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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Swiss Chamber Southern Africa, Johannesburg, 15 November 2011.
Gill Marcus: Assessing the risks to the inflation outlook – the challenges to monetary policy in highly uncertain times Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Swiss Chamber Southern Africa, Johannesburg, 15 November 2011. * * * Thank you for the opportunity to address the Swiss Chamber today. One of the many demands of being a Governor is that of travel. And it is in this capacity that over the past two years I have had the privilege of visiting Switzerland on a regular basis, as Basel is the home of the Bank for International Settlements (the BIS) – the bank for central banks. It is indeed a beautiful country, and one of the advanced economies that is experiencing the challenges arising from significant inflows of capital as investors seek safe havens. South Africa has had long-standing trade and financial ties with Switzerland, and in these troubled times it is important that such relationships are not only preserved but enhanced. We are certainly living in interesting but difficult times, because the possibility that things can go horribly wrong are very high. A break-up of the Eurozone, previously unthinkable, is now being mentioned by some of the European leaders who had previously dismissed such speculation. But even a less catastrophic scenario of a disorderly Greek default could have a disproportionate impact on the global economy. Unfortunately we do not know how long this process is going to take, and various attempts to resolve the problem have simply kicked the can forward, and perhaps bought more time. The dramatic leadership changes over the past week in both Greece and Italy demonstrate just how urgent the need for concrete and credible action is. We do know that we are getting closer to the end game at what seems to be increasing speed, but we do not know when that will happen and what form it will take. This makes policy-making extremely complicated, as it is difficult, if not impossible, to meaningfully quantify the risks, and build them into policy decisions. It is against this heightened global uncertainty that the Monetary Policy Committee met last week, and decided to keep the repurchase rate unchanged at a 30 year low of 5,5 per cent. The MPC assessed the risks to the inflation outlook to be on the upside, and today I will expand on two interconnected risks that featured strongly in the MPC deliberations, namely the global outlook and the impact of the exchange rate. As has been the case for the past two years or so, risks to the global outlook coming from the advanced economies have predominated policy discussions. There are three interrelated issues: the sovereign debt crisis in Europe, the unfolding banking crisis in Europe, and the inability of the advanced economies to generate sustainably higher growth. This is indeed an irony and a change from previous decades when the majority of the global risks emanated from emerging markets. And while these risk events, such as the Asian crisis of 1997/8, had contagion effects they were generally limited to other emerging markets, and the impact on advanced economies was minimal. In the MPC meeting, the global growth assumption in the forecasting model had been revised down, but did not reflect the worst case scenario for Europe. As the Eurozone crisis has engulfed Italy and parts of the European banking system, the stakes have increased. It was difficult enough to get agreement on actions to provide liquidity to the smaller countries, and Greece in particular. It is debatable whether the partial solutions that have been devised are adequate to build a fire-break around Italy, whose financing needs dwarf those of the combined European periphery. Rates on newly issued 5-year Italian debt exceeded 6 per cent yesterday (14 November) and at 6,29 per cent was the highest rate paid by Italy since June 1997. Rates on Spanish debt also exceeded 6 per cent. Thus it is clear that we are no longer talking about the periphery of Europe. BIS central bankers’ speeches Compounding the debt problem is the slow growth that is being experienced in the Eurozone, with the ECB now expecting a mild recession in the region. The European Commission sees stalled growth in the Eurozone until at least the middle of 2012, and has revised its forecast for Eurozone growth in 2012 from 1,8 per cent to 0,5 per cent. The Commission sees a high probability of a protracted period of economic stagnation. Italy is expected to grow by 0,1 per cent in 2012, due in part to fiscal austerity measures. Some analysts forecast a deep recession in Italy which would exacerbate the negative debt dynamics of that country. The Greek economy is expected to contract by –2,8 per cent. The AAA rating of France now at risk, and the European Financial Stability Facility (EFSF), which was established as a means to provide liquidity support to member states, is experiencing problems leveraging their funds. Despite its AAA rating from two of the main rating agencies, spreads on EFSF 5-year bonds have more than trebled in the past weeks, and lack of bids in a recent auction resulted in a failed auction with only €3 billion of an anticipated €5 billion worth of bonds being issued. The stability of the European banking system is also being brought into question as a result of the large exposures of French and German banks in particular to peripheral debt. At the same time, the requirements of Basel III have also meant that banks have had to increase their capital ratios. With bank share prices at low levels, the incentive is for banks to achieve their required ratios through deleveraging, i.e. through reducing lending. A credit crunch is a distinct possibility at a time when the region is already heading into a recession. Cumulative fiscal tightening in Greece and Portugal over 2011 and 2012 is around 8 percentage points of GDP, while in France, Italy, and Spain cumulative fiscal tightening over those two years of between 3 ½ to 4 percentage points of GDP is expected. Fiscal tightening on this scale would constitute a significant headwind to growth at the best of times. However, the headwinds are amplified as this fiscal tightening is being applied at a time when Europe as a whole looks like it is moving into recession and may be at the early stages of a credit crunch. There are no easy solutions to the European debt problem. There is a need for adjustment and for financing, and much of the policy paralysis is a result of different parties wanting to minimise their share of the burden. Not surprisingly, the creditor countries such as Germany see the solution for debtor countries to come from increased austerity. But not all countries can be creditors simultaneously. For every creditor there must be a debtor, and these debits and credits have their counterparts in the current account deficits and surpluses of these countries. For every net exporter there has to be a net importer. As Martin Wolf has recently reminded us, since the world cannot trade with Mars, creditors are joined at the hip to debtors, and any adjustment cannot be one-sided. These developments in the euro area have important lessons for other single currency areas, including moves towards monetary integration in Africa. Some of these lessons include the following:  It is not sufficient to have macroeconomic convergence criteria. This is a static approach, in the sense that once achieved, the pressure is off. Recent experience shows how quickly these ratios can be reversed. An effective monetary union needs to ensure that there are effective mechanisms to ensure that these criteria are sustained. The Growth and Stability Pact failed because there was no real sanction involved for countries that transgressed the rules.  This points to the need for a single fiscal authority. While this was previously recognised, the political difficulties of achieving agreement on this, and to allow politically sensitive issues such as tax policies, expenditure requirements, and fiscal transfers to be made by a supranational body, would have significantly delayed or even perhaps stymied the implementation of the single currency.  It is increasingly apparent that a further weakness in the design of the Eurozone was the lack of a lender of last resort. While in principle the ECB can, and has been in BIS central bankers’ speeches effect playing this role and taking a large amount of risky assets onto its balance sheet, it is questionable whether it can continue to do so without intense political pressure from some of the member states who feel that the ECB is operating outside of its mandate. At present it is the individual central banks that stand behind the ECB. There is no unified fiscal authority that guarantees its activities.  It would be wrong to think that sorting out the fiscal issues would have prevented the crisis. These issues are a manifestation of a deeper problem of divergent levels of competitiveness. The underlying assumption of a monetary union is that competitiveness will remain constant, i.e. the internal real exchange rates will be unchanged. In the past ten years the peripheral countries have lost competitiveness to varying degrees, in the case of Greece by about 30 per cent. There is no internal mechanism to prevent this, and in fact the single currency allowed for automatic and continuous financing of these divergent trends at low rates of interest. Italy’s problem is not only fiscal in nature. Italy is after all running a primary surplus. In the absence of an exchange rate adjustment mechanism, the only way to adjust is through an internal devaluation, implying falling nominal and real wages, and fiscal austerity. This is the classic expenditure reduction case under fixed exchange rates. The inability to change the nominal exchange rate imposes severe adjustment costs. While exchange rate flexibility would ease the burden of adjustment, countries that find themselves with appreciating currencies in response to developments elsewhere find it extremely uncomfortable as well. Countries with stable macroeconomic environments are better placed to shield themselves, but it is almost a truism that no country can actually escape the fall out of the global uncertainties that are currently prevailing. Switzerland, as a model of macroeconomic rectitude and with its safe banking system, is a good example of this. In the context of increasing risk aversion, there is a search safety rather than for yield. The interest returns from investing in Switzerland are minimal or negative, yet the country continued to receive significant capital inflows causing the Swiss franc to appreciate to uncomfortably strong levels. Attempts to stem the tide in 2010 through intervention were eventually abandoned after losses of around CHF 30 billion were incurred. At that stage the Swiss franc exchange rate was around CHF 1,45 to the euro. More recently, when the franc reached close to CHF 1 against the euro, the Swiss National Bank reentered the market and announced its intention to prevent the franc from appreciating beyond CHF 1,20. To date they have been successful, but it is unclear whether this will be sustainable in the face of an extreme bout of risk aversion in financial markets. While flexible exchange rates help with adjustment, these adjustments are not easy or without costs. South Africa’s attractiveness to capital flows and consequent appreciation pressures was in part due to the search for yield in an environment of abnormally low interest rates in the advanced economies. But the exchange rate response to risk aversion is the opposite to that of the Swiss franc. Since late July, as the Eurozone crisis intensified, the rand, along with numerous other emerging market currencies depreciated. Since July 2011, the rand has depreciated by about 20 per cent against the US dollar, and has traded in a range of between R6,65 and R8,50. As is often the case, the rand tends to be one of the more volatile currencies. Nevertheless these movements have been mirrored in a number of other currencies, for example the Mexican peso and the Brazilian real. These exchange rate developments have implications for monetary policy. As was noted in the MPC statement, the exchange rate is now seen to impart an upside risk to the inflation outlook. How inflation responds to exchange rate movements depends on a number of complex factors, including the speed, duration and the extent of the depreciation. Small changes usually have a relatively small impact on inflation, as is the case where the depreciation is expected to be of limited duration. Furthermore, the extent to which pricing was done at the BIS central bankers’ speeches previous level of the exchange rate could determine the extent to which producers can absorb the increased prices and costs. We must also distinguish between a once-off depreciation and a continuous depreciation. The latter is likely to lead to much more severe impacts on inflation, and most likely to lead to a price-wage-exchange rate spiral. A once-off depreciation would be expected to elicit some price response, but the impact on inflation is likely to be of limited duration, once the pass-through has occurred. So from a monetary policy perspective the challenge is not only to take a view on the future path of the exchange rate, but also the impact of these moves on inflation. The view of the MPC at this stage is that underlying support for the rand is still there, as the factors that led to the strong rand in the first place still prevail, and interest rates in the advanced economies are expected to remain lower for longer. However in the short run the volatility of the rand will be determined by bouts of risk aversion in global financial markets. The general expectation, as reflected in the consensus forecasts, is that the rand is unlikely to return to previous elevated levels of below R7 to the dollar, but is expected to appreciate somewhat from current levels. This view would seem to assume some orderly near-term resolution of the Eurozone crisis. Because the MPC assessed the risks emanating from the global economy to be on the downside, it sees an upside risk coming from the exchange rate. Does this necessarily imply that should the Eurozone crisis deteriorate, any further exchange rate depreciation would ultimately lead to a tightening of monetary policy? The answer clearly depends on what is happening to other factors as well. We should recall that at the height of the crisis in 2008/09 monetary policy was loosened despite the much more pronounced depreciation that is currently being experienced. At that stage there were a number of offsetting effects that meant that a more benign inflation outlook could be expected. These factors included the widening output gap and associated contraction in domestic expenditure, and the collapse of global commodity prices. We should not forget that the weaker rand also comes with its advantages. It makes our exports more competitive, and imported goods more expensive, which should provide a boost to domestic producers. This is in effect an easing of monetary conditions for domestic producers. However this advantage will be short-lived if offset by higher wage and other input costs which offset the advantage faced by producers. The decision to keep the repurchase rate unchanged was an outcome of a careful weighing up of the different risks to the inflation outlook, including the contradictory pressures coming from the exchange rate and the global economy. The MPC was of the view that monetary policy was sufficiently accommodative to support the economy at this stage, but at the same time it was concerned about the upside risks to inflation, which is now expected to breach the target for a longer period than previously anticipated. It still appears that inflation is being driven by cost-push factors, as illustrated by the benign core inflation outcomes. However, the interaction between higher headline inflation and inflation expectations of wage and price setters is critical. To date inflation expectations appear to be anchored at around the upper level of the target range, but the longer inflation remains outside the target, particularly if it surprises on the upside, the more precarious these expectations become, and the greater the upside risk to the inflation outlook. The Bank sees medium-term inflation outside the target range at this point, and regards the breach, although extended, to be temporary. In addition, the weak state of the economy also impacts on the approach taken. But we have to be vigilant on both sides. There is always a possibility of upside surprises to growth or a dislocation of inflation expectations from the target range, which could take inflation well above the target range. However, on the other side, although our assumption for European growth has been lowered, it does not contain the worst case scenario of a meltdown in the Eurozone which would have severe implications for the global economy and South Africa. Although this is seen as a tail risk, it is not a remote possibility. As noted in the recent statement, the MPC is prepared to take appropriate action should the need arise. BIS central bankers’ speeches In conclusion, the European environment holds many uncertainties and possible unthinkable consequences, and it is difficult to preempt this in our policy choices. At the same time, the combination of rising inflation and sluggish domestic growth holds the risk of a stagflationary environment. Monetary policy will maintain its focus on achieving the inflation target over the medium term, but will remain sensitive to the domestic economic situation. However, an accommodative macroeconomic environment cannot on its own generate the higher rates of growth that this economy requires for employment creation. Part of the solution will need to come from improving much needed infrastructure, such as energy, rail and ports, which will strengthen the country’s export capacity. There is also the need for sustained efforts to enhance South Africa’s ties with its traditional trading partners such as Switzerland, and also to develop new trading relations outside the Eurozone. These are indeed very challenging times, a time of great uncertainty. Nevertheless it is a time that needs thoughtful answers, collective action, courage and integrity. It is a time that questions what we know, what we thought we knew, and the paradigm of our thinking. Thank you. BIS central bankers’ speeches
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bank of America Merrill Lynch 10th Annual Investor-to-Corporate Conference 2011, Cape Town, 18 October 2011.
Daniel Mminele: A delicate balancing act – how to reconcile upside medium term inflation risks with near term growth concerns Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bank of America Merrill Lynch 10th Annual Investor-to-Corporate Conference 2011, Cape Town, 18 October 2011. * 1. * * Introduction Good morning ladies and gentlemen. The topic I have been asked to speak on is quite an appropriate one at this juncture, but also a very difficult one, consuming the minds of many central bankers around the world, particularly in emerging market countries. The world has never fully come out of the crisis that started in 2008; we have just seen the form of the crisis evolving over time. Now, four years later, the global economy appears to be once again on the precipice and could tilt in either direction, depending on the resolve of policy makers to finally put in place comprehensive and credible plans to fully address sovereign debt and banking sector risks, in order to deal with current near-term downside risks to the global economy. This should then open the way for undertaking the necessary structural reforms required to tackle underlying root causes, and thus put the global economy on a stronger, sustainable and more balanced footing in the medium term. My comments this morning will focus more generally on the dilemma facing many emerging market economies today, notably, elevated inflation and slowing growth. This is in stark contrast to the situation one year ago, when emerging markets were faced with rising inflation and stronger growth. Thereafter, I will delve a little deeper into the inflation and growth dynamics in South Africa. 2. Reconciling inflation and growth Real economic activity in advanced economies has slowed considerably, confidence has fallen sharply and financial sector risks have intensified. This has added to an already complicated environment, characterised by high levels of public debt. Growth dynamics in emerging market economies are in much better shape than advanced economies, but interlinkages in the global economy render emerging markets vulnerable and they may not be in a position, as they were in the past, to carry the global economy. Ultimately, emerging market growth is highly dependent on growth in advanced economies, as we saw recently after China recorded a sharp slowdown in exports, due to softer growth in the US and Europe. Emerging market central banks have also had to contend with strong capital inflows over the past few years owing to a search for yield, and resulting in appreciating currencies. We were, however, provided with a stark reminder a few weeks ago about the inherent risks associated with volatile capital flows, when we saw abrupt and sizeable outflows in the wake of sudden changes in investor sentiment, and the associated impact on currencies and emerging market assets in general. Signs have emerged of a slowdown in emerging market economies, while inflationary pressures continue to be somewhat elevated. South Africa’s situation has been a little different, as growth has been somewhat more subdued as compared to other emerging market economies and demand driven inflationary pressures largely absent. The Monetary Policy Committee statement after our most recent meeting in September highlighted the challenges facing monetary policy presently and going forward. These challenges are driven by recent data which have confirmed that while the domestic economic activity has slowed down considerably in the second quarter, at the same time, there is upward pressure on BIS central bankers’ speeches domestic inflation driven by a number of exogenous factors. The worst case scenario for monetary policy of course, is a combination of slow growth and higher inflationary pressures, a real double whammy scenario. Different shocks, depending on whether they be demand or supply driven, require different policy responses. What is important is to understand the source of the shocks, their magnitude and possible duration, as well as the associated inflationary consequences, and only once we understand this, judge what the suitable policy response will be. Sounds much easier than it is in practice! In the case of a demand driven shock or demand-pull inflation, monetary policy would generally be tightened sufficiently in an effort to bring inflation back towards any stipulated target. Cost push inflation on the other hand is caused by rising costs of production, such as a rise in oil prices, which will tend to drive up petrol prices and in turn, the prices of other goods as transportation costs increase. This type of inflation causes a certain level of inflation across the economy, but also tends to have a dampening effect on growth, as consumers will tend to adjust their spending habits to take into account increased spending on these items. The policy response in this case is not quite as straightforward. A tightening of policy may bring down inflation, but will not have any impact on the root of the problem being rising oil prices, and in fact would most likely exacerbate the fall in output and worsen the impact of the shock for households and businesses. Having said that, however, discarding a supply side shock, such as a spike in oil prices, may not always be advisable. What needs to be carefully assessed are the reasons for any supply shocks, whether such shocks are viewed to be transitory or permanent, and most importantly, whether or not they carry with them the risk of feeding through to underlying inflation or core prices. A feed through to core inflation and evidence of second round effects would most likely occur when there is very little slack in the economy and prices in general are under pressure, or if inflation expectations rise alongside the rise in inflation, and translate into higher nominal wage demands, which in turn would feed through to higher core prices. In this event, the supply shock will result in general price levels going up, generating inflation. Depending on the extent of this, policy makers at some point have to make a choice to either accommodate these pressures or seek to counter them. The manner in which the South African Reserve Bank has approached such supply side shocks, is to allow the initial price level effects to flow through to final prices, but to look out for second round effects that would push inflation above the target on a sustained basis. In the longer-run, the impact of the supply shock on prices of other goods will depend largely on how inflation expectations respond to the shock. The best case scenario would be if inflation expectations signal that the rise in inflation will only be temporary. However, if expectations show a more permanent rise in inflation, in response to the supply shock, then it is likely that wages and salaries will also rise across the economy and prices throughout the economy could be affected and adjusted higher. In this case, core inflation will generally tend to rise and converge with the higher measure of headline inflation. In this instance, monetary policy would need to ensure that relative price changes do not alter inflation expectations to the extent that it becomes difficult to achieve a moderate and acceptable inflation rate over the medium term . 3. South Africa’s inflation/growth profile South Africa’s year-on-year consumer price index has remained within the 3 – 6 per cent target range since February 2010. A combination of supply side shocks, administered price Eric S Rosengren, “A look inside a key economic debate – how should monetary policy respond to price increases driven by supply shocks?”, 4 May 2011. BIS central bankers’ speeches increases and wage settlements well in excess of inflation, resulted in the targeted CPI measure increasing from a low of 3.2 per cent in September 2010 to 5.3 per cent in August 2011. Administered prices increased well above the upper end of the target range for more than 20 months, accelerating from 7.1 per cent in September 2010 to around 12.0 per cent in August 2011. Rising prices for food, petrol and electricity contributed 1.1 percentage points, 1.6 percentage points and 1.0 percentage point respectively to the August reading, and greatly influenced what otherwise would have been a somewhat more benign inflation environment. Core inflation has also edged up in recent months, although the overall underlying inflation trend appears relatively well contained for now. Alongside the increase in inflation, inflation expectations, as measured by both the Reuters survey of financial analysts, and the Bureau for Economic Research, have adjusted higher towards the upper end of the inflation target range. Whereas inflation expectations remain on average within the target range for the forecast period ending 2013 and as such appear to be relatively well anchored at present, future developments in this regard will require careful monitoring. Nominal wage settlements, although well above the upper end of the inflation target range, have moderated. The average wage settlement rate in the first half of 2011 amounted to 7.5 per cent, compared to 8.2 per cent in 2010. Nominal unit labour costs decelerated from 10.7 per cent in the second quarter of 2010 to 5.3 per cent in the first quarter of 2011, despite a marked decline in productivity. Demand-side pressures are currently relatively subdued and not expected to exacerbate inflationary pressures in the short term. Economic activity in South Africa decelerated from 4,5 per cent real GDP growth in the first quarter of this year to 1.3 per cent in the second quarter. South Africa is currently growing at below its potential growth rate, which we estimate to be around 3.5%, with an output gap of around 3% in the second quarter of 2011. During this quarter the deceleration in economic activity was recorded across the agriculture, mining and manufacturing sectors, with only a marginally stronger performance recorded in the services sector. The combination of adverse weather conditions, industrial action and safety-related stoppages at certain mines contributed to this disappointing performance. High frequency data points to continued weak conditions in the mining, manufacturing and construction sectors and this is also reflected by declining business confidence, to well below the neutral level of 50. The manufacturing sector, which contributes about 15 per cent to GDP, contracted by 7 per cent year-on-year during the second quarter. The monthly manufacturing data and the Kagiso Purchasing Managers’ Index (PMI) indicate that the manufacturing sector will likely record another disappointing performance in the third quarter. The PMI remained below the 50 threshold for two consecutive months, before recovering to a level of 50,7 index points in September 2011, while the employment index has remained below the 50 index level. According to Kagiso, the PMI leading indicator, measured as the ratio between new sales orders and inventories, remained at an early-2009 low of 0.85 in September. This is reflective of high inventory levels, well above the demand for factory goods. Furthermore, the PMI average for the third quarter was 47.2 index points (55.1 recorded in the second quarter), which does not bode well for actual factory output and growth in the third quarter. Weak conditions on the production side reflect both the poor state of the global economy, as well as the deceleration in domestic demand conditions. Domestic expenditure grew by 1.3 per cent in the second quarter of 2011, from an annualised rate of 7.9 per cent in the first quarter. Household consumption expenditure decelerated significantly and government expenditure contracted. The combined impact of rising inflationary pressures that affect households’ disposable income, falling consumer confidence, the still relatively weak housing market, declines in the value of assets, high debt burdens and reduced access to credit further adds to households cautiousness in their spending decisions. Strong wage inflation during 2010 is also starting to take its toll on employment creation and the unemployment rate increased to 25.7 per cent in the second quarter of this year (although even through the boom periods, unemployment still remained high around 22 per cent). Continued labour BIS central bankers’ speeches shedding is expected to weigh on consumer spending going forward, while the lower growth trajectory, in turn, does not bode well for employment creation. Other indicators pointing to a slowdown in economic growth, include the weaker growth and/or in some instances a decline in retail sales, vehicle sales and house prices. Against this background, policy makers and economists have downgraded their growth forecasts for the year. The Bank has lowered its growth forecast, due to the lower-thanexpected GDP outcome in the second quarter, the impact of industrial action on key sectors such as manufacturing, as well as a downward adjustment to the global growth assumptions. The Bank’s latest projections show growth to average 3.2 per cent in 2011, lower than the previous forecast of 3.7 per cent, while the forecast for 2012 has been reduced from 3.9 per cent to 3.6 per cent. The risks to this outlook are seen to be on the downside, mainly on account of risk to the global economy. The Bank’s inflation forecast has been adjusted higher on a few occasions this year to take into account higher oil and food prices. At the last sitting of the MPC in September, the inflation forecast was left largely unchanged. It is expected that inflation could breach the upper end of the target range in the final quarter of 2011 and to peak in the first quarter of 2012 at around 6.2 per cent, but then to return within the target range in the second quarter. In the final quarter of 2012, inflation is expected to ease to around 5.5 per cent. The Bank’s measure of core inflation shows a rising trend, peaking at around 5.1 per cent in the second and third quarters of 2013. What is important for the Bank is the trajectory of inflation and to what extent any breach of the target is sustained. Our assumptions at this stage point to a temporary breach of the inflation target. However, there are a number of upside risks to the inflation outlook which require careful monitoring. The main upside risks continue to emanate from exogenous factors, as well as administered prices, and despite the easing in wage pressures this year, this could become a factor going forward. The stronger currency to some extent helped to contain inflationary pressures domestically, but more recently, the depreciation of the rand brought to the fore the potential upside risk emanating from a sharply weaker currency. To what extent one should be concerned about the recent depreciation in the rand exchange rate is a function of many factors, including whether it is short-term or longer-term in nature, the eventual magnitude of the depreciation, the pricing power of firms, the stickiness of prices, the history of inflation and the domestic content of traded goods. Clearly, the MPC is having to deal with a delicate balance at present between the upside risks to inflation and the downside risks to growth. Much is dependent on the unfolding global environment, in particular growth prospects in the US, and the sovereign debt crisis in the euro zone, whether or not this turns into a banking crisis and spills over to other areas of the world. Should European leaders manage to avert a full-blown crisis, this will go a long way to restoring the health of the financial system and injecting confidence into financial markets, business and consumers. The MPC will keep a close watch on underlying inflationary pressures, and to what extent these are reflected in inflation expectations and wage settlements, in addition to which, we will pay close attention to global economic and financial market events as they unfold. 4. Conclusion Monetary policy makers across the world have to make difficult decisions in a highly uncertain and volatile economic and financial market environment, and have to be careful and ensure that higher inflation expectations do not become entrenched, but also ensure that actions taken to contain inflation are not premature and risk a further slowing in growth. However, it is also important to also accept that while monetary policy has to contribute its fair share, shifting a disproportionate amount of the responsibility to resolve current challenges to monetary authorities can only result in sowing the seeds of future problems. BIS central bankers’ speeches In South Africa recent supply shocks have placed upward pressure on inflation, but there is no evidence this far to suggest that these pressures are becoming entrenched and that inflation expectations are becoming less anchored. Nonetheless, it is important to monitor these dynamics to ensure that second round effects do not take hold, that there any pass through to other prices is carefully assessed, and that inflation expectations do not diverge significantly from the recent past. As indicated, the key challenge will be to strike a delicate balance between a monetary policy stance which is appropriate to support the hesitant economic recovery, while ensuring that incipient inflationary pressures are managed, and that there is no doubt about the Bank’s commitment to its mandate. Thank you. BIS central bankers’ speeches
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Speech by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the Lereko Metier Capital Growth Fund Investor Conference, Magaliesburg, 1 March 2012.
Lesetja Kganyago: The impact of the Eurozone and global financial crisis on South Africa Speech by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the Lereko Metier Capital Growth Fund Investor Conference, Magaliesburg, 1 March 2012. * * * Programme Director Chair and Directors of Lereko Ladies and Gentlemen All protocols observed The waves of the global financial crisis hit our shores as expected. The ferocity with which they hit our country was more pronounced than we could ever imagine. Fortunately, South Africa had built strong policy anchors. Nevertheless, the impact reverberated across the entire economy. Tonight I would like to take you through our experience through the waves. I want to say a few things about the South African economy in the global financial crisis and its current European incarnation. In particular, I want to provide some perspective on the economy’s resilience to global shocks and how our macroeconomic policy settings enable the economy to weather global storms. A crisis in waves The global economic crisis came in waves. The initial surges were relatively supportive of the economy. Rising commodity prices in the period from 2003 to 2008 increased the terms of trade of the economy in a strong and sustained way, boosting export revenue and making rising import prices tolerable. Over this period, 2003 to 2008, the terms of trade increased by 7.1 percent. A steady flow of saving from non-residents into rand-denominated assets contributed to cheap financing and with a stronger currency made possible the importation of considerable capital equipment, a less costly infrastructure build programme, and improved welfare for households as imported consumer goods became less costly. From 2003 to 2008, real household consumption growth averaged 5.8 percent. Real gross fixed capital formation grew by an annual average of 12.6 percent. Compared with the 1990s, average annual real GDP growth was 4.6 percent over this period. The manufacturing sector alone had real fixed capital formation growth averaging 3.7 percent a year and grew by an annual average of about 4.0 per cent. The second wave was much less benign. This was the sustained rise in global food prices, which generated strong upward pressure on domestic food prices and eventually the overall price level. Headline inflation rose strongly, peaking at 11.1 per cent in September 2008. The rise in inflation and subsequent monetary policy response (the policy rate increased from 7.0 per cent to 12.0 per cent between May 2006 and June 2008) sharply worsened the financial conditions of South African households and corporates that had increased their levels of indebtedness in the period prior to 2007. The various positive factors of the 2003 to 2007 period had resulted in a sharp rise in indebtedness which could not be sustained as growth and income in the economy slowed and inflation increased. Indebtedness of South African households had increased from 54.5 percent of disposable income in 2003 to 82.3 per cent by 2008. The slowly unfolding financial crisis in the United States and the eventual shock of the Lehman bankruptcy in October 2008 hit an already weakening economy. As credit was BIS central bankers’ speeches restricted globally and trade volumes collapsed around the world, the value of real exports of goods and services from South Africa fell by 19.5 percent in 2009. For many economies, including South Africa, the decline in trade triggered the actual recession as it led to sharp contractions in output and labour retrenchment. South Africa’s quarter on quarter annualised growth in gross domestic product contracted by 1.7 per cent in the fourth quarter of 2008, falling to –6.3 and –2.8 per cent in the first and second quarters of 2009 respectively. The economy’s real GDP growth rate was –1.5 per cent in 2009 and 2.9 per cent in 2010. Stronger commodity prices in the boom period had pernicious effects as the crisis unfolded. Exogenous shocks from food and oil prices combined with domestic inter-sectoral dynamics pushed nominal wage settlements to very high growth rates given the slowing economy. Unit labour costs increased sharply as a result. The labour market outcomes in South Africa were severe. While about 1.6 million net jobs were created in the period 2003 to 2007, from 2008 to 2010 roughly 800 000 net jobs were lost. Job losses were heaviest in construction, retail, and financial services, which were the major job gainers in the boom period. A key distinction between South Africa and most other countries’ experiences in the crisis has been the extent of job destruction, particularly considering the relatively shallow recession we experienced. Stronger economic performance in 2010 gave way to much more volatile real economy outcomes in 2011. Some of this had to do with adverse international economic events, including the tsunami in Japan and sharply elevated oil prices due to the conflict in Libya and political uncertainty as the Arab Spring unfolded. But a large portion of the domestic output volatility was related to domestic factors, including the debate on nationalisation of mines, work stoppages in manufacturing industries, health and safety shutdowns, and a lower output in an agricultural sector that had grown very rapidly in previous years. The marginally stronger growth rate in 2011 (estimated at just over 3 percent) compared to 2010 (2.9 per cent) was due to better outcomes in tertiary sectors, particularly trade, catering and accommodation, transport, storage and communications, and financial services, underpinned by sustained growth in government spending. How did we respond to the crisis? Given the unfolding of the shocks hitting the South African economy, the monetary and fiscal policy responses were largely reactive. The main forward-looking macroeconomic policy setting and decisions were made some years earlier, and enabled a sustained moderation in the economic effects of the crisis. Like many other emerging market economies, capital inflows and upward pressure on the exchange rate played a complicating role in how the economy responded to the shocks and to policy. The inflation targeting framework, put in place in 2000, had largely aligned inflation expectations of economic agents with the Reserve Bank’s forecasts. With a change in policy on exchange market intervention, the IT framework also allowed the currency to float and absorb major shocks without forcing major interest rate adjustments. This cushioning role was critical at the time of the Lehman crisis, because it allowed the monetary authorities to continue lowering interest rates as inflation moderated even as investors sold rand denominated assets in the near-panic selling of “risky” assets of the time. Post-Lehman the value of the rand against the US dollar declined by about 35 per cent as did the currencies of many emerging market economies. South Africa’s sound fiscal position and the high level of commodity prices implied a return of capital into the economy once risk perceptions had moderated. Over the course of 2009, the rand strengthened, averaging R8.44 to the US dollar in the year, and beginning 2010 at R7.37. The underlying real equilibrium exchange rate of the rand was high because of the terms of trade and sound policy. BIS central bankers’ speeches The initial sharp depreciation of the currency might have generated stronger economic outcomes for exporting and import-competing sectors, but it is likely that the net effect of a persistent depreciation on the economy would have been negative at the time. It is also important to remember that these competitiveness gains would have been very small due to the sharp moderation in consumer spending and the fall in foreign demand for all South African exports. In other words, South African exporters outside of the commodity sector might have benefited marginally from higher domestic prices, but only for a short period as their input costs escalated. As those costs rose, the likely interest rate response to the inflationary effects of the exchange rate drop would have squeezed domestic demand even as rising inflation appreciated the real exchange rate and reduced the initial improvement in competitiveness. South Africa’s policy discourse at the time, centered on the need for a fiscal stimulus response to the fall in foreign demand and slowing domestic economy. This was incompatible however with a macroeconomic response to those advocating a moderation in the appreciation of the currency as it rebounded from the overshot depreciation in late 2008. In addition to the positive economic factors driving the resumption of capital inflows – the sound public debt position and high commodity prices – the high inflation rate and growth in unit labour costs were driving up the real effective exchange rate. The current account deficit remained high as a result of growth in gross domestic spending exceeding growth in domestic production. These factors meant that monetary policy alone – lowering the policy rate to reduce carry trade – could not have prevented the appreciation of the nominal and real exchange rates. To prevent the real appreciation would have required macroeconomic policy tightening to rein in domestic expenditure and moderate inflation. In practice this meant either that the foreign currency public debt would have to increase by the amount the authorities were willing to intervene in the foreign exchange markets, or fiscal policy would have to adjust to find the resources for foreign currency purchases out of current spending or from increased revenue. Short of increased borrowing and the implications for long-term interest rates, the other options entailed reducing public spending on current programmes or tax increases. The approach taken was to provide funding to purchase foreign currency inflows from foreign direct investment. Where there has been insufficient rand available for this purpose, forward market foreign currency swaps were conducted to finance the reserve purchases. Even the efficacy of macroeconomic policy adjustment to achieve the real depreciation is in doubt. Despite the sharp punctuations of risk aversion resulting in sales of emerging market assets, global macroeconomic rebalancing has been marked by a sustained flow of capital out of some advanced economies and into faster growing and higher return emerging and developing economies. For economies like South Africa that for one reason or another are seen as good investment destinations, this flow is unlikely to dry up soon. The corollary is to take a bet that China’s growth rate will slow permanently, resulting in much lower commodity prices, and hence a fall in South Africa’s terms of trade. This seems an unlikely bet to take. In that global context so heavily influenced by China as the world’s primary driver of economic growth, adjustment to the nominal exchange rate might be expected to generate further portfolio capital inflows. Another alternative was for the imposition of capital controls or taxes on capital inflows to reduce the return on rand-denominated assets. Such controls were put in place in some countries, primarily Brazil. These may have adjusted the composition of inflows somewhat towards more foreign direct investment, although the evidence provides little grounds for a robust assessment one way or the other. Like the option of a fiscal contraction, the imposition of taxes on capital inflows would force a reduction in domestic spending and would need to be large enough to tighten policy to offset the inflationary impact of eased policy rates. BIS central bankers’ speeches Perhaps the remaining option at the macroeconomic level would have been to fix the exchange rate against another currency. With lower inflation rates in major currencies, this would have likely resulted in the need to tighten monetary policy immediately. From a policy perspective, fixing the nominal rate would also have severely limited South Africa’s options and forced domestic monetary and fiscal settings to adjust domestic demand to maintain whatever currency peg was chosen. Imposing domestic economic volatility to solve exchange rate volatility would be a strange choice to make. On balance, it is unclear that any of the macroeconomic options not taken would have resulted in better economic growth, investment or employment performance than actually occurred. It is possible that somewhat tighter fiscal policy and somewhat looser monetary policy could have resulted in a slight change in the balance of production between traded and non-traded goods, but the economy-wide economic growth rate would likely have been lower and fewer jobs created. The non-traded goods sectors have tended to grow faster than traded goods and are more labour intensive, irrespective of the strength of global demand. The floating exchange rate has enabled South Africa to weather the global crisis without having to impose jarring interest rate hikes, meaning that households and firms could pay down debt more rapidly and the recovery initiate sooner. Perhaps more importantly, a series of clear constraints to growth in traded goods sectors have been identified for some years and new ones have emerged to frustrate sustained growth in output. The capital flows challenge needs fresh thinking. Over the medium term, to moderate the real exchange rate, we need fiscal and monetary policy settings that reflect that policy objective and seek to achieve it. For fiscal policy this means a credible consolidation path and a return to sustainable public debt levels. It also implies that public spending be directed at addressing South Africa’s competitiveness challenges and infrastructure needs. Getting these areas of policy right, in turn, implies that foreign investment will start to shift in composition towards greater FDI relative to portfolio investment and in a wider range of industries. More efficient infrastructure, more competitive firms with sustained productivity growth, and more skilled labour are as integral to achieving a permanently more competitive economy as forward-looking fiscal and monetary policy settings. How we address our home-grown economic challenges is not to suggest that global difficulties can be left unattended. Three serious disorders confront the short and medium term. The first is the effects of macroeconomic policy making in advanced economies. These policy settings, intended to resolve the combination of slow growth and over indebtedness, and conducted in a globalised world economy; contribute at some level to the flow of capital into emerging markets and the developing world. Like the experiences of the Asian crisis over a decade ago, for some economies these flows run the risk of pushing economies into very poor decisions of what to do with the surplus of capital. Capital pushed into uses where the returns are speculative and high will tend to result in inefficient use of capital and cause foreign currency liabilities that cannot be met. For other economies, such as South Africa, the flow of capital may ease the adjustment process by enabling a faster consolidation away from unsustainable fiscal positions. But they also can result in Dutch Disease effects, particularly as in South Africa, where shocks affecting one sector are transmitted to others via input pricing and sector-level collective bargaining. The trade channel works in the opposite direction. The markedly slower economic growth of advanced economies will result in lower exports in the short term and will accelerate the shift in exports towards more rapidly growing regions. China is the fastest growing export destination for South Africa, while India and a number of African countries are also receiving a rising volume of exports. The slowing advanced economies however also pose a less obvious trade challenge to South Africa’s manufacturing ambitions. The market space for South Africa’s relatively high cost and specialised manufactures will narrow and competition will increase with Asian competitors. BIS central bankers’ speeches For the time being, job creation is more likely to rebound in sectors that did well prior to the crisis, and indeed this is what we have seen over the course of 2011. Public sector job creation has been strong in 2010 and 2011, which has given way to stronger private sector job creation in the second half of 2011. Stronger public and private investment should be expected to result in better employment creation over the medium term. The second disorder is in financial markets in advanced economies. High debt levels in the developed world and the European sovereign debt crisis have triggered unconventional policy responses and a variety of risks is evident. The most troubling is the possibility of the current financial crisis intensifying sharply and resulting in even more credit contraction, sales of assets, and eventually stronger real economy effects. A severe worsening in the growth prospects for Europe would result in a calamitous fall in demand for exports from around the world. A global recession could ensue from this kind of risk. South Africa’s trade exposure to Europe is about 27 percent of total exports. A second and more plausible scenario is for a sustained period of very weak credit extension in Europe due to the combination of the Basel III capital requirements and exposure to sovereign debt in peripheral European economies. This outcome might play itself out as a serious drag on European growth, with GDP growing at roughly half the average rate achieved over the last twenty years. A third possibility would be for financial contagion to affect emerging market economies. In this instance, countries with financial and/or economic vulnerabilities would experience local currency asset sales, capital flight, and knock-on effects into confidence of consumers and businesses in the real economy. Such effects would very likely occur in the event of a financial and economic meltdown in Europe, but would not necessarily only come out of such a combination of circumstances. The private sector in emerging economies remains in deficit to the rest of the world and only Asian emerging economies have net foreign asset positions. As European banks recapitalise, the resulting deleveraging could reduce foreign funding for emerging markets significantly. European banks provide about 30 per cent of Latin American bank credit and 40 per cent of Eastern Europe’s so that a contraction in EU bank loans to these countries could constrain their economic growth significantly. The prolonged global crisis and the vulnerabilities created or exposed by policy efforts in South Africa and elsewhere to address the crisis have to some extent increased the risk of financial contagion. In that context, reducing vulnerabilities must be a key priority for the monetary and fiscal authorities. To conclude, SA fared better than many peers. Going forward, reducing vulnerabilities would entail strengthening our three key anchors. South Africa has almost no direct financial exposure to institutions in Europe, in part because of limited direct institutional linkages and in part due to our pre-existing macro- prudential policy framework, a key anchor. Nonetheless, reorganisation of the regulatory approach to the financial sector is underway to strengthen the capacity of regulators to address sectorspecific challenges that may arise in the future and enable appropriate responses in the event of shocks. Basel 2 provides the basic template for our domestic regulatory initiatives, even as discussions on Basel 3 plus appropriate flexibility for emerging market economies are ongoing. On the fiscal policy side, the medium term expenditure framework sets out a consolidation path that caps the rise in the public debt at comparatively low levels. As the economic recovery proceeds, the fiscal position will show further sustained improvements as we have seen in the latest budget numbers. Lastly monetary policy: the financial shocks that South Africa will face in future will continue to be best addressed with a flexible inflation targeting framework that allows the currency to cushion the domestic economy from volatility. Forward looking inflation expectations and transparency by the monetary authorities hold the key to minimizing exchange rate BIS central bankers’ speeches pass-through to domestic inflation. This will not always work as well as we would like, but is far better than the alternative of having to move domestic interest rates on a frequent basis to try to maintain a stable exchange rate. Underlying the sustainability of these macroeconomic policies must be efforts to improve productivity, skills development, and improve the flexibility of wages and prices. Stronger economic growth, sustaining people in jobs and more rapid job creation are our best defences against the economic shocks of the world in which we live. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Volkswagen South Africa Strategic Conversation Dinner, Sandton, 15 March 2012.
Gill Marcus: Perspectives on the global and domestic economic environment Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Volkswagen South Africa Strategic Conversation Dinner, Sandton, 15 March 2012. * * * Thank you for the opportunity to lead in the strategic conversation this evening. We have come through a difficult few years, and the road ahead is likely to be just as challenging. Right now there seems to be a small breathing space that might allow a better assessment of where the world is today. We have seen three elements of the global crisis come together, namely sovereign debt, a banking crisis, and the crisis of weak growth and rising unemployment, particularly among the young. There is also the increasing recognition that what is occurring is not simply a very deep economic crisis, but a fundamental shift in the balance of forces in the world. This is likely to take time to unfold, but significant changes are taking place, with the growing voice and economic power of emerging markets being heard more loudly. The global financial crisis is still with us, although it does appear that some of the worst case global scenarios may have been avoided or perhaps merely delayed. But even the optimistic scenarios for Europe are not good news as fiscal adjustments, bank deleveraging and the weight of the cumulative impact of the crisis thus far take hold. For this reason the outlook for the South African economy is not as bright as it could be, unless a concerted effort is made to do something different. Currently the domestic economy is characterised by rising inflation and slowing growth, which is a difficult combination for policy-makers to deal with. This evening I will give a perspective on aspects of the global and domestic economic backdrop. I will spend some time on the European situation, as the context within which we operate, formulate policy, adopt strategies is critical to enable all of us to ensure that South Africa is able to take advantage of what opportunities exist, and take appropriate measures to try to protect us from the ravages of the global crisis. From a South African perspective, what happens in Europe is important, given the trade links that we have with the region. Although the percentage of South African manufacturing exports to Europe have declined over the past few years, at around 30 per cent it is still an extremely important trading partner. In recent months there have been progressive downward revisions by analysts of the global growth outlook. The IMF, in its latest World Economic Outlook, also downgraded its forecast for world growth to average 3,3 per cent in 2012, and 3,9 per cent in 2013. There are still significant risks to the global environment, but the intensity and immediacy of these risks may have been reduced somewhat with the recent agreement on the Greek bail-out which has helped to prevent a disorderly default. This agreement is expected to allow for Greece to roll-over its debt that is maturing this month. It would be premature to think that the European crisis has been resolved as there are a number of interrelated and mutually reinforcing dimensions which mean that uncertainty remains. Although the risks from the sovereign debt crisis appear to have been reduced for the meantime, questions about the sustainability of the solution persist, particularly in the light of the fact that the European authorities have emphasised that the Greek bail-out model is not a precedent. The Portuguese economy is also under stress, and we could still see a repetition of the Greek crisis being played out there in the coming months. In the absence of a clear commitment to deal with a possible Portuguese crisis, the risk of contagion to other more systemically important economies, such as Italy and Spain, will increase. Although some of the peripheral European countries are relatively small, they have a combined BIS central bankers’ speeches sovereign debt of around US$1 trillion, with a significant proportion being held by European banks. The actions to resolve the Greek debt problem have involved significant losses to private sector bond-holders, many of which are European banks. In terms of the agreement, bond holders will accept losses in excess of 70 per cent of the value of the debt. Partly as a consequence of these developments, European banks are now undercapitalised, with estimates ranging between US$300 billion and US$400 billion. This has resulted in significant deleveraging by European banks, with indications of them selling assets in order to achieve their required ratios. This credit crunch in Europe is being exacerbated by the need to meet new capital requirements of raising the Tier 1 capital asset ratio to 9 per cent by June 2012. There are concerns that European bank lending could decline by around US$3 trillion over the next 18 months. The interbank market is also dysfunctional in Europe, reflecting the lack of trust between banks. The ECB has attempted to alleviate the situation with the establishment of the Long Term Refinancing Operation (LTRO) facility, which has to date granted an estimated US$1,35 trillion in loans to banks at low interest rates. There is some evidence that a significant proportion of this money has gone in to purchasing sovereign debt, but it is still too early to say how much will go to lending to households and businesses. The credit crunch is likely to reinforce the negative growth outlook for the region, and will in turn have its own negative feedback loop. The Euro area is expected to contract by around 0,5 per cent this year, and the European Commission expects negative growth in 8 of the 17 Eurozone countries this year. These countries include Belgium, Greece, Spain, Italy, Holland, Austria and Portugal. Widespread fiscal consolidation, even in countries with relatively strong fiscal positions such as Germany, has contributed to the negative growth outlook. A number of countries, such as Spain, Portugal and Ireland are attempting to reduce their deficit to GDP ratios by around 3 per cent per year for the next two years, and Italy by about 2 per cent per year. The negative growth outlook raises doubts about the ability of the Greek economy to adjust to the fiscal austerity that is being imposed on it. The economy has contracted by about 15 per cent in the past two years, and is expected to contract by a further 4,4 per cent this year, while unemployment has increased from 7,7 per cent in 2008 to almost 20 per cent. At the root of these problems is a balance of payments crisis within the euro area between northern and southern Europe. The loss of competitiveness experienced by the southern European countries and their consequent balance of payments deficits has in effect been financed by borrowing from the Northern Europeans. This is not sustainable indefinitely. Under normal circumstances the adjustment would be facilitated through exchange rate depreciation, but with this option ruled out, a more difficult path of “internal devaluation”, involving absolute reductions in wages and expenditure, has to be followed. The more reluctant the surplus countries are to increase their consumption of Southern European goods, the more difficult the adjustment becomes and the more politically unpopular these measures become in the deficit countries. Apart from the European situation, prospects for other parts of the global economy appear to be more promising, but risks remain. The US economic growth has surprised on the upside in recent months, but fears remain that this nascent recovery could be short-lived. In particular, there are risks that political conflicts over fiscal policy ahead of the November elections could result in premature fiscal cutbacks, which, according to some estimates could have the potential to reduce US growth by up to two percentage points. There are also indications that the Chinese economy may be slowing, but the Chinese authorities have the ability and resolve to intervene strongly to prevent a so-called hard landing. One region with a more favourable outlook is sub-Saharan Africa, which is expected to grow by around 5,5 per cent this year. South Africa’s financial and trade links with Africa have been increasing in recent years, and the continent is fast becoming the major BIS central bankers’ speeches destination for our manufactured exports. During the financial crisis, Africa was relatively protected from the fall-out, given the predominance of intra-regional trade, and South Africa would do well to encourage further two-way trade and investment with the region. One of the consequences of the global crisis has been the severe social dislocation that has accompanied it, and it is questionable how long such pain can be endured. The recent protests on the streets of Athens and general popular opposition raises questions as to whether or not the latest initiatives are politically sustainable. History is replete with examples of how circumstances similar to those described lead to political polarisation and the rise of nationalism and/or populism. This is happening in the context of a divided Europe, with no consensus on the appropriate solutions to the problems, and irresolute leadership reflected in weak and tenuous coalition governments. The social problems are reflected in the spiraling of unemployment in some of the advanced economies. This is particularly the case when it comes to youth unemployment. In this respect South Africa is no longer unique, with its estimated unemployment rate of 23,9 per cent, and youth unemployment at around 50 per cent. The negative trends in Europe in particular are quite dramatic. In the beginning of 2008 the unemployment rate in the European Union was 6,9 per cent and the unemployment rate amongst the youth (i.e. persons below 25 years of age) was 15,9 per cent. In January 2012 the unemployment rate in the EU was 10,7 per cent, while youth unemployment measured 22,4 per cent. The number of unemployed youth totaled 5,5 million. There are some stark divergences within the region, with overall unemployment ranging from 4,0 per cent in Austria, to 23,3 per cent in Spain, and youth unemployment ranging from 7,8 per cent in Germany to 48,1 per cent in Greece and 49,9 per cent in Spain. As a rule of thumb, the youth unemployment rate is between 2 and 3 times are high as the total unemployment rate. Of the 27 EU countries, 20 of them have youth unemployment rates of 20 per cent or more, and 7 of these are in excess of 30 per cent. This phenomenon is of particular concern, as the longer people remain out of work, the less likely they are to ever work, or work again. The unemployment get deskilled, demotivated and disaffected, leading to the attendant social hardships and drain on society. It is also not just Europe where unemployment has become a problem. US unemployment measured 5 per cent before the crisis, and peaked at around 10 per cent before declining to current levels of around 8,5 per cent. Youth unemployment is currently 16,0 per cent. In the UK, youth unemployment – at 22,2 per cent – is close to the 1 million mark. The problem of youth unemployment in the advanced economies is exacerbated by an ageing population which is putting strain on fiscal positions. The current low interest rate environment in these economies will make it even more difficult for private pension funds to generate adequate returns for this ageing population, with potential financial demands on governments. This factor has resulted in an extension of the working age in a number of countries, which makes it even more difficult to solve the youth unemployment problem, with the associated fiscal demands at a time when such programmes are being scaled back. The potential adverse social consequences of these developments are profound. The underlying lesson for South Africa from all of this is the importance of generating sustained and employment-generating growth that is needed to attend to the growing inequalities. It is also clearly preferable, particularly in the short run, to improve a debt to GDP ratio by increasing GDP growth, as opposed to cutting down on the absolute level of debt. Fiscal consolidation that is done too quickly could cause growth to decline, and this will cause the debt metrics to deteriorate and result in a negative debt spiral. When fiscal sustainability is called into question, the challenge is to find a balance between such fiscal consolidation and the need for growth. As I have indicated, South Africa’s growth outlook in the short to medium term will be impacted to a significant degree by global developments. Domestic economic growth in 2011 measured 3,1 per cent following growth of 3,2 per cent in the final quarter of the year. The BIS central bankers’ speeches growth forecasts for 2012 range between 2,5 per cent and 3,0 per cent, with the latest forecast of the Bank being 2,8 per cent. This followed successive downward revisions during 2011 as the European crisis intensified. Since the 2009 recession, growth has been driven primarily by household consumption expenditure, which is clearly an undesirable and unsustainable growth path. Emphasis must be given to ensure that growth is driven by investment. There are, however, signs that investment expenditure growth is gathering pace, and this will be reinforced if the proposals around increased infrastructure expenditure are followed through on. According to the latest budget, public sector projects totaling R845 billion have been approved for the MTEF period. This emphasis on infrastructure investment is appropriate as it is likely to contribute to improved economic efficiencies and helps with the alleviation of existing bottlenecks in the economy. But the focus on infrastructure is not new, and the plans have often not met expectations, particularly since the 2010 World Cup. For example in 2009/10, only 83 per cent of the amounts budgeted for infrastructure was spent. In 2010/11, this had declined further to 68 per cent. Importantly, it is not only the government and state-owned enterprises that need to invest. Michael Spence, the respected growth theorist, in his book “The Next Convergence”, has shown that countries which have sustained growth rates of around 7 per cent or more for 25 years generally have government and public sector investment ratios of between 5 and 7 per cent of GDP, and total investment rates of at least 25 per cent of GDP. Why emphasise a target of 7 per cent growth per annum? Because a consistent growth rate of 7 per cent will allow for a doubling of income every 10 years, whereas a growth rate of 3 per cent will take 24 years to double incomes. South Africa’s gross fixed capital formation as a percentage GDP averaged around 15,5 per cent in the decade from 1994 and then accelerated to peak at around 23 per cent in 2008. This positive trend coincided with economic growth rates in excess of 5 per cent and a decline in the unemployment rate to 21,9 per cent by the fourth quarter of 2008 . Since the crisis, this investment to GDP ratio has declined and in 2011 averaged around 19 per cent. Between 1994 and 2007, government and public sector investment averaged 4,4 per cent of GDP, but since 2008 it has averaged 8 per cent. We can conclude from this that the lack of investment is not simply a problem of government failure to invest. Private sector investment has also been lacking. But government does have an important role to play in providing the environment conducive to private sector investment. For example, a notable area where private sector investment has been severely lacking is in the mining sector. This may be due in part to uncertainties created by the regulatory environment, and lack of investment in rail infrastructure which has impeded the ability of the mines to get the ores to the ports. This also illustrates how government investment does not necessarily crowd out private sector investment. To the contrary it can also crowd in investment, as in this example. Michael Spence sums it up appropriately as follows: “Put bluntly, growth requires investment, and that means present sacrifice for future gain. The job of leaders is in part to get everyone on board, to build a consensus behind a forward-looking vision, underpinned by a growth and development strategy that is credible. Multiple classes of participants and organized stakeholders need to be willing participants. These include labour, unions, businesses and entrepreneurs, civil society organizations, and households at various levels in the income distribution.” It is not only investment in fixed capital that is essential. Human capital is as important, if not more so. It is generally recognised that South Africa’s schooling situation is seriously lacking in various respects, but of equal concern is the lack of training for technical skills. It is an indictment, for example, that South Africa needs to import skilled artisans such as welders. Germany has a very well established system of apprenticeships, but South Africa has gone backwards in this respect. Not only does an undertrained and undereducated workforce constrain economic growth, it reinforces the cycle of unemployment and widening BIS central bankers’ speeches inequalities. As Michael Spence has noted, in a world in which knowledge and connectivity are increasingly the basis for value creation, failures in the educational system are the surest form of exclusion there is. It would be inappropriate for me to conclude without saying something about monetary policy and inflation, and the contribution monetary policy can make to the growth and employment trajectory. We know that unemployment has serious socioeconomic consequences, but so does high inflation. It is difficult to find examples in history where sustained economic growth and high inflation went hand in hand. But it is easy to find glaring examples of high inflation contributing to socioeconomic dislocation. The inter-war years in Germany, Latin America in the 1980s, and closer to home in Zimbabwe in the previous decade are good examples. Zimbabwe got no advantages out of the hyperinflation, but it created severe hardships, and the Zimbabwe dollar has now disappeared. The burden of inflation gets borne by those who lose their jobs through this, and by those who are unable to hedge themselves against the ravages of accelerating price increases. These are generally the poor and often even the middle classes, whose savings and pension funds would have been rendered worthless. It is not only hyperinflation that is the problem. Even moderate inflation is bad for the poor and for workers. An annual inflation rate of 10 per cent for example, which is regarded by some as acceptable, means that a worker receiving R1000 per month will need to be earning R2590 in 10 years time simply to be no worse off. With a 20 per cent inflation, this amount would need to be R6,190 per month, and with a 25 per cent inflation, the required break-even income would be R10,000. The higher the inflation rate, the more purchasing power would be lost between bargaining rounds. In the latter case, workers will have lost a quarter of their purchasing power by the time of the next wage adjustment. If left unchecked, high inflation tends to breed higher inflation. Apart from its redistributive effects, high and variable inflation also tends to undermine long-term investment, so it is important that inflation is kept under control, and monetary policy is best placed to do this. But in trying to stem high inflation, monetary policy may have negative short run effects on economic growth. Conversely, monetary stimulus will only impact on cyclical growth. Therefore there has to be sensitivity on the part of policy makers to the state of the business cycle. This is what the essence of flexible inflation targeting is: that if inflation is outside the target, there is some flexibility with respect to the time horizon within which inflation is brought back to within the target, in order to smooth the cyclical adjustment. Monetary policy can help growth by providing a stable and low inflation environment conducive to investment, and by providing short-term stimulus, but it does not determine the underlying growth potential of the country. This is the domain of other policies and where the focus on infrastructure and other structural reforms is critical. Monetary policy is currently facing the challenge of a rising trend in inflation and a slowing domestic economy. According to the macroeconomic forecast of the Bank, inflation is expected to peak at around 6,6 per cent in the second quarter of this year and then to decline moderately before returning to within the target range by the end of the year. But there are a lot of uncertainties related to this outcome. Upside risks are seen to be coming from international oil prices, particularly in the context of elevated tensions in the Middle-East relating to the Iranian nuclear programme and associated sanctions. Administered prices also remain a concern, with the tendency for prices in many instances to be set without regard to the inflation target. However recent developments, including the below-inflation tariff increase granted to the ports, the reduction in the proposed e-toll tariffs and the reduction in the electricity tariff increase granted to Eskom are encouraging. The rand exchange rate could pose and upside or downside risk, depending on global developments. The rand tends to depreciate when there are heightened risk perceptions in Europe, as investors tend to seek so-called safe havens. But these flows tend to reverse as risk perceptions improve. Currently the markets appear to be taking a more positive view of BIS central bankers’ speeches global developments and this has been reflected in the recent appreciation of the currency. However, as I indicated earlier, this can change very quickly. Until recently, core inflation – that is inflation excluding petrol, electricity and food – was relatively subdued, reflecting the absence of significant demand pressures in the economy. In general, monetary policy can do little to combat the impact or first round effects of inflation that is driven by exogenous shocks. However the most recent data seem to suggest that inflation is becoming more generalised, and may reflect the emergence of demand pressures. This is something that the Bank will monitor very carefully. At this stage, monetary policy remains relatively accommodative, given the challenging growth environment, with real policy interest rates slightly below zero. As I have outlined earlier, raising the growth potential requires a concerted and sustained investment boost in the economy. An accommodative monetary policy environment is only part of this story, and as responsible monetary policy makers, we recognise that keeping inflation under control must be done with due regard to the possible impact on employment and growth. At the same time, maintaining price stability remains central to our mandate, and price stability should be part of the societal consensus that is essential for the successful implementation of a forward-looking sustainable growth strategy. Thank you. BIS central bankers’ speeches
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Speech by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, to the NEPAD (The New Partnership for Africa's Development) Business Foundation, Sandton, 17 April 2012.
