire consequences of inflation for the poor – those who are usually least able to hedge against inflation – in particular. Since 1994 average headline inflation has amounted to approximately 6,5 per cent per annum. Over the Steve Biko, I write what I like, A selected of his writings. preceding 15 years, 1979 to 1994, it had averaged almost 14 per cent per annum. Inflation has been uneven over the period, though, induced typically by significant changes in key exogenous drivers of inflation, such as oil prices. Secondly, the recent upsurge in strike action has led to some commentators describing the wave as a “winter of discontent”. In this regard, I would like to comment on some worrying trends in the settlements reached. Wage settlements above the projected rate of inflation and in excess of productivity gains tend to undermine the fight against high inflation. They lead to labour cost increases way above those of trade competitors and, therefore, loss of competitiveness. Though I will discuss the labour market in much depth later, I need to refer briefly to our labour laws. Many commentators have described the labour market as rigid and inflexible. As the country’s first post-1994 Minister of Labour, some of the blame has been pointed in my direction. I am the first to admit that some things could have been done differently. Hindsight, however, is useful only when it improves our foresight. I would like to take this opportunity to espouse some of the theoretical and philosophical underpinnings behind the Labour Relations Act. The labour movement regarded me as a hero then. Social ills The break with tradition, however, cannot be complete when addressing such an established forum. I will, therefore, digress slightly and venture an opinion on a few matters not related to economics and central banking. The shameful xenophobic tendencies we witnessed last year should have caused all South Africans to exclaim: “Oh, beloved country, what would Steve Biko have said?” At the height of the attacks on foreigners most of us were notable by our silence and inaction. Sadly, such indifference, anger, hatred and violence towards foreigners, particularly black Africans, still finds expression among many South Africans. This is at a time when we seek to accelerate economic integration in the SADC region, with all the lofty ideals of establishing a free trade area by last year (2008), a customs union by next year (2010), a common market and a monetary union by, respectively, 2015 and 2016. The ultimate objective of SADC is to build a region in which there will be a high degree of harmonisation and rationalisation to enable the pooling of resources in order to achieve collective selfreliance and improve the living standards of the people of the region. At central bank level, an important milestone has been the completion of the drafting of the proposed SADC central bank model law, which will pave the way for the harmonisation of legal and regulatory frameworks. Steve Biko observed that the most potent weapon in the hands of the oppressor is the mind of the oppressed. Indeed, the liberation of the oppressed is not only political, economic and social, but involves psychological liberation as well. Can we claim to have liberated our minds when the daily statistics of rape and other forms of violence against women and children leave us questioning the very essence of our humanity? This cannot be what Steve Biko envisioned when he wrote: “We have set out on a quest for true humanity, and somewhere on the distant horizon we can see the glittering prize. Let us march forth with courage and determination, drawing strength from our common plight and brotherhood. In time we shall be in a position to bestow upon South Africa the greatest gift possible – a more human face.” 2 Delivering this lecture three years ago, Archbishop Emeritus Desmond Tutu asked: “What has come over us? Perhaps we did not realise just how apartheid has damaged us so that we seem to have lost our sense of right and wrong, so that when we go on strike as is our Ibid. right to do, we are not appalled that some of us can chuck people out of moving trains because they did not join the strike, or why is it common practice now to trash, to go on the rampage? Striking municipal workers empty trash on the streets, other strikers break shop windows, loot and trash the premises? Even our students on strike will often destroy the very facilities they need for their studies. What has happened to us? It seems as if we have perverted our freedom, our rights into licence, into being irresponsible. Rights go hand in hand with responsibility, with dignity, with respect for oneself and for the other.” 3 We can pose exactly the same questions today when the Bus Rapid Transit system, a bold attempt to improve public transport, leads commuters in Johannesburg being inconvenienced by a stayaway from some in the taxi industry hell-bent on holding the country to ransom whenever they are not having it their way and perceive a threat to shrink their market share. They will even go to the extent of firing live bullets at buses ferrying commuters. We are witnessing social ills that are partly rooted in our history as well as in unintended consequences of policy interventions during the post-apartheid period. Health professionals abandon the sick in dire need of medical attention. Teachers abandon learners in favour of this it the other demand, usually very close to exams. Shopping at malls has become risking life and limb as marauding mobs, armed and ready to shoot to kill, strike brazenly and with such frequency. Striking municipal workers still trash our cities. Soldiers – those entrusted with the defence of the country and the constitutional order – disobey a court order and run riot near the Union Buildings, some of them armed. The scenes – the resultant mayhem and police firing at soldiers – would make responsible citizens to be very afraid and exclaim: “Oh, beloved country, what would Steve Biko have said about all those developments?” Economic growth Having been willing to give everything for the ideal of a democratic society, Steve Biko would have observed the progress of the country since democracy was introduced in 1994 with the greatest interest. In fact, he would have done more than that: he would certainly have been leading rather than observing, shaping events rather than being shaped by them. In reviewing the past 15 years in the South African economy, and with the wisdom acquired over the years, he might have chosen to draw up a balance sheet of assets and liabilities, the positives and the negatives encountered over this period. One of the highlights of the performance of the country has been the unprecedented levels of economic growth attained since the turn of the century. Calculated at constant 2000 prices, real gross domestic product per capita rose by more than 28 per cent, from R20 214 in 1994 to R25 897 in 2008. 4 Similarly, real gross national income per capita, which also allows for the effect of changes in the terms of trade on real income, rose by more than 29 per cent over this period. The level of real gross domestic product expanded by 63 per cent over the period 1994 to 2008, giving an indication of how much the overall cake had grown on a cumulative basis. The pace of growth, however, was uneven. Economic growth, however, has not yielded the most desirable results as far as employment creation is concerned. Researchers assert that improved income levels since 1994 were more driven by welfare transfers than labour market absorption. Up to 2005, growth in employment largely tracked real GDP growth, albeit at a less than sufficient pace to meet the Steve Bantu Biko Memorial Lecture, delivered by Archbishop Emeritus Desmond Tutu, University of Cape Town, 26 September 2006. Unless stated otherwise, data is from the Quarterly Bulletin of the South African Reserve Bank (various issues) and the SARS Customs and Excise database. rapid growth of the labour force. The revised Labour Force Survey estimates, for instance, reveal that between March 2001 and March 2007 the absorption rate trended downwards from 45,8 per cent to 44,1 per cent. 5 Even more disheartening is the number of discouraged job seekers which grew from 1 725 000 to 2 511 000 over the same period. Females were more adversely affected than males by all these disappointing labour market outcomes. Even though the demand side of the labour market has been disappointing, some strides have been made in enhancing the quality of labour supply. This, however, has not been even throughout all education levels. The proportion of the population aged 20 years and older without any schooling dropped from 19,1 percent in 1996 to 10,3 per cent in 2007, while the share of those with some secondary education increased from 33,6 per cent to 40,1 per cent. 6 At the post-matric levels, however, the improvements are less dramatic. Over the ten years starting in 1996, the population over 20 years of age which completed higher education grew marginally from 7,1 to 9,1 per cent7. 7 Sadly, reality dictates that it is the quality of labour that determines employability. Evidence shows that growth in inequality is partly attributable to the fact that skilled workers were more favoured by growth in job opportunities. Since the beginning of the new dispensation, our school system performed better in producing standard grade than higher grade matric passes in mathematics. Standard grade passes increased from 75 543 to 123 813 between 1997 and 2007. Higher grade passes dipped from an initial 29 475 to 19 327 in 2000 and recovered to 25 415 passes in 2007. Although the total number of graduates increased from 578 134 in 2000 to 741 380 in 2006, the share of science, engineering and technology graduates moved marginally from 25,5 per cent to 28,5 per cent over the same period. 8 Opening up to the international community Increased globalisation has been one of the defining characteristics of the world economy over the last two decades. The advent of democracy in 1994 ushered in a new era in South Africa’s economic history. At the heart of this process was the integration of the domestic economy into the world economy. Prior to 1994, apartheid South Africa faced large-scale international financial sanctions and isolation. This stifled economic activity in numerous ways. For instance, access to foreign sources of finance was blocked in the mid-1980s, resulting in a debt standstill in 1985 as South Africa could no longer roll over its foreign borrowing and honour its commitments. Unable to tap foreign savings, South Africa had to finance all its investment from its own domestic savings, and was therefore forced to run surpluses on the current account of the balance of payments. This, in turn, implied generally strict economic policy settings aimed at moderating domestic income and expenditure, thereby reducing imports. With the transition to democracy, international sanctions were lifted away as the global community embraced South Africa. Whereas from 1985 to 1993 net outflows of financial capital averaging 2,4 per cent of gross domestic product were recorded, financial inflows have subsequently been registered in every year but one. The average net inflow from 1994 to 2008 amounted to 3,2 per cent of gross domestic product, augmenting domestic savings and making it possible to import more and grow faster. Statistics South Africa. Labour Force Survey: Historical Revision March Series 2001 to 2007, Pretoria, August 2008. Statistics South Africa. Community Survey 2007, Pretoria, 2008. Ibid. The Presidency, Republic of South Africa. Development Indicators 2008 (www.thepresidency.gov.za), 2008. Significant reform of our trade policies has resulted in trade as a ratio of GDP increasing from around 40 per cent in the early 1990s to around 70 per cent in 2008. The nature of our trading relations has also changed significantly. In the early to mid-1990s, the developed countries – most notably those in Europe – accounted for around 60 per cent of South Africa’s trade. Since then our export markets have diversified, with countries in Africa and Asia gaining in prominence. Around 25 per cent of our total exports are sold in Asian markets. India and China’s rise in the global economy has been one of the main reasons for the rise in the demand for commodities. The two currently account for around 13 per cent of South Africa’s exports. The normalisation of international relations also involved a programme to gradually phase out exchange control. Up to March 1995 the so-called financial rand system applied to investment by non-residents. This not only inhibited outflows of financial capital, but also inflows. With the abolition of the financial rand system in March 1995, the country moved from two prices for foreign currency to a single price, thereby removing a dispensation prone to abuse, fraud and corruption. Moreover, while the door was opened for capital movements in both directions, it so happens that, subsequently, inflows have exceeded outflows quite substantially. The confidence in ourselves which was demonstrated by liberalising capital flows has been rewarded. Further exchange control reforms of the past 15 years include allowing South African individuals to invest money abroad, or as foreign-currency denominated investments with South African institutions. The applicable allowance was raised over time and currently the maximum amount per individual is R2 million. A more liberal approach has also been adopted as far as investment by South African companies abroad is concerned. Such investments have contributed to development, competition and growth on the African continent and elsewhere. Furthermore, a number of prominent South African companies have been allowed to shift their primary listing to foreign securities exchanges, thereby making it easier for them to borrow money or issue shares in those markets. People who had previously illegally built up foreign assets were also granted amnesty to declare and legalise such asset holdings. Numerous persons made use of this opportunity. South Africa seems to have benefited considerably from the greater freedom – with greater responsibility – which its citizens enjoy in the international arena. Both foreign assets and liabilities have risen considerably. Foreign currency markets have become more liquid. Under these circumstances the South African Reserve Bank has also been able to work down its oversold forward position in the market for foreign currency – its international liquidity position has changed from a negative US$25,2 billion at the end of 1994 to a positive US$36,9 billion at present. Apart from this, imports of goods and services have risen from 20 per cent of gross domestic product in 1994 to 38 per cent in 2008, while the corresponding ratio for exports has risen from 22 per cent to 35 per cent over the period. Government finance: reallocating resources to social spending In the area of government finance remarkable progress has been made over the past 15 years. In 1994 expenditure by the South African government had a significant racial bias. While significant additional expenditure was called for to correct this imbalance, government faced significant constraints: national government debt, for instance, was 50 per cent of GDP and debt service costs absorbed a considerable amount of funds. Mindful of the need to structure national finances in a sustainable way, government decided to do the right thing rather than go the macroeconomic populist route. Government expenditure and debt were kept under control, the capacity of the South African Revenue Service to collect taxes efficiently was enhanced, and an environment conducive to economic growth was fostered. Progress was made on all these fronts, with the growing economy expanding the tax base and the formidable Revenue Service ensuring that the fiscus received what was due to it. The buoyant tax revenue growth over the past 15 years made it possible to raise government expenditure and transfers quite substantially while, at the same time, keeping the budget deficit small enough to reduce the ratio of government debt to gross domestic product to 24 per cent in the second quarter of 2009. This prudent approach paid off recently when the international economic crisis led to a contraction in economic activity in South Africa. Low levels of government debt made it possible to adopt a much more expansionary fiscal policy stance under the circumstances, despite subdued tax revenues. Although this is set to raise the government debt ratio over the next few years, such increase is warranted in the interest of supporting economic activity and employment. While an expansionary fiscal policy stance can bolster economic activity, it is crucial to simultaneously ensure that the expenditure incurred is productive. Much can and must still be done in this area. For instance, as highlighted by ANC Secretary General Gwede Mantashe in an address on 2 September, the micro-organisation of school education leaves much to be desired, with actual teaching in township and rural schools averaging only threeand-a-half hours per day. To correct this is not rocket science, but would need sustained good organisation and discipline. Throwing money at the problem would not in itself be helpful. Financial sector developments In the area of finance the period from 1994 onward brought numerous opportunities, as major impediments to the majority of the population’s interaction with the financial system were removed. The demise of racially-based restrictions on the ownership of real estate, for instance, opened avenues for borrowing towards home-ownership and farming, and for using such fixed property as collateral. However, the removal of legal impediments alone is not enough to move rapidly to a satisfactory state of affairs. As the saying goes, the only place where one would find “houses” before “jobs” is in the dictionary. While considerable progress has been made with the extension of home and land ownership through government programmes and initiatives in the private financial sector, not enough jobs (and accompanying remuneration flows) have been forthcoming to support sustainable home-ownership on the larger scale needed. This has also held back the extent of deposits or investments with, and borrowing from, the financial sector. Nevertheless, the extent to which jobs were created and to which previously “unbanked” persons became “banked” was sufficient to raise considerably the amount of money and bank credit in the economy relative to the nominal gross domestic product. For instance, in 1994 the broadly defined money supply, M3, amounted to around 47 per cent of annualised nominal gross domestic product. Currently the same ratio is approximately 83 per cent. The many South Africans who did get a job frequently found that, in the wake of their new salary or wage flows, they received numerous offers to take up credit. Many of them became overextended, as suggested by the increase in the overall ratio of household debt to annualised disposable income from 56 per cent in 1994 to more than 76 per cent by mid2009. So much friction was generated by this dispensation and government had to introduce the National Credit Act in 2007 to improve consumer protection. This is accomplished through measures such as enhanced disclosure in credit contracts and thorough screening of prospective borrowers’ ability to repay debt before granting a new loan. Fixed capital formation It is gratifying to note the considerable strengthening of fixed capital formation in the South African economy. In 1994 capital expenditure was barely 15 per cent of gross domestic product. It took a long time to gain the momentum and put in place the processes necessary to raise capital spending, but since around 2003 this has started to happen. Currently fixed capital expenditure amounts to almost 25 per cent of gross domestic product. This says much about the self-confidence gained by South Africans and about the forward-looking focus of our society – characteristics which Steve Biko would have embraced and promoted with tireless energy. Socio-economic trends South Africa has come a long way in terms of rebuilding and healing from the legacies of the apartheid past. We all recognise that a lot still needs to be done. However, we can only learn by replicating what evidently works and reviewing what does not. A clear message emerging from socio-economic trends in the post-1994 period is that we should pay closer attention to policy implementation in terms of sequencing and understanding complementarities between macroeconomic and sectoral interventions. From the socio-economic point of view, we can point out with pride that significant ground has been gained in improving the living conditions of ordinary South Africans. After the turn of the century the overall levels of poverty showed a definite downward trend, albeit gradual. The proportion of the population living below the Income and Expenditure Survey poverty line of R250 per month (at constant 2007 prices) increased from 31 per cent in 1995 to 38 per cent in 2000, and dipped thereafter to 23 per cent in 2005. 9 Similarly, the levels of inequality peaked in 2000 and began to decline somewhat thereafter. The total Gini coefficient rose from 0,672 in 1993 to 0,685 in 1999 before trending downwards to 0,660 in 2007. 10 Inter- and intra-racial trends, however, remain worrisome. Although inequality has eased somewhat since 2000, among Africans it remains the highest compared with other population groups. Furthermore, according to the All Media and Products Survey data, notwithstanding the low base, the share of income accruing to Africans marginally gained ground against that of other population groups, rising from nearly 32 per cent to 39 per cent over the 10-year period between 1994 and 2004. 11 These trends are due more to the expansion of households receiving social grants. Whereas the year-on-year growth in welfare payments before 2000 averaged about 6 per cent, it soared to 40,4 per cent in 2001, thereafter decelerating to around 29 per cent to 2005 and 3,4 per cent in 2007. The total number of social grant beneficiaries expanded six fold from 2,409 million in 1996 to 12,386 million 2007. Nearly two-thirds, or just over 8 million of these recipients, were children. 12 While no one can dispute the positive impact social grants have made on poverty, we need to interrogate the sustainability of the social welfare grant approach in the long run. I fully appreciate the need for the state and society to provide welfare support to citizens who are physically or mentally incapacitated due to illness, disability, or old age. But when millions of our people depend on social grants for sustenance, and urban legend has it that teenagers go to the extent of falling pregnant so as to gain access to grants, we need to ask ourselves, as I think Steve Biko would: are we not running the risk of these social grants becoming an end in themselves and thus nurturing a dependency syndrome, destroying the fabric of our society? Ibid. Ibid. Van der Berg, S., et. al. A series of National Accounts-Consistent Estimates of Poverty and Inequality in South Africa, Stellenbosch Economic Working papers: 09/07, South Africa. The Presidency, Republic of South Africa. Development Indicators 2008 (www.thepresidency.gov.za), 2008. We have also witnessed notable improvements in living conditions of households. The number of households living in formal dwellings rose from 64 per cent in 1996 and peaked at 73,6 per cent in 2004 before moderating to 70,5 per cent in 2007. Access to services such as water and electricity also expanded. The proportion of households using electricity as the main source of energy increased significantly from nearly 58 per cent to 80 percent between 1996 and 2007. Access to piped water rose from 84,5 per cent in 1996 to 88,6 per cent of households in 2007. 13 Very commendable. Conclusion Steve Biko would be pleased to see South Africa emerging among the best performing economies on the global platform. He would be proud with our constitutional dispensation and Bill of Rights in which the rights for all are enshrined; the emerging Black middle class; the equitably structured welfare benefits; and the general decline in poverty. He would frown upon us for the failure to adequately intervene to address the spread of HIV and AIDS, and many social ills such as crime and, more specifically, rape and other forms of violence against women and children; the continuing racial and cultural intolerance as well as xenophobia. Steve Biko was most concerned about our worldview and value systems. For him this was more than just a manifestation of material well-being. Ladies and gentlemen, allow me therefore to argue that, apart from the need to strengthen our family and community systems, we should not lose sight of revitalising our knowledge systems which are essentially broader than preparing our children to be economically productive, asset-backed citizens of the future. Our knowledge system needs a complete overhaul in which the youth grow to understand their authentic history (less the romance), their cultural progressive value system and what it means to be a good citizen. The groundbreaking work done by such prominent South African anthropologists as Dr Harriet Ngubane should be celebrated and replicated. The growing unemployment rate combined with the partly undesirable inequality trends can be fertile ground for exacerbating polarisation among South Africans, leading to social tension across racial, class and gender lines. The current global economic recession adds to our woes. It is eroding some of the achievements we have made in stabilising the economy, broadening economic participation and improving the living conditions of many South Africans. In conclusion, the current financial crisis and global recession nevertheless gives us the opportunity to re-evaluate our craft in dovetailing macroeconomic policy with industrial, trade and other strategic sectoral policies to ensure that future economic growth translates into tangible and sustainable well-being for all, especially our rural communities, women, youth and other marginalised sectors of society. More fundamentally, we are struggling to realise broad-based transformation of political freedom into economic, social and cultural freedom with the required degree of integrity, loyalty and professionalism. If we can overcome these challenges, we would have surely achieved some but not all the wishes of our fallen visionaries like Steve Biko. “Keep the Faith”! Thank you. Statistics South Africa. Community Survey 2007, Pretoria , 2007.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 89th ordinary general meeting of shareholders, Pretoria, 17 September 2009.
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T T Mboweni: Overview of the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 89th ordinary general meeting of shareholders, Pretoria, 17 September 2009. * * * Introduction The past year has witnessed the most severe global economic downturn since the 1930s. At the time of the previous annual general meeting, the impact of the financial market crisis was becoming evident in various economies. However, at that stage the extent and depth of the global recession were still to be realised. In response to the slowdown, central banks and governments around the world have taken unprecedented and unconventional steps to protect their banking systems and economies. In South Africa the well-regulated banking system was relatively insulated from the fallout. However, the globalised nature of the downturn meant that the domestic economy was not spared, and the resulting domestic recession required appropriate fiscal and monetary policy responses. These developments posed a new challenge to monetary policy and resulted in a renewed focus on matters of financial stability. Appropriate supervision and regulation of the domestic banking sector and payment system have ensured an orderly financial market environment. Although inflation was outside the target range, the stance of monetary policy was loosened significantly in the face of an expected moderation in inflation and a weakening economy. Nevertheless, some upside risks to the inflation outlook remained and this constrained the monetary policy response somewhat. Apart from these concerns, the South African Reserve Bank (the Bank) also focused on maintaining and improving its internal operations. A comprehensive economic report, which is included as part of the Annual Report 2008/09, provides an analysis of developments in the domestic and international economy during the year under review. Particular emphasis is placed on those developments that have had implications for the operations of the Bank. As is usually the case, the focus of this address is on the main operational areas of the Bank. Monetary policy During the past year, monetary policy has been faced with new challenges. For the first time since the introduction of the inflation-targeting framework in 2000, monetary policy had to be implemented in the context of a domestic recession and against the backdrop of the severe and synchronised downturn in the world economy. At the same time, inflation remained well above the upper end of the inflation target range and, despite the downside pressures, targeted inflation was only moderating at a very slow rate. At the time of the previous annual general meeting, inflation was significantly outside the target range. The consumer price index excluding mortgage interest cost (CPIX) inflation peaked at 13,6 per cent in August 2008 and declined to 10,3 per cent by December. With the publication in February 2009 of the reweighted and rebased inflation measure, headline consumer price index (CPI) inflation for all urban areas was adopted as the new inflation target measure, with the target range remaining at 3 to 6 per cent. CPI measured 8,1 per cent in January, but increased to 8,6 per cent in February and has been declining gradually since then. By July, CPI inflation had declined to 6,7 per cent. However, the pace of decline has been constrained by substantial increases in some administered prices, particularly electricity prices, and persistently high food price inflation. As a result of the global turmoil, the outlook for inflation was subject to greater risk and uncertainty than usual, and this complicated monetary policy decision-making. Furthermore, the assessment of risks changed significantly in the course of the year in line with the reversal in the trends of a number of factors impacting on inflation. The international oil price had been one of the main sources of upside risk to the inflation outlook during 2008. However, in response to the global downturn, the price of North Sea Brent crude oil declined from levels of around US$146 per barrel in August 2008 to around US$34 in December. Domestic petrol prices followed suit and declined from R10,70 per litre in July 2008 to R6,01 per litre in January 2009. However, as global growth prospects improved, the oil price has recently increased to around US$70 per barrel. Nevertheless, as a result of exchange rate developments, the domestic petrol price is still lower than the levels that prevailed in 2008 and has contributed to downward pressure on inflation during the year to date. The behaviour of the rand exchange rate during the past year has reflected the volatile global environment. In the early stage of the unfolding crisis, the rand came under pressure, along with the currencies of most other emerging-market economies. In November the rand had depreciated to around R11,85 against the US dollar, and at the December meeting of the Monetary Policy Committee (MPC), the exchange rate was identified as the single biggest upside risk to the inflation outlook. However, as risk aversion abated, the rand recovered somewhat over the subsequent months and the risk to the inflation outlook from this source was reduced significantly. The rand has recently been at levels close to those prevailing in the first half of 2008. Global developments also reduced the risk to the inflation outlook. The synchronised global recession and generally lower commodity prices meant that the threat to world inflation had dissipated substantially. While there are concerns about the possible inflationary consequences of the accommodating monetary policy stance in a number of advanced economies, global inflation is expected to remain contained at low levels. The widening domestic output gap during the past period also posed a downside risk to the inflation outlook. After a number of years of growth of around 5 per cent, the economy began to slow to rates below potential output growth. The economy grew at an annualised rate of 0,2 per cent in the third quarter of 2008, but the full impact of the slowing world economy on the domestic economy became more evident in subsequent quarters. In the final quarter of 2008 a contraction of 1,8 per cent was recorded. In the first two quarters of 2009 the economy contracted at annualised rates of 6,4 per cent and 3,0 per cent respectively. Final consumption expenditure by households has been contracting since the third quarter of 2008. The weaker domestic demand was a result of declining real disposable incomes and employment, and negative wealth effects as a consequence of the significant decline in equity and house prices. The negative trend in consumption expenditure was reinforced by a significant deceleration in the growth of credit extension to the private sector. This was in response to both lower demand for, and restricted supply of, credit as banks applied stricter lending criteria in view of the increasing number of impaired loans. Despite these factors that were generally conducive to a decline in the inflation rate, there were other pressures and risks to the upside. Administered prices continued to exert upward pressure on inflation. The biggest thrust came from the electricity price increase of 27,5 per cent granted to Eskom in 2008, followed by a further increase of 31,3 per cent announced in June 2009. Wage settlements in excess of inflation have also posed a threat to the inflation outlook. These settlements partly reflected the deterioration of inflation expectations over the period. Food price inflation was the main contributor to overall inflation over the past year. This was despite significant declines in the prices of agricultural commodities, which were reflected at the producer price level with respect to both agricultural products and manufactured food. Nevertheless, food price inflation at the consumer price level has remained stubbornly high. However, there have been recent indications that the pace of moderation in food price inflation may be accelerating. In response to the downward trend in actual and forecast inflation, the monetary policy stance has been eased progressively by a cumulative 500 basis points since December 2008. The repurchase rate was reduced by 50 basis points at the December 2008 meeting of the MPC and by a further 100 basis points at each of the four subsequent meetings. At the June 2009 meeting the monetary policy stance remained unchanged, but at the August meeting the repurchase rate was reduced by a further 50 basis points as the committee assessed that the risks to the inflation outcome had tilted further to the downside. The easing in monetary policy was applied despite the fact that inflation was still outside the inflation target range. However, in a forward-looking monetary policy framework the MPC focuses on the expected path of inflation. Although subject to a high degree of variability and uncertainty, the inflation forecast during this past period has consistently indicated that inflation was expected to return to within the inflation target range over a reasonable time horizon. The MPC continued to apply monetary policy within a flexible inflation-targeting framework, cognisant of the economic downturn. Nevertheless, price stability remains the ultimate objective of monetary policy and the Bank remains committed to achieving the target over a reasonable time frame. Money-market operations In response to the consequences of the global financial market crisis, many central banks injected large amounts of liquidity into their money markets. However, domestic markets remained characterised by excess liquidity conditions and, therefore, no additional liquidity had to be provided to domestic banking institutions. In order to drain the excess liquidity, the Bank issued South African Reserve Bank (SARB) debentures and conducted reverse repurchase transactions. Liquidity was also drained from the money market through increases in the balances of the accounts held at the Bank by banks and the public sector, and increases in notes and coin in circulation. In the year to the end of August 2009 these factors were jointly responsible for draining a total amount of approximately R6,9 billion from the money market. The excess liquidity is partly associated with the increase in foreignexchange reserves over the past years. Foreign-exchange reserves The pace of accumulating foreign-exchange reserves by the Bank declined considerably as a result of the turmoil in the international financial markets. At the end of August 2009 the official gross gold and foreign-exchange reserves amounted to US$38,0 billion and the international liquidity position amounted to US$36,9 billion. The Bank will continue with its strategy of accumulating reserves when market conditions are favourable. However, further accumulation is expected to be constrained by the volatility in the foreignexchange markets, the level of global risk aversion and the cost of sterilisation. Managing the foreign-exchange reserves poses considerable challenges, particularly in the current uncertain global financial market conditions. As capital preservation represents one of the main pillars of the reserves management policy of the Bank, various steps have been taken to protect South Africa’s reserves from the instability and volatility experienced in these markets. Accordingly, counterparty risks, exposure to specific asset classes and the overall duration of the reserves portfolio were reduced, and the Bank’s conservative investment guidelines were tightened further. However, the demise of Lehman Brothers, in particular, gave rise to a series of downgrades in the credit ratings of financial institutions and investment instruments, which resulted in mark-to-market declines or unrealised losses in the value of some of the instruments on the balance sheet of the Bank. A comprehensive review of the external fund management programme was conducted during the year under review. The mandates of three of the existing fund managers will be renewed and three new managers will be appointed in September 2009, bringing the total number of external fund managers to six. Currency distribution Currency counterfeiting generally remains a risk to the Bank and the economy. Continuous efforts are being made to combat counterfeiting and to ensure the integrity of currency in circulation. The Bank has initiated a process for the introduction of a new series of banknotes and coin with new themes and improved security features. It is envisaged that the new currency series will be launched by mid-2013. The national payment system The Bank, in conjunction with the settlement banks, has been concentrating on the development and implementation of a national payment system information database, and a review of the real-time gross settlement (RTGS) network infrastructure and associated applications. A review of the current RTGS system – the South African Multiple Option Settlement (SAMOS) – indicated that the system was of a world-class standard. Potential enhancements to the SAMOS infrastructure and applications are due to be made in consultation with stakeholders during 2009. Although volumes and values of payment transactions increased substantially during the financial market volatility in September and October 2008, the operations and liquidity provision of the settlement system and associated foreign-exchange Continuous Linked Settlement (CLS) system performed well and without disruptions. In October 2008 the SAMOS system settled a record aggregate value of R8,5 trillion. The Bank continued its role as part of the CLS system oversight group chaired by the Federal Reserve Bank of New York. During the year the Bank and other participating central banks signed a CLS oversight protocol arrangement. CLS oversight arrangements and processes were thoroughly and successfully tested during the financial market crisis in September and October 2008. Financial stability Financial stability is of vital interest to central banks and, with the evolution of the global financial crisis, renewed attention has been paid to financial stability policy responses. Some central banks have responded by adopting more explicit and broader mandates for financial stability. The crisis also highlighted the need for macroprudential analysis of the financial system as a whole in order to identify and mitigate systemic risks. The Bank continually seeks to identify inherent weaknesses in the financial system and monitors risks that may result in financial system disturbances. Financial institutions and markets in South Africa were spared the worst of the direct effects of the global financial crisis as they were largely shielded by their limited exposure to risky foreign assets and liabilities. Developments in the domestic financial infrastructure and regulatory environment that are likely to strengthen the resilience of the financial system include new legislative developments to improve competition, consumer protection and corporate governance. Bank regulation and supervision As part of its bank supervision function, the Bank maintained its focus on promoting the soundness of the domestic banking system through the effective and efficient application of international regulatory and supervisory standards. The implementation of Basel II on 1 January 2008 and the application of the Core Principles for Effective Banking Supervision issued by the Basel Committee on Banking Supervision remain the cornerstones of the Bank’s regulatory and supervisory framework. The Bank continued to refine its Basel II-revised regulatory and supervisory approach during 2008 and 2009 by attending, inter alia, to the Internal Capital Adequacy Assessment Processes implemented by banks; thematic reviews of credit, market and operational risk; and the processing of applications by banks to use the advanced approaches to calculate their minimum capital requirements in respect of credit and operational risk. In line with international developments, the Bank held discussions with the banking industry on the stress-testing frameworks it implemented. In addition, the Bank continued to develop its own internal stresstesting expertise and methodology to facilitate the effective monitoring of the stress-testing frameworks of banks. The secondary effects of the international financial market turmoil, combined with cyclical economic developments in South Africa, worsened the operating environment of the banking sector during 2008 and the first half of 2009, with a significant decline in the rate of growth in loans and advances. Furthermore, increasing pressure on consumers continues to be clearly evident in the marked increase in impaired advances and rising credit impairments, which impact negatively on the earnings of banks. However, the South African banking system remains stable and banks are adequately capitalised. In response to the international financial market turmoil, the Bank commissioned an independent review of all securitisation schemes in which domestic banks were participating in order to determine whether such schemes were being managed prudently. Although no material issues were identified, the recommendations in the final report will be used as the basis for further consultation with the banking industry and for possible legislative and/or regulatory framework amendments in future. International co-operation The Bank addresses itself to regional and continental programmes that promote future regional integration. The Bank hosts the Secretariat of the Committee of Central Bank Governors (CCBG) in the Southern African Development Community (SADC) and supports the implementation of CCBG projects. The SADC Finance and Investment Protocol (FIP) was ratified by the South African Parliament in 2008 and work has begun in the various committees. Of note is the completion of the drafting of the proposed SADC central bank model law, which will pave the way for the harmonisation of the legal and regulatory frameworks of SADC central banks. The Bank plays a leading role in the SADC payment system project. During the past year the focus has been on the efficiency of electronic settlement systems and the collection of payment system statistics. Further work is being done on the interlinking of payment systems on a regional basis and the efficiency of remittance payment systems in the region. The Bank participated in several initiatives to strengthen financial systems in SADC. The Bank hosted or organised a number of regional workshops and conferences for SADC central banks in conjunction with international training institutions. These institutions included the International Monetary Fund Institute, the Bank for International Settlements (BIS) and the Toronto Centre. Participation in multilateral forums such as the Group of 20 (G-20) and the Financial Stability Board increased in the wake of the global financial and economic crisis. South Africa, as an active member of the G-20, contributed to the formulation of the co-ordinated G-20 response to the global financial crisis. The Bank also continues to foster relations with the BIS, and participates in a number of BIS committees and forums, including the Basel Committee on Banking Supervision. Internal administration The Annual Report 2008/09 of the Bank was distributed to shareholders before this meeting. The total assets of the Bank show an increase from R300 billion at the end of March 2008 to R344 billion at the end of March 2009. The Bank was not unaffected by the turmoil in the world’s financial markets. Low yields on prime investments and the collapse in prices of many traded financial instruments caused a decline in net income after tax from R2,5 billion in the previous financial year to R0,9 billion in the 2008/09 financial year. Operational expenditure is budgeted to increase by 22 per cent in the current financial year. This increase is due to an increase of 42 per cent in the production cost of currency; stock building of currency for the 2010 FIFA World Cup tournament; delivery of back orders of currency in respect of the previous financial year; and significant repairs and maintenance to Bank premises. The four subsidiary companies of the Bank, namely the South African Mint Company, the South African Bank Note Company, the South African Reserve Bank Captive Insurance Company and the Corporation for Public Deposits, achieved their objectives during the financial year. After a review of reports by their boards of directors, and internal and external auditors, the Bank is satisfied that the subsidiaries have continued to be managed in accordance with their objectives and best corporate governance practice. The results of the subsidiaries are reported on a consolidated basis with those of the Bank in the financial statements in the Annual Report 2008/09. The shares of the Bank continued to trade through the over-the-counter trading facility. During the 2008/09 financial year, 40 transactions were concluded, representing 57 980 shares. The permanent staff complement of the Bank increased by 34 in the year and totalled 1 930 at the end of the financial year. The overall staff turnover for the period was 6,2 per cent; slightly lower than in the previous year. In terms of overall employment equity, the percentage of black employees has increased by 2 percentage points to 60 per cent, compared with a target of 50 per cent for 2009. At management level an increase of 2 percentage points was also achieved. While the Bank has made advances with regard to gender representation generally, female representation at the more senior levels remains a priority area. The Bank consulted widely on employment equity, resulting in the implementation of a programme to educate and sensitise employees about disability issues. The Bank completed its disability verification process in which employees were given the opportunity to declare their disability status voluntarily. Performance management had previously been identified as the only remaining barrier to employment equity in the Bank. A task team investigated the Bank’s performance management system and made recommendations for improvement. The revised system is being implemented. As part of the Bank’s HIV/AIDS programme, almost 70 employees were trained to serve as peer counsellors. The programme is an ongoing initiative, and the next phase will address voluntary counselling and testing. The Bank continues to emphasise training and development. In the period under review the Bank received R2,4 million in the form of mandatory grants for complying with the reporting regulations of the Skills Development Act, 1998 (Act No. 97 of 1998). Seven students have completed learnerships and have all been appointed to permanent positions in the Bank. The Bank has also approved a new policy for external bursaries and 25 university students in their second year of study have been granted financial assistance. Besides the general central banking programmes offered, the Bank organised and hosted a number of specialised courses and seminars. Topics included the flow of funds, advanced econometric and computational methods, financial stability, and currency management. The Bank strives to promote a research culture in the Bank and a number of joint research projects have been completed under the auspices of the Visiting Research Fellows Programme. In October the Bank hosted its biennial conference with the theme “Challenges for Monetary Policy-makers in Emerging Markets”. The conference proceedings were published in book form and on the website of the Bank. The Bank has initiated work on an integrated workforce plan to ensure that Bank employees have appropriate skills. The plan will address the continuity of skills and ensure the effective transfer of the intellectual knowledge essential for the successful operations of the Bank. A number of the Bank’s branch buildings have been assigned heritage status, which creates challenges for cash-handling requirements, energy efficiency, environmental friendliness, the provision of uninterrupted power supply, fire-detection systems and access for people with disabilities, while preserving the integrity of the buildings. Most of the planned upgrades, additions or alterations to the branches have either been completed, have reached the construction stage or are near this stage pending the successful completion of the planning and tendering processes. The new Bloemfontein branch building is being designed. The existing fire-detection and evacuation communication systems at Head Office and in the Durban branch are being replaced to comply fully with health and safety regulations. Finally, the Bank has made considerable progress with the implementation of the new enterprise resource planning (ERP) solution, which is expected to enhance the efficiency of internal processes. The ERP will integrate the data and processes from various business units, and should offer numerous benefits to the Bank, including the introduction of proven best practices and the decommissioning of more than 20 legacy systems that have become difficult to maintain. The ERP should be fully implemented before the end of 2009. Conclusion Although the worst of the global downturn appears to be behind us, the recovery is expected to be slow and protracted. The domestic economy also appears set to recover somewhat in the coming months, and domestic inflation is expected to continue its moderating trend as a result of downward pressures from weak domestic demand and lower commodity prices. However, the rate of decline is being constrained by high and sustained administered price increases and wage settlements in excess of inflation. The Bank will continue to strive to achieve price stability within a flexible inflation-targeting framework in the interest of sustainable economic growth. The recent global financial market turmoil has highlighted the need for the Bank to maintain a commitment to financial stability. This includes the monitoring and supervision, where applicable, of the national payment system, the financial markets and the banking system. The domestic financial markets have come through the global banking crisis relatively unscathed. Nevertheless, credit impairments have been increasing, which poses a threat to the profitability of banks, and these trends will be monitored closely. Internally, the Bank will continue to concentrate on staff development, and to implement measures to retain staff and boost staff morale through more appropriate performance management. Emphasis will also be placed on enhancing the efficiency of the internal processes of the Bank and the introduction of the new ERP solution during the year is expected to contribute to this objective. Acknowledgements I wish to thank the Presidency, the Government and Parliament for their continued support. The good working relationship with the National Treasury was maintained, facilitated by the system of bilateral committees. I wish to thank the previous and current Ministers and Deputy Ministers of Finance for their support and co-operation during the past year, as well as the Director-General and staff in the National Treasury. I also wish to thank the Board of the Bank for the work they have done in ensuring appropriate corporate governance in, and the smooth running of, the Bank. Mr Daniel Mminele joined the Board of the Bank following his appointment as Deputy Governor. I wish to take this opportunity to congratulate him on his appointment. This is my last annual address to shareholders. I wish to thank the Presidency for the opportunity to serve the country as Governor of the South African Reserve Bank. It has been an honour and a privilege. I can look back on the past ten years with pride at the achievements of the Bank. In this respect, I wish to express my sincere appreciation to the deputy governors, the management and staff of the Bank for their professionalism, support and dedication in assisting to achieve the various objectives of the Bank during the past ten years. I also wish to congratulate Ms Gill Marcus on her appointment as my successor. Ms Marcus is no stranger to the Bank or to the financial sector, and I know that I will be leaving the Bank in extremely capable hands. I wish Ms Marcus, the deputy governors and the staff of the Bank all the best in facing future challenges.