Lesetja Kganyago: The impact of the Eurozone financial crisis on African Economies Speech by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, to the NEPAD (The New Partnership for Africa’s Development) Business Foundation, Sandton, 17 April 2012. * * * Programme Director Chair of Nedbank, Dr Ruel Khoza Ladies and Gentlemen All protocols observed It is now generally accepted that the global financial crisis showed its first signs in the sub-prime market in USA. It is thus tempting to think that it has got nothing to do with us. However we do know that in a world where the financial systems and the economies are closely integrated, this would have been cold comfort. The slowly unfolding financial crisis in the United States and the eventual shock of the Lehman bankruptcy in October 2008 hit an already weakening economy. As credit was restricted globally and trade volumes collapsed around the world, the value of real exports of goods and services declined. What I would like to do today is to address three questions that would hopefully spark a discussion during the panel discussion: What do we know about the Euro crisis? What are the channels through which it affects African economies? How did African economies fare and/or respond during the crisis? What do we know about the Euro crisis? Fiscal situation: The fiscal metrics of many Euro area countries have been deteriorating in the past five years. This culminated in the bailing out of Ireland and a Troika programme for Greece, including a very significant write-off. Most Euro area countries have debt to GDP ratios in excess of 60% and this includes even the stronger anchor countries such as Germany and France. In the case of Greece; Ireland; Italy; Portugal and Spain, the fiscal situation also got reflected in higher borrowing costs that made any fiscal stimulus a non-option for policy makers. Recent budget data suggest that the weaker countries in the euro zone will overshoot their official fiscal consolidation targets. These countries are caught between a rock and a hard place. Save for austerity, fiscal consolidation can only come from faster economic growth. The growth situation: Growth outcomes have been disappointing in the Euro area, to say the least. Recent data suggest that there could have been further contraction in the first quarter of this year while global growth has not been as supportive to the euro economy. There is also a policy dilemma of balancing fiscal consolidation and providing support to the economy to continue growing. With financial markets reluctant to lend to fiscally weak sovereigns, borrowing costs had risen to the point that it raised the issue of affordability and sustainability. This has left countries to choose a path of austerity to regain credibility. As these austerity measures kick in, developed economies are getting pushed back into recession with implications for the rest of us. BIS central bankers’ speeches The banking sector and the inter-bank market: The banking sectors in the peripheral countries of the Euro zone carry a large number of potentially bad assets on their balance sheets. Banks had stopped trusting each other leading to a fairly dysfunctional interbank market. There is clearly a clean up to be made. What is not clear is how much of it has taken place. The ECB had to step in to get the inter-bank market going again with two facilities. Initial indications are that the intervention has worked, at least for now. The markets have reacted positively to this. The Libor-IOS spread in the euro zone, a key indicator of liquidity conditions in the inter-bank market, has declined from its highs in the last quarter of 2011. The question that faces policy makers is whether the liquidity that has been injected has enabled credit to flow into the real sector of the economy. Initial indications seem to suggest that this is not yet the case. Bank lending to the private sector in the Euro zone barely grew in January and February. Governments seem to have been big beneficiaries from these liquidity operations. Data from the ECB show that banks’ lending to governments grew at 6 per cent in February. It shows acceleration from the 4.6 per cent growth in January. Portuguese banks increased their bank holding of euro area government debt by 4.24 billion euro, Greek banks by 4.12 billion euro while Italian banks increased their holding by 23 billion euro in February. What we observe is that it would take sometime before these liquidity injections start to flow to the real sector. How did we fare and/or respond to the crisis? How does this affect us as African Economies, what are the channels through which it affects us? Given the unfolding of the shocks hitting the African economies, the monetary and fiscal policy responses were largely reactive. The main forward-looking macroeconomic policy setting and decisions were made some years earlier, and enabled a sustained moderation in the economic effects of the crisis. Like many other emerging market economies, capital inflows and upward pressure on the exchange rates played a complicating role in how the economy responded to the shocks and to policy. The impact on African economies so far has been fairly limited. While the economic recovery has temporarily stalled in parts of Europe and growth slowed in North America, the IMF forecasts1 emerging and developing economies to grow by 5.4 per cent in 2012 – down from 6.2 per cent in 2011 – and by 5.9 per cent in 2013. Sub-Saharan Africa (SSA) is expected to grow by 5.5 per cent in 2012 (compared with 4.9 per cent in 2011) and is projected to grow further by 5.3 per cent in 2013. Generally speaking, African economies have benefited from stronger commodity prices and greater foreign direct investment. These gains were constrained by currency appreciation in some instances, and more importantly, by rising food prices. So the crisis did feed itself through the commodity channel and the commodities are a double-edged sword for African economies. African economies produce commodities that we export to Europe, China and the rest of the world. There are significant parts of the African continent, including ours, where we are actually importers of crude oil, and as commodity prices rise and the price of crude rises it feeds itself into domestic energy prices and it also feeds itself into domestic food prices. So it is a very important channel to understand. We have been fortunate not just in South Africa, but in many of the African countries, that the effect was actually muted by appreciating domestic currencies as prices of other commodities we export, rose. The patterns of gains across Africa depend on the proportion of commodities in the export basket and the extent to which countries import food and oil. Moderating global food prices should The data that I used to make the points with respect to the impact of the crisis is drawn extensively from the IMF Regional Economic Outlook published in October 2011. BIS central bankers’ speeches improve outcomes in most African economies, while sharply lower commodity prices hold some potential for a more serious negative economic shock. This is the double-edged sword of commodity prices that I talked about. The second channel that the Euro crisis had affected us had been through export growth through-out the Sub-Saharan African economies. When the global crisis set in, export growth from the Sub-Saharan economies declined from an annual average of 7.0 per cent between 2000 and 2007 to only 1.4 per cent between 2008 and 2010. A significant slow-down. Much of this deceleration comes from slower growth in Europe. The proportion of exports from Sub-Saharan Africa to Europe mirrors that of South Africa, where it has fallen from about 36 per cent in 2005 to about 26 per cent in 2011. This trend will continue as sub-Saharan African exports redirect towards faster growing regions of the world. As the IMF points out in the Regional Economic Outlook, between 1990 and 2010, the value of Sub-Saharan Africa’s exports expanded at an annual average rate of 8.5 percent. Of that rate, nearly 50 per cent came from growth in exports to emerging and developing economies. The contribution has increased to about 66 per cent between 2005 and 2010.2 Exports from Africa to the EU remain strongly biased towards minerals, crude oil and natural gas mainly from Nigeria (and the North African economies of Algeria and Libya) as well as other commodities from countries like South Africa and Botswana. Over the longer term, demand for and exports of commodities will remain strong. China will remain a critical consumer of African exports.3 Some forecasts show SSA exports re-achieving growth rates of around 10 per cent later this year. Considerable gains have been made in a number of industries in moving up the export value chains and expanding services exports.4 Using these gains to diversify export baskets should be an important long-term part of most countries’ economic development plans. The last channel is the FDI one. Foreign direct investment (FDI) flows from the European Union (EU-27) to Sub-Saharan Africa were EUR 11.5 billion in 2010 and this was a decline from EUR 13.1 billion the previous year; and these flows of FDI were mainly to South Africa.5 To Africa as a whole, FDI inflows reached Euro 21.3 billion in 2010. While this figure constitutes only 5.3 per cent of total EU FDI flows for 2010, the proportion of EU FDI flowing to Africa has increased considerably from 1.3 per cent in 2007. Positive long-term growth prospects in Africa should attract higher levels of FDI in the future. Forthcoming trends will be seen in countries like Brazil, India and China’s investments into Africa. As market growth continues and investment opportunities expand, we should expect to see complementary investments by European firms.6 Regional Economic Outlook, October 2011. Regional Economic Outlook, October 2011. China’s consumption during 2010 accounted for about 20 percent of world consumption of non-renewable energy resources (oil, gas, coal), 23 percent of major agricultural crops (corn, cotton, rice, soybeans, wheat), and 40 percent of base metals (copper, aluminium). Regional Economic Outlook, October 2011. Kenya and Ethiopia’s exports of cut flowers; Rwanda exporting branded coffee and has also broken into the U.S. handicrafts market; Mali (fresh mango exports to Europe), Lesotho (apparel exports), and Uganda (frozen fish). These are also landlocked countries. In Mali, the key innovation was to overcome obstacles by developing a multimodal transport system (road, rail, sea) as an alternative to air freight, while meeting quality and phytosanitary requirements. Service exports have been growing fairly strongly in sub-Saharan African countries, even though not as fast as in emerging partners. Eurostat describes SSA as central and southern Africa, so there could be some discrepancies with other figures. Regional Economic Outlook, October 2011. Chinese FDI to sub-Saharan Africa, as a share of total FDI to the region, climbed from less than 1 percent in 2003 to 16 percent by 2008. Investments from India are also significant: by 2006, Indian investment stocks in sub-Saharan Africa were almost as large as Chinese FDI flows in the region. These investments are increasingly widespread geographically and in terms of industries. Chinese investment is also directed toward manufacturing, construction, finance, agriculture, and service. BIS central bankers’ speeches SSA economies were in good macroeconomic shape going into the crisis. No wonder we were able to cope better during the crisis. Most countries had balanced budgets or modest surpluses and because of debt relief initiatives, debt levels were also low. Countries had accumulated reserves and modest savings levels and inflation was relatively low or under control. Thus, most countries had flexibility to ease policies, which helped to dampen the impact of the crisis particularly on poverty alleviating initiatives. However, countries that did not have flexibility of easing macroeconomic policies continued to rely heavily on foreign aid. Policy adjustments in most of the African countries have been country-specific. It should be pointed out that Africa is not a homogeneous geographic space, it is a continent made up of countries, so the policy responses were also country-specific. In response to price shocks, few flexible exchange rate countries have had to tighten monetary policy. However, interest rates remain at low levels set during the financial crisis. Nominal effective exchange rates have weakened in some countries and some oil-exporting countries have increased reserves sharply.7 Fiscal policy has loosened in many countries, including ours, to support growth and to finance more expansive capital investment projects. Weak control over public finances remains an issue in some countries, and needs to be countered by more aggressive institutional development, governance reforms, and human capital building. Now let me share with you some perspectives about Africa’s largest economy. Most of the comments that I would be making on SA flow mainly from a speech I delivered on the 17th March 2012 somewhere in Magaliesburg. South Africa’s policy discourse during the crisis centred on the need for a fiscal stimulus response to the fall in foreign demand and slowing domestic economy. This was incompatible however with a macroeconomic response to those advocating a moderation in the appreciation of the currency as it rebounded from the overshot depreciation in late 2008. In addition to the positive economic factors driving the resumption of capital inflows – the sound public debt position and high commodity prices – the high inflation rate and growth in unit labour costs were driving up the real effective exchange rate. The current account deficit remained high as a result of growth in gross domestic spending exceeding growth in domestic production. These factors meant that monetary policy alone; that is lowering the policy rate to reduce carry trade, could not have prevented the appreciation of the nominal and real exchange rates. To prevent the real appreciation of the currency would have required macroeconomic policy tightening to rein in domestic expenditure and moderate inflation. In practice this meant either that the domestic currency public debt would have to increase by the amount the authorities were willing to intervene in the foreign exchange markets, or fiscal policy would have to adjust to find the resources for foreign currency purchases out of current spending or from increased revenue. Short of increased borrowing and the implications for short-term interest rates, the other options entailed reducing public spending on current programmes or tax increases. Exactly what you do not want to do when you are in a crisis, because you want to act counter-cyclically. Taking that stance would have meant that you act pro-cyclically and you would have plunged the economy into recession. The approach taken by the fiscal authorities was to provide funding to purchase foreign currency inflows from foreign direct investment. Where there has been insufficient rand available for this purpose, forward market foreign currency swaps were conducted to finance the reserve purchases. How we address our home-grown economic challenges is not to suggest that global difficulties can be left unattended. Three serious disorders confront the short and medium term. Nigeria being an exception. Reserves have fallen and the exchange rate has depreciated. BIS central bankers’ speeches The first is the effects of macroeconomic policy making in advanced economies. These policy settings, intended to resolve the combination of slow growth and over indebtedness, and conducted in a globalised world economy, contribute at some level to the flow of capital into emerging markets and the developing world. The second disorder is in financial markets in advanced economies. High debt levels in the developed world and the European sovereign debt crisis have triggered unconventional policy responses and a variety of risks is evident. The most troubling is the possibility of the current financial crisis intensifying sharply and resulting in even more credit contraction, sales of assets, and eventually stronger real economy effects. A severe worsening in the growth prospects for Europe would result in a calamitous fall in the demand for exports from around the world. The third disorder that we need to be alive to is a possibility for financial contagion that will affect emerging market economies. In this instance, countries with financial and/or economic vulnerabilities would experience local currency asset sales, capital flight, and long term negative effects in confidence of consumers and businesses in the real economy. Such effects would very likely occur in the event of a financial and economic meltdown in Europe, but would not necessarily only come out of such a combination of circumstances. The private sector in emerging economies remains in deficit to the rest of the world and only Asian emerging economies have net foreign asset positions. As European banks recapitalise, the resulting deleveraging could reduce foreign funding for emerging markets significantly. European banks provide about 30 per cent of Latin American bank credit and they provide 40 per cent of Eastern Europe’s so that a contraction in EU bank loans to these countries could constrain their economic growth significantly. The prolonged global crisis and the vulnerabilities created or exposed by policy efforts globally to address the crisis have to some extent increased the risk of financial contagion. In that context, reducing vulnerabilities must be a key priority for both monetary and fiscal authorities. We have been lucky in South Africa because our fiscal and monetary authorities responded in sync. What we are not saying as South Africans or we are not saying it as strongly as we are supposed to, is that South Africa entered the financial crisis with a very resilient, robust and well capitalised financial system. The South African banking system is rated amongst the best in the world. It is rated just behind that of Canada by the World Economic Forum. It is a very strong financial system and is rated ahead of the financial system of the USA. It has become a national strength while elsewhere the financial sectors have become a key weakness and that actually matters. As this crisis continues, there is one distinguishing factor about the South African financial system, besides the fact that the South African financial system continues to function, the South African interbank market also continue to function. Banks in South Africa continue to trust each other and had been lending money to each other, thus facilitating the flow of credit for the real sector. Whilst credit in Europe is only growing at only 1 per cent, credit in South Africa is growing at close to 8 per cent, which means that indeed credit is flowing. But there is something else that is supposed to be highlighted. It is the fact that not only is the South African financial sector well capitalised, our big corporates actually have very strong balance sheets and borrow from the capital markets .They have no reason to be borrowing money from the banks save for working capital .Credit in SA used to grow at double digits. It now actually grows at 6 to 8 per cent, while we have inflation at 6 per cent. It is actually a fairly decent growth rate. As such from a regulatory perspective, it suggests that you do not have a credit fuelled bubble actually building up. As we look at our financial sector let us also not forget that even with the global regulatory standards coming into being, South African Banks already comply with most of the new standards, even before they come into effect. That is how strong our financial sector is. BIS central bankers’ speeches A lot has been said about the growth of unsecured lending in South Africa. Of course, as regulators we are concerned about the growth in unsecured lending, but South Africans, do we really know what we want. Two years ago we said to the banks, you only want to lend money to people who have security. So the banks have come around and said well it looks like South Africans want us to lend to people who don’t have security, unsecured. Then we turn around and we say that well there is problem here, you are lending money to people who are unsecured, so I’m not sure what we are actually looking for. Nonetheless from where I am sitting as a regulator, everything that is growing too fast is a reason for me to worry about. If the share prices rise too fast, I get worried. If property prices rise too fast, I get worried, if credit rises too fast, I get worried and if unsecured credit rises too fast, I get worried. That is why the National Credit Regulator decided they want to go and dig and understand what is driving this unsecured lending. That is why from the South African Reserve Bank we asked the Registrar of Banks to go around and understand what is driving this unsecured lending. It is growing and it is growing too fast, but this is from a low base. But let us also say something here, the banking sector is a three trillion rand industry, and unsecured lending has grown from 23 billion to some 50 billion rand; it has doubled and is growing too fast. But it is such a small component of the sector. I don’t know how many of you use this unsecured lending; I do use it, but I only use it through my credit card. The categories that have me worried are not the credit card lending or overdraft facilities, but it is actually more the personal loans and we would want to get to understand what is actually driving this. This said, even if this entire R50bn falls into default it won’t make a dent on the banking sector. To conclude, African economies need to strengthen the domestic and regional basis for growth. This is best done by strengthening regional and extra-regional commercial and trade agreements, developing cross-border infrastructure, strengthening macroeconomic policies, and developing institutions and human capital. Attracting foreign direct investment and making better and more use of imported technology and skills is also critical to long-term growth. These efforts are not made easier by the difficulties of the world economy, which have generated volatile capital inflows and depressed trade. The former complicates macroeconomic management somewhat. The latter reduces growth in exporting industries and increases competition for domestic firms. African economies entered the crisis with a very strong footing thanks to very prudent macroeconomic policies. Africa will continue to grow even as Europe slows down, but we better be alive to the fact that Europe is a very important trading partner for us. It is an important destination for our exports and it is a very important source of FDI and if you are from the lower income African countries, it is also a very important source of technical assistance and foreign aid. And with those words I would like to say thank you very much for your attention. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Gordon Institute of Business Science (GIBS), Johannesburg, 30 May 2012.
Gill Marcus: The changing mandates of central banks – the challenges for domestic policy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Gordon Institute of Business Science (GIBS), Johannesburg, 30 May 2012. * * * Good evening, and thank you for the opportunity to be with you. It is always a pleasure to return to GIBS as I was personally associated with this school after my term of office as a Deputy Governor expired in 2004, and have a great deal of respect for the forums you create for open dialogue. One would have thought that a return to the South African Reserve Bank would be relatively straightforward because of my previous experience in central banking. However, I found a very different world. Not only had the environment in which central banks operate changed dramatically, the expectations of central banks as reflected in their extended mandates had also changed. In the early to mid-2000s leading up to the global financial crisis there was an emerging macroeconomic theory and policy consensus. The period was known as the Great Moderation, following an apparent trend towards macroeconomic convergence, particularly in the advanced economies. Business cycles appeared to be more synchronised with lower amplitudes, and low inflation prevailed in most countries. Some went as far as to suggest that both business cycles and inflation were dead. Inflation targeting had become a broadly accepted monetary policy framework, making price stability the overriding objective. The framework was widely credited for contributing to this benign environment. Mervyn King, Governor of the Bank of England, once remarked that a sign of a successful monetary policy was when it became boring, and indeed it seemed that the world was on its way in that direction. Well, all I can say is “bring back boring”. At the same time, while many central banks had implicit financial stability mandates, the evolving trend at that time was for the regulation and supervision of the banking and financial sectors to move out of central banks. Notable examples were in the UK and Australia, and serious consideration was also given to moving bank supervision out of the South African Reserve Bank in the early 2000s. The focus of central banks appeared to be narrowing. Today things have changed quite dramatically. Monetary policy and central banking in general has become anything but boring, and rather than taking a back seat in the economy, central banks are now at the forefront of attempts to stabilise and repair the damaged global economy. The mandates of central banks have been extended in numerous countries, including in our own, bringing with it new and difficult challenges. In my remarks this evening I will focus on the growth and financial stability aspects of broadened mandates in the South African context. The modern mandate of central banks had focused primarily on price stability, reinforced by the increased adoption of inflation targeting. The simplistic view of inflation targeting is that all a central bank has to do is to conduct policy in such a way as to keep inflation in line with the target. Other possible objectives of monetary policy are seen to be secondary or not the concern of monetary policy. This relates in particular to economic growth, and by extension to employment. Although the Bank has often been criticised for not being sufficiently concerned about growth, we are also criticised by those who believe that we have gone beyond our mandate by focusing on growth. In the wake of the global financial crisis, it is clear that growth and employment became foremost concerns of most central banks, particularly in those economies where the recovery was slow and protracted, and where inflation was not perceived to be a threat. The persistence of the extraordinarily low interest rate environment in the advanced economies BIS central bankers’ speeches attests to that. So is this focus on growth a new mandate for central banks and an undermining of the primary inflation objective? In this respect, inflation targeting has often been misunderstood, or oversimplified. It is important to distinguish between strict and flexible inflation targeting. A strict inflation targeter is one that only focuses on inflation to the exclusion of all other possible objectives. As such, it is a theoretical construct as in reality no central bank acts in this way. A flexible inflation targeter, by contrast, puts some weight on the deviation of output from potential (the output gap), and this weight can change depending on circumstances. In effect this implies that the objective of monetary policy is to achieve the inflation target with output in line with potential. The focus however is on deviations from potential output, as it is generally believed that monetary policy has limited, if any, long run impact on the growth potential of the economy. This is the domain of other policies. The flexibility is manifested when concern for the state of the economy can result in deciding on a longer time horizon for achieving the inflation target, in order to minimise the negative impacts on output growth. It also follows that if inflation is in line with its target and if inflation expectations are well anchored, more weight can be given to stabilising or increasing growth that is below potential, without sacrificing much price stability. This does not imply a change in mandate, and is consistent with a flexible inflation targeting framework, such as we have in South Africa. What does appear to have changed is that the burden of stabilisation and growth stimulus is falling increasingly on central banks, particularly in those countries that no longer have any fiscal space. In many countries, the response to the crisis was initially through both monetary and fiscal policy easing. However, the measures taken did not resolve the crisis and an unanticipated consequence was that, in a many instances, this led to excessive and unsustainable deficits and debt ratios. For example, in 2007, government debt to GDP ratios in the US and the UK were 62 per cent and 44 per cent. By 2012 they have almost doubled and expected to reach 103 per cent and 87 per cent respectively. In the euro area, the debt ratios of Greece and Ireland increased from 105 per cent and 25 per cent, to 157 per cent and 122 per cent over the same period. Of these four countries, only the US is currently experiencing positive growth. The costs of servicing this debt has also increased significantly, particularly in the peripheral Eurozone countries, as doubts about their sustainability persist. This rapid expansion has resulted in fiscal consolidation or retrenchment becoming the order of the day in many, mainly advanced, countries, even where growth has not fully recovered. In short the global crisis has continued to mutate, and we now face the challenge of systemic banking weakness in a number of countries, for instance Spain, sovereign debt and possible default in parts of the Eurozone, and high and rising unemployment. The unemployment rate in the Eurozone has risen to 10,9 per cent, with Spanish unemployment at 24,1 per cent. Fiscal austerity has reinforced the slow growth, and consequently increased the burden on monetary policy. Although the mandate may be the same, the shared responsibility is no longer there, and more is expected from central banks. At times these expectations may be beyond what monetary policy can reasonably be expected to deliver. In this context we can consider whether the conduct of monetary policy in South Africa been much different in the post crisis period. Some have argued that the current accommodative stance of monetary policy is part of a new mandate, and a deviation from inflation targeting. We would argue that the Bank’s actions have been consistent with the flexible inflation targeting framework. Since the crisis, the economy has been growing at below what we estimate potential output to be (around 3,5 per cent), and the absolute output gap, that is the difference between the level of output and the potential level of output, coincidentally also at around 3,5 per cent, has been persistently negative. It will require a period of above-potential growth to close this gap, unless there has been a destruction of capacity which would reduce the size of the gap. A negative ouput gap also implies less pressure on inflation. Although inflation had moved outside the target, the considered view of the MPC was that inflation would return to within the target, and, given the subdued state of the economy, it was felt BIS central bankers’ speeches inappropriate to speed up this process through a tighter monetary policy stance. This view was also reinforced by the absence of excess demand-side pressures and relatively well-anchored inflation expectations. In the 2006–08 period, by contrast, when inflation exceeded the target, growth was in excess of the Bank’s estimates of potential, with measured growth at between 5 and 6 per cent per annum, with very high rates of growth in credit extension and household consumption expenditure. Under such circumstances, a tighter monetary policy stance was justifiable or appropriate. It is also important to note that recent central bank interventions have not always been about stimulating growth directly through low interest rates. In the context of the crisis, and again more recently when fiscal policy has been constrained, the focus has at times been on helping dysfunctional parts of the financial markets to work better. This is recognition of the central place that financial markets have in the efficient workings of the real economy. These policies have aimed at preventing a negative feedback loop from financial sector stress to the real economy, and have resulted in a number of significant forms of unconventional monetary policy actions, particularly in countries where interest rates had reached their zero bound. There are a number of illustrations of this. Quantitative easing (or credit easing as it was referred to in the US) was initially aimed primarily at providing liquidity to specific segments of the financial markets that were no longer functioning efficiently. During the crisis the loss of confidence in banks and some financial instruments, and the lack of trust between banks, disrupted some segments of the markets and the interbank markets. Central banks responded by becoming the counterparties and bought unconventional assets on a significant scale. Between 2007 and 2011, central bank balance sheets in the advanced economies increased from around 10 per cent of GDP to in excess of 20 per cent of GDP, a total of almost US$8 trillion. More recently the US Fed initiated its Maturity Extension Programme (more popularly referred to as Operation Twist), whereby the Fed sold short term Treasury securities and bought longer term securities, in an effort to bring down long term interest rates. The aim was to give a boost to the ailing domestic housing market, as mortgages are often priced off long-term rates in the US, as well as to the corporate bond market. The Long Term Refinancing Operations (LTRO) of the ECB, through which Euro1,3 trillion of liquidity was injected into the European banking system that was in danger of seizing up, is another example of such measures. The objective was to keep the banking and interbank system operating, and to cushion the real economy from banking sector stress. Some of these activities were intended to provide additional stimulus to economic growth, but some also had a strong financial stability element. This leads us to the area in which central bank mandates have changed most significantly: that is, responsibility for maintaining financial stability. Prior to the crisis, financial stability was generally an implied mandate for central banks. The fall-out from the crisis has led to an increasing number of central banks being given explicit financial stability macroprudential mandates. This is distinct from microprudential supervision and regulation of the banking system where the focus of the regulator is limited to individual banking institutions and the banking system. A broader macroprudential focus would look at the build-up of financial imbalances and the risks posed by the positions taken by leveraged financial institutions to the broader financial sector and to the economy in general. For example, in a low interest rate environment and high rates of growth of credit extension by banks, these funds can be used to finance purchases of assets and result in the build-up of bubbles in the housing or equity markets. The issue of how central banks should react to asset prices was the subject of much debate prior to the crisis. The dominant view at the time was that financial imbalances and crises should not occur in a low inflation environment, and where they did, central banks were not in a position to recognise or predict them. Nor did they have appropriate tools to prick incipient BIS central bankers’ speeches bubbles. Interest rates would had to have been raised to unacceptably high levels in a low inflation environment in order to deal with the bubbles that had emerged. The consensus view was that asset prices should be taken into consideration by monetary policy only to the extent they impact on inflation, and that the role of central banks should be confined to cleaning up after the bubble had burst. Unfortunately, as we are all now well aware, five years after some of these bubbles burst central banks are still cleaning up. But there were some influential voices, notably coming out of the Bank for International Settlements, that argued that the low inflation/low interest rate environment of the 2000s was the cause of the asset price bubbles in the first place. In other words, ironically, the successful attainment of low inflation was leading to longer term financial stability problems. This approach argued in favour of monetary policy leaning against these excesses. The view was that too narrow a focus, or too short a time horizon for policy, blinded policy makers to longer term systemic financial stability risks which could take a long time to evolve. Since the crisis, a widely accepted perspective has emerged which sees monetary policy and macroprudential policy having different objectives, and different instruments. This approach attempts to avoid a conflict of objectives or trade-offs in the application of the interest rate instrument. Others however contend that it is not feasible to completely separate the two policies, as interest rates affect financial stability, while macroprudential tools affect credit growth and therefore inflation. While macroprudential oversight has emerged as a distinct policy focus, there is still no unanimity as to the best governance arrangements for such oversight. Some central banks, for example the Bank of England, have established financial stability committees, and this places the mandate for financial stability squarely in the court of central banks. A different approach is expressed by Lars Svensson at the Swedish Rijksbank who argues that as is the case with fiscal policy, financial stability policy is conceptually different from monetary policy, and should be conducted by a completely different institution and different individuals. More significantly, while it is generally agreed that the interest rate should be the main instrument of monetary policy, the choice and efficacy of financial stability instruments is still very much work in progress. Given the different institutional structures in different countries, the type of instruments will also likely differ from country to country. However there are some common themes in the evolving thinking on this topic. It is generally accepted that excessive credit extension is at the heart of most asset price bubbles, and therefore the instruments that are used should be directed at preventing excessive leverage in the relevant markets. Charles Goodhart, for example, has argued that because housing markets are at the epicentre of most financial crises, it is sufficient to focus on instruments that prevent excessive build-up of housing related credit. These include setting maximum loan-to-value ratios on property transactions and borrowing restrictions in relation to disposable income. Other possible macroprudential instruments include reserve requirements for particular types of loans, contracyclical capital buffers for banks and capital surcharges for systemically important banks. In general these are microprudential tools, some of which had previously been applied in many countries as anti-inflation measures and since jettisoned, but are now being reconsidered with a narrower focus. It is still premature to pronounce on the efficacy or success of such policies, and this remains work in progress. In reality financial stability is generally a shared responsibility as financial crisis resolution often requires fiscal intervention and the application of public money. This has the potential to create challenges for central bank independence. Even if narrow monetary policy independence remains intact, the boundaries between monetary and macroprudential policies are often blurred. However, as Jaime Caruana of the BIS argued in his address at the Bank last year, because there will always be strong opposition to central banks resisting asset price accelerations, or taking away the punchbowl when the party gets going, the arguments for independence apply with even greater force, and such independence will be needed not only from political cycles but also from the financial markets. BIS central bankers’ speeches In South Africa, the implicit financial stability mandate of the Bank was made explicit in the letter from the Minister of Finance to the Governor in February 2010. The Bank’s financial stability committee has been reconstituted and meets in alternate months to the MPC. Furthermore, and in recognition of the shared responsibility for financial stability, a Financial Stability Oversight Committee has been established, jointly chaired by the Governor and the Minister of Finance. The focus of the Bank FSC is on crisis prevention, and while the FSOC does review current conditions, the primary purpose of this committee is crisis management and resolution. Furthermore, government has decided that regulation and supervision of the financial sector should move to a “twin peaks” approach. This means that all prudential regulation will become the responsibility of the SARB, while market conduct will be the province of the Financial Services Board. This is a very significant reform and adds to the tasks and responsibilities of the Bank. Work is ongoing to determine the appropriate policy instruments. To date, while counter-cyclical measures have been introduced to address the fallout of the ongoing global economic crisis, South Africa’s banking system has emerged largely unscathed. While there is no room for complacency, no policy decisions have had to be taken in respect of financial stability. One area of potential concern for financial stability is the acceleration in the growth of unsecured lending by the banking sector, although unsecured lending is not restricted to the banking sector only. This form of lending has been growing at rates in excess of 30 per cent and, at face value, anything growing at such elevated rates must be a cause for concern. But this also needs to be seen in context as total loans and advances, of which unsecured lending forms part, is still growing at relatively moderate levels. Both the FSC of the Bank and the Registrar of Banks are keeping a close eye on these developments, and are trying to understand this phenomenon more fully. Without coming to any definitive conclusion on the issue, a number of points can be raised. Firstly, should we be concerned about this from a financial stability, a microprudential, or a monetary policy perspective? From a monetary policy point of view, we would need to understand the extent to which this lending translates into excessive expenditure with potential inflationary consequences. At this stage, this does not seem to be the case. While it may well be that unsecured lending may have contributed to the growth rate of 5 per cent in household consumption expenditure, this growth was in line with real income growth and not considered unsustainable or excessive. In fact, there are signs of a moderation in the rate of growth of household consumption expenditure in the first quarter of 2012, particularly with respect to durable goods. Furthermore there is little evidence that CPI inflation is being driven in any meaningful way by excess demand pressures. A microprudential approach would focus on the risk profile and key ratios of the individual institutions. This is part of the function of the Registrar of Banks. At this stage, there are no signs of stress in any of the banks or in the banking system as a whole. To the contrary, the ratio of impaired advances to total loans and advances, which had remained stubbornly high for some time, has declined from 5,8 per cent in March 2011 to 4,6 per cent in March 2012. From a more systemic perspective, the risks to the banking sector at this stage appear to be limited, as unsecured lending (which includes traditional forms of unsecured lending such as overdrafts, credit cards and loans to SME’s), at around 8 per cent, is a relatively small proportion of total lending although this ratio has been rising. If loans to SME’s, overdrafts and credit cards are excluded, the ratio is 4 per cent. From a financial stability perspective, we also need to consider whether it is likely to lead to asset price bubbles elsewhere in the system. The housing market remains very subdued, with some of the house price indices still reflecting falling prices. Although the equity market reached an all-time high in April before falling back in recent days following increased global risk aversion, it would be difficult to argue that this is a bubble. In any event the link between high rates of growth in unsecured lending and equity or bond price movements is extremely tenuous at best. BIS central bankers’ speeches Growth in credit extension by banks to the private sector has been relatively muted. Growth over twelve months in private sector credit extension was 7,3 per cent in April, down from to 9,2 per cent in the previous month. It is significant that total loans and advances to households, which includes unsecured lending, is still only growing at annual rates of around 7 per cent. There is a potential concern about the possibility of an excessive burden of household debt. Although the ratio of household debt to disposable income is still high, it has been declining. Having peaked at 82,3 per cent in 2008, the ratio declined to 74,6 per cent in the final quarter of 2011. Household debt is nevertheless still rising, but at a slower pace than that of disposable incomes. So at a macro level, there does not appear to be a cause for concern. The concern, however, could be the distribution of these debts. There is the risk that some households are becoming over-leveraged, but this would suggest that the limits set by the National Credit Act are not being adhered to. A further concern that is often expressed is: what happens when the interest rate cycle turns and many of these new borrowers may find it difficult to service their loans. Some of these loans are on a fixed interest basis with monthly repayment commitments, thus the servicing of the loans should not be materially affected by interest rate increases. There is also evidence that some of the growth in unsecured loans is as a result of loans with a greater value and longer repayment term being extended to existing clients with a proven repayment record. It is also possible that we are observing a structural change with respect to bank lending. Mortgage credit extension is subdued and it is more difficult than in the past for households to access their mortgage bonds to finance consumption expenditure. So to some extent, this may be an adjustment away from mortgages and once the adjustment has taken place, more sustainable rates of increase should be observed. But because rates charged on unsecured lending are much higher than on mortgages, consumers are getting access to more expensive credit, although this is not evident yet in the data on the cost of servicing household debt which has declined consistently since the end of 2008. These developments are being closely monitored for signs of unsustainable increases which could have systemic implications for the banking sector, for financial stability in general or for inflation. But as I have illustrated above, the answer is not simple. In conclusion, the context that central banks operate in has become increasingly complex. The global growth outlook has deteriorated in recent weeks, and coupled with increasingly volatile and risk averse financial markets in response to uncertainties in the Eurozone, central banks will again be expected to play a core role in helping to manage or resolve the crisis. The scope for fiscal policy to play a meaningful role is limited by the high sovereign debt ratios which are part of the underlying problem. There are also increasing concerns about the sustainability of expanded central bank balance sheets and the abnormally low global interest rates, which are seen by some as already sowing the seeds of the next crisis. At the same time, the financial stability focus, the tightening of banking regulations and the move towards Basel III is having the effect of increasing deleveraging by banks, particularly in Europe, and raising the cost of capital for banks. These developments are focused on ensuring a more stable financial system in the future, but in the process are having a contractionary impact on growth. The potential for conflict between the different mandates are evident. In South Africa, we have not had to make any exceptional liquidity provision, and monetary policy has been more accommodative than it would have been in the absence of below-potential growth rates and a persistently negative output gap. Inflation is expected to return to within the target range in the near term, and to remain contained over the forecast period. The banking system is stable despite challenges expected in implementing Basel III, especially over the longer term. However, we vigilantly monitor global developments and the possibility of contagion to our economy. BIS central bankers’ speeches It is important that, in extending the mandates of central banks, there should be a clear understanding of what central banks can and cannot do, and an appreciation of the possible conflicts between the different objectives. Central banks, in normal times, function in an uncertain environment. In the prevailing difficult global conditions uncertainty is at an even higher level, and many of the actions taken have no precedence. It is therefore incumbent upon central banks to share information and together learn from our collective experiences. As the lines between the various mandates become increasingly blurred, there is a danger that the burden of expectations could be excessive, and ultimately undermine confidence and credibility in central banks themselves. These challenges are being considered by central banks and others, and require that all of us better understand the immediate challenges of the mutating, extremely severe global financial crisis. At the same time we need to appreciate that measures required to deal with the crisis may well have unintended consequences for central banks, their mandates, independence, capacity and role in society. Thank you again for the opportunity to speak to you. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 6th Annual Cocktail Function of the Financial Markets Department, Pretoria, 10 May 2012.
Daniel Mminele: Taking stock of the global and South African environment Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 6th Annual Cocktail Function of the Financial Markets Department, Pretoria, 10 May 2012. * 1. * * Introduction Good evening ladies and gentlemen and welcome to the Financial Markets Department’s annual cocktail function. It is customary for us to take stock every year of what has happened in the global and domestic environment. We last met in April 2011, at a time when adverse developments in the euro zone were gathering momentum and financial stability risks were intensifying, thereby threatening the sustainability of the global recovery. It is a year later, and while much has been done on various fronts to try and resolve the crisis, we continue to face significant global economic and financial market challenges. Downside risks remain elevated and continue to hold back a strong and sustainable global economic recovery. Geopolitical tensions remain a threat, with the potential to again trigger a sharp rise in oil prices. Central banks have continued to play a fundamental role, in an attempt to prevent a collapse of the financial system and continued downward economic adjustments. In the process central banks ventured even deeper into new territory, which Martin Wolf of the Financial Times last week described as the new world of post-financial-crisis central banking, which will create significant institutional and intellectual challenges. In Europe, firewalls were increased after long debates, and under the auspices of the G20 and IMF, countries have also come together to provide additional financial resources to the IMF for purposes of crisis resolution and prevention. Will these measures, beyond ensuring that the global economy does not fall back into recession, be enough to restore the required level of confidence in financial markets? Recent market moves appear to suggest not. Have all these actions not raised the risk of moral hazard, with investors expecting central banks to continue pumping money into the financial system; and will the system become hooked on central bank money? Jaime Caruana1 has pointed out that these actions have bought time, but in so doing, may have actually made it easier to waste that time, increasing the risk that the “balance sheet recession” leads to protracted weakness, and also potentially raising political economy risks. It would indeed be unfortunate if what is essentially a temporary relief were to breed a sense of complacency with regard to the repair work that is still necessary. While we may not be able to answer these questions tonight, let me briefly touch on global and domestic financial market developments, before updating you on the activities of the Financial Markets Department over the past year. 2. Global economic developments and financial markets While volatility in global financial markets declined during the first half of 2011, the third quarter witnessed a renewed rise in tensions, first driven by the congressional debate over the debt ceiling in the United States, and then by renewed concerns about the solvency of peripheral euro area sovereigns. Greece may have been at the forefront of the news flow, but by late 2011, concerns had spread to a number of other sovereign issuers in the euro Central banking in a balance sheet recession. Panel remarks by Mr Jaime Caruana, General Manager of the BIS, at the Board of Governors of the Federal Reserve System 2012 conference on “Central banking: before, during and after the crisis”, Washington, 23–24 March 2012. BIS central bankers’ speeches zone periphery, resulting in a sharp widening in spreads, which in turn spilled over to banks’ funding costs and generally tighter financial conditions in the rest of the world. As already indicated, it again became necessary for central banks to respond in an unconventional manner: the US Federal Reserve lengthened the maturity of its securities portfolios (in what became known as “Operation Twist”); the Bank of England and the Bank of Japan expanded their respective balance-sheets via additional securities purchases; while the ECB for the first time (and in two instalments) supplied banks with almost EUR1 trillion in three-year repo funding. The goals of these measures, however, were broadly similar: stabilizing the funding structure of the banking system, and thereby fending off the risk of a severe credit crunch. These measures helped to limit undue market volatility that risked forcing illiquid but solvent sovereigns into insolvency. At the same time, public and private creditors worked out a voluntary restructuring plan for Greek sovereign debt. The market’s initial response was positive. Risk indicators declined markedly from December 2011 to March 2012, with the VIX index in particular falling to a level of 15, which was more or less around the lows recorded at the beginning of the financial crisis. Intra-euro zone sovereign spreads underwent a sharp compression, as did bank CDS spreads, while the reduction in risk-aversion spurred a marked rally in equities. Yet many questions remained unanswered. For example, will vulnerable sovereign states take advantage of this “window of opportunity” to implement the necessary strengthening of their public finances and to improve their competitiveness? Will credit to non-financial entities start flowing more strongly again now that banks have been able to secure more solid financing? Will authorities manage to implement fiscal austerity measures without unduly damaging growth prospects in Europe? And then there is the issue of whether geopolitics will push oil to levels that threaten the fragile global recovery. Let me briefly add that Europe is not the only source of risk, as there are, e.g., major fiscal challenges in US, which could come to a head early next year. The jury is still out on these questions, but investor concerns seem to be rising again, especially with respect to the credibility of fiscal consolidation plans in Europe. At the most recent meeting of G20 finance ministers and central bank governors last month, there was some optimism that tail risks faced by the global economy had started to recede. However, the persistence of downside growth risks and the need for on-going structural reform and global rebalancing were also highlighted as needing to be kept firmly on the G20 agenda. 3. Implications for South Africa As has been the case since the beginning of the financial crisis, South Africa has not been immune to these fluctuations in international markets. Our banking system is solid and well-capitalized, our financial markets (including the interbank market) have not experienced any problems that required official intervention, and our external and public finance situation looks far more manageable than in many developed economies. Yet the country’s strong trade links with the European Union; its reliance on commodity exports; and its liquid and sophisticated financial markets provide as many channels for the transmission of external shocks. The past year’s fluctuations in domestic equities, bonds and the exchange rate, as well as the sensitivity of local GDP to the global cycle, bear testimony to this relationship. Supply-side problems undermined South African growth in 2011. Some of these were external, including disruptions to the automobile sector’s supply chain following the devastation in Japan. Others were internal – and I refer here to safety-related interruptions in mining and industrial action in both the mining and manufacturing sectors. The consequence, however, was that GDP growth only averaged 3,1 per cent in 2011, a lesser increase than what the Reserve Bank had been projecting this time last year. Admittedly, the latter half of the year brought some good news on the domestic demand front. Thus, real GDP accelerated to 3,2 per cent (quarter-on-quarter annualized) in the fourth quarter, driven by sustained solid expansion in consumer spending and an acceleration in both private and BIS central bankers’ speeches public fixed investment. Yet, many factors justify caution – above all the uncertain global environment – and the Reserve Bank’s latest projection for 2012 growth at 3,0 per cent still falls marginally short of the growth rate achieved last year, and of the rate of growth required to put a serious dent into unemployment. In this regard, latest figures show an unfortunate rise in unemployment in the first quarter of 2012. The past twelve months also saw a mild breach of the Reserve Bank’s 3–6 per cent inflation target, with the headline CPI rate increasing to 6,3 per cent in January before retreating to 6,0 per cent in March. Price pressures over the past year have remained essentially of a cost-push nature. The moderate pace of “core” inflation (4,4 per cent in March when excluding food, petrol and energy) shows that despite some evidence of price pressures becoming more broad-based, these are still expected to remain contained by the relatively subdued state of the domestic economy. In fact, as highlighted by the MPC on March 29, the Reserve Bank expects that CPI inflation will gradually decline from the second quarter of this year onwards, with a projected average of 5,2 per cent by the end of the forecast period at the end of 2013. The behaviour of domestic fixed-income markets over the past twelve months would suggest that investors by and large agree with the Reserve Bank’s interpretation of the inflation acceleration as temporary and largely supply-driven in nature. Despite volatile global markets, rand-denominated bond yields declined over the past year, testing post-recession lows, while breakeven inflation expectations are not markedly different from where they were a year ago. Both the government bond and swap yield curves are flatter up to the ten-year maturity. And while the performance of longer-term bonds appears in part to be dictated by investor expectations of subdued growth both globally and locally, the planned faster reduction in the government budget deficit compared with initial National Treasury targets may also have reassured investors. Activity in the domestic bond market by non-resident investors illustrates their relatively constructive approach towards emerging market debt in general, and South African bonds in particular. Statistics show that net foreign purchases of local bonds were positive in ten of the twelve months to April 2012, and despite a hefty selloff in September 2011, the cumulated net purchases amounted to R74,5 billion. In comparison, the previous calendar-year record in 2006 stood at R34,3 billion. In recent weeks, the announcement of the possible inclusion of South Africa into the World Government Bond Index later this year, has provided some impetus to the local currency bond market and non-resident inflows. This is a positive development as the criteria for inclusion is based on the level of sophistication of our bond markets with regard to size, credit quality and lack of barriers to entry, as well as on its liquidity and a transparent price discovery process. This represents another endorsement of South Africa’s financial markets as being world-class. Other financial assets, however, have experienced a more volatile environment over the past year. Equity prices, as measured by the JSE all-share index, failed to post any gain over the whole of 2011 despite a recovery in the latter part of the year. Furthermore, a continuation of the late 2011 rally into early 2012 quickly lost steam, bearing testimony to continued investor concerns about any speedy return to solid economic growth. In contrast to positive inflows into bonds, net non-resident activity into local equities has resulted in net sales of R25,4 billion in the twelve months to April 2012. The exchange rate of the rand, while not repeating the wild gyrations of earlier financial crises, has remained vulnerable to shifts in global risk appetite and swings in commodity prices. Following relative stability in the first half of 2011, the currency weakened beyond R8.00/US$ in September as foreign investors sold domestic bonds, and even the resumption of bond purchases in the ensuing months failed to bring the rand back to its previous range. The past few months have again been a period of moderate volatility, with the rand seemingly driven – as with other so-called “commodity currencies” and emerging market currencies – by the countervailing forces of abundant global central bank liquidity, fledgling investor appetite for risk and movements in the EUR/USD exchange rate. BIS central bankers’ speeches 4. Financial market operations The management of overall money-market liquidity continues to be one of the most important functions of the Financial Markets Department (FMD) as part of the implementation of the monetary policy decisions of the MPC. The Bank continuously reviews its monetary policy operational procedures for appropriateness and effectiveness, and changes are implemented when deemed necessary. As you are aware, various changes were implemented in August 2010 and March 2011 following research conducted within the Bank as well consultations with market participants through the Financial Markets Liaison Group (FMLG). As a result of the changes, the actual daily liquidity requirement increased markedly from a daily average of R10,3 billion in the twelve months before August 2010 to an average of R15 billion in the next twelve months, and further to an average of R16,8 billion from September 2011 to 30 April 2012. The number of banks participating in the main repo auctions has increased from four to a total of six and at times, seven banks, with the combined bid amounts tending to be higher than the announced average weekly liquidity requirement. The introduction of longer-term foreign exchange swaps with maturities of up to twelve months has improved the Reserve Bank’s open market operations and has led to the more effective management of money-market liquidity. The discontinuation of the practice of announcing the estimated weekly liquidity ranges to the market has significantly reduced the Reserve Bank’s activity in the money-market. Participation in SARB debenture auctions has also improved. Following further consultations with market participants, another set of enhancements to the Reserve Bank’s monetary policy operational procedures was implemented on 01 March 2012: • When the auction is oversubscribed, the amounts tendered for by commercial banks in the weekly main repo auctions are now allocated on a pro rata basis, up to the announced average daily liquidity requirement for the week; • The Bank now conducts 2- and 5 day main repo auctions during the week of the MPC meetings; and • SARB debentures and reverse repos are now issued with maturities of 7- and 14 days, in addition to the usual 28- and 56 days maturities. These enhancements have further improved the functioning of the money market, especially the interbank market, have also increased the level of flexibility in the Reserve Bank’s liquidity management operations, and have eliminated the lack of synchronisation between the Reserve Bank’s main repo auctions and the MPC interest rate announcements. This lack of synchronisation had previously led to discrepancies in the market, as interest rates in the interbank market changed when the repo rate was changed, while the interest rate for the main repo remained unchanged for the rest of the week. Financial market development initiatives remain an important strategic focus area of the Financial Markets Department in cooperation with members of the FMLG, its various working groups and other market participants. The focus for the next period will be on completing projects such as the pricing of the floating rate notes (FRNs) in the secondary market, gaining a better understanding of high-frequency trading in the foreign exchange market and developments in over-the-counter (OTC) market in foreign exchange derivatives and reviewing the calculation reference rates in the money-market. 5. Reserves management In line with stated policy of not targeting a specific level of the exchange rate, the Reserve Bank continues its activities in the foreign exchange market for purposes of building reserves when market conditions are conducive and to execute client transactions. The official gross gold and foreign-exchange reserves increased from US$49,3 billion on 31 March 2011 to US$50,7 billion on 31 March 2012. The change reflected a combination of valuation BIS central bankers’ speeches adjustments, maturing forward transactions, and proceeds of a government foreign bond issue. The international liquidity position improved from US$44,7 billion to US$48,9 billion during this period. The reserves accumulation strategy continued to be implemented in close consultation with the National Treasury. During the 2011/12 financial year, the Reserve Bank purchased approximately US$4,0 billion for reserve accumulation purposes. These purchases were swapped into the forward market by means of FX swaps in order to sterilise rand liquidity injected into the money market. By end-2011, foreign exchange reserves could comfortably cover a year’s worth of South Africa’s external funding requirements (consisting of the current account deficit and short-term external debt, as per the so called augmented Guidotti Ratio definition). The Reserve Bank has continued to manage official reserves following prudent risk management and governance principles. The strategic asset allocation is reviewed regularly, compiled in accordance with the Reserve Bank’s investment objectives and determines the structure of the foreign-exchange reserves in terms of currency composition, asset allocation and market risk. 6. Conclusion It is now time for me to conclude, by thanking you for your co-operation over the past financial year as many of you are counterparties in our transactions, participate in information exchanges bilaterally and in fora such as the FMLG, and readily make your research available to us. No doubt, future challenges lie ahead in what remains an unusually uncertain global financial environment. Yet I trust that the spirit of co-operation that we have developed in our financial markets over the years will help us to successfully meet these challenges. I also would like to extend thanks to my own colleagues, the management and staff of the Financial Markets Department. Their hard work and dedication during a rather challenging year for the department has been exemplary. They continue to make the Reserve Bank and the country proud. I would also like to thank colleagues from other departments within the SARB, many of which are present tonight, who work closely with the Financial Markets Department on a daily basis. Thank you also to the staff of the Reserve Bank’s Conference Centre for once again arranging this function for us. 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 Rand Merchant Bank FICC Research Macro Forum, Cape Town, 31 May 2012.
Daniel Mminele: Monetary policy implementation – the impact of the changing regulatory landscape on the policy transmission mechanism Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Rand Merchant Bank FICC Research Macro Forum, Cape Town, 31 May 2012. * 1. * * Introduction Good morning and thank you to Rand Merchant Bank for inviting me to what has certainly been an enlightening morning. The topic I have been asked to address you on is a very interesting one from a central bank policy perspective, and relates to an area of our work in central banking which is still evolving, and the real impact of which remains uncertain. The two speakers before me provided some interesting insights around the fiscal and political dynamics locally, both areas which in the international context carry a fair share of the responsibility for the current sovereign debt crisis and financial market stresses. It seems quite appropriate to round off the day with a discussion on monetary policy, which has been playing an increasingly central role in recent years, given the limited, and in some cases, exhausted fiscal space, and a seeming lack of political will to meaningfully resolve the crisis. The result of this has been an unprecedented expansion in the demands on monetary policy, which necessitated an enlargement of the toolkit in a manner that one would have thought impossible only a few years ago. However, as we know, all actions have consequences, and while central bankers in many ways can be credited with coming to the rescue when fiscal policy no longer could, there are many challenges going forward, not least of which remains the illusion of unlimited intervention1 and potential for moral hazard, when to exit from these unconventional measures and ultimately how best to exit without creating another crisis. It seems we keep returning to this question of “exit”, only to get derailed again by a further upset or deterioration in the global environment. In my remarks today I will touch on the costs of an unstable financial system and developments around macro-prudential policies, before I discuss the impact of regulatory changes on the transmission mechanism. 2. The costs of an unstable financial system The economic and social costs associated with an unstable financial system are well known. Fiscal policy went to extraordinary lengths to try and secure the stability of the real economy and the financial system, but in so doing, was sowing the seeds of the sovereign debt crisis. To remedy the situation in Europe, harsh austerity measures were implemented in order to put public finances on a sounder and more sustainable footing, and to inject the necessary confidence into financial markets. In reality, however, while one cannot doubt that such measures were implemented with the best of intentions, it is doubtful that the desired outcomes are being achieved, and in some instances these measures turned out to be self-defeating. Austerity measures came at the expense of growth, and as a consequence, public finances have not been able to recover as quickly as expected and fiscal deficit targets have not been met. The result has been that the debt crisis has lingered longer than anticipated, and ultimately spread from peripheral Europe to other countries within the Euro zone. Hence there is an argument now raging between those who continue to favour austerity and those who favour less austerity and more stimuli to support growth. The Monetary policy in the crisis: testing the limits of monetary policy, Herve Hannoun, Deputy General Manager, Bank for International Settlements BIS central bankers’ speeches austerity versus growth debate has found its way into the political discourse, such that the euro zone fiscal pact is now being challenged with the scales seemingly now tilted more in favour of growth rather than too much austerity. The ideal scenario would some combination of measures that support growth in the short term, but do not put fiscal sustainability in the medium term at risk. When it became clear that fiscal policy had been exhausted and in some cases over extended, monetary policy had to step in. Interest rates in a number of advanced economies had already been cut to near zero. Central banks found themselves turning to unconventional measures such as quantitative easing or balance sheet policies2 and conducting large scale interventions in financial markets to resuscitate market segments that were no longer functioning. Liquidity was provided to the dysfunctional interbank and credit market to mitigate a credit crunch and to prevent a complete collapse of the global economy. These policies were used to stabilize financial market tensions and dampen the rise in credit and liquidity risk premia. In short, the balance sheet policies were employed to target overnight and term money-market rates, long-term government bond yields and various risk spreads, with an impact on a wider range of asset prices. Via these channels the central bank actions were meant to be eventually transmitted to the real economy. These policy actions by central banks have certainly played a significant role, by preventing a higher degree of financial instability and buying some time to get the needed repairs done. Unfortunately, it seems the time bought is not being used in the most opportune manner. 3. Macro-prudential policy Given the severe repercussions of the financial crisis, the question arose as to whether “it is better to pick up the pieces after a bust or rather to try to prevent the build-up of bubbles”? Olivier Blanchard3 stressed that “financial intermediation matters” and while markets are segmented and there are specialized investors operating in specific markets, they are all linked through arbitrage. For this reason, a withdrawal by an important investor from a market (segment) might create severe distortions in asset prices and therefore policy interventions will become necessary to restore dislocated prices and to align them with fundamentals. This was quite clearly played out during the US subprime crisis. In this context he argues in favour of preventative measures, rather than to be reactive. We have learnt firstly that systemic risk cannot be prevented by focussing only on regulation and supervision, and secondly that achieving price stability does not equate to achieving financial stability. Hence, the birth of macro-prudential policy which pursues financial stability as its objective, whereas the objective of monetary policy is price stability. The latter uses interest rates as its instrument, but it is well known that interest rates can be a blunt tool in dealing with excess leverage, extreme risk taking, or unwarranted deviations of asset prices from fundamentals. A combination of monetary and regulatory tools is needed, such as increases in regulatory capital ratios when leverage is deemed too high, or changes in margin requirements to reign in excessive asset price moves. It is true also that macro-prudential policy is not sufficient on its own to ensure financial stability, as we have seen with the euro zone debt crisis, where markets doubted the solvency of the sovereign and in this manner, fiscal policy led to financial instability. Nonetheless, I will focus purely on macro-prudential policy for now. Balance sheet policies involve central banks using their balance sheets to influence broader economic and/or financial conditions, particularly when the policy rates have reached their zero limits. Chief Economist of the International Monetary Fund BIS central bankers’ speeches In an interview4, Olivier Blanchard notes that macro-prudential measures are likely to have a more targeted impact than the policy rate on the variables they are trying to affect. Whereas the policy rate is best used primarily in response to aggregate activity and inflation, the specific macro-prudential instruments should be used to deal with specific output composition, financing, or asset price issues. The two policies have different objectives, however, the implementation of macro-prudential policies will have an impact on the transmission mechanism of monetary policy, given that both work through the same channels (bank lending and balance sheets of financial institutions) and focus on the same institutions (monetary and financial). The question is whether macro-prudential policy will amplify or dampen interest rate cycles? Jaime Caruana5 noted that the troughs may become less extreme as macro-prudential policies should reduce the likelihood of financial crises and their disinflationary consequences. Similarly, interest rate peaks may be less severe, assuming that macro-prudential policy succeeds in restraining asset price and credit booms. On the other hand, by having to contribute to financial stability and thereby placing additional weight on the risk of imbalances, there may be a need for larger interest rate increases during expansions. Interest rates, he believes, could move more symmetrically over the financial cycle and there would be reduced risk of hitting the zero lower bound and of having to resort to balance sheet policies. As I mentioned in my introduction, this is uncharted territory and there is still much research which is going into this topic. South Africa has not used any macro-prudential tools, but a number of changes have been implemented to enhance macro-prudential policy. These changes include an elevation of the Financial Stability Committee to equal status as the Monetary Policy Committee, as well as the creation of a Financial Stability Oversight Committee, chaired by the Governor of the SARB and the Minister of Finance. 4. The regulatory changes and impact on the transmission mechanism The global financial crisis has forced a revision of the international regulatory framework. Reform is being implemented in a number of areas, including the strengthening of macro-prudential policies, strengthening the supervision of individual financial institutions, oversight of key market infrastructures, and the monitoring of the financial markets. Basel III capital and liquidity requirements are currently the most prominent regulatory changes with the greatest potential to impact the monetary policy transmission mechanism. Although Basel III is envisioned to increase the resilience of the banking system and in so doing, improve the effectiveness of the monetary policy transmission mechanism, and South Africa as a member of the G20, the Basel Committee for Banking Supervision and the FSB in principle supports these regulatory reforms, there are nonetheless risks of unintended consequences associated with the implementation of these requirements. Basel III requirements are not of a macro-prudential nature, but like previous Basel requirements, are aimed at the balance sheets of commercial banks and could therefore impact economic activity and hence monetary policy. I would like to focus specifically on the liquidity framework which requires banks to adhere to a new liquidity coverage ratio (LCR) to ensure that they have sufficient high-quality liquid assets to survive a month-long significant stress scenario. The LCR aims to ensure that banks maintain an adequate level of unencumbered, high-quality liquid assets that can be converted into cash to cover net outflows during the period of stress. Interview with Olivier Blanchard, IMF Survey Magazine, IMF Explores Contours of Future Macroeconomic Policy, February 12, 2010 Monetary Policy in a world with macro prudential policy, Speech by Jaime Caruana, General Manager of the BIS, at the SAARCFINANCE Governors’ Symposium 2011, Kerala, 11 June 2011 BIS central bankers’ speeches In South Africa, like in other countries, the Basel III liquidity regulations aim to reduce the reliance of banks on short-term funding. South Africa has very large and persistently high levels of income inequality, as reflected by a high gini coefficient of over 60. It is not surprising therefore, that households saving is very low, and that a large portion of the population is unable to make a significant contribution to national savings. Gross saving by the household sector has been around 1.6 per cent of GDP over the past two years. Consequently, national savings are concentrated in wholesale savings, resulting in a structural constraint, in that banks rely heavily on wholesale funding rather than retail deposits. The relatively high reliance on wholesale funding, increases the requirement in terms of both the LCR and the other component of the liquidity framework under Basel III, namely the net stable funding ratio (NSFR)6 , and therefore will result in a higher cost of funding for domestic banks. There is a double whammy, however, because at the same time, the opportunity cost to acquire high quality liquid assets will imply that there will be a decline in the supply of loanable funds. Implementing the Basel liquidity risk standards in South Africa could reduce the availability of long-term credit, particularly in South Africa where assets that meet the Basel III qualifying criteria for the new LCR are in short supply (paradoxically also as a result of having pursued responsible fiscal policies and avoided excessive government debt). This intuitively would result in a reduction in broader economic activity, without raising policy rates, and would possibly compromise the transmission mechanism based on the prevailing monetary policy settings. South Africa implements monetary policy through a classical cash reserve system, where a liquidity shortage is created in the money market through the cash reserve requirement and other open market operations, such as the issuing of SARB debentures and reverse repos. Through the shortage, the Bank impacts on marginal cost of funding of commercial banks, as banks have to refinance this shortage at the SARB once a week at the repo rate. This places additional pressure on the demand for liquid assets, because banks refinance this shortage against eligible collateral, which is in addition to the assets needed for the prudential liquid asset requirement. I should add that one of the national discretion options available to authorities in jurisdictions with inadequate qualifying liquid assets is to make available a committed facility from the central bank, from which commercial banks can draw in times of liquidity stress. As you are all aware, the Bank has recently announced its intention to make available such a committed liquidity facility against eligible collateral to all South African banks to help them meet the required LCR. This should help avoid any abrupt changes to the business models of bank, which could both complicate the transmission mechanism of monetary policy and have a detrimental effect on the real economy. The bank is presently investigating options to also deal with the challenges presented by the NSFR should it be applied in its current form. In addition to the economic impact, the LCR may have a host of other unintended consequences, such as increasing the interlinkages with governments (although in theory it should enhance the attractiveness of corporate bonds and therefore spur activity in this segment of the market), encouraging disintermediation, as well as cross-border interlinkages, while inadvertently negatively impacting on liquidity in debt markets. Thus, under Basel III, banks may appear safer, but systemic risk may not necessarily be lower. In sum, faced with these structural constraints, the Basel III liquidity requirements may result in South African banks reducing their lending, and therefore the availability of credit to the real economy. This will most certainly have negative consequences for economic growth and employment creation, which will further reduce available savings. The BIS concedes that Basel III will impact on the transmission mechanism of monetary policy, however, formal research studies are still in their infancy. While we understand the This funding ratio calculates the proportion of long-term assets which are funded by long term, stable funding. BIS central bankers’ speeches qualitative impact, it is not possible to measure it at this stage, while the impact will differ according to each country’s initial conditions. These are the issues which central banks are grappling with today and the challenges they present for the conduct of monetary policy going forward. The new Basel requirements do not suggest that there needs to be any changes to the South African monetary policy implementation framework, unless we change the operating framework from the current classical cash reserve system to an overnight targeted rate framework. South Africa’s money markets are not yet sufficiently developed to potentially justify a change from the current classical cash reserve system operating framework to an overnight target rate framework. This segment of the market needs to be developed much more, and this forms part of the on-going work at the Bank in consultation with market participants such as the Money Market Subcommittee of the Financial Markets Liaison Group. Thus, at least over the medium term, the monetary policy implementation framework in South Africa is unlikely to be affected by these regulatory changes, however, they will have an impact on the monetary policy transmission mechanism and therefore on monetary policy and interest rates and need constant monitoring. 5. Conclusion In conclusion, the global financial crisis has forced a rethink about monetary policy and financial stability, resulting in new macro prudential frameworks. The consequences thereof are still unknown but could have significant implications for the conduct of monetary policy and the institutional set up of central banks. What is certain is that the operating procedures of central banks will become much more complicated, with a much wider variety of tools available. I 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 Luncheon of the Southern African-German Chamber of Commerce and Industry, Johannesburg, 25 July 2012.
Daniel Mminele: Inflation targeting in the wake of the crisis and the South African experience Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Luncheon of the Southern African-German Chamber of Commerce and Industry, Johannesburg, 25 July 2012. * 1. * * Introduction Good afternoon and thank you to the Southern African – German Chamber of Commerce and Industry for the invitation. I thought it may be an appropriate time to take stock of monetary policy in general and more specifically in South Africa since the sub-prime crisis. The years between the mid-1980s until the outbreak of the sub-prime crisis are often referred to as the “Great Moderation”.1 This period of reduced macroeconomic volatility came to an abrupt end in 2007, following which uncertainty, instability, extraordinary volatility and strain in financial markets became the norm. Increasing trade and financial inter-linkages with the global environment meant transference of this volatility and uncertainty to the South African economy, with consequences for monetary policy. South Africa’s monetary policy has been influenced by developments in the US and Europe, however, it is also true that our experience has been vastly different to that of central banks abroad. I say this because at no time did we employ unconventional monetary policies, nor did we implement capital controls or intervene in the foreign exchange market. We were one of the few emerging market central banks not to have tightened monetary policy during this period. The crisis in Europe shows no signs of abating and the threat of the US fiscal cliff looms large. Judging by the most recent developments, things seem to be getting worse. Speculation about the likelihood of a third round of quantitative easing by the US Federal Reserve and a third long-term refinancing operation by the European Central Bank, is gaining impetus. Globally, the stance of m onetary policy is accommodative and one would be hard pressed to find anyone betting on a change in the state of affairs anytime soon. I will discuss how inflation targeting has fared through the crisis and then share some thoughts with you on South Africa’s experience and recent developments on the monetary policy front. 2. The appropriateness of inflation targeting? New Zealand was the pioneer of inflation targeting 2 and adopted the framework just over two decades ago. The idea of explicitly targeting inflation proved to be an attractive proposition for central banks and thus became much more widely embraced, with approximately 39 central banks 3 said to have inflation targets at the beginning of 2012. Much as there is no one correct way of implementing inflation targeting, as there are various nuances depending on individual country circumstances, it can be safely argued that it is the consensus position when it comes to monetary policy frameworks. Among the most recent central banks to move in this direction are Bank of Japan and US Federal Reserve System. Featuring a reduction in macroeconomic volatility, of both output and inflation Germany is known for having adopted many elements of inflation targeting earlier than 1990 Central Bank News, The Central Bank Inflation Targeting Report Card for 2011 BIS central bankers’ speeches Inflation targeting was thus presented as the primary mandate of central banks, although in reality even without an explicit inflation target, ultimately all central banks are concerned with inflation. The policy is not without its critics, of course, who argue that because it was implemented in a period of low and stable inflation and steady economic growth, that this environment paved the way for the success of the framework. Others would argue that it was precisely the adoption of inflation targeting that helped to contribute to the years known as the Great Moderation. Some steadfastly believe that inflation targeting is harmful to economic activity, failing to recognise that the adoption of inflation targeting is in fact consistent with stabilising output in periods when the economy may be faced with a shock (such as excessive growth in aggregate demand). Promoting lower and more stable inflation is important for long-run economic growth and stability. The belief that central bankers care only about inflation without any regard for factors such as output growth is clearly a misconception. Since 1990, the manner in which inflation targeting has been applied has largely converged, with many central banks practising flexible inflation targeting – allowing where appropriate for shifts away from the target, and returning within some reasonable time horizon, therefore taking into consideration factors such as output. It would therefore be fundamentally incorrect to characterize inflation targeting (as conducted in practice) as an iron-clad policy rule. Ben Bernanke, prior to being appointed as Chairman of the Federal Reserve, said that inflation targeting is better thought of as a policy framework, in which policy is “tied down” in the long run by the inflation target (which serves as a nominal anchor for the system), but in which there is also considerable leeway for policymakers to pursue other objectives in the short run. 4 Transparency and flexibility have been key in the success of inflation targeting and produced a sound underpinning for monetary policy in pursuit of price stability. The sub-prime crisis and subsequent developments raised question marks as to the suitability and relevance of inflation targeting in the aftermath of the crisis. During 2008, the significant financial market disruptions and rises in food and energy prices led to increases in headline inflation. As the financial crises worsened, many advanced economies entered recession or experienced sharp declines in economic activity as well as disinflation. Consequently, concerns swung from inflation to deflation. As you know, inflation targeting countries do not just operate with an upper bound but also with a lower bound for the inflation target or certain tolerances around the target where there is a point target as opposed to a range. The severity of the recession in fact strengthened the arguments in favour of inflation targeting, as the credibility of inflation targeting central banks resulted in stable inflation expectations, helping reduce the risk of deflation. Even in the current environment of loose monetary policy and substantial global liquidity, inflation expectations appear to be well anchored. This is not to say that the framework is perfect as it is, there are refinements to be made, not least of which would include incorporating financial conditions into monetary policy deliberations, and including financial stability as part of the central bank’s mandate, because as we know, achieving price stability does not equate to achieving financial stability. Including financial stability or macro-prudential policy into the central bank’s mandate requires a combination of monetary and regulatory tools, however, the implementation of macro-prudential policies will have an impact on the transmission mechanism of monetary policy, given that it works through the same channels (bank lending and balance sheets of financial institutions) and focuses on the same institutions (monetary and financial) as monetary policy does. It is uncertain exactly how macro-prudential policy and monetary policy will interact. This is uncharted territory and there is still much research which is The National Bureau of Economic Research, Ben S Bernanke, Inflation Targeting BIS central bankers’ speeches going into this topic. In this new world of co-habitation of monetary policy and financial stability, the challenge for the future will be to find the right mix between the two, such that some of the inherent conflicts that could arise in pursuing both simultaneously, are in some defensible balance. Interestingly, in an IMF staff position note entitled “Rethinking Macroeconomic Policy”,5 the authors argue that low inflation limits the scope of monetary policy in deflationary recessions and poses the question whether higher average inflation and higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration in fiscal positions. They question whether the net costs of inflation would be much higher at 4 per cent than at 2 per cent and how much more difficult it may be to anchor expectations around a higher level. These are interesting questions indeed, but as the quote about hindsight goes, “one cannot ride a horse backwards and still hold its reins”. The authors conclude by noting that the ultimate goals should be to achieve a stable output gap and stable inflation, but that policy makers will need to watch many more targets and have many more instruments at their disposal – the challenge is in learning how to use these optimally. In another interesting and unfolding debate, the view of the role of the exchange rate and intervention in the foreign exchange market, whilst having an explicit inflation target appears to be changing somewhat since the crisis. Under inflation targeting, the credibility of the regime entails an institutional commitment to price stability with other goals such as the exchange rate subordinated to price stability. The traditional view has been that inflation targeting was incompatible with intervention in the foreign exchange market. It appears there may be a shift in this view, and we have witnessed this in practise, where some countries have moved from freely floating exchange rates towards some form of managed float. There is also a growing conviction that flexible inflation targeting can include foreign exchange intervention, but not with a view to targeting a specific level or range for the exchange rate, but to “lean against the wind” to avoid abrupt adjustments and for purposes of smoothing volatility. Emerging market economies generally suffer high exchange rate volatility, as well as a higher pass-through from the exchange rate to inflation. For this reason, it is not feasible to neglect the exchange rate; consequently many emerging markets may adjust interest rates to contain the effect of temporary exchange rate shocks on inflation and financial stability. Since the global financial crisis, many emerging markets intervened in the foreign exchange market to try and limit exchange rate volatility. The view is that foreign exchange intervention could reduce exchange rate volatility and thus lead to a more favourable trade-off between stable inflation and real economic activity, and by so doing, could improve the overall performance of the inflation targeting regime. There is the risk of course, that central banks could lose credibility if they rely too heavily on intervention. 3. The South African experience The South African experience with the implementation of inflation targeting has been a positive one. Work done by my MPC colleague Brian Kahn and others has shown that South Africa has benefited from a flexible approach to inflation targeting and managed to weather the storms that came along with challenges of multiple supply side shocks of an extended duration, and exchange rate shocks. This was done by looking through short-term impacts and focusing on second rounds effects, thus resulting in inflation being allowed to be outside the target for longer, but not overreacting with policy, while keeping a close watch on inflation expectations. Rethinking Macroeconomic Policy, Olivier Blanchard, Giovanni Dell’Ariccia and Paolo Mauro, IMF Staff position note, February 12 2010 BIS central bankers’ speeches In August 2008, South Africa’s headline inflation rate peaked at 13.7 per cent, at which time the repo rate had been increased to 12 per cent. This occurred in a period when global inflation had started edging lower and policy rates in advanced economies were being reduced. Towards the end of 2008, when it became quite clear that the US sub-prime crisis was to have a much more devastating impact on the local economy than had initially been expected, the Monetary Policy Committee started to reduce the repo rate. At this time, inflation pressures had started to abate and by the end of 2010, the repo rate had been reduced to 5.5 per cent, by which time inflation had again started to rise. Nonetheless, the repo rate was kept at this low level in response to the crisis, taking into consideration that the nature of the rise in inflation over this period was largely cost-push, and did not appear to be feeding into more general price pressures in the economy. The CPI inflation rate has since come back within the 3 – 6 per cent target range, and looks likely to decelerate in the months ahead, given evidence of softer food prices and moderating demand. The Bank expects inflation to decelerate to 4.9 per cent in the second quarter of 2013 and remain stable around 5 per cent to the end of 2014. Like other countries, South Africa is drawing lessons from the financial crisis and the changing role of central banks. Our mandate has been clarified to more explicitly include a financial stability responsibility, and we are working on clarifying the role of financial stability in monetary policy formulation and implementation, having elevated the status of the Financial Stability Committee in the Bank. As for the exchange rate, the South African rand has been one of the most volatile currencies among emerging market currencies and also has a significant effect on inflation. The SARB did not at any time intervene in the foreign exchange market to try and influence the value of the rand. However, significant portfolio inflows and FDI flows have been absorbed by the Bank and used to build the country’s foreign exchange reserves. While sticking to the policy of not targeting the exchange, a much healthier position with regard to the level of foreign exchange reserves places the Bank in a better position to smooth abrupt movements in the foreign exchange market should conditions warrant in future. Of course some old lessons remain, namely that controlling inflation at lower and stable levels continues to be of paramount importance to central banks, given its vagaries and distortive and erosive effects. Questions are often asked as to why South Africa does not instead target employment. Monetary policy cannot contribute directly to economic growth and employment creation in the long run, but by creating a stable financial environment, monetary policy fulfils an important precondition for the attainment of economic development. The underlying rationale for controlling inflation is that low inflation will provide an appropriate basis for sustainable growth. The Bank’s view is that there is no long-run trade-off between unemployment and inflation. Flexible inflation targeting may not be perfect, but compared to whatever else there is to choose from currently, it is probably the closest you can get based on what we know today. 4. Recent developments The recovery thus far has been bumpy and fragile, largely led by private and public consumption growth, while export volumes and private investment have remained markedly below pre-crisis levels. South Africa has also not fully recovered the jobs lost in the previous recession, and although jobs are being created, it is not at sufficient enough a pace to absorb the new labour market entrants. The number of discouraged job seekers is increasing. Unemployment in the first quarter of 2012 was 25.2 per cent, and the level of the index of formal non-agricultural employment was still about 1 per cent lower than in the third quarter of 2008. BIS central bankers’ speeches World trade has improved since 2009, surpassing levels before the global financial crisis. Advanced economy exports have not fully recovered but emerging market exports have recovered robustly. In sharp contrast to the performance of most other emerging market economies, South Africa’s real exports have not recovered to 2008 levels, with real exports still 13 per cent lower in the first quarter of 2012 than in the third quarter of 2008, notwithstanding the recovery in trading partner country import demand to pre-crisis levels. South Africa’s share of global exports has increased modestly since 2005, despite strong terms of trade gains, whereas other comparable countries have seen significant increases in market share. The IMF estimates SA’s export volumes to remain around 15 per cent below their pre-crisis peaks.6 More recent economic data reveals a softening growth momentum, pointing to a moderation in household consumption expenditure, which has been the main engine of growth thus far during the recovery. The rise in unemployment is impacting aggregate demand, while consumer confidence declined considerably in the second quarter of 2012 to its lowest level since the most recent recession. Real retail sales also reflect a slowing momentum, as the strong year-on-year headline figure hides substantial base effects. Apart from signs of a further moderation in growth, there are continued risks emanating from the European sovereign debt and banking crisis which have culminated in a number of emerging market countries, resuming an easing monetary policy bias and advanced economies employing further unconventional measures. The Bank’s forecast for domestic growth has been revised lower from 2.9 per cent in 2012 to a modest 2.7 per cent and 3.8 per cent in 2013. The risks to this forecast are tilted to the downside. It was against this backdrop of soft growth and moderating inflation, that the Bank further reduced the repo rate to 5.0 per cent at the most recent Monetary Policy Committee meeting last week. As indicated in our most recent monetary policy statement, while we believe that the most recent policy action will alleviate certain pressures and will be supportive, monetary policy on its own will not overcome all the challenges that the economy is facing. While monetary policy needs to play its part and remain relevant to the context, there are limits to what monetary policy can do, and it needs to be part of a carefully defined overall macro economic policy mix. 5. Conclusion I would like to end my remarks by highlighting that the inflation targeting framework has served South Africa very well, both before and during the crisis. South Africa has practised “flexible” inflation targeting, and considers all factors driving inflation, including output growth and the external environment. With financial stability also being a part of the central bank’s mandate, the factors to consider have grown and the universe of instruments have to be expanded. We have an interesting time ahead as central bankers and no doubt still many challenges to face. I thank you. IMF Article IV Report, South Africa, 2011 BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the South African National Editors' Forum (SANEF) at the Nat Nakasa Awards, Durban, 28 July 2012.
Gill Marcus: Transparency, communication and democracy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the South African National Editors’ Forum (SANEF) at the Nat Nakasa Awards, Durban, 28 July 2012. * * * Good evening and thank you for the opportunity to address you this evening. You as members of the media are at the forefront of information dissemination. You pursue stories, are seminal in bringing issues to the attention of the public, and help inform and shape the discourse in society. And therefore you have a heavy responsibility to ensure that your reports are accurate and the information conveyed in such a manner that the reader and ordinary citizen has the ability to interpret and judge for themselves. But it is not just a matter of getting the correct facts, it is also how you analyse and convey such facts that is important. Differences in nuance or how a headline is phrased can change or shape the readers’ interpretation of seemingly objective facts. What a democratic country needs is an informed public, a public that is knowledgeable and able to express views precisely because it is knows what is happening, both globally and domestically. In 1976 Erich Fromm, recognised as one of the world’s most influential thinkers on social issues, when outlining what could be done to create a better society, wrote in To Have or To Be: “A system of effective dissemination of effective information must also be established. Information is a crucial element in the formation of an effective democracy … the so-called great newspapers inform better, but they also misinform better; by not publishing all the news impartially; by slanting headlines in addition to writing headlines that often do not conform with their accompanying text; by being partisan in their editorials, written under the cover of seemingly reasonable and moralising language. In fact, the newspapers, the magazines, television and radio produce a commodity: news, from the raw material of events, and barely gives the citizens an opportunity to penetrate through the surface and recognise the deeper causes of events … The information problem must be solved in a different way if informed opinion and decision are to be possible.” Transparency and communication have become integral to modern central banking, and although part of our communication is directly with the markets or the public, it is generally reported by the media as well. In this way how you report may impact on the interpretation and understanding by the public of our communications. More open communication by central banks is a relatively recent phenomenon. In his colourful narrative “Lords of Finance”, Liaquat Ahamed describes central banks as “mysterious institutions, the full details of their inner workings so arcane that very few outsiders, even economists, fully understand them”. Karl Brunner, writing in the early 1980s, rather unflatteringly referred to the “mystique” of central banking that “thrives on the pervasive impression that Central Banking is an esoteric art … The esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences”. Similarly, when a US senator said that he understood a comment made by Federal Reserve Bank Chairman Alan Greenspan, Greenspan famously replied: “If you understood what I said, I must have misspoke”. However, Greenspan was in fact at the forefront of what Alan Blinder called the “quiet revolution” or the opening up of central banks during the 1990s. As recently as the early 1990s, the Federal Open Market Committee (FOMC) of the US Fed would meet and not in fact announce its monetary policy decision. Market watchers would then have to deduce from the Fed’s actions in the money markets what the stance of monetary policy actually was. The “quiet revolution” is in fact about central banks not being so quiet anymore, and central banks are now anything but arcane. Transparency and its corollary, communication, have become fundamental to central banking operations and strategy. The South African Reserve BIS central bankers’ speeches Bank has not been left behind in these developments, with a marked evolution towards greater transparency and more open communication, particularly since the introduction of inflation targeting in 2000. There are two broad thrusts to our communication. The first is to create greater awareness about what the Bank does, what it should do, what it cannot do, and what it should not do. The second relates to the predictability and transparency of monetary policy. I will make a few comments on both of these issues. With respect to communicating what the central bank does, this is particularly important in the current climate of heightened global uncertainty and fragility. Central banks are being viewed as having powers way beyond their capabilities, and as more and more governments hit fiscal constraints, central banks are seen, in my view somewhat unreasonably, as the saviours of last resort or of only resort. Central bank mandates are becoming increasingly blurred as they are expected to, inter alia, simultaneously control inflation, generate growth, solve the unemployment problem, control interest rates, control exchange rates and capital flows, build reserves and ensure financial stability. Some areas, such as macroprudential policies, are still unchartered territory. But it is important that central banks have clear and achievable mandates, and for these to be communicated. Central banks build up credibility by achieving their goals, but can lose credibility and indeed legitimacy if they fail to achieve goals that society believes they ought to achieve but are beyond their capabilities. In South Africa, there have been periods when this lack of understanding of the role and scope of monetary policy resulted in the Bank becoming a lightning rod for all that was wrong in the economy, and unrealistic demands and expectations resulted. In order to try and contribute to this better understanding of the role of the Bank, we introduced an outreach programme which involves regular interaction with various stakeholder groups including political parties, trade unions, business groupings, different sectors of the economy and civil society. The Governors and senior staff speak at various forums and universities. Numerous meetings and interactions with investors, both domestic and foreign, take place on a continuous basis. We try to be as accessible as far as is reasonably possible, but at the same time ensuring an appropriate black-out period before MPC meetings. As part of our outreach programme we convene an economists’ round table on alternate months to the MPC, where economists and analysts from various sectors are invited to discuss topical issues with the Governors and other senior staff of the Bank. The aim of this outreach is not to preach or to take instructions. It is an interactive process of sharing information and ideas. We do not always agree. But we have found that the process has increased knowledge, mutual understanding and respect. Furthermore, in conjunction with the release of the Bank’s Monetary Policy Review we arrange a series of Monetary Policy Forums in 10 venues around the country, and each MPF is attended by at least one member of the MPC. This gives stakeholders and the general public the opportunity to interact with policy-makers. The issue of communicating monetary policy and in particular the future monetary policy stance is perhaps more contentious. The modern view is that central banks should not surprise the markets, but should rather guide them. This then implies more predictability which requires transparency and greater emphasis on communication. Improved and more open communication with respect to monetary policy has therefore been one of the main thrusts of central banking reform in the past two decades. Innovations in transparency and communications at the Bank include the MPC statement issued at a press conference after each MPC meeting; the publication of the Bank’s forecasting model; and publication of the Bank’s forecasts for inflation and GDP growth. Furthermore the Monetary Policy Review (MPR), which is published twice a year, gives a more in-depth guide to our thinking about monetary policy. More recently we have been giving the market more guidance as to how we view the risks to our forecasts. A number of independent academic studies have confirmed the increased predictability of monetary policy in South Africa. A study by Janine Aron and John Muellbauer at Oxford University shows that BIS central bankers’ speeches the forward rate agreements (FRAs) have anticipated repo rate changes well since the introduction of inflation targeting. More recently Monique Reid and Stan du Plessis at Stellenbosch University have shown that the MPC has succeeded in signaling its likely future policy decisions with consistency over the inflation targeting period. Explaining our actions is a central part of our communications. Again, this is a break with the traditional past, as illustrated in the earlier quote by Brunner. In a similar vein, Ahamed describes how Montagu Norman, governor of the Bank of England between 1920 and 1944, when asked by a parliamentary committee what his reasons for a particular policy were, tapped the side of his nose three times and said: “Reasons, Mr Chairman? I don’t have reasons. I have instincts”. In today’s world of central banking and monetary policy making, reasons are critical as they guide markets as to the thinking of the policy makers. Sound policy-making cannot be subject to ad-hockery. To be sure, subjective judgment comes into any decision-making involving forward-looking analysis, but it has to be backed up with sound and consistent theoretical basis or logic. While it is generally accepted that transparency is the way to go, there is less agreement about the limits to transparency and there will be disagreements over where to draw the line. One area where there has been a radical departure in communication by some central banks has been the guidance given with respect to the future path of interest rates. This has become a contentious issue and at this stage there is no generalised agreement as to “best practice”. Some central banks reveal a bias in their thinking about future interest rates or the balance of risks with respect to their forecasts. Broadly speaking, an upside risk to an inflation forecast which is already close to the upper end of the target range could reflect a higher probability that the next interest rate move would be up, although it does not reveal anything about the timing, the extent or the path over the forecast period. An upside risk however could also mean that a possible rate cut could be delayed. We have moved in the direction of revealing our risk perceptions, and recent MPC statements have indicated how the MPC views the balance of risks to inflation and growth forecasts. A different approach is taken by central banks in New Zealand, Norway and Sweden, where the expected path of official interest rates is revealed. This is an extreme form of transparency, but the jury is still out as to how helpful this actually is. Initially the skepticism around this approach related to the risk that market participants and the general public would interpret this as an unconditional commitment to act in the way specified. To date, this does not appear to have been a problem in these countries, despite the fact that these forecasted future paths change frequently. That they change frequently should not be a surprise: any future path would be conditional on the current circumstances remaining the same, and as we know, things do not remain the same, particularly in the current crisis environment that we find ourselves in. The eminent monetary economist Charles Goodhart argues that it is not so much the understanding of the conditional nature of the forecasts but more their usefulness, as a lot depends on the relative accuracy of these forecasts. As he argued in a recent Financial Times article: “If official predictions contain additional information beyond that already implied by market forecasts of the term structure of short-term interest rates, then well and good. If not, then all central banks are doing is exposing that they are as clueless about the future as the rest of us”. Similarly, Otmar Issing, a former Executive Board member of the ECB, has recently argued that in the context of the financial crisis and the subsequent elevated uncertainty about the impact of the crisis on potential growth, it is difficult to see how signaling the future path of interest rates based on such “shaky ground” can reduce uncertainty and guide expectations. Research undertaken by Goodhart shows that in the short run i.e. over the next three months, and to a lesser extent over the subsequent quarter, the central bank may have inside information about its own future actions. But beyond that, he argues, the extra informational content of central bank forecasts is zero, and that pressures to push central BIS central bankers’ speeches banks in the direction of publishing their interest rate forecasts are, in his view, “retrograde”. He argues further that the move by the FOMC to publish individual (but not attributed) views of when interest rates should change reveal such wide divergences as to be unhelpful. The reality is that the further we go into the future, the less confident we can be about our future actions. I do not know what the world will look like in a years’ time. It follows that I cannot be certain what the domestic economy and therefore domestic interest rates will be. I could give you my best guess, or a forecast based on all available information and reasonable assumptions, but this is likely to be wrong. Monetary policy operates in an uncertain environment all the time. We are constrained by the unknown, in the same way that the rest of the market is, and unfortunately central bankers are not bestowed with superior foresight. Yet we take decisions looking into this unknown future, while trying to see through the prevailing noise and uncertainties. And in acting in this way we also influence, however slightly, that future. At best, as Goodhart suggests, central banks can focus on a range of possible outcomes (not focus on point forecasts), on potentially varying scenarios and on the need for flexibility, not pre-commitment, to respond as the unknowable future unfolds. We are treading carefully in this respect, as signaling is difficult because of its conditional nature. However there have been times when we have given direction. For example, at the time of the May MPC meeting, the market appeared to be focused on the timing of the next interest rate increase, and we felt it was important to signal that the risks to the interest rate outlook were not only on the upside, and that should the global environment deteriorate significantly, the MPC would be prepared to respond by reducing the policy rate. Hence our statement that the MPC stood ready to move in either direction, as appropriate. In other words we were communicating that should inflation move out of the target range on a sustained basis, the MPC would be prepared to tighten policy, but in the event of a severe global downturn, monetary policy could in fact be eased. Judging by the response of the FRAs at that time to our signal, it seems that we were heard. The FRAs declined and reflected a high probability that the repo rate would be reduced before the end of the year, but expected the rate cut to come later. But it is again important to stress that this was not a commitment to lower interest rates. Rather, it was a signal that should the circumstances arise, we would be prepared to act. The reason for the signal was that we believed that the probability of this scenario unfolding was not negligible. And our concerns about the global economy were expressed strongly in our statement. At the subsequent meeting, we felt that the inflation and growth dynamics had changed sufficiently to justify further monetary accommodation. Since then, there has been much speculation as to whether the interest rate reduction was the beginning of a new interest rate cycle or whether this was a one-off move. At the beginning of an interest rate cycle, it is easy to forecast and signal the direction and timing of the next move. But the turning points are always more difficult to call. We view the recent move as part of the easing cycle that began in the wake of the crisis. We had previously thought that we were at the bottom of the interest rate cycle, but events unfolded in an unexpected way. Further easing, however, cannot be taken for granted and will be contingent on changing global conditions, further inflation and growth developments. I should emphasise that it is also important for the markets to pick up the signals from the changing fundamentals in the economy. If the fundamentals or circumstances change all of a sudden, this may lead to a change in policy. But our reaction should only be a surprise to the market if the market has not interpreted correctly how the initial surprise will impact on Bank thinking. Of course, if we act in an inconsistent way, then we would create further uncertainty. That would not be our intention. But there may be times when our signals may have been misinterpreted, and it may then be necessary to correct that misconception. The central bank must have credibility and act in a consistent manner in response to various shocks, as far as is possible. And part of successful communication would be that markets, analysts and BIS central bankers’ speeches yourselves would expect us to respond to significantly changed circumstances, and would not be surprised when we did so. However, central bank communication is not the only source contributing to market expectations of monetary policy. Hervé Hannoun of the Bank for International Settlements, for example, has argued that large global financial institutions, through their research and analyses to clients and to the media, also influence public and market expectations of monetary policy, to the extent that they could be trying to influence or lead central bank thinking. In some instances it could be argued that their interpretation of what central banks are saying becomes more important than what central banks are actually saying. It is therefore important that central banks retain their independence from the markets. We must hear what the markets are saying, and communicate with the markets, but in the end we need to do what we think is right, irrespective of what the market thinks, and not slavishly follow the market. After all, the “market view” is an outcome of often widely differing views. Central banks are institutions that must act in the interests of the country as a whole, and they are able to do so precisely because they do not have a profit motive. We should also bear in mind that our communication is not only with the market but with society as a whole. The “person on the street” is directly or indirectly affected by what the Bank does, and is therefore also interested in what it says and does. Here the role of the press is critical, not only for reporting directly what we have said, but also for interpretation, as the interpretation given by the press can become the conventional wisdom. To contribute to journalistic excellence and a deeper understanding of economic and monetary policy the Bank has, for a number of years, sponsored the training of financial journalists at Rhodes University and the University of the Witwatersrand. We need to have an informed public in the sense that they should have a good idea of what to expect from central banks, and not to raise expectations of what a central bank cannot in fact do. Unfortunately, as I noted earlier, during the crisis the pressures on central banks have multiplied, as have the expectations. George Akerlof and Robert Shiller, in their book Animal Spirits, identified five psychological factors that were important to understand animal spirits which, they argue, drive almost everything and are more than just confidence as measured by confidence indicators. They argue “that declining animal spirits are the principal reason for the recent severe economic crisis …” and see no clear indication that these spirits are yet revived. The news media are singularly lacking in any explanation for the recent resurgence of the world economy beyond the improvement in the leading indicators, such as stock market prices and retail sales numbers … “The five psychological factors are confidence, fairness, corruption and bad faith, money illusion and stories … (and) that human interest stories give vitality and emotional resonance to economic views that drive animal spirits …” They use the example of the US TV show, The Apprentice, and how this story spread rapidly all over the world through local remakes during a time of economic expansion, with the substitution of a local tycoon or personality – as for instance in South Africa where this role was filled by Tokyo Sexwale. They go on to ask: “With such contagion around the world, during the boom, of such a motivational TV story, is there any reason to doubt that the contagion of stories has economic significance, or that there could be worldwide fluctuations in animal spirits? … The stories people tell are also stories about how the economy behaves …” When we consider the above example of The Apprentice, what is not reflected is the question of power relations, how the power of the media is used to give voice to certain views, how this reinforces or reflects power relations in society. In The Apprentice what is also conveyed is the authority of the tycoon, and how the “boss” behaves: it conveys the power relations very clearly in the pay off line “You’re fired!” The voice that is aired also determines the parameters of the debate, so we need to ask: where is the voice of the powerless? And what BIS central bankers’ speeches lessons about voice, power relations and responsibility have been learned from The Apprentice and the appalling revelations of the News of the World/Murdoch inquiry? Therefore in conclusion before an audience of media professionals, is it not appropriate for each of us to ask ourselves: what is the story we tell, whose story do we tell, how do we convey the news, how do we impart information, what role do we play in creating an informed and knowledgeable citizenry, and how do we ensure that it is not our own goals and objectives that we project on a society hungry for information and a greater understanding of what is really going on. Finally, to remind all present that later this year the Bank is introducing a new bank note, which has the image of Nelson Mandela on the front of all denominations, while the big five animal theme has been redesigned and retained for the reverse side of the notes. We will be conducting an extensive media campaign to ensure the South African public is aware of the new note, which will co-circulate with the current note, and is of equal value. We count on your support to help ensure an informed public, so that we protect the integrity of our currency. Thank you for inviting me tonight, and for enabling an ongoing conversation in the very challenging times we live in. References Ahamed, L. 2009. Lords of finance: the bankers who broke the world. Penguin Books. Akerlof, G. and R. Shiller. 2009. Animal Spirits: how human psychology drives the economy, and why it matters for global capitalism. Princeton University Press. Aron, J. and J. Muellbauer. 2009. The development of transparent and effective monetary and exchange rate policy. In South African economic policy under democracy, ed. J. Aron, B. Kahn and G. Kingdon, Oxford University Press. Blinder, A. 2004. The quiet revolution: central banking goes modern. Yale University Press. Fromm, E. 1976. To have or to be? Harper and Row. Goodhart, C. 2012. Longer term forecasts are a step backwards. Financial Times, 1 February. Hannoun, H. 2012. Monetary policy in the crisis: testing the limits of monetary policy. Speech to the 47th SEACEN Governors’ Conference, Seoul, 13–14 February, Bank for International Settlements. Issing, O. 2012. Central banks – paradise lost. CFS Working Paper No.2012/06, Centre for Financial Studies. Reid, M. and S. du Plessis. (2010). Loud and clear? Can we hear when the Reserve Bank speaks? South African Journal of Economics 78(3). BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the ORT SA Fundraising Dinner, Sandton, 31 July 2012.