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Remarks by Mr A D Mminele, Deputy Governor of the South African Reserve Bank, at the Citigroup Global Issues Seminar, Istanbul, 4 October 2009.
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A D Mminele: Recent economic developments in South Africa Remarks by Mr A D Mminele, Deputy Governor of the South African Reserve Bank, at the Citigroup Global Issues Seminar, Istanbul, 4 October 2009. * 1. * * Introduction Good afternoon ladies and gentlemen, and thank you to Citigroup Global Markets for providing the opportunity for us to interact and for me to share some thoughts with you on recent economic developments in South Africa. It has been just over two years since the dawn of the global financial crisis, and just more than 12 months since we all thought the end of the world was upon us when Lehman Brothers collapsed. Financial institutions have written-off more than USD1,5 trillion in losses, governments and central banks around the world have taken unprecedented actions in an attempt to restore stability to financial systems and to prevent the global recession from becoming entrenched. The International Monetary Fund (IMF), the Bank for International Settlements (BIS), and various other institutions have been working tirelessly on several fronts to help countries, closely tracking economic and financial developments, giving policy advice, putting together forums to deal with issues related to regulation and supervision and assisting emerging markets and low-income economies, some of which were innocently caught up in the crisis. Fortunately, in South Africa’s case, there was no need for any unconventional policy measures, and there was no need to focus directly on financial stability issues as the domestic banking and financial system has remained sound. Money market operations continued as normal, and the interbank market has not experienced any difficulties. In discussing recent developments in South Africa I will limit my remarks to real economic developments, recent monetary policy developments, balance of payments and will also very briefly touch on fiscal policy developments and the state of our banking system. I will be happy to respond to questions, as best as I can, pertaining to other areas that may be of particular interest to you. 2. Real economic developments Last year this time, I delivered a speech at an investor gathering much like this one. I noted at the time that South Africa had been relatively shielded from the direct effects of the subprime crisis. The challenges at that time were mainly around increased financial market volatility, heightened risk-aversion resulting in less portfolio inflows and higher costs for raising capital in international markets. However, it was apparent then already, that as an increasing number of developed and emerging economies moved into recession, South Africa, as a small and open economy, would not be able to avoid the spillover effects thereof. The only thing which was uncertain was the magnitude of the spillover. Indeed, domestic economic activity had already started to slow on account of tighter monetary policy applied between 2006 and 2008, resulting in slowing domestic demand. However, the real impact of the decline in global growth started to be felt in the fourth quarter of 2008, when for the first time in a decade, the domestic economy contracted. In the first quarter of 2009, the domestic economy officially entered into a recession and a third consecutive quarter of negative growth was recorded in the second quarter of this year. South Africa was somewhat lagging the rest of the world. Initially, the declines in economic activity were concentrated in the manufacturing sector, but as international conditions deteriorated, the slowdown filtered through to other sectors as well. The strongest contractions were recorded in the export-oriented sectors. Virtually all sub-sectors of the manufacturing industry were adversely affected and manufacturing output contracted by almost 20,0 per cent in the first half of 2009. Significantly reduced demand for basic metal and mineral products as well as lower international commodity prices weighed heavily on output in the mining sector, which contracted by almost 17,0 per cent. The performance of the mining sector in the first half of 2009 was not that significantly different to the first half of 2008, when it contracted by 11,0 per cent mainly as a result of power supply problems. The tertiary sector was weighed down by a contraction in output by the financial services sector, contracting for the first time since 1992, as credit extension slowed and capital market activity was subdued. Consequently, all three major sectors – primary, secondary and tertiary – recorded negative real growth in the first half of 2009. It came as no surprise then that the labour market shed jobs on a broad front, but most notably in the manufacturing, construction and mining sectors. Following a period of robust growth between 2004 and 2007, employment in both the private and public sectors increased, pushing the unemployment rate down from 28 per cent in 2004 to 21,9 per cent in the fourth quarter of 2008. In the second quarter of 2009, the unemployment rate unfortunately increased to 23,6 per cent. The Reuters consensus forecast estimates that the economy will contract by around 2,0 per cent in 2009, 1 before growing at 2,3 per cent in 2010. Based on the composite leading business indicator, which has been increasing for the last few months, we may emerge from the recession later this year. Like in other parts of the world, there is uncertainty as to the strength of the recovery we are going to see. 3. Monetary policy During 2008 the MPC was more concerned about the generalised nature of the inflation dynamics that were brought about primarily by the succession of supply side shocks. It was only in the latter part of the year that global developments began to have a significant impact on the economy. The contraction in output, and hence the widening output gap, combined with an easing in inflationary pressures, allowed for a change in the monetary policy stance. The MPC also decided to meet more frequently in order to assess the rapidly changing operating environment in a timeous manner and to be able to act appropriately when deemed necessary. Given the lag in the reaction of inflation to interest rate changes, and its focus on the medium to long-term expected inflation trajectory, the MPC decided to reduce the repurchase rate by 500 basis points between December 2008 and August 2009, despite the fact that inflation was still above the upper end of the inflation target range. At the most recent MPC meeting in September, the repo rate was left unchanged at 7,0 per cent. The MPC is of the view that the risks to the inflation outlook appear to be fairly evenly balanced, and with the current monetary policy stance, the most recent forecast indicates that inflation should return to within the target range on a sustained basis by the second quarter of 2010. Upside risks to this forecast are mainly high increases in administered prices, above-inflation increases in nominal unit labour costs, as well as to an extent oil price developments. On the other hand factors such as weak consumption expenditure, weakness in credit aggregates, and the relatively strong exchange rate of the rand will provide downside pressure on inflation. Reuters consensus forecast, August 2009 survey. 4. Balance of payments The contraction in real gross domestic product and the steep decline in the volume of merchandise imports in the first half of 2009 led to a turnaround in the deficit on the trade account in the second quarter of 2009. South Africa’s trade balance, which had registered deficits since the third quarter of 2005, consequently changed from a deficit of R53,4 billion in the first quarter of 2009 to a surplus of R26,6 billion in the second quarter. The contraction in domestic economic activity since the middle of 2008 has also had a positive impact on the deficit on the country’s services, income and current transfer account with the rest of the world. Owing to a combination of continued lower net income and other service-related payments to non-residents, the deficit on this account narrowed considerably. As a result, the negative balance on the current account of the balance of payments improved from 7,0 per cent of gross domestic product in the first quarter of 2009 to 3,2 per cent in the second quarter. This deficit was financed through a combination of direct and portfolio investment inflows. 5. Banking sector developments South African banks have been largely shielded against the direct effects of the global financial crisis. Apart from a sound regulatory framework, reasons were, among others, the fact that domestic banks had not invested heavily in high-risk securities or complex structured products and had very limited foreign credit exposure in their loan books. Not surprisingly, though, the banking sector’s operating environment deteriorated, as a result of the adverse economic developments both in South Africa and internationally. This was felt by banks mainly through continuously rising credit impairments. Impaired advances as a percentage of gross loans and advances increased to 5,5 per cent at the end of June 2009 from 2,3 per cent in January 2008. Nevertheless, the weaker asset quality of banks at this stage is not a source of major concern. Banks have maintained high capital levels, with the capital-adequacy ratio for the banking sector amounting to over 13,7 per cent in June 2009, and continued to be profitable, albeit at a lower level. 6. Fiscal policy As a member of the G20 and in support of the commitments made to address the impact of the financial crisis, South Africa’s fiscal and monetary authorities have, like in many other countries, implemented counter-cyclical policies. The prudent management of the public finances during periods of robust growth has created the necessary space for fiscal policy to be expansionary during periods of slower growth. The expansionary fiscal policy, combined with monetary policy easing, should play a strong role in supporting both short and long-term economic growth and employment creation. In addition continued investment in a broad range of infrastructure should contribute to improving the productive capacity of the economy. The central bank is not overly concerned at this point in time about the impact of expansionary fiscal policy on inflation, as it is suitable given current conditions. 7. Outlook It would appear that the actions taken collectively and individually in global markets have borne fruit. A number of economies have since moved out of recession and forecasts from the IMF and OECD are looking more encouraging than just a few months ago. How permanent this improvement is, however, remains to be seen. Caution is warranted, nonetheless, as temporary monetary and fiscal stimulus measures may be providing a false sense of security. As for South Africa, although growth continued to contract in the second quarter of this year, the pace of contraction slowed from -6,4 per cent in the first quarter to -3,1 per cent in the second quarter. The manufacturing sector appears to be turning the corner; the Purchasing Manager’s Index seems to be steadily climbing back towards the 50 threshold. Businesses and consumers are also more optimistic as reflected by the confidence indices. The composite leading indicator of the South African Reserve Bank has been increasing during the last three, indicating that a recovery can be expected by the end of the year. 8. Conclusion In conclusion, there are encouraging signs that the global slowdown may have reached its lower turning point. There remains a high degree of uncertainty attached to the speed and extent of the recovery, however, the swift manner in which authorities reacted have certainly borne fruit. Developments in the South African economy are very much influenced by global economic developments. While we lagged on the way down, it is likely that we will lag on the way up. Taking cognisance of the global financial and economic environment, and domestic developments with regard to growth, monetary policy will remain primarily focused on inflation management. Thank you.
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Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 12th Kgosi Edward Patrick Lebone Molotlegi (EPL) Annual Memorial Lecture, Phokeng, 10 October 2009.
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T T Mboweni: Not there yet – charting a future for Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 12th Kgosi Edward Patrick Lebone Molotlegi (EPL) Annual Memorial Lecture, Phokeng, 10 October 2009. * * * Introduction I thank Mmemogolo Semane Molotlegi for inviting me to deliver this, the 12th annual lecture in memory of the late Kgosi Edward Patrick Lebone Molotlegi. This event has become one of the most celebrated days in the calendar of the Bafokeng, African people and all those who truly treasure Africa’s development from wherever they come. I am truly honoured to be here today. It is always difficult to meet the challenge of delivering lectures such as this, particularly when talking about someone among his own people, who know him much better than one can ever claim. I am aware that a lot has been written about the history of the Bafokeng, and I am not going to repeat that. I am also equally aware that you cherish the legacy of Kgosi Edward Patrick Lebone Molotlegi through the many truly impressive programmes which attempt to deal with the challenges that the Bafokeng face today. I want to acknowledge that the founders of this community had prescience and foresight that ought to be emulated by many African peoples. The thought of acquiring land for themselves in the 19th century with the attendant legal title to it, owning the resources beneath the soil, ranks the founders of the Bafokeng pretty high in any leadership group. This at a time when the world had not taken notice of the precious metal, platinum, in general and the platinum group of metals in particular. In the recent past the Bafokeng have steadily begun to reap some benefits from these resources, thanks to the founding fathers of the Bafokeng community. Over the years the Bafokeng have been blessed with many good and outstanding leaders who have successfully kept the community together, but also left no stone unturned in protecting that which is their heritage. Today we are meeting in honour of one of these giants of our society, His Majesty Kgosi Edward Patrick Lebone Molotlegi. We all know about his running battles with the past oppressive regimes and their stooges, who wanted to denude this community of its heritage. Kgosi chose to defend his people, an act that invited the wrath of the then regime, who detained and harassed him and his family until he went to seek refuge amongst the Batswana in Botswana. With the advent of democracy in South Africa, however, he returned and continued to lead his people until his passing on in 1995. Unfortunately, Kgosi Mokgwaro George Molotlegi left us too soon thereafter. Kgosi Leruo stepped forward and here he is, continuing the work of his forebears. The day you were enthroned was a most unforgettable one. We are all too aware that Kgosi Leruo has a challenging task before him but he has already demonstrated that he has the requisite leadership capability. And as we remember Kgosi Edward Patrick Lebone Molotlegi, we lower our banner also in remembrance of my dear brothers Moholwane and Fosi. In the midst of a global recession As we meet here today, we are all too mindful of the fact that we are in the midst of one of the most severe economic recessions since the 1930s. We all know the trigger point of the crisis, being the US sub-prime housing market and its subsequent spread through the banking sector and financial markets. The collateral damage has been of unimaginable proportions. Today, the US investment banking model is all but a thing of the past, more regulations for banks are on the way (bankers are not trusted anymore!) and many reputations have been damaged. The global economic recovery The financial crisis that started in 2007 has developed into the deepest economic recession since the Second World War. Most developed economies started to contract from mid-2008, and the International Monetary Fund’s (IMF) latest published projections indicate that, as a group, they would contract by 3,4 per cent in 2009. Individually, some countries face even worse scenarios: Japan is expected to contract by 5,4 per cent, and Germany by 5,3 per cent in 2009. It was impossible for emerging-market and developing countries to escape the effects of such severe contractions in the advanced economies, and they soon experienced the spillover effects of lower commodity prices and lacklustre demand for their exports. Nevertheless, as a group, they are faring significantly better, with growth expected to be 1,7 per cent in 2009. In particular, China and India managed to maintain some growth momentum, providing a much needed cushion for the global economy There are now some signs of stabilisation in the developed economies and there is a general expectation that the worst of the recession is over, although the recovery is not by any means expected to be fast and smooth. It would appear that the world-wide co-coordinated policy response has borne fruits. The significant reduction in interest rates coupled with the huge injection of fiscal stimuli which is currently estimated to be in the region of 2 per cent of world gross domestic product in the past year, has proven to be vital in stimulating the recovery in many countries. The most recent (August 2009) OECD composite leading indicators (CLIs) point to recovery in all the major economies. Projections released by the IMF last week indicate that world growth is expected to average -1,1 per cent in 2009 as compared to -1,4 per cent envisaged in July 2009. Of interest is that the world economy is expected to grow at an estimated 3,1 per cent in 2010. This represents a 0,6 percentage point upward revision to the forecasts released three months ago. It is encouraging to note that much of this growth is being underpinned by the emerging and developing countries which are expected to grow at 5,1 per cent in 2010 compared with 4 and 7 per cent projected in July 2009. The HSBC Emerging Markets Index (EMI) released recently, which is meant to reflect economic conditions and prospects in developing countries, provides additional support to the view that emerging markets will lead the global economic recovery. Most emerging markets have recorded a strong economic performance in the third quarter of 2009 and leading indicators point to further improvements ahead. Financial markets conditions have improved somewhat in many countries as is evident from the stock market rallies and recent rise in commodity prices. In general, sentiment within financial markets seems to have rebounded. The support provided by central banks in the credit markets has played a significant role in the current recovery process. But it is not time to celebrate. Global inflation is expected to remain relatively subdued in the foreseeable future. Projections by the IMF show world inflation moderating from 6,0 per cent in 2008 to 2,5 per cent in 2009, before accelerating marginally to 2,9 per cent in 2010. Inflation in the advanced economies is projected around zero per cent in 2009, whilst in emerging-market economies as group inflation is expected to be around 5,5 per cent. The moderate global inflationary pressures are essentially due to the widening negative output gaps in many economies. Some concerns While there are signs that the global economic recovery is well underway, there are still numerous challenges ahead. Firstly, the pace of recovery is likely to be slow, protracted and uneven across countries. The recovery in the advanced economies is expected to be slower than in the emerging-market economies. Advanced economies are expected to grow by an average 1,3 per cent next year as compared to the projected 5,1 per cent growth rate for developing and emerging economies. This may have implications for our domestic recovery to the extent that our export sectors are dependent on the performance of the industrialised economies. Fortunately our trade with emerging markets, particularly with China, has been expanding in recent years, and the recovery in Asia could encourage exports to that region. Banking sector concerns still persist in some countries which could hinder the pace of recovery in these countries. There is little doubt about the need for structural reforms at both the international and national levels. While consensus has been reached at an international level on how to reform and strengthen financial markets, the measures to be adopted and structural reforms to be implemented at the national level will be more challenging. Then there is the issue of the timing of the appropriate exit strategies from the current policy stance. Monetary and fiscal stimuli will have to be withdrawn at some stage in such a way as not to undermine the current recovery. The lessons of the 1930s appear to have been learnt; namely, that if the stimuli is withdrawn too quickly, the process of recovery is undermined. However, fiscal deficits cannot be expanded indefinitely and will have to be reversed, while excessive monetary policy accommodation may not only became inflationary down the line, but may in fact sow the seeds of the next asset price bubble. So a fine balance has to be found between the recovery and its sustainability. The slow response of consumer expenditure coupled with subdued developments in labour market conditions will be of particular concern to policymakers. In the advanced economies in particular, the declines in property and stock market prices have had significant negative wealth effects. Traditionally the US consumer is the main driver of growth in that country, but the rebuilding of household balance sheets could take some time and constrain the recovery in expenditure. While much of the current recovery is being induced by an inventory cycle, if the new production is not consumed, the recovery could be reversed. The bottom line is that, while the downturn appears to have bottomed out, the strength of the recovery will remain uneven and uncertain across countries. As we reflect on these developments, many questions still require answering from policymakers and society in general. How do we prevent the emergence of another severe recession? How do we as African countries learn the lessons from this recession? One thing for certain is that there have been significant outflows of capital to the developed countries. Many banking facilities have been undermined. Again this poses the question about what the structural ownership of banks in our economies should be in the future. Although we all rejoice when one or the other bank in our economies is owned by non-resident shareholders, the question arises as to the sustainability of such a model? Let me not be misunderstood: we need foreign direct investment in the same way as we want our own banks and other companies to invest abroad. This is a globalised world and cross border investment flows are part of that. But still, the questions remain. These and other questions would have been asked by Kgosi Edward Patrick Lebone Molotlegi. A finite resource This area, like the rest of the region, depends heavily on mining the platinum group of metals as a major economic activity. We all know that all minerals are a finite resource – there are limited reserves and we, therefore, have to ensure that we bequeath wealth unto the future generations of Bafokeng. If anything, the global slowdown experienced earlier in the demand for metals, indicates that we, like the leadership here has noticed, cannot depend solely on these resources. This point is best illustrated by the fact that South Africa was once a global leader in gold mining and gold constituted well over fifty percent of South African exports, well that is no longer the case. South Africa has been overtaken by China as the world’s number one gold producer. This is largely due to gold reserves in this country being depleted and what little is left getting more and more difficult to extract as mining becomes a deeper and deeper activity and, therefore, too costly and a high risk effort. It is today a misnomer to speak of Johannesburg as the city of gold as there is no more gold mining in the city other than the reprocessing of those mine dumps. Gauteng and eGoli only bring fond memories of goldmining in and around Johannesburg. The challenge that we face, and I know it is being confronted head-on here, is that one day our mineral resources will be depleted and we have to depend on other economic activities. South Africa's Diamond Coast illustrates the point further. Globally, according to forecasts, known diamond reserves are expected to run out in 30 years. As the precious gem runs out, previously vibrant towns in Namaqualand are becoming ghost towns – schools, houses and clinics stand mostly deserted. It is reported that, since 2007, the De Beers mining company has drastically reduced its operations at its Namaqualand mines, reducing staff from about 3000 to 250. 1 This is a major blow to that region and provides enough proof that what the leadership of Bafokeng have identified for a diversified economy is appropriate and will stand us in good stead in the future. A matter that is closely associated with mining is the challenge of substitution. As prices of commodities continue to increase, the consumers of these commodities always attempt to look for cheaper substitutes. In the early 70’s, as most of us are no doubt aware, copper mines in Zambia, which were the main source of income and also the largest providers of employment, were forced to scale down their operations as the price of copper plummeted and consumers joined the rush to find substitutes. The consequences for the Zambian economy were terrible, to say the least. Although the demand for copper worldwide is still high, attempts to find substitutes have increased over the years. In the recent past, prices of all commodities have hit historically high levels. Just to remind all of us, the price of the North Sea Brent crude oil peaked at US$145, 66 per barrel on 3 July 2008 and some analysts were calling for the price to reach US$200. The price of gold also increased to US$1050 per fine ounce on 8 October 2009. Finally, the price of platinum increased to US$2308 on 4 March 2008 before declining to the current levels of around US$1332. At this elevated price of platinum, global car manufacturers started looking for substitutes to use in the manufacture of catalytic converters. There was talk that some manufacturers were at an advanced stage in developing a substitute for platinum in the manufacture of these catalytic converters. Earlier talk was that the most probable substitute was palladium which, at least, is part of the platinum group of metals. In pointing out these challenges a suggestion is not being made that we should cease all the mining production. The point being made here is that while platinum might be the most significant source of revenue for this community today; this will demand of us to re-double our diversification efforts within the context of a well defined and strategic plan. And that is exactly what is been done in this community. SA’s diamond devastated.htm. towns devastated - http://www.miningmx.com/news/diamonds/SA's-diamond-towns- Diversification is fundamental I am most certainly impressed by the forward thinking that obtains in this community. Your diversification programme will most certainly guarantee sustenance beyond the availability of mineral resources and is testimony to the quality of leadership that is to be found here. It is indeed laudable that the Bafokeng have recognised this need, as shown in the portfolio of investments that includes telecommunications, financial assets, manufacturing, services and cultural development programmes. And if there is one thing I know about the Bafokeng that is their ability to implement. That capability is found wanting in many countries on our continent and also in parts of our own spheres of government. One marvels daily at countries that do not have the benefit of mineral resources like us, but have done wonders for themselves. Take a city- state like Singapore which does not have any mineral resources, let alone enough land for agriculture, but has managed to develop to such impressive levels (a high income status). Opening a Human Capital Summit recently, the Prime Minister of Singapore, Mr Lee Hsien Loong, said: “For a small country like Singapore, acquiring and nurturing human talent is a matter of survival. Without much of anything else, we rely on human ingenuity and effort to build our economy and society. We have therefore made major investments in education, lifelong learning and talent development.” 2 In fact, the major manufacturing centres of Asia, such as Japan, Singapore, and Hong Kong, have few or no significant natural resources. South Korea, for example, was at almost the same level of development as Ghana 50 years ago. While the latter is well endowed with natural resources and has recently discovered oil, South Korea has none of these but has successfully grown its economy to be ranked 14th by GDP at purchasing power parity. There are possible and practical responses. The question then arises, why Africa is not using its mineral and other resources to the benefit of its people? There is the possibility of (the tired subject of) beneficiation which has really not been pursued much in Africa. We seem, as Africans, to have been satisfied to continue as “extractive economies”. I gather that platinum jewellery is very much in demand in certain parts of the market. I am quite certain that the leadership of this community has already considered and explored this possibility for beneficiation as this might make a significant contribution to the economic and social development of Phokeng and Rustenburg. We have the opportunity through existing bursary and scholarship programmes to send some of our young people to study and understand all the technical issues around jewellery manufacturing. Another challenge is the manufacture of catalytic converters. South Africa has a welldeveloped car manufacturing capability with car plants in East London, Port Elizabeth, Durban and nearby Pretoria in Rosslyn and Silverton. It would seem that opportunities abound in the manufacture of catalytic converters. As the community explores many of the new frontiers of economic development, there will be many agenda items such as the challenge that might be posed by considering tasks such as these. One thing is for certain, there will always be many cars on the road which have catalytic converters! Growing human capital and developing leadership are crucial. Endowment with natural resources should spur even larger investment in expanding the talent pool. It is gratifying, therefore, to acknowledge that the Royal Bafokeng Holdings, the entity responsible for the management and development of the commercial assets of the Royal Bafokeng community, has the following focus areas: health, education, entrepreneurship development, social development and sports development. Speech by Mr Lee Hsien Loong, Prime Minister, at the Singapore Human Capital Summit opening, 29 September 2009, Raffles city Convention Centre. Embracing modernity In today’s globalised world all countries and communities are faced with the challenge of embracing change, new technologies and communications systems. Some might try to resist change by keeping old traditions and continuing to do things in the same old way with the danger of being left behind and thus condemning their future generations to “poverty, backwardness, ignorance and disease”. Today, we know that many great nations have made a deliberate choice to learn from others for survival. This quest to learn from others continues. It is fairly easy to obtain a green card in the United States of America if one has the skills that they need and which are in short supply globally. In sport this is so common to a point of nationhood being made a joke. All you have to ask is how many Brazilian soccer players have been naturalised to play for national teams outside Brazil. South Africa has also exported many cricket and rugby players to many countries. Despite the danger of overuse of non-citizens, all nations can benefit by learning from others. Xenophobia is a backward tendency. In the speech by the Prime Minister of Singapore cited above, he refers to the Chinese example: “For example, last year China launched the “One Thousand Talents Scheme” to attract top global research talent to base them in China. Major Chinese cities such as Shanghai and Shenzhen have also launched their own schemes to bring in professionals from other parts of the world. If a country like China, with a population of approximately 1, 3 billion people and the largest number of PhD candidates in the world, still needs to draw in overseas talent, the rest of us must have an even stronger imperative to do so.” 3 The challenge of nationhood and embracing modernity and learning from others is well captured by Thomas Friedman in his famous book “The Lexus and the olive tree” 4 . In 1992 he was on an assignment as a journalist to Japan and visited the Lexus factory which was the most memorable in his life. At that time, the factory was producing 300 luxurious sedan cars each day, made by 66 human beings and 310 robots. Humans were there mostly for quality control and robots were doing all the work. In Beirut and Jerusalem, where he had lived for many years, people whom he knew very well were fighting over who owned which olive tree. He goes on to assert that olive trees are important as they represent everything that roots them, anchors them, identifies them and locates them in the world. Olive trees give them warmth and all that is associated with human security. But the human race at times fights over the olive tree. The symbolism in this Lexus and the olive tree brings out the challenge, on one hand, of either having intentions to build a Lexus, which represents “sustenance, improvement, prosperity and dedication to modernisation” and all that goes with it, for example, embracing innovation and sending human beings to the moon. On the other hand we may be preoccupied with the fight over who owns the olive tree. Conclusion Kgosi Leruo, I accepted the invite to speak at this gathering with the aim of posing the day to day questions which might have some bearing on Africa’s development. Kgosi Leruo, working together with his collective, has already gone a long way towards dealing with these challenges in this small but well-known community. He has demonstrated quality leadership and, therefore, no-one is better placed to protect the legacy of all the previous leaders of Bafokeng than him. Let all those who appreciate the efforts of genuine African leadership support the challenging task of protecting the memory and legacy of Kgosi Edward Patrick Lebone. Ibid. Thomas Friedman, 2000, The Lexus and the Olive tree, Harper Collins Publishers. You lead a people whose earlier leaders had foresight while others were pre-occupied with fighting over the ownership of the olive tree. They were modern in thinking when they sent those men to work in the diamond mines in Kimberley and used their earnings to acquire this prosperous land. This task, keeping the memory of the past leadership of this community alive, is our burden. This can be done by looking beyond the present and chart a future for all our people, this community and beyond. Perhaps you may build a Lexus in Phokeng. Thank you very much. Kea leboga!
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Address by Mr A D Mminele, Deputy Governor of the South African Reserve Bank, at the "Spire Awards" Ceremony, Johannesburg Stock Exchange, Johannesburg, 3 November 2009.
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A D Mminele: South Africa amidst the crisis Address by Mr A D Mminele, Deputy Governor of the South African Reserve Bank, at the “Spire Awards” Ceremony, Johannesburg Stock Exchange, Johannesburg, 3 November 2009. * 1. * * Introduction Good evening distinguished guests, nominees for the 2009 Spire Awards, Sponsors of the Awards, ladies and gentlemen It is an honour to be invited to speak at this prestigious event, which is held in recognition and celebration of excellence in South Africa’s fixed income market. The Spire Awards have become a key event in the South African financial markets calendar. BESA has undergone numerous changes over the past two years, having successfully completed its demutualisation and recapitalisation at the time of the 2008 Spire Awards and now, just more than a year later, has become a wholly owned subsidiary of the Johannesburg Stock Exchange (JSE). BESA should be congratulated for the role it played in the development of South Africa’s bond market. In the more than 10 years of its existence, BESA played a prominent role in advancing South Africa to its position as one of the most liquid and developed amongst global bond markets, and a leader in emerging markets. This fact is clearly illustrated by the significant rise in turnover in recent years, from R9, 5 trillion in 1998 to R19, 1 trillion in 2008. The World Federation of Exchanges places BESA as the fourth largest exchange in terms of turnover recorded for bond trades in 2008. We wish BESA well in the new partnership with the JSE, which will benefit the interest rate and derivatives market in South Africa and contribute towards the further development of our financial markets. Allow me to take this opportunity to convey my appreciation for the manner in which the JSE has kept the markets and relevant stakeholders informed about the integration process. 2. Importance of a well developed bond market I need not tell you that the central bank takes a keen interest in the fixed income market, having played a key role in the development and expansion thereof prior to 1998. The bond market plays a vital role in the achievement of both monetary and financial stability. A well functioning bond market should improve the transmission mechanism of monetary policy, allow the central bank to infer inflation and interest rate expectations of market participants, and contribute to the promotion of economic growth, by facilitating more efficient pricing of borrowing and lending. Without a well-developed local currency debt market, balance sheet vulnerabilities could emerge, the risk of default would increase, there would be a concentration of credit and maturity risks in the banking system, and vulnerabilities from capital inflows and limited macroeconomic policy instruments would increase. The ability to cope with financial distress would be diminished. 1 Because of our well-developed local currency bond market, the Government has over the years been able to meet its funding requirements mainly in the domestic market, and this has indeed been one of the reasons why South Africa fared rather well in the global financial crisis. For many emerging markets, the further development of local currency debt markets has become a priority. CGFS Papers no.28, Financial stability and local currency bond markets, June 2007. It is also for these reasons that the Committee of Central Bank Governors in SADC (CCBG) approved the creation of a financial markets subcommittee during 2008. This committee was established precisely because of the recognition that robust, well diversified and liquid financial markets are critical to the implementation of monetary policy, for maintenance of financial stability, and that they can contribute towards increased economic activity throughout the region. Under the auspices of this committee, central banks have agreed to co-operate in developing and strengthening their national financial markets with the intention of creating a regional financial market as part of the initiatives towards the implementation of the SADC Finance and Investment Protocol (FIP). I am aware that the JSE, as part of the Committee of Stock Exchanges in SADC (CoSSE) is already in conversation with this subcommittee to advance the development of bond markets in the region. 3. Conundrum or catastrophe? As we have witnessed in recent times, even in well-functioning, deep and liquid bond markets, inefficiencies and market failures can still occur. It was not too long ago that the world was perplexed by the so-called “Greenspan conundrum”, where there appeared to be a decoupling of monetary policy from long-term interest rates. The increase in the US policy rate from 1 per cent in 2004 to 5, 25 per cent in 2006 had little or no impact on long-term US Treasury yields, ultimately resulting in low and stable long-term mortgage rates. This phenomenon raised concerns that a possible housing bubble was brewing in the US, concerns which were not unfounded. There were many explanations put forward for this conundrum, from the immense credibility the Fed had gained in keeping inflation and inflation expectations low, to Fed Chairman Bernanke’s “global savings glut”. Whatever the reason, it was not long before the Greenspan conundrum turned into a disaster. Risks of the housing bubble bursting indeed materialised and the rest of the story you all know very well. Needless to say, the conundrum that existed is no longer. As central bankers began to ease monetary policy, investors began to worry about inflation, boosting long-term interest rates and in the process mitigating the action that policymakers thought was necessary. Unconventional forms of expansionary monetary policy were instituted, for fear that long-term interest rates would not remain low and therefore would dull any possible improvement in economic activity. The combined impact of quantitative and credit easing on central bank balance sheets has been extremely large. 4. The rise of emerging economies It is said that the crisis did not derail but rather accelerated the rise of emerging economies. 2 It is now just more than two years since the onset of the sub-prime crisis and it appears that the global economy is finally emerging from recession, even if significant risks remain. The IMF’s latest World Economic Outlook shows improved prospects for global growth in 2009 and 2010 compared to previous forecasts, with a strong performance by Asian economies supporting the global recovery. Emerging markets, accounting for one third of global output, play an increasingly important part, and it is for this reason that the G20 has assumed a leading role as a forum for global co-ordination. After losing approximately 60 per cent of value since the collapse of Lehman Brothers until the low point reached in March 2009, the Morgan Stanley Capital International Index (MSCI) gained more that the 60 per cent until the end of October, led by an almost 90 per cent improvement in the MSCI for emerging markets. The EMBI plus yield had increased Antoine van Agtmael, FT.com. by almost 600 basis points between January 2007 and October 2008, and has since declined by a similar magnitude. Emerging market currencies have also appreciated significantly, the rand being no exception. A currency remaining at non-competitive levels for too long might have adverse consequences for the real economy. Some countries opted to deal with currencies perceived to be too strong through a combination of verbal and actual market intervention. Brazil, in addition to previous measures, also recently imposed a 2 per cent tax on capital inflows into both equity and bond markets to contain short-term capital flows and to reduce any further upward pressure on the currency. The appreciation in emerging market currencies, including the rand, has been mostly driven by external factors, such as increased global liquidity, the depreciation of the USD and renewed investor-appetite for more risky assets. Domestic factors, such as relatively strong macroeconomic fundamentals and wider interest rate differentials, have also played a role. These gains, unfortunately, increase the likelihood of an uneven economic recovery. Whilst the monetary and fiscal authorities in South Africa have at times expressed concern about the impact of the appreciated currency on the overall macroeconomic balance, SARB policy remains that of no intervention in the foreign exchange market with the objective of managing the currency. The floating exchange rate regime helped to cushion South Africa from more severe effects of the global crisis. The Bank will, within the broader context of policy coordination with the National Treasury, continue with its strategy of accumulating foreign exchange reserves when market conditions are conducive. Over the past year, reserves accumulation was constrained by the volatility in the foreign-exchange markets, the level of global risk aversion and cost considerations. More recently, conditions in the foreign exchange markets have been somewhat more favourable, allowing the Bank to increase its purchases of foreign exchange in a responsible manner. 5. South Africa amidst the crisis As we are all aware, South Africa was not immune to the global crisis, the domestic economy contracted for three consecutive quarters. The monetary policy tightening cycle which commenced in June 2006 came to an end in June 2008. The MPC was initially more concerned about the impact of multiple supply shocks on inflation. It was only later that global developments began to have a significant impact on the economy. Keeping in mind that the MPC’s focus is on the medium to long-term expected inflation trajectory, and that there is a lag in the reaction of inflation to interest rate changes, the significant widening in the output gap and inflation continuing its downward trend after peaking at 13, 6 per cent in August 2008, allowed for the MPC to reduce the repurchase rate by 500 basis points between December 2008 and August 2009. The contraction in economic activity and the change in the monetary policy stance impacted the domestic bond market in two ways. Firstly, while monetary policy easing exerted some downward pressure on bond yields, this was counteracted by increased supply of government bonds. Given the rapidly slowing economy, revenue intake was substantially lower than projected, causing an increase in the budget deficit. Increased risk aversion also resulted in non-residents reducing their exposure to the domestic bond market. Amid the economic conditions described above, the benchmark yield curve inverted. The dynamics in the bond market changed significantly over the past year. Whereas in previous years, strong economic growth and revenue collections resulted in government being net redeemers of bonds, since the end of 2008, activity in the primary bond market has been driven primarily by the public sector, Government and state owned enterprises. For the first nine months of 2009, the public sector issued a net R74, 5 billion, compared with net issuance of R800 million in the same period last year. The Medium Term Budget Policy Statement indicates that for 2009/10, revenue collections will be R82 billion lower than projected in the February Budget, resulting in the projected budget deficit for 2009/10 increasing from 3,4 per cent of GDP to 7,6 per cent. Notwithstanding the turmoil in global financial markets and conditions in the domestic economy, bond listings on BESA grew in 2008, albeit at a slower pace. While on the one hand, the bulk of growth was attributed to the increased issuance of commercial paper by corporates as well as increased issuance by state owned enterprises, on the other hand, growth in listings was dampened by contractions in the securitisation and “other” corporate categories. Similarly, conduit sizes have almost halved, driven by negative perceptions towards asset back commercial paper following the sub-prime crisis and the slowdown in economic growth. As for corporate listings in general, these were held back by the slowdown in domestic economic activity which forced many corporates to scale down activities. There are, however, indications that appetite for credit in the South African market is returning, judging from the strong senior bank bond issuance in the third quarter. South Africa has fared rather well throughout the crisis in comparison to some other emerging and developed economies. 6. Conclusion In conclusion: While there continues to be much uncertainty regarding the strength and sustainability of the recovery, increasingly central banks are beginning to ponder exit strategies. The quantitative easing employed by central banks, the fiscal stimulus packages and record increase in government debt issuance has created concerns about exit strategies of central banks and their impact. The question is whether central banks will be able to exit from these unconventional policies in such a manner that the nascent economic recovery is not jeopardized, while also ensuring that the timing is correct such that inflationary pressures do not build. Central banks face important challenges in several areas, such as determining the timing and extent of reversing policy easing, coordinating with fiscal authorities and other central banks, and communicating their strategies to the public. A disciplined analysis of the data will test the science of central banking, whereas a good assessment of the operating environment and judgement will put the spotlight on the art of central banking. Finally, I would like to congratulate all the nominees for this year’s Spire Awards. Whether you or your team walk away with a prize or not, the fact that you were nominated is indeed already a great recognition by your clients and your peers for the contribution you have made to the South African bond market. I thank you all for your attention.
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Rand Merchant Bank Fixed Income Seminar, Cape Town, 28 January 2010.
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Daniel Mminele: A perspective on South African monetary policy Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Rand Merchant Bank Fixed Income Seminar, Cape Town, 28 January 2010. * 1. * * Introduction Good afternoon ladies and gentlemen. Thank you to Rand Merchant Bank for the invitation to participate in this fixed income seminar. The global crisis has certainly changed the way many people think about things and has changed the manner in which the world operates. It has also taught us that a lot of people actually know far less about how the economy works than they would like others to believe, the implication being that it is particularly when things are going well that we should be asking ourselves “why”, and not assuring ourselves that it has been good judgement only 1. Since the emergence of the global financial and economic crisis, the interest in the role of central banks and their work has risen to an unprecedented level. As you are aware that interest has also been accompanied by a much higher level of scrutiny. South Africa has not been an exception and indeed the debate is continuing. My speech today will initially briefly touch on recent monetary policy responses to the global crisis. I will then provide a perspective on the mandate of the South African Reserve Bank, our monetary policy framework and its implementation in recent times, and conclude by making some remarks on the exchange rate within that context, as this is a topic which has also received much attention recently. 2. Monetary policy responses to the global crisis The global financial crisis that started in 2007 and the ensuing deterioration in world economic growth necessitated drastic adjustments to fiscal and monetary policy in developed and emerging market economies in order to support economies and to ease credit market conditions. The origins of the crisis, its widespread nature and the extent of the financial market turbulence and the spill-over effects to other sectors of the economy prompted central banks to review their monetary policy implementation frameworks and to implement policies that, only a few years back, were not on their radar screens, and certainly outside the “comfort zone” of many. Central banks responded with both conventional and unconventional monetary policies to the global financial crisis. During the early stages of the crisis, central banks adjusted their normal refinancing facilities, for example, they lengthened the maturity of their money market operations and extended the universe of securities they were prepared to accept as collateral for borrowing from the central bank. During this period several initiatives were announced by central banks acting both individually and in concert (e.g. US dollar swap lines between the Fed and various other central banks). This was followed by the introduction of unconventional monetary policy strategies, including various forms of quantitative easing. These unconventional monetary policies, sometimes called balance sheet policies, involved central banks using their balance sheets to influence broader economic and/or financial conditions during the crisis, particularly when the zero bound for policy rates was reached. William White, BIS. These policies were also used to provide liquidity to dysfunctional interbank and credit markets and to prevent the fire sale dumping of assets in order to contain the realisation of excessive losses by banks and investment funds. During the crisis balance sheet policies were employed to target term money-market rates, long-term government bond yields and various risk spreads. In contrast to interest rate policy, balance sheet polices generally result in substantial changes in the central bank balance sheet – in terms of size, structure and risk profile. This stems from the fact that central banks targeted market segments that fell outside the traditional ambit of monetary policy, and that went well beyond the market for bank reserves, which is more familiar territory for central banks, and over which they tend to have more control. Generally, these interventions did not inject large amounts of liquidity on a net basis, and the increase in bank reserves has not as yet translated into a generalised increase in broad money supply. The balance sheets of commercial banks have contracted, but as financial market conditions normalise and economies recover, private sector credit extension and money supply is likely to accelerate, and with that inflationary pressures may start to build as output gaps narrow. Central banks will have to ensure that exit strategies to reverse quantitative easing do not constrain interest rate policy, and are well timed and carefully sequenced. This unwinding of central bank risks could undoubtedly have far-reaching consequences for debt markets and needs to be well co-ordinated with national governments in order to prevent their operational independence and anti-inflation credentials from coming under threat in the longer term. While there are clear signs of a modest recovery in the global economy, the challenges for policy makers have not abated. In addition to the reversal of balance sheet policies, policy makers still have to ensure that: the economic recovery becomes sustainable; that national budget deficits revert to levels that could be justified in terms of financial stability and sustainable economic growth; that global imbalances are addressed; that appropriate financial sector reform is implemented and that inflationary pressures are well contained. We can only hope that the recovery process will not encourage complacency with regard to the significant amount of repair work that still needs to be done, because the idea is not simply to return to where we came from, but to effect changes that will ensure that next time we will be at least better prepared and be in a position to limit the damage and its costs. Difficult as the process is, the work under way in different fora pertaining to the reform of the international financial architecture and enhancing regulatory and supervisory standards needs to continue, and we cannot afford to lose the sense of urgency. 3. Inflation targeting in South Africa During the global crisis, South Africa was in the fortunate position, where it did not have to consider responding to the economic slowdown with unconventional monetary policy. However, before I look at more recent monetary policy developments in South Africa, I thought that it may be useful to touch briefly on the Bank’s mandate. As is the case in many parts of the world, the role and responsibilities of the South African central bank and the appropriate focus of its work has come into much sharper focus. Section 224 (1) of the South African constitution, from which the Bank gets its mandate, describes the primary objective of the South African Reserve Bank as being “to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic”. Therefore price stability is core to the mandate of the Bank. However, it is clear that price stability is not an end in itself, but in the interest of balanced and sustainable growth. It follows then that, as far as the constitutional mandate is concerned, both economic growth and by implication employment, need to be taken into account when making decisions on monetary policy. To give effect to these constitutional imperatives, the Bank has been mandated by government to maintain low inflation within an inflation targeting framework. This framework is a means to achieve the objective. It is not an end in itself. We note the current debates around the appropriateness of our mandate and questions about how that mandate is executed. The SARB has indicated its willingness to openly engage various stakeholders to both explain its approach and to explore with them any ideas they may bring forward. Governor Marcus has identified improved communication and stakeholder engagement as a priority, and has underlined this by creating dedicated capacity in her office for stakeholder engagement and outreach. Inflation-targeting was introduced by several countries in the 1990s under relatively benign conditions with generally favourable outcomes. The financial crisis has sorely tested this framework. However, the goal of maintaining low-inflation is inescapable as the alternative of high inflation is unsustainable. The distinction between countries that officially target inflation and the non-targeters is blurred. Irrespective, monetary policy must achieve low inflation, which will provide a stable environment conducive to long-term growth. Inflation targeting was introduced in South Africa in 2000, with a clear and concise mandate. The democratically elected government sets the monetary policy goal in the form of a pre-announced numerical target, while this goal establishes a benchmark for accountability. The attainment of this goal is the responsibility of the Reserve Bank. In this regard the constitution is again very clear and indicates that the South African Reserve Bank “…must perform its functions independently and without fear, favour or prejudice…” and makes provision for regular consultation between the Bank and the Cabinet Minister responsible for national financial matters. This framework helps to anchor inflation expectations and is transparent. It requires forward-looking policy-decision making based on expected inflation and allows for flexibility to respond to shocks not offered by strict monetary rules and fixed exchange rates. Inflation targeting in effect tries to strike a balance between the application of inflexible policy rules and potentially undisciplined monetary policy discretion, and has been aptly referred to by Bernanke (2003) as a framework of constrained discretion. In abiding by these principles, the Bank has the latitude that inflation can be outside the target range as a result of first-round effects of a supply shock. The Bank, furthermore, has discretion as to the time horizon for bringing inflation back into the target range. In this regard a distinction is made between so called strict inflation targeters and flexible inflation targeters. The SARB undoubtedly is a flexible inflation targeter. This flexible medium-term focus policy approach adopted in South Africa provides for interest rate smoothing over the cycle, with the focus on second-round inflationary effects of exogenous shocks. This is evidenced by lagged increases in interest rates in response to exogenous shocks, for example the currency crisis during the second half of 2001 and the tightening of monetary policy only in early 2002. Similarly, in the current interest rate cycle, the repurchase rate was reduced, while expected inflation was still somewhat above the inflation target range. This approach was also informed by the forward-looking nature of policy implementation, which took into account the opening output gap and the downward pressure it would exert on inflation going forward, a clear example of how economic growth dynamics have played a role in monetary policy decision-making. The challenge of the inflation-targeting approach is to maintain monetary policy credibility as measured, among others, by how well inflation expectations have been anchored and, by applying the correct mix of policy discretion together with a broad enough focus that extends beyond inflation to affect output variability or cyclical growth and employment. Monetary policy cannot directly impact on the long-run trend growth. The latter is determined by real variables such as land, labour productivity, capital and infrastructure together with other factors such as regulations, the judicial system and the efficiency of government as well as external factors such as the terms of trade. With respect to inflation and output variability, a recent study by Kahn (2008) compared the relevant inflation-targeting period (first quarter of 2000 until the second quarter of 2008) with the period from the first quarter of 1991 until the fourth quarter of 1999 and concluded that in the pre-targeting period, CPIX inflation averaged 9,7 per cent and this declined to 6,5 per cent in the inflation targeting period. The average growth rates in the two periods were 1,6 per cent and 4,3 per cent respectively (measured as a percentage change on the same quarter in the previous year) 2. In South Africa, despite the challenges posed by supplyside and exchange rate shocks, the variability of both output and real interest rates has, therefore, declined during the inflation-targeting period. Fears that the implementation of inflation targeting has been inimical to growth in South Africa are therefore unfounded. This shows that inflation targeting has been consistent with (although not necessarily the cause of) higher average growth. At the very least it would appear that inflation targeting is not the enemy of growth! Kahn’s paper also concluded that there has been greater stability in real interest rates. The real policy rate averaged 5,7 per cent in the 1990s and 3,3 per cent in the relevant inflationtargeting period. Of greater significance perhaps is the relative stability of the real rate in the inflation-targeting period. It is clear that monetary policy has not resulted in a tighter policy stance on average when measured in terms of real interest rate developments. The South African experience has illustrated the difficulties that are faced when dealing with exchange rate or supply-side shocks. Kahn has also quoted research arguing that the monetary policy decisions taken in response to the sizeable domestic and external shocks have improved significantly during the inflation-targeting period. In response to these exchange rate and commodity price shocks, the MPC adopted a relatively flexible approach and did not attempt to get back to within the target over the shortest possible time horizon. In general, the MPC attempted to look through the short-term impacts of the shocks and to focus on the second-round effects. Some interest rate smoothing was applied as evidenced in the gradual changes that were applied during the interest rate cycles. Although the recent debate in South Africa has focused on the impact of the inflationtargeting regime on output, there are other positive aspects of the system that should be highlighted. Monetary policy has also become more transparent after the implementation of inflation targeting, reducing uncertainty, and raising the level of investment and the quality of decision-making. Monetary policy has become more predictable, especially if one considers the forward market which has anticipated repo rate changes well and has done so from the very beginning of explicit inflation targeting in 2000. In the absence of an explicit target for inflation, as provided for in the inflation-targeting framework, monetary policy would still have remained focused on achieving price stability, responding to the self-same supply shocks that the economy has recently faced. In my own view, whilst one can argue about the exact timing of certain decisions, I doubt that the trajectory of monetary policy would have been any different. 4. Monetary policy in South Africa during the crisis The global financial crisis resulted in the widespread adoption of more accommodative monetary policy globally. South Africa’s monetary policy easing began in December 2008, and since then the repurchase rate was reduced by 500 basis points to 7 per cent, which is the same as the low point of the interest rate cycle reached in 2005, and the lowest nominal policy rate since the late 1970s. However, the inflation rate in 2009 was significantly higher than that which prevailed in 2005. The decisive downward adjustment in the central bank’s key policy rate reflected the severity of the impact of the global downturn on the domestic economy and the consequent dissipation of inflationary pressures. The inflation rate remained outside the inflation target range, but the inflation forecasts of the staff of the Bank consistently showed that the inflation rate was expected to follow a persistent downward trend to within the target range. We continue to be of the view that the consistency of our Extending the analysis to the third quarter of 2009 does not detract too significantly from these results. policy approach will result in inflation readings being back within the target range on a sustainable basis from the second quarter of this year. This should be a clear manifestation of the flexible approach followed by the Bank, which reflects its awareness of the impact of monetary policy on economic growth and the forward looking approach of inflation targeting. 5. The role of exchange rates in monetary policy Before I conclude I would like to touch on our exchange rate policy as an integral part of monetary policy. The level of the exchange rate has elicited comments from diverse stakeholders, and there have been calls for a more activist approach towards its management by the Bank. Allow me to reiterate and clarify our views in this regard. The South African Reserve Bank remains committed to a flexible exchange rate regime and is of the view that the exchange rate of the rand should be determined by the market. The floating exchange rate regime helped to cushion South Africa from more severe effects of the recent global financial crisis. However, the commitment to a flexible exchange rate should not be misconstrued to suggest that we are indifferent as far as the level of the exchange rate is concerned. The level of the exchange rate is a very important factor in the inflation process and gets taken into account when considering policy within the framework I have just described. Its possible impact on the potential future path of inflation very much forms part of our considerations. Our current involvement in the foreign exchange market is mainly for the purpose of reserve accumulation and domestic liquidity management. As stated previously, our participation in the foreign exchange market is also informed by volatility conditions, the liquidity situation in the market and cost considerations. As regards the level of the exchange rate and competitiveness, while it is acknowledged that certain sectors of our economy have been affected by what may be perceived to be a relatively strong exchange rate, it is crucial to highlight the importance of inflation management in this regard. If the nominal exchange rate were to depreciate without inflation being controlled at the same time, there would be no improvement in the level of competitiveness. So the real exchange rate is more important. Any consideration for more active participation in the foreign exchange markets would also have to be carefully assessed against, among others, the prospects of success given the factors that may be driving the exchange rate in any particular direction at any given point in time. 6. Conclusion Having initially under-estimated the interconnectedness of financial markets, and how powerful a role this interconnectedness would play to transmit loss of confidence across the globe, central banks acted decisively to avert a total meltdown of the world financial system and to prevent an even more severe economic crisis. The challenge facing central banks around the world is planning and timing their exit strategies from unconventional policies so as not to jeopardise the recovery, whilst at the same time keeping close watch on possible inflation pressures that may start to emerge. The fact that we have stepped away from the brink should not allow complacency to creep in with regard to the repair work still required in terms of the reform of the international financial architecture and enhancing regulatory and supervisory standards in a coordinated manner. Economic and financial conditions in South Africa did not reach the stage where the Bank had to broaden the scope of monetary policy to unconventional policies. In my view the interest rate policy within an inflation targeting framework and the flexible approach followed by the South African Reserve Bank in its implementation has served the country well and is a good basis to move forward from. Thank you for your attention. References 1. Opening remarks by William R White at the Seventh BIS Annual Conference on 26–27 June 2008 on “Whither monetary policy?, Monetary policy challenges in the decade ahead” 2. South African Reserve Bank Monetary Policy Review, November 2009 3. Unconventional monetary policies: an appraisal, Claudio Borio and Piti Disyatat, Bank for International Settlements Working Papers No 292, November 2009 4. Challenges of inflation targeting for emerging-market economies: The South African case, Brian Kahn, South African Reserve Bank, 2008 5. South Africa amidst the crisis, Spire Awards Ceremony, Mr A D Mminele, Deputy Governor, South African Reserve Bank, 3 November 2009
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Bureau for Economic Research Annual Conference, Johannesburg, 22 April 2010.
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Gill Marcus: The outlook for monetary policy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Bureau for Economic Research Annual Conference, Johannesburg, 22 April 2010. * * * Introduction The global economy appears to be emerging from one of its most turbulent periods in living memory. Due in part to the unprecedented and largely coordinated policy responses that were undertaken by monetary and fiscal authorities around the world, we seem to have weathered the storm. However, while there are many positive developments, we cannot be blind to the risks and uncertainties that persist which could have systemic implications globally. It is against this uncertain global backdrop that we have to implement monetary policy domestically. Because monetary policy has to be forward looking, it is a truism then that monetary policy is always conducted in an uncertain environment. However it is probably true to say that the current environment is still characterised by heightened uncertainty. We therefore face difficult challenges in ensuring that inflation remains under control while allowing for the continued recovery of the domestic economy, which remains fragile. In my address today I will make a few comments on the lessons of the crisis for the monetary policy framework. I will then give a brief overview of the current domestic and global situation and end with some remarks on the outlook for monetary policy. The global crisis and monetary policy In South Africa, there has been considerable focus on inflation targeting. The debate has generally revolved around the impact of monetary policy on domestic growth. Globally, there has also been a renewed focus on inflation targeting, but for very different reasons. The argument put forward by, amongst others, Bill White, formerly of the BIS, argues that inflation targeting contributed to the global crisis precisely because it was too successful. The period of the 2000s was one where global inflation was low and, in terms of the narrow focus on inflation, it meant that central banks could keep interest rates at very low levels. These low interest rates, the argument goes, led to excessive credit extension and asset bubbles in the housing and equity markets, and to the lending excesses that ultimately caused or exacerbated the crisis. In other words, by focusing too narrowly on inflation, monetary policy ignored the financial stability implications of low interest rates. This throws the issue of financial stability squarely into the monetary policy arena. What should the appropriate policy have been under these circumstances? Bill White argues that it means that interest rates should have been higher than they were, and this would have prevented the need for such low interest rates later on. In other words, monetary policy should have a clear financial stability mandate that is part of the objective function of the Bank. Others have a different take on this. It is argued that higher interest rates on their own would not have prevented the credit excesses, and that they would have been prohibitively high. The alternative then is to assign different instruments to the financial stability objective while maintaining the interest rate for the broader monetary policy objective. But it is not immediately obvious what these tools are and how effective they will be. In a recent review of macroeconomic policy issues, Olivier Blanchard and others of the IMF argue that previously discarded tools need to be reactivated and used for focused intervention, even though they may be partially circumvented. Such tools include reserve requirements, contra-cyclical capital requirements on banks, and loan-to-value ratio restrictions. A related question is: who should be responsible for financial macro-prudential oversight? Should this be a central bank role, a separate entity or a joint role? If it is a central bank role, does it form part of the mandate of the Monetary Policy Committee (MPC), and how does it relate to the Bank’s supervisory role over the banking system? These are important questions currently being explored by central banks, and there is no simple or correct answer. Our own view is that the central bank already has an implicit financial stability mandate, and there is widespread expectation that, should a systemic financial or banking crisis occur, the central bank has, and would be expected to have, a key role to play. Central banks already compile and analyse much of the macroeconomic data of a country. However, should a financial stability mandate be made explicit, a way needs to be found for co-ordination with government. Our suggestion, at this stage, is that while the compilation of data and analysis would primarily be the responsibility of the central bank, a financial stability committee co-chaired by the Governor and the Minister of Finance could be considered. These issues have been the focus of much discussion at the bi-monthly BIS meetings. While there is broad agreement that monetary policy should have some focus on macro-prudential issues, there is far less agreement on the application and efficacy of these proposed policy tools. Much of this is unchartered territory, and we do not really know what instruments to use, or how to separate micro- and macro-prudential instruments and banking oversight. It is also clear that in future the conduct of monetary policy, even within inflation targeting mandates, will need to have a more pro-active financial stability focus. The idea that central banks cannot recognise or pop asset price bubbles, and that they should only take them into consideration to the extent that these bubbles impact on the inflation outlook is overly simplistic. Until now the conventional wisdom has been that the best that monetary policy can do is to clean up the mess after the bubble has popped. The recent cleaning up that central banks and governments have had to undertake in the aftermath of the crisis points to a need for a reconsideration of this issue. Although there will be more focus on financial stability issues in future, it will not be at the exclusion of other objectives, and we will continue to implement inflation targeting in a flexible manner. This means that while our primary objective remains the containment of inflation, it is not to the exclusion of factors such as growth and employment. In our analysis and policy implementation we take account of these factors, not only through their impact on the inflation outlook, but also in terms of how our policies impact on these variables. Our objective in this respect will always be to minimise the shocks to the system, and to avoid unnecessary volatility in output and interest rates. Furthermore, if inflation is, or is expected to remain within the target, monetary policy will have greater flexibility to focus on growth issues, particularly when the growth rate is below potential. This is entirely consistent with a flexible inflation targeting environment. But we also have to recognise the limits to our impact on growth. Monetary policy can and does affect cyclical growth around long run potential output growth. In other words, we can affect the size of the output gap by impacting on cyclical growth. However, our impact on potential output itself is limited – this is really the job of micro-economic policies. These include industrial and trade policies, investment in infrastructure and physical capital, technological innovation and productivity, and the quantity and quality of labour. Low inflation or price stability can contribute to long-term growth by providing greater stability and reducing uncertainty, which will be positive for longer term investment. However we cannot buy more growth with high inflation, and we cannot expect monetary policy to solve what is essentially a structural unemployment problem in the economy. The review by Blanchard et al also identified the need for a reassessment of exchange rate policies, particularly in emerging market economies. The authors challenged the conventional wisdom that inflation targeting emerging market economies should adopt a policy of benign neglect with respect to the exchange rate, given the significant resource misallocation that could result from extended periods of exchange rate misalignment. There is increasing recognition that emerging market economies are, in effect, being forced to adjust to disequilibrium positions in the advanced economies where abnormally low interest rates are still prevalent. There is also an expectation that these low rates are likely to persist for some time. The resultant search for yield, particularly when risk aversion is low, has seen a wall of money moving into emerging markets, with consequences for their exchange rates. Year to date has seen non-resident purchases of South African bonds and equities totalling around R35bn, and the consequent impact on the exchange rate. This can be compared with net sales of R76 billion in the second half of 2008 and net purchases of R90bn for 2009. The fortunes of the rand exchange rate followed these trends. There is little doubt that the rand exchange rate is one of the most volatile currencies, and is also currently assessed to be overvalued by many market participants and analysts, including the IMF. However, estimates of the degree of overvaluation differ markedly. More vexing is the question as to what can be done about it. Direct intervention is constrained by the costs of sterilisation; the jury is still out as to whether taxation of inflows, such as applied by Brazil, are effective; and while economic theory tells us that a narrowing of interest differentials should lead to a decline in inflows, this is not always the case, particularly if lower interest rates encourage growth-sensitive flows. The Bank has continued to buy foreign exchange as part of its strategy to increase the level of foreign exchange reserves. Despite significant foreign currency purchases at times, the rand has remained at elevated levels on a trade-weighted basis, but the cost of sterilisation has been significant, given the wide interest rate differential. One of the consequences of these interventions, and building up the gross foreign exchange reserves of the country to US$42 billion, is that the SARB will report an after-tax loss of around R1billion for the financial year 2009/10. While it may appear that in the past months there has been minimal reserve accumulation, our overall reserves are reported in dollars, and the recent weakening of the euro and sterling have resulted in significant valuation changes which have, at times, dwarfed the net accumulation. The SARB has continued to build reserves as and when this has been appropriate. The recent reduction of interest rates was seen by some as an attempt to weaken the rand. This was not a factor in our decision. Past experience has shown that the response of the rand to lowering or raising interest rates is unpredictable, and it has previously responded by both appreciating and depreciating for varying periods of time. However, the recent rand strength has resulted in an improved inflation outlook, which in turn gave room for a further rate reduction. While we do not target the exchange rate, we would want to see the rand at a stable and competitive level. Unfortunately, we have seen that achieving this is not straightforward. The global outlook In assessing the future direction of monetary policy, it is important to have a view of the global and domestic outlook. Previous speakers will have dealt with these issues at greater length. Overall the global outlook is a lot more positive than it has been for some time. Many growth forecasts have been revised up progressively over the past months as the fear of a “double dip” or W shaped recovery has receded. The latest World Economic Outlook expects global growth to average 4,2 per cent in 2010 and 4,3 per cent in 2012. In September 2009 their forecast for 2010 was 3,1 per cent. Emerging markets in general, and China in particular, which is forecast by the IMF to grow by 9,6 per cent this year, have been growing strongly, and there are now fears of evolving asset price bubbles in China. Growth prospects in the advanced economies have also improved: the WEO forecasts US growth to measure 3,1 per cent in 2010, and 2,6 per cent in 2011. In September 2009 the forecast for 2010 was 1,5 per cent. Growth prospects in the euro area have also improved, but remain subdued at 1,0 per cent for this year. Despite the good news and increasingly positive outlook, we cannot ignore the significant risks and uncertainties that still abound. The responses by governments and central banks around the world were necessary to prevent a full-blown depression. However the reversal of these positions is a significant challenge and timing will be crucial. In particular, we have seen unsustainable increases in fiscal deficits and debt ratios in a number of advanced economies. For example, fiscal deficits in the United Kingdom, Greece, Ireland and the United States are expected to exceed 10 per cent of GDP in 2010, What happens when these fiscal stimuli are withdrawn is critical. Much depends on whether the consumers in these countries are in a position to take up the slack. The answer is not clear cut, and will differ in various countries. In the US, the latest indications are that retail sales are rebounding and the consumer appears to be recovering. However, the housing market is still under pressure and unemployment remains high at around 10 per cent on a narrow definition, and around 18 per cent on a broader definition. The employment response to the downturn was far greater than in previous downturns, and the question 8 remains as to whether this decline is merely cyclical or structural. If it is structural, the US consumer may be constrained for longer. There are similar concerns about the health of the consumer in several European economies, particularly Greece, the UK and Spain, where unemployment has risen to in excess of 20 per cent. While the immediate threat from Greece appears to have passed, the issue has not been fully resolved and significant risks remain. It is clear that there are limits to further government expenditure stimuli, and at the same time a number of European economies will find the adjustment process painful because of the lack of an exchange rate safety valve. The IMF also expects global inflation to remain low, at 1,5 per cent in the advanced economies, and just under 3 per cent globally, in both 2010 and 2011. This, coupled with the relatively fragile economic recovery in some countries, is likely to result in monetary policy in some advanced economies being accommodative for some time. This is turn means that emerging markets, including South Africa can, in the absence of general risk aversion, continue to expect capital inflows. A further potential constraint on the growth outlook relates to the recovery of the global banking sector. According to the latest IMF Global Financial Stability Report, current estimates are that global bank write-downs through to end of 2010 will amount to US$2,3 trillion. As at the end of 2009, US$1,5 trillion of the $2,3 trillion had already been realised. These pressures mean that, in some countries, banks are still reluctant to lend. Hanging over the banks are the impending changes in global bank regulations. The nature of the changes and the implementation date are still to be decided by the Basel Committee on Banking Supervision. These proposed changes are aimed at building up stronger buffers to counteract the build-up of excessive procyclical leverage. Changes in the regulatory framework are necessary to prevent a recurrence of the recent crisis. However, we do need banks to be in a position to lend, and to be engaged in maturity transformation. A fine line has to be drawn: we cannot admonish the banks for not lending, but at the same time introduce regulations that make it difficult for them to lend. Decisions on the final proposals and their calibration will be made only after an analysis of the impact assessments that are currently underway, and comments received on the consultative documents. The domestic outlook The domestic outlook also looks increasingly more promising, but risks remain. Our current forecast is for growth to average around 2,6 per cent in 2010 and around 3,5 per cent in 2011. Growth is expected to be driven in part by the external sector, and is therefore dependent on the global growth outlook. If global growth is sustained, we can expect commodity prices to be well supported, but our manufacturing export performance may be affected by continued low growth in some of our traditional export markets. The manufacturing sector is experiencing positive growth again, driven primarily by external rather than internal demand. Domestic demand is still relatively weak but is showing signs of recovery. We believe it will remain relatively constrained for some time by elevated household debt levels, high levels of unemployment and the fact that credit extension by banks remains very subdued. Overall we would expect the deficit on the current account of the balance of payments to widen somewhat as imports respond to the higher infrastructural expenditure. Private sector investment expenditure is expected to lag that of the public sector, particularly if domestic consumption expenditure remains under pressure. Despite the more positive growth outlook, employment is expected to lag somewhat. The inflation outlook has improved despite significant risks posed by administered price developments. Our forecasts indicate that inflation is expected to remain within the target range for the remainder of the forecast period. The combination of an improved inflation outlook, and a decline in the risks to the inflation outlook, allowed us to reduce the repurchase rate by a further 50 basis points at the most recent meeting of the MPC. The factors that contributed to a decline in the risk to the inflation outlook included the persistent strength of the rand exchange rate and increased certainty with regard to the electricity price increases granted to Eskom. The view was that despite the indications that the economy was turning around, this recovery was expected to be relatively slow, particularly with respect to household consumption expenditure. Since that meeting, there have been a number of data releases that have heightened speculation about further reductions in the repo rate. In particular, the February retail sales came in well below consensus, and some of the manufacturing sector releases also disappointed. I should, however, warn against jumping to conclusions, particularly on the basis of one month’s data that is open to various interpretations. It is important to look at the reasons for the latest repurchase rate reduction. Our statement emphasised that despite clear signs that the economy had emerged from the recession, the pace of recovery was still below potential. We saw the improvement in consumption expenditure in particular as being tenuous. It does not however follow that one bad retail sales number automatically leads to a need for further easing. The latest data were a confirmation of the fragile nature of consumption expenditure growth, rather than necessarily being a downside surprise requiring further stimulus. I am sure that the general view of the MPC which prevailed at the time would therefore be unchanged in the light of recent data: that is, that the relatively low growth in consumption expenditure, together with other factors, provided a window of opportunity to reduce rates without jeopardising the inflation target. However, the scope for further easing is limited, and the repurchase rate is likely to remain stable for some time. I must emphasise that this is not an unconditional commitment. It is dependent on there being no major developments that change the inflation outlook, or significant changes in the risks to the outlook. Such occurrences would include markedly lower than expected output or expenditure trends, or a sustained further appreciation of the rand exchange rate, which overall would lead to a significant decline in the long term inflation forecast. Conclusion Monetary policy always has to be implemented in a forward-looking manner, given the lags between a policy change and its full impact on the economy. We will continue to examine the data in a forward-looking manner and, taking all factors into account, will decide accordingly. At this stage inflation appears to be consistently within the inflation target range and the domestic economy appears to be on a recovery path. However, significant risks to the domestic and global outlook remain and we will maintain our vigilance. We will continue to try to contribute to long-term economic growth through our endeavours to achieve our mandate and through our commitment to price stability. Thank you.
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Introductory remarks by Dr Xolile P Guma, Deputy Governor of the South African Reserve Bank, at the launch of the March 2010 Financial Stability Review, Pretoria, 28 April 2010.
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Xolile P Guma: South Africa’s macroprudential policy framework and economic overview Introductory remarks by Dr Xolile P Guma, Deputy Governor of the South African Reserve Bank, at the launch of the March 2010 Financial Stability Review, Pretoria, 28 April 2010. * * * Members of the press, other guests and colleagues, The Financial Stability Department has existed since 2001, its task being to identify possible threats to financial stability and suggest ways in which these could be mitigated. In pursuit of this objective the department, on behalf of the Bank, publishes the Financial Stability Review semi-annually. Today the Bank releases the March 2010 edition of this publication. Following the international financial crisis, the financial stability responsibilities of various central banks have become more explicit. The financial crisis has demonstrated, in general, that, although microprudential supervision makes a valuable and indispensable contribution to financial stability, it may be insufficient on its own to ensure systemic financial stability. For this reason, a macroprudential approach to policy formulation is necessary to complement microprudential supervision, and in fact monetary policy. The aim of such a policy would be to smooth the impact of the economic cycle on the financial system and contain the build-up of systemic risks in the financial system as a whole. The Bank is, therefore, currently in the process of developing an integrated framework for a macroprudential policy approach to achieve its financial stability objective, and to help co-ordinate financial stability policy of other authorities. The global financial crisis has also led to wide-ranging debate on the need to enhance the international regulatory framework in order to strengthen the global financial system and improve its resilience to shocks. The proposals for reform have gone beyond banking sectors and have been expanded to include insurance industries, rating agencies, hedge funds and accounting standards. Since the release of the September 2009 Financial Stability Review, the risks to global financial stability have eased and systemic risks have continued to subside as the global economic recovery has gained momentum. The recovery has been instrumental in moderating earlier high levels of uncertainty. Financial stability, nevertheless, remains to some extent, fragile in many economies, including those emerging-market economies hardest hit by the crisis. Advanced economies, in particular, are still faced with the challenge of repairing damaged financial systems, on the one hand, and introducing regulatory reform, on the other. Relatively conservative monetary and fiscal policies and structural reforms before the global financial crisis have helped many African countries to withstand the effects of the crisis better than during previous crises. The main risk facing Africa remains a stalling of the global economic recovery. This could place downward pressure on commodity prices, which could also undermine government revenues and raise public debt to unsustainable levels. In South Africa, economic performance started improving in the third quarter of 2009 and continued at a markedly stronger pace in the fourth quarter, as the economy gradually emerged from the recession. Confidence in the financial services sector increased further in the fourth quarter of 2009, boosted mainly by higher levels of confidence among investment managers and life insurers. The banking sector continued to maintain levels of capital well above the minimum prudential requirement. Despite the recovery in real economic activity, bank loans and advances contracted during the period under review. The contraction in credit extension had both demand and supply-side elements. On the demand side, it would appear that households continue to be reluctant to incur more debt, while on the supply side lending standards have remained tight. Although credit losses had been increasing consistently over the past two years, the pace of deterioration in the asset quality of banks moderated during the second half of 2009. Banking profitability dropped somewhat during the second half of 2009, but efficiency has remained fairly stable over this period. The financial strength of long-term insurers in South Africa was assessed as being generally sound, based on the capital-adequacy levels. Other financial soundness indicators for typical long-term insurers, however, suggest that this sector continued to experience some strain. Financial conditions in the short-term insurance sector also deteriorated during the fourth quarter of 2009. In line with developments in international equity markets, the upward trend in the domestic equity market, which started in March 2009, continued in the second half of the year. Business confidence increased in the fourth quarter of 2009, following persistent declines since the third quarter of 2006. The improvement in business confidence is consistent with some of the other leading indicators that generally precede a recovery in economic activity, and currently herald an improvement in economic conditions. Other indicators for the corporate sector, however, confirmed that the sector was still under pressure. Confidence in the residential property market also showed some signs of recovery. In addition, the decelerating growth in mortgage advances, as reported by banks, bottomed out in December 2009 and started to show signs of an upward trend. The business operations of non-residential building contractors were, however, still constrained by a lack of demand for building work. The household sector experienced some financial strain as job losses constrained disposable income. Although most indicators show that the decline in the real economy had bottomed out in the first half of 2009, consumers were, until the third quarter of 2009, still somewhat pessimistic about the prospects for future performance of the economy and its impact on their finances. The elevated rate of unemployment continued tight lending conditions and a need to address weaker household balance sheets are expected to continue to impact consumption expenditure negatively. Also, on average, the credit standing of consumers has continued to deteriorate. I have briefly highlighted the key issues raised in the Financial Stability Review. More detailed analyses are available in the publication itself, and will be highlighted by the authors’ presentations. I trust that you will find these interesting, stimulating and relevant to the current environment and invite you to provide comment as part of the important process of ongoing debate on financial stability. Thank you.
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Market Department's Annual Cocktail function, Pretoria, 3 June 2010.