Gill Marcus: Headwinds from the global crisis – the need for proactive responses Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the ORT SA Fundraising Dinner, Sandton, 31 July 2012. * * * This evening is a celebration of the work that ORT does in promoting education and training in South Africa. The focus could not be more appropriate: education and training is key to giving each and every South African a real chance in life, the ability to break cycles of poverty, and is an imperative for long term economic growth in this country, which faces huge legacy challenges in the education system. Sadly, despite significant resources being allocated to education, many parts of the system remain dysfunctional. A literate and skilled labour force is necessary to ensure domestic growth, employment opportunities, social stability and cohesion, and the ability to compete globally. Unfortunately the global environment in which we find ourselves is extremely difficult and is likely to remain so for a good number of years. The challenges facing Europe are of a long term nature, so even if appropriate steps are taken at this stage to deal with some of the issues that are making the headlines, the best case scenario will still be one of slow growth for some time to come before the required structural reforms can take place and take effect. This is supposed to be a light-hearted evening where we can relax, share jokes and enjoy ourselves. Unfortunately, we cannot ignore what is happening in the world around us, recognising that behind the numbers, often in the hundreds of billions, that are frequently referred to stand tens of millions of people whose lives, hopes and dreams have been altered forever. Central bankers have the reputation of being the party poopers, the ones who take away the punch bowl as the party really gets started, as our function is often to guard against excesses of various kinds. Tonight my role will be no different. We are living through extremely challenging times, and unless we recognise the gravity of the situation, we will not take the required steps in time to create a buffer against the risks that we face. At the root of the problem is the global economy, but underlying problems and the structure of our own economy and society will shape how the global downturn will impact on us. The recent data coming out of the world economy makes depressing reading. In the last two weeks or so alone we learned the following: the UK economy contracted by 0,7 per cent in the second quarter (an annualised rate of –2,8 per cent), far more than expected, and remains in recession; the US economy grew at an annualised rate of 1,5 per cent in the second quarter, about half its potential growth rate, and is in danger of falling over its selfinduced fiscal cliff; German business confidence declined for the third successive month, far more than expected, to its lowest level in two years; Eurozone business declined to a three year low in July, while almost half of the members countries are experiencing negative growth; unemployment in the Eurozone reached new euro-era highs at 11,1 per cent in May, with youth unemployment in excess of 22 per cent; spreads on Spanish and Italian sovereign debt have reached new and unsustainable highs; the global PMI is now indicating a global contraction; and systemically important emerging markets, until recently the main ray of hope in a dismal world, are also slowing markedly, particularly China, India and Brazil. The litany is almost endless. If you were hoping for some countervailing good news, it has been hard to find. Perhaps we can point to remarks by the ECB Chairman, Mario Draghi, that the ECB would “do what it takes” to safeguard the euro generated a relief rally in global financial markets late last week. But we would be fooling ourselves if we think that the problems are over. Verbal intervention by central banks can have an impact, but the sustainability of these effects will be dependent BIS central bankers’ speeches on evidence that their words can be backed up with deeds. Until the substance of such assurances materialise, we are likely to see continued volatility as markets react to good news, more in hope than anything else, only to be disappointed and to revise their assessment soon after. The ECB is a central part of the solution, but it cannot act unilaterally to extend its mandate, and getting agreement on these issues at a political level is far more complex. Perhaps some other relatively good news is that the downward revisions in July by the International Monetary Fund (IMF) to its global growth forecasts were relatively modest- by 0,1 and 0,2 for this year and next year respectively. But we can take cold comfort from the size of the revision. Of concern is that the downside risks are seen to “loom large”, as the forecasts are predicated on a number of conditions, one of which seems unlikely to be met very soon: namely that “there is sufficient policy action to allow financial conditions in the euro area to ease ...” According to the IMF, the situation in the Eurozone will “likely remain precarious until all policy action needed for a resolution of the crisis has been taken”. There seems to be no near-term or easy solution in sight, as the problems are multifaceted, and there is no agreement within the euro area as to how to go forward. Indeed there is no agreement among economists either. And as the situation worsens, negative feedback loops intensify. The underlying problems involve three distinct but interrelated problems: a sovereign debt crisis, a systemic banking crisis and a growth crisis, which have combined in a way that has significantly increased unemployment. But while everyone will agree that there is a growth crisis, analysts differ as to the causes and therefore the cures for this. Much of the focus is on the fiscal side, with many seeing the solution being one of fiscal austerity all round. However, as Paul Krugman and Richard Layard have recently argued in their “manifesto for common sense”, the crisis did not originate in the public sector, but rather, expanding public sector deficits were a consequence of the bursting of the unsustainable private sector expenditure bubbles which then contributed to reductions in output and tax revenues. They argue that the crisis, which originated in the advanced economies, was fundamentally one of excessive private sector expenditure, driven by excessive borrowing and lending and over-leveraging by banks. When the bubble burst, the public sector had to fill the expenditure gap. With the private sector still deleveraging, fiscal austerity will only intensify the downward growth spiral. This can be clearly seen from the data of public sector deficits before and after the crisis. In 2007, the overall gross debt/GDP ratio of the euro area was 66,4 per cent. In 2011 it had risen to 87,4 per cent. If we look at some of the countries that have come under the spotlight recently, we see pre-crisis debt ratios at relatively modest levels in some cases, but accelerating significantly thereafter. For example in 2007 the Spanish debt ratio was 36,3 per cent but in 2011 had grown to 68,5 per cent; the debt ratio of Portugal increased from 68,3 per cent to 107,8 per cent; that of Ireland from 24,8 per cent to 108,2 per cent; that of Greece from 107,4 per cent to 165,3 per cent and the Italian ratio increased from 103,1 per cent to 120,1 per cent. These data illustrate three important points: first, that sovereign debt crises in some countries did not originate in the public sector; that debt ratios can accelerate very quickly from seemingly benign and sustainable levels; and that any given level of debt may be seen to be sustainable, but if the bond markets change their view on this, spreads rise to the extent that the costs of servicing these deficits can rapidly turn sustainable deficits into unsustainable ones. These debt ratios have increased because of widening current fiscal deficits in response to the crisis, and not necessarily because of previous excessively large deficits. For example, in 2007 Ireland and Spain had fiscal surpluses and the deficit/GDP ratio in Portugal and Italy were 3,1 per cent and 1,6 per cent respectively. Greece on the other hand already had a deficit of 6,5 per cent. BIS central bankers’ speeches At a time of continued private sector and bank deleveraging, excessively deep public sector austerity is likely to generate and reinforce negative growth and debt dynamics: as growth falls, the debt to GDP ratio increases, and if debt is reduced too fast, growth will fall even more. There is no doubt that some countries have excessive fiscal burdens and unsustainable fiscal positions. Those countries have to adjust, and take the pain, but a key question is over what time horizon. Nor does it mean that all countries should be following austerity measures. If they do, and the austerity measures proposed are excessive, it will only reinforce the global downturn. The pace of fiscal consolidation has to be more measured, and it is for governments and the central banks to ensure that their interventions keep the markets in check. As Krugman and Layard have argued, “at a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilising force, attempting to sustain spending. At the very least, we should not be making things worse with big cuts in government spending or big increases in tax rates on ordinary people”. This does not mean that governments should go on a spending spree. More focus should be placed on the efficiency of government expenditure, to ensure that it is of the type that is likely to generate growth, and not simply be an irreversible increase of social expenditure. Furthermore, expenditure that is likely to crowd in private sector investment would be even more appropriate. But the focus does not need to be only on expenditure. Tax reductions or tax incentives, appropriately focused on growth-generating activities, for example on small businesses, would have a similar effect. The sovereign debt crisis is intertwined with the banking crisis. Banks are major holders of sovereign debt, and they have seen the value of their holdings declining. At the same time, many banks had excessive exposures and leverage to the property market, particularly in Spain, and the property market bubble has since burst. In addition, the stricter global banking regulations, commonly referred to as Basel III, have imposed higher capital adequacy ratios on banks, and they are trying to achieve these by selling assets and reducing lending. The Spanish banking system in particular is under stress and requires a bail-out, which in turn will put further pressure on the Spanish fiscal position, as was the case in Ireland. One of the currently intractable issues in the Eurozone is whether the ECB can bail out these banks directly. Fiscal austerity and bank deleveraging, while contributing to the negative growth outlook in Europe, are not the only growth constraints. There is no doubt there is also a structural element to the Eurozone crisis, in part a result of very different structural features in the member states. After unification, the German economy underwent an extended period of restructuring. The economy became more efficient, more productive and competitive, particularly relative to many of its Eurozone partners. In the face of labour and product market inflexibility and higher wage growth in many of these countries, current account deficits were widening and were readily financed at low Eurozone rates of interest, given the prevailing assumption that all euro area sovereign bonds were the same. As we have seen, this assumption no longer holds, but the divergences in competitiveness remain. It has been estimated that most of the peripheral European economies have lost competitiveness relative to Germany in the order of magnitude of between 20 to 30 per cent since the introduction of the euro. This is a longer term structural issue that is likely to take a while to reverse. But it is debatable whether the required increases in productivity, with associated significant wage and price declines and increased unemployment can occur without causing major social upheaval and this at a time when government safety nets are being cut back on. The adjustment will be that much more severe given the lack of an exchange rate policy lever. An early resolution to the crisis is unlikely because there is a lack of trust at a number of levels. There is a lack of trust in the leadership of the Eurozone to take difficult decisions; there is a lack of trust between countries; there is a lack of trust of the banking system, and BIS central bankers’ speeches the recent revelations concerning Libor fixing and money laundering reinforce that lack of trust; and there is a lack of trust between banks, as evidenced in the dysfunctional nature of the interbank system in Europe. And as austerity measures bite ever deeper, there are limits to how much the electorate can take. Ultimately, the situation becomes increasingly economically and politically untenable. As the Eurozone crisis impacts increasingly on the rest of the world, it again raises the question that was asked at the beginning of the crisis: can the emerging market economies decouple from the advanced economies? While there seems to be little doubt that the centre of gravity of the global economy is shifting eastwards, and the Asian economies as a bloc may be better able to withstand a renewed global downturn given increased intraregional trade, a complete decoupling is unlikely. Already a number of institutions have downgraded their emerging market growth forecasts and we have seen slowdowns in Asia and Latin America, including China, India and Brazil. In 2010 Brazil recorded an annual growth rate of 7,5 per cent. In 2011 this had moderated to 2,7 per cent, and in the first two quarters of this year, annualised growth rates of 0,8 per cent were recorded. While Chinese growth of 7,6 per cent may seem extremely fast to us, we must bear in mind that it is significantly slower than the levels previously achieved, and further moderation is expected. A recent IMF Survey viewed the slowdown in China as having been initially self-induced, to correct overheating asset markets, but more recently is due to the effects of the global slowdown. The channels of contagion to emerging markets from the slowdown in the advanced economies are likely to be similar to those experienced in 2008. We have already seen declining emerging market exports and weaker commodity prices, although what happens in China will be an important determinant of the outlook for commodity prices. In general it will be difficult to sustain growth in many emerging markets, particularly those that are non-food commodity exporters, as well as those that have strong manufactured export markets in the advanced economies. There is also some evidence that tightness in bank lending in Europe may be impacting on the cost and availability of trade financing as well, putting further pressure on trade. Emerging markets are also being affected by the volatile risk perceptions in global financial markets and associated capital flows. In 2009/10, emerging markets were faced with strong capital inflows from advanced economies in search of yield. However, since the intensification of the Eurozone crisis in August 2011, the so-called risk-off scenarios have become dominant. During bouts of risk aversion, the overriding concern becomes security rather than yield, and investors are prepared to pay for such security as seen in the recent negative bond yields in Germany and the negative interest rates on bank accounts in Switzerland. As capital has moved to safe havens, a number of emerging market currencies, including those of Mexico and Brazil, have depreciated significantly. This will not provide a strong stimulus to export growth if the demand is not forthcoming, but may have inflationary consequences, which may limit monetary policy flexibility. For this reason some emerging market economies have intervened to prevent excessive depreciations. Increased intraregional trade has been an important contributor to the resilience of the Asian economies. The recent emergence of sub-Saharan Africa as a significant growth region, with growth rates in excess of 5 per cent in the past 3 years, has been instrumental in helping cushion South African exports from the global crisis. In 2007, 36 per cent of South Africa’s manufactured exports went to Europe, while 24 per cent went to Africa. In 2011, 29 per cent went to Europe and 34 per cent to Africa. Apart from direct trade, there has also been increased penetration of Africa by South African companies, particularly in the retail, construction and banking sectors, facilitated in part by more generous exchange control allowances for investment into the continent. Some of the reasons for the recent resilience of regional growth, highlighted by the IMF, include the fact that financial systems in Africa are relatively insulated from global financial developments with banks obtaining funds from domestic deposit bases rather than external BIS central bankers’ speeches sources; increased infrastructural expenditure; improved macroeconomic policy frameworks during the 2000s; fiscal policies generally being supportive of growth since 2009, with average fiscal deficits increasing by three percentage points in that year, with some consolidation (about 0,5 percentage points) since then; variations in monetary policy stances, depending on inflationary pressures; and until recently, relatively strong commodity prices. However, although there is good news coming out of Africa, the continent will also be impacted by a global downturn, although as was the case in 2008/09, it may be relatively more insulated than other regions. But we cannot be complacent about it. Although growth in sub-Saharan Africa is faster than the global average, it is still lower than the pre-crisis level of around 6,5 per cent. According to the latest IMF Regional Economic Outlook (April 2012), growth in the region is expected to average 5,4 per cent in 2012 and 5,3 per cent in 2013. However, it is mainly the oil-exporting countries that are expected to have higher growth this year (7,1 per cent up from 6,0 per cent in 2011), as non-oil exporting middle income country growth is expected to decline from 4,3 per cent to 3,4 per cent in 2012, and low income countries more or less unchanged. Overall, the risks are seen to be on the downside due to global developments and their possible impact on commodity prices. Natural resources and commodity exports remain the main growth driver for sub-Saharan Africa, and the region is therefore vulnerable to the global downturn through this channel. The recent increase in global food prices should, however, benefit African food exporters. Just under half of the 45 countries in sub-Saharan Africa are viewed as significant exporters of natural resources, and most of the remainder are dependent on agricultural commodity exports. About half of the region’s exports are non-renewable natural resources, but seven countries are oil exporters and account for more than half the natural resource exports. Thirteen others have at least a quarter of their export proceeds coming from mining. Resource exports as a percent of non-resource GDP is 110 per cent in Angola; 68 per cent in DR Congo; 116 per cent in Gabon; 54 per cent in Nigeria; 38 per cent in Botswana; 52 per cent in Zambia and 8,6 per cent in South Africa. The impact of the global downturn on South Africa is already evident. Growth has been below potential and moderating, with a progressive downward revision of growth forecasts. In the middle of 2011, the Bank was forecasting a growth rate of 3,9 per cent for 2012 and 4,4 per cent for 2013. The most recent forecasts now show forecasts of 2,7 per cent and 3,8 per cent for these two years, and the MPC viewed the risks to these forecasts to be on the downside. The value of merchandise exports contracted by 2,4 per cent in the first quarter of 2012and the terms of trade have deteriorated for two consecutive quarters. The resulting current account deficit contributed to a weakening of the exchange rate. Capital flows have been highly volatile in response to changing global investor risk perceptions which in turn have impacted on the exchange rate. Since August 2011, the exchange rate has depreciated by around 23 per cent against the US dollar, and the volatility has increased. Employment growth has been positive but sluggish, and we have yet to get back to pre-crisis employment levels. Growth has been driven primarily by consumption expenditure, but even this is expected to moderate, as seen in the sharp decline in the FNB/BER consumer confidence index in the second quarter. Investment expenditure has also lagged. There appeared to be a steady recovery during 2011, but private sector gross fixed capital formation grew by only 1,8 per cent in 2012. Fortunately some growth is being seen at the public sector level, but the private sector accounts for around 65 per cent of total fixed capital formation. In such an environment, South Africa’s policy options are constrained. However we cannot just sit back and hope that the world will somehow turn around. And when it does turn around, we should be well-positioned to take advantage of the improved situation. Macroeconomic policies can help to alleviate the cyclical elements of any possible downturn but both monetary and fiscal policies have less room for manoeuver than was the case in 2008. The recent monetary policy easing should be seen in the context of alleviating some BIS central bankers’ speeches of the strains in the economy, but we emphasised that monetary policy cannot solve the underlying problems of the economy, which will still exist even if the global economy recovers sooner than expected. We need to recognise the structural nature of the challenges facing the economy, and in addressing them we can reduce our vulnerability to global headwinds. These include addressing the structural nature of unemployment, and require concerted policy coordination across government departments, and between government, the private sector and civil society. It is not my role to provide a comprehensive plan for structural change in the economy but allow me to mention briefly what I think are a few of the top priorities. The continued focus on infrastructure is essential. This 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. Lack of infrastructure has been an impediment to the mining sector’s ability to get the ore to the ports, and capacity constraints at the ports are also well documented. Electricity supply remains a binding constraint on growth. While more capacity is being built, we need to ensure that further delays do not occur, and that planning for future capacity is not left till too late. Incentives need to be given to encourage the growth of small and medium enterprises, while competition policy should be enhanced to reduce the occurrence of monopolistic pricing and other anti-competitive pricing policies. We need to encourage regional trade and integration. The advantages of such diversification and expansion are obvious. But we must also heed the lessons of the Eurozone and not focus on monetary union. The focus should be on trade, investment and infrastructure. Finally, we come full circle from where we began earlier. Skills development and education are key. Although this is a long term issue where formal schooling is concerned, 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. This is particularly true at the provincial and local government level where we have seen how the lack of technical skills has impacted on the ability to achieve an adequate level of service delivery in many instances. None of this is new. All of this has been said before and by many people. The problems of the global economy should be the impetus for action. We need to find ways to minimise the negative impact of the prevailing crisis, and be ready to take advantage of the global recovery when it comes. As we emphasised in our recent monetary policy statement, a sustained increase in the potential output of the economy will require a concerted and coordinated effort from both government and the private sector. Policy consistency and coordination is essential if we are to achieve a growing economy and significantly reduce unemployment. All of you who are here tonight have significant spheres of influence and a role to play in building cohesion in our society. The future will be what we, all of us, make of it. Thank you for inviting me to be here with you this evening, and congratulations to all of you who ensure that ORT touches and changes the lives of so many people. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Noah Gala fund-raising dinner, Sandton, 21 August 2012.
Gill Marcus: South Africa’s challenges at a difficult time for the global and domestic economy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Noah Gala fund-raising dinner, Sandton, 21 August 2012. * * * Distinguished Guests, thank you for the invitation to address you this evening. The work that Noah does with orphans in our disadvantaged communities is admirable, and it is heartening to see the support that the organisation receives from the private sector at a very difficult time for our economy. It is estimated that the HIV/AIDS pandemic will leave more than 5 million children orphaned by 2015, which will add to the demands on the public sector and private sector organisations such as Noah. Helping to ensure a positive present and future for these children is not just a question of money. To achieve the aims and vision of Noah requires dedication and commitment to train and build capacity to foster stronger communities capable of caring and providing for children, whether these children have been orphaned by AIDS or any other cause. Noah’s basic message is that every child must be allowed the possibility to dream and you provide that hope for the children and their communities. It was stated in the Noah Annual Report 2012 “Looking ahead” that “the key to success lies in a collective effort”. That “government … has laid a foundation for change (through) grants and payments for caregivers that make the Noah approach sustainable” and that “getting to all needy children is the problem”. While there is much negative comment about government policies, it is important to recognise that at the core of health care there has been a critical shift that holds the potential to improve collaboration across all sectors involved in primary care, and to reach the adults and children who are presently underserved or excluded. When considering Community Oriented Primary Care I am aware that the ideas are very familiar to many of you in your practice. What is exciting is that they are now being integrated through the National Department of Health into the health care system. I will return to this in some detail later on. Noah is undertaking this work at an extremely difficult time for the global and domestic economy. Let me first deal with the advanced economies, particularly the Eurozone and the United States. The crisis in the advanced economies persists, despite the temporary breather that global financial markets appear to be taking in the past few days. However, on the ground, growth outcomes and prospects have been deteriorating. Growth in the Eurozone was negative in the second quarter, having contracted by 0,4 per cent, and eight of the 17 members experienced negative growth. The engine of growth of the region, Germany, barely managed to register positive growth, and the short term indicators are not promising. The UK remains in recession, growth in Japan declined sharply to 0,3 per cent in the second quarter, and the prospect of a sharp fiscal cutback in the US early next year remains a dark cloud over the already slowing economy. To illustrate the depth of the very complex problems faced, Greece, which is at the forefront of the unfolding tragedy, is expected to have negative growth of some 6 per cent for 2012, with its GDP expected to have shrunk by around 20 per cent over the three-year period 2010–2012. Growth in the larger systemically important economies, notably China, India and Brazil, is also moderating under the strain of declining exports, illustrating the interdependent nature of the global economy. Behind the growth numbers are the millions of people who have lost their jobs and their dreams. The unemployment rate in the Eurozone has now risen to 11,2 per cent, and youth unemployment to 22,4 per cent. This places enormous stress on the fabric of society which not only struggles to provide for those such as AIDS orphans, but now needs to deal with the demands of a growing number of people around the world who previously had jobs and BIS central bankers’ speeches aspirations, many of them with skills and education, and who now find themselves in a situation where the chance of finding employment diminishes by the day. The demands on governments multiply under such circumstances, at a time when excessive fiscal austerity is the order of the day in the advanced economies, with large cutbacks in government spending and provision of basic social services. Unless governments can get growth going again, social and political disaffection is likely to spread, as we have already seen in a number of countries in Europe. But not all of the challenges facing us are man-made. While growth in the developing economies is more positive, the global economy and developing economies in particular are facing new danger, and that is the sudden emergence of a possible food crisis which can only exacerbate the fragile social situation in many countries. The past few weeks have seen significant increases in several agricultural commodity futures prices, including grains, soya beans and cattle. Since the beginning of June, futures prices of maize and wheat traded on the Chicago Board of Trade (CBOT) have increased by around 60 per cent and 40 per cent respectively, and these increases are already having a global impact. On the South African Futures Exchange (SAFEX), for example, futures prices of wheat have increased by 20 per cent, and those of maize by 30 per cent since the beginning of June. The main cause of these price increases has been severe drought conditions in the United States in particular, which is said to be facing its worst drought in 56 years, with 88 per cent of the maize crop facing these conditions, and parallels are being drawn with the “dust bowl” episode in the 1930s. Similar conditions are being faced by the soya bean crop in the US, and much of the damage to the crops has already been done. This outcome, and its severity, was quite unexpected, which illustrates our vulnerability to global weather shocks. As recently as June, the UN’s Food and Agriculture Organisation (FAO) was predicting an improved outlook for world cereal production in 2012, based on expectations of a much bigger maize crop in the United States. Furthermore, mild weather had led to early plantings of maize in the US which is now making the crop even more vulnerable to drought damage. While the US drought is the main factor behind these latest agricultural price developments, other food producing regions are also experiencing adverse weather conditions. The Black Sea region, which is a major wheat producing area, has reported dramatically reduced crop yields; the monsoon in India has been below average; and the development of an El Nino pattern in the South Pacific is raising fears of crop damage later in the year in India, China, South-East Asia and Australia. The food riots that were seen in a number of developing countries around the world at the time of the global food price spike in 2008 are a stark reminder and warning of how the current food crisis could unfold. A lot will depend on how sustained the adverse weather will be in various countries, particularly in the United States and India, but there is no doubt that as countries begin to restrict food exports, the potential is there for these developments to spread beyond one of food affordability to one of food availability. As food prices increase, diets deteriorate, malnutrition spreads and demands on public health services increase further. The South African economy therefore finds itself in an extremely challenging environment, with the domestic economic growth outlook being dependent to an important degree on external developments. Given that the negative global growth outlook is likely to persist for some time, and we need to be mindful that the prevailing financial crisis has already lasted five years, with no end in sight, the challenges facing the domestic economy are daunting. But not all of our problems can be ascribed to these global factors. There are numerous underlying structural problems in the economy which are exacerbated, but not necessarily caused, by these global developments. In line with the weak and deteriorating global outlook, the Bank has been progressively downgrading its economic growth forecasts over the past year. Growth in 2012 is expected to average around 2,7 per cent, down from 3,1 per cent in 2011. The most recent forecast for BIS central bankers’ speeches 2013 is a growth rate of 3,8 per cent, but the risks are seen to be on the downside. According to Reuters, the market consensus forecast for 2013 is 3,3 per cent. Growth rates of this order of magnitude will not have an appreciable impact on South Africa’s unemployment rate which currently stands at 24,9 per cent. It is instructive that during the high growth years between 2004–2007, when growth averaged around 5 per cent, unemployment declined to 21,9 per cent but this was quickly reversed following the crisisinduced recession in 2009. So if these patterns are to be repeated, we would need a number of years of significantly higher growth than we are currently expecting simply to get back to pre-crisis levels of unemployment. However, the sustainable growth rate itself is constrained by the potential output of the economy, which, in turn, is determined by capacity and other structural constraints. At a simple level that implies that if we have unemployed resources or spare capacity in the economy, output can be increased in a non-inflationary manner. Research done in the Bank prior to the crisis showed that the potential output growth of the economy was between 4 and 4,5 per cent. Since the crisis, that has declined to around 3,5 per cent. This decline may have been due in part to some destruction of capacity and we also now know that growth will be constrained by the lack of adequate electricity provision until sometime next year at the earliest. I should note that this does not imply that a growth rate in excess of 3,5 per cent would necessarily be inflationary. Currently the economy still has a negative output gap, which we estimate to be around 3,5 per cent, which is indicative of excess capacity in the economy. This means that the economy should be able to grow at rates in excess of potential without creating inflationary pressure until that output gap is closed. South Africa’s patterns of employment strongly suggest that the unemployment rate is not simply cyclical in nature, and is in fact structural. Even if we manage to grow at higher levels, it will be difficult to absorb such vast numbers of unemployed, especially in the short to medium term. In other words the natural rate of unemployment in South Africa appears to be in excess of 20 per cent, and significant structural changes will be required in order to make inroads into this. The structural nature of South Africa’s unemployment and the structural constraints to growth are recognised in the various growth plans that have been published by government, the most recent being that of the National Planning Commission. It is generally accepted by growth theorists that sustained growth and structural change go hand in hand. So the challenges are to close the output gap by getting growth to increase to be in line with potential, and to increase the potential output itself. Monetary policy can help with the former, but it cannot increase the potential output of the economy. This requires structural change, which includes a focus on investment and infrastructure spending to unclog some of the blockages in the economy. Since the crisis, what growth we have had has been mainly driven by consumption expenditure. However, sustainable economic growth needs to be driven by investment. A reliance on consumption as a driver of growth is neither sustainable nor desirable: it implies a lack of savings and a build-up of imbalances, notably unsustainable and widening current account deficits. While the favourable pre-crisis growth rates were driven in part by strong consumption expenditure, they were also reinforced by strong growth in investment expenditure. Between 2003 and 2008, growth in fixed capital formation accelerated and averaged in excess of 12 per cent per annum. The ratio to GDP averaged around 20 per cent and peaked at 24,6 per cent in the final quarter of 2008. This compares favourably with the average of around 15,5 per cent of GDP in the previous 10 years. Not surprisingly, investment expenditure was one of the casualties of the crisis, and has still not recovered fully. This is part of the explanation as to why South Africa’s growth rates have lagged those of its peers. Investment expenditure contracted in both 2009 and 2010, but recovered somewhat in 2011 when it grew by 4,4 per cent. However, in the first quarter of 2012, while public corporation and general government fixed capital formation grew by BIS central bankers’ speeches 13,1 per cent and 9,3 per cent respectively, that of the private sector grew by a mere 1,8 per cent. This is a major source of concern should this trend continue, as private sector investment accounts for around 65 per cent of total fixed capital formation in the economy. The lagging private sector investment is consistent with the recent decline in business confidence that has been evident in the various indices. As a ratio to GDP, gross fixed capital formation had declined to 18,9 per cent in the first quarter of 2012. As a proportion of GDP, government and public sector investment now averages around 8 per cent, compared with 4,4 per cent between 1994 and 2007. To achieve the desirable growth rate of 6 per cent will require an investment ratio of around 25 per cent. We are far from this and therefore require much higher rates of growth of investment from both the public and private sector over the next few years. To finance this in a sustainable manner will require more domestic savings, in other words a sacrifice of current consumption for higher future growth and employment. While there are various and conflicting views on the role of government in the economy and in promoting growth, most people agree that an important job of government is to facilitate growth and investment by creating a positive investment environment as well as investing in infrastructure which enables growth directly and indirectly by freeing up logistical bottlenecks in the economy. But as important, if not more so, is investment in human capital, through provision of education and access to basic services, which has a growth support and a distributional element as well. This form of support includes the provision of public health. So let me turn to the matter of Community-Oriented Primary Care or COPC, which I have become aware of and wish to share as an example of what can and is being done. In 2010 the Minister of Health, Dr Aaron Motsoaledi, initiated a proactive household and communityfocused approach to promote healthy living, prevent, detect and treat disease early, and to manage, rehabilitate and palliate the ill. COPC in Tshwane District, for example, is being implemented and is designed around health posts. These are structures that are physically located in communities, with are health care practitioner teams, initially comprising professional nurses and community health workers. As teams, their responsibility is to interact in a proactive way with every household – as a collective as well as with individual members – in their jurisdiction. Their role is to promote health, prevent disease and detect disease early, and support treatment, rehabilitation and palliation; and to do this in a way that both develops capacity and shared responsibility for health care between service providers and service users. Since 2010, Community Oriented Primary Care has been implemented in Tshwane in nine ward-based sites built on a partnership between the University of Pretoria (Family Medicine), the Department of Health and FPD (Foundation for Professional Development) in collaboration with private sector companies especially IT, health care providers and NPOs. The initiative involves inter-disciplinary and inter-professional practice. Schools and local NGOs are used as the premises for health posts and professional nurses head these PHC outreach teams and provide clinical and mentoring support. These health posts work very closely with health facilities within the geographic area and former home-based care givers are being trained to provide door-to-door services with each community health care worker being assigned 200 households. Households are registered using mobile phone technology, giving the care workers a more accurate way to capture data and focus interventions. The GeoMed system currently registers households and has 8 modules to assess the health status of each family member. To date 14 745 households have been visited and registered and about 40,000 individuals have completed a health status assessment. Health posts have begun interventions, especially around TB and immediate health care needs. Fourth-year medical and other University of Pretoria students are attached to health posts, thereby learning on site and providing much-needed services, while community health workers are being trained on site and in a continuous way. BIS central bankers’ speeches In this way the five principles that guide COPC, namely local situational analysis, comprehensive care, equity, practice with science, and service integration around users, are being given effect, building communities and partnerships, and making a real difference to people’s lives. This is an example of how, working together, we can make a real difference to the lives of our people and communities. To get things done we need to work together, and this requires trust and confidence which is essential for building a healthy and equitable society. This evening you have all taken time out of your busy schedules to come here and contribute to Noah, an important initiative and example of the generosity of spirit and willingness to give both financially and personal time: one of the hallmarks of many South Africans. Noah’s mission, values and objectives are helping build a resilient and resourceful society, which takes responsibility for those who are vulnerable, brings hope and a supportive environment. The character and strength of our democracy will be forged by, among other things, how we care for those who are vulnerable. Noah is an example of such commitment and care. Thank you for inviting me to join you this evening, and I wish you well in the challenging times ahead. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the launch of the communications campaign for the Mandela banknote series, Pretoria, 5 September 2012.
Gill Marcus: South Africa’s new banknotes Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the launch of the communications campaign for the Mandela banknote series, Pretoria, 5 September 2012. * * * Good morning and thank you for being with us today. I know a number of you have travelled from abroad to be here, and we appreciate your attendance and participation. Today is a momentous occasion. The South African Reserve Bank is launching a communication campaign to showcase the country’s new banknote series and to inform the public about the unique features of South Africa’s new banknotes. The front of the new banknotes feature the image of South Africa’s first democratically elected President, Nelson Mandela. The reverse side of each denomination features an image of one of the “big five” animals. The new notes have the same denominations, sizes and colours as the existing series, which was adopted twenty years ago. The design and production of this new series of banknotes has been a long but exciting journey for the Reserve Bank and our key partners in the public and private sectors. A country’s currency is a fundamental component of its national identity. It should be a reflection of its culture and heritage. South Africa’s banknotes have reflected aspects of its culture and heritage since the inception of the South African rand in 1961. In earlier days, South African banknotes featured such diverse images as that of Jan van Riebeeck, and later the “Big Five”. What will surely become known as the “Mandela banknote series” reflects South Africa’s pride as a nation and pays tribute to a much-loved world icon. To give a brief history of South African banknotes: About 230 years ago the Dutch Governor Joachim van Plettenberg first introduced paper money in the Cape. All the notes had to be handwritten because there was no printing press in the Cape. The money featured a government fiscal hand stamp that showed the value of the money and the authority date of the issue. It was only in 1803 that notes were printed, but they still bore the fiscal hand stamp. The early currency, including the rix dollar and stiver denominations, played a significant role in the early economic development of our country. South Africa later used the British pound sterling as its currency until 1961, when the rand was introduced. The “big five” theme was adopted after the unbanning of political parties and the release of political prisoners, reflecting what was considered as a design that would be acceptable to all South Africans. The currency was last upgraded in 2005 when enhanced security features on the “Big Five” banknote series were added. Internationally, it is regarded as best practice for central banks to upgrade the security features of their banknotes every six to eight years. This is to combat counterfeiting, which diminishes the value of real money, robs countries worldwide of billions of rand annually, and tarnishes the credibility of a currency, thereby impacting on the growth of that economy. One of the responsibilities of the South African Reserve Bank is to protect the value and integrity of the South African currency. Through this comprehensive communication campaign, we want to ensure that all our citizens and organisations familiarise themselves with the look and feel of the new banknotes, and reinforce the culture of knowing our money. I also want to emphasise that the current notes remain legal tender and are of equal value to the new note. So whether you have the existing R200 note or a R200 Mandela note, they are both worth the same. This is the launch of the communication campaign about the new banknotes, which we plan to introduce into circulation before the end of this year. The date on which these notes will be available and co-circulate with the current note for a while will be made public in due course. BIS central bankers’ speeches Before then, much remains to be done and the SARB Team is hard at work with many of you to make this happen in a seamless manner. I would like to thank all our partners: the cash industry, including commercial banks and cashin-transit companies; the retail sector; government departments; the Society for the Blind; and the Pan South African Language Board for their sound support and willingness to a play an important role in informing the broader South African public about the country’s new banknote series. We will now share with you the details and roll-out of the new banknote communication campaign. Through the campaign we hope to reach all South Africans and ensure that they are aware of the new banknotes and, more importantly, that they can recognise and become familiar with the key security features. 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 SWIFT Business Forum, Johannesburg, 6 September 2012.
Daniel Mminele: The importance and development of sound financial market infrastructures to position South Africa in SADC, BRICS and worldwide Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the SWIFT Business Forum, Johannesburg, 6 September 2012. * 1. * * Introduction Good afternoon ladies and gentlemen. It is a privilege to be here today and to participate in this SWIFT Business Forum. It is taking place at a special time, coinciding with the celebration of South Africa’s three decade long association with the SWIFT community. It is quite fitting then that today is also the first forum that focusses specifically on the South African financial community. I should also at the outset acknowledge SWIFT as a worldwide Financial Market Infrastructure which is extensively used in South Africa and also indicate that South Africa has recently joined the SWIFT Oversight arrangement headed by the National Bank of Belgium. The program looks to be one that should provoke a lot of discussion, particularly around South Africa’s role in international fora such as BRICS, and how we can best contribute towards and leverage off these relationships. 2. Why is BRICS important? In December 2010, it was announced that South Africa had been invited to become a full member of the BRIC group. In April 2011, South Africa joined the BRICS group at the third Summit in China. South Africa’s inclusion into BRICS was met with surprise by many, for a number of reasons, not least of which relates to the economics. It is true that South Africa’s economy is dwarfed by the other BRIC countries when measured in GDP purchasing power parity terms. South Africa’s unemployment rate is also much higher, while in terms of population, we are similarly much smaller. Had it been on the basis of economics alone, South Africa probably would not be part of BRICS today. Why then? South Africa is strategically important, boasts a relatively developed economy, deep and liquid financial markets, a well-regulated banking sector, strong institutions, democratic governing standards, and has the ability to influence the global agenda as a result of its participation in fora such as the G20 and the Basel Committee on Banking Supervision. South Africa is also systemically important in the African context. To quote from the 2012 New Delhi BRICS report, “With the most developed industrial and financial capabilities on the African continent, South Africa’s role in the integration of policies, markets, finance, and infrastructure is vital to Africa’s economic development and realization of the continent’s potential as a growth pole in the global economy. Outwardly oriented South African companies are among the largest sources of FDI in Africa and the country’s development financing institutions are playing an increasing role in the funding of regional infrastructure investment.” Therefore, our inclusion in BRICS has implications not just for South Africa but for the continent as a whole and adds a continent-wide dimension to BRICS, which lends it greater credibility and significance. Rather than being a mere “gate-crasher” at somebody’s party, South Africa has an important role to play and can add significant value to BRICS. Why is BRICS important? Globally, BRICS accounts for over 40 per cent of the world population, over a quarter of world GDP and 16 per cent of world export volumes. In the medium to long-term, the significance of BRICS countries on the global arena is expected to BIS central bankers’ speeches grow, and this presents immense opportunities for cooperation in a number of areas, including trade, infrastructure development and finance. The BRICS have identified a number of areas for cooperation. Among these is the proposed new BRICS Development Bank. A feasibility study is being conducted currently, and it is hoped that the creation of such a bank will help mobilise resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries. These efforts are to supplement the existing efforts of multilateral and regional financial institutions for global growth and development. A report back is expected by the fifth Summit to be held in South Africa in 2013. There are also ongoing discussions about the possibility of local currency swap agreements. We look forward to further developments with respect to BRICS, and the hosting of the fifth BRICS Summit in March next year provides South Africa with an opportunity to give strategic and directional input into various BRICS initiatives. 3. The importance of financial market infrastructure I will now turn to the topic of this forum, being the importance of financial market infrastructures. All of us sitting here today understand and appreciate the importance of sound financial market infrastructures. They play a critical role in the global financial system, often likened to the “plumbing of a building”, largely going unnoticed, until such time that there is a leak or a pipe bursts. A problem with the plumbing of the financial system can have severe repercussions for financial markets and the real economy. A disorderly failure in the financial market infrastructure can interrupt or impede the effective operation of markets, causing severe systemic disruptions and financial instability. Financial market infrastructures went largely unnoticed until the global financial crisis broke, and although they performed well through the crisis, it was only then that an appreciation was found for the true importance of such infrastructures, reflecting the fundamental role they play in ensuring financial stability. With this in mind, in April 2012, the Committee on Payment and Settlement Systems at the Bank for International Settlements (CPSS) and the International Organization of Securities Commissions (IOSCO) published new international standards for payment, clearing and settlement systems, including central counterparties. The main objectives of the new principles are to ensure a robust global financial market infrastructure, which if faced with the financial shocks of the magnitude experienced in 2007/2008, will continue to operate effectively. These new standards are tougher and are due to be adopted by CPSS and IOSCO members by the end of 2012. However, I note that the next session will be dealing specifically with this issue, insofar as it pertains to South Africa and our state of readiness, and so I will refrain from going into any further detail. 4. Financial market infrastructure developments in South Africa It is important to indicate at the outset that financial market infrastructures in both the payment and securities markets require a collaborative approach from all the stakeholders. Clearing and settlement processes in both these areas involve the interaction of various parties, including participants, infrastructure providers and regulatory authorities, who all have an important role to play. As early as 1993, discussions were initiated between the South African Reserve Bank (the Bank) and the banking industry to modernise and develop the domestic payment system. In this process, a strategic approach for the development of the payment system was adopted and meetings were held at different levels with various stakeholders, which culminated in the publication of the Framework and Strategy document for the National Payment System (commonly known as the “Blue Book”), in 1995. The Blue Book BIS central bankers’ speeches outlined various strategies envisioned for the payment system over the next ten years, leading up to 2005. The strategies addressed various aspects of payment system reform that had been identified, as well as the establishment of key pillars of the desired financial market infrastructures and appropriate supporting arrangements. One of the strategies, for example, relates to the establishment of a sound legal framework which culminated in the promulgation of the National Payment System (NPS) Act in October 1998. A review completed in 2003, revealed that all major payment system strategies that had been identified in the Blue Book had been achieved. The South African payment industry has matured immensely since the launch of the Blue Book and subsequently two additional vision documents with a shorter time horizon of five years, namely, Vision 2010 and Vision 2015, were established to guide the development of the payment system into the future. I would like to briefly sketch a broad outline of the payments industry in South Africa, before delving into the achievements made in the payment space since the introduction of the Blue Book. At the end of August 2012, there were 24 active settlement participants in the South African Multiple Options Settlement system (SAMOS). The bulk of settlement happens in the real time stream, which captures over 90 per cent of settlements, the remainder accounted for by the retail stream. The latter has experienced a significant increase in electronic funds transfer (EFT) credits over the years, increasing from 58 per cent of the retail stream in 2005 to 74 per cent in 2011. There has also been a substantial decline in cheque usage, given that this is a relatively expensive payment instrument and much more vulnerable to fraud. In volume terms, the bulk of purchases at retailers are in cash (5.3 billion), as compared to credit (360 million) and debit cards (460 million). In value terms, however, the difference is less stark, as cash accounts for R332 billion worth of purchases at retailers, and credit and debit cards accounting for R134 billion and R120 billion respectively. As at December 2011, there were a total of 24 063 automatic teller machines and 277 478 point of sale devices. If one looks at the number of cards in issue, debit cards are by far the most widely used, amounting to 42 million out of a total number of cards in issuance of 62 million. Credit cards in issue are just under 8 million and gifts or pre-paid cards being the next highest at 5.8 million. The growth in the credit card industry has been hit by the global financial crisis, largely owing to more stringent borrowing terms and shrinking credit limits. The use of mobile devices by banks’ clients, to access their accounts and to initiate/facilitate transactions, has also grown significantly over the past few years. These mobile devices include mobile phones and the various tablets available in the market today. There has also been a steady increase in the use of mobile phones to facilitate person to person payments/transfers. Since the launch of the Blue Book, numerous achievements have been made. On 9 March 1998, the South African Multiple Options Settlement (SAMOS) system was implemented. Since then various upgrades have taken place to ensure that the settlement system is well-functioning, safe and efficient. Thus far during 2012, the average value settled through SAMOS on a monthly basis equates to approximately R7.3 trillion. In October 2008, at the height of the global financial crisis following the collapse of Lehman Brothers, a record settlement of R8.5 trillion took place. The upgrades to the SAMOS system were undertaken in the interest of the financial system as a whole and in order to ensure South Africa’s continued participation in the global financial arena. Some of these include facilities that enabled the integration of the payment system and securities clearing and settlement system. This enabled the South African financial markets to conform to international best practice with the introduction of the delivery versus payment (DVP) principle, as well as various other liquidity saving mechanisms to make settlement more efficient. BIS central bankers’ speeches The low value Rand payment clearing systems have also evolved to current best practice and interfaces for these systems to the core SAMOS system have been established to ensure that settlement of all transactions is undertaken in central bank money and, as far as possible, the principle of same day settlement is achieved. As was mentioned earlier, the NPS Act was promulgated in October 1998. The Act provided the SARB with the mandate to oversee the payment system and several amendments have been effected over time where necessary. Clearing and settlement agreements and rules have also been implemented as part of the objective of creating a sound legal and regulatory framework. One of the most important achievements in the NPS was the inclusion of the South African rand in the Continuous Linked Settlement (CLS) system in 2004. CLS is a worldwide industry initiative implemented to reduce the risks associated with cross-currency transactions by settling the two legs of a foreign exchange (FX) transaction simultaneously in order to eliminate FX settlement risk. 1 Leading up to the Rand joining the CLS settlement system, the SARB issued a position paper late in 2002 supporting the inclusion of the rand as a settlement currency in the CLS system and encouraged South African registered banks to support this initiative in areas where their actions were required to enable this initiative. On 6 December 2004, CLS Bank International (CLS Bank) announced that four new currencies went live in the CLS system, one of them being the South African rand. At the time, this brought the number of currencies being settled through the CLS system at the end of 2004, to fifteen. This achievement ensured the integration of the domestic financial market infrastructure to the international system that enables our local participants to benefit from the risk reduction opportunities offered by the CLS system. We are aware that while none of the other BRICS countries have joined the CLS, they are currently in the process of joining the CLS system, although they are at different stages in the process. Such initiatives, when implemented, will provide a platform for transactions among the BRICS countries to be undertaken in a safe and efficient manner and will help facilitate the many initiatives underway in the BRICS and the achievement of our objectives. Another major project which is currently underway is the integration of the payment systems in the Southern African Development Community (SADC), so as to create a regional financial market infrastructure. The approach adopted in this process is to implement the desired infrastructure on a small scale, initially linking a few countries and thereafter rolling it out to more countries in a controlled manner. This will go a long way in facilitating trade within the region. International standards are adopted in this process to ensure that where appropriate in the future, the regional financial market infrastructure is enabled to integrate with other market infrastructures in other regions as well as internationally. It is envisaged that this infrastructure could be launched for testing as early as 2013. It is imperative that domestic financial market infrastructures are developed with due consideration of international standards and best practice. This will enable integration with those operated by other countries and/or regions and thus facilitate cross border trade. Financial market infrastructures should endeavour to meet the highest standards of security, availability and operational effectiveness in order to retain the confidence of its users. In this regard, reputational risk is key in maintaining a high level of confidence and trust in the system. FX settlement risk is the risk that originates once a currency has been irrevocably paid by one party, and thereafter the counterparty fails to meet its obligation in the trade. BIS central bankers’ speeches There are, however, challenges that need to be managed in the development of a financial market infrastructure. Some of these relate to striking a balance between interoperability and innovation. It is an accepted fact that interoperable systems are effective and convenient for their users. On the other hand, during the early stages of innovation, it is difficult to also meet the interoperability objective. A managed process is thus necessary to move new innovations to interoperable standards. Another important factor relates to regulation vs. innovation. While regulators should avoid stifling innovation in terms of how they introduce their regulation, there is sometimes a thin line in balancing this act. In the South African context, we have chosen an approach where regulation follows innovation. In this regard, we closely watch innovative developments and develop appropriate regulation to manage any possible risk as the system develops. Another aspect of focus in the development of financial market infrastructures relates to considerations for public policy objectives such as financial inclusion. We recognise the importance of understanding the needs and requirements of the market so as to avoid putting effort into initiatives that would not address the core needs of the targeted users. Examples of such initiatives such as the Mzanzi account that have been undertaken in the quest to address our financial inclusion objective exist and some lessons have been drawn from these initiatives. Financial inclusion has been placed on the Mexico G20 agenda in 2012, focussed on improving access to finance and improving the confidence and integrity of the financial sector. The work is divided into three subgroups, being data measurement, standard setting bodies and principles, and SME financing. South Africa co-chairs the first sub-group and will be hosting a Global Partnership for Financial Inclusion (GPFI) forum and the first plenary meeting in Cape Town at the end of this month. The second subgroup has commissioned a study into the relationship between financial inclusion, financial stability, financial integrity and financial consumer protection with South Africa as the first country to be studied in this regard. 5. Concluding remarks Overall, the South African financial market infrastructures are well developed and always strive to meet international standards and best practice in order to be open for integration with other markets. Our participation in regional formations, international standard setting bodies and oversight arrangements also offers a platform for us to gain insight and learn from developments elsewhere. This also offers us an opportunity to make a contribution to these regional and international developments. I thank you for the opportunity to share our experiences and look forward to hearing your views. BIS central bankers’ speeches
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Address by Gill Marcus, Governor of the South African Reserve Bank, to the Nordic Business Chamber of South Africa, Johannesburg, 2 October 2012.
Gill Marcus: Crisis and confidence Address by Gill Marcus, Governor of the South African Reserve Bank, to the Nordic Business Chamber of South Africa, Johannesburg, 2 October 2012. * * * Good afternoon, and thank you for the invitation to address you today. As you know, on the 20th of September we made our latest interest rate decision. As with all of our deliberations on the Monetary Policy Committee, this decision to keep rates at the current level was not an easy one. The global economy remains a source of extreme uncertainty, while the domestic economy is beset by its own challenges – some related to the travails of the rest of the world and others home-grown. I thought it might be useful to speak today about current economic conditions and our latest interest rate decision, before moving on to say a few words about rebuilding confidence in our economic future. Crisis The global growth outlook has weakened in recent months, despite some moderation in the risks surrounding Europe’s financial situation. The European Central Bank, the Federal Reserve and the Bank of Japan have launched new programmes to add liquidity to key markets and to encourage economic growth. The QE3 decision by Chairman Bernanke and the FOMC seeks to improve outcomes in a US labour market struggling with slow growth. But the economic outlook going forward is weak, clouded over by the risk that the US will walk over a “fiscal cliff” of combined tax increases and spending cuts, causing a sharp slowing in US growth. Despite renewed stimulus in the United States and agreement to continue funding the government until March 2013, growth is expected to remain subdued at least until the “fiscal cliff” issue is resolved.1 In the Eurozone, the immediate risks posed by the continuing debt crisis appear to have abated somewhat. The ECB’s Outright Monetary Transactions (OMT) programme, the decision of the federal constitutional court in Germany to uphold the ratification of the treaty to establish the European Stability Mechanism, and the pro-euro outcome of the Dutch election have lent some stability to the zone. Nonetheless the risk of a Greek exit from the Eurozone remains high, and growth prospects in the region have deteriorated as banks deleverage further and cross-border lending falls. Growth has also slowed in some of the systemically important emerging market economies, particularly in China, Brazil and India. In line with weaker growth worldwide, global inflation remains relatively benign. And yet supply side shocks in the form of higher food prices, due to droughts in the US and some parts of Eastern Europe, and resilient international crude oil prices pose potentially serious risks to the outlook. The combination of slowing growth and rising prices presents difficult challenges for monetary policy. Global conditions impact on South Africa, and this, alongside domestic factors, has been reflected in our own downward revisions to the forecast for domestic economic growth. For 2012 we expect the economy to grow by about 2.6 per cent, rising to 3.4 per cent in 2013 as the global economy starts to recover. The economy grew by 3.2 per cent in the second quarter of 2012, but this reflects a distortion arising from the strong contribution from the mining sector which recovered from a deep contraction in the first quarter. Non-mining real output growth measured a low 1.7 per cent. The US Congress passed a “continuing resolution” which authorizes funding of the US government through March 2013 at current spending levels. This provides room for discussion about the scheduling of withdrawal of tax cuts and enactment of spending cuts over the next few months without the risk of needing to address a government shutdown. It does not remove the fiscal cliff. Household spending continues to provide much of the growth in the economy. Investment strengthened in the latter half of 2011 and growth has been sustained into 2012, rising by 5.7 per cent in the second quarter of this year. However, private sector gross fixed capital formation remains weak, with the balance of growth in investment arising from activities of public corporations. Job creation has picked up, but again remains sluggish. Statistics South Africa shows 123,000 jobs created from mid-year 2011 to mid-year 2012, about one third of which were in the public sector. The current level of formal sector employment is still about 60,000 less than that reached before the onset of the crisis. The stronger growth in the domestic economy that we saw in the first half of 2012 was reflected in better credit extension figures. These have since moderated from 9.2 per cent in March, to 7.3 per cent and 7,8 per cent in July and August respectively. Credit extension to households rose by 8.1 per cent in July and 9,0 per cent in August, while credit extended to the corporate sector eased somewhat. Mortgage loans remained subdued, while instalment sale credit and leasing finance reflect robust vehicle sales. Unsecured lending has continued to rise rapidly, although again somewhat slower in recent months than in the first quarter of this year. Partly as a result of this lending, household debt as a ratio to disposable income increased slightly, from 75.6 per cent to 76.3 per cent between the first and second quarters of 2012. The asset quality of the banking sector however remains sound. Impaired advances as a percentage of gross loans and advances measured 4.4 per cent in July 2012 compared with 5.5 per cent a year earlier. The trends in wage growth have been relatively benign from an inflation perspective, with nominal unit labour cost growth of 6.1 per cent in the first half of 2012 compared to a year earlier. However, there is a risk that the recent wage settlements in the mining sector could set a precedent for wage demands more generally. We expect consumer prices in South Africa to remain contained within the target range over the forecast period. The decline in inflation in recent months to 4.9 per cent in July appears to have stopped with the August outcome of 5.0 per cent. Food and petrol prices continue to be the main drivers of consumer prices, set largely in international markets and then feeding through into South Africa. Food prices increased by 5.1 per cent, petrol by 9.3 per cent and electricity by 10.0 per cent in the year to August. Core inflation, as measured by the exclusion of food, petrol and electricity from CPI measured 4.6 per cent, up from 4.5 per cent in July. Administered prices excluding petrol increased at a year-on-year rate of 7.5 per cent. The inflation forecast of the Bank reflects a moderate deterioration for 2013 compared with the previous forecast, and a relatively flat trajectory over the entire forecast period. Inflation is now expected to average 5.3 per cent in the final quarter of 2012 and 5.6 per cent for the year, 5.2 per cent in 2013, and 5.0 per cent in 2014. Inflation expectations continue to be roughly in line with the Bank’s forecast, although anchored near the upper end of the 3 to 6 per cent target range. The rand exchange rate has fluctuated generally within a range of R8.10 and R8.50 against the US dollar since May, and continues to be affected by changing risk perceptions in global financial markets and domestic issues, such as the tragic events at Marikana. Capital flows into South Africa remain robust this year, rising by a net R72.5 billion. Investor interest in emerging market debt and South Africa’s inclusion in the Citibank World Government Bond Index (WGBI) have contributed to the inflows. In recent months, the rand depreciated against the euro by about 7.5 per cent and about 2.4 per cent against the US dollar. The current account of the balance of payments has emerged as a risk to the exchange rate outlook following the widening of the deficit to 6.4 per cent of GDP in the second quarter. This widening deficit is a consequence of declining commodity exports and increased imports and service payments. We expect the current account for 2012 to moderate somewhat to about 5¼ per cent of GDP. Food and petrol prices continue to be the main upside risks to the inflation outlook. Following a sharp spike in July, global grain prices appear to have stabilised and then moderated somewhat. Domestic prices of maize and wheat have followed global trends, increasing by about 40 per cent and 20 per cent respectively between the beginning of June and the end of July. These increases are expected to filter through to domestic consumer prices in the coming months. Following sharp decreases in petrol prices earlier this year, since August, the price of petrol has increased by a cumulative R1.15 per litre. A further increase is expected in October. These petrol price increases are driven by international oil prices, which reached US$117 per barrel on 14 September.2 Oil prices have moderated in recent days to US$110 per barrel as Saudi Arabia committed to increase the supply of oil, but geo-political factors will remain a source of underlying volatility in the oil price. Creating confidence With this backdrop in mind, let me turn now to say a few things about how we might think about steps to improve confidence in South Africa and the region. As some of you will know, we participate in many international forums, the G20, the governors’ board of the IMF, the Financial Stability Board in Basel and the Bank for International Settlements, among others. Participation enables us to give voice to our concerns about the trajectory of the world economy, make suggestions on how to approach or resolve problems, and influence the development of regulatory frameworks that affect us. And yet, there is little or nothing we can do, other than express our views, to help other countries find their way out of the difficult prevailing economic circumstances. The spill over of global factors to our economy can be profound, changing the size and direction of capital flows, global inflation, trade, commodity prices, and more. This means that as South Africans, we need to develop the policy and regulatory frameworks, and adjust our policy stance, to do as much as we can to offset harmful economic effects from abroad while taking advantage of the beneficial dynamics. Above all, it means encouraging local economic growth and development, including the development of an active, integrated regional economy. Our basic macroeconomic policy framework cushions against global economic shocks. It allows for flexibility in our approach to achieving the inflation target. The Reserve Bank has the responsibility and the latitude to identify and understand shocks to consumer prices as being temporary or permanent, and to view inflation pressures alongside economic conditions and developments in key markets. The gap between the economy’s potential growth rate, which is currently 3,5 per cent, and its actual growth performance is an important factor in understanding the domestic economy. South Africa’s economic stability is further supported by a macroprudential framework that has adjustable limits to the foreign currency exposure of South African households and institutions. The inflation targeting framework allows the exchange rate to be determined more fully by market forces than under a policy framework that tries to fix the currency. This has various advantages, with perhaps the key one being that movements in the currency help to moderate the very forces causing the currency’s value to move. When the currency depreciates, moreover, the costs to some economic agents are balanced by gains to other agents, like exporters. This in turn reduces the cost of international contagion to the domestic economy. This is a lesson learned well in some Nordic economies. Exchange rate flexibility has critical macroeconomic advantages for small open economies that either have diversified trade and financial connections to other economies and regions, or that desire some autonomy to determine their own monetary policy. Sweden and Norway, for instance, have extensive trade ties with the Eurozone but also with North America and Russia. Economies much more closely integrated with larger dominant economies may find fixed exchange rates a more useful way of maximizing the economic gains of their relationship to the main trading partner. Or USD$12 per barrel higher than at the time of the July MPC. The floating currency and independent monetary policy become especially beneficial for economies that need to adjust to negative economic shocks – both self-imposed and external. Sweden discovered this as it adjusted to a severe balance of payments crisis in the period after 1991. 3 It enabled Swedish banks and industry to restructure at a more favourable exchange rate and allowed the economy to achieve a more sustainable long-run growth path. The current global crisis provides further support to this notion. Sweden’s growth rate rebounded post-crisis, but should be roughly in line with its average over the previous decade as the global economy recovers in coming years. In South Africa’s case, the floating currency supported economic growth in the wake of the Argentine crisis of 2001, and in the current crisis the economy suffered a quite modest decline in the economy of 1.7% in 2009. Other factors also played an important role in supporting the economy in this period, including counter-cyclical fiscal policy and sustained high commodity prices. Real currency depreciation is, however, only one part of what it takes for economies to weather adverse shocks or to counter domestic economic developments that weaken competitiveness. Achieving a new sustainable economic growth rate after a shock or internal adversity requires economic adjustment – changes in rates of return to different economic activities and shifts in labour and capital between those activities. Adjustment should be easier to achieve when an economy is reasonably diversified. For South Africa, large commodity, manufacturing, financial and services sectors helps to keep the economy going even when one or more of them runs into trouble. This economic diversification is also critical to thinking about where to get the financial means to assist the economic adjustment process. And here an important idea comes from Norway, with which South Africa shares a commonality in a strong natural resource base. The idea is to shepherd natural resource earnings and use it for long term, inter-generational, development. There are various ways this use of resource rents can be channelled into higher welfare, through direct transfers of income to households, stronger communitarian claims on private sector firms involved in extraction, or through more highly developed public services. But achieving anything via these channels depends on some ground rules being set out and protected in policy, regulation and/or law. One ground rule is the approach taken by the fiscal authorities to set the taxation of the resource rent at a level commensurate with sustainable long-term extraction and the life of the endowment. Another ground rule is how to manage the pay out of the revenues accruing from the resource. The benefit to citizens needs to spread over generations, rather than consumed up-front. This implies that public borrowing needs to be carefully managed to ensure that future resource revenues are not committed in advance to debt repayment. A focus on long-run infrastructure development by the public finance authorities could help to ensure that additional borrowing pays back the debt without reducing the benefit of future resource revenues for future generations. Once all that is in place, how do we benefit from the resource endowment? Clearly there are various options, with spending to enhance the potential growth rate of the economy the most important. But where should we focus such efforts? In my view, the greatest gains over the longest period of time are likely to come out of efforts to develop a well-integrated regional economy, founded on real economy links of trade, transport, telecommunications, energy, and labour mobility. These are the fundamentals that enable talent to find opportunity and firms to grow. This kind of focus is a far cry from the integration vogue of the last 20 years, which emphasised the integrating-effects of common monetary systems. Greater regional economic integration should not be founded on common monetary arrangements. Sweden implicitly recognized that it was not feasible to be part of a European economic arrangement that approximated an optimal currency area. And, that after monetary union, it was unlikely that the common In 1991, Sweden’s economy contracted by –1.0%, in 1992 by –1.2, and in 1993 by over –2%. For the remainder of the 1990s it grew by an average of nearly 4% per year. The average annual growth rate slowed to about 2.75% in the 2000s, prior to the crisis. Annual growth rates were –0.61, –5.0, +6.1, and +3.9 from 2008 through 2011. Finland had a much larger fall in 2009 (–8.3%), while Norway’s was comparable to SA at –1.7%. currency would generate the optimal currency area conditions. This was prescient of course as the Eurozone’s present circumstances show. In the Southern African Development Community a set of ambitious programmes were drawn up and agreed about 10 years ago, including moving to the Africa-wide monetary arrangements (agreed by the African Union), a Regional Indicative Strategic Development Plan, and a macroeconomic convergence framework. The macroeconomic convergence framework deliberately eschewed formal mechanisms for forcing convergence on the grounds that asymmetric shocks to regional economies would dominate and more formal arrangements would lack credibility. Without considering optimal currency area criteria, a convergence programme needed to be more of a peer review mechanism where policy dialogue and sharing of ideas could occur rather than an exercise in grilling wayward economic officials. As a peer review mechanism, the convergence programme should generate some benefits to SADC members. At the same time, however, 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 continues to ignore the criteria for optimal currency areas. An important lesson of the European crisis is that macroeconomic convergence is not enough. Fiscal conditions need to be supporting of macroeconomic convergence and of monetary arrangements, and institutions built to ensure that fiscal policy sustains those conditions over time. 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. At the end of the day, the hard work of developing markets, laying out infrastructure, and enabling the flow of factors of production will develop our regional economy more effectively than any monetary arrangement or international institution to enforce sound fiscal policy. Such economic integration initiatives can be supported by a sustainable and far-sighted resource revenue policy. Efforts to develop the regional economy need greater impetus. It is not hard to see why. South Africa’s long-standing economic ties to Europe and North America, important as they are, made it vulnerable to the collapse of these economies. African economies have 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. Africa is the second-fastest growing region in the world, and this looks likely to continue for some time. Foreign direct investment into Africa remains quite high, at USD$42.7 billion last year. This is lower than at its peak of USD$57.8 billion in 2008 but still robust, and reflects a fall-off in investment to parts of North Africa. For Sub-Saharan Africa, FDI declined from the USD$34.7 billion achieved in 2008 to USD$27 billion in 2010 and then rebounded to USD$35 billion in 2011. The rebound was caused by large inflows to South Africa (USD$5.8 billion) and Nigeria (USD$8.9 billion). 4 Direct investment into Africa will continue to grow as oil and gas exploration continues to expand known reserves and markets for telecommunications and other services are opened to competition. Our goal should be to expand trade broadly but not in the interest of trade diversion, but to grow the level of economic activity in South Africa, the region, and farther flung trading partners FDI inflows to Africa are highly concentrated with eight countries, including Algeria, the Congo, Ghana, Morocco, Mozambique, Nigeria, South Africa and Zambia receiving more than 70 per cent of the total FDI inflows in 2011. South Africa and Nigeria accounts for more than 40 per cent of the FDI inflows to SSA in 2011. like the Nordic economies. Africa still has a multiplicity of, and in some instances overlapping regional trade blocs, and has some way to go to achieve full trade integration. Further trade integration in Africa should be pursued more purposefully, supported by network industry development. Conclusion Confidence is a critical factor in whether our economies sink or swim. South Africa has in place a range of policy frameworks and a fairly developed level of diversification that cushions the domestic economy from adverse international conditions. These create confidence for domestic businesses and have in recent years contributed to inflows of capital from abroad. We need to build confidence much more, however, by ensuring that the people behind the numbers are able to respond to the demands of economic adjustment in constructive ways. Using our resources wisely can provide the means for developing our human capabilities over successive generations, in part by developing markets and creating economic opportunities across the region. Thank you. 19 September 2012 GDP Annual percentage growth rate Year Swede Norwa Finlan n y d 0.94 5.62 2.36 2.29 5.27 7.74 3.97 4.48 6.98 3.2 3.82 3.24 2.55 5.03 1.8 1.06 5.79 0.34 -1.6 4.14 0.24 1.75 3.85 2.92 3.84 4.36 7.12 1.7 4.5 5.39 -0.2 1.55 1.29 1.19 0.12 3.05 1.81 3.87 3.02 4.27 5.89 3.11 2.19 5.35 3.3 2.86 4.04 2.64 3.46 1.78 3.49 2.67 -0.17 5.22 2.78 5.08 1.01 1.93 0.51 -1.12 3.11 -6 -1.2 3.52 -3.48 -2.06 2.79 -0.81 4.01 5.05 3.65 3.94 4.19 3.96 1.61 5.1 3.57 2.71 5.39 6.21 4.2 2.68 5.03 4.66 2.03 3.91 4.45 3.25 5.32 1.26 1.99 2.28 2.48 1.5 1.83 2.34 0.98 2.01 4.23 3.96 4.12 3.16 2.59 2.92 4.3 2.45 4.41 3.31 2.65 5.34 -0.61 0.04 0.29 -5.03 -1.67 -8.35 6.13 0.68 3.73 3.94 1.6 2.85 BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Gordon Institute of Business Science Conference on Flourishing in Financial Markets Post Crisis - How do we achieve this?Ž, Johannesburg, 2 October 2012.