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Daniel Mminele: The South African Reserve Bank’s activities in financial markets Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Market Department’s Annual Cocktail function, Pretoria, 3 June 2010. * * * Introduction Good evening ladies and gentlemen and welcome to the fourth annual cocktail function of the Financial Markets Department (FMD). It is our privilege to host this event. Thank you for accepting our invitation. You are all familiar with recent economic and financial market developments, but please allow me to just briefly touch on these events from the perspective of the central bank. I will then discuss the Bank’s activities in the financial markets given that, in some form or another you are all counterparties to our operations and activities in the financial markets, or are affected by what we do. International developments Since the previous FMD Cocktail at the end of July 2009, there have been a number of economic developments, which have had a significant impact on global risk appetite and trends in financial markets. For much of 2009, the EUR was relatively strong, appreciating to USD 1,51 in early December 2009. Speculative currency positioning, as represented by weekly data from the Commodity Futures Trading Commission (CFTC), showed aversion towards the USD in this period. The USD showed a net short position of over 280 000 contracts. The VIX index, a popular measure of expected volatility, and often referred to as the “fear index”, hovered around its long-term average of 20 index points, while advanced and emerging market equity markets were recording double digit gains. In developed bond markets, short dated yields were declining owing to the still lax monetary policy, while long-term yields were rising in reaction to increased government debt issuance. Emerging market bond spreads as measured by the Emerging Market Bond Index (EMBI) plus spread, had come off their high levels of almost 900 basis points in October 2008 to 280 basis points in December 2009. Credit Default Swap (CDS) spreads for the advanced economies and for certain European countries recently in the spotlight were also stable over this period, indicating little concern about sovereign default risks. Money markets were also relatively stress-free, as reflected by the continued narrowing in Overnight Index Swap (OIS) spreads at the time. The global economy emerged from recession in the latter half of 2009, much sooner-thanexpected and at a pace that was stronger than even the most optimistic forecasts. This development proved to be the catalyst for the rally in financial markets. Furthermore, the pace and speed of the recovery, differed vastly across countries and regions, with emerging markets proving to be the engine for global growth. Together with record-low interest rates in advanced economies, risk aversion having dissipated and abundant liquidity, emerging market countries started to attract significant capital inflows. However, towards the end of 2009, some headwinds emerged, which more recently intensified with the sovereign debt crisis in southern Europe and with markets becoming particularly concerned about a possible default by Greece and the contagion effects thereof. Was this to be the start of a new crisis? Was the nascent global economic recovery now at risk? Was the confidence we saw in financial markets misplaced and needed to be replaced by renewed risk aversion? The initial comfort provided by the EUR750 billion rescue package announced in early May by the European Union (EU), IMF and European Central Bank (ECB), soon gave way to concerns and uncertainty as to whether the measures taken would be sufficient to resolve the underlying solvency problems and whether the required fiscal consolidations would be politically and socially feasible. Budget cuts imposed across the euro zone spurred debate about the sustainability of the euro, the ramifications of fiscal tightening on European economic growth and the impact of a slowdown in the euro zone demand on the overall global recovery. Speculative currency positioning now showed aversion towards the EUR instead of the USD. The net long EUR contracts changed to net short positions of almost 120 000 contracts. Over the same period, the EUR depreciated to USD1,21 in mid-May. Risk aversion subsequently increased and the VIX index spiked to over 40 points in May 2010. Equity markets lost ground and CDS spreads, most particularly for Portugal, Ireland, Greece and Spain, increased. Strains in the money market came to the fore once more and the US OIS spread ticked up from around 10 basis points to approximately 30 basis points. Central banks that had been slowly and carefully embarking on exit strategies from unconventional policies, found themselves pondering about and indeed implementing re-entry strategies. It is clear that there is an urgent need for countries to consolidate their fiscal positions and bring their public debt ratios and fiscal deficits back to within more sustainable parameters. Domestic financial markets These developments are important for South Africa, being a small and open economy with deep and liquid financial markets. Against the backdrop of the stronger global and domestic economic environment, domestic financial markets also rallied in the latter part of 2009. The ZAR appreciated by almost 23% per cent on a trade-weighted basis in 2009, reversing the 23.5% decline recorded in 2008. This appreciating trend continued until mid-May 2010, supported by stronger commodity prices, the search for yield, liquid domestic markets, a relatively favourable economic and fiscal backdrop and the reduction in risk aversion. The All share index, as well as the Morgan Stanley Capital International index (MSCI) for South Africa, registered double digit gains, P/E ratios improved and domestic government bond yields declined. The fixed income market was supported by the easing in monetary policy and healthy appetite for domestic bonds by non-residents. Non-residents purchased a net R24 billion worth of domestic bonds in the fourth quarter of 2009 and purchased over R 30 billion in the first four months of 2010. The international bond issues of the South African Government in 2009 and 2010 were also well received, as confirmed by the latest USD 2,0 billion issue in March 2010, which realised the lowest coupon ever achieved on a USD bond issue. Nonetheless, the recent bout of risk aversion caused the rally in domestic financial markets to also run out of steam, while the appreciation in the ZAR dissipated and volatility increased from 13 per cent in April to almost 18 per cent in May. Market development initiatives An important milestone was reached in February 2010, when South Africa’s multibillion rand money market industry officially commenced the electronic issuing, trading and settlement of securities in place of the manual paper based system. As the largest issuer of money market securities (on our own behalf and on behalf of Government), the Bank welcomed the implementation of a fully-dematerialised money market. All SARB debentures and Treasury bills are now being processed in the new electronic format, representing not only a milestone for the South African financial markets, but also being the very first fully automated dematerialised settlement environment globally. Many of the people here tonight were involved in this project, and I want to sincerely thank you for your contributions to this very important project. As part of the FMD’s own contribution to market development and to enhance our exchange of information with market participants, a platform known as the Money Market Liaison Group (MMLG) was initiated in 2005, mainly to consult with banks on the modifications to the Bank’s refinancing system at the time. Earlier discussions were dominated by issues such as the extension of the pool of eligible collateral for the Bank’s refinancing operations and improvements to the benchmark overnight interbank rate. More recently, the need to reform this body to make its scope wider became apparent. A review of the MMLG was undertaken, resulting in the reconfiguration of its membership to cover the broader spectrum of financial markets, and the change of its name to the Financial Markets Liaison Group (FMLG). To meet the objectives of this consultative body, the FMLG will have four subcommittees that are in the process of being finalised. The Money Market subcommittee will focus on issues impacting the functioning of the money market, the Financial Market Infrastructure subcommittee replaces the former Money Market Association and will discuss ways of strengthening and improving market infrastructure. The FMLG will also have a Foreign Exchange and Fixed Income and Derivative Market subcommittee, which will engage on the safe and efficient functioning of these underlying markets, as well as derivative-related developments. Open market operations Managing the overall liquidity in the money market is of the utmost importance to the successful implementation of monetary policy. Having not had any difficulties previously, since December 2009 the Bank began to encounter some challenges in conducting its open-market operations in order to manage overall liquidity. In the process, the money market shortage at times declined to quite low levels. This was mainly due to dwindling demand for SARB debentures, owing to a slowdown in the growth of banks’ balance sheets, which resulted in lower demand for liquid assets that banks have to hold for prudential purposes. The National Treasury’s increased funding in Treasury bills and government bonds similarly impacted demand, while the longer-term reverse repos (LTRRs) were constrained by the ample availability of government bonds in the secondary market, in addition to traditionally limited participation in this instrument. The Bank consulted market participants not only to obtain a better understanding of reduced participation in the debenture auctions , but also to explain why the participation of banks in central bank open-market operations is essential for the effective implementation of monetary policy. An effective monetary policy implementation framework contributes towards financial stability, which is in the interest of all banks and the system as a whole. In light of the aforementioned challenges, we are considering some changes to the way in which the Bank conducts its open-market operations and we will be in a position to make announcements soon. For example, the measures being considered relate to modifications in the operation of standing facilities offered by the Bank as well as the use of longer-term foreign exchange swaps. The Bank conducts money market swaps in foreign exchange as a fine-tuning tool to manage money market liquidity. Foreign exchange market The size of the South African foreign exchange market, measured in terms of average daily turnover in USD, has fluctuated between USD10bn and USD15.2 since the time of the last FMD cocktail, with the composition in terms of spot, forward and swap transactions remaining relatively unchanged. Very much like in other parts of the world, conditions in the foreign exchange market continued to be volatile. The Bank has continued its involvement in the foreign exchange market mainly for reserves accumulation purposes. As a result of the appreciation in the rand exchange rate in 2009 and earlier this year, there were heightened calls for the Bank to intervene aggressively in the foreign exchange market or to even peg the rand to the US dollar. As indicated before, the Bank remains committed to a flexible exchange rate regime, with the exchange rate determined primarily by the market. The commitment to a flexible exchange rate should, however, not be misunderstood as an indifference towards the exchange rate. The rand is one of the most volatile currencies and the Bank is cognisant of the impact that this can have on business, and the uncertain operating environment it creates. Extended periods of misalignment can lead to a misallocation of resources between sectors within the economy and lead to an uneven and unbalanced economic recovery. Having acknowledged that certain sectors of the economy have been affected by what may be perceived to be a relatively strong exchange rate, it is also crucial to again highlight the importance of inflation management. One must bear in mind that a depreciation in the nominal exchange rate together with an increase in inflation would not lead to an improvement in the level of competitiveness of the rand. Any consideration for more aggressive participation in the foreign exchange markets would also have to be carefully assessed against, among others, the prospects of success given the factors that may be driving the exchange rate in any particular direction at any given point in time. More aggressive intervention or pegging the rand to the US dollar would be a very costly exercise. Firstly, how much foreign exchange reserves would be required to artificially peg the rand to the US dollar and to maintain this peg in the event of pressure to depreciate? South Africa’s reserves, at just over USD42 billion, are relatively low for that type of exercise. Furthermore, pegging the rand to the US dollar would not imply an automatic peg to other currencies, such as the EUR, which is the currency of our biggest trading partner bloc. Pegging also has the problem that if prices and wages are increasing, any competitive advantage will soon be eroded and there will be calls for changing the peg. Aggressive reserves accumulation either in the context of a peg or to prevent or moderate appreciation also carries significant costs, given the wide interest rate differential between the interest paid on sterilization and the interest earned on reserves. This results in a negative cost of carry and places the Bank’s income position at risk. The Bank recorded a loss of approximately R1,0 billion during the 2009/10 financial year. It is however important to point out that this loss was incurred as a direct result of the bank executing its public policy responsibilities rather than owing to any inappropriate risk taking or wasteful expenditure. Over the past year, the Bank continued to purchase foreign exchange as part of its strategy to steadily increase the level of foreign exchange reserves. Gross reserves increased by approximately USD8,0 billion from April 2009 to USD42,3 billion in April 2010. The international liquidity position increased by USD5,0 billion to USD38,5 billion over the same period. Apart from foreign exchange purchases by the Bank, this increase in official reserves was also due to foreign currency deposits from government, the allocation by the IMF of SDRs to South Africa and valuation adjustments. Although valuation adjustments contributed positively to reported USD official reserves over the financial year, there were periods where the Bank published substantial declines in the level of reserves due to valuation losses stemming from the diversified nature of reserves in terms of currencies. The Financial Markets Department continued to enhance reserves management policies in order to adjust and streamline our investment strategies. The Investment Policy, which provides a strategic and operational framework for reserves management, was reviewed during 2009/2010. The Investment Policy is reviewed every three years for governance purposes and also to ensure that it is responsive to and keeps pace with changes in the reserves management activities of the Bank and the external environment. The recent global financial crisis provided an ideal opportunity to incorporate into the policy the lessons learned, while also aligning the policy with refinements to international best practice. Conclusion The turmoil experienced in the euro zone with regard to sovereign debt risks highlights the importance of fiscal sustainability. Markets have become increasingly sensitive towards sovereign risks and therefore policymakers need to recognise the urgency of reducing excessive public debt. Fortunately, in this regard South Africa is on a solid footing when compared to challenges faced elsewhere. South African financial markets are an integral part of global markets and will continue to be subjected to global developments. As one of my colleagues recently said: “the best defence is to stick to sensible policies”. But we must now turn our focus to successfully hosting the 2010 FIFA Soccer World cup starting in about a week’s time, for the first time ever on the African continent. South Africa has again shown its mettle, and has overcome all scepticism, and we are now ready to welcome the world! In closing, I would like to convey my appreciation to the management and staff of the Financial Markets Department, not only for paying the bill tonight, but for the sterling work that they do for the Bank and our markets. Thank you also to the staff of the SARB Conference Centre for taking care of us tonight. Thank you and enjoy the evening.
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Comments by Ms Gill Marcus, Governor of the South African Reserve Bank, at a Power Business Breakfast function, Johannesburg, 7 July 2010.
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Gill Marcus: Recent global developments and their implications for South Africa Comments by Ms Gill Marcus, Governor of the South African Reserve Bank, at a Power Business Breakfast function, Johannesburg, 7 July 2010. * * * The global economy is at a crossroads. The world is in the midst of significant change, and the events in Europe are the most vivid examples of how complex and difficult the current environment is. The previous euphoria that the recovery was well underway has now translated into greater caution. Last week saw an almost synchronised decline in PMIs around the world, with the slowdown in manufacturing taking place more quickly than previously anticipated. While some analysts now see a double dip as a likely scenario, even the more optimistic who have retained a positive outlook now have a downside risk built into their forecasts, or greater “fat tail” risks. The reality is that we probably never really emerged from the crisis, which is now entering its next phase. These developments have serious implications for the domestic growth outlook. The global economy Until recently there had been a progressive upgrading of growth forecasts. For example, in the April World Economic Outlook, the IMF exemplified what can be regarded as the perceived wisdom: that the recovery was proceeding faster than expected; that the recovery would be uneven but would proceed; that exit strategies from expansionary monetary and fiscal policy would be required, and that these should be done carefully so as not to upset the recovery. It soon became evident that the extent of the required fiscal consolidation would be much more significant than initially thought: the explosion of fiscal deficits and debt ratios, that were seen to be part of the initial solution to the crisis, was now seen as a problem, as both solvency and sustainability issues came to the fore. The Secular Outlook of May 2010 issued by PIMCO’s Mohamed El-Erian, stated that “the drama paying out in Europe (includes) … the generalised and simultaneous nature of the debt explosion in industrial countries, the application and content of regulatory initiatives across the globe, the headwinds to job creation in some industrial countries, the extent of political polarisation and … the further shift of growth and wealth dynamics to emerging economies…” It also became clear that in a number of countries and regions growth was dependent on the continued stimulus provided by the fiscal and monetary authorities. Initially fiscal expansion was required to fill the gap left by the collapse in private sector demand. However, the private sector, particularly in the advanced economies, was not ready to step back in to support domestic demand, largely because of impaired balance sheets. Households remain cautious, and the initial driver of the recovery – inventory adjustments – cannot continue indefinitely without a recovery in domestic demand. The withdrawal of the fiscal stimulus in the US is therefore coming at an inopportune time. In some countries, eg in Europe, the approach has moved beyond mere fiscal stimulus withdrawal, as in the US, to one of fiscal austerity or consolidation. These measures, while necessary from a sustainability point of view, are coming at a time that is in effect premature, and could well undermine the pace of recovery further. For example, it has been estimated that an attempt by the Greek government to reduce its budget deficit over the next three years by the 10 percentage points of GDP needed to bring that deficit into line with the Maastricht criteria could cause GDP to decline over the next few years by between a cumulative 15 and 20 percent. The process of fiscal consolidation will place most of the burden of adjustment on monetary policies. In effect, we are likely to have low interest rates globally for much longer than previously thought. These low interest rates will counteract the negative growth impact of the fiscal consolidation. Furthermore, central banks will, in all likelihood, need to continue to use their balance sheets to help support the financial markets. The PIMCO Secular Outlook has described the crisis as one of serial balance sheet contamination. It started off with private sector balance sheets being expanded unsustainably (households and banks). With too many balance sheets deleveraging simultaneously, threatening global depression, governments were forced to step in with their balance sheets which led to the current sovereign risk issues. Now fiscal authorities have to deleverage, leaving the monetary authority balance sheets as the only ones left to prevent a downturn. At a regional level, it is the German balance sheet that is bailing out the rest of Europe. There are concerns that this implies inflationary pressures down the line. Given the size of output gaps, it is probably premature to be concerned about inflation at this stage in the advanced economies, but there are limits to what can be done by monetary policy on its own. There is also the risk of temptation to solve debt crises through monetisation. All this is also playing out in the political terrain, and social contracts are coming under considerable stress. Nowhere more so than in Europe where the social fabric in a number of countries is coming under strain as people are being asked to pay the price of the adjustment in terms of either lower wages, or in terms of their jobs. This is occurring at a time when elections are resulting in an increasing number of weak coalition governments, reflecting a lack of social consensus on the way forward. The obvious solution, namely to grow out of the crisis, is not that easy as growth is likely to remain lower for longer. Strategies for dealing with unemployment, particularly in Europe, are creating further problems. For example, the extension of the working life of individuals in a number of countries, while helping with the demographic problems of dealing with an ageing population, is leading to more youth unemployment. In Spain the unemployment rate is 20 per cent, but youth unemployment is closer to 40 per cent. There is a real danger of young people remaining unemployed for some time to come, resulting in deeper structural and social problems. Europe remains the biggest area of concern: The weaknesses of the fixed exchange rate system have been exposed. It is not enough to have currency union, as there has to be a credible fiscal union as well, with enforceable limits. While there was growth, the decline in competitiveness in the peripheral European countries could be papered over, and the burgeoning fiscal and current account deficits could be financed, provided that the sovereign debt of these countries was seen to be of the same risk category as the core countries. But that has changed in a dramatic way, although it was surprising that it took the downgrades by the rating agencies to get the markets to react to something that had been evident for some time. The fiscal adjustment in Europe and the UK means that growth is going to be very low for some time, perhaps not even in positive territory. However, some countries may have stronger growth, eg Germany, if they do not require much fiscal adjustment, and are able to increase productivity and take advantage of the weaker euro. In the US, consumption expenditure is not recovering at the pace initially expected, as high levels of unemployment, a de-leveraging banking sector and a weak housing market remain a constraint on households still faced with excessive debt. China and the Asian region in general, as well as some countries in South America, are seen as the main growth poles. However, there are signs that the policy-induced slowdown in China is having some effect. The latest forecasts are for growth of “only” 9 per cent. While a policy to cool down the Chinese economy was envisaged at the beginning of the year, at that stage it was not seen as a threat to the global picture given the expected rebound in the global economy. The fact that this cooling down is taking place at a time of a more general slowdown has reinforced the increasingly negative global outlook. The growth outlook is also affected by the slow banking sector recovery, and uncertainty related to regulatory reforms. The need for higher capital adequacy, de-leveraging and increased liquidity requirements could also discourage lending. At the same time, a downturn in growth will also impede the banking sector recovery. The South African outlook Given this very challenging global environment, what are we observing in South Africa? The recovery is taking place, but it is hesitant, fragile and uneven. Its sustainability will be dependent on the global recovery in general and in Europe in particular, which is the destination for about one third of our manufactured exports, as well as how effectively we use those opportunities that are there to enhance our economic infrastructure and human capital capacity. Although our exposure to the Southern European countries (Greece, Italy, Portugal and Spain) is relatively small – approximately 5 per cent of our exports – Europe as a whole accounts for about one third of our manufactured exports. A slowdown in the euro area as a whole will not be inconsequential for South African exports. We appear to have become a 4.6 per cent economy: First quarter GDP growth measured 4.6 per cent (seasonally adjusted and annualised); the current account deficit measured 4.6 per cent in the first quarter; and the May CPI inflation rate measured 4.6 per cent. Although growth has improved, the output gap remains wide, and it will take some time to get back to pre-crisis levels of output. While the growth outlook remains positive, our growth is expected to remain much slower than that in many other emerging markets. In recent days, a number of analysts have also downgraded their quarterly growth forecasts for this year in the light of global developments and the weaker PMI. Nevertheless we still expect growth to average around three per cent in 2010. The manufacturing sector has led the recovery since the second half of last year, mainly a result of an export recovery. The outlook therefore depends on the global prospects. Unfortunately the most recent data shows that manufacturing may be slowing down, and the PMI is down at 48.4, the fourth consecutive monthly decline, indicating a possible contraction going forward. This poses a risk to the growth outlook for the rest of the year. Gross fixed capital formation turned positive in the first quarter of 2010, but only marginally so (0,2 per cent), driven mainly by public corporations. Of concern is the continued contraction of private sector investment. Household consumption expenditure appears to have improved and turned (weakly) positive (1,6 per cent) in the final quarter of 2009, after five consecutive quarters of negative growth. In the first quarter it measured 5,7 per cent quarter-on-quarter annualised, though some moderation may be expected. This is also reflected in the credit extension numbers, which although remaining low, recently turned positive. The inflation outlook remains favourable: in May it measured 4,6 per cent, and we expect inflation to remain within the target range for the remainder of the forecast period, but our forecasts are that it will begin to rise moderately by the fourth quarter of 2010. This outlook has enabled us to reduce the repo rate to its lowest level in nominal terms at 6,5% since the late 1970s. Unfortunately, despite positive growth, employment continues to lag. This is not unusual in the early phases of the cycle, but there are other factors that seem to indicate that the pickup in employment is likely to be slow. We lost a disproportionately large number of jobs during the crisis compared with other countries, but despite this, wage settlements remain well above inflation, particularly in the public sector. If this is not matched by improved productivity there are likely to be inflationary consequences. The public protests seen abroad in Greece and elsewhere do not reflect the same demands ie for higher wages. In Europe the protests are against losing jobs, and the severe austerity measures that have been introduced to reduce double-digit sovereign debt. South Africa cannot, on the one hand, put employment creation as its priority, and then at the same time demand (and agree to) wage and salary increases that are, in some instances, double the level of inflation. In this regard the behaviour of management is critically important. Outrageous increases or bonuses are simply not acceptable. Management has to lead by example. According to Computus, a forensic accounting firm, executive pay has increased notwithstanding the financial crisis and global recession. In its sample of 326 listed companies and parastatals, it reports that CEO remuneration increased by 11,5% on average from 2006 to 2009. South Africa as a whole needs to have a greater understanding of the global financial crisis and its consequences for all of us. This requires greater interaction and a common purpose determining the appropriate course of action that we, as a nation, need to take to stave off the worst ravages of the crisis. We have experienced the most remarkable period of togetherness in the past month, built around Soccer 2010 and being host to the world, both the hundreds of thousands who have come in person, and the millions who have watched on TV and other media. We need this togetherness and sense of what we can achieve to continue beyond the world cup, and to permeate other aspects of society. There also needs to be greater coordination and cooperation between policies. It is not possible to have loose monetary policy and loose fiscal policy and a weaker exchange rate. This will not translate into a depreciated real exchange rate. Rather, it is a simple recipe for higher inflation. We need an appropriate mix or combination of both macroeconomic and microeconomic policies that will bring about higher productivity, higher growth and employment in a low inflation environment. Today, what is clear is that central banks the world over have been given additional responsibilities, explicitly or implicitly. Expectations are that central banks will, and can, deal with macro-prudential, micro-prudential, financial stability, crisis management, provision of liquidity and still meet their core responsibility, namely independent execution of monetary policy. Financial stability crises build up over years, and what the prevailing global crisis has shown is that it is much harder to restore financial stability once it has been lost than previously anticipated. Another lesson is that there is an increasing need for co-ordination and cooperation between central banks, governments and markets, within a sound regulatory environment and with a focus on maintaining systemic stability. In conclusion, what we are seeing is a bifurcated world where the developed countries face gradual de-leveraging with lower growth for longer in a more regulated environment, impacted upon by severe austerity measures and poor public finances. Furthermore, the US faces increasingly large structural headwinds, including deteriorating public finances, while the Eurozone is likely to see low inflation for some time to come. On the other hand, key emerging countries such as China, India and Brazil, seem set to continue to grow and develop. Our challenge is to ensure that South Africa, with so much going for us, is one of these key emerging countries.
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Address by Mr A D Mminele, Deputy Governor of the South African Reserve Bank, at the 13th Southern Africa Internal Audit conference, Sandton, Johannesburg, 18 August 2010.
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A D Mminele: Insulating South Africa against global risks – challenges Address by Mr A D Mminele, Deputy Governor of the South African Reserve Bank, at the 13th Southern Africa Internal Audit conference, Sandton, Johannesburg, 18 August 2010. * 1. * * Introduction Good morning ladies and gentlemen, and thank you to the Institute of Internal Auditors for the invitation to speak at this 13th Southern Africa Internal Audit Conference. It has been well over three years since the onset of the global financial and economic crisis. As with any crisis, many questions have been asked. Could it have been avoided? What were the causes? What needs to be done to safeguard the financial system in the future? Blame was apportioned everywhere. Central banks were not spared the scrutiny, with some even suggesting that central banks were to blame for having a too narrow focus in the fulfilment of their mandates. It is argued that low policy rates, as a result of low and stable inflation, created the necessary environment for excessive risk taking. Others blamed the crisis on a lack of proactive risk management practices. While there is no risk management system that can provide absolute assurance that events such as the financial crisis will not occur, it certainly did heighten awareness about risk management practices of companies. There is little doubt that the expectations of the internal audit profession have been raised considerably since this crisis. In my remarks today I shall touch on the evolution of the crisis, discuss some of the key global risks and their impact on South Africa, look at some of the challenges that central banks are facing, and conclude with a few observations around what we need to do to ensure that, as a country, we are resilient and better prepared for future challenges. 2. From sub-prime debt to sovereign debt No sooner had the global economy emerged from recession in 2009 that it seemed there was yet another crisis brewing. Some have argued that we actually never emerged from the crisis and that we were dealing with a continuum and just moved into the next phase of it. Extraordinary policy measures implemented by governments and central banks around the world helped lift global output. However, in the process, there was also a significant transfer of debt from the private to the public sector as government spending in advanced economies was ramped up and substantial tax incentives were implemented. The combined effect of slower growth and higher spending was an increase in budget deficits in many advanced economies, to levels in excess of 10 per cent of gross domestic product (GDP). The International Monetary Fund (IMF) projects that as a consequence, public debt ratios will most likely increase from around 70 per cent of GDP to average approximately 110 per cent of GDP in 2014. While credit standing, funding conditions, and thus the degree of vulnerability vary across countries, we have to remind ourselves that not too long ago, a debt to GDP ratio in excess of 60 per cent was viewed to be bordering on fiscal irresponsibility, much as we are facing exceptional circumstances that require exceptional solutions. As the European sovereign debt crisis intensified, it increased the likelihood of a systemic financial crisis. The solvency of European banks was questioned, given their large holdings of debt of affected countries. At the end of 2009, European bank holdings of Portuguese, Spanish and Greek bonds totalled EUR1,2 trillion, with a high concentration of holdings by German and French banks 1. The credit default swap (CDS) spreads of European banks Europe’s sovereign debt crisis: no place to hide?, John Makin, June 2010. moved in tandem with sovereign CDS spreads, reflecting the exposure of European banks to sovereign debt. Spillovers between sovereigns and the banking system increased market and liquidity risks during May 2010, and in some of the euro area countries, banks became less willing to lend to each other, risk appetite declined and asset prices in financial markets experienced increased volatility. CDS premia in respect of the debt of certain European sovereigns increased substantially. Market strains have receded somewhat since May 2010, largely due to the EUR750 billion package assembled by the European Union and the International Monetary Fund, and the results of the European banking sector stress tests, which indicated that the banking sector was in better shape than feared. 3. Key global risks The rise in CDS spreads for various southern European countries, by and large did not affect emerging markets. The stability of emerging markets during the sovereign debt crisis can be ascribed to comparatively low government debt to GDP ratios, better growth prospects and a limited use of countercyclical fiscal policy during the global recession. Furthermore, the prognosis looks good as the public debt ratios in emerging markets are expected to decline from around 60 per cent of GDP to 40 per cent over the next four years. Although emerging markets came away relatively unscathed from the recent debt crisis in Europe, problems in advanced economy debt markets could very easily spill over to emerging markets, as we have already seen on numerous previous occasions. A sharp rise in investor risk aversion could lead to funding strains in emerging markets as European banks withdraw cross-border credit facilities. Cross-border bank exposures can be the conduit for spillovers of sovereign risks to banks and for this to spread further to other banking systems in the region and beyond. Heightened uncertainty about financial sector exposure to sovereign risks and increased funding costs could curtail the supply of bank credit. Lower consumer and business confidence, together with fiscal consolidation, could suppress private consumption and investment. The combination of these forces would derail global growth owing to substantial negative spillovers to other countries and regions due to financial and trade linkages. Even in the absence of an increase in risk aversion, the process of fiscal consolidation will place most of the burden of adjustment on monetary policies, implying that policy rates in advanced economies would have to remain “lower for longer”. Indeed, the exit from extraordinary fiscal, monetary and financial policies has become more complicated. We have already witnessed the Fed’s decision last week to plough proceeds from maturing mortgage bonds into government bonds, effectively implying a continuation of the quantitative easing policy. In contrast to a situation of heightened risk aversion, such a scenario would result in increased portfolio inflows to emerging markets, intensifying pressure on exchange rates to appreciate with potentially negative ramifications on growth, increasing the potential for asset price bubbles. 4. Impact on South Africa The financial crisis has shown us that countries such as South Africa with limited or no exposure to toxic assets were also severely affected by developments in the rest of the world. While a stronger budget balance and lower debt ratio did allow some room for countercyclical policy, the South African economy still contracted by 1,8 per cent in 2009 as compared to an average GDP growth rate of 4,9 per cent achieved during the preceding 5 years. The South African economy emerged from recession in the third quarter of 2009, and growth has since accelerated to 4,6 per cent in the first quarter of 2010. Growth was fairly widespread, with the manufacturing sector playing a strong role, together with commerce and mining and a pick-up in household and government consumption expenditure. While the South African growth trajectory has improved considerably, indications are that second quarter growth is likely to have been less stellar. The Bank’s latest projections show that economic growth should average around 2,9 per cent during 2010, with the uncertainties emanating from the global economy posing the main downside risks. CPI inflation has been inside the target range since February 2010, with the outlook being generally favourable, although developments around wage settlements and administered price increases continue to pose upside risks. The low interest rate environment prevailing in advanced economies has resulted in a consistent search for yield, and as a consequence, South Africa, like other emerging markets, has attracted significant capital inflows. Since the beginning of the year, nonresidents have purchased over R75 billion worth of domestic bonds and equities. The rand exchange rate has been somewhat volatile and in the past two months the rand/dollar exchange rate fluctuated between R8.10 and R7.18. After declining from 45 per cent in October 2008 to 13 per cent in April 2010, historical volatility of the rand increased briefly to 18 per cent in May 2010, but has since eased from these levels. Much of the underlying volatility can be ascribed to changes in global risk aversion related to events in Europe in particular, with significant volatility experienced in the USD/EUR exchange rate. However, it is worth pointing out that the volatility in the exchange rate of the rand has been in line with the volatility observed in respect of currencies of other emerging market and developed countries. It is generally accepted that currency volatility and excessive appreciation unrelated to economic fundamentals can have an undesirable effect on the domestic economy, through adverse impacts on both the export and import-oriented sectors. While the Bank is cognisant that an over-valued exchange rate over an extended period can be very costly to the economy, it also needs to be recognised that the open nature of our economy makes us more susceptible to all kinds of spillovers from the global economy and financial markets, making any attempts to seek to control the exchange rate at a particular level not feasible. Not having or not seeking any particular target for the exchange rate, however, does not imply that reasonable and responsible steps cannot be taken to manage abrupt adjustments. As we have said on numerous occasions, any actions would have to be consistent with the inflation target. While the rand exchange rate is a critical variable, we need to take a more holistic view to ensure that the overall policy mix is designed and implemented in such a way that policies are complementary in order to raise economy-wide productivity, growth and employment while keeping inflation in check. 5. New challenges for central banks? Over the past two decades, central banks in advanced and emerging economies adopted monetary policy frameworks with price stability as the primary objective. Monetary policy worked through interest rates and therefore, only influenced current and future expected short-term interest rates, which in turn, impacted on long-term interest rates and asset prices. Central banks were successful in bringing down inflation to levels not seen since the 1950s and were credited with contributing to an exceptionally long period of stable growth 2. Through focusing on price stability, monetary policy was believed to have contributed to financial stability. The crisis has taught us that too narrow or single-minded a focus on price stability can contribute to unintended outcomes. Conventional monetary policy proved not to be sufficient. Exceptional policy actions had to be implemented which resulted in the Central banking lessons from the crisis, International Monetary Fund, May 27, 2010. expansion of central bank balance sheets in advanced economies, in certain instances to more than twice their pre-crisis size. A number of weaknesses were exposed in the process, in particular, the role of central banks in maintaining financial stability. It is clear that more attention needs to be given to macroprudential policies and central banks can bring a wealth of expertise and information to increase the effectiveness of macro-prudential policies. Ineffective macro-prudential tools increase the onus on monetary policy to reduce the build-up of financial imbalances and can increase the likelihood that central banks have to provide emergency liquidity, which could ultimately impair their balance sheets and complicate the conduct of monetary policy. It is argued that if macro-prudential policy had been able to increase the resilience of the system, and to moderate the supply of credit to the economy, the crisis could have been less costly. The debate as to whether central banks should lean against emerging financial imbalances by altering policy rates has therefore been reopened by the crisis. Previously, the argument was that such an approach could lead to inflation volatility, requiring strong interest rate responses and therefore impose high output costs which may be counterproductive in small open economies where high interest rates can attract capital inflows 3. However, the costs of the financial crisis appear to strengthen the case for using monetary policy to counter asset price bubbles, but much more work is needed on how monetary policy can best deal with the potential conflicts of attaining both financial stability and price stability. Monetary authorities are increasingly shifting towards the view that central banks should be in charge of the microprudential supervision of banks, and overseeing systemic risks. However, the crisis also exposed the weaknesses in central bank liquidity management and the need for more flexible frameworks. 6. Insulating South Africa Given this background, what is it then that South Africa can do to insulate itself against these global risks? Well-coordinated and sound policies are required going forward. South Africa’s macroeconomic policies have served us well and the need for fiscal consolidation, whilst important to ensure continued fiscal sustainability, is less pressing if one compares the country to other developed markets. It has already been noted that while countercyclical policy did prevent a more severe recession, our public debt ratio remains comparatively low while there is a clear medium-term plan to reduce the budget deficit. Policymakers need to monitor at all times global economic and financial sector developments, understand linkages between global and domestic developments, and ensure that policies and regulations are calibrated to allow appropriate responses in a flexible and quick manner. One of the reasons for South African banks coming out of this crisis in good shape is due to the prudent regulatory and supervisory framework. The G-20, of which South Africa is a member, continues to do much work on financial regulation, through the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS). South Africa is represented on both the BCBS and the FSB as well as various working groups. Consequently, the developments and discussions in international fora are closely monitored to ensure the ongoing alignment of the South African framework with international developments where applicable and appropriate. South Africa is also an active participant in the Mutual Assessment Process (MAP), a working group formed by the G-20 as part of its work to deal with the impact of the financial Bank of England, 2009, The Role of Macro-prudential policy. crisis. The MAP working group was formed to provide the G-20 with a framework for strong, sustainable and balanced growth. Global co-ordination and global responses are required given the nature of the challenges we are facing, but that does not necessarily always imply uniform measures and synchronised timing. Country-specific circumstances must continue to be taken into account. 7. Conclusion Although the worst of the sub-prime crisis is behind us, it has left behind a legacy of indebted nations, which will complicate the future conduct of both fiscal and monetary policy. These challenges, unless adequately addressed, could derail the nascent global economic recovery. The continued recovery in emerging markets and South Africa in particular, is dependent on how some of the key global risks unfold. Being a small and open economy, it is impossible to insulate ourselves against global risks, however, it is possible to manage the risks and minimise our exposure in such a manner that we are less affected by events such as these. The events of the past two years have exposed an essential need to alter the thinking on global risks and how they are managed. The financial crisis has determined that there will be “no return to business as usual”. The link between the financial sector and the real economy is now considerably stronger than was the case in the past. The attainment of financial stability is heavily dependent on improved regulation and its effective implementation at both the domestic and international levels. The role of the audit profession in this process should not be underestimated. Thank you.
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Introductory remarks by Dr Xolile P Guma, Senior Deputy Governor of the South African Reserve Bank, at the launch of the September 2010 Financial Stability Review, Pretoria, 7 October 2010.
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Xolile P Guma: South Africa’s financial regulatory environment Introductory remarks by Dr Xolile P Guma, Senior Deputy Governor of the South African Reserve Bank, at the launch of the September 2010 Financial Stability Review, Pretoria, 7 October 2010. * * * Members of the press, guests and colleagues On behalf of the South African Reserve Bank, I would like to welcome you to the release of the September 2010 edition of the Financial Stability Review. The Bank has been publishing its Financial Stability Review on a bi-annual basis since 2004, and this is the fourteenth publication of its kind. The Financial Stability Review aims to identify and analyse potential risks to financial system stability, communicate such assessments and stimulate debate on pertinent issues. The Bank recognises that it is not the sole custodian of financial system stability, but believes that it can contribute significantly towards a larger effort to achieve stability involving the government, other regulators, self-regulatory agencies and financial market participants. As a result of the recent global financial and economic crisis there have been considerable developments that have influenced, and quite radically changed, the theoretical thinking about financial stability and its integration with the other tasks of central banks. The extraordinary measures taken to resolve the most impaired financial systems have changed the thinking about a central bank’s role in financial crisis management. The very high fiscal cost of resolving the crisis and stimulating growth when it led to a global slowdown has also caused politicians to be more involved with the inevitable process of regulatory reform that has followed. Several of the most affected jurisdictions have announced substantial changes to their financial regulatory policy processes and regulatory structures, and the manner in which these are integrated with monetary and macroeconomic policies. Not only have more powers been given to some central banks to monitor and coordinate financial stability, but governments in some jurisdictions have chosen to oversee the process of resolving “too big to fail” financial institutions in future crises. Common features of most of the thinking reflected in recent discussion forums, literature and structural changes are an increased emphasis on the formulation of macroprudential policy and tools, and a recommendation for the creation of an independent policy decision-making structure to help consider financial stability issues and integrate any necessary policy decisions with monetary policy. Crucial to the approach to be developed by the Bank is the concept of macroprudential policy. There have been many different attempts to define this concept and the Bank for International Settlements recently referred to “an orientation or perspective of regulatory and supervisory arrangements that is systemic rather than institutional”. 1 A macroprudential approach firstly, has a time dimension which deals with how risk evolves over time, with procyclicality as the primary source of risk. Secondly, it has a cross-sectional dimension dealing with how risk is allocated within the financial system at a given point in time, with common exposures and inter-linkages between financial firms as the primary sources of risk. In simple terms, a macroprudential policy approach is therefore one where fiscal, monetary and regulatory policy are all aimed at either changing or countering the collective behaviour Borio, C. 2010. Implementing a macroprudential framework: blending boldness and realism, Bank for International Settlements, July. of financial institutions in order to reduce the systemic risk emanating from such behaviour. This is a very complex task which poses big challenges for policymakers and regulators. I turn now to the Financial Stability Review and the key issues it addresses. During the first half of 2010 downside risks to the steady economic recovery and improving macrofinancial conditions rose sharply in advanced economies. Concerns about the fiscal positions of a number of euro area countries soon turned into a sovereign debt crisis. Reprieve only set in with the announcement of a comprehensive rescue package by the joint European authorities and the International Monetary Fund. In emerging market economies GDP growth has been robust and incentives for capital inflows are expected to remain strong. As a result asset-price bubbles, financial market instability and uncertainty and fragility of financial systems in general, present risks to the outlook in emerging economies. Generally, conditions in the global financial system are still influenced by above-normal levels of uncertainty, highlighting the fact that the process of repairing impaired financial systems is far from complete. In South Africa, despite positive signs of economic recovery, employment continued to decline, placing a significant damper on the domestic financial system. Nevertheless, the banking and insurance sectors maintained high-quality capital buffers well above the minimum prudential requirements, and remained profitable. Growth in bank credit granted has begun to increase, the growth rate in impaired advances is decelerating and lending standards of banks are showing signs of loosening. Although indications are that initial expectations of a vigorous recovery in real economic activity were too optimistic, business confidence rebounded in the third quarter of 2010. Despite the negative sentiment brought about by rising unemployment, the level of consumer confidence remained almost unchanged in the second and third quarters of 2010, following a strong recovery in the first quarter. Consumers also remained optimistic about the prospects for the economy as a whole, although they were still somewhat reluctant to commit to the purchase of durable goods. Current developments in enhancing the strength of the financial regulatory environment include the publication of the Companies Amendment Bill, with the purpose of improving the administration and effectiveness of the Companies Act; the South African Reserve Bank Amendment Act to enhance the Bank’s governance framework and to uphold its public interest role; and the proposed draft Banks Amendment Bill, taking into account new international best practices and standards as issued by the Basel Committee on Bank Supervision, and to align the provisions of the existing Banks Act with the new Companies Act. In addition to international efforts to strengthen the overall robustness of the regulatory environment, some countries have responded by reforming national regulatory systems. These reforms include the extension of central banks’ powers with regard to supervision, market conduct and consumer protection; the provision of more appropriate structures and policy instruments to assess and mitigate “systemic risks”; the need to address the “too-bigto-fail” moral hazard problems associated with systemically important financial institutions; and the need to close the regulatory gaps that were prevalent in the build-up to the financial crisis. Although some countries are proceeding with regulatory changes, a degree of international convergence around a common international framework is needed. I have briefly highlighted the key issues raised in the Financial Stability Review. More detailed analyses are available in the publication itself, and will be highlighted by the authors’ presentations. I trust that you will find these interesting, stimulating and relevant to the current environment and invite you to provide comment as part of the important process of ongoing debate on financial stability. Thank you.
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south african reserve bank
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Wesgro Investor lunch, Cape Town, 19 October 2010.
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Gill Marcus: The challenging global and domestic economic environment – implications for monetary policy and the economic outlook Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Wesgro Investor lunch, Cape Town, 19 October 2010. * * * Introduction The global crisis which erupted in 2008 is unfortunately still with us. Whereas it was relatively easy to get unanimity between countries with respect to coordinated responses to the severity of the crisis, it is proving to be far more difficult to achieve this common purpose during the current recovery phase. The recovery has been very mixed across countries and regions. The emerging markets in general, particularly those in Asia and Latin America, appear to be recovering strongly. By contrast, the US, the UK, the euro area (excluding Germany) and Japan are struggling to get growth going on a sustained basis. These countries’ attempts to reinvigorate their growth are having implications for emerging markets, leading to what the Brazilian Minister of Finance has recently described as a currency war. Although South Africa did not have a banking crisis, we nevertheless experienced the pain of recession along with most other countries. Similarly, we have not been able to avoid the fall-out of the current phase of the crisis: the recent global developments have had a profound affect on the domestic economy through their impact on trade, capital flows and consequently the exchange rate. The economy has emerged from recession, but it is a fragile recovery. Unfortunately our growth rates are not in line with those of many of the emerging market economies, but are more in line with those of the advanced economies. We need to face up to the challenges, not all of which are external. We face a number of domestic challenges, requiring a concerted and coordinated effort. In my talk today I shall address the challenges posed to the economy by these international developments and the impact on monetary policy. By way of conclusion I will offer some thoughts as to the type of structural or microeconomic reforms that are required to improve South Africa’s growth and competitiveness. Many of the problems of this economy are deep-rooted and require coherent structural reforms, and are not easily solved. Recent global developments During 2009 the global economy began to emerge from the worst financial crisis since the Great Depression, and by the beginning of 2010 there was wide-spread optimism in the markets that the extraordinary steps that were taken by monetary and fiscal authorities to overcome the crisis would be reversed relatively soon. The focus at the time was about the appropriate pace and timing of these exit strategies. This optimistic view envisaged US policy rates being increased by the middle of 2010. There were, however, more pessimistic views which believed (and some still believe) that the risk of a double-dip recession was high. The current emerging consensus appears to be that while the risks of a return to negative growth are not trivial, the most likely outcome is for a protracted period of low growth in the advanced economies while the emerging markets are seen as the new growth engine. In essence, we have emerged from the recession, but not from the crisis. The reasons for the poor growth outlook vary across countries and regions. In the United States, the consumer is still deleveraging in the face of a housing market that has not fully corrected, and a withdrawal of the fiscal stimulus. In the euro area, the replacement of private credit and expenditure with state credit and expenditure resulted in a ballooning of fiscal deficits and debt ratios in a number of countries where debt to GDP ratios were already under pressure, particularly in southern Europe. Greece and Italy, for example, have debt to GDP ratios of 130 per cent and 118 per cent respectively. Pressure from the markets as well as the conditionalities related to the IMF-led bail-out packages resulted in the implementation of austerity measures in a number of countries, and fiscal retrenchment became the order of the day at a much faster pace than was originally thought appropriate. Fiscal adjustment in Greece is planned to reduce the deficit from over 13 per cent of GDP to around 3 per cent of GDP in 2014, while in Spain the objective is to reduce the deficit from 9,6 per cent of GDP to 3 per cent by 2013. In the UK, government spending cuts for the current fiscal year have averaged 25 per cent across departments. The danger with such an approach is that the adverse impact on growth could set in motion negative debt dynamics which would make the overall debt situation even worse. It has been suggested by Desmond Lachman of the American Enterprise Institute, that the Greek austerity programme would result in growth contracting by between 15–20 per cent, leading to an increase in the debt to GDP ratio to 180 per cent. While there is general agreement around the risks of excessive debt, there is less agreement as to how much is excessive, and how quickly it should be reduced. As George Soros has recently argued, the premature pursuit of fiscal rectitude could wreck the recovery. At best it is likely to cause a continuation of the low growth scenario, persistently elevated levels of unemployment, and in the context of ageing populations in Europe, even further pressures on the fiscus. The current social unrest being observed in many parts of Europe is an outcome of this. A further implication of these developments is that monetary policy becomes the main countercyclical policy instrument. With interest rates close to their zero bound in a number of countries, quantitative easing has continued. There are some concerns about the possible inflationary consequences of the current policies of quantitative easing, namely that the injection of liquidity will ultimately translate into higher inflation or asset market bubbles. Some point to the gold price, which has reached record levels in recent weeks, as an indication of the market expectations of future inflation. However long-term interest rates have remained extremely low in the advanced economies, an indication that the markets do not expect an imminent inflationary outcome. To the contrary, there are still lingering fears of deflation in the US and Japan. In the context of persistently wide output gaps and weak household consumption expenditure, global inflationary pressures emanating from the advanced economies appear to be benign. A future challenge will be to withdraw this liquidity at a pace that will not derail the recovery, and at the same time minimise possible inflationary pressures. The monetary policy stances adopted in these countries imply abnormally low interest rates for longer, and expectations of the normalisation of interest rates have been pushed out to 2012 or even 2013. The resultant increase in global liquidity has resulted in a surge of capital flows to emerging markets, which have higher growth rates, relatively higher interest rates and favourable fiscal environments. According to the Institute for International Finance, private capital flows to the emerging market economies are expected to total US$825 billion in 2010, up from US$581 billion in 2009. These flows are expected to be sustained at similar levels in 2011. Inevitably these flows have had implications for the exchange rates of many emerging markets, including South Africa. The impact on the South African economy The South African economy reverted to positive growth in the second half of 2009. However, this growth has been relatively slow and below potential. Our expectation is that growth this year will be in the region of 2,8 per cent, increasing to 3,2 per cent in 2011, which is not sufficient to have a marked impact on unemployment. On the positive side, commodity prices have improved from their lows during the crisis, although they have not recovered to pre-crisis levels. A notable exception has been the gold price which has almost doubled over this period. Unfortunately our mining industry has not been able to take advantage of this recovery, nor in fact did the sector respond to the pre-crisis commodity price boom. The manufacturing sector remains under pressure and the recent high frequency data indicate that this sector is likely to experience continued difficulties. While there are indications that household consumption expenditure is recovering, it is still not clear to what extent these trends were temporarily boosted by the World Cup. Growth in gross fixed capital formation remains extremely weak, adding to the fragile growth outlook. What are some of the implications of the recent global developments for the South African economy? One third of our manufactured exports go to Europe, and slow growth in the region could affect this trade. New markets need to be found in other parts of the world, particularly in Asia, Latin America and other parts of Africa, where growth is generally higher. However, the more pervasive impact on the economy has come from a rapid rise in unemployment, the changing pattern of capital flows and the impact on the exchange rate, which has appreciated on a trade-weighted basis by about 7 per cent since the beginning of this year. The increased inflows are partly a result of a positive interest rate differential, but also a result of South Africa’s relatively favourable fiscal position. Although the fiscal deficit was allowed to expand in a contracyclical way in response to the recession, the trend is firmly downward and is expected to be lower than the initial deficit estimates. The debt/GDP ratio, currently at around 32 per cent and expected to peak at around 40 per cent, also compares favourably with those of the advanced economies. Until recently, equity purchases by non-residents were the predominant form of capital inflow. Net bond purchases by non-residents were relatively small by comparison. For example, in the four years to 2007, net purchases of equities amounted to R220 billion, compared with net bond purchases of R34,5 billion. In 2009 the respective net purchases amounted to R75 billion and R15,5 billion. During the latter part of 2009 this pattern of flows began to change, in line with the changing pattern of global flows, and to date in 2010 non-residents have purchased R70,9 billion of bonds and R22,2 billion of equities. What has also changed is the nature of these inflows into bonds. A significant proportion of the inflows appears to be from pension funds and other asset managers who are investing in South Africa in search of higher yields. Unlike in the past when a large portion of inflows into bonds appeared to be speculative in nature and often did not involve actual currency flows as they were funded domestically, these new inflows involve real money and have a direct impact on the exchange rate. However, we have to bear in mind that these are not the only drivers of the exchange rate. Apart from these portfolio flows, we have seen reports of a number of high profile potential FDI inflows, a sign of confidence in the economy. Furthermore, a recent BIS survey showed that more than half of total rand turnover takes place offshore which also have an impact on the rand. There is no doubt that the rand is overvalued relative to its fundamentals, although the extent of the overvaluation is uncertain. The challenge is what can be done about it. There are no clear-cut or easy choices. All options involve significant costs and trade-offs, and there are no guarantees that they will work. Direct intervention is expensive, and is not always effective under current extraordinary circumstances. Controls on capital inflows also have a questionable track record in terms of their effectiveness in reducing the amount of inflows, or the impact on the exchange rate. Some of these policies may be effective in the short run or in changing the composition and maturity of flows, but are less effective in the long run as the markets find ways of circumventing them. A number of countries have tried various means to lean against these inflows, with limited success. In July, the Swiss National Bank reduced its purchases of euros after reporting losses of SF14 billion related to intervention activities. These activities did not prevent an appreciation of the Swiss franc. Recent Bank of Japan intervention amounting to trillions of Yen a day only had marginal short-term impacts on the exchange rate. Emerging market economies have also tried to stem the tide through aggressive accumulation of reserves and through imposing taxes on inflows. Brazil imposed an inflow tax of 2 per cent, which was recently increased to 4 per cent. The impact on the exchange rate appears to have been short-lived, while bond rates increased to compensate investors for the tax. Last week Thailand imposed a 15 per cent withholding tax on non-residents who were previously exempt from this tax on bonds. While we clearly recognise the problem, the solution is not clear-cut. The costs of intervention are not insignificant and involve serious policy choices. Nevertheless the Bank is engaging with the National Treasury, and we are examining the effectiveness and appropriateness of what other countries are doing. Under current exceptional circumstances, where we are experiencing considerable inflows – FDI, bonds and portfolio – we will act to alleviate some of the pressure on the exchange rate by purchasing the FDI inflows either through direct transactions or from the market. Consequently we are already working with the relevant parties to give effect to this. Apart from possibly contributing to moderating current appreciation pressures on the exchange rate of the rand, such purchases are in keeping with our stated policy of building reserves. In the past few days the Bank has absorbed the foreign exchange inflows related to the Didata transaction. Although the exchange rate is posing problems for a number of sectors of the economy, we should ensure that we do not miss out on the possible advantages. South Africa, primarily through the state-owned enterprises Eskom and Transnet, but also with regard to rebuilding infrastructure such as health facilities and equipment, has a considerable capital commitment. Much of this will require that the country imports specialist and capital equipment. At current exchange rates, the cost of such purchases could be considerably reduced. Government as a whole, as well as these two SOEs, need to consider ways of front-loading some of these purchases to take advantage of the strength of the currency, and thereby considerably reduce the cost of the build/capital programme. Implications for monetary policy What are the implications for domestic monetary policy? Monetary policy is conducted within a flexible inflation targeting framework. By this we mean that although the primary objective of monetary policy is to keep inflation within the target range of 3–6 per cent, this is done with due regard to the impact of our policies on growth, employment and financial stability. Inflation is at a 5 year low, at 3,5 per cent, and we expect it to remain within the target range at least until the end of 2012. The global developments have had a favourable impact on inflation. Not only is global inflation low, reducing the threat of imported inflation, but the strong rand has also impacted positively on our domestic inflation outcomes. We have seen this effect very directly on petrol prices, where the higher international product prices have been counteracted to some extent by the exchange rate. Since September 2009, the cumulative moderating effect of the exchange rate on domestic petrol price increases has been in excess of 50 cents per litre. The producer price index also shows that while the headline PPI inflation increased by 7,8 per cent, the imported component increased by 2,1 per cent. This favourable inflation prognosis has allowed us to reduce interest rates to their lowest levels in about 30 years. Our real interest rates are also low by comparison with recent experience. Throughout the 2000s, depending how one measures real interest rates, the average real policy rate was between 3 and 3,5 per cent. In the recent past this has declined to around 1,5 to 2 per cent. Under the conditions outlined, monetary policy is expected to remain relatively accommodative for some time, but contingent on changes in the outlook for inflation and the factors that impact on inflation. Where does the economy go from here? South Africa’s biggest internal challenge is unemployment, currently in excess of 25 per cent on the narrow definition. There is no doubt that addressing this must be the national policy priority. South Africa’s unemployment is of a structural nature, and not something that can be solved by interest rates or the exchange rate alone. As we have noted on numerous occasions, interest rates can have a cyclical effect on growth or employment, but on their own will not be able to solve an inherently structural problem. It is incorrect to look at the interest rate or the exchange rate as the silver bullet that will solve the country’s growth problems. The exchange rate is just one element in the story, and excessive focus on the exchange rate could result in the neglect of other factors that would constrain growth even with an appropriately valued exchange rate. To improve South Africa’s competitiveness and growth prospects requires concerted policy coordination across government departments. There are some obvious microeconomic reforms or initiatives that should be prioritised, and I will refer to only a few. A continued focus on infrastructure is essential. Because the World Cup is behind us, there should not be a decline in spending on infrastructure. This is one of the best forms of expenditure that can be undertaken. It is investment in the future as opposed to current consumption. It is productive, it provides jobs, and it helps alleviate constraints to growth and to exports. While there is a clear need to address the blockages affecting the mining sector, it does not help to increase mineral extraction if the rail infrastructure is unable to get the ore to the ports, and if the ports cannot cope with additional pressure. Our ports are reportedly amongst the most inefficient and expensive in the world. We are well aware of the need for the accelerated build plan of Eskom, as the economy cannot grow beyond a certain capacity without hitting against electricity supply constraints. Currently the civil construction industry is an underperforming sector in the economy, and one experiencing significant job losses. This should not be the case. Skills development and education are key areas where structural reforms are required. This is a long term issue where formal schooling is concerned. But skills development is not confined to the formal school or academic environment. We need skilled artisans, yet we have far too little by way of apprenticeship training. There remain a significant number of vacancies, which, if they were filled, could contribute to economic growth and job creation. The response to the recent crisis, when about one million jobs were lost, demonstrates that we do have a fair amount of labour market flexibility. However, if we are looking at job creation as a priority to address unemployment, then current labour legislation, which extends wage determination to all firms in a particular sector, needs to be examined regarding its effects on small and medium enterprises which should be a focus of growth and employment creation. At the same time, competition policy should be enhanced to reduce the occurrence of monopolistic pricing and other anti-competitive pricing policies. Conclusion South Africa is one of a number of countries impacted upon by global economic events as the advanced economies attempt to emerge from the crisis. Unfortunately we have not been unscathed by these developments. In the short-term, there needs to be coordination of measures to alleviate the immediate pressures. While the Bank is ready to do what it can to alleviate the impact of the stronger currency, we need to recognise the limits to what can be done by the Bank alone in the face of these extraordinary events. The various forms of direct intervention on their own will not suffice, as international experience has suggested. Consideration should be given to combining intervention policies with direct special targeted support measures for those sectors of industry that are hardest hit by the exchange rate developments. These could include direct subsidies or using tax concessions to encourage continued production and/or the retention of employment. These are extraordinary times which call for extraordinary measures. From a longer term perspective, we must also ensure that these exogenous forces do not deter us from introducing necessary structural reforms or policies that will stop further job losses and help improve the overall efficiency and competitiveness of the economy. Policy consistency and coordination is essential if we are to achieve a growing economy capable of absorbing the increasing number of unemployed people in the country. Thank you.
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Welcoming remarks by Ms Gill Marcus, Governor of the South African Reserve Bank, at the biennial conference of the South African Reserve Bank, Pretoria, 4 November 2010.
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Gill Marcus: Monetary policy and financial stability in the post-crisis era Welcoming remarks by Ms Gill Marcus, Governor of the South African Reserve Bank, at the biennial conference of the South African Reserve Bank, Pretoria, 4 November 2010. * * * Introduction It gives me great pleasure to welcome you to the third biennial policy conference of the South African Reserve Bank. The aim of this conference series is to stimulate debate on current topical issues and to add value to these discussions. In order to ensure this, we have invited economists from the policy arena, the private sector and academia. Having a wide crosssection of economists with different perspectives in our midst should enrich a lively debate. We are particularly fortunate to have a number of well-respected local and international economists present, and we are grateful for the opportunity to interact with them. Allow me to also welcome participants from some of our neighbouring countries, including Governor Shiimi of Namibia, Governor Senaoana of Lesotho, and Deputy Governor Mdluli from the Central Bank of Swaziland accompanied by senior officials from their Central Banks. The previous conference, held in late October 2008, took place a few weeks after the outbreak of the global economic crisis. At the time, the full implications were unclear. Two years later, the world has emerged from the recession, but is not out of the crisis, and the global outlook remains uncertain. Some advanced countries are still struggling to stimulate their economies: quantitative easing continues in the United States and Japan, and monetary policy remains accommodative in the United Kingdom, and in the euro area. The banking sectors in Europe and the US remain under pressure. Against the backdrop of fiscal austerity measures, monetary policy is likely to remain loose for longer, which has implications for emerging-market economies in particular, where significant capital inflows have put pressure on their currencies. Unfortunately, the global imbalances that were at the heart of the crisis in the first place are still with us, with few prospects for an imminent resolution of the problems. Nevertheless, it is an opportune time to assess some of the implications of the crisis. Many questions are being asked: for instance, is there a changed role of Central Banks regarding Monetary Policy, Financial Stability and Regulation? This year the theme of the conference is: “Monetary Policy and Financial Stability in the Post-crisis Era”. Within this broad theme we will be focusing on three important areas, namely the implications for banking sector regulation, for emerging markets and for monetary policy. Three plenary sessions will address these themes and I will make a few introductory comments on each of them. The regulatory response to the financial crisis The global financial crisis has spurred a review of banking regulations. Much of the discussions in international forums, such as the International Monetary Fund and the Bank for International Settlements, have centred round the appropriate regulatory responses to prevent a recurrence of unfettered lending by banks in future. Achieving global consensus on these issues has not been easy, and while progress has been made, significant differences still remain. There is the risk that the crisis will result in excessive politicisation of regulatory issues in a quest to ensure that someone is seen to be responsible for the crisis. This has the potential to create a new moral hazard by giving the impression that with the agreement on Basel III, the system is safe. But the regulators do not run the institutions and there are no absolute guarantees of safety. Nevertheless, if things do implode, it would be the regulator that would be deemed to be responsible. The possibility also exists that there has been too much of a focus on banks, rather than on the broader financial system. Over-regulation of banks could not only reduce lending, but it could result in more disintermediation, thus preparing the ground for the next crisis. What the recent crisis has shown is the inventiveness of financial markets to come up with products or institutions that circumvent existing regulations. Furthermore, there is the danger that the pendulum could swing too much in the direction of an excessively tight regulatory regime which could, in turn, stifle the recovery of the banks and their ability to lend, with adverse consequences for the broader economic recovery. South Africa did not have a banking crisis, thanks to prudent management and appropriate regulation and supervision. Nevertheless, the country has not been spared the fall-out of the crisis, nor is its regulatory environment immune to the changes that are being implemented at the global level. Experience and implications of Europe’s economic policy challenges: lessons for emerging-market economies The crisis was characterised by a sharp and relatively synchronised global downturn. The recovery, however, has been varied across countries and regions. The euro area has been particularly hard hit. Its banking sector is still in recovery mode, and while there appears to be some stability currently, the sovereign debt issue that threatened the existence of the euro zone as a single currency area earlier in 2010 remains unresolved. The fiscal austerity measures that have been adopted in response to the sovereign debt overhang are likely to result in a low growth scenario in the region, especially in southern Europe, for some time. These developments and policy challenges have implications for emerging-market economies, including South Africa. About one third of SA’s manufactured exports go to the euro area, so there are obvious implications for South Africa from a slow-growing region. The IMF has revised down its projections for euro area growth in 2011 to 1,5 per cent, a figure that is positively affected by the 2,0 per cent growth expected in Germany. There are also important lessons to be learnt from the euro area for future economic and monetary integration in Africa, where the euro was previously held up as the model to follow. The crisis, however, exposed two particular problems that were more easily hidden during periods of economic growth. First, there was a lack of an effective mechanism to ensure uniformity in fiscal policy. The Stability and Growth Pact was not able to constrain fiscal deficits and in 2010 widely divergent fiscal deficits were apparent, which ultimately led to the sovereign debt crisis. According to the OECD, fiscal deficits in 2009 ranged from 3,1 per cent of GDP in Germany, to 13,6 per cent and 14,6 per cent in Greece and Ireland respectively. The associated debt build-up led to the sovereign debt crisis earlier in 2010 and the spreads on this debt indicate that the markets are not convinced that these issues have been fully resolved. This suggests that in order to have viable economic and financial integration, there may be a case for a single fiscal authority, in the same way that there is for a single central bank. Such a move, however, is likely to be far more politically sensitive than reaching agreement on a common monetary authority. Second, the crisis in the euro area has shown that having a fixed exchange rate mechanism does not imply that a country’s international competitiveness is automatically maintained. Fixing a nominal exchange rate does not imply real exchange rate stability. This is a wellknown fact, but generally forgotten by the proponents of a fixed exchange rate, including those in South Africa who view it as the silver bullet to solve to country’s problem of competitiveness. If exchange rates are pegged, or if countries adopt a common currency, differences in wage settlements, productivity changes and fiscal stances can cause real exchange rates to diverge between different regions. In the euro area, for example, Greece’s unit labour cost competitiveness declined by around 30 per cent in the course of the 2000s. Adjusting to this without the exchange rate as an equilibrating mechanism requires standard expenditure reduction policies. A number of euro area countries are now experiencing such pain. Professor Desmond Lachman’s analysis of the Eurozone outlook provides a thoughtprovoking perspective on the challenges that lie ahead. Monetary policy and financial stability in the post-crisis era The crisis also had implications for how monetary policy is viewed. In particular, the role of monetary policy and its relationship with financial stability has come under intense scrutiny. During the 2000s, economists at the BIS were at the forefront of warnings against a singular focus on price stability at the expense of financial stability. The previous Economic Adviser and Head of the Monetary and Economic Department at the BIS, Bill White, argued that such a focus, in the presence of low inflation, was likely to lead to the emergence of asset price bubbles. While many of his predictions proved to be correct, there is still much debate about the interaction of monetary policy and price stability, the practical implementation of these policies, and appropriate policy instruments. It is clear that the core focus of central banks has changed. It is no longer the case that monetary policy can be conducted in a vacuum, and there has to be a focus on financial stability issues. The challenge is to determine how best this is done. One has to determine what central bank measures are and what are not, and ensure that the core responsibilities and independence of the central banks are not overwhelmed or compromised. Things will have to be done differently: central banks need to create better levels of knowledge and skill− perhaps also collect different data − or change the way in which they look at data. There is still no general agreement on what the role of the central bank should be with respect to financial stability or, indeed, what financial stability actually means. However, the discussions raise some important questions about the changes in the design of central banks, and possible changes in the relationship between a central bank and government. There needs to be an understanding of who is responsible for financial stability and how it should be executed. Clear parameters need to be set and formalised arrangements made. There can be little doubt that the central bank plays a key role in financial stability. In fact, most central banks already have an explicit or implicit responsibility in this regard. The question is, however, should this be the sole prerogative of the central bank? During times of crisis, it is usually the case that the first port of call of banks that are in trouble is the central bank. This is the case even if the bank supervision function is not located inside the central bank. The central bank has a role of lender of last resort: it generally oversees the payment system, it has the ability to inject liquidity into the markets in general or into specific dysfunctional sectors of the markets and, in many instances, it is responsible for the micro supervision of banks. But it does not necessarily follow from this that the macro prudential oversight or the financial stability mandate should be located solely within the central bank. Financial stability requires a national response influenced by political priorities. During the crisis, the fiscal authorities in a number of countries made large capital injections into ailing banks and also provided government guarantees. Furthermore, any lender-of-last-resort activities have fiscal implications, even if they are initiated by the central bank. The bottom line is that it would be difficult to define a financial stability objective for the central bank alone, and it would be difficult for the central bank to carry out the financial stability functions on its own. This points to a shared responsibility for financial stability, within clearly defined parameters. Therefore, a way needs to be found to co-ordinate with government as many of the policy options and their funding requirements blur the boundaries between the central bank and the fiscal authorities. Financial stability decisions are generally more political and require more interaction with government. It is finding a balance of engagement with government with regard to financial stability, and maintaining the independence that is an imperative in conducting monetary policy, that will be important going forward. Both Professor Charles Goodheart’s paper, and that of Dr Stephen Cecchetti, provides a very challenging and thoughtful contribution to these deliberations. Conclusion These broad topics will broadly cover the theme of the conference, and we are honoured to have such a distinguished line-up of world authorities to present their perspectives on these issues. In particular, I wish to thank and extend a warm welcome to our presenters, Charles Goodhart, Desmond Lachman and Stephen Cecchetti for their participation. I also wish to thank the discussants and panel members who I am sure will encourage vigorous dialogue. And to all participants, please do not hold back on your thoughts and views. Although we will not solve the problems of the world, hopefully our interactions over the next two days will contribute to a better understanding of the issues involved.
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the 1926 Rand Club, Johannesburg, 30 November 2010.
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Gill Marcus: Has monetary policy independence been undermined? Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the 1926 Rand Club, Johannesburg, 30 November 2010. * * * Introduction We are nearing the end of a difficult year, a year that began with so much promise but is now ending on a note of high uncertainty. On the global front, the expectations of a normalisation in the advanced economies were proved to be wrong, and indications are that low growth and accommodative monetary policies are likely to be sustained for some time. This has contributed to the strength of the rand exchange rate as capital continues to flow out of the advanced economies in search of higher yields. Domestically, growth has also disappointed. However the strong rand has contributed to the more benign inflation environment which, along with a persistent negative output gap, has contributed to lower interest rates. During the year there has been a focus on issues relating to monetary Policy Independence in response to the letter from the Minister of Finance clarifying the mandate of the Bank, as well as the recent New Growth Path document, in which reference was made to a looser monetary policy stance. There are perceptions that these documents have undermined the independence of the Bank, and there has been a tendency to over-interpret monetary policy actions in terms of these discussions. For example, when the repo rate was reduced at the previous meeting, some analysts argued that because there was no economic rationale for this move, it therefore must have been politically inspired. A few days later, when the disappointing growth figures were announced, these analysts conceded that our decision was vindicated on economic grounds. There are some who believe that any reference we make to growth or unemployment is an indication that we are not independent enough. At the same time there are elements in society who believe that we are too independent and that the goals of monetary policy should be changed. In my talk this evening, I will state the Bank’s perspective on these issues and then briefly review our monetary policy actions over the past year. Monetary policy independence In discussing the issue of monetary policy independence, it is useful to distinguish between goal independence and instrument or operational independence. The former refers to the setting of the objectives of the central bank, while the latter relates to the actual implementation of the mandate that is given to the bank. It is generally accepted that the goal of monetary policy should be set by the elected representatives of the country. But even here choices are constrained by what monetary policy can achieve. The objectives should be set within the parameters of what monetary policy can achieve, not what we would like it to achieve but is unattainable. Monetary policy independence generally relates to operational independence, and derives from the need to avoid using monetary policy for political expedience and to avoid the so-called political interest rate cycle, where there was a temptation for some governments to reduce interest rates before a general election and then raise them soon thereafter. In South Africa, monetary policy independence is enshrined in the Constitution. In terms of the Constitution, the primary objective of the Bank is to “protect the value of the currency in the interest of balanced and sustainable economic growth … 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.” There are three important issues that come out of this. First, the goal of monetary policy is to maintain the value of the currency, which means low and stable inflation. The current framework is one of inflation targeting with the actual target set by the government. This is very much in line with the practice in many countries. But it is important to note that the objective of low inflation is not for its own sake, but in the interest of sustainable and balanced growth. In other words it is a recognition that monetary policy should contribute to long-term growth, which it does through providing a conducive environment for growth. But as we have stated before, we also have to recognise the limits to our impact on growth. Monetary policy can and does affect cyclical growth around long run potential output growth. In other words, we can affect the size of the output gap by impacting on cyclical growth. However, our impact on potential output itself is limited – this is really the job of microeconomic and structural policies. Second, while the Bank does not have goal independence, it has independence in the application of monetary policy. Thus it is we who are responsible and accountable for how we implement policy within a given goal. Third, we are required to consult regularly with the Minister of Finance. This is not an undermining of independence, but rather a mechanism to ensure effective macroeconomic coordination. It should be clear then that central bank independence is not absolute. We are an integral part of the economy and therefore not independent of the economy. We are not an ivory tower, or in our case a glass and granite tower that is independent of and impervious to the economy in which we operate. We also take our cue with respect to our goals from the constitution and from government. The “mandate letter” We are aware that there is still some uncertainty in the public domain relating to the letter that was sent by the Minister of Finance to myself in February, in which he clarified the mandate of the Bank. The letter very clearly confirms that the primary objective of monetary policy is the containment of inflation within the target range of 3 to 6 per cent. Furthermore the letter confirmed the flexibility of the mandate in allowing for deviations from the target in the event of exogenous shocks, and the need to avoid unnecessary instability in output and interest rates under such circumstances. This is the essence of flexible inflation targeting. At the same time it is stated that in taking monetary policy decisions, we should have due regard to the factors that might impact on the attainment of balanced and sustainable growth. These factors include the output gap, credit extension and asset bubbles, employment and other labour market developments and the stability and competitiveness of the exchange rate. These factors are not only taken into account with respect to their impact on inflation, but our actions have also been affected by a concern for the impact of our actions on these variables. A number of studies have borne this out, including a 2007 paper by Ortiz and Sturzenegger in which the reaction rule of the Bank was estimated and found to be in line with those estimated for a number of advanced economies. The study showed that compared to emerging markets, South African monetary policy has been more stable, with a more consistent anti-inflation bias but with a somewhat larger weight on output, although a low weight on the exchange rate. There is nothing in the mandate letter that we feel undermines our independence with respect to monetary policy implementation. There was however an additional aspect to the letter which is often overlooked. That is the additional specific mandate for financial stability that was given to the Bank. Although the role of financial stability is generally implicit in the mandates of central banks, it is often not explicit. The financial crisis underlined the importance of clarifying the roles of the different institutions in the economy with respect not only to normal microprudential regulation and supervision of the banking sector, but also to broader macroprudential oversight. The central role of the Bank in this respect was reaffirmed in the recent Medium Term Budget Policy Statement. A great deal of work is currently under way in various international fora to get a deeper appreciation of what macroprudential oversight actually entails, and the organisational structures and legal framework that needs to be in place. Monetary policy and the New Growth Path Government’s new growth path was published recently and places employment creation at the centre of government’s strategic focus. Given the high rate of unemployment in the economy, this is as it should be. While I would not want to comment on the detail of the plan, it would be appropriate for me to say a few words about the proposals that affect the Bank directly. But before doing so, I wish to emphasise an aspect that came through strongly in the Growth Path proposals: that is, the need for policy cohesion and coordination. Apart from the need for common purpose, different elements of policy can only work effectively if there is an appropriate policy mix, and if the different policies are coordinated. Policy consistency, coordination and sequencing are essential requisites for policy success. The macroeconomic proposals outlined in the new growth path should be seen in this context. According to the New Growth Path, the macroeconomic stance will be guided by “a looser monetary policy and a more restrictive fiscal policy backed by microeconomic measures to contain inflationary pressures and enhance competitiveness … The monetary policy stance will continue to target low and stable inflation but will do more to support a more competitive exchange rate and reduced investment costs through lower real interest rates. This will be accompanied by measures … to contain inflationary pressures and enhance competitiveness”. These latter measures include more effective competition policies, and a review of administered prices to ensure that their increases are not higher than inflation unless there are compelling reasons. Furthermore, the proposals include a social accord to moderate or cap wage and salary increases. Our interpretation of this is that the proposals recognise that the Bank’s mandate remains the achievement of low and stable inflation. In a low inflation environment, nominal and possibly real interest rates will be lower, and the real exchange rate will be more competitive because our prices and wages will not be increasing relative to those of our competitor countries. Monetary policy actions are guided to a large extent by the pressures that are being placed on inflation. For a long time we have noted that the main risks to the inflation outlook are administered price increases, many of which are significantly above inflation, as well as wage increases that are unrelated to inflation and productivity increases. The lack of competition in some sectors of the economy has also been identified as a constraint to price-setting that is more responsive to domestic demand conditions, and therefore more responsive to changes in the monetary policy stance. Improvements in these areas can help to reduce inflation and create the space for a more accommodative monetary policy stance. The same is true for a tighter fiscal policy. There is a clear theoretical rationale for a tight fiscal policy and loose monetary policy mix, and this was at the heart of the macro-economic proposals of the Harvard-led international panel in 2007. Theoretically, lower interest rates will allow for a weaker exchange rate because of the narrowing of interest rate differentials which make it less attractive for foreigners to buy interest-bearing securities. But because of the inflationary impacts of the low interest rates and the weaker currency, fiscal policy needs to compensate for this by reducing expenditure and providing the additional policy instrument. At this stage further work needs to be done to determine the degree to which fiscal policy needs to be tightened in order to support monetary policy in this way. It is also not clear that fiscal policy has the flexibility to take over the role of monetary policy as an antiinflationary policy on a cyclical basis. Discretionary changes to the fiscal policy stance take time to implement, unlike in the case of monetary policy. The current fiscal policy stance is tighter than it was at the height of the crisis, but the estimated structural deficit of around 4 per cent represents a much looser stance than was the case during 2000–2008 when it was generally well below 2 per cent. Similarly, real interest rates are currently much lower than was the case over the past years. The long term real repurchase rate has averaged between 3–3,5 per cent over the past decade. The current real repurchase rate, assuming an expected inflation of around 4,5 per cent, is equivalent to 1 per cent. Should inflation surprise on the upside, this real rate would decline as well. This suggests that currently both fiscal and monetary policies are relatively loose, which in our view is appropriate for the current state of the economy and the low global real interest rate environment. However, should the economy, particularly domestic expenditure, start to pick up significantly, this mix would have to be changed. We must also not forget the issue of sequencing and coordination. Some of these proposals may take some time to implement and to be effective. Monetary policy cannot be loosened in advance of these other reforms unless there is a clear notion of the extent of fiscal tightening and certainty about the time horizon over which microeconomic reforms can be effectively implemented and achieve results. In the absence of such coordination, excessively low real interest rates will not necessarily bring about increased investment. They are more likely to result in higher inflation and consequently higher long term interest rates, which will impact negatively on the cost of government borrowing and the cost of capital. Under such circumstances, real long term interest rates are likely to rise even further because of a possible increase in the risk premium. The proposals as set out, if successful, will help to contain inflationary pressures and thereby give an additional degree of freedom to monetary policy and allow for the “looser” monetary policy stance that is proposed. Such a stance of monetary policy would in fact follow automatically under such circumstances, particularly under conditions of weak domestic demand. The Bank’s view therefore is that the independence of monetary policy is not undermined in the New Growth Path proposals. Our mandate remains the attainment of low and stable inflation, and to the extent that other policies and micro-economic interventions are supportive, we will have greater flexibility in the conduct of monetary policy. However, as I indicated above, we have to be realistic about what monetary policy can achieve in solving an unemployment problem that is essentially structural in nature. Part of the rationale for the monetary policy proposals were to deal with the strong exchange rate. The New Growth Plan recognises that intervention in the foreign exchange market is not a simple solution as intervention is expensive and not necessarily effective. Nevertheless further intervention is not ruled out and is consistent with the Bank’s activities in the foreign exchange market. However we must bear in mind that competitiveness of the currency refers to the real exchange rate i.e. the nominal exchange rate that is adjusted for relative inflation rates. Achieving a more depreciated nominal exchange rate will not help with competitiveness if it is simply offset by higher inflation. Therefore the need for low and stable inflation cannot be overemphasised, and this is apart from the adverse effects that inflation has on the poor in particular. In advocating the macroeconomic policy mix of tight fiscal policy and loose monetary policy, there is an underlying assumption that the main determinant of the exchange rate is the interest rate differential, and that lower domestic interest rates will reduce interest sensitive capital flows. However, experience has shown us that reality is not so simple. There have been periods in the past, and this was true for much of the 2000s, when capital inflows were dominated by flows into the equity markets. In other words, capital was attracted by growth prospects rather than interest rate yield differentials. To the extent that lower interest rates improve the growth outlook, the decline in interest-sensitive inflows may be more than offset by flows into the equity market or to direct investment. Finally, I should emphasise that while the proposals may have an internal economic logic, the reality may be far more complicated. In particular, it is not always possible to achieve the goals of low and stable inflation, a competitive exchange rate and low real interest rates simultaneously. There are unfortunately times when conflicts between these objectives will arise, and the bank should be in a position to act independently, in line with its constitutional mandate, when such a situation arises. Recent monetary policy The past year was a challenging one for the conduct of monetary policy. At the beginning of the year, the view that policy normalisation in the advanced economies would begin by the middle of the year implied an expected moderation of capital flows to emerging markets during the year. Domestic growth was also expected to be positively affected by the improved global environment. At that stage, when the repurchase rate was still at 7 per cent, the exchange rate was at around R7,60 against the dollar and inflation expected to average just under 6 per cent over the year. It was also our view that we had possibly reached the bottom of the interest rate cycle. The interpretation of the high frequency data at that time was also complicated by the distortions created by the World Cup. As the year progressed, it became increasingly apparent that the monetary policy environment in the advanced economies was likely to remain highly accommodative for longer, and this view was reinforced by the emerging sovereign debt crisis in Europe. This had implications for the rand exchange rate and its expected future path, as well as for the outlook for domestic inflation. Domestic growth was also expected to be negatively affected by these events. As a result, our inflation forecast was progressively revised downwards. For example, at the March meeting, the expected low point for inflation in the third quarter of 2010 was 4,9 per cent. By the September meeting this had been revised down to 3,7 per cent. Furthermore, and of greater significance, the longer term expected trend of inflation was also revised downward to the extent that the entire expected inflation trajectory over the forecast period was seen to be comfortably within the inflation target range. The forecast in November 2010 indicated that inflation was expected to be 4,8 per cent at the end of the forecast period in the final quarter of 2012. Against the backdrop of relatively weak domestic demand, we felt that there was room for further monetary accommodation to help stimulate the economy without jeopardising the inflation target. If inflation is, or is expected to remain within the target, monetary policy will have greater flexibility to focus on growth issues, particularly when the growth rate is below potential. This is entirely consistent with a flexible inflation targeting framework. The repurchase rate was reduced by 50 basis points on three occasions: in March, September and November. On each occasion it was the view of the MPC that we were either at or close to the bottom of the interest rate cycle and we had signalled that the room for further cutting was limited. However, in subsequent meetings, as I have said already, the outlook had changed significantly, and in effect the real interest rate was increasing with the decline in expected inflation. It is important to reemphasise that any signal is not a commitment, but a signal conditional upon no significant changes in the outlook. Under periods of heightened uncertainty, as we have been experiencing, it is likely that conditions will change more rapidly, although the direction and extent is not always clear. As we signalled in our most recent meeting, the room for further rate cuts is limited by the fact that we are now seeing more definite signs of a sustained recovery in household consumption expenditure and domestic credit extension. Conclusion Monetary policy is always made under conditions of uncertainty. The lags in the impact of monetary policy mean that policy has to be made on the basis of expected developments and expected inflation outcomes. The more uncertain the environment is, the more difficult it is to have a clear future path of interest rates. Monetary policy settings will need to change in line with changing circumstances. At the very least, we should strive to be consistent on the basis of how we view the rapidly changing world. Our actions have been and will continue to be guided by how we see and interpret these developments, and we will continue to implement monetary policy independently, but mindful of the impact on other variables in the economy. The policy rate is currently at its lowest level in over 30 years, the real rate is below its long term average and the inflation rate is expected to remain within the inflation target range for the forecast period. These developments are a result of a consistent application of a flexible inflation targeting mandate. As always the Bank stands ready to play its part in contributing to longer term sustained economic growth in the economy by ensuring a low inflation environment. Low inflation or price stability can contribute to long-term growth by providing greater stability and reducing uncertainty, which will be positive for longer term investment. Thank you.