Daniel Mminele: Flourishing in financial markets post crisis – how do we achieve this? Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Gordon Institute of Business Science Conference on “Flourishing in Financial Markets Post Crisis – How do we achieve this?”, Johannesburg, 2 October 2012. * 1. * * Introduction Good morning ladies and gentlemen and thank you to the Gordon Institute of Business Science (GIBS), Payments Association South Africa (PASA) and Strate, for the invitation to provide the opening remarks this morning. Let me at the outset congratulate the organisers for putting together a programme that is quite wide-ranging in terms of content, and brings together a broad spectrum of speakers to provide different perspectives from their respective vantage points in the financial markets and financial market infrastructure space. Unfortunately, I will not be able to stay for the rest of the day. The theme of the conference: “Flourishing in Financial Markets Post Crisis – How do we achieve this?” is encouragingly forward-looking and results- oriented – how do we get there, how do we achieve this? Allow me, however, to sound a word of caution when it comes to post crisis, because such a characterisation would be pre-mature at this stage. The crisis is not over yet, and in fact may be deepening. Global economic prospects and financial market conditions have been deteriorating in recent months, growth projections for 2012 and 2013 are being adjusted lower, and indications are that the balance of risks is firmly on the downside. The three main risks to a sustained recovery of the global economy on our way to a post crisis environment are: (i) the on-going sovereign debt crisis in the euro area (with feedback loops into the banking system), (ii) the fiscal situation in the United States with regard to the so-called “fiscal cliff”, and (iii) resurgent oil prices and rapidly rising global food prices. All three factors represent external shocks that weigh on household disposable income and economic growth, with a disproportionate impact on emerging markets and lower income households (where food is a larger share of the consumption basket). While the authorities in the euro area have recently made significant efforts to help address weaknesses in their economies, such as through the recent announcement of the European Central Bank’s Outright Monetary Transactions programme and the ratification of the European Stability Mechanism by the German Federal Constitutional Court, the success and credibility of these efforts, which have resulted in near-term risks to global financial markets at least subsiding somewhat, is critically dependent on timeous activation and effective implementation. But, let me not divert too much and turn to the topic I have been asked to speak on, namely, the importance of inter-regulatory harmonisation in the Financial Markets including cooperation at the industry level. 2. The importance of cooperation and collaboration The global financial crisis has brought to the fore and encouraged an environment of increased cooperation and coordination among regulatory authorities, with the view of preventing or at least minimising the impact of possible market disruptions arising out of financial crises. In the wake of the global financial crisis, the international community embarked on various initiatives aimed at improving the regulation of the financial sector, and by so doing, creating an environment that fosters financial stability, in support of growth and development. In addition, a number of changes are also envisaged in the areas of market BIS central bankers’ speeches conduct, consumer protection and financial inclusion. South Africa participates in various international fora (such as the G20, the Basel Committee for Banking Supervision, the Financial Stability Board) and standard setting bodies where these initiatives are being undertaken, and thereby contributes towards building a safer and more efficient global financial system. The G20 in particular has been at forefront of international efforts to harmonise regulation. G20 Leaders have endorsed the broadening of the regulatory net to all markets, institutions, and infrastructures that are systemic (like hedge funds, credit rating agencies, OTC derivatives, and the catch-all phrase of “shadow banking”), thereby encouraging agreed international standards in this regard to be translated into domestic environments. While South Africa’s financial sector may have come through the crisis relatively unscathed, we are part of the global community and are also undertaking various regulatory reforms to ensure that our financial sector is further strengthened. To this end, in early 2011, the National Treasury published a document entitled “A safer financial sector to serve South Africa better”, which is the guiding document in migrating South Africa towards a twin-peak approach to financial regulation, addressing both prudential regulation and market conduct. Collaborative engagements are underway among various South African regulators and stakeholders to ensure the successful implementation of these regulatory reforms in the near future. A safe and effective financial system supports the regulators’ objective of ensuring financial stability. Systemic and prominent market participants and infrastructures (such as the National Payments System, which my colleague Dave Mitchell will provide more detail on later) require appropriate regulation, supervision and oversight. It is thus imperative that relevant regulatory authorities have the oversight powers and resources to carry out this task. In exercising these powers, authorities should be transparent, adopt relevant standards and principles and apply them consistently. It is also crucial for central banks, market regulators and other authorities to cooperate in undertaking these tasks. The need for increased cooperation also stems from the fact that the crisis has made us appreciate more the interconnectedness (domestically and internationally) of the various parts of the financial system we operate in, and how, in the absence of cooperation and coordination, regulatory arbitrage (on the back of financial innovation) can lead to a rapid build-up of systemic risks. Market regulators should always strive to implement interventions that are in the interest of the system as whole and do not serve the interest of individual participants only, or certain sections of the market. Although it is recognised that a disorderly failure in the financial market infrastructure or problems with systemic market participants can interrupt or impede the effective operation of markets, and cause severe systemic disruptions and financial instability, it is imperative that all regulatory actions or interventions should still maintain the correct balance. This is of course easier said than done! In most instances the impact of any crisis would differ across jurisdictions, depending on the stance of the relevant authorities on regulation and oversight, that is, whether regulators adopt more of an intrusive approach or take an arms length approach. Depending on the approach taken, the market participant’s risk management practices will be different and therefore the impact will differ accordingly. A coordinated approach by regulators is thus imperative to ensure that the swing does not move to over-regulation, based on the experience of only one, thereby having detrimental effects or even introducing systemic risk in other jurisdictions. It is therefore imperative to ensure that any changes in the regulatory environment in different parts of the financial sector, whether within one country or across countries, are not in conflict with each other. The potential for spill overs has increased substantially over recent years, as global financial market systems have become highly interlinked, creating significant dependencies. Under these circumstances, it thus becomes crucial that regulators have formalised arrangements to harmonise their regulatory practices and align these to appropriate best practice. Appropriate international standard setting bodies thus become key in driving the agenda to BIS central bankers’ speeches achieve these practices. These platforms should have appropriate structures that will foster effective consultation, so as to ensure the appropriateness of the desired harmonised standards or regulatory frameworks and avoid unintended consequences. That is where the role of the G20, the Basel Committee, the Financial Stability Board and IOSCO becomes very important. Once appropriately harmonised standards or regulatory frameworks have been adopted and implemented, a consistent assessment of implementation should be undertaken. These assessments could take three forms: • Systemic participants and financial market infrastructure operators should conduct periodic formal full or partial self assessments of their observance of the set standards and principles. The outcome of these assessments would lead to continuous improvement or enhancement of risk management practices, which should also meet organisational objectives rather than being just relevant for regulatory compliance purposes. • Regulatory and oversight authorities, as part of discharging their mandates, should regularly assess adherence to standards and observance of relevant principles by entities that they regulate or oversee • Independent assessments could be undertaken by international financial institutions (IFI) such as the IMF and World Bank, or take the form of country peer reviews, also in order to ensure that there is a standardisation of assessments to determine best practice. Current requirements that have been set for banking institutions are being interrogated by various jurisdictions to see how best they could be adopted and to ensure implementation. As many of you will be aware, a second draft of revised regulations to give effect to the Basel III Accord in South Africa was released in September 2012. The revised regulations will come into effect on 1 January 2013, and steps had been taken to ensure that South African banks will be in a position to comply with the Liquidity Coverage Ratio by 2013. Some jurisdictions and entities viewed international standards as only the minimum benchmark and rather strive to achieve higher goals, an approach that South Africa has tended to follow when it comes to capital adequacy. It is also important to always reiterate that in the implementation of standards and principles, as much as there is an important role for regulators, similarly, there is also an important role for market participants. It is in the interest of market participants to cooperate with regulators to ensure a safer financial system in which they operate. 3. Areas of cooperation and collaboration by regulatory authorities Cooperation among regulatory authorities should be fostered both domestically and internationally. This should happen in normal times where ideas and experiences are shared with a view to strengthening the overall financial system. This also allows for building and strengthening of relationships that would be useful in more stressful situations. Due to the interlinkages of the various markets and their financial systems as well as global financial institutions that operate in multiple jurisdictions, the need for cooperation will also be crucial in crisis situations. It is specifically in such times that it is in the interest of all the regulatory authorities to coordinate their actions in the interest of achieving a smooth recovery or resolution that could have affected entities or infrastructures in which they have some form of regulatory authority. In the implementation of standards and principles, various authorities with common interests will have to cooperate and collaborate in various areas such as oversight, supervision and recovery and resolution. BIS central bankers’ speeches 4. Regulation of financial market infrastructures As mentioned earlier, financial market infrastructures went largely unnoticed until the global financial crisis broke, and although they performed well through the crisis, it was only then that an appreciation was found for the true importance of such infrastructures, reflecting the fundamental role they play in ensuring financial stability. With this in mind, in April 2012, the Committee on Payment and Settlement Systems at the Bank for International Settlements (CPSS) and the International Organization of Securities Commissions (IOSCO) published new international standards for payment and securities clearing and settlement systems, including central counterparties. The main objectives of the new principles are to ensure a robust global financial market infrastructure, which if faced with the financial shocks of the magnitude experienced in 2007/2008, will continue to operate effectively. South Africa is expected to adopt these principles and ensure that systemic and prominent financial market infrastructures in its jurisdiction do observe them. These principles will apply to payment systems, securities settlement systems, central security depositories, central counter parties as well as trade repositories. The principles will in most probability be adopted in either of the following ways: • through policy positions that are outlined by regulatory authorities in a transparent manner; • incorporated in relevant regulation applied by the relevant regulatory authorities; or • incorporated in law or legal provisions administered by the relevant authority. This will happen in parallel with the regulatory reforms that South Africa has chosen to undertake in the effort to drive towards “A safer financial sector to serve South Africa better” as stated earlier, and it is envisaged that the two objectives will be complementary and aligned. South Africa also sees itself as part of the broader region as well as the international community and thus also strives to drive its financial sector development initiatives with this goal in mind. 5. Concluding remarks There can be no doubt that going forward we need better and appropriately regulated financial markets, institutions and infrastructures, such that strong, sustainable and balanced growth can be achieved in order to support our national objectives. Luckily when it comes to regulatory reform in South Africa it is the case of making good even better, or great, rather than having to fix what is broken. South Africa’s financial system is rated among the best in the world. In the recent World Economic Forum’s (WEF) Competitiveness Survey, South Africa ranked third on overall financial market development, first in the regulation of securities exchanges and first in the strength of auditing and reporting standards. But there is no room for complacency, and the need for various regulators to work together more closely is crucial. We also have our work cut out in the area of financial inclusion, to address the challenge of a large proportion of the population not having access to formal banking, insurance and investment products. Financial Market Infrastructures are a source of strength for the financial system, but could also bring risk that could be catastrophic. It is heartening to say that the South African regulatory environment is well developed and should foster confidence in our financial institutions as well as our financial market infrastructures. These institutions strive to meet international standards and best practice in order to be open for integration with other markets to ensure that we take advantage of opportunities that present themselves and manage risks appropriately. It is also encouraging to note that some of our domestic Financial Market Infrastructure operators are already conducting self assessments based on the recently released international principles in the positive spirit of accepting the standards BIS central bankers’ speeches as being good for their risk management rather than viewing them as something that is being imposed on them by regulatory authorities. Our participation in regional formations, international standard setting bodies and oversight arrangements also offers a platform for us to gain insight and learn from developments elsewhere. This also offers us an opportunity to make a contribution to these regional and international developments and shape them. I thank you for the opportunity to share these thoughts and trust that you will have a good conference. References: Principles for Financial Market Infrastructures, BIS CPSS & IOSCO, April 2012 A safer financial sector to serve South Africa better, National Treasury Policy Document, Republic of South Africa, February 2011 BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Rhodes University Business School strategic conversation series, Grahamstown, 10 October 2012.
Gill Marcus: The financial crisis and the crisis of trust in the banking sector of the advanced economies Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Rhodes University Business School strategic conversation series, Grahamstown, 10 October 2012. * * * Thank you for the opportunity to address you in this beautiful city of Grahamstown. Your city may be out of the hustle and bustle of the financial markets, but that does not mean that you have been spared the fallout of the continuing global economic crisis, which is now well into its fifth year, and many commentators are now talking about the possibility of a “lost decade”. The Eurozone contracted by 0,7 per cent in the second quarter of 2012, with 12 out of the 17 members experiencing negative growth. US economic growth is below potential and the prospect of a significant fiscal contraction early next year – the so-called “fiscal cliff” – looms large. Unemployment in the advanced economies has on average more or less doubled, with both Spain and Greece reporting rates of just over 25 per cent. The sovereign debt crisis in Europe remains unresolved, and continued fiscal austerity continues to retard growth prospects. Compounding this bleak outlook in the advanced economies and in the Eurozone in particular, is a banking sector under stress, characterised by shrinking lending or deleveraging, as they adjust to new regulatory requirements, amid increasing reluctance to lend outside their own countries. The travails of the Eurozone are likely to last for some time, and it is ordinary people around the world who are suffering, who have lost their jobs and future dreams, and are losing confidence and trust in economic and political institutions. Trust and alignment of purpose are essential ingredients of a harmonious economic and political system, and while the crisis has had a number of dimensions, one of the aspects often forgotten or not talked about is how it has undermined trust and how critical restoring confidence is to the success of any initiatives taken. Barry Eichengreen notes that everyone talks about Europe’s deficits, southern European external deficits, and the Eurozone’s institutional deficits. But, he argues, none of these is the deficit that really matters: “the deficit that prevents Europe from drawing a line under its crisis is a deficit of trust”. He identifies a number of levels where trust has been undermined. Firstly, there is a lack of trust in leadership, where leaders say one thing when everyone knows they mean something else, and eventually they will have to acknowledge reality. He points to the example of German leaders promising their citizens that no extra money would be spent on erecting firewalls for Eurozone countries. Secondly, there is the lack of trust between European states: northern European countries do not want to bail out the peripheral countries because they do not trust them to use the money wisely, and cause them to relax their reform effort. As a result, he argues, the core countries are prepared to provide just enough assistance “to keep the ship from capsizing, but not enough to set it on an even keel”. And finally, he argues that there is a lack of trust between social groups called on to make sacrifices. If I have to make sacrifices, will I trust others to do the same? Furthermore, research has also shown that inequality within society reinforces lack of trust and lack of cohesion. While these trust deficits are critical, I will focus on another element of trust, and that is lack of trust in the global financial system in general and in banks in many of the advanced economies in particular. It is important to stress that, without being complacent, the South African banking system remains sound and well capitalized. The South African authorities have not had to assist any bank, nor provide liquidity to prop up the system. The anger that has been exhibited against the banking sector in various countries, for example the on-going “Occupy Wall Street” campaign, is indicative of a lack of trust in the financial BIS central bankers’ speeches system, and the recent revelations of Libor fixing and allegations of possible money laundering and fraudulent activities reinforce that lack of trust. The issue of distrust in the advanced economy banking system was exacerbated by at times obscene severance packages paid to bank CEOs after the banks were bailed out by public funds. These golden handshakes were in effect excessive rewards for failure. In the past few days we have seen the New York Attorney General filing a civil fraud lawsuit against JPMorgan over mortgage-backed securities packaged and sold by Bear Stearns, which JP Morgan bought in March 2008. The importance of trust in the financial system cannot be over-emphasised, because without it the financial system breaks down, and without an efficiently working financial system, the economy will not operate effectively. A lack of trust in banks or in financial markets can undermine the system as a whole. If clients do not trust their banks they will not borrow from them; if banks do not trust their customers they will not lend to them. The development of relationships and trust between bankers and their clients leads to the build-up of what Bernanke has referred to as knowledge or informational capital. As bankers get further away from their clients and trust is lost, this knowledge is lost as well. A New York Times columnist David Leonhardt, in commenting on the vanishing of trust in the banking system, wrote: “Banks now look at longtime customers and think of that old refrain from a failed marriage: I feel like I don’t even know you.” Much has been written in the economics literature about the central role of the financial and banking system in the economy. Real investment in an economy, which generates economic growth and jobs, requires funding. Similarly, households require funding to finance housing and other forms of expenditure, whether of a longer-term investment nature, such as education, or more consumer-type expenditure. Banks and other financial intermediaries play a unique role in channeling savings to investors. Both savers and investors face risk and uncertainty: savers cannot always easily assess the risk of an investment, and by pooling savings, banks allow for increased returns for savers. Investors, on the other hand, who require funds for investment projects, can take advantage of pooling of savings and the intermediation services of banks or other financial intermediaries. It is generally accepted that a healthy, well-functioning financial sector is essential for growth. It is also the case that when the banking sector becomes dysfunctional and stops lending, the implications for the real economy can be extremely serious. Bernanke, for example, has argued that the so-called “lost decade” of Japan can be attributed substantially to the financial problems banks faced with nonperforming loans and insufficient capital. Furthermore, the financial sector is not only important for the smooth channeling of savings to investors, it also has an important role in propagating business cycles. According to the “financial accelerator” theory, which helps to explain the procyclical nature of bank lending, adverse conditions in the financial markets impact on the real economy, which in turn reinforces the negative conditions in the financial markets. This negative feedback loop propagates and amplifies the downturn. The opposite is true for favourable feedback loops. This accelerator principle implies that there are disproportionate increases or decreases in credit extension in response to changes in underlying conditions. For example, during a boom, asset prices rise, and this increases the value of collateral available, allowing for increased leverage and credit expansion. More investment is undertaken and more jobs created, which in turn leads to further expansion in the financial sector. Conversely, when asset values fall, deleveraging occurs as the value of existing collateral declines, with negative implications for the real economy. Related to this is the work of Reinhart and Rogoff in their book “This time is different” where they show that the recovery from a financial crisis takes much longer than that of other crises. Unlike normal economic cycles or recessions, financial crises are protracted. 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 BIS central bankers’ speeches only loss of output and employment but applies to debt, credit and 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 moderated by a reversal of the monetary policy stance. Unfortunately we are not in a normal cyclical downturn, and as we have seen, despite the extraordinary efforts of central banks, 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 weak property and other asset markets and stubbornly high unemployment, rebuilding of household balance sheets may take a protracted period of time. There are differing views as to the origins of the global financial crisis, but it is widely accepted that that a combination of weak or light-touch regulation of the banking system, coupled with some rather questionable innovations in the banking sector, were at the epicenter of the crisis. The sub-prime crisis which originated in the United States showed how such innovations could have global repercussions. It became clear in the aftermath of the crisis that many of the senior bank executives did not fully understand these complex products and the risks associated with them. This led to a breakdown of trust between banks, as they did not know what was lurking on the balance sheets of banks they were lending to in the interbank market. It also became clear that in some jurisdictions, prudential oversight was inadequate and that the “light touch” regulation approach did not work. But with the increased complexity of products it was little wonder that the regulators could not keep up with financial innovation. The real impacts of the crisis were amplified by financial flows, where the motto was “bring cash home”. Fund managers in the advanced economies repatriated their investments, and a study by Philip Lane has argued that the most dramatic turnaround in capital flows took place with respect to banking-sector flows, with foreigners draining liquid funds from local stressed banks, and domestic investors draining foreign liquid assets. As Lane notes: “In both directions, banks were the main proximate investor in other banks, so were instrumental in the cross-border retrenchment as part of the general breakdown in interbank markets during the crisis. While individually rational, the collective exit from these markets contributed to the illiquidity problems that defined the acute phase of the crisis. Given the lack of an adequate international regulatory framework, cross-border liquidity runs were more difficult to forestall than domestic liquidity runs.” Other research also showed that banks were most likely to withdraw capital from countries that were geographically more remote from the home market. The global nature of the financial crisis also meant that solutions needed to be global, with a reversal of the lax regulatory environment that emerged in the years preceding the financial crisis. Banks and other financial institutions had become larger, and they crossed national boundaries with branches and subsidiaries all over the world. This made it more difficult to regulate them, as different countries had different regulations, and banks often engaged in regulatory arbitrage. In an attempt to restore trust and to ensure that banking excesses BIS central bankers’ speeches would not be repeated, various fora, including the G20, the Basel Committee for Banking Supervision and the Financial Stability Board (FSB) engaged in revising regulations and standards. Regulation has become more stringent with the impending introduction of what is known as the Basel III framework. There was, however, always a concern that the regulatory pendulum would swing too far in the other direction, and there is the danger that their implementation may further impede the slow global recovery. In the Eurozone for example, the need to increase bank capital has contributed to the reluctance of banks to lend. Higher capital adequacy ratios are ideally achieved through raising capital, but in the prevailing economic climate this is difficult and expensive. Banks have consequently been adjusting to these tougher ratios either through selling off some of their assets or by reducing their lending or both. The continuing crisis in Europe is in part a function of continued bank deleveraging, and has required at times extraordinary intervention from the ECB. Mario Draghi, for example, reported in Davos earlier this year that a “major, major credit crunch” had been avoided in Europe, following the €489bn emergency loans to Eurozone banks in December 2011. Our concern has been that changes to the Basel Committee rules to which South Africa subscribes, are intended to solve problems in the banking systems of some of the advanced economies, but would apply equally to countries such as South Africa, that did not experience these excesses. In other words, the changing regulation would solve problems that we did not have, and could in fact cause unnecessary difficulties for the banks and for the broader macroeconomy. To some extent the revised principles have proved to be challenging, but we are nevertheless expected to abide by them as members of the FSB and the G-20. Some aspects of these changes could have significantly negative implications for our banks and for the economy in general if applied in the forms that are currently being proposed. We are committed to meeting the Basel III requirements, and are actively working with the global policy makers to see how these proposals can be modified or allow for country discretion in their application. But this is an example of how global solutions if applied indiscriminately to all countries, even to those such as South Africa that did not experience regulatory failures, could have adverse consequences for some. The Basel III Accord provides for high capital ratios in order to ensure that banks are adequately capitalised. In this respect South African banks more than comply with the provisions. Currently banks’ capital adequacy ratios are well above the requirements, and our banks have a relatively low leverage ratio. Other provisions, however, will be more challenging, and South Africa, along with other countries in a similar position, has actively participated in these discussions in order to avoid possible unintended consequences. An important provision relates to the liquidity coverage ratio (LCR), to be implemented in 2013, which requires banks to have sufficient high-quality liquid assets to survive a month-long significant stress scenario. Studies by the Bank for International Settlements showed that South African banks generally would be short of such liquid assets by virtue of their dependence on wholesale, short-term funding, which means that there would be a shortage of assets that satisfy the prescribed criteria. The Basel III liquidity framework does however give discretion to national supervisors to make available to banks a committed liquidity facility (CLF) at a fee. In May of 2012 the registrar of banks announced the introduction of such a facility, which will be provided for an amount of up to 40 per cent on any particular bank’s net cash outflows under stressed scenarios. This access will be against acceptable collateral. The facility was introduced to prevent excessive increases in the cost of funding of banks and possible distortionary effects on the domestic financial markets, and takes account of the structural features of our system. We are, however, still concerned about the impact of the proposed net stable funding ratio (NSFR) which is expected to be implemented in 2018. Again, the structural features of our financial system may pose a challenge, given that most long-term saving in the economy is done through the non-bank financial institutions, which in turn provide short term deposits to BIS central bankers’ speeches the banks. To achieve the required ratios would mean that banks to try to attract more long term deposits, or need to reduce the maturity structure of their lending. Such adjustments could have adverse consequences for the economy. However, we are not the only country with such concerns, and discussions with the Basel Committee on Banking Supervision are ongoing. Our banking system was one of the few that emerged relatively unscathed from the crisis. At no stage did the Reserve Bank have to take any extraordinary measures to protect the banks, and the interbank market ran smoothly. Prudent banking practices and oversight by the bank regulator meant that our banks did not create the type of toxic products that were central to the crisis. In general, our banking system has not suffered the same excesses that I have described. That is not so say that everyone trusts their bank, and there are some who, because of the actions of banks seen abroad, tar all banks with the same brush. There are also, no doubt, many people who can tell you stories about their negative experiences with their banks. But in general the conduct of our banks and financial system over the past few years has been very different to that in a number of the advanced economies. However, we cannot be complacent and for this reason there is ongoing work to strengthen the regulatory architecture with the move toward a twin peaks model of financial regulation. This approach will see the consolidation of all prudential regulation of financial institutions within the Bank, while market conduct regulation of the financial sector will be consolidated within the Financial Services Board. In conclusion, it is important that banks around the world try to regain the trust of ordinary people. The lack of trust is epitomised in a recent article by Financial Times columnist John Gapper who notes that “if regrets, apologies and promises to behave better were redeemable for cash, the world’s banks would be rolling in it … But what are the odds of these noble promises enduring past the usual period of sackcloth and ashes at the bottom of the banking cycle? Not very high, I’m afraid. Although the new generation of bank leaders probably has good intentions – as well as needing to assuage public outrage – these pledges will be difficult to enforce, or even recall, when it matters.” The banks have a lot of work to do to change the culture that has crept into the sector. Fortunately our banking sector does not appear to have been prone to the same excesses, although they are by no means perfect. As I have outlined, it is critical for a growing economy to have a vibrant, stable banking sector, and given the importance of this sector it is imperative that it be appropriately regulated and supervised. Given their important role in the economy, banks have a particular responsibility to act is such a way that engenders trust. I have focused on the issue of trust in the banking sector. But the issue of trust must permeate society in general. If we want to nurture a stable democracy, we need to behave in ways that will create trust in our political, social and economic institutions, and between social groups. Such trust cannot be demanded, it needs to be earned through appropriate actions and behaviour. During the current difficult times that we are experiencing in our country, the building up of trust takes on even greater importance. All of you who have taken the time and made the effort to be here today, both from schools and Rhodes University, are the ones who will be entering the labour market in the near future. It is you who will need to grapple with the very complex world of the 21st century. Nothing can prepare you for all eventualities, but the fact that you have a sound education will provide you with the knowledge essential to navigate into unknown territory. Remember, while certificates are important, it is the knowledge that goes with the certificate that will bring you the life you want to live. There is no substitute for hard work, for seeking knowledge, and using your drive and sense of purpose for the greater good of society and fellow human beings. Your future also depends on you. As South Africans, let us work together, young and old, across all our historic divides of race and gender, to build a future that belongs to all of us. Thank you. BIS central bankers’ speeches References: Bernanke, B (2007). The financial accelerator and the credit channel. Speech at the Credit Channel of Monetary Policy in the Twenty-first Century Conference, Federal Reserve Bank of Atlanta, Georgia. Eichengreen, B (2012). Europe’s trust deficit. Project Syndicate, March 12. Gapper J (2012). Incentives for banks to stray will persist. Financial Times, September 12. Lane, P. (2012). Financial globalisation and the crisis. Paper presented at the 11th BIS Annual Conference on “The Future of Financial Globalisation”, Lucerne. Leonhardt, D (2008). Lesson from a crisis: when trust vanishes, worry. The New York Times, September 30. Reinhart C, and K Rogoff (2011). This time is different: Eight centuries of financial follies. Pricenton University Press. BIS central bankers’ speeches
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Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the 3rd UBS Economics Conference, Cape Town, 12 October 2012.
Francois Groepe: Monetary policy and inclusive growth Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the 3rd UBS Economics Conference, Cape Town, 12 October 2012. * * * Monetary policy and inclusive growth I wish to thank UBS for inviting me to address you in my beautiful home town. The topic I have been asked to discuss today is monetary policy and inclusive growth. This topic is particularly relevant given South Africa’s income inequality as reflected in the most recently estimated Gini-coefficient of 0,69. The top ten per cent of the population earn approximately 58 per cent of the income and the bottom 50 per cent less than eight per cent. We furthermore have had to contend with structural unemployment, which currently stands at 24,9 per cent. I will now proceed with a brief overview of the concepts of inclusive growth and productive employment before discussing the South African Reserve Bank’s (the Bank) mandate, the monetary policy framework and how the achievement of the Bank’s mandate enables the most appropriate backdrop for inclusive economic growth. Inclusive growth Inclusive growth refers to long-term sustained economic growth that is broad-based across sectors and inclusive of a large part of a country’s labour force, thereby reducing unemployment significantly. Policies that encourage inclusive growth tend to emphasize removing constraints to growth, creating opportunity, and creating a level playing field for investment. According to the World Bank’s Commission on Growth and Development, a persistent, determined focus on inclusive long-term growth by governments is a key ingredient of all successful growth strategies.1 Long-term sustained high growth rates are further also dependent on productivity gains. Productivity gains lead to higher rates of growth that in turn result in rising demand for labour as the economy expands and incomes rise in a virtuous circle. One well-known survey, by Lopez of the empirical literature on economic growth concludes that macroeconomic stability, low inflation rates, and appropriate education and infrastructure-related policies have positive effects on growth and reduce inequality. More recent research initiatives have focused increasingly on constraints to future development and showed that a country’s initial conditions have a critical impact on long-run growth. Initial conditions include levels of income and its distribution, the extent of poverty and many other factors including geography, governance and the set of existing macroeconomic policies. World Bank research in 2005 highlighted the extent to which institutional structures, policies, and resource endowments interact in unique ways to support necessary policies such as a stable macroeconomic environment, the enforcement of property rights, openness to trade and effective government in achieving higher growth rates.2 The line of enquiry further suggested that local peculiarities would tend to result in unique sets of distortions that impede growth. In South Africa this would include inadequate infrastructure, skills shortages and inefficient administration at the local authority level. Efforts Commission on Growth and Development Growth Report: Strategies for Sustained Growth and Inclusive Development, World Bank, (2008). World Bank. Economic Growth in the 1990s: Learning from a Decade of Reform. Washington DC: World Bank (2005). BIS central bankers’ speeches to address the distortions and constraints could in practice result in short-term costs, in particular if local circumstances are not well understood. If however approached judiciously, it should yield positive results over the medium to longer term. It was against this background that Hausmann, Rodrik and Velasco developed their approach to identifying binding constraints to growth. Important lessons from this and other research were that development policy is country specific rather than being one-size-fits-all and that sometimes large positive welfare impacts could be achieved by optimally sequencing just a few reforms to relax binding constraints. Empirical evidence also showed that in every country structural transformation and economic diversification are required to achieve significant income growth and poverty reduction. For countries with relatively small domestic markets like South Africa this implies export diversification in order to access foreign markets and achieve economies of scale. Productive employment Productive employment is the main instrument for achieving sustainable and inclusive growth. Employment growth generates new jobs while productivity growth lifts the wages of the employed and the returns to the self-employed. The key objective with any growth strategy is to strengthen the productive resources and capacity of individuals on the labour supply side and to open up new opportunities for productive employment on the labour demand side. An inclusive growth strategy should also recognize the time lag between reforms and outcomes as in the case of investments in education and the time elapsed before improved labour skills become available. Efforts to narrow the knowledge gap with the goal of developing creative and competitive human resources are an important prerequisite for higher productivity. South Africa should aim to not merely catch up in this regard. We need to pre-empt the type of skills and knowledge that will be required over the next say two decades and ensure that our education and training strategies are adequately aligned so as to ensure that we have a work force with the appropriate skills. It is, therefore imperative that our human capital development strategy is forward-looking and proactive. This necessitates us to take a hard look at our education system, as a recent assessment of the quality of state education amongst 142 countries, ranked South Africa at 133rd, despite the high levels of investment in education which now stands at R207bn per annum. Planning must therefore focus sharply on upgrading the quality and relevance of training while enhancing the skills of the labour force. In order to upgrade human resource skills to meet the need of an increasingly sophisticated economy, training at every level must be strengthened to generate well-trained labour to meet industry demand both now and in the future. An inclusive growth strategy looks for ways to raise the pace of growth by utilizing the labour force to the fullest possible extent. High unemployment is the result of chronic skill and geographical mismatches and of policies, product market structure, and labour market arrangements that often protect insiders at the expense of the unemployed. High margins in product markets and upward wage pressure in labour markets have resulted in uncompetitive domestic costs of production in a number of sectors. This erodes external competitiveness and as a consequence excludes part of the population from formal economic activity. It also ends up constraining a country’s ability to diversify exports. Entry-level wages are also sometimes above the productivity levels of less experienced workers and new entrants to the labour market. This discourages labour demand. Sustainable job creation that significantly reduces unemployment can be achieved with labour and product market reforms that specifically target labour intensive production processes. A more flexible wage setting mechanism that better aligns wages with productivity levels at the firm level will improve the business environment and our BIS central bankers’ speeches competitiveness and should significantly contribute towards increasing employment opportunities. Important factors that serve to improve individual and enterprise or micro productivity include improved management skills, updated technology and better capital equipment. Collective factors at the enterprise level that have a decisive influence on productivity outcomes include the adoption of the continuous-improvement-type work ethic and overall quality consciousness that is so prevalent in Developing Asia. In many countries, active labour market policies also serve to raise the rate of employment creation. This includes, transport subsidies for job seekers, on-the-job training and in some instances, temporary youth wage subsidies. Infrastructure as a key jobs driver Emerging-market and developing country growth is on average higher than that of South Africa and is indicative of country specific structural constraints. A sustained increase in the potential output of the economy requires not only a concerted and coordinated effort from government, but also the support and buy-in of the private sector and labour if we were to succeed in improving the growth performance. It may even require a new social compact. In the past, infrastructure development in particular has been held back largely due to limited implementation capacity. This has resulted in bottlenecks in electricity generation, transport, and port infrastructure and South Africa has therefore not benefited as much as other resource intensive emerging market economies from large terms of trade gains in recent years. This also discouraged investment in South Africa’s natural resource industry, and has made it difficult in some instances to maintain export volume growth. Policy certainty and investor confidence have proven to be essential prerequisites for the capital formation South Africa requires for substantive export led growth. The New Growth Path sets the goal of creating 5 million new jobs by 2020 and to this end identifies the structural problems in the economy that need to be overcome as well as the key opportunities or job drivers in specific sectors and markets. One of the key jobs drivers is infrastructure development which provides the basis for higher growth, inclusivity and job creation. Government has also established the Presidential Infrastructure Coordinating Commission (PICC) to address the challenges of delivery through coordination, integration and accelerated implementation. A single common Infrastructure Plan will in future be centrally driven and monitored. The objective is also to develop a twenty-year planning framework beyond one administration to avoid the typical stop-start pattern of the past. The PICC’s mandate is to ensure systematic selection, planning and monitoring of large projects. An infrastructure book that contains more than 645 infrastructure projects across the country has now been compiled by the PICC. An Infrastructure Plan with identified Strategic Integrated Projects has also been developed by the PICC and adopted by Cabinet and although this in itself will not address all the challenges, it forms an important part of the National Development Plan’s (NDP) proposals to increase employment and growth Other key proposals of the NDP include improving the functioning of the labour market, supporting small business through better coordination of activities and improving the capacity of the state to effectively implement economic policy. Although South Africa has at times over the past 18 years, achieved significantly improved real economic growth outcomes, built democratic institutions, transformed the public service, extended basic services and stabilised the economy, too many people are still trapped in poverty and too few South Africans have obtained employment over this period as growth has not been sufficiently inclusive. The quality of education for the majority has remained poor and government has continued to experience insufficient capacity in critical areas. Some years were characterised by jobless capital intensive growth while the large employment losses that this country suffered during the recession have still not been BIS central bankers’ speeches recovered fully. The NDP aims to eliminate poverty and reduce inequality significantly by 2030 by growing an inclusive economy and creating 11 million jobs by 2030. Recent developments in the labour market Although employment levels have increased at a slower pace this year compared to 2011, the rate of job creation has been sufficient to decrease marginally the unemployment rate in the second quarter of 2012. Employment creation has nevertheless remained hesitant, consistent with the moderate pace of recovery in real economic activity in South Africa and against the backdrop of the challenging global economic developments. The moderation in average wage settlement rates in 2011 levelled off in 2012. In the second quarter of 2012, both the rate of increase in remuneration per worker and productivity increased somewhat resulting in the growth in nominal unit labour cost remaining the same. These developments mitigated inflationary pressures, but the outlook for wage growth has become uncertain. Recent industrial action has spilled over from mining to the manufacturing, transport and agricultural sectors and has raised investors’ concerns. Moody’s Investors Service also mentioned spreading labour turmoil as an important factor in its decision to cut South Africa’s debt rating to Baa1 from A3. Widespread labour unrest has already shut down large parts of the mining industry and given that we are the world’s top platinum producer and a major supplier of gold, prices of precious metals have risen. The rand’s exchange value has reflected investor concerns in recent weeks, and although the negative consequences of the unrest cannot be underestimated, I am confident the currency will return to more appropriate levels. The rand will remain vulnerable to any signs of intensifying labour turmoil, but government has taken steps to address the labour unrest as a speedy resolution is crucial to restoring broader investor confidence and medium-term growth prospects. The government has also given the assurance that it is putting immense efforts into bringing together the employer community, trade union movement and the government itself in order to stabilise the situation as rapidly as possible. The longer strikes continue, the greater the implications will be for economic growth, employment creation and fiscal outcomes in the long run. The role of monetary policy I have earlier made reference to the Lopez survey that concluded that macroeconomic stability and low inflation rates inter alia have positive effects on growth and reduce inequality. It is my contention that transparent, well-understood monetary policy is critical to achieving stable macroeconomic outcomes. The mandate of the South African Reserve Bank is to achieve and maintain price stability in the interest of balanced and sustainable economic growth. The Bank also plays a central role in overseeing and maintaining financial stability. Price stability reduces uncertainty in the economy and provides a favourable environment for growth and cumulative employment creation over the longer term. Low inflation helps to protect the purchasing power and living standards of all South Africans. Although low inflation may not necessarily in itself reduce income inequality, it does ensure the protection of income which is particularly important for poorer South Africans who generally do not have the means to adjust their nominal incomes to take account of rapid price increases. An inflation target range is set by government after consultation with the Bank. The commitment is to pursue a continuous target of 3 to 6 per cent for headline CPI inflation. The Bank conducts monetary policy within a flexible inflation-targeting framework that allows for inflation to be temporarily outside the target range as a result of mainly supply shocks. The Monetary Policy Committee (MPC) takes into account the appropriate medium-term time horizon for inflation to return to within the target range, considering the lags between policy BIS central bankers’ speeches adjustments and economic effects. This provides for interest rate smoothing over the cycle and makes growth more sustained and consistent. Since the implementation of inflation targeting, the instances when inflation outcomes exceeded the target could be attributed to external shocks which exacerbated domestic inflationary pressures. These shocks, amongst others, included depreciation of and volatility in the exchange rate of the rand and sharp increases in international oil, commodity, and food prices. Structural features of the South African economy such as backward looking wage settlements, uncompetitive product markets, rapidly rising administered prices and low productivity have also been important sources of inflationary pressures. It is very difficult to distinguish comprehensively between the specific impact of inflation targeting and the general impact of other concurrent economic reforms or global developments. However, empirical evidence shows that gains in inflation performance in inflation targeting countries were achieved with no adverse effects on output and interest volatility. The inflation targeting framework has also served South Africa well and the most important outcomes it has contributed towards can be summarised as follows: • The nominal policy interest rate has declined. This has lowered the interest rate structure at the short end of the maturity spectrum. • The real policy interest rate has declined and has become less volatile. This has reduced the inflation risk premium embedded in interest rates as inflation expectations became better anchored. • Nominal bond yields have declined. This has lowered the cost of borrowing of government and the cost of funding of the private sector to the benefit of real economic activity. • Growth in real gross domestic product and real gross fixed capital formation has increased and become less volatile. This has encouraged employment creation, particularly in the pre-crisis years. The extent of the gains derived in part from inflation targeting largely depends on the Bank’s ability to anchor inflation expectations within the inflation target range. Anchored inflation expectations reduce the effect of external shocks and require less policy intervention. The inflation targeting framework has been important in providing greater resilience to the large shocks coming from the global external environment. As the nominal exchange rate of the rand is determined by supply and demand conditions, exchange rate flexibility serves as an important transmission mechanism and shock absorber of external shocks. This approach allows output growth and interest rates to be less volatile and delivers the best outcomes in terms of price stability and lower exchange rate volatility subject to the risk of over- or undervaluation in response to external shocks. Inflation targeting has also been successfully practiced in a growing number of countries over the past 20 years, and many more countries are moving toward this framework. Empirical evidence on the performance of inflation targeting is supportive of the effectiveness of the framework in delivering low inflation. The monetary policy framework has allowed the Bank to provide stimulus when required while keeping inflation expectations well anchored. Since its introduction in 2000, inflation targeting in South Africa has been applied as a flexible framework that has been resilient to changing circumstances, including the recent global financial crisis. The inflation targeting framework has thus far enabled the Bank and most of the other inflation targeting countries to steer clear of unconventional measures in achieving their key monetary policy objective. The Bank’s inflation forecast shows inflation remaining within the inflation target range over the forecast horizon to 2014. BIS central bankers’ speeches Conclusion Although there is a short-run trade-off between economic activity and monetary policy, it is generally accepted that low and stable inflation produces an environment in which overall economic performance and inclusive growth can flourish. The Bank’s flexible approach to inflation targeting, I believe positions South Africa to best deal with external shocks and minimise their disruptive impact on the domestic economy. Growth, employment and income levels have been more stable and consistent since 2000 and the introduction of the current inflation targeting framework. Achieving greater economic inclusion is a critical need for the country. Monetary policy should be complemented by growth-oriented and job-creating fiscal, industrial and labour policies. Emerging market and developing economies are now more resilient than in previous decades but structural issues still need to be addressed. Weaknesses in any subsector or in regulation or corporate governance will limit monetary policy efficacy and lead to weak growth, which in turn is a drag on fiscal consolidation. Policies in general must therefore emphasise the resolution of underlying structural problems within the economy, and monetary policy must be as supportive as possible, with due regard to ensuring price stability. Although monetary policy can therefore contribute to inclusive and sustainable growth (and you will probably agree that the SARB has indeed adopted policies that are supportive in this regard), one needs to recognise the limitations of monetary policy and hence acknowledge that other policymakers and stakeholders also have an important and significant role to play in achieving both inclusive and sustainable growth over the longer term. Thank you. References: Aron J. and Muellbuaer, J., “Transparency, credibility and predictability of monetary policy under inflation targeting in South Africa”, Department of Economic, Oxford and Nuffield College, Oxford, 31 March 2007. Ianchovichina, E and Lundstrom, S. What is Inclusive Growth?, Policy Research Working Paper No. 4851, The World Bank. 2009 Hausmann, R., Rodrik D., and A. Velasco. Growth Diagnostics. Mimeo, Harvard Kennedy School. Cambridge. 2005. Lopez, H. “Pro-Poor Growth: A Review of What We Know (and of What We Don’t)” Mimeo. World Bank. 2004 The Infrastructure Plan, Presidential Infrastructure Coordinating Commission (PICC), April, 2012. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Partners in Performance 2012 Celebration Lunch at the Maths Centre, Braamfontein, 12 October 2012.