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Southern African Development Community (SADC) Payment System Integration Workshop, Centurion, 22 March 2011.
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Daniel Mminele: The current state of payment system integration Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Southern African Development Community (SADC) Payment System Integration Workshop, Centurion, 22 March 2011. * * * Good morning ladies and gentlemen. It is a pleasure to be with you once again, and an honour to have been asked to make a few remarks at the opening of the SADC Payment System Integration workshop. It is only little more than a year since we launched the project to integrate the region’s payment systems. If we cast our minds back, at that time we were all reasonably constructive about where the world was going. Most parts of the world had just emerged from a severe recession, the global economy had been successfully pulled away from the brink, and economic indicators were generally pointing the right way, albeit with some risks that we could identify. We had subsequently seen very encouraging growth rates during the first quarter of 2010. All this, however, started to change during the second quarter, when the European sovereign debt crisis presented new challenges, which are still with us today, and in the process exposed how fragile the banking and financial systems still were after the crisis, and delivering the very sobering message that the road to a strong and sustainable global recovery was going to be a rather slow one, and would be uneven across countries and regions. More recently, we have witnessed a series of natural disasters, and geopolitical risks increasing, the full impact of which on the global economy remains uncertain at this stage. And of late in some parts of the world inflation concerns are coming to the fore again, requiring delicate balancing acts on the part of policy makers to ensure that inflation expectations remain anchored while avoiding any undue damage to recovery prospects. As we will be starting our monetary policy committee meeting later today, I will certainly not comment on the South African situation, but refer you to the statement that we will issue on Thursday afternoon. We have many lessons to learn from the crisis, while the crisis has also left many questions unanswered. These challenging and uncertain times that we are experiencing will in some way or another also have a bearing on the SADC payment system integration project. Two areas specifically spring to mind: The one being the evolving agenda and package of measures to address the root causes of the global banking crisis, the other being the events in Europe, where certain euro zone member countries had to be rescued by others together with multilateral organisations, resulting in the European integration project being put to a rather severe test. The two circumstances can present very different sets of challenges and could impact the SADC integration project in different ways, in that each could impact a different set of roleplayers. The emergence of measures to address issues that led to the global banking crisis has a direct impact on commercial banks, and on regulators who are required to refine existing or introduce new regulatory and supervisory measures. The events in Europe, which revealed that, while there are no doubts about the benefits of monetary unions, under certain circumstances they can put serious constraints on countries, on the other hand may harbour even broader implications. Countries in the SADC region will probably carefully monitor the situation in Europe to reassess the admittance criteria and control measures for a future SADC monetary union. BIS central bankers’ speeches Commercial banks will be required to conform to more stringent regulatory requirements because of the new measures introduced following the banking crises. Regulators are required to review their oversight and supervisory procedures of commercial banks. A higher level of co-operation between regulatory bodies is becoming essential to ensure that different facets of a commercial bank’s structure and operation are adequately examined. Joint oversight and mutual co-operation initiatives between regulators are being formalised by memoranda of understanding and we are observing the formalisation of roles of the different regulators in integrated environments. The significant commitment required of commercial banks to meet the new requirements could result in a shift in focus away from regional initiatives. Regional initiatives could take lesser priority for the banks. The role of the SADC Banking Association becomes even more crucial in the effort to integrate the payment system environment. Commercial banks, despite their commitments to effect changes to meet new regulatory requirements, should continue to play their part in making the regional integration initiative a success, not least because they stand to benefit from the opportunities that regional integration will bring with it. The SADC Banking Association is ideally positioned to work with the banking community, and a close working relationship with the project team is similarly of paramount importance. Events of the recent past in Europe have prompted SADC to examine more carefully the criteria for admittance to the monetary union. This together with the time being taken for the establishment of control measures and procedures, will more than likely delay the eventual establishment of the SADC Central Bank and the introduction of the SADC single currency. The dates initially contained in the Regional Indicative Strategic Development Plan (RISDP), which called for the establishment of the SADC Free Trade Area (FTA) by 2008; a SADC Customs Union by 2010; a SADC Common Market by 2015; a SADC Monetary Union by 2016; and a Single Currency by 2018, are now being reviewed. With the target dates being reviewed, sufficient care should be taken to ensure that the momentum of the individual projects is not lost, and that the project teams should continue to focus on their goals. As members of these project teams, you are required to manage the uncertainties and the changing operating environment, and deliver a system in time for the introduction of the SADC currency. The changing environment and possible change in schedule requires flexibility in the approach to managing the project. The SADC Payment System Project team has therefore made some adjustments in its approach and strategy. I believe that the consequences of this changed approach will be the focus for discussions at this workshop. Established regional structures could possibly make a significant impact in the integration process. By simply broadening the base they could make ideal starting points for the SADC integration. It is being increasingly suggested that structures like CMA and SACU can be leveraged and expanded to include the other SADC countries. Legal constraints could be addressed and legal frameworks enhanced to create an environment, which allows SADC countries to be included as and when they meet the convergence criteria. The Payment System Project team has adopted this approach for the payment system integration project and is introducing the concept of a model for integration based on the CMA. I am sure the technical and legal issues will be discussed in detail at this workshop and that there will be ample opportunity to exchange views around the proposed strategy. The significant aspect of the CMA solution for payment systems is that parity already exists between the four currencies involved. This allows the project team to build a single-currency system and have it tested, implemented and have the legal, emotional and psychological BIS central bankers’ speeches barriers removed. We all know how emotive an issue it will be to eventually let go of national infrastructures, even if it is for the greater good. The SADC integration project is wide ranging. It will require the co-operation and commitment of varied role-players to make it a success. It is therefore significant that the different sub-committees of the CCBG are represented here today. The speed at which different sub-committees are moving needs coordination so as to avoid a situation where the payment system project is running ahead of other projects. Your presence will enhance the discussions and will ensure that relevant issues are tabled and that they are adequately addressed. Your agenda for the next three days is quite rich. This could be a very significant three days for the SADC integration project. You may look back at this workshop, when the project is successfully completed, and appreciate some of the preparatory work that you would have completed over the next 3 days, and I am sure be proud to have been part of it. I wish you well in your discussions and that you have a successful workshop. Thank you. BIS central bankers’ speeches
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Introductory remarks by Dr Xolile P Guma, Senior Deputy Governor of the South African Reserve Bank, at the launch of the March 2011 Financial Stability Review, Pretoria, 20 April 2011.
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Xolile P Guma: South Africa’s Financial Stability Review – key issues in March 2011 Introductory remarks by Dr Xolile P Guma, Senior Deputy Governor of the South African Reserve Bank, at the launch of the March 2011 Financial Stability Review, Pretoria, 20 April 2011. * * * Members of the press, other guests and colleagues On behalf of the South African Reserve Bank, I would like to welcome you to the release of the March 2011 edition of the Financial Stability Review; the fifteenth publication in this series. The Bank knows that it is not the sole custodian of financial-system stability. Financial stability is a responsibility that it shares with other role-players and it is well placed to take a leading role. To pursue the maintenance of financially stable conditions and contain systemic risk, the Bank continually assesses the stability and efficiency of the key components of the financial system and formulates and reviews policies for intervention and crisis resolution. The assessment largely takes the form of the Financial Stability Review. I turn now to the Financial Stability Review and highlight some of the key issues that the March 2011 edition addresses. First, the Review indicates that during the second half of 2010 global macrofinancial conditions improved broadly, although pockets of vulnerability and risk remain and significant policy challenges still need to be addressed. Global economic activity moderated somewhat as the brisk recovery phase following the global financial crisis turned into a slower and, hopefully, more sustainable recovery. The multi-speed nature of the recovery continues with subdued economic growth and high unemployment in advanced economies, and buoyant economic activity and rising inflationary pressures in many emerging market economies. The financial risks in advanced economies that might impact on the stability of the South African financial system, and which are discussed comprehensively in the Financial Stability Review, are vulnerabilities in the euro area; banking-sector vulnerabilities; negative sentiment and declining prices in real-estate markets in a number of advanced economies; and a broadening of the concept of global imbalances as trade, fiscal and investment imbalances have increased. Emerging market economies as a group remained important drivers of global economic growth in the second half of 2010 with countries in developing Asia recording the most rapid growth among all of these countries. Emerging market economies are, however, also exposed to lingering downside risks in the form of rising inflationary pressures, the possibility of sudden reversals of capital inflows and sharp increases in the level and volatility of commodity prices. In many sub-Saharan African countries economic growth has returned to pre-crisis levels, but growth prospects will depend on a sustainable recovery in the global economy. Recent political instability in the Middle East and North Africa region, and the resulting rise in oil prices, coupled with rising food prices, pose significant challenges to the economic outlook in the sub-Saharan Africa region. Various groupings of financial authorities and international standard setters, including the Group of Twenty Forum, the Basel Committee on Banking Supervision and the Financial BIS central bankers’ speeches Stability Board are actively contributing to initiatives to create a stronger international regulatory framework. At the same time, countries have responded by reforming national regulatory systems. The roles and responsibilities of central banks in regulating and supervising financial systems have been extended in some jurisdictions. Principles are being developed to deal with the “too-big-to-fail” moral hazard problems and to increase the capacity to absorb losses of systemically important financial institutions. In addition, regulatory gaps are increasingly being closed in various jurisdictions by extending the regulatory perimeter to include hedge funds, private equity funds and rating agencies, and more transparency and accountability in the derivatives market are envisaged. It is trusted that these initiatives will contribute to a more stable global financial system. In South Africa, despite positive signs of economic recovery, high levels of unemployment continued to place a damper on activity in the domestic financial system. Nevertheless, the banking and insurance sectors maintained high-quality capital and liquidity buffers well above the minimum prudential requirements, and remained profitable. Gross loans and advances increased in December 2010 compared to a year ago, albeit at a moderate pace. The rising trend in the growth rate of impaired advances seems to have peaked and indications are that it may start to decline in the near future. The high levels of capital inflows that featured in many emerging economies in 2010 and that created significant policy challenges for South Africa, reversed somewhat in the fourth quarter of 2010. This trend continued into 2011 as non-residents became net sellers of local currency bonds and equities. The way forward will depend largely on the future recovery of the global economy and the unfolding events in Europe. Recent tensions in the Middle East and North Africa countries, the substantial impact on oil prices, and developments in Japan, together with increased prospects of further monetary policy tightening in advanced economies, will be developments of which to take note. Although household debt to disposable income remained at elevated levels and the profile of credit-active consumers worsened somewhat in the fourth quarter of 2010, the improved outlook for economic growth in 2011 could boost the confidence level of consumers in South Africa. In the corporate sector, the increase in profitability, as reflected by the gross operating surplus, and the increase in the annual growth rate of credit extended to the sector, are possible indications of a recovery in business confidence. In the property market, property price indicators have been declining over the past year, despite lower interest rates and rising real income. Job losses, which negatively affect consumers’ ability to take up new credit, might have had an impact on prospective homeowners’ ability to purchase a residence. Recent developments enhancing the robustness of the financial regulatory environment in South Africa include reviewing the prudential framework for foreign investment by private and public pension funds, reviewing the framework for cross-border direct investment in South Africa, the release of the final draft of amendments to regulation 28 of the Pension Funds Act, and reviewing the Securities Services Act as part of a process to consolidate several financial services acts. I have briefly highlighted the key issues raised in the Financial Stability Review. More detailed analyses are available in the publication itself, and will be highlighted by the authors’ presentations. I trust that you will find these interesting, stimulating and relevant to the current environment and invite you to provide comment as part of the important process of ongoing debate on financial stability. Thank you BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bank's Financial Markets Department's Annual Cocktail Function, Pretoria, 7 April 2011.
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Daniel Mminele: Global economic and financial market developments – implications for South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bank’s Financial Markets Department’s Annual Cocktail Function, Pretoria, 7 April 2011. * 1. * * Introduction Good evening, ladies and gentlemen, and a sincere welcome to you all to the fifth annual cocktail function of the Financial Markets Department. As you are aware, the Financial Markets Department hosts this function both to convey its appreciation for the co-operation it receives from counterparties in its market operations and to give an update on its operations to market participants. Tonight’s function also provides an opportunity for us to bid farewell to our long-time colleague and friend, Dr Roelf du Plooy, who officially retires from the service of the Bank at the end of this month. I know that many of you have already met and interacted with Ms Zanele Mavuso Mbatha in her new capacity, but I should also like to use this opportunity to introduce her formally to market participants as the new head of the Financial Markets Department. She took up the role in January 2011, and has been working with Roelf du Plooy to facilitate a smooth transition and succession. Before I give you an update on the market operations of the Financial Markets Department, allow me briefly to touch on the global economic and financial markets backdrop and its implications for South Africa and our operations. 2. Global economic and financial market developments Global economic developments continue to be characterised by high levels of uncertainty. While the global economic recovery appears to be on track, it remains uneven with the advanced economies growing slower than emerging-market economies. Sovereign debt challenges and high levels of unemployment still present risks to growth in advanced economies, and many emerging-market economies have to grapple with risks of overheating economies and rising inflationary pressures. More recently, downside risks to growth have increased on the back of recent developments in the Middle East and North Africa (MENA), which have led to a further increase in the oil price, to more than double the levels that prevailed about a year ago. Food prices have increased substantially in many countries and have added to the pressures being observed. It is generally anticipated that the effects of the earthquake in Japan on the global economy will be of a short-term nature, but until the full extent of the damage and implications of the nuclear disaster are known, risks and uncertainty remain. Global financial markets have been reflecting these levels of uncertainty and have been experiencing increased levels of volatility, with the VIX index spiking to 30 index points in mid-March. Efforts to try and find lasting solutions to the European sovereign debt crisis, currency interventions in the wake of the Japanese disaster, sovereign rating downgrades and bank stress tests are all impacting on developments in financial markets. As they say, the only certainty in financial markets is uncertainty. The recent global and financial market developments are presenting challenges for monetary policy makers around the world, who have to ensure that they maintain credibility and protect macroeconomic stability by managing inflation risks, while at the same time avoiding undue damage to growth prospects by possibly acting too hastily to remove accommodative policies. BIS central bankers’ speeches 3. Implications for South Africa As a relatively small and open economy with sophisticated financial markets, South Africa will not escape the impact of global economic and financial market developments. A third of South Africa’s exports of manufactured products are destined for Europe. The country sells commodities to Asia and has been witnessing increased exports to that region. Japan is South Africa’s fourth largest trading partner, with platinum and other semi-processed metals being the major exports. South Africa is a significant importer of oil. At the conclusion of the most recent Monetary Policy Committee (MPC) meeting on 24 April 2011, we highlighted these international developments and indicated that, based on shortterm economic indicators, the domestic growth momentum would likely be maintained. We lifted our forecast for economic growth from 3,4 to 3,7 per cent for 2011. Consumption expenditure – particularly by households – is holding up well, credit extension figures released last week show a better take-up of credit by businesses, implying that the recovery in investment spending will pick up and that subdued growth in gross fixed capital formation will improve. The improved reading on the most recent Purchasing Managers Index to a level of 57,2, with very encouraging readings for the business activity and new order components, appears to confirm the favourable outlook for the manufacturing sector. Unfortunately, the employment subindex confirmed the serious challenges the country is facing with job creation. The MPC also highlighted the Bank’s view that the risks to the inflation outlook are on the upside, with food and administered prices – particularly oil prices – being among the biggest risks. While we expect to remain inside the target range until the end of 2012, our most recent forecast, showing CPI averaging 5,7 per cent for 2012, indicates that the room to manoeuvre is becoming less. We all witnessed another significant increase in petrol prices earlier this week, and while South Africa’s food price inflation is coming off a low base as a result of previous bumper maize crops and a favourable exchange rate, Producer Price Inflation (PPI) numbers show rising trends for both agricultural and manufactured food prices. This situation will require careful monitoring going forward. The MPC is committed to achieving the inflation target within the parameters of its mandate. However, given that inflationary pressures are currently seen to be mainly of a cost–push nature and not demand-driven, any future policy action and its timing will be based on the MPC’s assessment of any second-round impacts. During the global financial markets crisis – and even now with the current risks that could threaten markets and financial stability – the South African financial markets continue to function effectively. We have, however, experienced capital and foreign-exchange market volatility in line with international developments. When we met here about a year ago, sentiment in the domestic and international financial markets improved amid a plethora of positive global economic indicators that pointed to a sustainable global economic recovery. The JSE All-Share Index traded at a level of over 29 000 points while the VIX Index declined to well below 20 index points in March 2010. The strong upward momentum in the domestic equity market continued until mid-February 2010, when the All-Share Index reached near-record levels. However, since then, gains in the domestic equity market have been limited, although on a year-to-date basis, the All-Share Index has increased by about 2,4 per cent. The domestic market continues to be impacted by negative developments in the euro zone and the MENA region, as well as global inflation concerns and monetary policy tightening by some emerging-market economies. In addition, the All-Share Index has been affected by industrial action, volatile exchange rate movements and sharp losses in the platinum index, following the shutdown of auto production in Japan. On the domestic bond market front, government bond yields were on a declining trend in March last year, supported by subdued inflation, reductions in the repo rate, the appreciation in the rand and improved public finances. In 2011, however, yields on domestic government bonds increased significantly amid increased volatility. From slightly below 7,0 per cent, the BIS central bankers’ speeches yield on the R157 (2016) bond increased to almost 8,0 per cent in March 2011, due largely to a sell-off by non-residents, increased supply and expectations of higher interest rates in response to rising inflationary pressures. After recording strong bond inflows for most of 2010, non-resident demand for South African bonds started to wane in October 2010. During the fourth quarter of 2010, non-residents sold R22 billion worth of bonds. The sell-off was attributed to a global reallocation of emergingmarket portfolio investment towards equities, given the favourable economic backdrop for this asset class and increasing policy rates in some emerging-market economies. Domestic factors that contributed to the sell-off in domestic bonds were related to perceptions that the interest rate cycle had bottomed out and to profit-taking. Nonetheless, in 2010 non-residents bought R53,2 billion worth of bonds; three times the amount purchased in 2009, representing a shift from previous trends when portfolio inflows tended to be dominated by equity inflows. The strong appetite for domestic bonds continued to diminish in 2011. Non-residents sold R8,3 billion worth of bonds in the year to 6 April 2011, although we have seen significant net purchases in the last few days. Despite net sales by non-residents, and the continued purchases of foreign exchange by the Bank, the rand has remained firm but volatile, and in the process appreciated to R6,6848 on 6 April 2011. For 2010 as a whole, the rand appreciated by about 12 per cent against the US dollar and by around 10 per cent on a trade-weighted basis. Total turnover in the domestic foreign-exchange market increased to a record high of almost US$20 billion in January 2011, mainly due to an increase in hedging activities by non-residents. Strong capital inflows into emerging market economies (including South Africa) witnessed during 2010 have presented policy-makers with some challenges, such as appreciating exchange rates (which raised concerns regarding the competitiveness of export markets) and increased sterilisation costs. In the light of these considerations, some emerging-market economies made noticeable shifts towards curbing capital inflows and, hence, currency appreciation. Measures considered and implemented include limits being placed on government bond investment by foreigners; taxes imposed on the purchase of fixed-income securities and stocks by foreign investors; and the pre-announcement of currency market intervention programmes in order to build foreign-exchange reserve balances and to limit currency appreciation. Other countries imposed reserve requirements on foreign-exchange swaps and forward trades conducted by non-residents, and on non-resident accounts with domestic banks. South Africa has carefully studied these measures, and our view is that the efficacy of most of them, in terms of what they were intended to achieve, has been rather doubtful and that such means would not be appropriate for South Africa at this stage. Any potential consideration of any such measures would need to be informed by our own countryspecific circumstances, which include the fact that our savings/investment imbalance makes us dependent on portfolio flows to finance our current-account deficit. 3. Financial market operations The market operations conducted by the Financial Markets Department are associated with two of the key functions of the Bank, that is, (i) the implementation of monetary policy and (ii) the management of the official gold and foreign-exchange reserves. My remarks in this section will therefore cover open-market operations, reserves management and also touch on market development initiatives. 3.1 Open-market operations As you are aware, the successful conduct of the Bank’s open-market operations is essential for the effective implementation of monetary policy. A number of refinements to the monetary policy implementation framework, and measures aimed at streamlining the daily monetary policy operations were identified and have been implemented since August 2010. The changes comprised the following: BIS central bankers’ speeches – The Bank discontinued the practice of providing estimated ranges of the weekly liquidity requirement and began to announce, at 9 o’clock on every business day, the actual liquidity requirement of the previous day, while announcing on a weekly basis only the average estimated weekly liquidity requirement – As from 1 March 2011, there was no longer any need to accept Category 2 assets (bonds issued by Eskom, Transnet, Trans-Caledon Authority, the Development Bank of South Africa and the South African National Roads Agency) as eligible collateral for the Bank’s refinancing operations – The South African Multiple Option Settlement (SAMOS) penalty facility was abolished after a new automated end-of-day square-off process had been introduced to replace the previous system of manual auctions – The spread between rates on the standing facilities and the repo rate was widened from 50 to 100 basis points below and above the rep rate – The Bank started using longer-term foreign-exchange swaps with maturities up to 12 months to manage money-market liquidity more efficiently. The changes were intended to streamline the Bank’s daily activities in the money market and to enhance the participation in the SARB debenture and longer-term reverse repo auctions. The success of the changes made to the open-market operations resulted in an increased take-up of SARB debentures and reverse repos, and led to an increase in the level of the money-market shortage. The shortage was, on average, above R15,0 billion, with a high of R22 billion on 7 March 2011, compared with an average of R10,0 billion for the period August 2009 to August 2010. The phasing out of Category 2 assets as eligible collateral in the Bank’s refinancing operations also had no adverse impact on the yields of bonds issued by the state-owned enterprises concerned. It is also important to note that more banks are now participating in the Bank’s weekly repo. The number has increased from four banks to five and, more recently, to six, with a seventh institution also occasionally taking up a portion of the amount on offer in the weekly repo. The broader participation by banks in the main weekly refinancing operations is encouraging, and will further enhance the implementation of monetary policy. The Bank started using longer-term foreign-exchange swaps with maturities of up to 12 months as an instrument to manage money-market liquidity and to facilitate accelerated foreign-exchange purchases. The consequence of using foreign-exchange swaps is that the Bank now reflects an overbought forward position, currently amounting to approximately US$4,0 billion. The bulk of the forward position represents swaps related to foreignexchange purchases and the Bank’s ongoing objective of foreign-exchange reserves accumulation. 3.2 Reserves management, including accumulation Strong capital inflows into South Africa in 2010 provided the Bank with an opportunity to increase the level of foreign-exchange reserves. Gross reserves have increased by approximately US$9,6 billion since January 2010 to US$49,3 billion in March 2011 (with an increase of about US$5,5 billion recorded in the first quarter of 2011). The international liquidity position or net reserves increased by US$5,7 billion to US$44,7 billion over the same period. During the 2010 calendar year, the Bank purchased US$7,4 billion for foreignexchange reserves accumulation, while approximately US$3,8 billion was purchased during the first three months of 2011. Going forward, the Bank will continue to work closely with National Treasury to continue building reserves. The Bank’s policy remains that of accumulating reserves and not of defending or achieving a particular level for the exchange rate. The exchange rate remains market-determined, and any speculation that the Bank may currently have a preference for a stronger currency or may have even been selling foreignexchange reserves is misplaced. BIS central bankers’ speeches The Bank continues to manage the country’s official foreign-exchange reserves in a prudent manner, and has continued its successful partnership with its external private and officialsector fund managers. 3.3 Market development initiatives The Financial Markets Liaison Group (FMLG) is a joint initiative between the Bank and key participants in the financial markets. The objective of this consultative forum is to promote the efficiency, integrity and stability of South Africa’s financial markets, and to discuss international market and structural developments that could affect domestic financial markets. The FMLG, which emerged from the Money Market Liaison Group, has recently been reconstituted and held its first meeting in November 2010. The November 2010 meeting was preceded by several meetings of the sub-committees comprising the FMLG, namely the Money Market, Foreign Exchange and Fixed Income and Derivatives subcommittees, and progress on a wide range of projects was reported. These projects include, among others, investigating the maturities of SARB debentures and longerterm reverse repos; the pricing of floating rate notes in the secondary market; the impact of algorithmic trading on the foreign-exchange market; the monitoring of the over-the-counter (OTC) market in foreign-exchange derivatives; and the revision of reference rates in the money market. A working group was also established to review credit value adjustments (CVAs) and credit support annexures (CSAs), which might impact the efficiency and liquidity in the interbank derivative market. 4. Concluding remarks Let me conclude by thanking you for your co-operation during the past financial year. We may find that when we gather here next year, the financial and economic landscape may be vastly different to what it is today. No doubt the future holds surprises and interesting challenges in store for us, but I trust that the spirit of co-operation and co-ordination that we have developed in our financial markets over the years will allow us to rise to these challenges. In conclusion, I should also like to thank my own colleagues, the management and staff of the Financial Markets Department, for their hard work and dedication to the task at hand, both for the Bank and in the interest of our financial markets. Thank you also to the staff of the South African Reserve Bank’s Conference Centre for, once again, arranging this function. Last, but not least, I indicated that we are saying “goodbye” to Dr Roelf du Plooy who is going on retirement. On behalf of all of us, I should like to wish Roelf a happy and healthy retirement. Roelf retires after many year of service at the Bank, having first joined the Bank in 1974. He has been head of the FMD since 2007, having occupied a number of other positions in the Bank. Roelf has been instrumental in the implementation of the repo-based accommodation system in the Bank. He was active in the development of the domestic fixed-income market at the time when the Bank was the market maker in government bonds and options on government bonds. He has also contributed significantly to the MPC, as one of the presenters since its inception. He has assisted in regional development initiatives and was an active member of various other external and internal committees. We thank Roelf for his good leadership and wise counsel over the years. and wish him well for the future. Thank you and enjoy the evening. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the JP Morgan Investor Conference, Washington DC, 16 April 2011.
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Daniel Mminele: Thoughts on South Africa’s monetary policy Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the JP Morgan Investor Conference, Washington DC, 16 April 2011. * 1. * * Introduction Good afternoon ladies and gentlemen. Thank you to JP Morgan Emerging Markets Research Group for inviting me to share with you some thoughts on South Africa’s Monetary Policy. In the years prior to the most recent global financial crisis, central banks in general appeared to have almost perfected the conduct of monetary policy.1 Inflation targeting central banks were given operational independence to vary the short-term interest rate in order to achieve an inflation target. While this worked very well for some time, the global financial crisis showed us that achieving price stability by no means equated to achieving financial stability. This has resulted in somewhat of a paradigm shift for traditional monetary policy, and it seems we may be on the cusp of a new era in central banking. I would like to briefly discuss global economic developments and the changing role of central banks, highlighting the challenges and lessons learnt from the global financial crisis. I will then talk about South African monetary policy, as that is the reason for which I was invited to speak to you today. 2. Global economic developments and monetary policy The International Monetary Fund’s (IMF) latest World Economic Outlook (WEO) reflects a similar picture to that of a few months ago. The global economic recovery proceeds at an uneven pace and although it is broadening, the divergence in economic activity remains wide. The growth momentum in advanced economies is gaining traction, but is insufficient to meaningfully impact on unemployment. Emerging markets, on the other hand, are characterised by robust growth with signs of overheating in certain economies. The IMF projects that global growth will moderate in 2011 to 4,5 per cent from 5 per cent in 2010. Advanced economies are forecast to expand by 2,5 per cent and emerging economies by 6,5 per cent. The IMF has also identified a number of old and new risks, including the threat of spill overs from the euro area periphery to core Europe, exacerbated by continuing weakness among many European financial institutions, a lack of clarity on exposures and weak sovereign balance sheets. This last point is not confined to Europe, but a risk to advanced economies in general and the US and Japan more particularly. It is plausible that this state of affairs, if not addressed, could result in an abrupt increase in interest rates, which could destabilise global bond markets and emerging markets more particularly. In emerging economies, the IMF highlights the risk of overheating and the threat of a hard landing. The IMF is of the view that policy responses so far have been inadequate to address these pressures. Finally, oil and food price risks are also on the upside. The combination of these factors makes central banking a somewhat more complex environment to operate in. The global economy has emerged from recession, but has not yet BIS Working Paper 326, November 2010, The changing role of central banks, CAE Goodhart. BIS central bankers’ speeches returned to pre-crisis levels of output and employment. The very actions taken to mend the global economy have contributed to a new set of challenges, in particular, ballooning sovereign debt ratios. At the same time, inflation is picking up speed, owing to the spike in food and oil prices, and the very tools central banks use to combat inflation run the risk of attracting even more capital inflows into emerging economies. Monetary policy in the developed world remains accommodative, policy rates are still close to zero and quantitative easing remains a feature of some of the advanced economies. As with any crisis, there are always lessons to be learned. One of these as I mentioned in the introduction, is the limitations of monetary policy and the fact that the achievement of price stability by itself does not lead to financial stability. We are already seeing greater emphasis on financial stability compared to prior the crisis. Not only will central banks need to pay greater attention to financial considerations in framing monetary policy, but will also most likely play a greater role in macro prudential policy. In this respect, central banks are well placed to deal with these challenges, having the relevant expertise in macro-economic analysis, knowledge of financial markets, overseeing payments and settlements infrastructure and (in many cases) explicit responsibility for the regulation and supervision of financial institutions.2 Nonetheless, the financial stability objective of central banks remains clouded with uncertainty. It is unclear to what extent it can be an additional objective of monetary policy, and even if it is, how do central banks adjust the policy response, are there sufficient and appropriate instruments available to central banks to fulfil this dual mandate and would macro prudential policy at times not run the risk of undermining the effectiveness of the monetary transmission mechanism. In addition, there are implications for legislative and governance arrangements. There is much work underway in trying to understand exactly what all this means. So while central banks may have perfected the art of monetary policy in the last decade, they have also undergone a tectonic shift in the last few years, which still has some way to go. 3. Emerging markets and capital flows One of the consequences of the easy monetary policy employed over the past few years has been the surge in capital flows to emerging market economies. The Institute of International Finance (IIF) records that net private capital inflows to emerging markets increased from just below US$200 billion in 2002 (1,5 per cent of GDP) to US$908 billion in 2010 (7 per cent of GDP). The IIF estimates that inflows will rise to US$960 billion in 2011 and to over US$1 trillion in 2012. These inflows reflect a combination of greater macroeconomic fundamentals in emerging markets, significant fiscal deterioration and loose monetary policy in advanced economies, and the increased integration of emerging economies into international capital markets. Many emerging market economies have taken various actions towards curbing capital inflows in an attempt to limit currency appreciation. Measures considered and implemented range from taxes on inflows, limits being placed on government bond investment by foreigners, to pre-announced currency market intervention programmes, just to name a few. South Africa too has experienced large capital inflows, with the resultant upward pressure on the exchange rate of the rand. A favourable fiscal position, deep and liquid capital markets and sound macroeconomic policy have made the country an attractive destination for portfolio inflows. South Africa has studied the measures imposed by other emerging market economies, but questions the efficacy of most of these measures. Furthermore, it is doubtful that such measures would be appropriate for South Africa given our savings/investment The role of central banks after the crisis, Mr Jaime Caruana, General Manager of the BIS, January 2011. BIS central bankers’ speeches imbalance and dependence on portfolio flows to finance our current-account deficit. Like the Philippines, where measures to encourage greater capital outflows were implemented, so too has South Africa lifted some of the limits on outward investments for local pension funds, insurers and individuals. South Africa has also taken advantage of strong capital inflows to increase the level of foreign-exchange reserves. Gross reserves have increased by approximately US$9,6 billion since January 2010 to US$49,3 billion in March 2011. Of this amount, an increase of about US$5,5 billion was recorded in the first quarter of 2011. During the 2010 calendar year, the South African Reserve Bank purchased US$7,4 billion for foreign-exchange reserves accumulation, while approximately US$3,8 billion was purchased during the first quarter of 2011. The Bank’s policy continues to be that the exchange rate remains market-determined, and therefore the policy is to accumulate reserves and not to defend or achieve a particular level for the exchange rate. 4. Recent domestic economic developments The improvement in global economic activity and in international commodity prices, along with domestic monetary and fiscal stimulus, resulted in a cyclical improvement in the South African economy. After emerging from recession in third quarter of 2009, growth accelerated to 4,8 per cent in the first quarter of 2010, but moderated to 4,4 per cent in the fourth quarter of 2010. On an annual basis, real GDP growth contracted by 1,7 per cent in 2009 but improved by 2,8 per cent in 2010. There was a marked turnaround in manufacturing production in 2010. After contracting by 10,4 per cent in 2009, the manufacturing sector grew by 5,0 per cent in 2010. Despite the increase in activity, manufacturing production remains well below the peak reached in 2008 and has been primarily driven by the motor vehicle sector. In general, a lack of new private sector investment projects, relative strength of the rand and unfavourable economic developments in some of the country’s key export markets, led to a subdued performance. High commodity prices and strong export demand also lifted mining output in the fourth quarter. The economy, however, continues to be characterised by a significant degree of underutilisation of productive capacity, measuring 80,7 per cent in the fourth quarter of 2010, well below the pre-crisis average of around 85 per cent. Among the expenditure components, real final consumption expenditure by the household sector contracted for five successive quarters before resuming an upward trend from the final quarter of 2009. In the fourth quarter of 2010, real final consumption expenditure by households increased by just over 5,0 per cent, reflecting positive consumer sentiment and disposable income growth. Credit extension figures show a better take-up of credit by businesses, implying that the recovery in investment spending will pick up and that subdued growth in gross fixed capital formation will improve. However, while the Bank is of the opinion that consumption expenditure may remain relatively robust, it is unlikely to accelerate to excessive levels in the short-term, owing to continued high levels of household indebtedness (77,6 per cent of disposable income). The ratio of impaired advances to gross loans and advances has remained at elevated levels of around 5,8 per cent for some time, but has stabilised. Bank credit extension to the private sector is also relatively subdued, with total loans and advances growing by 4 per cent since September 2010, house prices are either declining or growing at low nominal rates, while equity prices will most likely also have a moderating impact on wealth effects and consumption. The Bank forecasts that growth will average 3,7 per cent in 2011 and 3,9 per cent in 2012. Various high frequency indicators suggest a positive growth momentum going forward. The composite leading business cycle indicator has remained in positive territory, both business and consumer confidence levels are relatively high, and the Purchasing Managers Index for the manufacturing sector maintained a level above the key 50 threshold. Notwithstanding these developments, unemployment remains very high. Even the improved growth rates are BIS central bankers’ speeches insufficient and well below what is required to significantly impact on the unemployment rate, which measured 24,0 per cent in the fourth quarter of 2010. As with any forecast, there are many risks. Notably, global developments present some challenges. Peripheral Europe and the unfolding sovereign debt crisis remains a wildcard, the US economy is still fragile despite substantial stimuli, events in North Africa and the Middle East and their impact on oil prices, and the recent disasters in Japan could all derail the nascent global recovery and hence, South Africa’s economic outlook. 5. Recent monetary policy developments The global inflation outlook has deteriorated somewhat over the past few months, driven by higher prices for food and oil. Inflationary pressures in emerging market economies are more pronounced, resulting in a few emerging economies already embarking on monetary tightening. For South Africa, cost-push pressures have increased the upside risks to the inflation outlook, while demand driven pressures remain subdued. The year-on-year inflation rate for consumer prices increased by 3,7 per cent in February. Despite rising global food prices, food price inflation in South Africa is still relatively low, helped by recent bumper maize crops and exchange rate developments. But recent data releases clearly show an accelerating trend at both producer and consumer levels. The Bank’s CPI forecast has been adjusted higher, but still reflects that inflation should remain within the target range over the forecast period to the end of 2012. CPI inflation is forecast to average 4,7 per cent in 2011 and 5,7 per cent in 2012, peaking at 5,8 per cent in the first quarter of 2012. Much of the increase in inflation is based on higher assumptions for international oil prices. The most recent survey shows that inflation expectations of financial analysts have deteriorated slightly, but expectations of business and trade unions have shown some improvements. The Bureau for Economic Research Inflation Expectations Survey shows that inflation is expected to average 5,3 per cent in 2011 and 5,7 per cent in 2012, compared to 5,5 per cent and 6,2 per cent in the previous survey. One of the key upside risks to the inflation outlook has been high real wage settlements. There are, nonetheless, indications of a moderation in wage settlements, with the overall wage settlement rate amounting to 8,2 per cent in 2010, compared to 9,3 per cent in 2009. Nominal unit labour cost growth has similarly moderated, from 9,3 per cent in the third quarter of 2010 to 7,7 per cent in the fourth quarter. Food and administered prices remain significant upside risks to the inflation outlook, most particularly, oil prices. It seems likely that oil prices will remain at elevated levels, even if current geo-political challenges can be resolved. The Monetary Policy Committee has kept the repo rate steady at 5,5 per cent since November 2010. While the risks to the inflation outlook are tilted to the upside, they are predominantly of a cost-push nature, but need to be monitored very closely for any second round effects. 6. Conclusion In summary, the past year has brought some recovery in global economic activity, although the momentum has slowed somewhat. There are still many risks on the horizon, and South Africa is subject to the same risks facing the global economy. The economic recovery in South Africa is on track and short term economic indicators suggest that we will continue to see further improvements. However, growth continues to be at levels that are insufficient to meaningfully address unemployment. Inflation has picked up, but is expected to remain within the target range over the forecast period. At the conclusion of its last meeting, the Monetary Policy Committee deemed the BIS central bankers’ speeches policy rate to be at an appropriate level. However, inflationary pressures will be monitored, especially insofar as second round inflationary pressures may negatively impact the inflation outlook, so as determine when policy adjustments may be required. Thank you. Enjoy the rest of the conference. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the breakfast of the Association of Corporate Treasurers of Southern Africa, Johannesburg, 27 May 2011.
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Daniel Mminele: Monetary policy in volatile and uncertain times Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the breakfast of the Association of Corporate Treasurers of Southern Africa, Johannesburg, 27 May 2011. * 1. * * Introduction Good morning ladies and gentlemen. Thank you to the Association of Corporate Treasurers of Southern Africa (ACTSA) for extending this invitation to share some thoughts with you this morning on monetary policy. However, before I delve into issues related to monetary policy, I would like to provide a brief overview of the global policy agenda, how it has been shaped by the crisis and efforts underway to restore macroeconomic and financial stability and a more balanced global economy. As the title of my speech suggests, the global economic and financial environment is one fraught with volatility. While we may have emerged from the crisis, the recovery has been difficult and risks remain large. Sovereign debt difficulties in peripheral Europe as well as in some other advanced economies, banking systems still in need of repair, and geopolitical risks, all compounded by natural disasters, are issues we need to grapple with. It is within this highly uncertain environment that central banks need to manoeuvre and find ways to best deal with rising inflationary risks without jeopardising the recovery and creating threats to financial stability. 2. An uncertain and volatile global landscape The sovereign debt crisis in peripheral Europe shows little signs of abating. Speculation around a possible Greek debt restructuring or, in some quarters even around an eventual exit from the euro zone is gathering momentum and threatens the outlook for Ireland and Portugal, and could possibly cause disruptions in Spain and core Europe. We have recently seen further rating downgrades and revisions to rating outlooks by rating agencies. Martin Wolf,1 in an article in the Financial Times, relates the euro zone’s approach to the fiscal crises to the story of a man sentenced to death by his king. The king tells him that he can keep his life if he teaches the monarch’s horse to talk within a year. Surprisingly, the condemned man agrees. Asked why he did so, he answers that anything might happen: the king might die; he might die; and the horse might learn to talk. In essence, Martin Wolf argues that policymakers have decided to play for time in the hope that the countries in difficulty will restore their creditworthiness. The significant rise in the cost of borrowing for peripheral European countries shows that, if this indeed was a deliberate strategy, it is not succeeding. It is unclear how a debt restructuring would affect markets and the real economy. Some argue that this would be the most practical solution for Europe, while others say that, given the interconnectedness of sovereign debt markets and the banking systems in Europe, this has the potential to trigger developments similar to what was witnessed around the Lehman Brothers collapse. The International Monetary Funds’ (IMF) latest World Economic Outlook and Global Financial Stability Report (April 2011) reflects a recovery that appears to have solidified. However, growth on average remains below pre-crisis levels, unemployment is high, and The euro zone’s journey to default, 10 May 2011, FT BIS central bankers’ speeches inflationary risks have picked up. The story of the two-speed economic recovery is well known – modest growth and still high unemployment in advanced economies, contrasted with robust growth in emerging market economies, but marred by high rates of youth unemployment and rising inflation. In many emerging economies output gaps have become positive, inflation is rising and capital flows from developed to emerging economies continue unabated. The combination of weak sovereign balance sheets, weak real estate markets, high funding requirements for sovereigns and banks in advanced economies, together with overheating and booming asset markets in emerging market economies, tilts the balance of risks to growth to the downside. Political and social unrest in the Middle East and North Africa as a result of rising food and commodity prices also threatens to add to already heady inflationary pressures. Thus, while the global recovery may be on a firmer footing than a year ago, it is questionable whether growth is more balanced than before the crisis. Improved growth prospects in developed countries have largely been driven by fiscal spending and loose monetary policy, although more recently, certain advanced economies have begun to reduce the fiscal stimulus and started raising policy rates. On the other hand, emerging markets reflect robust consumer spending and private sector investment. Such an uneven recovery could fuel further imbalances and delay the current recovery while also sowing the seeds of future crises. 3. The global policy agenda and South Africa Global imbalances were one of the foremost causes of the crises and therefore, have become a significant agenda item for the G20, which effectively replaced the G8 as the leading forum for international economic co-operation and coordination. Since 2008, the status of the G20 has been elevated, recognising that co-operation on a global scale is required to successfully and sustainably deal with the crisis. To this end, the vital role of emerging market economies was recognised, and rightly so. Over the past five decades, the global balance of power has shifted towards emerging-market economies, whose share of global GDP has increased alongside the decline in that of advanced economies. Between 1960 and 1985, advanced economies on average accounted for about 75 per cent of global GDP (based on purchasing power parity weights), this share declined gradually to 57 per cent in 2009. In contrast, over the same period, the share of emerging market and developing economies increased steadily from 17 per cent to almost 40 per cent.2 At the height of the financial crisis during 2008 and 2009, emerging markets were the sole engine of world growth. In 2009, G20 countries committed to a new framework for strong, sustainable and balanced growth (referred to as the Framework), as well as a Mutual Assessment Process (MAP). The Framework is intended to ensure that the individual country actions contribute to a coherent path forward, while the MAP is intended to gauge the degree of collective consistency of G20 macroeconomic policy actions. To this end, a number of indicators have been agreed upon to enable the identification of globally systemic imbalances and to ensure that preventative and corrective action is taken timeously. The co-operation to a large extent proved to be highly effective in the immediate aftermath of the financial crisis, but is now facing some challenges given the increasingly divergent developments across countries and regions. There is wide recognition that there is a need for an adjustment in exchange rates in order for global rebalancing to occur. This process is also referred to as demand rotation and requires deficit economies to save more and consume less, while surplus economies are required to spend more and save less. Surplus countries are therefore expected to shift Emerging Markets come of Age, Finance and Development, December 2010, Vol 47, No 4 BIS central bankers’ speeches focus from external demand to domestic demand in order to sustain growth. In contrast, deficit economies will need to rely more on external demand. This implies that exchange rates will adjust, with the exchange rates of deficit economies depreciating, while the surplus economies will need to let their currencies appreciate. As you can well imagine, this is a contentious issue amongst G20 countries, given that developed and developing economies have differing policy priorities. However, what is important is that co-ordination does exist on various economic aspects, including sustainable, balanced growth, financial sector reforms, and reform of international financial institutions. Excess global liquidity on account of easy monetary policies in advanced economies, coupled with the combination of promising growth prospects, improved governance and capital account liberalisation, made emerging market economies very attractive investment destinations. Consequently, currency tensions came to the fore early last year as volatile capital flows returned to emerging market economies, resulting in currency appreciation and thereby eroding export competitiveness and disrupting macroeconomic stability. Apart from currency appreciation, these inflows have also increased the possibility of bubbles in asset prices in emerging economies. There have been a range of responses to the surge in capital inflows, from outright intervention to the imposition of capital controls. The thinking behind the management of capital flows has shifted somewhat in the process. In essence, where previously much criticism was directed at measures to deal with capital inflows, it is now widely accepted that under certain conditions this can be a legitimate component of policy responses to deal with the surge in capital inflows. To this end country-specific circumstances are an important consideration when deciding what measures may be appropriate or not. Accordingly, although an old topic in economic literature, the G20 under the French Presidency has added a new agenda item, namely, the “Reform of the International Monetary System”. A working group was established to discuss the future global monetary system, with a view to achieving a more stable and representative system. A key focus area of this working group centres on developing a better understanding of the consequences and causes of capital flows, with a view to developing a framework of non-prescriptive guidelines to govern currency interventions in the face of volatile flows. This agenda item is very much aligned with the Framework. Movements in currency markets over the past few years are indicative of global developments, where the US dollar’s role as the sole global reserve currency is increasingly being questioned. Other currencies, including those of major emerging market economies (when they satisfy relevant criteria) are likely to play a larger role in future. But, it will be a long journey before there is any significant change to the US dollar’s status as the world’s reserve currency. South Africa, being the only African country represented on the G20, supports efforts towards strong, balanced and sustainable growth and the reform of the international monetary system, and officials from the National Treasury and the South African Reserve Bank actively participate in G20 working groups. There is certainly a need for global co-operation, as we have clearly seen, economic and financial disruptions in one place can cause not just ripple effects elsewhere, but crises of significant proportions. Co-operation at the global level is essential to ensure that the seeds of the next crisis are not inadvertently sown in the measures currently being developed and implemented, and to ensure that we will be adequately prepared to tackle future challenges. In April this year, South Africa was also accepted officially as a fully-fledged member into the BRIC (Brazil, Russia, India and China) bloc, bolstering its position on the global economic arena, and strengthening political and trade ties within the bloc. South Africa accounts for about a third of gross domestic product in sub-Saharan Africa. This membership is mutually beneficial, opening up vast opportunities for Africa, while at the same time offering BRIC members improved access to mineral resources and approximately one billion consumers on BIS central bankers’ speeches the continent. It is important for South Africa to harness the opportunities that come with its membership of BRICS and to leverage its position to support growth, development and employment creation initiatives in the country. 4. South Africa’s growth outlook Although the South African financial system has to date emerged relatively unscathed from the financial crisis, largely owing to sound financial regulation and supervision, the real economy did suffer. The economy contracted by 1,7 per cent in 2009, following growth of 5,6 per cent in 2006 and 2007 and 3,6 per cent in 2008. Growth in real gross domestic product has improved since the recession experienced in 2009, but is insufficient to address the burgeoning joblessness rate, which measured 25 per cent in the first quarter of 2011. The output gap remains negative, as growth remains below trend and output below levels achieved prior the crisis. The accommodative monetary policy stance of the Bank over the past few years has certainly helped to prop up household consumption expenditure. Household consumption expenditure has been the main driver of growth, making the largest contribution of 2,8 percentage points to growth in GDP during 2010. Even so, growth has not been excessive and there are tentative signs that this positive momentum may be levelling off, as suggested by recent economic data in the form of retail sales, motor vehicle sales and credit growth. Consumers remain relatively highly indebted, while impaired advances as a percentage of total loans and advances have remained somewhat sticky since the end of 2009 at levels close to 6 per cent. High levels of household indebtedness together with the elevated level of the number of consumers with impaired credit records, is likely to constrain consumers to some extent going forward. Positive trends in the composite leading business cycle indicator and the Kagiso/BER Purchasing Managers Index suggest that the recent trends and outlook for the manufacturing sector has improved. The details in the various business confidence surveys confirm this view. The year-on-year increase in the physical volume of manufacturing output measured 4,6 per cent in March, following the 5,7 per cent increase registered in February. On a three-month on three-month basis, the increase was 4,0 per cent. These developments are encouraging especially when viewed against the backdrop of the appreciation in the currency. However, there is still a substantial degree of slack in the manufacturing sector. The Bank’s forecast reflects GDP growth averaging 3,6 per cent and 3,9 per cent in 2011 and 2012, respectively. These forecasts are somewhat lower than those of some other emerging market and developing countries. 5. South Africa’s monetary policy response Inflation in a number of emerging market countries has been rising steadily over the past year, driven by the rise in global food and commodity prices. The large share of food and energy in the CPI baskets of many emerging market countries is a major factor behind rising inflation. In addition, in many cases output gaps have closed, resulting in a tightening of monetary policy in many emerging market economies. In contrast, South Africa has maintained a repo rate of 5,5 per cent since November 2010, following the reduction in the policy rate by 650 basis points since March 2008. South Africa’s inflation picture has been somewhat benign compared to other emerging markets. Domestic CPI reached a low point of 3,2 per cent in September 2010, at a time when other emerging market countries inflation rates had already started rising owing to rising commodity prices. South Africa’s inflation rate has risen steadily since then, with CPI measuring 4,2 per cent in April 2011. BIS central bankers’ speeches At this stage there are no discernible inflationary pressures coming from the demand side of the economy, the output gap remains negative and there are tentative signs that the momentum in consumer demand may be levelling off. Furthermore, core inflation readings, when measured by adjusting overall CPI for food, non-alcoholic beverages and energy prices, were relatively subdued at 3,4 per cent in March. However, the inflation outlook has deteriorated over the past couple of months, largely due to external cost-push factors. The main factors behind the upward trend in inflation have been food, and transport prices. Food price inflation increased from 3,5 per cent in February 2011 to 4,8 per cent in April, while petrol prices increased at a rate of 16,3 per cent. Other administered prices also placed upward pressure on prices, with electricity increasing by 19,0 per cent in April. Administered price inflation increased by 10,7 per cent in April, driven by a 12,1 per cent increase in the regulated component. If one excludes administered prices from CPI, the CPI would have measured 3,1 per cent in April. So far, these developments have not filtered through to broader price pressures and the appreciation bias in the rand exchange rate for most of this year, has helped to contain price pressures. That said, April inflation data does suggest that core measures may be beginning to rise. The Bank has revised higher its inflation forecasts over the past few MPC meetings. The main risks to the inflation outlook continue to emanate from cost push pressures, including administered prices. While annual inflation rates are expected to average 5.1 per cent and 6.0 per cent in 2011 and 2012, respectively, our latest forecast shows that inflation is expected to breach 6 per cent in the first quarter of 2012 and to peak at 6,3 per cent. Inflation is expected to return to within the target range thereafter, but remain close to the upper end of 6 per cent. The breach is likely to be temporary, but is also dependent on further developments in food and oil prices and the potential second round effects, and the risk that these price pressures feed through to more generalised inflation. The recent decline in oil prices and moderation in international food prices to some extent alleviates some of the inflationary pressures that have confronted the South African economy. Another risk factor on the domestic front is the developments in wage inflation. Despite high unemployment, wage increases remained in excess of inflation and in the first quarter of 2011, measuring 8,2 per cent according to Andrew Levy Employment Publications. At the same time, labour productivity has declined, resulting in an increase in unit labour costs. Despite the upward revision to the inflation forecasts, the repurchase rate was maintained at 5,5 per cent at the most recent MPC meeting in May. This is essentially due to the large influence of exogenous factors on current and projected inflation trends. The MPC is however cognisant of the current cost-push pressures and the potential of these to filter through to more generalised price pressures. These pressures will be closely monitored, and the MPC will take timeous action to ensure that second round effects do not take hold and that inflation pressures are kept in check. 6. Conclusion To conclude, uncertainty in the global environment has not abated, as reflected by increased volatility in financial markets. While the global recovery has proceeded at a moderate pace, it remains unbalanced and uneven. To this end, the G20 is addressing issues of global imbalances and also reflecting on the future global monetary system. Such developments will have an impact on South Africa and policy developments going forward, as we are part of the global economy and one of the more liquid amongst emerging market financial markets. South Africa’s growth outlook has improved, although it remains below pre-crisis levels and below that of other emerging and developing countries. Inflation has recently trended higher, and while the Bank’s forecast shows that CPI will breach the upper end of the target range, based on current information the MPC expects that this will be a temporary breach. However, developments will be closely monitored for any second round effects which could result in broader based price pressures. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 91st ordinary general meeting of shareholders, Pretoria, 30 June 2011.
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Gill Marcus: Overview of the South African economy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 91st ordinary general meeting of shareholders, Pretoria, 30 June 2011. * * * Dear Shareholders, Members of the Board, Deputy Governors, Ladies and Gentlemen The business of an ordinary general meeting (OGM) of the Bank is to receive and discuss the minutes of the previous meeting, the financial statements for the preceding financial year, the report of the Board on the state of affairs and business of the Bank, the auditors’ report, to attend to the election of directors and to attend to the appointment of auditors and the approval of their remuneration (this being referred to as the ordinary business of a general meeting). In addition, special business of which proper notice was given, may be transacted at the general meeting. This special business would be resolutions proposed by shareholders that relate to the ordinary business of a general meeting. As in recent times the conduct of special business has been an issue at general meetings, it is necessary to record that special business is not any business that shareholders wish to raise relating to the Bank and/or criticism of reports or documents presented at the general meeting. It must clearly relate to the ordinary business of a general meeting referred to above and must, more particularly, be framed as a resolution that is capable of being implemented, if adopted. Business framed as criticism or demanding action on behalf of the Bank and which does not relate to the ordinary business of a general meeting as referred to above does not constitute special business. In addition, matters relating to legislation under which the Bank operates and the requirements thereof are matters that do not constitute special business and are incapable of being implemented by the adoption of a resolution. These are matters that ought to be raised with the National Treasury and Parliament. Criticism of the reports and documents presented at the general meeting does not in the normal course of business qualify as special business, unless properly framed as a resolution that is capable of being adopted. Any criticism, or for that matter queries, relating to reports and documents presented at the general meeting is properly dealt with and addressed at the general meeting as part of a discussion around these reports and documents. And this is the basis on which we intend to conduct the business of this meeting. The Bank was founded at a time of great turmoil in the international monetary system and amid vigorous debates about the appropriateness of a return to the gold standard. In that context the Bank was established to ensure that the banknote issue was in line with the gold stock; in other words, the Bank had to ensure the convertibility of the currency or the maintenance of the value of the currency. The early 1920s were also characterised by a high degree of capital flows and exchange rate volatility, and ultimately the 1929 collapse of Wall Street ushered in the worldwide Great Depression of the 1930s. Today, we unfortunately find ourselves in a very similar context. The global financial crisis, which is now in its fourth year, and persistent global imbalances and volatile capital flows BIS central bankers’ speeches have again put the nature of the international monetary system and the international adjustment mechanism at the centre of the debate on global reform. Such turmoil and periodic systemic crises – in this instance the most devastating since the great depression – underline the need for strong central banks to be beacons of stability. Our focus therefore continues to be on stability, which includes price stability, financial stability and the stability of the banking system. Such stability is essential to providing an environment conducive to economic growth and employment creation. Global developments have continued to impact on our domestic economic conditions and policy environment. The recovery in the advanced economies, which had appeared to be more sustained, has become increasingly uncertain in recent months. While some view this as a “soft patch” from which countries will emerge fairly soon, there are still significant risks emanating from some peripheral countries in Europe in particular. These risks have the potential to derail the already slow recovery in the advanced economies and to have serious negative global repercussions. Although countries such as Greece, Ireland and Portugal are relatively small in the European context, the exposure of the banking systems of the rest of Europe to these countries’ debt means that in the event of even a partial default, a systemic banking crisis could ensue. And notwithstanding the measures taken through initiatives such as Basel III, and an increased focus worldwide explicitly on financial stability, the possibility of a systemic banking crisis emanating from Europe cannot be dismissed. While I do not want to overburden you with numbers, it is important to use some examples for illustrative purposes. According to the European Commission, the debt to GDP (Gross Domestic Product) ratio of Greece is expected to increase to 166 per cent in 2012, from 142 per cent in 2010. Its fiscal deficit is expected to decline from 10,5 per cent to 9,3 per cent. In Ireland, the debt to GDP ratio is expected to increase from 96 per cent in 2010 to 118 per cent in 2012. It is argued by some that in the case of Ireland it is more useful to look at the debt to GNP (Gross National Product) ratio, which stands at around 150 per cent. The fiscal deficit of 30,3 per cent in 2010 is expected to decline to 8,5 per cent in 2012. Portugal’s debt to GDP ratio is expected to increase from 93 per cent in 2010 to 107 per cent in 2012, while austerity measures envisaged are expected to reduce its fiscal deficit from 9,1 per cent to 4,5 per cent next year – that is, to be cut in half in two years. According to Bank for International Settlement (BIS) data, the total exposure of foreign banks to Spain, Greece, Portugal and Ireland was around US$2,3 trillion at the end of 2010, with a significant portion of the exposure being to German and French banks. There is also a difference in exposure to the different countries, for instance the United Kingdom (UK) banks have an exposure of US$190 billion to Ireland. The International Monetary Fund (IMF) estimates that the European banks have an exposure to the periphery of around 10 per cent of Europe’s GDP, and about 80 per cent of the capital of European banks. These growing uncertainties have resulted in periodic changes in risk perceptions in the international financial markets, resulting in continued volatility of exchange rates and capital flows. The tragic events in Japan earlier in the year also underlined the fragility of the recovery in the advanced economies. At the same time, the strong recovery in most of the emerging markets, and Asia in particular, coupled with unfavourable weather conditions and political developments in the Middle East and North Africa, has put upward pressure on commodity prices, in particular oil and food. This has led to an end of the benign global inflation environment which had prevailed since the onset of the financial crisis. BIS central bankers’ speeches At the risk of over-emphasising the deteriorating situation in Europe and the United States, it must be cause for concern when, within the space of a week, three of the world’s leading central bankers – Ben Bernanke of the Federal Reserve, Jean-Claude Trichet of the European Central Bank (ECB), and Mervyn King of the Bank of England – all explicitly stated their concerns that the recovery from the financial crisis will be very slow, that there are real risks to the European banking system, and that this situation poses a great threat to financial stability. It is within this fragile global outlook that the domestic economic outlook should be considered. Since March 2010, domestic inflation has remained within the target range of 3–6 per cent. CPI inflation reached a recent low of 3,2 per cent in September 2010, but has since increased to 4,6 per cent in May. This benign inflation environment enabled the Bank to reduce the repurchase rate to 5,5 per cent, which is the lowest nominal level of the policy rate in over 30 years. Real rates are also significantly below their long-run averages. The accommodative stance of monetary policy has been maintained, given the relatively hesitant nature of the domestic recovery. There are signs that this recovery is becoming more self-sustained, following the 4,8 per cent annualised growth rate recorded in the first quarter of 2011, driven mainly by a strong performance in the manufacturing sector. However, the fragility of this recovery is illustrated by the contraction in the manufacturing sector recorded in April 2011 and the continued slow pace of growth in the construction sector and in private-sector fixed capital formation. Employment growth has also remained subdued. Although there are no signs of pressures on domestic inflation generated from the demand side of the economy, the inflation outlook is being adversely affected by global commodity prices. As a result of these developments, inflation is expected to breach temporarily the upper limit of the inflation target range in the first quarter of next year, and then remain close to the upper end of the target range for the rest of the year. The Monetary Policy Committee (MPC) will continue to monitor closely any indications of second-round effects on inflation emanating from these cost pressures. We will continue to give primacy to our objective of price stability, and implement monetary policy within a flexible inflation-targeting framework. The policy challenges we face are complex. While data at one level may suggest an upside risk to the inflation outlook and a possible change in the interest rate stance, other data may well indicate a need for the opposite policy approach. In times of such great uncertainty it is important for a central bank to remain focused on its primary responsibilities, but vigilant and aware of what is happening in the global and domestic economic environment. The financial crisis has focused attention on financial stability issues. In the past most central banks had implicit financial stability mandates and the conventional wisdom was that price stability would ensure financial stability. The crisis has shown that financial stability should be seen as a separate objective, and a number of central banks have been given explicit financial stability mandates. The Bank has also been given a mandate to take a leading role in maintaining financial stability. To this end, the Bank’s Financial Stability Committee (FSC) has been reconstituted and given responsibility for macroprudential oversight and policy implementation. This is unchartered territory, and work is being undertaken both globally and domestically to determine the exact nature of such oversight as well as what appropriate policy instruments could be. Without being complacent, our view is that at this stage there are no obvious threats to domestic financial stability: credit extension by banks is subdued and there is no evidence of incipient asset market bubbles. However, we remain vigilant as to the possible impact of any global financial stability or systemic banking matters that might arise. BIS central bankers’ speeches The Bank’s microprudential responsibilities have also been impacted by global developments with respect to the regulatory and supervisory environment. The Bank, as a member of the Basel Committee on Banking Supervision (Basel Committee), has been an active participant in the deliberations on banking regulatory reform. Meetings of the committee have culminated in the publication of the global regulatory framework for more resilient banks and banking systems, known as Basel III, which incorporates the details of global regulatory standards on bank capital adequacy and liquidity. The changes should not have a material impact on South African banks which remain well capitalised and characterised by low leverage ratios. The proposals regarding liquidity are likely to pose a greater challenge, and it is important to recognise that it is not only South Africa that faces this hurdle. Given the relatively long phasing-in period allowed, these challenges are not viewed as being insurmountable. Capital flows to a number of emerging markets moderated in the final quarter of 2010 and early 2011. A similar pattern was observed in South Africa, and between November 2010 and March 2011 there were cumulative net sales of bonds and equities by non-residents. More recently, renewed net purchases have been experienced and year to date the net purchase of bonds and equities stands at approximately R27 billion. Despite this relatively volatile pattern of capital flows the Bank, with the assistance of National Treasury, has continued with its policy of Foreign-exchange reserve accumulation. In the 2010/11 financial year the Bank purchased approximately US$10,3 billion for this purpose. The need to sterilise the impact of these purchases of foreign exchange on domestic liquidity resulted in the Bank reporting an after-tax loss for the second consecutive financial year, amounting to a little under R1,2 billion. Having given a brief outline of the global and economic outlook, let me now address a number of questions raised by various shareholders during the three shareholder road shows held in Pretoria, Durban and Cape Town in the run up to this meeting. I would also like to thank all shareholders who attended these road shows, and encourage others to take advantage of this opportunity for more in-depth interaction next year. Question 1 – The losses incurred and explanation of Gold and Foreign Exchange Contingency Reserve Account (GFECRA) The Bank acquires foreign exchange for reserves accumulation purposes, and in the process injects rand liquidity into the domestic money market. In order for domestic money-market conditions to reflect the prevailing monetary policy stance as determined by the MPC, such liquidity needs to be sterilised (or drained) from the system. This is done, inter alia, by openmarket operations conducted by the Bank by way of issuing SARB debentures, and conducting reverse repurchase transactions. These transactions, which effectively amount to a borrowing of rands, are undertaken, in terms of cost, at or around the repo rate which is currently 5,5 per cent per annum. The foreign currency that is purchased is then invested in different currencies, that is, in US dollars, euros and pound sterling. In the current difficult economic climate, these investments generally earn low rates of return, currently below 1 per cent per annum. This negative interest rate differential has resulted in the R1,16 billion loss reported in the Annual Report 2010/11. Unrealised and realised fair value gains and losses on financial assets and financial liabilities are also included in the interest income line item and are for the account of the Bank. The losses incurred, as in 2009/10, were covered by drawing down on the contingency reserve, which declined from R9,1 billion to R7,94 billion for the Bank. Once the Bank returns to profitability, there will be a need to rebuild the contingency reserve, and reconsider the level that this should stand at taking account of recent experience. BIS central bankers’ speeches It is important to point out that the losses were incurred in the execution of the Bank’s public duties and do not in any way relate to operational deficiencies or undue risks being taken. The Bank has a sound risk management framework, a disciplined budgeting process, and prudent expenditure management. Gold and foreign exchange contingency reserve account The Gold and Foreign Exchange Contingency Reserve Account originates from sections 25 to 28 of the SARB Act. The GFECRA consists of three sub-accounts which reflect the following transactions: (a) Gold price adjustment account All profits and losses on gold holdings arising from price fluctuations and revaluation movements are recorded in this account. (b) Foreign-exchange adjustment account All revaluation profits and losses on foreign assets arising from exchange rate movements against the rand are recorded in this account. (c) Forward exchange contracts adjustment account All revaluation profits and losses arising from exchange rate movements against the rand on outstanding commitments in the forward Foreign-exchange market and foreign currency – denominated liabilities of the Bank are recorded in this account. All the above amounts are for the account of Government in terms of the SARB Act. Settlement of this account is subject to agreement between the Bank and Government. The current arrangement is that only transactions that have affected liquidity in the South African money market will be settled. Question 2 – Reserves management and holding thereof, including the issue of US dollar vs gold While South Africa follows the international convention of reporting official reserves in US dollars, the portfolios of reserves are diversified in approved currencies which predominantly comprise US dollars, euros and pound Sterling. The notes to the financial statements (Note 29 on page 98 of the Annual Report) give an indication of the extent of currency diversification. Gold reserves constituted approximately 12 per cent of total official reserves at the end of March 2011. The Bank has held around 4 million fine ounces of gold for some time, and when such holdings are reviewed account is taken of both the cost of acquiring further gold reserves and any returns that could be earned from owning more gold. The Bank has adopted a conservative and prudent approach to investing the reserves, guided by a clear governance framework and investment policy. The investment policy captures the objectives, rationale and the risk tolerance of the Bank for holding these reserves. The inherent risks in reserves management are mitigated by well-defined investment guidelines. Question 3 – Clarification of certain aspects of the remuneration of directors (Note 30 on page 102 of the Annual Report) The remuneration of directors for the year ended March 2011 reflects a general adjustment of 6 per cent over the amounts paid for 2010. In addition, the amounts paid in 2011 include: BIS central bankers’ speeches an “arrears adjustment” of 3,1 per cent in respect of the 2009/10 financial year. In keeping with a decision taken at the start of the 2009/10 financial year that the increase be inflation outcome linked, Board members were paid only an interim adjustment of 3,4 per cent, on the understanding that the balance would be paid once the inflation-outcome for that year was known. Consequently, the “arrears adjustment” was paid in the 2010/11 financial year with the resultant percentage increase distortion; payments for service as chairpersons and/or members of Board committees, and changes in the composition and chairpersons of the Board committees between the 2010 and 2011 financial years. This implies increases in retainers and attendance fees; the establishment of the Board Risk Committee on 25 February 2010, which resulted in payments to the Chairperson and members of this committee during the 2011 financial year, compared to the previous financial year when the committee was in existence for only one month, and hardly any payments were made; an above-average increase in the remuneration of Dr X P Guma with effect from 29 May 2010 owing to his appointment as Senior Deputy Governor from that date; and an above-average increase in the remuneration of Prof R W K Parsons for services as non-executive director of a subsidiary owing to the fact that he served for a longer period than before in such capacity during the 2011 financial year. He also served on one additional Board committee of the subsidiary during the 2011 financial year. Question 4 – Code of ethics The Code of Ethics was adopted by the SARB Board in February 2010, and has been part of internal discussions throughout the Bank. It will be published on the Internet in due course, together with a comprehensive value statement that is being developed throughout the Bank. Question 5 – Additions to property, plant and equipment A question was raised with regard to the additions in plant, vehicles, furniture and equipment (Note 10.1 page 85), which has increased from R52 million in the prior year to R205 million. It has been necessary to invest in machinery and equipment at the branches and manufacturing subsidiaries. Going forward, we expect more such investment to take place to ensure optimal functioning and best use of new technology to maintain both quality and performance from the Bank and its subsidiaries. Question 6 – Panel process and nominations A question was asked as to whether the Bank remains satisfied with the quality of candidates available to serve as non-executive directors on the Board. It was also said that the Panel process is not transparent as to who has nominated the candidate, what the quality of candidates is and shareholders have not been given the opportunity to meet and interview the candidates for election. The Panel was established in terms of section 4(1C) of the Act, which Act further stipulates the process of nominating the candidates and the review process. I can confirm that nominations were received during March 2011 from the general public and were collated by the Secretariat for circulation to the Panel members. BIS central bankers’ speeches The Panel met on 16 April 2011 to assess the nominations and to confirm the selected candidates for consideration by the shareholders. In total, 84 nominations were received. The experience and qualifications of the candidates varied, and included business people, academics, accountants, lawyers and other professional persons. The Panel was satisfied with the level of qualifications, skills and business acumen of the majority of the candidates, as could be determined from the curriculum vitae (CVs) presented. Three candidates have been identified and confirmed in each of the categories where vacancies will arise on 1 July 2011, and the Panel is satisfied that these are persons of good standing and have the requisite knowledge and skills to fulfil the roles and responsibilities of a non-executive director. From reading the CVs of the nine possible candidates circulated to you, I have no doubt you will concur that all nominees are well known in their fields of expertise and reflect the highest standards of integrity and professionalism. Moreover, it is the responsibility of the Panel to assess the candidates, not that of shareholders. I am not aware of any precedent in the Bank where shareholders interviewed prospective nominees. It is also important to point out that this process allows for the public at large to make nominations, and therefore the pool of participants, both proposers and nominees, has been broadened. This is important as, given the small number of shareholders of the Bank, nominations limited to them could be construed as contrary to sound principles of central bank governance. Question 7 – King III compliance The Bank has been requested to expand upon its King III Code of Governance (King III) compliance and to explain where it does not apply the recommendations as set out in King III, in more detail. As discussed at the 2010 (OGM), the Bank has conducted a Bankwide gap analysis, and steps are being taken to address those areas we regard as having room for improvement. It is necessary to emphasise that King III is a voluntary code, and a tool for enhancing governance, which is the approach the Bank has taken. Question 8 – Definition of corporate body A request has been made to set out clearly the definition and status of the Bank with regard to profitability. The SARB Act clearly stipulates that the Bank is a juristic person, with its primary objective being to protect the value of the currency of the Republic in the interest of balanced and sustainable economic growth. There should be no ambiguity about this matter. The Bank does not perform its duties with a profit motive. On the contrary, in the exercise of its responsibilities, it may well take actions that are in the national interest but will result in the Bank being loss-making. It is the obligation of the Bank to act in the best interests of the country, and not in the narrow interests of the profitability of the Bank or its shareholders. There are legal limits placed on the rights of the shareholders of the Bank – for instance a limit of 10,000 shares, a fixed dividend, the election of only some of the non-executive Board members and no role in the appointment of the Governor and deputy governors, among others. Amendments to the SARB Act The amendments to the SARB Act were promulgated in September 2010. In terms of these amendments, membership of the Board of the Bank was expanded from 14 to 15. The Board has also agreed to use as a guideline the nine-year rule contained in King III for the service periods of Board members. As a result, three new non-executive directors will be elected by shareholders at this OGM. There are currently four vacancies for non-executive directors appointed by Government. Once all these appointments have been made, the Board will comprise a significant proportion of new members. While this may raise challenges for BIS central bankers’ speeches continuity, I am confident that the new-look Board will continue to maintain effective corporate governance oversight of the Bank. Other changes to the Board have come about as a result of the appointment of Mr Lesetja Kganyago as Deputy Governor, who assumed office on 16 May 2011. I would like to take this opportunity to welcome him again to the Bank. He brings a wealth of knowledge and experience, and his positive impact is already being felt. I would also like to take the opportunity to bid farewell to Senior Deputy Governor Dr X P Guma who has indicated to the President of the Republic that he is not available for reappointment when his contract expires at the end of July 2011, after 10 years as Deputy Governor. I wish to thank him for his service to the Bank. It is also fitting to pay tribute on this occasion to Mr Errol Kruger whose career in the Bank spanned 34 years. As Registrar of Banks he played a critical role in ensuring the soundness of the South African banking system. We wish them both well in their new undertakings. Let us now turn to the formal business of the day, which includes the following matters: Firstly, to consider the minutes of the Ordinary General Meeting of shareholders held on 8 December 2010. Secondly, to present and discuss the annual financial statements and the reports of the Board of Directors and the auditors of the Bank for the financial year ended 31 March 2011. Thirdly, to request shareholders to elect non-executive directors, to fill the three vacancies on the Board of Directors for persons with knowledge and skills in commence or finance; labour; and mining. Fourthly, to approve the remuneration of the auditors of the Bank for the past audit. Fifthly, to appoint auditors for the 2011/12 financial year. And finally, to consider any further business duly placed and to be transacted at an ordinary general meeting. The Office of the Secretary received no requests for special business to be placed on the agenda of this meeting from any shareholders other than Mr Duerr. Mr Duerr attempted to place some 15 items of purported special business on the agenda of this meeting, including 5 items which he attempted to place on the agenda of last year’s OGM. None of the items qualified as special business as contemplated in regulation 7.3(d) read with regulation 12.3 of the Regulations, and Mr Duerr, was in writing, together with reasons, informed of this position. The matters addressed above during my speech do, however, cover many of the items raised by Mr Duerr as they formed part of the ordinary business of the meeting. Notwithstanding the above, I would like to deal with some matters relating to Mr Michael Duerr. It is unusual to single out one shareholder, but given the extent to which Mr Duerr claims to speak on behalf of all shareholders, and his consistent communication of all issues raised with the Bank to a wide range of media, we feel it is necessary to put the record straight. Mr Michael Duerr has been a shareholder in the Bank since about March 2006. Mr Duerr is a shareholder who does not normally reside in South Africa, and is therefore subject to the legal provisions applicable to shareholders who are not ordinarily resident in South Africa. In the main, the legal implication is that Mr Duerr (as is the case with all other non-resident shareholders) cannot vote at any general meeting of shareholders of the Bank. Non-resident shareholders, of whatever nationality, even if South African nationals, have not been permitted to vote virtually since the inception of the Bank, and this is clearly spelt out in the SARB Act. Mr Duerr should have been aware of this and other limitations on shareholders at the time he bought the Bank’s shares. However, Mr Duerr refuses to accept that the SARB Act lawfully prohibits persons who do not ordinarily reside in South Africa from voting, and he has raised issues with regard to the enforceability of this measure with the Bank on numerous occasions. BIS central bankers’ speeches We have spent literally hundreds of management hours responding to often spurious, slanderous and sometimes downright bizarre interventions by Mr Duerr. The Bank’s Legal Counsel and his team have spent some 385 hours since the middle of last year just responding to his queries. We have received more than 60 e-mails and other correspondence, running to more than 160 pages. Apart from the tone, language, unfounded allegations and abuse contained in this correspondence, there have been no less than 61 demands, often stipulating responses expected within hours. By any standards, this is not in the interest of good governance or efficient or effective operations. We have reflected the hours spent by the Legal Counsel, but the interaction also takes up the time of the Governors, the Secretary of the Bank and the Head of Strategy and Communications. We can only conclude that harassment appears to be the actual intention, which is most unfortunate and hardly a good reflection on Mr Duerr, who claims that in these actions he is the “caretaker shareholder” acting for all shareholders. In this way he ostensibly abrogates to himself powers that can never be his, and seeks in the process to disempower the vast majority of shareholders by evidently suggesting that he speaks in your name. Allow me to quote from some of the public statements that have been made by Mr Duerr. On 2 March 2009 Mr Duerr forwarded an article titled “The Central Bank Hunter”, which had been published in an overseas publication styled “Börse Online”, to the Bank. It consisted of an interview with Mr Duerr in which he, among others, made the following statements: (a) he had stumbled upon the astonishing fact that the Bank (being a central bank) was 100 per cent privately owned, and started buying himself into the organisation; (b) in order to side-step/circumvent the limitation of half a per cent of the issued shares that may be owned by a single shareholder, he ordered shares in the name of family members to their personal limit, resulting in his wife, children, parents and parentsin-law becoming part of the deal; (c) his family held about five per cent, his personal friends an estimated five per cent and partners who had joined the business owned an estimated five to ten per cent of the Bank’s shares; (d) this business was not expensive for him, measured against the two million issued shares and their value expressed in euros; (e) his initial purpose for buying the shares, namely to prevent the erection of a nuclear power plant near his property, had been superseded by an approach of achieving the maximum possible return on capital from his investment; (f) in his opinion it would amount to R4 206 per share and this would be most easily achieved through nationalisation of the Bank as in such an event shareholders would be entitled to 40 per cent of the reserves of the Bank; (g) he was persisting in his attempts to acquire more Bank shares; and (h) from his side he wanted to increase the pressure on the central bank and threatened to pass on shares under his influence to the Chinese or the Indians. In this vein he pointed out that there are many investors who would be prepared to pay millions in order to have access to a political lever. In various correspondence Mr Duerr has behaved in a threatening manner, including laying criminal charges against the Bank’s Legal Counsel, which have been dismissed as without foundation by the National Prosecuting Authority. To give a sense of the tone he tends to adopt, I quote from his letter to Dr Johann de Jager of 19 November 2010: “Dear ‘old foe’ Johann, this is the only nickname you can expect from me after your seriously bad behaviour, stupidity and arrogance over the last few years …Just delay the AGM otherwise you ask for the next fracas, with all the media bells and whistles attached. I hope this finds BIS central bankers’ speeches you well and you have your blood pressure tablets handy. Do you choose the carrot or the stick?”. Correspondence from Mr Duerr is regularly copied to the media and other parties. As an example, in submitting questions to me on 17 November 2010, over 80 people from national and international media, the Government, Parliament and members of the legal fraternity were included in the mailing list. This is no doubt part of his efforts to question the integrity of the Governor and the governance of the Bank. Profit maximisation has never been a motive for holding shares in the Bank. The limits set out in law of a fixed dividend and the limited holding of shares and voting rights available to private shareholders underline the fact that the Bank – like its counterparts in other countries – is a national asset that acts in the public interest. Shareholding in the Reserve Bank is not the same concept as shareholding in a JSE-listed commercial enterprise. It is a simple but incontrovertible fact that shareholders have an interest in, but do not own, the Reserve Bank. Parliament has reconfirmed this in the most-recent amendments to the SARB Act, and every shareholder is aware of the numerous legal limitations when he or she purchases shares. That is a pretty clear state of affairs. It is accepted and embraced by the vast majority of the Bank’s shareholders, from the large commercial banks to individuals from many walks of life for whom a shareholding is a contribution to the entrenchment and enhancement of the Bank’s independence. Given the claims made for a distribution of the profits and reserves of the Bank, I take this opportunity to refer to the judgement of the Court of Appeal in Brussels regarding the claims against the National Bank of Belgium by a group of its shareholders. The Court of Appeal in Brussels on 1 June 2011 delivered judgement in the final pending legal dispute between a group of shareholders and the National Bank of Belgium. The Court confirmed, in a clear and convincingly motivated judgement, an earlier judgement delivered on 30 September 2010 in which it was held that shareholders had no right whatsoever to the gold reserves and the profits realised thereon. The appeal was dismissed as unsubstantiated and a cost order was granted against the appellants of twice 30,000 euro (or twice 207 euro per share) which was payable to the National Bank and the Belgium Government respectively. The judgement concluded a series of legal disputes instituted against the National Bank/Belgium Government by two groups of shareholders, representing a small minority of shareholders in the National Bank. Ladies and gentlemen, Responsible shareholders help entrench and enhance the Bank’s independence. They support its public interest mission. They see in a private shareholding in the Bank first and foremost an opportunity to interact with the Bank and gain a deeper insight into the economy. They recognise this is not a get rich quick scheme. Diversity of stakeholders remains a key intention of the Reserve Bank, of the Government, and of all serious shareholders. In fact, the most-recent amendments to the SARB Act have significantly broadened and strengthened our diversity and our ability to act without fear, favour, or undue influence from any quarter, whether at home or abroad. Your responsible exercise of your rights and duties as shareholders make a significant contribution to the diversity and independence necessary for us to fulfil our mandate. With this contribution you help build the enormous goodwill and trust the Bank enjoys from across a wide spectrum of communities in the country. In so doing, you help build the South African economy and you contribute to nation building. Allow me to express my appreciation for your contribution and to ask that you continue to BIS central bankers’ speeches support the very important work of the South African Reserve Bank, particularly at this very crucial time in history. To the best of my knowledge, all business included in the agenda of today’s meeting has been transacted. I wish to thank President Zuma and the Presidency, the Government and Parliament for their continued support. The sound working relationship between the Bank and the National Treasury has continued, and I thank Finance Minister Pravin Gordhan, Deputy Minister Nhlanhla Nene and the staff of the National Treasury for their ongoing support. We also thank Mr Lesetja Kganyago as the former Director General, and are confident that the strong ties between the Bank and the National Treasury will continue to bear fruit as we build on the firm foundations already in place. We look forward to our continued sound working with the new Director General, Mr Lungisa Fuzile, and wish him well. Sincere thanks are also due to the members of the Board for ensuring appropriate corporate governance in the Bank. We pay particular tribute to the three Board members whose terms of office end today, namely Ms Thandi Orleyn, Dr Len Konar and Ms Zodwa Manase for their years of service and support. Sincere appreciation is also due to Senior Deputy Governor Guma and Deputy Governor Mminele, as well as the entire management and staff of the Bank for their dedication and commitment in dealing with the issues we have had to face in these very challenging times. As was the case at the time of the establishment of the Bank, we face a challenging global and domestic environment. In the 90 years of its existence, the Bank has been able to navigate successfully through many turbulent periods. Over the years, economic theory and policies have also evolved in response to changing circumstances. The Bank is fortunate to have skilled and professional staff who will enable it to continue to keep abreast of the latest developments in the policy environment, and remain focused on the implementation of appropriate and sustainable policies in the interests of all South Africans. BIS central bankers’ speeches
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Reuters Economist of the Year Award, Johannesburg, 5 August 2011.