Gill Marcus: Why education is important to the South African Reserve Bank Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Partners in Performance 2012 Celebration Lunch at the Maths Centre, Braamfontein, 12 October 2012. * * * Good morning to the Board of Trustees, the partners, donors, members and friends of the Maths Centre for Professional Teachers. It gives me great pleasure to be here today. This is an institution whose work I have long admired, ever since I came to know its Executive Director, Ms. Sharanjeet Shan during my tenure at the Gordon Institute of Business Science. In my opinion, both Sharanjeet and her team are wonderful examples of what can be achieved when a small group of committed people sets out to make a difference in the world. From its humble beginnings in 1985, when it was only a very small outreach project run from Auckland Park school under the directorship of Mrs. Patchitt, the Centre has done extraordinary work to grow to the impressive organisation that it is today; one that is making a clear and important difference to the teaching, learning and understanding of Maths, Science, Technology and even entrepreneurship in the country. Without question, all of us are stakeholders in the outcomes of the South African education system. While the Maths Centre and other NGOs may work more directly in it and on it on a daily basis, as South Africans we see the reports and headlines. We know the statistics and we know the reality. We all know how critical it is to make every effort to steadily fix the education system, and to ensure that NGOs such as the Maths Centre, whose work is outstanding, act in a manner that renders such support. Why is education important to the South African Reserve Bank? This is not only for all the reasons we are familiar with, but because, as Michael Spence, the recipient of the 2001 Nobel Memorial Prize in Economic Sciences, has noted, “in a world in which knowledge and connectivity are increasingly the basis for value creation, failures in the education system are the surest form of exclusion there is.” It is also because the Bank, in fulfilling its mandate of price stability, touches the lives of every South African, directly or indirectly, and the greater the financial literacy in a society is, the better the understanding of the economy and the more effective is the inclusion in how society functions. So bear with me as I revisit some of South Africa’s educational facts and figures with statistics drawn from the National Planning Commission’s work. As the NPC points out, education is one of the Millennium Development Goals. It is also a prominent feature of South Africa’s Constitution. As such, our education system, one which encompasses just over 14 million learners, has received significant attention from government: • Grade R has been made mandatory for children turning five, resulting in a significant increase in the participation rate of these children. 80.9% were enrolled in 2007 compared to 22.5% in 1996. • Compulsory education for children aged 7 – 15 has been introduced. • Almost 6 million learners are fed nationally through the National School Nutrition programme. • The poorest 40% of our schools are exempt from school fees and have a no fee policy. BIS central bankers’ speeches • An equalisation of per capita government expenditure between races has been achieved. But despite this attention, as we all know, and as the NPC Commissioners put it clearly, “the system is grossly underperforming.” They go on to say that “several comparative studies show that South Africa’s educational outcomes are poorer than many poorer countries. Apart from a small minority of black children who attend former white schools and a small minority of schools performing well in largely black areas, the quality of education received by African learners remains poor. Literacy and numeracy tests are low by African and global standards, despite the fact that government spends about 6% of GDP on education and South Africa’s teachers are among the highest paid in the world (in purchasing-power parity terms)”. At the risk of stating the obvious, the causes and symptoms of this systemic underperformance are complex. Sometimes they seem intractable. But it is almost impossible to overstate the consequences since there is a clear relationship between the education that an individual receives and their prospects in life. Of course, there will always be exceptional individuals who transcend this generally true cause-and-effect relationship; those who, despite their lack of education, make notable successes of their life. Equally, the converse is true; there are many people who, despite all the educational opportunities in the world, never realise their potential. But for most of us, the relationship between education and success is a reinforcing one, one which starts with our socio-economic prospects at birth. It is these prospects which set the first potential parameters of our lives. They have a significant impact on our cognitive ability in early childhood and on the degree to which the foundations of learning, including our capacity to be numerate and literate, will be successfully laid. In turn, these early childhood foundations have a direct bearing on our educational performance in our early school years. These early school years then go on to influence our Matric educational achievement. And despite all the limitations of a Matric qualification, it was for most of us the key determinant of our ultimate educational achievement. It still is. Finally, more than any other factor, it is the quality of our educational achievement that ultimately affects our labour market performance, not least because it is a large determinant of whether we will be able to enter the job market at all. And from there, the cycle continues because our ability to enter the labour market – or not – then goes on determine the socio-economic situation of our own children. This inter-dependency between many causal factors is something that we ignore at our peril. This critical early phase is also one that we too often overlook in our relentless focus on pass rates and one pass rate at that, namely Matric exam results. This focus, while important, occurs far too late in the learning cycle of a child. Without question, Matric results are the obvious and critical ones to measure and assess ourselves against. It is simply unacceptable that we have such poor matric results in such an unacceptably high number of South African public schools. It is wholly without justification that our statistics show that of our university graduates, only 22% of 60 000 students graduated within the specified number of years. With the result that, to use Heather Dugmore’s words, our universities “become playgrounds for those who completed a substandard matric (instead of) places of higher education established to nurture top academic skills” But, as Professor Ruksana Osman, Head of the Wits School of Education pointed out so correctly: “To look at the end result, Matric, and declare the public education system is failing without attending to the issues in early learning gives us a distorted picture of the schooling system as a whole.” She makes it clear that she is arguing “for looking at the teaching and learning BIS central bankers’ speeches input from the earliest stage of schooling and not just the final output of schooling – the matric examination results.” This same point has been made by many others and I could not agree more. We need to be looking at the whole cycle and many indicators of success or signs of failure. We need to be broadening our definition of success to extend beyond just university degrees as an indicator and enabler of skills. Of the experts who have made this point are Mary Metcalfe, Mark Orkin and Jennie Glennie. In a newspaper article earlier this year, succinctly titled “Our pass rate focus is too narrow”, they outlined three critical additional indicators of success for education. The first is retention. In other words, are learners staying in school for a reasonable amount of time? This is not to say that all learners must, or will, finish 12 years of schooling. While this is unquestionably the ideal, the reality will always fall short. But how far does the reality fall short and for how many learners? Any situation where significant numbers of learners are leaving the schools system at a point before which they have a fundamental and critical mass of skill, cannot consider itself successful. The second is quality. Again, this is a self-evident and common sense indicator; one that speaks of meaningful teaching and learning and reasonable proportions of good and excellent marks within a framework of high standards. Access to education is of minimal benefit if the quality of that education is at best only marginally better than no education at all. The third additional indicator of success, over and above Matric pass rates, is equity. When education provides social mobility across issues such as gender, race, income and / or geography, it can be judged to be successful. When a lack of equity entrenches, rather than transcends, social patterns, the opposite is clearly true. Within this cycle of interdependence, and the debates around what successful education really looks like, quality Maths skills are critical – both as ends in and of themselves as well as means to various ends. In the same article I referred to earlier, Mary Metcalfe and her coauthors called Maths results “the litmus test of system quality for the needs of a modern economy.” And once again, the results of our litmus test are deeply troubling. While it is true that South Africa’s Maths pass rates have remained unchanged over the past few years, given that the number of candidates writing Matric Maths has declined, i.e. the denominator has decreased, basic Maths tells us that the numerator must have decreased too for this ratio to have remained constant. And this is precisely the case. The number of maths passes at the 40%-plus level were down from 85 000 to 67 000 for the period 2009 to 2011. Consequently, we have 18 000 fewer matriculants able to enter university programmes requiring this level. This decrease is compounded by marked differences between the provinces. While the pass rates of 27% in Limpopo and 20% in the Eastern Cape are deeply concerning, there is scant consolation to be had from looking at the best performing areas; only 54% of learners in the Western Cape achieved Maths passes at the 40% plus level compared to 45% in Gauteng. In defence of Limpopo and the Eastern Cape, however, it should be noted that 47% and 58% of matric candidates, respectively, at least attempted maths. In the Western Cape and Gauteng, however, it was only 35% and 38%. So, as with many things in life, the first and seemingly obvious problem we are presented with is not always the right problem and / or the only problem. Maths results are a litmus test not only because of the usefulness of maths skills in and of themselves but because such skills help develop a number of integrated thinking skills that BIS central bankers’ speeches are needed, today more than ever, to navigate a complex and changing world. Of course, maths is not the only thing that develops such integrated and integrative skills but it certainly helps lay a foundation. The first of these is creative thinking skills. While it may not seem so to many learners attempting to tackle an impenetrable calculus or algebra exam question, Maths really does help develop creative thinking skills, i.e. the ability to make connections between concepts and ideas that seem unconnected and unrelated. It was Steve Jobs, the founder of Apple, who said it best: “Creativity is just connecting things. When you ask creative people how they did something, they feel a little guilty because they didn’t really do it, they just saw something. It seemed obvious to them after a while. That’s because they were able to connect experiences they’ve had and synthesize new things.” Secondly, maths develops those problem-solving skills that allow people to recognise not only that a problem exists but also to be clear on what the right problem is, and, from there, to devise appropriate means of resolving it. This is a skill that is much more difficult than it sounds. Not least because there is a marked difference between the complex problems of real life and the exercises we get presented with in text books. Thirdly, maths helps develop decision-making skills, i.e. the capacity and competence to weigh up options and trade-offs between alternatives and, in the face of them, to make the best decision you can, at the time that you have to, with the information that you have. Finally, it helps develop the visualisation skills that allow us to imagine how things work – or could work – by looking at drawings, sketches or schematics. These integrative and holistic thinking skills are the ones that, at precisely the time we need them the most, are in chronically short supply. Not least because, in a world irrevocably changed by technology, we all too often fall into the trap of confusing instant access to almost infinite information with knowledge itself. Clearly, information and knowledge are very different. Just as real education is very different from much of the education that gets offered up. Real education is not the rote learning of facts that many of us were subjected to. Instead, it is the development of all our latent abilities. Similarly, real education concerns itself less with teaching us what to think and more with teaching us how to think. With these kinds of pressures facing all of us, the Reserve Bank is as subject as any other institution to the pressure to find positive ways to contribute and meaningfully enhance the capacity of our country. As part of our assessing our impact on stakeholders, the Bank recently concluded an extensive corporate reputation study. It was the first of its kind that we had undertaken and helped us to understand how we are perceived by our stakeholders, what the key drivers of our overall reputation are and what critical improvement areas and areas of strength we should address or leverage to further build our reputation. With the baseline now in place, we will be able to measure our progress as we proceed. The results of the survey were overwhelmingly positive, with the Bank considered highly respected and credible. It was clear that our stakeholders trust and respect us. However, their feedback also made the important point that the excellence that they see in us also imposes additional obligations on us. Specifically, stakeholders want and need us to engage even further with those parts of our society that are facing the most challenges, specifically education and the development of our youth. This feedback was very much in line with what the leadership of the Bank wanted to achieve. We had recognised the need to be more engaging with society and our stakeholders, and as part of a number of initiatives had taken a long, hard look at our Corporate Social Investment (CSI) policy. BIS central bankers’ speeches Of course CSI is only a small component of a company’s overall Corporate Social Responsibility. In the description offered by the World Economic Forum, Corporate Social Responsibility is “the entire contribution that a company makes to society through its core business activities, its social investment and philanthropy programmes and its engagement in public policy.” In the context of the current financial crisis, fundamental questions are being asked of central banks around the world. These questions go to the heart of our Corporate Social Responsibility. What is the role that central banks should have played in averting the crisis? What is the role we should play going forward? What is our contribution to society and to public policy? What should it be? As with education, these are complex, and in some quarters, contested issues. But as these debates continue, one of our responses at the SARB has been to institute a new Corporate Social Investment strategy based on four principles. First of these principles was that the Bank’s CSI policy and activities should be informed. In other words, our funding and partnership decisions should be grounded in research, benchmarking and an understanding of the legislative and other imperatives that underpin the South African CSI environment, one in which billions are spent every year. Education and skills development are universally accepted to be one of the key challenges facing South Africa. It is therefore a critical area for support and investment, not only when it comes to filling the Bank’s needs for skilled and trained employees but also for meeting the many challenges South Africa faces. Secondly, they should be meaningful. We want to ensure that whatever activities the Bank engages in are undertaken in such way that there is a real investment of effort and commitment from our side. This will not only maximise benefit for the Bank but also for partner organisations and, by extension, for society as a whole. Given the Bank’s unique role in the country, as well as its strong base as an institution of knowledge and research, it has a unique opportunity to add considerable value to many organisations, especially those working in education. Critically too, our activities should be partner orientated. We were adamant that the Bank should not seek to “reinvent the wheel”. Instead, it should focus on finding examples of best practice organisations and initiatives and partner with them. As and where the Bank does initiate something on its own, this would be the exception rather than the rule and only where a unique opportunity, one which by definition only we can fill, presents itself. Finally, we agreed that our CSI efforts should be aligned. In other words, we needed to be clear that the Bank’s CSI policy should be congruent with the Bank’s role as the central bank of the country, its strategy and its values. Our consequent focus on education is not only aligned with the Bank’s culture but also with its strategy, one which sees the Bank increasingly positioning itself as a knowledge institution with domestic and international stakeholders. Within our educational focus, there are a number of initiatives that we are very proud of as the Bank. These include our partnerships with three of the country’s universities – Rhodes, WITS and Pretoria. The partnerships with the Centre for Economic Journalism at Rhodes and WITS Journalism were motivated by the recognition that the Bank should seek to actively play a role in improving the level of economics journalism in the country. Monetary policy is a complex subject and it became of increasing concern a few years ago that the reasoning behind our decisions was not always sufficiently understood by the journalists who communicated them to the broader public. Our work with the Chair of Monetary Policy Economics at the University of Pretoria also aims to deepen the understanding of, and research into, the subject and to develop capacity in the field in South Africa and the continent. BIS central bankers’ speeches Our relationship with the South African Institute of Chartered Accountants is also one that we think is an important one given that we are working together to find, and nurture, talented upand-coming learners. At the same time, the generous bursaries that we give to talented students literally provide the potential to change the course of such student’s lives. But the project that we are particularly excited by this year is the pilot MPC Challenge which was initiated at the end of 2010. The Challenge was run in conjunction with the Gauteng Department of Education and modelled on initiatives run by other central banks around the world, including the Bank of England and the Reserve Bank of New Zealand. The aim of the challenge was threefold. Firstly, to increase understanding in South African schools of the role played by monetary policy and of economics. Secondly, to build relationships between the Reserve Bank, schools and learners and, thirdly, to get learners and schools excited about the subject of economics. Eighty three schools from across the province were chosen to participate in the inaugural challenge. The initial selection of schools was done having reviewed all Gauteng schools’ 2011 Matric Economics results. Only schools that received at least a 90% pass rate were invited into the inaugural challenge and invited schools represented all income quintiles and districts. The 56 schools that finally entered needed to select a team of between four and five Matric Economics learners. These teams were given data from the Bank’s Research Department to interrogate over the course of a few weeks in May and June. At the conclusion of the analysis period, each team then submitted a 1000 word essay to the Bank. Team essays followed the same format as the Bank’s Monetary Policy Statement, i.e. analysed local and global conditions and concluded with a decision as to what the country’s repo rate should be. Reserve Bank economists went through the initial essays and choose 5 finalist teams, who were then invited back to present to members of the Bank’s Monetary Policy Committee (MPC). The months of hard work by both Bank staff and learners and schools culminated on the 7th of August at a function at the Bank where Krugersdorp High School’s team were announced as the winners of the inaugural challenge. Both the team and the schools received cash prizes, the winning teacher a laptop and the team also became eligible for Reserve Bank bursaries. If you don’t remember the 7th of August, let me jog your memory by saying that it was the day that it snowed in Gauteng. Members of the Bank’s MPC Challenge team are still convinced that this is less to do with meteorological conditions and more to do with the fact that the walls of the Bank’s Conference Centre auditorium were resounding to the sound of The Black-Eyed Peas’ “I gotta feeling” as part of the winners announcement and celebrations. For those of you who know central banks, this is about as common as snow on the Highveld. The team’s final prize was to come to the Bank on the 20th of September with their teacher and school principal, as my guests, to be present at the live MPC decision announcement to the media. They then joined members of the MPC at a small function hosted in their honour afterwards. The challenge really offered a wonderful opportunity to Matric Economics learners and their teachers to make a very abstract subject come alive; to step into the shoes of the Bank’s Monetary Policy Committee and become central bankers for a few weeks and to be exposed to opportunities that might never have occurred to them otherwise. In this regard, Matthew Lester, a member of the winning team from Krugersdorp High School, made an indelible impression on me and all the judges of the MPC Challenge at the function after the MPC statement. In response to the question “What are you going to do after school?” he quite calmly and confidently informed us that he was going to study economics. While we were all nodding our approval, Matthew followed this up by pointing at BIS central bankers’ speeches Brian Kahn, my special advisor, and announcing that, once he finished his studies he was “going to join the Bank and then take his job.” The feedback from the Gauteng Department of Education, learners, teachers and the Bank’s members of staff who were involved was overwhelmingly positive; so much so that it was clear that we needed to continue with the Challenge and to take it further. How to do this most successfully is being considered at the moment and we look forward to announcing further details as soon as all necessary requirements are finalised. In conclusion, the words of one of the Gauteng Department of Education subject advisers we worked with on the MPC Challenge bear repeating and remembering by all of us. As she said it, “it’s not about how much we pour into learners but how much we plant”. A more feminine version perhaps of the Greek historian Plutarch’s wise admonition that “the mind is not a vessel to be filled but a fire to be lit.” Whichever way you say it though, the need to inspire and act was as true 2000 years ago in ancient Rome as it is in the world of the 21st century. It is as true for the Maths Centre as it is for the Reserve Bank. And it is as true when we work outside our respective organisations with our stakeholders as it is when we work within the boundaries of our organisation with each other. So, as we all navigate extremely challenging times – ones that show no sign of ending soon – may we all work together to contribute to fixing the education system, to plant seeds of hope and opportunity and to light fires of commitment and ability. Only then will we truly be able to deliver on the potential that South Africa holds. Thank you. References http://www.careerkey.org/asp/career_development/thinking_skills.html http://www.mcpt.org/about-us/history.html http://www.npconline.co.za/pebble.asp?relid=132 http://psychology.about.com/od/developmentalpsychology/ss/early-childhooddevelopment.htm http://www.timeslive.co.za/opinion/commentary/2012/01/15/our-pass-rate-focus-is-too-narrow http://www.wits.ac.za/alumni/news/features/12724/educationsystem.html Michael Spence (2011) The Next Convergence: the future of economic growth in a multispeed world. Farrar, Straus and Giroux, New York 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 Seminar, Tokyo, 14 October 2012.
Daniel Mminele: Macro policy priorities during an extended period of global sub-par growth Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the JP Morgan Investor Seminar, Tokyo, 14 October 2012. * * * Introduction Good morning ladies and gentlemen and thank you to JP Morgan for inviting me to share some thoughts with you on what is indeed a very pertinent subject. The topic chosen for my contribution to this seminar, “Macro policy priorities in an extended period of global sub-par growth”, has indeed become a very real challenge for most policymakers around the world. Not surprisingly, your debates and discussions over the past two and a half days highlight just how much of a challenge it is to generate the kind of growth needed in the pursuit of development in an environment where previous engines of global expansion have almost “stalled”. This is particularly so in emerging economies. The fact is, the global financial crisis is now running into its fifth year and yet normalization still looks a long way away. Projections of economic growth made in the years prior to 2008, when increasingly stable price and policy expectations fostered hopes of stronger expansion on a sustainable basis, now look exceedingly optimistic. Between 2008 and 2012, if we take into account the latest projections of the International Monetary Fund, the world economy will have grown by an average of 2.9 per cent a year, contrasting with 4.8 per cent in the preceding five years. Few countries have been immune to this pattern. In South Africa, based on the latest Reserve Bank projections, the 2008–12 average growth is expected to be around 2.1 per cent, down from 4.8 per cent in the previous five years. The typical policy responses to slowing growth Economic cycles have been present for as long as economic historians can remember, and even the policymaker equipped with the best knowledge and intentions would struggle to neutralize their impact. Nevertheless, macro policy should aim at smoothing out the potential variations of economic activity over the cycle, and in so doing, limiting the risk of these variations causing unnecessary, permanent damage to different sectors of the economy. The shallower the recession, the lower the risk is that normally-productive employees will be forced into a long period of unemployment that can lead to a permanent loss of skills. The milder the downturn, the lower the risk is that fundamentally sound, yet temporarily illiquid companies may be forced into bankruptcy. Both sides of macroeconomic policy can play their part. On the fiscal front, maintaining a relatively stable growth rate of public expenditure, even as revenues slow, can dampen the impact of private demand swings on overall activity. On the monetary front, a reduction in interest rates may ensure the continued viability of otherwise threatened capital spending projects; lessen the burden of servicing private debts; limit corporate and individual bankruptcies and discourage the deferment of consumption. Such policies were indeed implemented in South Africa as the economy went into recession in the latter months of 2008. The consolidated government budget balance was allowed to shift from a surplus of 1.0 per cent of GDP in the 2007–08 fiscal year to a deficit of 6.5 per cent of GDP two years later, not through aggressive discretionary spending but by letting the “automatic stabilizers” work as described above. At the same time, the repurchase rate of the South African Reserve Bank was lowered from a cyclical peak of 12.0 per cent in October 2008 to 7.0 per cent by the end of 2009, and to 5.5 per cent by the end of 2010. BIS central bankers’ speeches Dealing with an unusual economic cycle As 2008 drew to a close, it became evident that globally, the response of policymakers to the sharp deterioration in economic and financial conditions was bearing fruit. By 2010, world economic growth had rebounded to 5.3 per cent, and the South African economy, while lagging the pace of the global upswing, nonetheless reversed a 1.5 per cent contraction in 2009 with an expansion of 2.9 per cent in the following year. Yet as I highlighted in my introductory comments, the pace of activity has fallen short of what we had been accustomed to in previous years. In many countries, including South Africa, the output gaps that opened up in the wake of the 2008–09 recession have not closed, implying that unemployment rates remain stubbornly elevated by recent standards, and that an unusually large number of companies operate far below capacity. The nature of the imbalances that built up during the pre-recession boom largely explains this subdued, “L-shaped” recovery. Heavily-leveraged financial and household sectors had to undergo a phase of balance-sheet “repair” that in many instances is still taking place. Households took advantage of interest rate relief to repay some of their liabilities, rather than fund renewed consumption of goods and services. Faced with a higher share of non-performing loans, banks tightened lending criteria, dampening the stimulative effect of lower central bank policy rates. As asset prices adjusted to more realistic levels, the implied negative wealth effect reigned in consumption and banks’ appetite for lending. The gradual reduction of excess housing inventories delayed any recovery in residential construction. We did observe these developments in South Africa, even though the pre-2008 degree of private-sector leveraging had fallen short of what was seen in many developed economies, and as a result, the adjustment required was somewhat less brutal. For a while, the recovery in prices of South Africa’s commodity exports, a direct consequence of Asia’s strong recovery in 2010 and early 2011, partly offset the impact of these internal adjustments. Higher commodity prices boosted the profits of resource exporters; they allowed for some recovery in overall employee compensation; and as the higher terms of trade encouraged a trade-weighted appreciation of the rand, they further boosted real disposable income via a decline in imported inflation. It was no coincidence that growth in South Africa in 2010 and 2011 was strongest in the consumer sector, and in particular goods consumption. But even this “safety valve” seems to be gradually closing. South Africa’s terms of trade have now declined for three consecutive quarters up to the second quarter of this year. The most obvious impact of this deterioration has been on the current account deficit, which increased from 3.3 per cent of GDP on average in 2011 to as much as 6.4 per cent in the second quarter of 2012, the largest shortfall since the third quarter of 2008. But economic growth has also borne the brunt from poorer terms of trade, as well as slowing global demand, domestic work stoppages, and business concerns over the long-term supply of energy and skilled labour. At the time of the September MPC meeting, the Reserve Bank projected GDP growth to decelerate to 2.6 per cent this year from 3.1 per cent in 2011, and to re-accelerate to 3.4 per cent in 2013, but warned about possible downside risks to this forecast. The room for fiscal support is closing How can policymakers respond to extended low growth? In most cases, it would be futile, and indeed erroneous to try and prevent some of the adjustments mentioned above. Healthier bank and household balance-sheets, more reasonably valued assets, and the end of demand-supply mismatches in the real estate sector are conditions necessary for a more solid, sustainable recovery. Yet policymakers cannot stand idle and wait for these imbalances to resolve themselves. The experience of the 1930s is there to teach us that failure to act, or an anchoring of policy to standards that are no longer adapted to the economic realities of the day, can easily turn low growth into a recession, and a recession into a depression. If structural adjustments in an economy result in an elevated degree of BIS central bankers’ speeches slack for an unusually long period, then the macro policy mix should equally be characterized by an unusually long phase of accommodation. This way, the risk of permanent damage to the economic tissue will, if not removed, at least be mitigated. Yet should it be the fiscal or the monetary policymaker at the forefront of this response? Over an extended period, both policies are not perfect substitutes. Running large budget deficits for several years (say, for as long as the output gap remains sizeable), will quickly raise public debt as a share of GDP. In turn, this will result in a greater share of state resources being absorbed by the service of that debt; a higher risk premium embedded into domestic interest rates as bondholders worry about fiscal sustainability; and potential capital outflows as a consequence thereof. At worst, deteriorating public finances could more than offset the impact of monetary stimulus. It should be remembered that Spain, currently mired in recession and facing an elevated credit risk premium on its sovereign debt, had the second largest budget surplus in the euro zone (2.2 per cent of GDP) in 2007, and a debt ratio of 36 per cent of GDP. In a word, prior to the crisis, Spain did not have a fiscal problem. Prudent fiscal management for almost two decades means that South Africa does not face at present a meaningful fiscal constraint. At a projected 36 per cent of GDP in the present fiscal year, public debt is way below the levels seen in most developed economies, and relatively in line with the emerging world’s average. Nonetheless, the situation leaves no room for complacency, and indeed the scope for responding to the current lack of strong economic momentum with additional fiscal stimulus appears very limited. The South African government has on many occasions reaffirmed its commitment to gradually reduce the budget deficit, so as to ensure that the net debt to GDP ratio stabilizes no higher than 40 per cent. It is in part for that reason that the National Budget presented in February 2012 targets a reduction in the deficit from 4.6 per cent of GDP in 2012/13 to 3.0 per cent in 2014/15. Does the responsibility now shift to the Reserve Bank? Does this relative fiscal constraint mean that the responsibility of “sheltering” the economy from unnecessary strains largely rests on the shoulders of the Reserve Bank? Once again, such an argument must be nuanced. Monetary policy cannot, on its own, generate stronger and sustainable growth in the long run. Ultimately, all it can do is provide a framework of price and financial stability that facilitates the private sector’s decision to invest, save and plan for the future. However, persistent economic slack normally dampens inflationary pressures, and as a result, the central bank should be able to keep the level of interest rates below their medium-term norm without endangering its long-term goals of price stability. This ability, however, is influenced by other factors, notably the stability of longer-term inflation expectations, the degree of rigidity in the wage and price formation process, and the level of imbalances in the economy and financial sector. Stable inflation expectations are an indication of the credibility of the central bank and of how confident economic agents are that it will not tolerate price slippages in the longer run. This stability therefore significantly reduces the risk of undesirable consequences from a reduction in interest rates. It is encouraging that in South Africa, broad-based measures of inflation expectations – based on surveys of businesses, trade unions as well as market analysts – remain anchored at around the upper end of the target range, despite the recent elevated volatility of the energy and food components of the CPI basket. South Africa is often described as a country with relatively rigid wage and price settings. There is undeniably some truth in that assertion, and the relatively large losses in privatesector employment in the recession of 2008 and 2009 – both when compared to the contraction in GDP and to international trends – seems to illustrate the sticky, backwardlooking pattern of wage settlements in South Africa. Yet, core measures of inflation – including in private services, where labour is a major input cost – remain benign by historical standards. The major impact of elevated wage demands so far seems to have been BIS central bankers’ speeches more on employment levels, as firms sought productivity gains to avoid having to raise prices more quickly. Admittedly, the tragedy at the Marikana platinum mine in August this year, followed by a spate of labour protests, some of them illegal and often violent, in other mining or economic sectors, has refocused the attention of financial markets and rating agencies alike on South Africa’s labour market challenges. While there are at this stage no indications of a broadbased, sharp acceleration in wages as a result of recent protests, the Reserve Bank will have to carefully monitor possible spillovers of any such development into prices and price expectations. We have already seen an impact on the exchange rate of the rand, which almost touched R9.00 against the USD about a week ago. The rand appears to have decoupled from the EURUSD movements, taking its cue instead from domestic developments, including the credit rating downgrades, widespread strike action and the current account deficit. Growth forecasts will most likely need to be revisited. As for the recent actions by rating agencies, these were obviously unfortunate and disappointing developments. The South African authorities are concerned about assessment of the South African credit at this point in time by the two rating agencies that recently adjusted their ratings. It has to be acknowledged, however, that some of the challenges they are pointing out, that as South Africans we need to deal with, are not new, are known to us and are in fact valid. As already indicated, we will have to, collectively inside and outside government, and in a coordinated and consistent manner, engage rating agencies, to communicate the strength of the fundamental underpinning of the South African economy and its institutions, and more clearly convey our commitment to addressing areas of weakness and potential vulnerability highlighted, and to put South Africa on a different rating trajectory going forward. Macro-prudential variables are also key to a central bank’s margin of manoeuvre in responding to adverse economic shocks, and the Reserve Bank is paying particular attention to these indicators. Indeed, back in April this year, the IMF pointed out in its World Economic Outlook that emerging and developing economies needed to “avoid over-stimulating activity to make up for less demand from advanced economies”, pointing to the risk of overheating pressures from activity, credit growth or high commodity prices. But in contrast to some of its peers, South Africa benefits from a relative absence of such potentially inflationary pressures. Private credit growth has remained in single-digit territory for more than three years now; home prices are failing to display any clear uptrend in real terms; and the banking sector’s prudent approach to lending has enabled a decline in impaired advances to 4.4 per cent of total loans and advances, from 5.5 per cent a year earlier. A caveat is the current account of the balance of payments, which has emerged as a risk to the exchange rate outlook. It is against this background, and noting the increase in downside risks to the economy from global developments, that the Monetary Policy Committee of the Reserve Bank decided on 19 July 2012 to reduce its repurchase rate by 50 basis points, to 5.0 per cent. The MPC still deemed this stance to be appropriate as of its meeting of 20 September 2012, supported by projections of benign inflation over the forecasting period. As of that meeting, the Reserve Bank projected a relatively flat trajectory for consumer price inflation, averaging 5.3 per cent on the final quarter of 2012, 5.2 per cent in 2013 and 5.0 per cent in 2014. The MPC made it clear, however, that future global and domestic developments, and their potential impact on the risks to the outlook, would guide decisions going forward. The potential impact on consumer prices of future wage trends, as well as of the recent rand depreciation – if sustained over the coming months – will of course be closely monitored in that respect. Ultimately though, additional central bank policy action in response to a weakening growth outlook would only be able to limit deviations in economic output from its potential. To the extent that a prolonged moderation in economic growth is structural and not cyclical, these challenges are most effectively addressed by measures which are geared towards reducing BIS central bankers’ speeches an economy’s rigidities, such as facilitating a fair price formation process and clarifying the long-term outlook for potential investors. The best way a central bank can assist in attaining these goals, is through the entrenchment of price stability over the longer run. I thank you. BIS central bankers’ speeches
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Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Afrikaanse Handelsinstituut (AHI) National Congress, Kruger National Park, 19 October 2012.
Francois Groepe: The role of business in the National Development Plan (NDP), to deal with the threefold challenge of unemployment, poverty and inequality by 2030 Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Afrikaanse Handelsinstituut (AHI) National Congress, Kruger National Park, 19 October 2012. * 1. * * Introduction Chairperson, ladies and gentlemen, I can truly say that I am pleased to be part of the proceedings of the day, hosted at this beautiful venue. In addressing my topic, namely “The role of business in addressing the threefold challenges that unemployment, poverty and inequality pose to our society”, particularly highlighting the role that small and medium sized enterprises can play in addressing these issues, it is necessary for us to first reflect on the current state of affairs. 2. Inequality in South Africa Most recently, the World Bank in its assessment of South Africa, said that for South Africa to create jobs and reduce unemployment, it needs to tackle economic inequality. It goes on to say that South Africa can be considered as one of the most unequal countries in the world with the most recent estimate of the Gini coefficient being 0,69. The so-called Gini coefficient is an internationally accepted measure that indicates the degree of income inequality in a country. The higher the coefficient, the more unequal the income distribution is. Despite the fact that this Gini coefficient is disputable given that the Government Social Grants system was not taken into account when this measure was calculated, I am sure that none of us will dispute the fact that inequality and poverty is rife in our country. In South Africa, it is estimated that the top ten per cent of the population earn as much as 58 per cent of the income, the bottom ten per cent as little as 0,5 per cent, and the bottom 50 per cent less than eight per cent. Inequality is a reality and simply forms part of any deliberations when it comes to steering a new course of development in this country. At the heart of high inequality lies the inability to create employment opportunities on a large enough scale. South Africa’s unemployment rate of 24,9 1 per cent1 in the second quarter of this year, is amongst the highest in the world. Admittedly, we are no longer an outlier when compared with countries such as Greece and Spain, but that of course does not make it any more acceptable, recognising also that the high unemployment rates in these countries has not been a persistent problem but rather owing to the severe debt crisis facing Europe. It is worth noting that social grants constitute as much as 70 per cent of the income of the poorest 20 per cent of this country’s citizens. Had it not been for these grants, around 40 per cent of South Africans would have seen a decline in their income in the new South Africa during the first decade post 1994. To reduce inequality to more reasonable levels over the long run, social assistance is clearly not enough and should be complemented by other initiatives. These levels of social assistance are not sustainable over the long run and may be somewhat counter-productive in the end. Statistics South Africa BIS central bankers’ speeches Focussing on the development of human capital, particularly among the youth, given our youth unemployment level which stands at 50 per cent, is paramount. Similar opportunities have to be created for all, regardless of personal background and circumstances, race, gender or geography - this should be our uncompromising goal. Access to a basic set of goods and services during childhood could be an important predictor of future outcomes, including educational achievements and earnings. These basic services comprise education, health care, essential infrastructure such as water, sanitation and electricity, and early childhood development programmes. In South Africa, access to these services is affected by factors such as ethnicity, including gender, the composition of households, taking account of the number of children in the household, the education level of parents, the gender and age of the person heading the household, orphan status, and where the household resides. Encouragingly, near universal access to schooling for those under the age of 16 has been achieved in South Africa, but access to certain other services is found to be lacking. The services that are not that universally readily available include health insurance, safe water supply, improved sanitation, adequate space without overcrowding. Opportunities such as early childhood development programmes, neighbourhood safety and access to electricity are found to be somewhat less problematic. Following from the assessment that the World Bank has done on South Africa, despite it being found that school attendance is comparable to other countries, the school completion rate falls short of that of our peers. Children’s inequality is mainly shaped by circumstance, and inequitable access to opportunities also affects the labour market. The causes of unequal access to available jobs have changed in recent years with education and location becoming more prominent. Education deficiencies now account for more than 50 per cent of the inequality of employment, with the premium for skills rising continuously. In an assessment of the quality of state education amongst 142 countries, South Africa’s ranking was 133, despite having one of the highest rates of government investment in education in the world, with expenditure reaching R207 billion for the 2012/2013 financial year. These outcomes necessitate an urgent and critical review of our education system and its outputs. 3. The National Development Plan The National Development Plan (the Plan) offers us some hope in this regard, with its central focus being the elimination of unemployment, poverty and inequality by 2030. Within this Plan, nine main challenges are being highlighted, including, inter alia: • Too few jobs; • The standard of education for most black learners is of poor quality; • Infrastructure is poorly located, under-maintained and insufficient to foster higher growth; • Spatial patterns exclude the poor from the fruits of development; • Public services are uneven and often of poor quality; etc It is most encouraging that business investment is identified as the cornerstone of the new proposals within the National Development Plan, aiming to create 11-million jobs and eliminate poverty by 2030. It sets a target of reducing the unemployment rate to 14 per cent in 2020 and to 6 per cent in 2030, while increasing the labour force participation rate from 54 per cent to 65 per cent. Per capita income is also envisaged to increase from about R50 000 per year currently to about R120 000. It is worth emphasising that it is envisaged that 90 per cent of jobs should be in small and expanding firms with the goal of mass entrepreneurship. BIS central bankers’ speeches The Plan is business friendly in that it suggests that some labour regulations be loosened in an effort to encourage business enterprises to employ more easily, as well as lower entry-level wages to facilitate a higher uptake of young people in the jobs market. Some of the proposals in the Plan are in conflict with those of organised labour, and will require intense negotiations and possibly trade-offs prior to implementation. The Plan takes a pragmatic and broad-based approach to the challenges that South Africa faces in eradicating unemployment. The role that the Plan sees for government’s intervention is permeated with a greater willingness to work with the private sector, as it leans towards less regulation of the economy. The Plan envisages small and expanding companies creating around 90 per cent of the new employment opportunities in the economy in the next 20 years. This will place South Africa in step with global employment trends. Small firms would benefit from bold proposals to drastically reduce so-called “red tape” and improve employment and dismissal procedures. The National Development Plan continues by indicating that the economy will be more enabling for business entry and expansion, with an eye to credit and market access. Regulatory reform and support will also boost mass entrepreneurship. The topic of strained labour relations is also addressed, indicating that it is inconceivable that the economy will evolve into a more labour-intensive structure if tensions between employers and labour persist. These tensions need to be dealt with in a transparent and honest manner to be conducive to enhanced labour absorbing growth. Central to the propositions made in the National Development Plan related to the jobs market, is the statement that over a 20-year horizon, wage growth needs to be linked to productivity growth as it is not feasible to sustain a labour absorbing path unless both are growing in tandem. In an effort to enhance the labour absorption rate of the economy, the Plan advocates a tax subsidy to employers to reduce the initial cost of employing a young labour-market entrant, and facilitating an agreement with labour unions on entry level wages. The Plan goes further in suggesting a subsidy to the placement sector to secure, prepare and place matric graduates in work opportunities. It is also proposed that dismissal procedures for performance or misconduct be simplified, and that compliance requirements for employment equity and skills development rules for small companies be simplified, or even done away with. A small business should be afforded the opportunity to focus on making its business work, within a nurturing environment that will enable it to grow, in the process creating more employment opportunities. In developing such a nurturing environment, cognisance should be taken of the fact that small businesses are diverse in nature, each with its own unique set of needs. Small businesses operate in both the formal and informal sector, where some can be classified as survivalist, while others are being managed by individuals with entrepreneurial flair. Also, some are start-ups, other are growing rapidly while others are well-established and of a stable nature. The level of business skills also differs from inexperienced to highly sophisticated. The markets in which they operate range from local, national to global. It is of crucial importance that these diversities be reflected in any policies and actions taken to support the small business sector. Over and above the focus on the jobs market, the National Development Plan also advances some frank recommendations in areas such as education, health and the public sector, as part of the creation of a nurturing and enabling environment for business to prosper, and create those jobs that we so urgently require. A set of integrated actions is being proposed to address the issue of inefficiency and a lack of service delivery by the state. To improve educational outcomes, the Plan head-on confronts issues such as teacher performance, appointment procedures and accountability. The challenges in public health management are also addressed, and in building a capable state, detailed recommendations are made on professionalising the public service. Some areas of Government where improvements have occurred, include both the Department of Home Affairs and at the South African Revenue BIS central bankers’ speeches Service, through an improvement in operational procedures, management and delivery systems. These improvements should be emulated by all other organs of state. The implementation of this Plan will surely require decisiveness on the part of the state and a strategic approach to negotiations, in an effort to build trust between all stakeholders in the economy. The National Development Plan constitutes a powerful, integrated and inspiring development agenda for the state and the whole of South Africa, and for the Plan to bear fruit, it must not only be accepted as a policy framework by Government, but should be translated into a plan of action, with clear milestones along the way, within realistic time frames. 4. The role of business To honour the main purpose of my talk this morning, it is necessary for us to now proceed with a focussed discussion of the contribution that business can make in addressing unemployment, poverty and inequality. It is imperative that youth unemployment receives a special focus, because low participation of young people in the economy constrains future economic growth and will have profoundly harmful consequences for poverty levels, equity, social stability and the self-worth of unemployed people. In South Africa, there are a number of factors that act as disincentives to the employment of new labour market entrants, such as a lack of appropriate skills, high wages in relation to productivity, high training costs and somewhat inflexible labour legislation. Processes to bring young people into the labour market require somewhat of a developmental approach where dedicated youth programmes need to target the youth and then effectively screen, select and place them. Anecdotal evidence suggests that placement costs are exorbitantly high, creating opportunities for business to innovate more cost effective screening and placement processes, thereby raising the overall effectiveness of the system to absorb labour. In collaboration with Government, Business can contribute project management, process and administration skills to assist government in addressing capacity shortfalls in the most expedient manner possible. For these collaborations to be productive an environment of trust must be cultivated between all constituencies. In South Africa, the level of trust between government and business is particularly low, and has on numerous occasions been highlighted as a serious impediment to progress. From the side of Business, an acknowledgement should be fostered that trust requires a dual responsibility and that more should be done to build bridges with government. Known instances where private sector service providers have rendered work of extremely poor quality in deliverance of tenders been awarded to them by the state, do not contribute towards establishing trust between parties. In an effort to try and eradicate such practises that undermine trust between parties, there is much room to accommodate private-sector initiatives with the aim of combating these undesirable practises. Similarly, postponing, and in some instances not honouring contractual payments from the state’s side for services rendered by private sector companies, also do not contribute to a harmonious relationship from developing between the state and the private sector. The focus within the National Development Plan on the eradication of corruption from the system is most welcomed, in taking cognisance of the fact that for corrupt state officials to be accommodated within the system, a willing counter party from the private sector is necessary. There are no innocent parties in this battle; a battle that we must jointly tackle, bringing all perpetrators to book. The National Development Plan recognises the need for increased fixed investment in the economy. In fact, it sets a target of raising the level of gross fixed capital formation from around 17 per cent of GDP currently, to as high as 30 per cent by 2030. Inarguably, well-planned and appropriate infrastructural development is conducive to higher levels of economic growth and job creation. The Development Plan clearly distinguishes between BIS central bankers’ speeches investment that generates immediate financial returns such as in airports, power stations and toll roads and those projects where financial returns are far less measurable such as in schools and hospitals. The role of business in increasing the overall level of fixed investment in the country, will most appropriately lie in the area of fixed investment where financial returns are more lucrative, through public private partnerships. International experience has shown that private sector participation in infrastructure provision is most successful in the transport and energy sectors. The participation of the private sector contributes to effective cost containment through the profit motive, improves efficiency and leads to more sustainable jobs through more prudent skills transfer. In the process complementing the capacity of the state by addressing gaps that are not viable for the state to attend to and taking on development risks. An area in which the private sector can excel, given appropriate incentives, is that of research and development which act as a driver of competitiveness and job creation. Many infrastructure investment projects can act as an attractive asset class for private investors due to the predictable nature of returns, thereby providing a low risk investment profile. Infrastructure investment projects may provide a means whereby a consistent real return over inflation can be attained through a low volatility investment vehicle. Private sector funding is, however, subject to policy certainty so that private investors can be assured that they will be able to realise a return on their investments. To this end, the National Development Plan proposes that Regulatory Impact Assessments be done on all new regulations, and that an expert panel be appointed to prepare a comprehensive regulatory review for small- and medium-sized firms in an effort to assess whether special conditions are required for such establishments. The implementation of this proposition by the National Development Plan will create a direct channel for business to assist in the formulation of new regulations. For the establishment of small-, micro- and medium-sized enterprises or SMMEs, as they are better known, that have a crucial role to play in the creation of sustainable jobs in the economy, a spirit of entrepreneurship within the economy should be cultivated, anew. Instead of talking jobs, I also advocate that we should start talking the establishment of SMMEs and how an environment of support to these enterprises can be created, and also how SMMEs can best interact with their environment to increase their likely hood of survival and ultimately expansion. It is a common feature across countries to make available large amounts of money in an effort to try and facilitate the growth of SMMEs. Disconcerting though is the fact that limited systematic research or data are available informing the various policies in support of SMMEs, especially in developing countries. Moreover, empirical evidence concerning the relationship between the size of firms and growth has been mixed. Recent work on this topic by Haltiwanger, Jarmin and Miranda suggests that so-called “start-ups” and surviving young businesses are most critical for job creation and contribute disproportionately to overall employment growth. It is found from this study that was carried out across 99 developing economies between 2006 and 2010 that small- and medium-sized enterprises are the largest contributors to employment across countries but that SMMEs contribute more to employment in low-income countries than in higher-income countries. Across countries, firms that are both small and that have been in existence for more than 10 years employing between 5 and 99 employees have the largest proportional share of total employment compared with other size-age groupings. Small and mature firms do not only employ the largest number of people, but they also create the most new jobs, across country income groups. While SMMEs are found to create more jobs, their contribution to productivity growth is found to be less than that of larger firms. Growth and increases in productivity amongst SMMEs require that policy should be focussed on the likely obstacles faced by SMMEs that range from a lack of access to finance, the need for business training and literacy programs as well as addressing other constraints such as taxation, regulations and corruption. BIS central bankers’ speeches It is interesting to note that SMMEs in the United States have created as much as 80 per cent of all new jobs over the past 10 years and account for over 98 per cent of all employers. In India, the figure is closer to 90 per cent and similarly in Ghana it is estimated to be in excess of 90 per cent. In South Africa, small firms employing less than 50 people are falling short of 70 per cent of employment. Of some concern is the fact that South Africa is ranked 44th in the world for “ease of starting a business”. It takes around a month and 5 procedures to start a new business in South Africa, whereas in New Zealand, one combined procedure executed within one day, can accomplish the same outcome. The World Economic Forum places South Africa in the 112th position regarding the “Burden of Government Regulations”. The proper implementation of the National Development Plan will be conducive to an increased level of entrepreneurship in the economy, as the ease of doing business improves. The obvious outcome of such a process will be the creation of jobs with longevity, unlike those jobs that sometimes follow projects undertaken by the state in an effort to address the scourge of unemployment, that are not sustainable over the long run. Small businesses generally have the capacity to attract those who are low to moderately skilled, and are therefore best placed to engage the overwhelming pool of the unemployed. Small businesses should not only rely on tax incentives for encouragement to expand their businesses but should also drive the agenda in an effort to engage government in seeking most appropriate ways to incentivise their activities. The premise of this approach lies in the fact that small business is in the best position to tell what is restricting their own operations, unlike officials who sometimes have limited insight into sector specific issues. In short, instead of pushing the proverbial string from behind to make it move, rather start pulling it from the front by collectively making small business’ voice heard, more so than in the past. In this regard business formations, such as the AHI, have an important role to play. Larger companies holding monopolies based on incumbent technologies generally have less incentive to innovate than potential rivals, and could therefore eventually lose their technological leadership role, when technological innovations are introduced by new firms, as they leapfrog ahead, taking on risks. The adoption of solar energy technology is an example of an area in which small businesses could leapfrog ahead, as countries become more inclined to embrace a Green Growth development approach, as we enter the so-called Solar Age. The benefits derived from the expansion of business linkages should also not be underestimated. So-called vertical business linkages that can be both backwards, where large companies acquire goods and services from small businesses, or forward, where large companies sell to small enterprises or distribute their goods and services through them, should actively be pursued. Small enterprises should also consider to more actively join themselves in groups to increase their capacity to access markets through combined production for large orders or collective purchasing to secure better purchase prices. Such initiatives can also be beneficial in assisting small-scale farmers entering the agricultural sector. More opportunities should also be created for informal business socialisation which is important for entrepreneurial success, through sharing of experiences, developing of peer networks and the establishment of role models to be emulated. Peer groups create an environment in which members can share their challenges, brainstorm solutions and acquire additional information that can be to their benefit in running their businesses. Learning from the peer group can contribute to small business development, establish business linkages, build business confidence, expand business relationships, help shape corporate expectations and also contribute to the cultivation of business professionalism. Once again the AHI is well positioned to facilitate such interaction learning and sharing which can be crucial in assisting SMMEs to reach new levels of performance. BIS central bankers’ speeches 5. Conclusion Ladies and gentleman, I wish you well during your deliberations for the rest of the day as we search for new and innovative ways to address the challenges that we collectively face in an effort to make this country of ours truly great, in amplification of the inspiring achievements of Teams SA at the London 2012 Olympic games, that have made us all proud. I thank you. BIS central bankers’ speeches
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Introductory remarks by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the launch of the September 2012 Financial Stability Review, Pretoria, 24 October 2012.
Lesetja Kganyago: South Africa’s Financial Stability Review – key issues in September 2012 Introductory remarks by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the launch of the September 2012 Financial Stability Review, Pretoria, 24 October 2012. * 1. * * Welcome and introduction Members of the press, Guests, Colleagues, Ladies and gentlemen. Welcome to the release of the September 2012 edition of the Financial Stability Review. The Financial Stability Review has been published semi-annually since 2004 to promote a stable financial system. In addition to its primary objective of price stability, the Bank has a mandate to oversee and maintain financial stability. In pursuit of this mandate and to 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. Through the publication of the Financial Stability Review the Bank endeavours to communicate its assessment of potential risks to financial system stability and the mitigation thereof. The Bank also hopes to enhance the understanding of, and encourage informed debate on these complex and challenging matters related to financial stability. 2. Key issues from the September 2012 Financial Stability Review 2.1 International macro-financial developments Since the publication of the March 2012 Financial Stability Review global economic growth has remained weak and the volatility in global financial markets persisted. The negative prospects for economic growth in advanced economies are not only affecting emerging-market economies in various ways, but are also posing serious threats to global financial stability. Downside risks to growth such as elevated levels of unemployment, continued uncertainty for a lasting solution in the euro area, and the threatening fiscal cliff in the United States present serious challenges to financial systems globally. The programmes of increased liquidity provisioning by central banks in the United States, Europe, Japan and the United Kingdom would hopefully mitigate these threats. Although emerging market economies remain important drivers of global economic growth, concerns about the structural nature of the economic slowdown in China have led to fears that the slowdown may be protracted and may have significant economic and financial implications for other emerging market economies in particular. The volatility in capital flows to emerging economies has also increased as global uncertainty causes regular changes in the risk appetite of investors. BIS central bankers’ speeches Impediments to global economic growth are also challenging the resilience of economic growth in sub-Saharan Africa. 2.2 Domestic macro-financial developments The uncertain and subdued global economic environment also negatively impacted on real economic activity in South Africa. As a result the Bank’s forecasts of growth in real GDP for 2012 and 2013 have been revised down. Although confidence in the financial services sector has recovered strongly in 2009 and remains at high levels, confidence still has not returned to its pre-crisis level. The banking sector plays a key role in the stability of the South African financial system and remained stable during the first half of 2012: • the sector remained adequately capitalised in terms of the current minimum regulatory requirements; • banks continued to post healthy profitability numbers, supported by generally improved quality of assets; • although the banking sector’s total unsecured gross credit exposure increased further in the first half of 2012, it remains only about 10 per cent of total gross credit exposure of the sector; • the sector’s credit exposure to counterparties with legal jurisdiction in the GIIPS countries (Greece, Italy, Ireland, Portugal and Spain) remained insignificant with negligible exposure to sovereigns; • draft 2 of the proposed amended Regulations relating to Banks, incorporating all Basel III related changes, was published in August in preparation of the adoption of Basel III as from 1 January 2013 in South Africa. The life insurance industry maintained adequate capital buffers, and healthy increases in income contributed positively to confidence levels in the industry. The Financial Services Board as the regulator of insurance companies is in the process of implementing the Solvency Assessment and Management framework for the insurance sector. This framework is aimed at enhancing the soundness of domestic insurance companies and protecting policyholders through a risk-based solvency regime. The domestic bond market generally performed strongly in the first half of 2012, underpinned by South Africa’s inclusion in Citibank’s World Government Bond Index. Domestic financial markets, nevertheless remained vulnerable to global oil and food price shocks as well as to domestic concerns following turmoil in the labour market. As important clients of banks, conditions in the corporate and household sectors play an important role in gauging the stability of the financial system: • in the corporate sector much needed investment is still lacking, but recent data suggest a slight but broad based recovery in business confidence in the third quarter; • the household sector’s appetite for debt seems to be increasing further, but data show that their savings portion of disposable income also increased, albeit only marginally; • the declining trend in consumer confidence was borne out by a weakening Consumer Financial Vulnerability Index as well as a decline in the FNB/BER consumer confidence index; BIS central bankers’ speeches • in addition, residential real-estate market activity remained under strain as growth in mortgage advances by banks remained subdued, also negatively impacting profitability and confidence in the building and construction sector. 2.3 Infrastructural and regulatory developments Regulatory reforms currently in the process of being investigated or implemented that would enhance the robustness of the financial regulatory environment in South Africa include: • progress made with the implementation of a twin peaks model of financial regulation in South Africa; • enhanced standards for bank capital and liquidity through the implementation of Basel III; • the development of legislation for risk-based supervision of insurance groups; • the strengthening of resolution regimes; • resolution planning for systemically important financial institutions. Internationally, the harmonisation of standards and principles for payment, clearing and settlement systems applied to systemically important payment systems and financial market infrastructures is also being investigated, while the oversight and regulation of shadow banking are being strengthened. 2.4 Concluding remarks The South African financial system has proved to be relatively resilient in the wake of a volatile and uncertain global environment and some domestic socio-economic concerns; Although the recent conjuncture is uncertain and several challenges remain, the financial system is generally sound. 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 invite you to engage with the Review as part of the important process of ongoing debate on financial stability. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the G-20 Study Group, "South Africa and the G-20 - challenges and opportunities", Southern Sun Pretoria, 31 October 2012.