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Daniel Mminele: Forecasts, errors and what we can learn from them Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Reuters Economist of the Year Award, Johannesburg, 5 August 2011. * 1. * * Introduction Good morning ladies and gentlemen. Thank you to Thomson Reuters for inviting me to address you this morning and to celebrate with you your achievements in economic forecasting. May I take this opportunity to extend my sincere congratulations to the winner of this prestigious award to be handed out this morning, and also to congratulate all of the nominees present here today. I was very tempted to start off my remarks this morning by telling a little joke about economists, but decided against it, as I have been warned that an economist is someone who did not have enough personality to become an accountant. I promise to keep my remarks this morning quite brief. 2. Economic forecasting tested during the crisis Thomas Kida1 noted, “...the amount of knowledge we have in a certain area will not help us predict what will happen if the events are inherently unpredictable.” The recent global financial crisis and recession has proved to be a humbling experience for economists, financial market participants, policy makers, regulators and many others that derive their income from economic forecasting, understanding the world economy and that which governs it. The crisis was not foreseen by most forecasters, although there was a minority who had been warning of a pending disaster for some time. The failure to forecast the “Great Recession” caused the Queen of England herself to ask why it had not been foreseen. The turmoil of recent years has prompted critics to maintain that many economic models, and particularly macroeconomic models based on rational expectations, have been proven to be fundamentally flawed. Much of the criticism directed towards forecasting and macroeconomic analysts has probably been misplaced. It has never been so much about economic models being wrong, as it is about understanding that all models are limited – by definition – and that models that limit certain types of relationships will eventually fail when those relationships in the real world change. In other words, the right criticism is to say that economic models constructed in particular ways need to be used and understood in similarly particular ways. A model that does not include household balance sheets and what drives them will not tell you if you will have a household debt crisis. By the same token, a model that says that future wage inflation will be a perfect function of expected future inflation will always be at odds with reality. Criticising economists for thinking that their models replace what actually happens in the real world may be satisfying, but it is also off-key. By the same token, placing complete faith in an economic forecast or model is equally unhelpful, as we know that no model can fully capture the complex relationships we find in the real world. Therefore models should never be used mechanistically. Forecast errors Thomas Kida is a professor at the Isenberg School of Management at the University of Massachusetts. BIS central bankers’ speeches cannot tell us anything useful about financial and economic panic and crashes unless the models on which they are based account for the build up of imbalances that become unsustainable. Clearly, the conditions for sustainability also need to be included. For example, the ability of Greece to manage its current debt load differs depending on how fast the Greek economy can grow. The mistake was to allow so much of the global community, especially the financial markets and policy makers, to rely on economic analysis that placed little emphasis on structural factors and balance sheets and which ignored the herd behaviour occurring in financial markets. It was not a model of real estate prices that failed to see the absurdity of ever-rising prices in the US housing market, but the assessment of the bull market in property by many, often famous, economists. So how might we think about dealing with this problem of economic models and forecasting that will be by definition insufficient and, in fact, wrong, and the need for robust and useful economic analysis both of what models tell us and what they don’t? Certainly part of the answer lies in making progress with developing models that are useful in the appropriate contexts. For the Reserve Bank, a major step forward in modelling came with the implementation of the inflation targeting monetary policy framework in 2000. More accurate modelling and forecasting activities were (and are) required for inflation targeting, and the Research Department of the Bank set up a so-called “suite of models”. This ranges from single equation, high frequency data models to longer-term structural multivariate models, and also varies according to the combination of economic theory and statistical techniques applied.2 It is useful to supplement the forecasts from structural models with information obtained from higher frequency models to establish the starting point for the forecast trajectory. This approach allows the forecasters to optimise the positive characteristics of a particular model type and use the different approaches to improve the trajectory of the forecast and minimise errors. The suite of models approach can be useful to obtain different forecasts for the same variable which can then be pooled together to obtain the final forecast. Models differ in their focus and consequently in their characteristics and transmission mechanisms. Different outcomes are useful in gaining new perspectives on what is driving particular outcomes. There are of course limits to this approach. Too many different model properties make the assessment of the transmission mechanisms ambiguous and complicates the interpretation of the results. The success of any modelling and forecasting endeavour should be measured not by the sophistication or complexity of the techniques used or the accuracy of the data employed, but rather the degree of forecast error minimisation and the quality of the analysis that it supports. More and better information is critical to model building, forecasting and analysis. And here, the Reuters Survey provides a valuable service to the modelling activities of the Reserve Bank, and of course other forecasters. It is useful to compare forecasts to shed light on how other participants view the future and how they quantify the most important transmission channels of the economy. The analysis of surveys over time, moreover, tells us something about the nature of shocks hitting the economy, how the economy adjusts to the shocks, and the extent of policy reaction expected by the markets. For example, time series models help us forecast high frequency data for a horizon up to 2 quarters. However by definition, these models rely solely on past data patterns and are unable to predict turning points. Structural models are better suited to forecasting over longer horizons. BIS central bankers’ speeches In our recent discussions of the economy, considerable attention was devoted to understanding the combination of inflation, growth, and monetary policy reaction functions exhibited in private sector forecasts. Greater uncertainty in the global economic environment and newer data from international and domestic sources made it critically important to gather more views of conditions in the world and understand how they were being interpreted by the markets. A levelling-off of commodity prices and weaker economic growth in many economies presented significant differences from how we understood the world even two months ago. There have been other changes too, including on the domestic front, such as signs of weaker second quarter growth rates. Our task is to try to peer through these various changes, in part to ask ourselves hard questions about our forecasts and test them against potential scenarios. Scenarios, in turn, imply probabilities of events actually transpiring, and here our analysis has had to cross the boundaries into other fields. We noted for instance in the Monetary Policy Committee Statement our concerns about the debt crises in advanced economies and considered in our discussions the possibilities of how this crisis might be resolved. This general increase in uncertainty has become a characteristic of the post-recession world, and one that appears especially hard to cast off. Uncertainty demands a greater application of judgement across a broader range of perspectives than in times when variables move in clear directions and risks are low. 3. Conclusion These thoughts prompt us to recognise that flexibility is a key ingredient of useful macroeconomic forecasting exercises, even as flexibility may seem to violate the very idea of a model. This tension is in fact quite important. The inflexibility of a model’s fixed relationships help us to assess whether today’s actual outcomes will continue in the future or adjust in line with the historical relationships reflected in the model. As real world outcomes change, we in turn ask ourselves what is wrong with our model relationships or what other conditions have changed to generate outcomes beyond what the model suggests. In short, the framework used to produce forecasts must be dynamic and able to change should circumstances require. One area for future work for us in the Reserve Bank is to incorporate the lessons of the financial crisis and recession into how we use our macro econometric and other models. The financial crisis that has occurred was so unexpected that very few, if any, macroeconometric models captured the inter-linkages between the real and the financial spheres. Beyond interest rates, macro econometric models generally do not include financial transmission mechanisms. Clearly this needs to change, but we also need to recognise that even much more extensive coverage will not compensate for intensive regulatory focus on financial and asset markets and the balance sheets of institutions operating in them. And from a policy-making perspective, we need to recognise that whatever progress we make in refining and calibrating our models, and achieving a higher level of their sophistication, they will never be able to absolve us from our responsibility to ultimately exercise judgement in reaching any policy decisions. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the US Chamber of Commerce in South Africa, Johannesburg, 23 August 2011.
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Gill Marcus: Perspectives on recent global economic developments Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the US Chamber of Commerce in South Africa, Johannesburg, 23 August 2011. * * * Good morning and thank you for the invitation to address this meeting of the US Chamber of Commerce in South Africa. We meet at a challenging time, with the global economy moving perilously close towards a precipice, as the financial crisis moves into its fifth year. Recent developments underline just how central the role of the US economy in the global economy remains. The current global outlook is therefore highly dependent on the health of the US economy, which is also important from a local perspective as the US is one of South Africa’s main trading partners, with a positive trade balance in South Africa’s favour. In 2010, almost 9 per cent of our total exports, totaling R52 billion, went to the US, while around 7 per cent of our imports, valued at R42 billion were sourced in the US. A number of recent developments have resulted in a high degree of market turbulence in recent weeks. These include the realisation that the outlook for US growth is not as favourable as previously believed, the damaging US debt ceiling debate and the consequent ratings downgrade of US debt, and the further deterioration of the European sovereign debt crisis which has now spread from the periphery to the core, and potentially to the European banking system. What started in 2007 as a banking crisis related to the US housing market has turned into a sovereign debt crisis, and recent events in the US and Europe illustrate how quickly the crisis can mutate. At the heart of the problem is a lack of strong unified and credible leadership, leading to a loss of confidence and trust in this leadership and potentially in the system as a whole. Behind the statistics are real people who find their lives in turmoil and livelihoods and future ambitions at risk. And in these circumstances those presenting easy answers to what are very complex and difficult issues can readily gain support. Given the backdrop against which we are meeting, it would be appropriate to make some comments about the current global developments and their possible implications for Africa in general and South Africa in particular. It would also be useful to draw out some of the lessons for Africa from the problems being faced by the Eurozone. What we are witnessing currently is not a new crisis, nor is it part of a normal economic cycle. We can learn a lot from the work of Reinhart and Rogoff who have shown that unlike normal economic cycles or recessions, financial crises are protracted affairs. According to their research, conventional recessions involve a relatively quick return to normalcy, and generally the economy makes up the lost output and resumes its pre-recession growth trend within a year. A recession involving a financial crisis involves not only loss of output and employment but applies to debt, credit and the deleveraging, which takes much longer to work through. Their work shows that the aftermath of severe financial crises share three main characteristics: that asset market collapses are deep and prolonged; that such crises are associated with profound declines in output and employment, with the latter being particularly protracted; and the real value of government debt tends to explode, on average almost doubling over a short period. This debt increase is apart from possible banking bailout costs, and is a result of an inevitable collapse in tax revenues as well as countercyclical expenditure policies. Their findings also not only show that banking crises do not discriminate between emerging markets and developed markets – leading them to label such crises as equal opportunity menaces – but developed countries generally take much longer to recover than emerging markets, possibly due to greater wage flexibility in (some) emerging markets. Normal cyclical downturns are often reinforced by tight monetary policies in response to an overheating economy and inflationary pressures, and the downturn can be effectively BIS central bankers’ speeches moderated by a reversal of the monetary policy stance. Unfortunately we are not in a normal cyclical downturn, and the crisis cannot be solved through monetary policy alone. Households in the advanced economies are still in the process of deleveraging and repairing their impaired balance sheets, and monetary policy can only help to a certain extent. In the context of low and falling house prices, declining equity prices and stubbornly high unemployment, rebuilding of household balance sheets may take a protracted period. The problem facing the US currently is this uncertainty relating to the self-sustainability of private sector consumption expenditure. At the start of the crisis, the gap left by the consumer, usually the main driver of growth, was filled in part by increased government expenditure. By the beginning of 2010 the recovery appeared to be underway and the consensus view was that by mid-2010, the US economy would be on a self-sustaining recovery path, and the focus then was on exit strategies or normalization of both monetary and fiscal policies. By mid-2010 it had become apparent that this positive outlook was misplaced, and an additional fiscal stimulus, in the form of the extension of the Bush-era tax cuts followed, along with a further round of quantitative easing. The result of this, however, was a further build-up of public leverage. There were concerns, however, that the impact of this additional stimulus would disappear by the middle of this year, and that consumption expenditure would not yet be on a selfsustaining path. The slowdown in the US economy in the first half of the year was widely interpreted as a temporary soft patch, attributed in the main to supply chain issues relating to the disasters in Japan. There is now a more general recognition that the US economic recovery is weaker than anticipated, and fears of a possible return to recession have replaced the earlier confidence. This is particularly the case after the significant downward revision of US growth performance in the first quarter of 2011 from 1,8 per cent to 0,4 per cent. The announcement by the FOMC that the policy rate in the US is likely to remain accommodative until mid-2013 is more a statement about the weak outlook for the US economy, and the structural nature of this weakness, rather than a commitment about interest rates. Unfortunately the outlook is no better in the UK and the Eurozone. For some time the focus has been primarily on the sovereign debt problems of the peripheral European economies. As suggested by Reinhart and Rogoff, there has indeed been a spiraling of indebtedness of many Eurozone economies. For example, the debt to GDP ratio in Spain is expected to have increased from 40 per cent in 2008 to an estimated 75 per cent in 2012, while that of Greece from 105 per cent to 166 per cent over the same period. Fears of default abound as the different European countries failed to make the difficult decisions about burden sharing between countries and the private sector. Policy pronouncements and packages have not been fully followed through, or have generally disappointed the market in their failure to fully deal with the problems. Countries such as Greece have been forced into austerity programmes which are likely to be either politically unsustainable, or if they do manage to achieve the proposed expenditure reductions, may result in declines in real growth rates which would then reinforce the negative debt dynamics. The recent announcement by the Greek Finance Minister that Greece is expected to contract at a worse-than-expected 4,5 per cent or above in 2011 is a case in point. Debt sustainability is, after all, partly a function of both the cost of servicing the debt as well as the real growth rate of the economy. As the markets reassessed the ability of a number of countries to consolidate their fiscal positions, the spreads on sovereign debt increased, which in turn undermined the sustainability criteria. The failure of the Eurozone economies to deal decisively with the issue has resulted in a spill-over to the broader region, with the focus leap-frogging firstly Spain and then both Spain and Italy, and on to France, where the markets are now questioning the sustainability of the country’s AAA rating. The interconnected nature of these economies is reinforced by the exposure of the banks in France and Germany in particular to the debt of the peripheral European economies. The IMF estimates that the European banks’ exposure to the BIS central bankers’ speeches European periphery constitutes around 10 per cent of Europe’s GDP and about 80 per cent of the capital of European banks. In effect we have seen a banking crisis turning into a sovereign debt crisis, which in turn has the potential to undermine the banking sector recovery in Europe. In recent weeks there have been reports of US money market funds reducing their exposures to European banks. Bank equity prices have come under pressure, and interbank rates have also widened somewhat. Banking systems rely on confidence, and a collapse of confidence relating to counter-party risk can easily cause a liquidity crisis to translate into a solvency crisis with negative feedback effects to the real sector of the economy. For this reason it is important for central banks to stand ready to support their banking systems by providing appropriate liquidity support if and when required. Fortunately, central banks are probably better prepared for such actions than was the case in 2008. As the financial crisis gathered momentum in 2008, a feature that was widely recognised was the synchronised nature of the downturn. Current developments are disturbingly similar, with evidence of a synchronised downturn in many of the advanced economy. It is unclear at this stage if a reversion to recessionary conditions is likely, but at best the advanced economies appear to be in a stalled state. Even Germany, which until recently had been the powerhouse of Europe, only managed growth of 0,1 per cent in the second quarter of this year, while the Eurozone as a whole averaged 0,2 per cent. Growth in the UK is also expected to be 0,2 per cent, and 4 per cent below the pre-crisis peak. This raises serious concerns for two main reasons. First, there will inevitably be an impact on growth in the rest of the world. In 2008 the hopes of decoupling by emerging markets proved to be vain ones, and while there does appear to be an increased amount of intraregional trade, in Asia in particular, it is almost inevitable that the rest of the world will not escape unscathed. Second, a general growth slowdown will exacerbate the debt dynamics in many of these countries, and may indeed reinforce these negative dynamics if further fiscal stimulus is provided. So what can be done? The cumulative nature of this crisis means that many parts of the world have reached this stage having sold off most of the family silver. In 2008, the coordinated response by many countries resulted in fiscal and monetary policy reactions which are simply not possible this time round. The response at this stage has been limited as governments generally face fiscal consolidation, and their room for manoeuver appears to be constrained. In most of the advanced economies, monetary policy remains extraordinarily accommodative. As interest rates in many of these countries are close to the zero bound, the scope for further reductions is limited apart from further quantitative easing and actions to provide liquidity or support to dysfunctional segments of the financial markets. There is no doubt that the burden of the policy response will fall disproportionately on monetary policy, but it is unclear if such actions will be effective in providing additional stimulus as opposed to simply facilitating the functioning of markets. The lack of fiscal space creates a real policy dilemma. On the one hand countries require a fiscal stimulus to try and counteract the slowdown, while on the other hand the inevitable further build-up of debt means that sustainability issues become paramount. So there is the conflict between short term exigencies and longer term sustainability issues. Ultimately the policy focus has to be on growth, which will help with fiscal sustainability, rather than on debt reduction in the short run. There needs to be a clear distinction between short and medium term needs, with a clear commitment to medium and long term fiscal sustainability. The focus should also be on fiscal initiatives that have a durable growth-enhancing capacity and structural reform, and not simply fiscal impulses for their own sake. Unfortunately this is easier said than done. In order to avoid a replay of 2008, there needs to be a cohesive understanding of the situation, and a unity of purpose at the global and national levels. An effective response requires confidence and trust in leadership, and this appears to be lacking. The fractious nature of political processes seems to be making it BIS central bankers’ speeches difficult to have the level of coordinated and purposeful responses that the crisis demands. This is well illustrated by the debt-ceiling debacle in the United States, where some factions were willing to take the country and indeed the world over the brink. Similarly, the inability of the leadership on the Eurozone economies to agree on a credible and durable solution for the region has undermined support not only for the leadership but for the whole Eurozone project. Until now, there have been piecemeal responses to the European crisis, which have merely delayed the need for a credible solution. There are no easy or painless solutions, but the longer they are delayed, the more difficult and painful the outcome will be. It is not just the markets that have lost confidence, it is the ordinary people who are bearing the brunt of the consequences of the crisis. These social and the social consequences are becoming increasingly apparent and disturbing with a growing structural unemployment problem, particularly amongst the youth in some countries, and in a number of instances, increased civil unrest. The South African economy will not be immune to these developments. The economy has made a fragile and uneven recovery from the recession, but the future growth prospects will be affected significantly by global developments. Favourable growth outcomes were achieved in the final quarter of 2010 and the first quarter of 2011, when annualised growth rates of 4,5 per cent and 4,8 per cent respectively were recorded. However the second quarter performance had been disappointing, with both the manufacturing and mining sectors likely to have subtracted from growth. The main driver of growth over the past quarters has been growth in household consumption expenditure, which has averaged around 5 per cent since late 2009. However, for some time the Monetary Policy Committee of the Bank has questioned the sustainability of this consumption growth given the slow pace of employment growth, high levels of consumer indebtedness, low levels of bank credit extension as well as negative wealth effects emanating mainly from the weak housing market. Recent retail sales developments indicate that there may be some slowdown in the growth of household consumption expenditure. A worrying feature of the domestic recovery has been the slow growth of gross fixed capital formation, particularly by the private sector. This may be due in part to the relatively low levels of capacity utilisation in manufacturing, and the unfavourable export climate, due in part to slow growth in Europe, and declining competitiveness due to a relatively strong exchange rate and high rates of domestic input cost increases (including wages and electricity). South Africa’s export recovery has not been as robust as that in other emerging markets, and much of the increase in export values has been due to higher global commodity prices. The main destination for South Africa’s manufactured goods remains Europe and the United States, so a prolonged slowdown in these regions will have negative implications for the country’s exports. Should a more generalised slowdown transpire, we could see a decline in commodity prices as well. The low interest rate environment in the advanced economies has resulted in elevated levels of capital flows to emerging markets, in search of higher yields, with consequences for both the level and volatility of the rand exchange rate. There has, however, been a change in the pattern of these flows, which are now predominantly into bond markets rather than into equity markets. In South Africa, for example, since the beginning of 2011, non-residents have been net purchasers of bonds to the value of R51 billion, but have been net sellers of equities to the value of R8 billion. Given the prospects for a protracted period of low interest rates in the advanced economies, these flows are expected to continue, although are likely to become more volatile and uncertain during episodes of heightened risk aversion. Monetary policy has remained relatively accommodative in response to these developments. The policy rate, at 5,5 per cent, is at its lowest levels in 30 years, and the real policy rate is around zero. Inflation has been within the target range since March 2010, but is currently on an upward trend, mainly as a result of food and energy price pressures, with few obvious BIS central bankers’ speeches signs of excess demand pressures. In the event of a significant global downturn, monetary policy will react appropriately. The policy room available on the fiscal side is more limited, as there is now less fiscal space than was the case at the onset of the crisis. In 2008 South African was running a small budget surplus and the debt/GDP ratio stood at 27 per cent. Since the crisis, government spending levels have been elevated in historical terms, and although the deficit before borrowing has declined from a high of 6,6 per cent in 2009/10 to an estimated 5,3 per cent for the current fiscal year, the debt/GDP ratio has increased to 40,3 per cent, one of the largest percentage increases when compared to other countries over the same period. A domestic growth slowdown would reduce tax revenues, and there are limits to which the debt/GDP ratio can expand without bringing its sustainability into question. Any further fiscal stimuli would therefore need to ensure a focus on growth-enhancing expenditure. The weakness in South Africa’s traditional trading partners underlines the need to seek new markets for manufactured exports in Asia, and more particularly in Africa. According to the IMF, African economies, with the notable exception of South Africa, displayed remarkable resilience during the crisis. Although most countries experienced lower growth, mainly a result of lower global commodity prices, in general they managed to avoid recession. Unlike South Africa, the trade channel was less important because of the predominance of intraregional trade, and the stronger trade links with Asia. Since then, most sub-Saharan African countries have returned pre-crisis growth rates, in line with those in developing Asia. The IMF estimates growth in SSA to average 5,5 per cent in 2011 and 6 per cent in 2012. In addition to the above, a further reason for these positive outcomes is a recovery in commodity prices as well as improved policy environments Recent developments in Europe have important lessons for future moves towards economic integration in Africa. Following the European experience in its 40 year move towards monetary integration, it became conventional wisdom that the appropriate sequencing was for full trade integration to precede monetary integration. Africa still has a multiplicity of, and in some instances overlapping regional trade blocs, and has some way to go to full trade integration. At the same time, African monetary integration initiatives are still going ahead in various forums, for example initiatives by SADC and the AU, with different and overlapping timetables, and with inordinate haste in some instances. Unfortunately the thinking behind these initiatives ignores the criteria for optimal currency areas, and focuses primarily on macroeconomic convergence criteria. An important lesson of the European crisis is that macroeconomic convergence is not enough. It is not sufficient for countries to comply with the initial conditions. It is now clear that necessary conditions include the need for institutions to ensure that these initial conditions are maintained. It is one thing to require countries to achieve certain debt ratios and fiscal deficit ceilings, for example, but are there appropriate mechanisms for ensuring that these guidelines or limits are adhered to? While the need for harmonised fiscal policies was recognised by the architects of the Eurozone, the issue was dealt with through the Stability and Growth Pact, which has turned out to be a loose, often ignored and unenforceable agreement that countries would abide by certain fiscal guidelines. We have seen the implications of the lack of a centralised fiscal authority, or fiscal counterpart to the ECB. Reaching agreement on, and implementing monetary policy is difficult enough. Fiscal policy is far more complex and political, as it involves policy levers that have more pervasive distributional impacts. It involves for example, decisions relating to tax policies, expenditure policies, and deciding on politically sensitive social and economic priorities. But ignoring the need for such an institution can lead to the difficulties currently being faced by the Eurozone. That is not to say that regional integration should no longer be a goal in Africa. If anything, the importance of trade diversification has been reinforced by the crisis, and further trade integration in Africa should be pursued more purposefully. But the excessive focus on BIS central bankers’ speeches monetary integration is misplaced and premature. South Africa’s trade links to the advanced economies makes it particularly vulnerable to slowdowns in those regions, and more attention should be given to encouraging regional trade and investment flows. In conclusion, we are living in difficult times. The global economy is on the brink of falling back into what could be a prolonged recession unless purposeful and coordinated action is taken. There are no easy or automatic solutions, but to date policy responses have been incomplete and irresolute. This has led to a loss of confidence and a lack of trust. It is not just the markets that have lost confidence, it is the ordinary people behind the statistics. And as austerity programmes bite further, we are likely to see more scenes similar to those that were recently played out in London and Athens. The challenge for leadership is to rebuild this trust and confidence. It can’t be through more talk. There has to be action, but the room for action is limited. Any measures taken are likely to entail significant financial commitments, and these need to be big enough to put a stake in the ground. Such costs should not be looked at in isolation, but in relation to the costs already incurred, and the costs of not resolving the crisis. There is a long, painful path ahead for all of us. Unless there is a cohesive understanding of who does what, and what is likely to succeed, then we will not rebuild confidence. Not only can it be done, it has to be done. Thank you. BIS central bankers’ speeches
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Opening remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, on the occasion of the launch of the South African National Payment System Framework and Strategy document - Vision 2015, Pretoria, 12 September 2011.
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Daniel Mminele: South African National Payment System Framework and Strategy document – Vision 2015 Opening remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, on the occasion of the launch of the South African National Payment System Framework and Strategy document – Vision 2015, Pretoria, 12 September 2011. * * * Good day ladies and gentlemen. Thank you for accepting our invitation to the launch of the South African National Payment System Framework and Strategy document – Vision 2015. The mandate of the South African Reserve Bank’s National Payment System Department (NPSD) to oversee the payment system, emanates from the enabling legislation which is the South African Reserve Bank Act, 1989 (Act No. 90 of 1989 – SARB Act). Section 10 (1) (c) of the SARB Act makes provision for the Bank to perform such functions, implement such rules and procedures and, in general, take such steps as may be necessary to establish, conduct, monitor, regulate and supervise payment, clearing or settlement systems. During 1995 the Bank published its first South African National Payment System Framework and Strategy document – Vision 2005. The Vision 2005 document spanned a 10-year period and contained strategies to modernise the South African national payment system (NPS) and to align the domestic NPS developments with international best practice. With the achievement of the major milestones and objectives envisaged in this document, a process was embarked upon to re-evaluate the NPS vision, which process culminated in the strategy document published in April 2006, referred to as Vision 2010. The Vision 2010 focused, inter alia, on access for bank and non-bank participants, oversight of the NPS, enhanced security and operational resilience in the NPS, regional and international participation in payment system development, as well as increasing awareness of the features NPS. The key strategic objectives outlined in the Vision 2010 document have similarly been implemented and achieved. In late 2009 and early 2010, the NPSD embarked on an extensive consultation and factfinding process to determine any new challenges facing the NPS, and to establish if refinements to the strategic direction of the NPS were required. Payment systems are by nature dynamic and fast changing, and various challenges emerged nationally and internationally. It was decided that due to the demands and challenges facing the NPS, a refinement of the strategic direction was required. The purpose of this framework is to provide a high-level updated strategic direction for the payment system up to 2015. New objectives and strategies have been developed, and some of the Vision 2010 objectives and strategies have been reconsidered, resulting in a refocus in, and/or redefinition of the Vision 2015. Major strategic objectives and challenges up to 2015 include the following: To continue to evaluate opportunities for further access to the NPS and improve the participation of non-bank stakeholders in the clearing system and/or in the formal payment system management structures. The recent financial crisis has reemphasised the importance of sound risk management policies and practices in the maintenance of a safe and efficient payment system. To enhance the oversight of banks and non-banks. As non-bank stakeholders are playing a larger role in the payment system, effective payment system risk management policies need to be considered. BIS central bankers’ speeches To enhance communication among stakeholders regarding NPS matters. Better communication improves the understanding of payment system stakeholders of the multifaceted nature of the payment system, which is complex and at times appears to be misunderstood. To participate in international workgroups and forums. Continued participation in international forums ensures that South Africa stays abreast of international developments spanning the many dimensions of the payment system universe. To enhance human resources capacity in the broader NPS. An intensified focus on human resources development initiatives will enable depth skills and the building of much needed capacity in the industry. To ensure high-level operational effectiveness of the payment system infrastructure. Operational effectiveness ensures the circulation of funds in the financial system and efficient liquidity management by participants. Failure of the infrastructure components of the payment system could result in substantial systemic operational risk. To facilitate regional payment infrastructure integration that meets the needs of the Southern African Development Community (SADC) region. The emphasis will be on commencing the process towards an integrated infrastructure. To formalise and implement an interchange determination process in South Africa that is fair, transparent and sustainable. This process should include all payment streams. Vision 2015 is the product of inter-organisational brainstorming, debate and consultation between the Bank, the banking industry and various other specific stakeholders. The successful implementation of the strategies will, once again, depend on co-operation between all the payment system stakeholders. I would like to take this opportunity to thank the bank and non-bank stakeholders for the input provided and their continued co-operation with the Bank. Finally, allow me to also convey my appreciation to my colleagues from the National Payment System Department, under the able leadership of Dave Mitchell, for their important contribution to the development of this forward-looking Vision 2015. Thank you. BIS central bankers’ speeches
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