Daniel Mminele: South Africa and the G-20 – challenges and opportunities Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the G-20 Study Group, “South Africa and the G-20 – challenges and opportunities”, Southern Sun Pretoria, 31 October 2012. * 1. * * Introduction Good afternoon ladies and gentlemen. Thank you to the South African Institute of International Affairs and the Centre for Human Rights at the University of Pretoria for the kind invitation to participate in this study group meeting. I have been asked to introduce today’s discussion by sharing some thoughts with you on the G-20, insofar as South Africa, including the central bank, has thus far experienced and shaped our relationship with this global forum. I have no doubt that there is a lot to learn from each other on this topic, and I look forward to the discussion later and to the contributions from the discussants sitting on the panel with me. 2. G-20 and its participation structures As much as you may all be quite familiar with the G-20, I thought it best to start with a brief review of the forum, so as to better place the discussion in context. Established in 1999, comprising 19 countries and the European Union, the G20 was initially a forum of Finance Ministers and Central Bank Governors. The group was created in response to the Asian financial crisis of the late 1990s, and as reflected in its founding mandate, its role is “...to prevent another regional or global financial crisis” through the involvement of systemically relevant advanced and emerging-market economies in discussions relating to the global economy and global economic governance. Since inception, G-20 Finance Ministers and Central Bank Governors have met annually, however, in the wake of the global financial crisis in 2008 it was recognised that given the enormity of the crisis, coordination at the highest level of member countries was required, and this resulted in the forum starting to meet at Heads of State/Heads of Government level, with the first so-called Leaders’ Summit convened in Washington, D.C. by US President George Bush. As you are aware, six more such summits followed, with the most recent taking place in June this year in Los Cabos. At the 2009 Pittsburgh Summit, G-20 Leaders declared the G-20 the premier forum for international economic co-operation, effectively replacing the G-7 which comprised only the advanced economies. This move was in recognition of the critical role emerging-market economies could play in driving global growth and their potential to provide resources for global financial stability and contribute to in crisis prevention and resolution initiatives. The G-20 has no permanent secretariat of its own, and the G-20 chair rotates among members, selected from a different regional grouping of countries each year. The incumbent chair establishes a temporary secretariat for the duration of its term, co-ordinates the group’s work and hosts its meetings. The work of the G-20 is organised in two main streams or tracks: the so-called “Sherpa track”, which prepares for the Leaders’ Summits, and the “Finance track”, which prepares for Finance Ministers and Central Bank Governors’ meetings. The Leaders’ Summits are attended by the Heads of State, Finance Ministers and Foreign Affairs Ministers. Central Bank Governors do not generally participate in the Leaders’ Summits, but in some instances do form part of the government delegation. G-20 Finance Ministers and Central Bank Governors meetings, as well as Leaders’ Summits provide political guidance and direction on BIS central bankers’ speeches the key focus areas of the G20 work programme. Work of a technical nature is normally undertaken by G-20 working groups and study groups, as well as key international organisations and standard setting bodies, providing regular interim reports to Finance Ministers and Central Bank Governors in the build-up to the Leaders’ Summits. The dialogue, especially under the Mexican Presidency, has been broadened to include a multitude of consultative fora, such as the so-called B20 (global business leaders from member countries), G20YES (Young Entrepreneurs Summit), Think20 (academia and think tanks), Y20 (Youth Forum), L20 (trade unions from member countries), as well as meetings of G-20 Agricultural and Trade Ministers. Essentially we are now looking at the G-20 being a forum which addresses wide range of economic, financial, social and cultural issues. 3. The agenda of the G-20 The Presidency of the G-20 in a particular year develops its agenda in consultation with the other members of the forum. The G-20 Troika, consisting of the past, current and next presidency of the G-20, plays a major role in this regard. The Agenda of the G-20 has evolved over the years, although the focus has remained broadly unchanged since the 2008 global financial and economic crisis. Much of the work in the G-20 has since revolved around three key areas, namely: a. Policy coordination between members in an effort to achieve global economic stability and sustainable growth; b. Promoting global financial regulation to reduce risks and prevent future crises; and c. Reform of the international financial architecture/international monetary system. Other areas of focus are development issues, commodities, and climate finance. A number of working groups have been formed since 2008, and South Africa has been nominated to co-chair some of these working groups, such as the Reform of the IMF, Development, Financial Inclusion and the Climate Finance Study Groups. South Africa also participates in all the working groups, contributing to the discussions and putting forward our country positions and views and to ensure that our positions are captured in meetings of the Finance Ministers and Central Bank Governors, and at Leaders’ Summits. Although G-20 documents have no legal status, they serve as binding statements for members, and are a basis for further work. I thought I would briefly give you a flavour of how the work of the G-20 has evolved over the years, although much more detail is available on the G-20 website. Leaders’ Summits are the key agenda setting fora, and I will touch on some of the key milestones in this regard. The first G-20 Summit in 2008, held in Washington D.C. during the very early stages of the global financial crisis, was primarily focused on G-20 co-operation, strengthening economic growth, dealing with the financial and economic crisis, and laying the foundation for stricter financial regulation. There was also recognition of the need to reform the IMF, World Bank and other Multilateral Development Banks (MDB) and the need to resist trade protectionism and work towards the conclusion of the Doha Round. During the London Summit in April 2009, the focus turned towards co-ordinated fiscal and monetary stimulus measures to avert the threat of global depression. Leaders also agreed on additional resources for the IMF and MDBs to assist countries weather the financial crisis, and resources of up to US$1 trillion were provided to the IMF. The FSB was established as a successor to the Financial Stability Forum (FSF) at the Bank for International Settlements (BIS), with key emerging-market economies represented on the Board, which was a departure from the FSF which represented only advanced economies. In September that same year, at the Pittsburgh Summit, Leaders agreed on the implementation of a Framework for Strong, Sustainable and Balanced Growth. BIS central bankers’ speeches By the June 2010 Toronto Summit, fears were escalating over the fiscal health of various advanced economies, and advanced deficit economies agreed to at least halve fiscal deficits by 2013, and stabilise or reduce sovereign debt ratios by 2016. These commitments included on-going structural reform across all G-20 members to rebalance and strengthen global growth. An agreement to conclude work in the Basel Committee on Banking Supervision on a new global regime for bank capital and liquidity was also reached. In November 2010, Leaders adopted the Seoul Action Plan which outlined the actions that members committed themselves to implementing to kick-start global growth, and the Seoul Development Consensus for Shared Growth which relates to commitments by members to support the global development agenda, including contributing towards achieving the Millennium Developments Goals. At the June 2012 Los Cabos Summit, Leaders pledged over US$450 billion in financial resources to boost the IMF firewall. The European sovereign debt and banking crisis has received much attention, with the spillover effects to other member countries in a globally interconnected world taking centre stage, and the need for policy makers in Europe to take decisive and credible action featuring strongly. Much of this focus on short-term crisis management measures have unfortunately come at the expense of progress on other important medium-term objectives of the G-20. As we near the end of the Mexican Presidency, the next key decision on the IMF quota formula needs to be taken, which I will come back to later. Under the Mexican presidency in 2012, an impact study of Basel III on emerging-market economies was conducted, and financial access, innovative sources of financing and addressing corruption have also been adopted as Agenda items. In 2013, Russia takes over the Presidency of the G-20. We await further details on the Agenda, which we hope will be more focused and concentrate on the three main issues of global growth, regulation and the international monetary system. 4. Opportunities and challenges of South Africa’s participation in the G-20 South Africa’s membership of the G-20 provides enormous opportunities. As a small and open economy, South Africa has an interest in seeing the G-20 Agenda succeed because of our level of interconnectedness within the global economy. As the only African country represented in the G-20, this membership provides South Africa with the space to influence key international policies that could have an impact on our own economy, the region and the continent as a whole. As the sole African representative at the table, South Africa also endeavours to highlight regional and continental issues, albeit without any formal mandate. Our network of contacts from our interactions in various G-20 formations provides great opportunities to leverage these to advance various other objectives and to enhance South Africa’s international profile and reputation. The key players to ensure meaningful participation in deliberations at G-20 meetings with the view to influence outcomes in line with South Africa’s and Africa’s development and growth priorities are the Presidency, the Department of International Relations and Cooperation (Dirco), the South African National Treasury, the South African Reserve Bank (the Bank), with the support of various other governmental departments and the Cabinet. The Presidency, Dirco and the National Treasury normally play the leading role on behalf of South Africa in the forum, while the Bank plays a meaningful role in its areas of expertise, particularly on financial and regulatory matters. Domestically, South Africa consults with a number of stake holders, including NEPAD, civil society including NGOs, and the academia. Regionally, the Group of Ten African Countries (the C10) was formed in 2009 in order to solicit views and opinions from countries across the continent on how the G-20 may address their concerns. It has to be admitted, however, that the consultation process could be more effective, and that more could be done to strengthen these initiatives and to ensure that they work as intended. Hence, a key challenge for South BIS central bankers’ speeches Africa is to identify key priority areas where it could influence the G-20 policy and agenda for the benefit of the country and region. Another challenge is to ensure that as South Africa’s role grows internationally, and we are more and more recognised as an important voice at the table, we are able to commit sufficient resources to be able to respond appropriately. In order to address this challenge, the South African Reserve Bank is currently in the process of setting up a dedicated international economic relations and policy department. South Africa chaired the G-20 in 2007, and focused predominantly on IMF quota and voice reform. As a result of South Africa’s efforts, together with other members of the G-20, the 2008 quota and voice reforms of the IMF were adopted. Significant deadlocks were overcome during deliberations among the G-20 members, most importantly agreeing to include Purchasing Power Parity as a component of GDP in the quota formula, which paved the way for several emerging-market countries to gain from the future quota reforms. Hence, South Africa, alongside Australia, was asked in 2010 to co-chair the G-20 Working Group on IMF reform. In this regard, South Africa and Australia played a key role in guiding the IMF’s governance reform programmes. A key challenge for South Africa, however, will be to ensure that while it supports the reform agenda of the IMF, it does not end up, together with Africa, being net losers in this reform process. This remains a major obstacle for the country in this year’s G-20 discussions, as we near the conclusion of the Fourteenth Review of the quota formula. The issue of a third chair for Sub-Saharan Africa in the IMF executive board is a clear example of the difficulty the Continent faces in IMF governance deliberations. As a member of the BRICS, South Africa also has the opportunity to align some of its positions with those of its BRIC partners, while gaining support from BRIC for its positions within the G-20. However, this is easier said than done, because even among the BRICS, positions are not always aligned. Whilst on the subject of alignment, although the G-20 is essentially a grouping of the G-7 plus systemically important emerging-market economies and Australia, there is no natural alignment of groups within the forum. It has become necessary to move away from the traditional views of alliances that address issues along the lines of North/South or advanced versus emerging/developing countries, etc. to alliances that are outcomes based and follow specific interests as regards various agenda items. Depending on the issue at hand, South Africa aligns itself with different groups to ensure that decisions on key issues reflect our country’s best interest. With regard to quota and voice reform in the IMF, for example, South Africa is mostly aligned with emerging-market economies. However, with regard to the financial transactions tax that was mooted by the Europeans, South Africa opposed this proposal and was supported by a few other advanced economies. South Africa is aligned with advanced economies on the issue of climate finance, while other developing countries generally feel that this issue is best addressed at the United Nations. The challenge for South Africa is to formulate its positions carefully, taking into consideration country circumstances, and partner with countries, be it emerging-market or advanced countries, to push forward these positions. 5. Prospects for South Africa within the G20 South Africa has the potential to contribute significantly to the Growth and Development Agenda of the G-20, with a particular focus on low-income countries and sub-Saharan Africa. In 2010 the G-20 Leaders declared in Toronto that “Narrowing the development gap and reducing poverty are integral to our broader objective of achieving strong, sustainable and balanced growth and ensuring a more robust and resilient global economy for all.” 1 Toronto Declaration, June 26–27, 2010. BIS central bankers’ speeches At the Toronto Summit, the G-20 Leaders confirmed the inclusion of development as a key agenda topic at the Seoul Summit and agreed to establish a Working Group. In 2010 South Africa, alongside Korea, was nominated to co-chair the G-20’s Working Group on Development, which sought to address issues of significant importance to the African continent, in particular infrastructure development. In 2011, South Africa was included as the co-chair of this group together with Korea and France. While development issues are not prominent on the G-20’s Agenda, South Africa together with Korea, provided the necessary leadership when it was decided to include development issues on the G-20’s Agenda. South Africa could use this process to position itself strongly in the G-20 discussions on growth and development, to focus on the underdevelopment of various regions in the global economy, including sub-Saharan Africa, and promote these discussions on the global policy agenda. As part of the G-20’s focus on financial inclusion, South Africa and Germany co-chaired the SME finance sub-group, with the focus to crowd-in the private sector by incentivising it to develop innovative ways of financing SMEs through a G-20 SME Challenge launched in Toronto. In 2012, South Africa remained actively involved in this area together with the United States. While South Africa, together with other emerging-market countries, acknowledges that it still has a long way towards improving financial inclusion in the country, the fact that it is encouraged to play a leading role in this endeavour within the G-20 could help it to expedite financial inclusion policies in the country. South Africa has a strong financial sector, and has used this to its advantage to contribute to G20 discussions to highlight its experience. In this regard, South Africa together with other emerging-market countries put in a concerted effort highlighting the potential unintended consequences of some of the Basel III proposals, without detracting from its firm commitment to implementing regulatory reform. Working together with peers within the G-20, a review was done of potential unintended consequences of financial regulations on the economies of emerging-market countries, and a number of changes were proposed to the address some of these unintended consequences. South Africa will continue to utilise its experience in the area of financial regulation and supervision to influence the outcomes of financial reform initiatives. South Africa is actively promoting reform measures that enhance the credibility of its financial system, while promoting the principles of fairness and global accountability and harmonisation of financial regulations across jurisdictions, as well as to ensure that commitments agreed upon at a global level are implemented locally as appropriate. Its efforts to implement Basel III regulations including twin peaks regulatory reform measures underline these endeavours. South Africa’s participation in the G-20 helps leverage its voice and effectiveness in other international standard-setting bodies such as the Financial Stability Board, the Basel Committee on Bank Supervision; the Committee of Insurance, Securities and Non-banking Financial Authorities, the Financial Action Task Force and the International Association of Deposit Insurers. We have also been supportive of the efforts to strengthen the financial position of the IMF, as reflected by our inclusion in the IMF’s New Arrangements to Borrow Initiative (NAB) and US$2 billion loan made available towards strengthening the IMF firewall. However, the IMF is a quota based institution and there is a general recognition that the current IMF quota formula, while an improvement on previous formulas, remains flawed in that it does not fully recognise the changing economic weight of emerging market and developing countries. I have already touched on this issue earlier, but would like to reiterate that any shift in quota shares that may benefit specific emerging and developing countries should not come at the expense of other emerging-market and developing economies, and it is important that South Africa ensures the protection of its quota share. BIS central bankers’ speeches Finally, South Africa and France have been appointed to co-chair the study group on climate finance. G-20 countries are divided on whether this issue should be considered in the G-20 forum, or be addressed within the United Nations under the so-called United Nations Framework Convention on Climate Change (UNFCCC). No matter what the final decision will be, South Africa is in this instance considered to be a credible broker to hear the views of the opposing parties, which enhances the stature of the country in the forum. 6. Challenges for the G-20 as a forum The G-20 as a forum has the potential to contribute significantly to global dialogue and policy debate. Of late, it seems that the forum has moved beyond its teething problems and idealism as a forum for co-operation and co-ordination, towards being viewed as an institution where process issues are becoming more prominent and actions more difficult to agree on or to implement. At the start of the global financial crisis, there was significant co-operation and co-ordination within the G-20, however, many G-20 countries have since become increasingly inwardly focussed and critical of the policies of other members of the forum. This was particularly so in the aftermath of the implementation of quantitative easing, which had repercussions for capital inflows and currency appreciation in emerging-market countries. Advanced countries have countered that some emerging-market countries were accumulating reserves beyond what was needed for economic reasons, which has contributed to weaker exchange rates than was dictated by economic fundamentals. Another challenge for the G-20 relates to its increasing number of meetings alongside an ever growing agenda, which has led some members to question the validity of so many meetings and the ability to focus with such a wide ranging agenda. While the G-20 as a group makes up about 80 per cent of global trade and global GDP, it consists of only 19 countries, which effectively excludes more than 160 countries. Only one African country is represented in the forum. The Nordic countries in particular are very critical of the group, given that the regulatory policies adopted by the G-20 through the FSB and the Basel Committee affect them directly. Hence, the G-20 needs to do significantly more outreach to obtain the views of countries that are not in the forum, but that are affected by G-20 policies. Recently, some G-20 countries asked whether a permanent G-20 Secretariat for the group should be formed. This is, however, unlikely to be easily accepted as countries tend to use the opportunity to host the G-20 forum to showcase their countries. 7. Conclusion While the expansion of the agenda and the role of the G-20 in the global economy are seen as an opportunity by some and a threat by others, South Africa will continue to focus on key issues of particular concern to both the country and the region. The G-20 has been relatively successful in promoting regulatory reform, and South Africa was a keen participant in this process, recognising the importance in providing stability to the global financial system, but also understanding the domestic challenges posed as a result. Furthermore, South Africa continues to argue at the G-20 and other forums that the cost of the new regulatory framework to African countries should be recognised and that these countries should be supported in strengthening the financial systems. The G-20 up to now has been less successful in implementing the Action Plans that it has adopted to foster strong, sustainable and balanced growth. The co-operation that was present at the start of the crisis has faded somewhat and home bias and political considerations play a key role in preventing countries from adopting the needed reforms. Negative feedback loops between sovereign debt, banking sector problems and slow growth BIS central bankers’ speeches have also played a role in delaying the implementation of medium term plans, including structural reform. This has increased the risk of credibility loss for the G20, especially given that previously the G20 was able to demonstrate political will and decisive action. The G-20 played a pivotal role in advancing the reform agendas of the international financial institutions, particularly that of the IMF, while also helping to strengthen the IMF financial position. Finally, there have been concerns expressed about the growing G-20 agenda, particularly as it relates to issues that are considered to be the domain of organisations such as the United Nations (particularly on climate change issues). South Africa, while recognising this difficulty, supports an agenda that also focuses on development issues and climate finance is considered in this light. Even when one accepts that there may be legitimacy and credibility problems from time to time, the G20 has evolved into a very powerful forum for international cooperation and coordination, and if South Africa can carefully define its priorities, and continues to leverage its seat at the table, the country only stands to benefit from its participation in the G20. Thank you. References: Various G-20 Communiqués and Leaders’ Declarations available on the G20 website: www.G20.org. Bradlow, D. Positioning Africa for a Role on Global Economic Governance, Sunday Independent, June 2012. Draper, P. The Financial Crisis and G20 Summitry: Decoding (South) African Positions, A workshop hosted by the South African Institute of International Affairs, March 2009. German Development Institute. The G20: Its Role and Challenges, Briefing Paper, 16/2011. Jokela, J. The G20: A Pathway to Effective Multilateralism? April, 2011. Wade, R. Emerging World Order? From Multipolarity to Multilaterism in the G20, the World Bank and the IMF, Politics and Society, August, 2011. Woods N, Global Governance in the Aftermath of the Financial Crisis: A New Multilateralism or the Last Gasp of Great Powers? Global Policy Volume 1, Issue 1, January, 2010. BIS central bankers’ speeches
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Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the launch of SAICA Northern Region Trainees Committee, Park Town, 29 November 2012.
Francois Groepe: The role of Chartered Accountants in grass roots development and accelerating the realisation and economic emancipation of the majority in South Africa through better management of government resources and efficiently delivering services to the masses Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the launch of SAICA Northern Region Trainees Committee, Park Town, 29 November 2012. * * * I wish to thank SAICA and the Chairperson of the SAICA Northern Region Trainees Committee for inviting me to speak and to be part of this momentous occasion. I believe that the topic is very relevant against the backdrop of the significant levels of inequality in our country as reflected in the most recently estimated Gini-coefficient of 0,69. The top ten per cent of the population earn approximately 58 per cent of the income and the bottom 50 per cent less than eight per cent. We furthermore have had to contend with an unemployment rate currently of 25,5 per cent in the third quarter of this year, much of it likely structural. Global economy In considering the economic conditions in South Africa, one is compelled to take cognisance of global economic developments due to the impact they have on local economic developments and the risks of spillover. Economic activity in both the advanced economies and the emerging market economies continue to disappoint, while continued uncertainty further weighs on the outlook. Although the US recorded an uptick in growth in Q3/2012, there is an expectation of lower growth in 2013, due to the risk of a fiscal cliff. In the event that the fiscal cliff is avoided, there remains a real possibility that the agreed settlement may include some degree of fiscal consolidation as well as an increase in the effective taxation rates, which may act as a drag on consumption expenditure. The Euro area contracted in Q3/2012 and is now in technical recession. There is a possibility that recessionary conditions may continue for two reasons, namely: • An accentuated drag on growth due to the continued fiscal austerity measures, amidst indications that fiscal multipliers may be higher than previously estimated; and • A number of the leading indicators seem to suggest that growth prospects are tilted to the downside. Unemployment levels in Europe remain at elevated levels historically, the social implications of which should not be underestimated. A further concern is that cyclical unemployment could evolve into structural unemployment. This could add a further dimension to an already challenging and complex set of circumstances. Emerging market economies have decelerated recently and this has spilled over and amongst others, impacted negatively on world trade volumes. Domestic economy South Africa continues to suffer from the aftermath of the tragic events that occurred recently. Economic activity has slowed down sharply, particularly in the mining sector. The recent downgrade of the country’s sovereign credit rating, as well as increased uncertainty, may impact negatively on both FDI as well as investment by the household sector. BIS central bankers’ speeches The export performance of domestic companies continues to deteriorate. Latest estimates by the SARB show that the country’s global exports have declined over the past 50 years. Some of the factors contributing to this trend in recent times are: (i) The decline in the contribution of gold mining sector to growth and the decline in the role of gold globally; (ii) Binding constraints related to infrastructure bottlenecks; (iii) Skills shortages and mismatch; (iv) The dominance of low-cost production bases which are export oriented in many emerging market economies; and (v) Sluggish growth in SA’s key trading partners. Economic activity on the production side has changed noticeably when compared to the 1980s. The agriculture and mining (primary) sectors have shrunk since then and contribute less than 5 per cent to GDP. Although the manufacturing sector has shrunk as well, it contributes roughly around 15 per cent. Significant growth has emanated from the tertiary sector, with finance, insurance, real estate and the business services sector contributing around 21 per cent. Government services have also aided economic activity in line with the countercyclical spending. On the expenditure side, growth has been largely driven by final demand – in particular consumption expenditure by households. Consumption expenditure by general government, which has been driven by countercyclical fiscal policy, in particular on-going spending on the expanded public works programme, which is aimed at labour intensive infrastructure projects. However, under-spending by national, provincial and local governments continued to subtract from growth in capital formation, in particular social infrastructure. At some level, albeit at non-spectacular growth rates, all of these factors have helped with dealing with the cyclical aspect of unemployment, although since the beginning of the most recent recession, the unemployment rate has risen and hovers above 25 per cent. In the period 2004 to 2007, the average annual growth rate was well above 4 per cent and unemployment reached a record low level of 21 per cent. This is an indication that sustained elevated growth rates are required to reduce the levels of unemployment in a meaningful manner. Role of chartered accountants In the most recent World Competiveness Report, the deteriorating state capacity was one of the areas that contributed to the slide in the country’s ranking to 52nd place out of 144 countries that were ranked. Some of the more problematic areas identified included an inefficient bureaucracy, corruption and policy instability. On the positive side South Africa was recognised to be at the forefront of governance and was ranked number one in the following areas: • Strength of Auditing and reporting; • Regulation of securities exchange; and • Efficacy of corporate Boards; It is therefore evident that South Africa’s auditing and accounting professionals are among the best in the world, and I do believe that accountants have an important role to play in ensuring that some of the structural challenges in this country are addressed effectively. The profession can make a tangible contribution towards ensuring that the public sector is capacitated to deal with its many challenges, using the skills and aptitude that members BIS central bankers’ speeches acquire during their academic and practical training, and which include skills such as analytical ability, professionalism, integrity, understanding complexity, etc. It is also important that members of the profession respond positively to the call of public service and that members do not only become service providers to the public sector, but that they also join the ranks of the public service in order to address the shortage of skills within that sector. In this context they have much to contribute to root out corruption, design monitoring and early warning systems so as to ensure improved service delivery, institute controls that would minimise instances of wasteful and fruitless expenditure, design reports so that politicians and officials have access to accurate and timely information, and which should contribute to improved decision-making and policy outcomes. Conclusion In conclusion, in order for us as a country to move forward it is important that we all own up to the responsibility that we have to ensure that South Africa reaches its full potential and that it thrives and succeeds at all levels. Our challenges are daunting but not insurmountable! If we all display a positive ‘can do’ attitude and one that places the national interest first, we can achieve higher levels of economic growth, reduce the stubborn levels of unemployment and successfully address the dual challenge of poverty and inequality. The time has come for us to adopt an attitude of ‘South Africa First’ and to respond affirmatively to a similar challenge JF Kennedy put to his compatriots during his inaugural speech, “And so, my fellow Americans: ask not what your country can do for you… ask what you can do for your country.” So lets us all begin by asking what we as loyal and committed South Africans can do for our country, South Africa, and let us strive to be the change we would so much like to see. I 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 Tradition dinner, Johannesburg, 28 November 2012.
Daniel Mminele: South African monetary policy in the context of central banking developments abroad Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Tradition dinner, Johannesburg, 28 November 2012. * 1. * * Introduction Good evening and thank you to Tradition South Africa for the kind invitation to speak to you this evening. I have been asked to talk about South African monetary policy in the context of the influences from monetary policy globally. Monetary policy has evolved in leaps and bounds over the past few years and unconventional measures, in particular, quantitative easing (QE), has become a fundamental part of monetary policy around the world. Japan, known as the pioneer of QE, unfortunately has not had much success with this policy, failing to boost either growth or inflation despite very accommodative monetary policy. There are many views about Japan’s so-called lost decades and why it is different for the US and others, and how the speed, vigour and manner in which QE applied can make a difference. Japan’s experience is translated into what is happening in the US and elsewhere, and doubts are raised about the appropriateness and success of such unconventional measures. It is too early to draw any definitive conclusions, but no doubt in time economic textbooks will be full of evidence of the success or otherwise of QE. I will start my remarks off by firstly looking at countercyclical monetary policy, in particular as it pertains to emerging market economies, and the spill-over effects of monetary policies abroad. I will end my remarks by talking about the more recent developments pertaining to South Africa, with reference to the Monetary Policy Committee meeting held last week. 2. Counter-cyclical monetary policy and spillovers Monetary policy in advanced economies has undergone a drastic makeover since the 2008–2009 crisis, from the implementation of unconventional policies, to forward guidance being provided, and increasingly talk of moving towards specific numerical measures to which monetary policy tightening should be tied. The so called “7/3 threshold rule” 1 has often been bandied about as an alternative to the explicit forward guidance provided thus far by the Federal Reserve Bank. Under such a rule, the Federal Open Market Committee (FOMC) may indicate that it will maintain the fed funds rate at current levels until such time as unemployment moves below 7 per cent or inflation above 3 per cent, at which point, the federal funds rate may be raised. Alongside such unconventional policies in advanced economies, emerging market economies have witnessed a break from past behaviour, where central banks have graduated from conducting pro-cyclical monetary policy to counter-cyclical monetary policy. This is significant because counter-cyclical policy was seen to be largely the domain of advanced economies, and in crisis situations, emerging markets instead opted to tighten monetary policy as they sought to defend the value of their currencies, contain capital flight and reinforce policy credibility. In February 2012, the Board of Governors of the Federal Reserve System published a discussion paper entitled “Monetary policy in Emerging Market Economies: What Lessons Proposed by Charles Evans of the Federal Reserve Bank of Chicago. BIS central bankers’ speeches from the Global Financial Crisis?” 2 The paper looked specifically at the counter-cyclicality of emerging market central banks’ monetary policies during the 2008–2009 crisis, and found that at the height of the crisis, over 80 per cent of emerging market economies loosened monetary policy. Similarly, a study 3 conducted in 2012 found that between 1960–1999, 51 per cent of developing countries were pro-cyclical with an average correlation between GDP and interest rates of –0.02 per cent. This compared to 0.38 per cent for industrial countries. In contrast, for the period 2000–2009, around 77 per cent of developing countries showed counter-cyclical monetary policy. In both periods, South Africa was found to be counter-cyclical, with the correlation increasing from around 0.25 to 0.75 per cent. The Bank for International Settlements (BIS) in its June 2012 Quarterly Review made reference to this shift among emerging market central banks, and pointed out the benefits of counter-cyclical policy, in particular, the associated reduction in output volatility, which also helped to stabilise the global economy. It is important to realise, however, that not all countries can benefit from counter-cyclical monetary policy. In particular, a country with large short-term foreign currency borrowings could suffer massive exchange rate depreciation, the costs of which could offset any potential costs of a pro-cyclical policy. The discussion paper I referred to earlier investigates the factors that allowed for this shift to happen, and poses the question whether this marks the beginning of a new era in which emerging markets can now conduct counter-cyclical policy in a sustainable manner. The study finds that robust institutions, stronger macroeconomic fundamentals, reduced vulnerabilities, greater openness to trade and international capital flows and more importantly, financial reforms and adoption of inflation targeting, helped to facilitate this shift. By adopting inflation targeting and implementing financial reforms, greater policy credibility was achieved. Not only does the development of local financial markets enable a more efficient transmission of monetary policy, but the promotion of local financial markets has also encouraged greater borrowing in local currencies in domestic markets, which has helped to reduce the risk of capital flight, as well as currency and maturity mismatches. As such, the development of domestic financial markets has helped to facilitate the conduct of counter-cyclical monetary policy. Central banks that have adopted inflation targeting and moved to a low inflation environment were also seen to be more independent and credible, which also helped to facilitate the loosening of monetary policy. The BIS notes a few caveats: • Firstly, that low interest rates in advanced economies may have allowed emerging market central banks to cut policy rates more sharply than they could have done otherwise, which would then overstate the degree of counter-cyclicality. • Secondly, that the prolongation of low interest rates in advanced economies could complicate counter-cyclical monetary tightening in the future. • Finally, the BIS also provides the example of some euro area countries which despite following counter-cyclical policies are facing a crisis today – underlining the importance of continuously monitoring financial imbalances and sustainability of policies. These caveats brings me to the subject of spill-overs, an issue the G20 spends much of its time discussing, and requested of the IMF to produce spill-over reports for the five most systemically important economies. 4 These reports quantify, inform and educate about the spill-over effects of the policies of these five economies. Brahima Coulibaly, International Finance Discussion Papers, Number 1042. “Graduation from monetary policy procyclicality”, Vegh,c and Vuletin,G, 22 August 2012. US, euro area, Japan, China, UK. BIS central bankers’ speeches The arrival of QE brought much scepticism and unease, with talk of currency wars gaining momentum owing to the spill-over effects of such easy monetary policy on emerging markets. In particular, QE led to increased liquidity globally; amplified carry trade activity owing to favourable spreads; the financialisation and resultant boom in commodity prices; volatility in financial markets, in particular exchange rates; and robust capital inflows into bond and equity markets. The IMF 2011 Spill-over report for the US 5 provides an analysis of QE spill-overs and finds that from both conventional and unconventional US monetary stimulus, there were in fact substantial output gains, occurring predominantly via significant reductions in nominal bond yields and increases in equity prices, with exchange rates also appreciating both in advanced and emerging market economies. Under conventional policy, for example, the IMF estimates peak output gains of 0.3 per cent in the US; 0.1 – 0.3 per cent for other advanced economies; and 0.0 – 0.2 per cent for emerging markets. Under QE1, the IMF estimates peak output gains of 0.4 per cent in the US; 0.1 – 0.3 per cent for other advanced economies; and 0.0 – 0.4 per cent for emerging markets. The study also finds, however, that the effect of QE2 was somewhat smaller than QE1. In September 2012, the Fed announced a third round of QE, the impact of which is yet to be seen. Nonetheless, the results of these studies are not surprising, given that the US is the benchmark for pricing of other global assets, and was long hailed as the engine of global growth. Unconventional monetary policies may very well complicate policymaking for emerging market central banks and create significant challenges going forward, not least of which relate to the unwinding of loose monetary policy in the advanced economies and the implications for capital flows. This could have significant repercussions for emerging markets, and the rest of the world, given the increased weight of emerging market economies in global output. Strong capital inflows to emerging markets over the past few years also means that emerging market assets have taken up an increasing share of investor portfolios. In its 82nd Annual Report published in June 2012, the BIS notes a number of longer-term risks for central banks related to prolonged monetary accommodation. These include a threat to advanced economies central bank credibility should they feel pressured to do more and therefore complicate even further the eventual exit from monetary accommodation; a gradual dislodging of inflation expectations in emerging markets should there be doubts about the determination to pursue price stability and exit large scale foreign exchange interventions; and undermining of operational autonomy and financial independence. Having said this, and understanding the significant risks introduced to emerging markets as a result of QE, there is no denying that in the earlier phases of the crisis, QE policies did help to stabilise markets, support trade and help to prevent a breakdown in demand and economic activity. 3. Recent monetary policy developments in South Africa We are often asked how much influence global monetary policy has on domestic rate setting. Of course, the Monetary Policy Committee does take into consideration in its deliberations, the decisions of policymakers elsewhere. These are important inputs into the decision-making process, given the large spill-overs associated with global policymaking on economic and financial market variables. Like other emerging market countries, South Africa has witnessed significant portfolio inflows. In 2008, net outflows of R78 billion were recorded, and since 2009 until 26 November 2012, non-residents have bought a cumulative R280 billion worth of bonds and equities. The nature of these flows has changed, from being primarily equity inflows (turning IMF, The United States: Spillover Report, 2011 Article IV consultation, IMF Country Report no 11/203. BIS central bankers’ speeches from net inflows of R75 billion in 2009 to net outflows of R17 billion in 2011 and outflows of R8.3 billion year-to-date) to being predominantly bond inflows (from net inflows of R15.5 billion in 2009, to R85 billion year-to-date). Factors such as South Africa’s inclusion into the World Government Bond Index have supported this trend, as well as the appreciation of the rand for much of the past three years, and are a clear reflection of the interest rate sensitivity of capital flows. Having twin deficits (fiscal and current account) and a low domestic savings rate, these inflows were not unwelcome, also to the extent that they helped to lower long-term borrowing costs. One can also argue that rather than inflows being diverted to South Africa because of expectations of rand appreciation, it was the inflows that in fact caused to the rand to appreciate. Whichever view is taken, the exchange rate of the rand did nonetheless appreciate from almost R12 against the USD in 2008 to under R6.60 in 2011. Other emerging markets lowered policy rates to support growth; they also intervened in the exchange rate markets to try and stem appreciation pressure, or imposed capital controls. South Africa’s policy rate was also lowered, although we were less aggressive than other emerging markets in dealing with these inflows as we did not at any time feel it necessary to intervene in the exchange rate market nor were any capital controls imposed. We did, however, with a surplus position on our Balance of Payments, mop up extra liquidity from both portfolio and direct investment flows, and consequently managed to grow the official foreign exchange reserves. We have been consistent in our approach, and have maintained an easy stance throughout the crisis, given that inflation largely remained under control and growth was moderate. Exchange rate appreciation has been both a positive and a negative, on the one hand lowering South Africa’s trade competitiveness, but also helping to dampen inflationary pressures given the influence of the exchange rate on consumer prices. CPI receded from 13.7 per cent in August 2008 to 3.2 per cent in September 2010, at the same time growth slowed somewhat, never quite recovering from the recession, while unemployment increased to over 25 per cent. It is the combination of these factors, a large output gap, the absence of any significant underlying price pressures and a still dismal outlook for the global economy, that has given the Bank room to manoeuvre and reduce the repo rate from 12.0 per cent in 2008 to 5.0 per cent in July 2012. However, since July domestic developments in the form of labour unrest, credit rating downgrades, and a widening in the current account deficit, have taken centre stage and been the prime determinant of exchange rate movements, which previously was primarily determined by movements in the USD/EUR exchange rate and other global developments. The exchange rate of the rand has weakened considerably from just above R8.00 against the USD at the beginning of August to levels close to R9.00 against the USD in November. Such developments, together with the lagged effect of higher food prices and higher wage settlements as seen in certain sectors of the economy, do not bode well for inflation going forward. A wide range of estimates have been released from various analysts trying to ascertain the potential impact of the rebasing and reweighting of the CPI basket in 2013. Our own estimates indicate some upward pressure on both headline and core prices, as noted in the MPC statement, to the magnitude of around 0.2 per cent on headline CPI. However, I should caution that these estimates are subject to the final set of price-updated weights which will only be published in January 2013, and as such, are subject to change. Alongside a less favourable outlook for inflation, the domestic growth outlook has deteriorated, not only due to developments in the euro zone and US, but intensified further by labour market instability. Such actions as we have seen in the mining and agricultural sectors in particular, not only amplify wage pressures, but hurt output growth and export volumes, raise the prospects for even higher unemployment and aggravate the widening in the current account deficit. The third quarter GDP figures provided the first glimpse of the negative impact from the strike action, as growth slowed from 3.4 per cent in the second quarter to 1.2 per cent quarter-on-quarter. Mining reflected a contraction of 12.7 per cent, BIS central bankers’ speeches while manufacturing grew a paltry 1.2 per cent. The negative impacts of the strike action on growth have not fully fed through and we are likely to see further weakness in the quarter ahead. Both business and consumer confidence are far from robust and it is unlikely that the demand side of the economy will provide much support. The Bank has lowered its growth forecast to 2.5 per cent for 2012, improving to 3.6 per cent in 2014 – with risks tilted to the downside. Inflation forecasts on the other hand, have been adjusted higher and the risks are tilted to the upside. The forecast do not take into consideration the new CPI weights or the rebasing that will take place in January 2013, nonetheless, the CPI forecast was revised higher to 5.5 per cent for 2013 (previously 5.2 per cent), and the forecast for 2014 kept unchanged at 5.0 per cent. The outlook for core inflation remains relatively benign, with a peak of 5.0 per cent in the first quarter of next year and an average of 4.8 per cent in 2013, dropping to an average of 4.5 per cent in 2014. The combination of low global growth, domestic challenges further hampering the growth outlook, rising wage settlements, a weaker rand and higher current account deficit – makes for a very difficult combination of factors to consider when making policy decisions. Olivier Blanchard in 2006 presented a paper entitled “Monetary Policy; Science or Art”. He said that monetary policy can pretend to be close to science if it can be conducted using simple and robust rules, however, monetary policy must be closer to art if it is frequently confronted to new, poorly anticipated and poorly understood, contingencies. In that case, each of these contingencies requires fast thinking and having to make decisions, not fully based on existing research but rather on well trained intuition. There is little doubt that monetary policy has gravitated towards being more of an art than a science. Thank you BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the workshop on "The outlook for financial markets, for their governance and for finance", Cernobbio, Italy, 8-9 March 2013.
Gill Marcus: The economic and financial outlook for the South African economy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the workshop on “The outlook for financial markets, for their governance and for finance”, Cernobbio, Italy, 8–9 March 2013. * * * Thank you for the opportunity to speak to you in this beautiful environment. It is hard to believe that we are in the epicentre of a global financial crisis that is now entering its sixth year, and that Italy itself is grappling with what appears to be a period of Italian political instability against a backdrop of an economy that contracted by around 2,4 per cent in 2012, and within a challenging Eurozone environment. The continued synchronized downturn in the major advanced economies – the US, Eurozone, Japan and the UK – will impact on the global outlook for some considerable time. It is to the United States that we look to build on its slow recovery and begin to lead the advanced economies out of this very difficult economic environment. And we all need to recognise the way in which the global financial crisis has mutated and that, even if there is no further deterioration in the outlook, it is going to take many years to recover. While the crisis originated in the advanced economies, the impact differed across countries. The nature and scale of the spillover effects have been dependent on the extent of trade and financial linkages. The crisis and the continued weakness in the advanced economies have also underlined the need for emerging economies to diversify traditional trade and financial relationships. This is part of the rationale underlying the formalisation of the BRICS grouping (Brazil, Russia, India, China and South Africa), as well as the reorientation of South Africa’s trade relations towards the rest of the African continent. Growth in sub-Saharan Africa, apart from South Africa, was remarkably resilient during the crisis. Although most countries experienced lower growth, mainly due to lower commodity prices, in general they managed to avoid recession. Unlike South Africa, the trade channel was less important because of the predominance of intra-regional trade, and stronger trade links with Asia. Most sub-Saharan African countries have returned to pre-crisis growth rates due in large part to the recovery in commodity prices. This positive trend is expected to be sustained in most of the region. According to the latest World Economic Outlook, economic growth in subSaharan Africa is expected to average 5,8 per cent in 2013 and 5,7 per cent in 2014. Oilexporting countries, of which Nigeria and Angola are but two, are expected to continue to grow at rates in excess of 6 per cent. South Africa has been able to benefit from these favourable developments and we have seen significant shift in trade patterns in recent years. In 2007, 38 per cent of South African manufactured exports went to Europe, with 25 per cent going to Africa. By 2012 the picture had reversed, with 25 per cent going to Europe, and 38 per cent going to Africa. The impact of the recession in Europe, for example, has been felt particularly hard in the motor vehicle export sector. However the decline in exports to Europe in 2012 was more than compensated for by a 19 per cent increase in vehicle exports to Africa in that year. The focus of South Africa’s regional interactions has not only been on the trade side. Foreign Direct Investment in the region grew from less than US$1 bn in 1990 to almost US$40 bn in 2012. South African companies have been very active in this respect and have increasingly made their presence felt on the continent in mining, the retail sector, construction, telecommunications, agri-business and banking in particular. According to a recent Ernst & Young survey (Building Bridges: Ernst & Young’s 2012 attractiveness survey: Africa), South African companies featured in the top 5 investors in FDI in Africa in 10 of the 14 sub-Saharan BIS central bankers’ speeches African countries surveyed. By 2011 the value of South African FDI in sub-Saharan Africa amounted to 6 per cent of South African GDP. South African-based banks have subsidiaries in 16 countries in the region, and according to the IMF, in 11 of those countries South African subsidiaries are among the five largest banks. These growing regional ties have, however, only partially insulated the South African economy from the global slowdown. Following a brief crisis-induced recession in 2009, economic growth recovered, but at lower levels than were the case in the few years prior to the crisis. The economy grew by 3,5 per cent in 2011, but moderated to 2,5 per cent in 2012. The output gap remains negative, and with growth expected to remain below potential (3,5 per cent) this year, the gap is not expected to be closed within the Bank’s forecast period ending 2014. The Bank’s latest forecast is for growth of 2,6 per cent in 2013 and 3,8 per cent in 2014. The more favourable outcome for next year is predicated, to a significant degree, on a stronger recovery in the advanced economies, particularly in Europe. Therefore this forecast is subject to downside risk. Part of this disappointing growth story has been due to weak global demand for South Africa’s exports, combined with the impact of low advanced economy interest rates on the exchange rate. The consequent global search for yield contributed to the appreciation of the currency for an extended period until around April 2012 which negatively affected South Africa’s competitiveness. This adverse trend was reinforced by domestic factors including higher input costs of electricity, transport and labour, as well as a decline in the terms of trade since 2010. These factors contributed to the widening of the current account of the balance of payments from 2,8 per cent of GDP in 2010, to 6,4 per cent in the second and third quarters of 2012. The value of merchandise exports declined by 6,6 per cent between the fourth quarter of 2011 and the third quarter of 2012, while the value of merchandise imports increased by 4,4 per cent. Net exports have contributed negatively to recent growth. South Africa has been seen as a particularly attractive investment destination because of its well-developed financial system, including its foreign exchange and capital markets. Furthermore, the depth and liquidity of the foreign exchange market, with a daily turnover of about US$17 billion, made it attractive for hedging emerging market risk, which contributed to the volatility of the exchange rate. While other emerging markets were implementing measures to stem these inflows, such measures were not seen to be appropriate in the South African case given these structural features. Although we did not intervene directly to prevent the appreciation, we did take advantage of these circumstances to add to our holding of foreign exchange reserves, with gross reserves increasing from US$34 billion in 2008 to current levels of around US$50 billion. For most of the 2000s, portfolio investment into South Africa was dominated by equity inflows, while inflows into the bond market were relatively small. However, as emerging economy bond markets became more attractive, this pattern changed. Inflows into the bond market were given additional impetus with South Africa’s inclusion in the Citibank World Government Bond Index in 2012, when bond flows totaled R88 billion (compared with R47 billion in 2011) , more than offsetting a net outflow of equities to the value of R3 billion. While bond inflows also declined in the last two months of 2012, both bond and equity inflows have resumed on a moderate scale, and totaled R18 billion in the first two months of this year. Non-resident investors now hold 36 per cent of South African government bonds, up from 13 per cent in 2008. In response to these inflows, the rand appreciated by almost 30 per cent against the US dollar between the beginning of 2009 and March 2012, although around a volatile trend. For much of the period, the rand moved in line with other liquid emerging market currencies, particularly the Mexican peso and the Brazilian real. These currencies were highly sensitive to the so-called “risk-on” and “risk-off” scenarios, particularly relating to risk perceptions of BIS central bankers’ speeches the Eurozone. This co-movement in effect indicated that the underlying movements of the rand were determined to a large degree by external rather than internal factors. Since April 2012, however, domestic factors have come more to the fore. The rand has decoupled from its emerging market counterparts and has depreciated by about 15 per cent against the US dollar and by a similar amount against the Mexican peso. The rand initially depreciated in response to the widening of the deficit on the current account of the balance of payments but depreciated further largely as a result of a rising risk premium, following protracted labour disputes in the mining and agricultural sectors in particular, as well as downgrades by the three main ratings agencies. While the depreciation should help to reduce the current account deficit, the adjustment will not be easy given the slow or negative growth in the advanced economies. The deficit is expected to persist for some time, although at a narrower, more sustainable level in the face of the import-intensive nature of South Africa’s infrastructural investment expenditure. Such expenditure is seen as growth enhancing, and therefore sustainable on an inter-temporal basis. The underlying reasons for capital flows to emerging markets remain, and are likely to persist for some time. Furthermore, with increased certainty about the domestic policy framework, the risk premium is expected to decline. However, as financial markets are highly sensitive to changing developments, sentiment can change very quickly, and so too the direction and quantum of flows as can be seen from the financial markets’ reaction to the recent FOMC minutes that were interpreted as a signal of an earlier-than-expected reversal of quantitative easing. The main export sectors of the South African economy therefore face a challenging outlook, from both external and internal sources. Commodity prices, apart from the gold price, have not generally recovered to pre-crisis levels. At the same time input costs, particularly electricity and wage costs, have risen significantly, contributing to the contraction in the sector in 2012. Furthermore the sector is beset by an increasingly difficult labour relations environment, which resulted in protracted industrial action in the final months of 2012. The manufacturing sector remains vulnerable to the continued weak demand from Europe while its import and export competitiveness was also adversely affected by the appreciation of the currency in 2010/11. Following the recent depreciation of the rand the outlook for the sector is more positive, but nevertheless fragile. Where do South Africa’s short term growth prospects lie? Investment by the private sector, which accounts for around two-thirds of gross fixed capital formation, remains constrained by relatively low levels of capacity utilisation in the manufacturing sector. Electricity supply constraints are also an impediment to investment growth, and are likely to remain so until new capacity, currently under construction, comes on stream during 2014. The main impetus to growth is likely to come from infrastructure-related investment expenditure by the state-owned enterprises, which have a particular focus on power generation, road and rail transport, as well as port efficiencies and capacity. The National Treasury estimates that R827 billion will be spent on infrastructure over the next three years. A significant portion of this will be on electricity generation as well as the development of transport infrastructure, where rail transport is particularly lacking. A focus on infrastructure not only provides a boost for job creation, but also helps overcome some of the constraints to growth, improves economic efficiencies and increases the potential output of the economy. Scope for further macroeconomic accommodation is relatively constrained. The fiscal space achieved by prudent fiscal policies prior to the crisis allowed for a counter-cyclical fiscal policy stance, but this space has been eroded. The budget deficit in the past fiscal year is estimated to have expanded to 5,2 per cent of GDP, compared with an initial estimate of 4,5 per cent, mainly a result of lower-than-expected tax revenues. Nevertheless the government remains committed to achieving a fiscal consolidation path, and expects the deficit to GDP ratio to decline to 3,1 per cent by 2015/16 . At the same time the net debt to BIS central bankers’ speeches GDP ratio is expected to stabilise at around 40 per cent over the same period. These trends constrain the room for further stimulus. As is the case in many countries, the lack of fiscal space inevitably raises expectations for further monetary accommodation. Monetary policy in South Africa is conducted within a flexible inflation targeting framework, with an inflation target band of between 3 and 6 per cent, set by government. Although our nominal policy rate at 5 per cent is above those in most advanced economies, the real policy rate is currently negative. Inflation averaged 5,6 per cent in 2012, and our forecast is that inflation is likely to temporarily breach the upper end of the inflation target range in the third quarter of 2013. We see the risks to the inflation outlook to be on the upside, coming primarily from the exchange rate depreciation and higher unit labour cost pressures. The relatively subdued growth outlook and the negative output gap have meant that we have been more tolerant of inflation at the upper end of the target range. However, our room for further accommodation is constrained by the need to keep inflation within the target over a reasonable time horizon. The main challenge facing the economy remains the high level of unemployment, currently 25 per cent, with youth unemployment about double that. It is cold comfort that we are now in the same company as countries such as Spain and Greece, or that rising unemployment has become a major issue in many advanced economies. The persistence of the high rate of unemployment indicates that in South Africa it is a structural phenomenon, and therefore beyond the scope of monetary policy. The current low growth scenario is also insufficient to appreciably reduce unemployment. The government, together with all opposition parties in Parliament, has committed itself to a recently developed National Development Plan as the framework for growth going forward, which provides a coherent approach to help overcome some of the structural constraints in the economy. The main elements of the plan include various measures to increase employment creation; to increase the efficiency and capacity of the state; and initiatives to improve the quality of education. It is perhaps appropriate at this point to make a few comments about the outlook for South Africa’s banking sector in the light of global regulatory changes. According to the World Economic Forum Competitive Survey 2012/13, South Africa was ranked third in terms of financial sector development and, within this category, the banking sector was ranked second in terms of soundness. South Africa’s banking system remains strong, and at the beginning of this year we implemented Basel III. But the new global rules are not without their challenges. Our concern has been that changes to the Basel Committee rules, to which South Africa subscribes, are intended to solve problems in the banking systems of some of the advanced economies, but apply equally to countries such as South Africa that did not experience a banking crisis or regulatory failures, and could in fact cause unnecessary difficulties for the banks and for the broader macro economy. Nevertheless we are committed to complying with the Basel III requirements. The Basel III Accord provides for higher capital ratios in order to ensure that banks are adequately capitalised. Currently South African banks’ capital adequacy ratios stand at 15,84 per cent, with a Tier 1 capital adequacy ratio of 12,55, which is well above the Basel III requirement of 4,5 per cent (and the domestic requirement of 6,0 per cent). Our banks also have a relatively low leverage multiple of 13,35 per cent. Other provisions, however, will be more challenging. The liquidity coverage ratio (LCR) requires banks to have sufficient high-quality liquid assets to survive a month-long significant stress scenario. Studies by the Bank for International Settlements showed that South African banks generally would be short of such liquid assets by virtue of their dependence on wholesale, short-term funding. The Basel III liquidity framework does however give discretion to national supervisors to make available to banks a committed liquidity facility (CLF) at a fee against acceptable collateral. South Africa introduced such a facility for an amount of up to 40 per cent on any particular bank’s net cash outflows under stressed scenarios. This facility BIS central bankers’ speeches should prevent excessive increases in the cost of funding of banks and possible distortionary effects on the domestic financial markets. We are, however, still concerned about the impact of the proposed net stable funding ratio (NSFR) which is expected to be implemented in 2018. Again, the structural features of our financial system may pose a challenge, given that most long-term saving in the economy is done through the non-bank financial institutions, which in turn provide short term deposits to the banks. However, we are not the only country with such concerns, and discussions with the Basel Committee on Banking Supervision are ongoing. Although our banking system emerged relatively unscathed from the crisis, with no extraordinary measures needed to protect the banks or the financial system, we cannot be complacent. There is ongoing work to strengthen the regulatory architecture with a move towards a twin peaks model of financial regulation. This approach will see the consolidation of all prudential regulation of financial institutions within the Bank, while market conduct regulation of the financial sector will be consolidated within the Financial Services Board. In conclusion, significant advances have been made over the past 18 years in alleviating poverty in South Africa by providing essential services to the poor and through an improved social security system. According to the recent census, marked improvements have been made, for example, with respect to the provision of housing, water and electricity with 85 per cent of South Africa’s population now having access to electricity, while 78 of our citizens now live in formal housing. The OECD’s Survey of South Africa 2013 – released earlier this week – characterises South Africa as progressing, with good institutions and generally favourable momentum in important areas. However it also recognises sluggish economic growth coupled with rising inflation and an entrenched structural unemployment and inequality challenge. South Africa is an extraordinary country of great contrasts. The Atlantic and Indian Oceans meet at the most southerly tip of the continent. The cold water current of the Atlantic and the warm water current of the Indian oceans perhaps reflect the contrasts that epitomise our country: A country of great wealth and extreme poverty; of gold, diamonds, platinum and other mineral wealth that has contributed to the wealth of many nations; a country where the first heart transplant was performed, whose skills and expertise lead many fields of science, space, finance, business and the search for global and regional peace. It is a vibrant country full of hope and promise, but a country that has to rebuild its values in keeping with a constitution that entrenches democratic principles and respect for human life and dignity. The economy needs to grow faster and more inclusively, taking account of regional and continental opportunities. This is what we are committed to, and success will be in all of our interests as together we seek ways to break the stranglehold that the prevailing global crisis has on many parts of the world. 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 Institutional Investor, Africa Sovereign Funds Roundtable, Cape Town, 7 March 2013.
Daniel Mminele: Establishing a proper governance framework for central bank reserves management Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Institutional Investor, Africa Sovereign Funds Roundtable, Cape Town, 7 March 2013. * 1. * * Introduction Good morning ladies and gentlemen. Thank you to Institutional Investor for inviting me to address this roundtable meeting, and for choosing to host it in Cape Town. I trust those of you visiting South Africa or Cape Town for the first time will have an opportunity to see the exceptional beauty that this part our country offers. Judging by the agenda, I have no doubt that the discussions will be rich, as the topics being covered are all pertinent, and should allow us to exchange views and gain valuable insights to inform the work in our respective institutions in strengthening sovereign funds management operations and their oversight. I have been asked to talk on the topic of governance for central bank reserves management. With the increase in reserves assets observed in recent years, there has come a higher level of scrutiny with regard to how these assets are managed, in particular heightened interest around proper governance structures. As public investment managers we should welcome this trend, because reserves are public assets, which should be seen to be managed prudently and carefully while achieving appropriate returns. As some of you may be aware, the South African Reserve Bank (the Bank) has made significant progress in recent years in enhancing our governance framework. 2. Evolution of reserves management in South Africa Before I talk about the governance aspects of foreign exchange reserves management, I would like to first provide a brief history of the build-up of reserves in South Africa, and the evolution of reserves management activities. In 1998, South Africa had gross reserves of just US$6 billion, but was running an oversold forward book and consequently had a negative net open foreign currency position (NOFP) of US$25 billion. This huge forward dollar commitment left the country in a precariously dangerous and vulnerable external position and resulted in our currency being deemed a one-way downward bet. The Bank and the National Treasury embarked on a drive to reduce the NOFP to zero, and to build up the reserves of the country, with the former being achieved in March 2003. Subsequently, there was a rapid build-up of reserves over the years, made possible by a combination of purchasing the proceeds of Government’s foreign bond issues; taking advantage of large FDI related inflows; and purchasing foreign exchange in the open market, when conditions were deemed to be favourable. At the end of February 2013, South Africa’s gross gold and foreign exchange reserves amounted to US$50.4 billion and the international liquidity position of US$47.2 billion. While South Africa does not target a specific optimal level of reserves, we do look at various measures that inform what could be deemed an acceptable level of reserves for the country, taking into account factors such as the balance of payments position and debt dynamics. Much as by international comparison, when looking at other emerging market countries or similarly rated countries, our reserves are still relatively low, the level of foreign exchange reserves exceeds short term foreign exchange commitments of the country, and we broadly satisfy commonly accepted reserve adequacy measures. The build-up of foreign exchange BIS central bankers’ speeches reserves will continue when market conditions are conducive, and taking into account a careful cost/benefit analysis. A higher reserves cushion will not only make South Africa more resilient in crisis situations and in the wake of volatile capital flows, but should also help to increase policy flexibility, for example, if exchange rates are perceived to have deviated significantly from what is considered “fair value” as suggested by macro-economic fundamentals. It goes without saying then, that with the increase in reserves their efficient management became a key focus area of the Bank. The Bank graduated from being a pure liquidity manager to building what by now has become a relatively sophisticated investment management operation. In the process, our investment objectives have not really changed, still conforming to the old definition contained in the 2001 IMF guidelines, and guided by the classical trilogy of objectives, placing emphasis on capital preservation, such that investments are undertaken in a manner that seeks to preserve the capital of portfolios over the investment horizon; liquidity to enable the Bank to meet its day-to-day foreign-exchange commitments as well as for unforeseen circumstances, without incurring significant penalties when liquidating the investments; and return having a lesser emphasis, but the objective of which is to enhance the returns on the Bank’s official reserves within an acceptable risk-return framework and to help defray the costs of acquiring and holding reserves. The reserves are separated into various tranches, around which specific portfolios have been constructed, with the abovementioned objectives in mind, to ensure an appropriate balance between them. Each portfolio’s objectives have specific liquidity requirements and investment horizons. In determining the size, liquidity requirements and investment horizons of these tranches, foreign exchange liquidity needs of the Bank and the National Treasury are taken into account. While return has always been a lesser objective, it has received more prominence in recent years, given the increase in reserves globally and the low yielding environment in which the reserves are invested in. The Bank, like many other central banks, complements its internal reserves management activities with a carefully structured external fund management programme. The first group of external fund managers were employed in 1999. We have refined the external fund management programme as we went along, with the most recent review initiated in 2012, with a view to completing this process by September 2013. Apart from delivering excess returns against set benchmarks, this programme also has at its core a skills and technology transfer component. Our staff members have benefited vastly from the knowledge transfer, which now allows them to manage more complex portfolios. But, over time our initial objective changed and we now also look at external fund managers with diversification in mind, allowing them, given their higher level of professional expertise, to do things that we can’t do. In this respect, they get more leeway in terms of risk taking and asset classes they can invest in. The Bank established its first formal Reserves Management Investment Policy (IP) in 2007, to provide the strategic and operational framework and to define the investment criteria for the management of reserves. The aim of the process was to set investment objectives and related parameters for the reserves portfolios. In this, relevant target durations and benchmarks which are consistent with the Bank’s risk tolerance were established. The evolution of the Bank’s reserves management activities has necessitated the review and enhancement of the IP. The first such review took place in 2010, and apart from being a governance related review, provided an opportunity to not only take into account some of our own lessons learnt from the crisis, but also to align the policy with emerging best practices. The 2010 IP review led to the strengthening of the governance structure for reserves management and a reconfiguration and strengthening of the Reserves Management Committee (Resmanco). Other initiatives currently under way involve improving our IT infrastructure, and upgrading our risk management tools, monitoring, compliance and reporting systems. The IP has been reviewed again in 2012/2013, during which time we also BIS central bankers’ speeches undertook a benchmarking exercise, the results of which revealed some further areas of improvement, which we are taking on board where appropriate. To align the investment of reserves with the objectives of holding the reserves, the Bank employs a Strategic Asset Allocation (SAA). The first SAA programme was developed in 2007, the purpose of which was firstly to calculate/agree on a tracking error consistent with the Bank’s risk tolerance, and secondly, to establish strategic benchmarks against which reserves would be managed. The SAA for the various tranches is meant to ensure that the tranches maintain sufficient liquidity while maximizing returns, subject to a low probability of capital loss over a given investment horizon. We are currently in the process of reviewing our SAA to be in line with the IP and to take into account the changing financial markets environment, with a view to greater diversification in terms of investment destinations, so as to improve the risk-return profile of the reserves. It will be rolled out later in the year following the approval of the IP and to coincide with any changes deemed necessary emanating from our external fund management review. 3. Governance, accountability and oversight of investment management Sound governance and oversight around the management and investment of foreign assets has become a critical discussion point in central banks and governments globally, especially so following the financial crisis. The ability of central banks to make decisions and respond to specific market developments within a sound risk management framework were tested during the 2008 financial crisis, when capital markets malfunctioned and liquidity became a major constraint. At the time, potential systemic risks in the banking sector required a tightening of risk management guidelines, placing greater emphasis on liquidity considerations in terms of the asset classes in which reserves portfolios are invested. Central banks generally have a large proportion of reserves invested in highly liquid fixed income assets which include short-term bank deposits. At the peak of the financial crisis, default risk was high and central banks withdrew their investments in the banking sector, which was in desperate need of funding.1 Although these actions were plausible from an individual reserve manager’s perspective, the collective withdrawal exacerbated the already tight funding situation of commercial banks. This pro-cyclical behaviour of reserves managers during crises may conflict with central bank’s objective of maintaining financial stability, which again highlights the need for sound governance and oversight in the investment of reserves. Clarity of mandates and objectives is an important part of the governance framework, especially in more recent times when a balance has to be struck between not taking too much risk, and the expectation of higher returns. The Bank’s reaction to the global financial crisis centred on a risk-averse philosophy and we responded to the deterioration in liquidity by tightening investment guidelines to reduce credit risk by limiting counterparty exposures. When a second wave of the crisis emerged in Europe through potential sovereign defaults, the Bank decided to rebalance its portfolios in order to manage exposures to affected peripheral euro area countries. Foreign exchange reserves make up a significant component of total assets of central bank balance sheets. Due to this concentration, central banks are subject to stringent reporting requirements from the general public, and more specifically, governments and shareholders. To this end, central banks have been developing sound governance structures, improving accountability through more transparency and introducing a culture of higher risk awareness across all their operational activities. Efficient management of foreign exchange reserves has become vital for maintaining sound perceptions of central bank credibility. Undoubtedly, a Jukka Pihlman and Han van der Hoorn (2010), Procyclicality in Central Bank Reserve Management: Evidence from the Crisis, IMF Working Paper BIS central bankers’ speeches loss of reputation through bad governance could undermine the ability of a central bank to perform its primary tasks of ensuring price and financial stability. Good governance and sound functional organisational structures are therefore necessary for the efficient management of reserves. In establishing these structures, clear decision-making processes; appropriate delineation of roles and responsibilities, clear execution guidelines, and accountability through adequately transparent regular reporting, should be well defined, documented, adopted and institutionalised. It goes without saying that there is no one correct way of establishing a governance framework, and that country- and institution-specific circumstance must be taken into account, while not compromising on the principles. Borio et al note that there are two dimensions to consider in governance – vertical and horizontal governance.2 Vertical governance ensures that decisions are taken at the right level (senior executives), that is, where the strategic direction of the organisation is established. Senior management of the institution should carry out the responsibility of oversight on the investment process and management of reserves. Horizontal governance ensures that business areas and reporting lines are organised in a way that minimises the potential for conflicts of interest. The senior governing body needs to provide overall strategic direction through an investment management policy, which encapsulates the risk tolerance for the institution, while an investment committee should be responsible for the tactical position and for establishing the investment guidelines, and whereas day-to-day trading activities and taking active positions should be the responsibilities of portfolio managers within a control environment which separates them from middle office functions of risk and reporting, as well as accounting and settlement functions. What is of critical importance is to insure that investment committee members are competent, have relevant skills, and bring the right level of commitment. This can be a challenge for central banks that are busy building professional investment management operations, and when the traditional skills-set in a central bank has been around macroeconomics, monetary and exchange rate policies. A structured programme needs to be developed to capacitate investment committee members, and which seeks to continuously enhance their expertise as part of making the governance structure more solid. We have found that the external fund management programme provides a good opportunity and can be used very effectively for skilling up investment committee members. The Bank has a three-tier governance structure where the responsibilities for executive authority, strategic management and the actual portfolio management are clearly segregated. This comprises of the Governors’ Executive Committee (GEC), the Reserves Management Committee (Resmanco) and the Financial Markets Department (FMD). The GEC is responsible for making decisions such as the risk tolerance of the organisation and policies on reserves accumulation and management. The Resmanco is the investment committee which functions within the parameters set-out by the GEC, and provides guidelines on the framework of reserves management and approves the SAA. In other words, Resmanco designs the investment policy and guidelines for the portfolio and risk management functions, and submits them for approval by the GEC. Portfolio management activities are carried out in the Financial Markets Department. In line with principles of sound internal governance, the Bank has separated portfolio management activities from those of performance measurement, risk control and compliance, accounting and settlement. Claudio Borio, Jannecke Ebbesen, Gabriele Galati and Alexandra Heath (2008), FX reserve management: elements of a framework, Bank for International Settlements Working Paper No. 38 BIS central bankers’ speeches Figure 1 SARB Structure and responsibilities in governance structure GEC Resmanco FMD Review and approve Investment Policy Approve the Terms of Reference of RESMANCO Approves the appointment and removal of external fund managers Approves the appointment of custodians & SLAs Approves benchmarks and guidelines and risk management limits and procedures Approves target tranche sizes and currency composition of tranches within IP parameters Approves the SAA Approves the investment guidelines Approves deviations from benchmarks within approved risk budget and asset classes Evaluates performance and future strategies Portfolio and risk management activities On an annual basis, the Internal Audit Department provides the GEC with a report on the adequacy of internal policies, procedures and processes around reserves management, while at the same time a report is prepared for the Board of Directors. The latter report focusses on the current investment of the reserves including matters such as duration, credit risk, asset class and currency composition, as well as the results of the investment management activity over the year. As I mentioned earlier, some very useful contributions were received from the benchmarking exercise undertaken, which may result in some adjustments to the governance structure. 4. Current challenges in reserves management As I come to the end of my remarks, let me leave you with what could be the challenges that reserves managers will have to deal with going forward, and I am sure some of these issues will feature in the discussions over the next two days of your programme: (i) Do central banks need to redefine what an acceptable risk-return balance for official reserves is and think differently about risk tolerance? (ii) As we are central banks, what is an acceptable level of trade-off between risk management and financial stability? A recent IMF paper dealt with this and I alluded to it earlier, pointing to the pro-cyclical behaviour of central banks when withdrawing deposits from commercial banks during the crisis. Do there need to be rules around how central bank reserves managers need to behave in a crisis so as not to make matters worse? (iii) Should there be a greater segregation between reserves that are held for policy purposes (i.e. monetary policy, intervention, etc.) and those that are purely for investments and who is best placed to manage those, central banks or other dedicated public entities? The low return environment has exacerbated the opportunity costs of holding reserves and induced a debate amongst central banks about ways of enhancing returns by moving higher on the risk-return frontier. Considerations of seeking excess returns (or alpha) carry with them challenges of balancing central banks trilogy of objectives and the related financial risk management issues which will arise with the inclusion of riskier asset classes in the portfolio. BIS central bankers’ speeches Added to this is also the potential for global monetary policy normalisation which may cause bond yields to rise and hurt the return on fixed income investments. Furthermore, there are large carry costs (the interest rate differential between the domestic and foreign economy multiplied by the change in reserves) associated with foreign currency accumulation. Whenever foreign currency is purchased in the domestic foreign exchange market, local currency liquidity is injected into the domestic money market and due to the related potential inflationary impact, in most cases central banks have to sterilise these purchases. Indeed, sterilised purchases of foreign exchange can be expensive when the central bank earns a lower interest rate on the foreign currency reserves than it pays on the instruments that are issued in the sterilisation process. Finally, the complex and changing regulatory framework in financial markets could make the investment landscape for reserves even more challenging given all the uncertainties related to new requirements and potential impact on asset prices. What does this all mean? Could the outcome be that the pendulum swings all the way back to the other extreme? Are central banks going to become overly risk-averse? Are we going to find it difficult to retain staff members that were attracted to central banks, because of the increased level of sophistication, which they may feel is going to go into reverse? 5. Conclusion The pressing need for good governance and oversight in reserves management has been emphasised during this financial crisis. The crisis impacted portfolio performance and as a result tighter risk management frameworks had to be implemented. Given the rising challenges faced by reserves portfolios in this low global interest rate environment, the investment processes must remain guided by sound investment principles and solid risk management policies which are supported by effective information technology platforms. I trust that you will glean useful information over the next two days and that you will assist your respective institutions in overcoming some of these challenges which are faced by central banks in reserves management. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at IRBA's Public Practice Examination Function, Johannesburg, 9 April 2013.
François Groepe: The role of chartered accountants in South Africa’s economic growth and development Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at IRBA’s Public Practice Examination Function, Johannesburg, 9 April 2013. * * * Introduction I wish to thank the Independent Regulatory Board for Auditors (IRBA) for inviting me to speak and to be part of this auspicious occasion at which the top ten candidates in the most recent Public Practice Examination (PPE) are honoured. Allow me to extend my heartfelt congratulations to each of the top ten candidates. In the most recent World Economic Forum’s Global Competiveness Report, South Africa achieved a country ranking of 52nd out of 144 countries that were ranked, and beat stiff competition to be ranked number one in the following areas: • Strength of auditing and reporting; • Regulation of securities exchanges; and • Efficacy of corporate boards. It is therefore evident that South Africa’s auditing and accounting professionals are among the best in the world, and hence you should feel a deep sense of pride to be admitted to a profession, that is not only held in high regard in South Africa but very clearly throughout the world. You are fully justified to feel proud to use the designation CA (SA) – and so do all of us gathered here today share in that pride. I wish, however, to remind you of a quote by John F Kennedy, “To those whom much is given, much is expected.” As newly qualified chartered accountants many of you have had the benefit of good schooling and tertiary education. You have further benefitted from the investment in you and opportunities created for you by this society. This privilege imposes upon you a moral obligation to plough back into both, your immediate communities and our society at large by ensuring that you adhere to, and promote the high ethical and professional standards of your profession. I further wish to appeal to you to retain your sense of curiosity and eagerness to learn. The attainment of this qualification does not imply that you have acquired all there is to know. I would sincerely encourage you to continue on the path of learning, whether it is the pursuit of further formal qualifications or more informal modes of learning. I would also encourage you to broaden your knowledge base by studying other disciplines as it would add further depth and perspective to your analysis, understanding and knowledge of various issues, and therefore should improve the quality of solutions you develop for the evermore complex problems that we face. I implore you to be critical thinkers. In your career, you will encounter those that will tell you “well this has been the way we have always done things around here”. Yes, it is indeed so that one does not fix something that is not broken, but simply continuing to do something in the same manner in an unquestioning way means that opportunities to come up with smarter and better ways to do things may be lost. You should also continue to contribute to the debate and continuous improvement of the international standards and frameworks. Andy Haldane, Executive Director for Financial Stability at the Bank of England, in a speech in December 2011 to a conference, hosted by the Institute of Chartered Accountants in England and Wales, for example, questioned the appropriateness of fair value accounting for the banking sector. He claimed that, “historically, BIS central bankers’ speeches fair value accounting principles have gained ground when the going has been good, and lost it when it has got tough. …During the downswing, fair value principles are rolled back.” Similarly, Brenton Saunders a director at an asset management firm in a recent article in a local financial magazine questioned the appropriateness of full fair value accounting and the mark-to-market of reserves and resources of mining companies. I shall refrain from expressing an opinion on the appropriateness of fair value accounting, as we know that other conventions such as amortised cost valuation also have their own shortcomings, particularly when it comes, for example to the recognition of interest rate risk. I do, however, believe that both Andy Haldane and Brenton Saunders touch on issues that are worth debating and I would like to see far more robust public discourse by a wider range of stakeholders as to both the appropriateness but also the possible unintended consequences of some of the international reporting standards and frameworks. A further example of critical thinking would be that you, as new members of the auditing profession ask whether auditing firms, despite being private bodies but given their public function, in the interest of greater accountability and transparency, should not fully disclose their audited financial statements regardless of the fact that this is not an explicit legal requirement. The global economy On the global front a number of concerns remain. Most recently, the euro-zone crisis flared up once again as Cyprus became the fifth European country to receive a bail-out. Cyprus is a relatively small country with a population of about 1.1 million but interestingly, it has a banking sector with assets approximately seven times its GDP. The initial bail-out proposal offered on 16 March 2013 would have required all depositors (including those with balances below €100,000) to contribute a once-off levy of 10 per cent to raise €5.8 billion. This proposal was rejected by the Cypriot Parliament mainly due to the “bailing-in” of small deposit-holders and thus, undermining the deposit insurance guarantee, which is a central tenet of their banking system. The final agreement reached entailed, amongst others, a substantial haircut to be imposed on deposits above €100,000, the resolution of Laiki Bank into a “good” and “bad” bank with full protection of deposits under €100,000, and the “good” bank being absorbed by the Bank of Cyprus. The rest of the Cyprus banking sector would be unaffected by the resolution process. The Cyprian banks reopened on 28 March 2013 and one hopes that the authorities can sufficiently restore public and investor trust in their banking sector so that they are able to quickly lift the capital controls without contagion spreading throughout Europe, as such contagion may result in spill-over to the rest of the world. Whilst in the case of Greece the concept of private sector involvement was introduced, the Cyprus package involved the „bailing-in‟ of bank creditors and certain categories of depositors as part of the rescue effort. This may yet have wider unintended consequences, as it may contribute towards undermining of public confidence in vulnerable banks and also lead to outflows from the more risky peripheral euro-zone countries. This approach may also deter investors from returning to periphery bank debt markets, and has the potential of reversing some of the recent improvements in wholesale funding conditions in that region. These developments must be seen against a euro-zone economy that contracted by 2.3 per cent in the final quarter of 2012 and that is expected to remain in recession during the first half of this year. Furthermore, unemployment is at a historically elevated level of 12 per cent. There exists the real possibility that cyclical unemployment could evolve into structural unemployment, while the social implications of persistent high unemployment levels, especially among the youth, in the euro-zone should not be underestimated. BIS central bankers’ speeches The domestic economy South Africa’s economic growth accelerated to 2.1 per cent in the fourth quarter of 2012 compared to the 1.2 per cent recorded in the third quarter. Despite this improvement, the growth rate continues to remain significantly below the potential output growth rate of 3.5 per cent. The manufacturing sector recorded a robust growth rate of 5 per cent in the final quarter of 2012. However, the primary sector contracted for a second successive quarter and this remains a matter of some concern. Although the primary sector have shrunk significantly in the last three decades and now contribute less than 12 per cent to GDP, the agricultural and mining sectors remain important due to their significant contribution to exports, and hence the Balance of Payments situation. These sectors furthermore have relatively higher labour absorption rates. The picture is however not only doom and gloom. South Africa’s growth rates are expected to increase to 2.7 per cent in 2013 and to 3.7 per cent in 2014. While seemingly not very robust growth rates, it is important that these are considered against the challenging global economic climate. The current account deficit widened in 2012, to an average of 6.3 per cent of GDP compared to 3.4 per cent of GDP in the prior year. South Africa’s trade volumes in 2012 declined to below pre-crisis levels – resulting in the largest deficit since 2008. Export volumes have unfortunately not responded fully to the significant rise in export prices which have more than doubled over the last decade. The deterioration in South Africa’s international trade has in turn acted as a drag on domestic economic growth. Recent analysis by the South African Reserve Bank shows that South Africa’s export performance has been affected by, inter alia, the following factors: (i) The decline in the contribution of the gold mining sector; (ii) Binding constraints related to infrastructure bottlenecks; (iii) Skills shortages and mismatch; (iv) Competition from low-cost production bases which are export oriented in many emerging market economies; and (v) Sluggish growth in South Africa’s key trading partners. If we therefore wish to remedy the current account deficit in the longer term we would need to address these factors comprehensively. It is therefore clear that we would need to undertake significant structural adjustments, improve skills and human development, and labour productivity to name but a few in our quest to grow exports and in the process contribute towards lowering unemployment levels. The recent depreciation in the exchange rate provides an opportunity for South African exporters to become more competitive. However, a sustainable improvement in competitiveness requires that cost pressures are kept in check and productivity enhancements are achieved. The role of chartered accountants From the above it is clear that we face many challenges in the years ahead of us. The global recovery may continue to take several years before output gaps are closed. Domestically we have significant structural challenges to overcome, but I believe that all of us, including the accounting profession, have an important role to play in this regard. The profession can make a tangible contribution towards ensuring that our businesses and public sectors are appropriately capacitated to deal with their many challenges, using the BIS central bankers’ speeches skills and knowledge that members acquire during their academic and practical training, including analytical capability, professionalism, integrity, understanding complexity, etc. It is also important that members of the profession respond positively to the call of public service. Members should not merely become service providers to the public sector, they should also join the ranks of the public service in order to address the shortage of skills within that sector. In this context, they have much to contribute to root out corruption, design monitoring and early warning systems so as to ensure improved service delivery, institute controls that would minimise instances of wasteful and fruitless expenditure, and design reports so that politicians, officials, and other stakeholders have access to accurate and timely information. This should contribute to improved decision-making and policy outcomes. In time, the baton will pass to you and you will assume leadership positions both within the professional service firms, but also in the private and the public sectors. I do hope that you will do your best to strive to uphold not only the professional and ethical standards that is expected of you, but that you would in fact improve it further and ensure that in the process you tirelessly work towards both transforming the profession but also ensuring that it grows in an inclusive way. Conclusion In order for us as a nation to move forward it is important that we all own up to the responsibility that we have to ensure that South Africa reaches its full potential and, that it thrives and succeeds at all levels. As newly qualified chartered accountants many of you have a particular contribution to make to improve our competitiveness and performance, both domestically and within the global context and in that way help to improve the lives of all our people. Once again, allow me to congratulate you on your outstanding achievement and be assured that we will be closely watching your progress. I thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Southern African-German Chamber of Commerce and Industry luncheon, Johannesburg, 19 April 2013.
Gill Marcus: Lessons for South Africa from Germany in a challenging global environment Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Southern African-German Chamber of Commerce and Industry luncheon, Johannesburg, 19 April 2013. * * * Thank you for the invitation to speak to you today. We meet at a time when the IMF Spring meetings are taking place in Washington. The mood in Washington appears to be less sombre than was the case in the previous meetings, as the three big high-risk, high impact concerns of last year – a possible Eurozone breakup, the US fiscal cliff and a possible hard landing in China – have been avoided or at least postponed for now. However the low growth environment looks set to persist, and the World Economic Outlook of the IMF published earlier this week indicates that global growth is unlikely to be much better than was the case in 2012. Recent political and banking sector developments in Cyprus, Portugal, Spain and Italy illustrate just how fragile the recovery remains. Although in recent years there have been important shifts in South Africa’s trade ties, diversifying away from our traditional partners, Europe remains an important destination for our exports and an important source of both direct and portfolio investment. Germany ranks second in terms of destination of South Africa’s manufactured exports and the outlook for the South African economy therefore remains intricately tied to the fortunes of the region, and to Germany in particular. In my remarks to you today I will outline how we see the outlook for the global economy. However, beyond our trade and investment relationships, there are a number of lessons that South Africa can learn from Germany’s experience with labour relations and skills training, which are important elements of the kind of structural shifts that are required if South Africa is to compete effectively in the international trade arena, and to make appreciable inroads into the country’s unemployment problem. Global developments are critical for the South African economy going forward, and we look forward to a revival in world trade to help drive the domestic recovery. The cautious optimism that was evident at the beginning of the year, what some refer to as the “new year effect”, has now given way to renewed concerns. The IMF forecasts global growth this year to average 3,3 percent, compared with 3,2 per cent in 2012 but down on their previous estimates. The IMF still sees the recovery as fragile, with downside risks remaining, particularly in advanced economies. The World Trade Organisation last week downgraded its forecast for growth in world trade in 2013 from 4,5 per cent to 3,3 per cent (well below the long run trade growth of 6 per cent), mainly a result of renewed risks coming from the Eurozone and the impact of rising protectionism. We are in effect seeing a continuation of the crisis which has mutated between a subprime crisis, a growth crisis, a fiscal crisis, a sovereign debt crisis, a systemic banking crisis and a political crisis. All of these aspects are of course interrelated, and very often the resolution of one creates problems in another sphere. Nowhere is it more evident than in Europe where weak politics and weak economic outcomes and outlooks feed off each other. The banking crisis in Cyprus illustrates clearly how even very small countries can be potentially systemically important. While it appears that the tail risks related to the Eurozone have receded somewhat, these risks have not disappeared. Recent interventions by governments and the ECB, in particular the OMT, have shown a credible commitment to maintaining the integrity of the region, but important structural changes will need to be made in the medium to long term. In the short term, Europe is experiencing a recession and rising unemployment, due in part to fiscal BIS central bankers’ speeches austerity and banking sector deleveraging. The economic downturn in the periphery has been worse than official projections, and this could reinforce the adverse government debt dynamics and raise anew the questions of the sustainability of the regional arrangements, and the political acceptability of fiscal austerity. At the same time, progress seems to have stalled on banking reforms in the region, and the initial indecision regarding the bail-out of the Cyprus banking system has probably undermined progress on these reforms, as well as raising new concerns about safety of deposits. The other major lagging economy is Japan, and the outlook is perhaps a bit more difficult to assess following the announcement of significant monetary and fiscal stimulus packages. It is not clear to what extent the massive liquidity injection US$1,4 trillion over the next two years announced by the Bank of Japan will result in higher domestic expenditure. What is more certain is that the monetary stimulus is likely to lead to renewed capital flows to emerging market economies, with their attendant challenges. We have already seen the short term impact of this policy announcement, with the recent recovery of the rand to levels below R9,00 against the US dollar. The outlook for the United States is a bit more positive, with the worst of the fiscal cliff scenarios having been averted. The nascent recovery in the US housing market, the pick-up in private sector investment, and the recovery in the banking system point to a more favourable outcome than was feared in the latter part of last year. But some of the fiscal issues have merely been delayed and not fully resolved, so the potential for a further negative shock to growth remains. The so-called “sequester” came into effect a few weeks ago, and the negative impact of this will become apparent in due course. The most recent data coming out of the US suggest a moderation in the second quarter following weak retail sales in March, slower employment growth and the fall in the Michigan consumer confidence index to a nine-month low in April, as the effects of higher taxes begin to take effect. Even in the event of a relatively positive growth scenario, US monetary policy is likely to remain highly accommodative for some time to come, with implications for the persistence of capital flows to emerging markets. The recently published minutes of the FOMC suggest that there has been consideration given to moderating the pace of quantitative easing, and there are fears that this could result in significant reversals of capital flows from emerging economies. However, we believe that for this reversal to occur will require a sustained improvement in the unemployment situation. Any exit strategy is likely to be measured, to ensure that it does not undermine any nascent recovery. The eventual normalisation of US monetary policy is likely to signal a return to sustained growth, which will contribute positively to the global recovery. Furthermore, an early reversal of quantitative easing may also be offset by quantitative easing in Japan. Fears of a hard landing in China have abated, and although a return to previous elevated growth rates is unlikely, the expected growth rates of around 8 per cent should help to underpin the demand for and the price of commodities, which is critical for South Africa’s growth outlook. There is little doubt that there has been a tectonic shift in the drivers of global growth. The emergence of countries such as Brazil, Russia, China and India, for example, has changed the epicentre of global economic activity. The Brics share of global GDP has increased threefold in the past 15 years, and this share is currently around 20 per cent in market terms and about 30 per cent in PPP terms. According to Arvind Subramanian of the Peterson Institute of International Economics, this latter share is expected to increase to as much as 45 per cent by about 2030. South Africa is now part of the BRICS grouping, and although a relatively small partner, we are full members and are working to maximize the opportunities that present themselves. We are also aware that there are other countries that are also deserving of being members of this club, and a further indication of how a growing number of emerging markets are part of the shifting economic paradigm. Our membership should also be seen in the context of the BIS central bankers’ speeches economy being a gateway to Africa, which has been one of the outperforming regions in the past number of years, and which is expected to continue to grow at rates of around 5 per cent. As a region, Africa is the most important destination of our manufactured exports, and China has now become South Africa’s largest trading partner, although much of our exports to that country are commodities or commodity based. Despite these developments, the experience of the past few years has shown that emerging markets cannot completely decouple from the advanced economies. But the continued weakness in South Africa’s traditional trading partners in the Eurozone and the UK underlines the need to seek new markets for manufactured exports. Germany has long been one of South Africa’s traditional trading partners, and remains the second largest destination by country for South Africa’s manufactured exports, after the United States. In 2012, the value of these exports, mainly machinery and electrical equipment, amounted to R21,8 bn and accounted for about 60 per cent of our total exports to Germany. On the trade front, we still run a fairly large deficit with Germany, with total exports of R37,8 billion, and imports of R84,0 billion. Most of these imports are manufactured goods. In addition, Germany is one of the most important sources of direct foreign direct investment, with around 620 German companies operating in the country, employing approximately 90,000 people. German firms have invested R33.7 billion in South Africa since 2003. Trade and investment flows are important not only for employment, but also from a balance of payments perspective. Since the crisis, the weak recovery in the advanced economies constrained South Africa’s export growth which impacted adversely on the trade account of the balance of payments, particularly at a time when the exchange rate was relatively strong in response to strong capital inflows to emerging market economies. The current account of the balance of payments widened significantly in 2012 when it measured 6,3 per cent. This deterioration was driven in part by strong import growth, particularly those related to infrastructural expenditure investment by the state-owned enterprises. These imports will contribute to expansion of existing capacity and efficiencies in the economy as well as to future growth, but are likely to remain at elevated levels and relatively insensitive to exchange rate developments. However, the disturbing aspect of recent trends has been the weak recovery of South Africa’s exports despite a marked improvement in our terms of trade since 2010. Part of this has been due to the slow global recovery. But this is not the whole story, as South Africa’s export performance has lagged that of its emerging economy peers who have faced the same global environment. Slow export growth was also an outcome of the widespread stoppages in the mining sector last year, which adversely affected the export performance of our main source of exports. But non-mining exports have also underperformed, and we need to learn from the experience of countries such as Germany as to how to improve competitiveness under adverse circumstances. The main export sectors of the South African economy therefore face a challenging outlook, from both external and internal sources. Commodity prices, apart from the gold price, have not generally recovered to pre-crisis levels, and their volatility is illustrated by their sharp decline in recent days. At the same time input costs, particularly electricity and wage costs, have risen significantly and the sector is beset by an increasingly difficult labour relations environment. The manufacturing sector remains vulnerable to the continued weak demand from Europe while its import and export competitiveness was also adversely affected by the appreciation of the currency in 2010/11. Following the recent depreciation of the rand the outlook for the sector is more positive, but nevertheless fragile. The exchange rate is an important part of this story. As we have seen the rand has been on a depreciating trend over the past few months, but has also been highly volatile. BIS central bankers’ speeches The Consumer Price Index increased by 5,9 percent in March this year, the same increase as in February. The year-on-year price increases were mainly driven by the categories of housing and utilities and transport, with the higher petrol prices impacted by the weaker exchange rate, and the exchange rate remains an upside risk to the inflation outlook. These factors are expected to contribute to a temporary breach of the inflation target during this year. It also appears that medium term inflation expectations remain anchored inside the inflation target. Although the depreciation of the exchange rate does create challenges for monetary policy because of the adverse impact on inflation, a floating exchange rate acts as a shock absorber and is an important part of the adjustment process in dealing with a deteriorating current account deficit. Nevertheless the underlying structural issues remain, which will make it all the more important for South Africa to improve its domestic savings performance, as well as to continue to attract sufficient volumes of foreign capital, preferably in the form of direct investment, an area where German companies have been particularly strong. But the importance of Germany goes beyond simply looking at our economic ties. There is a lot that we can learn from the German experience. This is particularly the case with respect to labour relations and skills training. Much of Germany’s post war economic success can be attributed to its Social Market model. While this model is peculiar to Germany, there are many lessons for South Africa. Allow me to expand on three of these aspects – industrial relations, training and investment in continuous competitive enhancements. Naturally, these three aspects are mutually reinforcing. Germany’s industrial relations are characterised by a high degree of cooperation between employer and employee organisations. Both workers and firms take a long term view of the economy and both parties recognise the importance of continuously raising productivity. Both parties understand the need to share the productivity gains. This allows for an alignment of incentives between workers and employers. At a micro or firm level, there are appropriate mechanisms to resolve disputes early and in a win-win spirit. In South Africa, we need to find models that enable earlier dispute resolution in the workplace before labour disputes affect the broader economy. We also need to find ways that enable the work force to have greater knowledge of the financial affairs of the company and sector, while management needs to better appreciate the living and working conditions of their employees. Germany has a dual training system with high quality vocational training institutions complementing on-the-job training by firms. In Germany, nearly two-thirds of the country’s workers are trained through partnerships among companies, technical schools and trade guilds. In 2011, German companies took on and trained nearly 600 000 paid apprentices. The schools provide theoretical lessons on the side, while trade unions help ensure training is standardised. German firms take in young work-seekers and provide a period of training and induction in order to prepare young workers for the rigours of work and to give new workers the skills required to raise their own productivity. These apprenticeship schemes are based on a partnership between the state, employers and training institutions. Firms benefit by receiving support from the state to take on new work seekers. More importantly, they benefit from the high quality training provided both by public training institutions and by on-the-job training provided by the firm. The outcome for the firm is a steady supply of young workers with the knowledge and training to fit into a globally competitive economy. The outcome for society as a whole is that new entrants can gain access to work and training quickly, meaning that long term unemployment is low. Germany has amongst the lowest youth unemployment rates in the world, currently standing at 7,7 per cent, compared with the Eurozone average of 23,9 per cent. South Africa by contrast, has amongst the highest rates of youth unemployment in the world at 51 per cent, with our young people locked out of the workplace both due to poor skills and a lack of suitable experience. The pre-1990 system of apprenticeship that prevailed, although BIS central bankers’ speeches by no means perfect, was abandoned without an adequate replacement being put in place. The record of the SETA’s has been patchy at best, so there is no overall coherent focus on skills training in the country. The result is that when large scale infrastructure projects are undertaken, many of the skills have to be imported. Germany is one of the few developed countries to maintain a globally competitive manufacturing sector. It has done this because it has been able to invest in capital to continuously raise productivity and because of its ability to produce a steady stream of competent and appropriately skilled young workers. Germany has used the furnace of an open economy to put pressure on both workers and firms to remain productive and remain at the cutting edge of technology. While several sectors in South Africa are globally competitive, there are too many sectors that are not. South Africa has to raise its competitiveness across the board, but particularly in the tradable goods and services sector. This is the only long term solution to structural weaknesses in our economy that presents itself through large current account deficits. The combination of these three policies; industrial relations, training and competitiveness has allowed Germany to emerge from the global financial crisis in a much better position than almost any other advanced economy. When demand for goods and services fell in 2008 and 2009, many countries saw large-scale job-losses. In most countries, including South Africa, it is seen as normal for firms to reduce staff numbers when demand falls. During the crisis, almost one million jobs were lost in South Africa, and we are still not back at pre-crisis levels. The unemployment rate measured 21,8 per cent in the third quarter of 2008, but deteriorated during the crisis to reach a peak of 25,7 per cent in the second quarter of 2011, and currently stands at 24,9 per cent. In Germany, both firms and workers opted to reduce working hours and hence income, rather than face retrenchments. Government supported firms by subsidising training, allowing firms to use the period of slower demand to retool and to raise the skills profile of its workforce. The result was that unemployment increased moderately from 7,1 per cent in October 2008 to a peak of 8,0 per cent in July 2009, and in February of this year measured 5,4 per cent, compared with a Eurozone average of 12,0 per cent. Low unemployment in turn meant that domestic demand held up more strongly than in other comparable countries. And despite significant pressure from new emerging market competitors, Germany has remained competitive in its key high tech, specialised manufacturing sectors. In South Africa, we too introduced a training lay-off scheme whereby firms would move workers from production to training when demand was low, partly subsidised by the Unemployment Insurance Fund. Sadly, this scheme was not subscribed to as widely as the policy-makers intended. This is partly due to uncertainty on the pace of economic recovery and partly due to low levels of trust between firms, workers and government. We have seen some aspects of these policies applied by German firms in South Africa. There has been considerable success in raising productivity in the motor industry, thanks in large part to the training model of many German firms. Our challenge is to broaden these lessons. When economists talk of the benefits that foreign direct investment brings, they do not only talk about the direct benefits of capital and machinery. They also talk about technology, management practices and systems of innovation. When these occur, the recipient country benefits far more than can be measured by the amount of money that has flowed in. In order to tackle high levels of unemployment in South Africa, we seek not just foreign investment. We seek long term partnerships, partnerships that will be mutually beneficial. South Africa has a huge skills mismatch. This mismatch will not be resolved overnight, but firms can take the lessons from Germany and help to build a workforce that is skilled, satisfied and globally competitive. Unless firms realise that it is in their long term interests to develop their workers, we are not likely to benefit from the synergies of public education and training and firm level training. BIS central bankers’ speeches The year ending March 2013 was declared the German – South African year of science. This partnership between our two countries to advance scientific cooperation and development is a practical example of how our countries can cooperate to achieve mutually beneficial outcomes. We call on both South African and German firms to use partnerships such as these to pursue scientific and technological cooperation to the benefit of all parties. We trust that our strong relationship can and will be further strengthened in the coming years through deeper cooperation, higher bilateral trade and greater investment in capital and people. 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 7th Annual Financial Markets Department Cocktail, South African Reserve Bank, Pretoria, 30 May 2013.
Daniel Mminele: Financial market and reserve management challenges in South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 7th Annual Financial Markets Department Cocktail, South African Reserve Bank, Pretoria, 30 May 2013. * 1. * * Introduction Good evening and welcome to the South African Reserve Bank. It gives me great pleasure to welcome you all to the 7th annual cocktail function of the Financial Markets Department. As usual there are two reasons for this function tonight. The first one is to update you on the Financial Market Department’s (FMD) market operations and to inform you about the progress made with regard to various initiatives we are involved in, which are aimed at developing our markets and making them more efficient. The second reason is to thank you for your co-operation during the past financial year and to provide an opportunity to exchange notes and interact with one another. You will be glad to know that I am the only speaker, the rest of the programme should be fine and entertaining. I will try and be relatively brief, because they say it’s best to leave your audience before your audience leaves you. Allow me to formally introduce the new Head of the FMD, who is well known to most of you. Leon Myburgh joined the Bank on 1 March 2013, to take up this very challenging but rewarding role, and we wish him every success. I have no doubt that he can count on your support and cooperation. I don’t think it would be appropriate to address a Financial Markets cocktail function and not at least touch on the latest developments. I would like to spend just a few minutes taking stock of the economic and financial market landscape, before turning to matters related to the Department and market development initiatives. When we last met in May 2012, the key challenges we faced related mostly to an uncertain and fragile global economic and financial markets environment, in particular the euro zone crisis and the US fiscal situation. Even if we can’t quite declare victory, the global economy and financial markets have witnessed some improvement since then, as continued action by the world’s major central banks to provide the necessary liquidity to sustain the global economic recovery has largely removed the “tail risks” that unsettled global markets. While these actions have removed acute financial stability risks, the transmission mechanism into the real economy remains generally impaired, resulting in what continues to be a slow, unbalanced and fragile recovery. As you are aware, possible risks attached to the timing and pace of the reversal of these extraordinary measures, are the subjects of intense debate at the moment, including the possible impact on higher yielding assets of emerging economies, such as South Africa. Unfortunately, despite the easing in some global risks, the challenges in the domestic environment have intensified. The rand has been on a depreciating trend, partly explained by the recent strengthening of the US dollar and the decline in commodity prices. The rand exchange rate has steadily underperformed the currencies of its commodity-producing or emerging market “peers” over the past year. This trend, which contrasted with the more stable pattern of the rand versus its peers in earlier years, clearly indicates a growing sensitivity of the currency to domestic factors such as concerns about the funding of a wider current account deficit, as well as broader socio-economic issues illustrated by increasingly violent labour conflicts in the mining and other sectors. While an adjustment of the currency to changing economic fundamentals represents one of the benefits of a flexible exchange rate, excessive currency volatility and vulnerability of BIS central bankers’ speeches investor sentiment, increasingly risk complicating the tasks of both monetary and fiscal policy. The most recent exchange rate movements, including today’s, are somewhat exaggerated. The SARB continues to be committed to a flexible exchange rate and does not have an exchange rate target. This commitment should not be misread to suggest that any abrupt and disorderly movements in the exchange rate would not be of concern to us. For most of the past year and until recently, the bond market had shown little sensitivity to the currency’s depreciating trend, as it was underpinned by a combination of “push and pull” factors: Global investors’ search for higher returns; the inclusion of SA bonds in Citi’s World Government Bond Index; and a relatively benign domestic inflation environment which led market participants to reduce the probability attached to an early start of the eventual policy tightening cycle. In April, in particular, one witnessed a flattening of the bond yield curve, with larger declines seen in yields of longer dated bonds, those very maturities where National Treasury had just been increasing its issuance levels. The most recent episode of rand weakness has not left the bond market untouched, however, and the sell-off has been more pronounced at the long end. The equity market clearly reflects the challenges present, and although the Alsi is up almost 7 per cent year to date, the mining, platinum and gold sectors have witnessed hefty declines, while in US dollar terms, the MSCI for South Africa is almost 13 per cent lower. 2. Financial market operations Over the past year domestic money market operations have continued in an orderly manner. The money market shortage increased from R20.6 billion in March 2012 to over R24.0 billion in March 2013. This increase was largely due to a 14 per cent or R13.0 billion rise in notes and coin in circulation to R103.1 billion, and a R2.6 billion increase in the cash reserve balances of banks to R66.1 billion. These actions were somewhat offset by declines in outstanding debentures, longer-term reverse repos and CPD balances with the Bank. Foreign exchange swaps, both for liquidity management purposes and to sterilise foreign exchange purchases amounted to R43.7 billion as compared to R53.9 billion in March 2012. Swaps previously conducted to sterilise foreign exchange purchases amounting to R16.2 billion were matured, which increased the level of gross reserves, but were offset by sizeable valuation adjustments during the year emanating from the appreciation of the US dollar against other major currencies and the decline in the gold price. As such, the country’s gross reserves declined marginally from US$50.7 billion to US$50.0 billion between March 2012 and 2013, increasing marginally to US$50.3 billion in April 2013. From time to time the Bank reviews its operations in the money market with the aim of enhancing their effectiveness. The last enhancements to the Bank’s market operations were implemented in March 2012. The changes were implemented successfully, but there were also some unintended consequences. Since the introduction of the enhancements, the main repo auctions have reflected tendencies of commercial banks overbidding so as to ensure adequate allocation of funds. While this overbidding is not indicative of any stresses in the market, it does interfere with the signalling mechanism and would make it more difficult for the Bank to detect any possible stresses in the market should they arise. The Bank is currently looking at various options by which it can ensure that such overbidding does not continue. The Bank is also currently investigating the efficient functioning of the interbank money market, the over-utilisation of the automated standing facilities and the averaging on the banks’ cash reserves for the daily end-of-day square-off. In addition, one of the key strategic focus areas for the Financial Markets Department is a comprehensive review of the Bank’s monetary policy implementation framework, and the money market shortage as it relates to achieving the intended purpose of ensuring that decisions of the Monetary Policy Committee are transmitted effectively through the interbank market. BIS central bankers’ speeches 3. Financial market development Well-developed and smoothly operating financial markets promote investment, growth and job creation and contribute to a healthier and more efficient economy. During the past year the FMD has continued to work closely with the Financial Markets Liaison Group (FMLG), which is a consultative forum between the Bank and market participants, meant for information sharing and identification and management of challenges facing the South African financial markets in the interest of efficiency and further development. One of the major projects undertaken during the past year was the review of reference rates, and specifically the Johannesburg Interbank Agreed Rate (Jibar) which was completed successfully, with the co-operation of many people here tonight. This project was part of the normal work programme of the Money-Market Subcommittee (MMS) of the FMLG which had already commenced in 2011. However, the events that took place in the international market regarding the manipulation of the Libor heightened the urgency of the Jibar project. On 16 November 2012, the Bank published two documents. The first, “A review of the ratesetting process of the Johannesburg Interbank Agreed Rate as an interest rate benchmark”, presented the findings and recommendations that emanated from the review of the Jibar. The review indicated that while there were no fundamental concerns around the Jibar determination process, and no trends and patterns of anomaly, certain aspects of the process could benefit from enhancements and formalisation, more specifically the governance process. The second document, “The Johannesburg Interbank Average Rate (Jibar): Code of Conduct, Governance Process and Operating Rules” released together with the review document, was for public comment. The Code of Conduct, implemented on 1 March 2013, formalised the recommendations of the review project and is important to ensure the integrity and reliability of the determination process of the Jibar. The Bank is responsible for ensuring overall compliance with the Code of Conduct, and does so through the Reference Rate Oversight Committee (RROC). The RROC had its inaugural meeting earlier this week and will serve as an interim arrangement pending the finalisation of the legislation relating to the Twin Peaks model of financial regulation, after which this function, given that it relates to market conduct, will likely be transferred to the market conduct regulator. Since the Libor scandal, many institutions (including the Monetary Authority of Singapore, The European Security and Markets Authority, the European Banking Authority, and the Bank for International Settlements) have undertaken reviews of their reference rates and FMD continued to monitor these reviews and recommendations for relevance to our endeavours regarding the publication of credible reference rates. Currently, the MMS is working on a review of the South African Benchmark Overnight Rate on deposits (SABOR) and will report back to the FMLG its findings and recommendations. This work will feed into another project being undertaken by the Fixed Income & Derivatives subcommittee of the FMLG, namely, the development of the South African Overnight Index Swap1 (rand OIS). A well-developed rand OIS market would have many risk management benefits. Market participants predominantly use the OIS market for hedging activities, to hedge either their funding costs or their exposure to short-term interest rate movements, and to alter the term structure of a portfolio. The fixed-rate portion is also used by some market participants to derive market expectations of the Bank’s future policy rate changes. This work will culminate in an industry-wide consultation to deliberate on the format of a rand OIS An interest rate swap involving the floating rate being exchanged for a fixed interest rate. An overnight index swap is a particular form of interest rate swap, whereby parties agree to swap a floating interest rate – based on compounded overnight interest rates (eg EONIA, SONIA) – for a fixed interest rate (ie, the OIS rate). The overnight index is considered to be a good indicator of the interbank credit markets, and less risky than other traditional interest rate spreads. BIS central bankers’ speeches product that would enable South Africa to be on par with its developed market peers, and to be part of a handful of emerging markets to deliver a more sound derivatives pricing and risk management landscape. The central banks of most jurisdictions play a key role in the collation of information and the publication of the overnight reference rates, which are subsequently used in the OIS markets and in other money-market indices. Much work still has to be done to develop a fully-fledged rand OIS market, but the working group is making good progress. The Foreign Exchange Subcommittee has embarked on a project to formalise a rand fixing at prescribed intervals during trading hours. This project is necessitated by the need for local foreign-exchange market players to have a local fixing page for the rand. With the development of the currency futures market, it would provide quicker dissemination of fixing information across the market. A daily rand fixing will also enhance market transparency and can be used as an objective and verifiable reference rate for the settlement of foreign exchange transactions. Through the FMLG and its subcommittees, a Liquidity Forum has been established, whose mandate is to deliberate on market liquidity including the viability of a collateralised interbank market. This Forum will address other liquidity challenges and settlement issues that could arise. Another area of important consultation and co-operation between the Bank, through FMD and the Banking Supervision Department, has been the operationalization of the Committed Liquidity Facility (CLF) as part of Basel III implementation. In May 2012, the Banking Supervision released a guidance note on the CLF, which would be made available to banks to assist with meeting the Basel III Liquidity Coverage Ratio (LCR). Since then, market consultations on the outstanding issues around the CLF have been concluded and the Bank Supervision Department is finalising a revised Guidance Note, which will be issued together with an updated Operational Notice from FMD dealing with collateral arrangements for the CLF. 4. Reserves management The Bank has continued to make good progress in enhancing its reserves management operations. During the past year the Bank has faced numerous challenges in managing and maintaining high quality liquid foreign reserves portfolios in a low-yield environment, which was compounded by the on-going European sovereign debt crisis and numerous ratings downgrades. The Bank did, however, benefit from the increase in liquidity and the improvement in the credit risk profile of its investments as the euro zone authorities and the International Monetary Fund (IMF) have enhanced their efforts in solving the financial crisis. The Bank remained prudent and risk-averse in its investment strategies and the Bank’s holdings continued to be dominated by government bonds, supranational agency debt and high quality and short-term money market securities. The Bank benchmarked and just recently completed a review of its Investment Policy and also reviewed the Strategic Asset Allocation (SAA), to take into account the current lowyielding environment and expectations of future monetary policy actions by major central banks. The new SAA will encompass a wider variety of investments, in order to improve the diversification of reserves, while not abandoning the basic principles of portfolio construction based on our traditional objectives of capital preservation, liquidity and return enhancement within clearly defined risk parameters. Included in this is the investment in the onshore Chinese interbank bond market. Apart from ensuring that the currency composition of reserves better reflects underlying shifts in trade patterns, investing in the Chinese markets will provide an opportunity to familiarise ourselves with this market, given the expected major role that the Renminbi is going to play in the future. The Bank is finalising operational arrangements pertaining to this investment. BIS central bankers’ speeches In March this year, the Reserves Management Unit started trading in interest rate futures, which allows for more efficient portfolio management, and in particular as a hedging mechanism to more optimally manage the risk of negative returns in a rising interest rate environment. The Bank reviews its external fund management programme approximately every three and a half years. We are busy with this process at the moment and expect to appoint external fund managers and implement the programme by September 2013. The FMD is currently also reviewing its custodial arrangements alongside a Systems Renewal Project which commenced in 2011. Much progress has been made on both fronts, and it is expected that the final system selection will be completed in August 2013, with the implementation of new custodial arrangements taking place soon thereafter. 5. Conclusion As you can tell, the Financial Markets Department has had an incredibly busy year with many projects on the go simultaneously, both internally as well as with market participants. All of this can only be achieved with committed, dedicated and passionate people, who understand the importance of their role. I would like to extend thanks to the Department, its management and staff, for the hard work, professionalism and commitment shown. The fact that many of these projects, which by no means are small projects, are near completion and moving into implementation phase is a reflection of this. Thank you also to the colleagues from other departments within the Bank, who work closely with the Financial Markets Department and contribute to the success of the Department. I also thank all market participants for your cooperation and willingness to work with the Bank and helping develop South Africa’s financial markets. I would also like to take this opportunity to congratulate all the winners of the Financial Mail 2013 rankings of broking firms and analysts, well done to you all! Finally, to the staff of the Reserve Bank’s Conference Centre, thank you for once again arranging this function for us. They have agreed that, because my colleagues from the FMD are your hosts tonight, they will take care of liquidity management operations tonight. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Bureau for Economic Research Annual Conference, Sandton, 6 June 2013.
Gill Marcus: The implications of the crisis for monetary policy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Bureau for Economic Research Annual Conference, Sandton, 6 June 2013. * * * Ladies and Gentlemen, thank you for inviting me to be part of this important conference. At a recent IMF conference, the managing director Christine Lagarde suggested that central banks have emerged as the heroes of the crisis. In her view, one which is also widely held, the extraordinary actions undertaken by central banks, particularly in the advanced economies, probably saved the global economy from a far worse fate than we are currently experiencing. But this view of central banks as the heroes places inordinate pressures on them, not least because it leads to unrealistic expectations or a perception that they have become too powerful. In either instance this could ultimately lead to a backlash. What is clear is that the crisis has changed expectations of what central banks should do, and mandates have generally been broadened markedly. While price stability remains a core objective of central banks, the persistence of the global crisis has raised expectations about what central bank can and should do and, in particular, how their expanding mandates regarding economic growth and financial stability should interact with their price stability objective. The SARB faces similar challenges in South Africa, which have become all the more pressing given recent domestic developments that have focused increasing attention on the Bank. While the global crisis continues, the challenges have been compounded by recent South African idiosyncratic developments. I will address these issues today, and make a few comments about the current stance of monetary policy. The global crisis continues to mutate and it is still not clear what direction it is going to take next. Systemic banking issues, liquidity, fiscal deficits, unsustainable sovereign debt, recession and extremely low growth, fiscal austerity and rising unemployment, particularly in the Eurozone, as well as the danger in some countries of deflation, remain the key challenges facing many of the advanced economies. It is also evident that there is no decoupling of the emerging market economies, many of whom have seen slowing growth, upside inflation risks and capital outflows. The one bright spot appears to be the United States where private sector investment and the housing market are showing signs of sustained recovery. However, the big risk facing the US economy is the nature of the fiscal contraction. The fiscal policy political gridlocks have led to what is in effect haphazard fiscal contraction. The possible headwinds from this could be quite significant and pose a risk to the sustainability of the recovery. Ironically, a rapid US recovery poses other risks, as we have seen in the past few weeks arising from the possibility of an earlier-than-expected reduction in quantitative easing. There is not only uncertainty about the timing of this reversal, but also of the implications for capital flows and bond markets in emerging markets. Global factors are again coming to the fore, particularly in the market overreaction to the Federal Reserve’s possible tapering off of QE, which it has clearly stated that should this commence, will be done very slowly and would be highly conditional. This is affecting many emerging markets. For instance, since late April both the Brazilian real and the Mexican peso have depreciated by between 6 and 7 per cent against the US dollar. So part of what we have seen in the rand depreciation can be attributed to the question of QE expectations. At the same time, although the risks of a break-up of the Eurozone have receded significantly following the announcement of support measures by the ECB in the form of the (still unused) Outright Monetary Transactions, the growth outlook has deteriorated further. The recent OECD report suggests that the Eurozone will contract by 0,6 per cent this year, and only grow by 1,1 per cent next year. Although the UK shows tentative signs of recovery, it is still BIS central bankers’ speeches very weak. A big question mark hangs over Japan, as it remains unclear how the recently implemented stimulus packages will impact on the real sector. Systemically important emerging markets such as Brazil, India and China have slowed. In particular, the slowdown in China and the shift from fixed investment towards domestic consumption has contributed to lower global commodity prices, negatively affecting South Africa’s export earnings. There has been increasing attention paid to many parts of the African continent, which is expected to maintain a growth rate in excess of 5 per cent for the next few years. But all in all, there is a very difficult export environment for South Africa. This difficult trading backdrop is only part of the challenge facing the domestic economy. Although the economy recovered relatively quickly from the 2009 recession and grew by 3,1 per cent 3,5 per cent in 2010 and 2011 respectively, growth moderated to 2,5 per cent in 2012 and since the crisis has lagged that of our emerging market peers, as has our export growth. Growth moderated further in the first quarter of 2013 when it measured 0,9 per cent, the lowest growth rate since the 2009 recession. Furthermore, employment is still below levels attained before the crisis. The combination of lower competitiveness and declining terms of trade led to a widening of the current account of the balance of payments. This was exacerbated last year by the widespread wildcat labour disputes and high wage demands in the mining sector in particular, while the related work stoppages negatively impacted on exports. South Africa has to contend with these issues at a time of heightened vulnerability. The current account deficit needs to be financed, particularly at a time of uncertainty with respect to global capital flows. This is compounded by a threat of downgrades from the ratings agencies, while non-residents already hold a sizeable proportion of both domestic government bond (around 38 per cent) and domestic equities (around 42 per cent). The country also has a relatively low level of foreign exchange reserves. Household debt ratios remain high, while the fiscal deficit leaves limited fiscal room to respond to a further deterioration in the economy. Electricity supply constraints have also emerged as a risk to the growth outlook. These developments and vulnerabilities have adversely affected both domestic and international business confidence and investor sentiment towards South Africa. This has been reflected in the currency, which has depreciated by about 12 per cent on a trade weighted basis since the beginning of this year. Although the rand is part of the adjustment mechanism, the disorderly nature of the movements and the risks to inflation are a major cause for concern. It is against this difficult global and domestic backdrop that monetary policy has to operate, while at the same time learning the lessons from the crisis for macroeconomic policy. There are a number of aspects worth noting. First, while there is no doubt that fiscal expansion was called for at the onset of the crisis, an important lesson was just how quickly that fiscal space can run out. Many believe, erroneously, that the current problems of the Eurozone were due to profligate spending by governments. But many countries entered the crisis with low fiscal deficits and low debt ratios. For example, in 2007, government debt to GDP ratios in Ireland and Spain were 25 per cent and 36 per cent respectively, and by 2012 these ratios were 118 per cent and 91 per cent. Similarly the respective US and the UK ratios were 62 per cent and 44 per cent and by 2012 they had increased to 107 per cent and 89 per cent. The speed with which countries ran into fiscal constraints and the need to rein in these deficits focused increasing attention on monetary policy to provide a stimulus to growth and employment. Second, monetary policy has still got some traction when it is at the zero bound, as seen in the unprecedented quantitative easing in a number of the advanced economies. But it is clear that these interventions are more of a holding operation, and we still do not know what, if any, the unintended consequences of these policies will be. In particular it is uncertain what the impact will be when this liquidity is withdrawn. There are increasing concerns about the BIS central bankers’ speeches risks that this could pose, especially if such withdrawal is disorderly, as well as about the ability of the monetary authorities to fine-tune these exit strategies. Third, and perhaps most significantly, the crisis taught us the importance of focusing on financial stability, as an overly narrow focus on price stability can lead to imbalances in the financial sector, with potentially disastrous consequences. This is where much of the debate around macroeconomic policy currently revolves, and is creating challenges for central banks generally. The crisis focused attention on two particular issues: firstly the role of monetary policy with respect to output stabilisation or economic growth, and the second on the objective of financial stability. For some time it has been widely accepted that the core objective of monetary policy is price stability. During the 1990s inflation targeting was increasingly accepted as the preferred monetary policy framework, and during the 2000s, in the lead up to the crisis, the world experienced what became known as the great moderation, with inflation seeming to have been tamed in almost all countries. The continuing accommodative monetary policy stance in many countries has raised the question of whether growth is now a new objective for monetary policy with a retreat from the price stability objective. There are countries such as the United States where monetary policy has an explicit dual mandate. But in a flexible inflation targeting framework a concern about output growth is in reality an implicit target of monetary policy. In effect, monetary policy places some weight on the output objective in addition to the primary price stability objective, but these relative weights may differ over time depending on circumstances. In situations where inflation diverges from the target, the speed with which monetary policy aims to bring inflation back in line with the target is dependent on the concern about what is happening in the real sector of the economy. So when output is significantly below potential, and inflation exceeds the upper end of the target range, the policy horizon can be lengthened in order to reduce possible adverse impacts of tighter monetary policy on economic growth. This also implies that even if inflation is within the target, but uncomfortably close the top of the target range, monetary policy may be more accommodative than in the event of a zero or positive output gap. In other words, a relatively higher weight is placed on the output stabilisation objective under such circumstances. Monetary policy actions in the wake of the crisis can be seen in this context. In the immediate aftermath, monetary policy also focused on trying to ease liquidity in dysfunctional segments of the financial markets, although such interventions were not required in South Africa. Monetary policy has been focused on growth in a number of the advanced economies, but not necessarily because they have become “soft on inflation”. In many instances the absence of inflationary pressures gave policy makers the space to focus more on stimulating growth. In other instances there was a risk of deflation, and expansionary monetary policy responses are appropriate under such circumstances. But there have been cases, for example in the UK, where above-target inflation has been tolerated for extended periods against the backdrop of low growth and a tight fiscal policy stance. There are three important issues here: one is the behaviour of inflation expectations. When inflation expectations are firmly anchored, monetary policy has a much wider scope to tolerate these deviations. It is significant that despite the abnormally low interest rates and the enormous amounts of liquidity that have been injected into various of the advanced economies, inflation expectations have remained remarkably well contained. Second, monetary policy may be effective in affecting cyclical growth, or the deviation of actual output from potential output, but it is not very effective in determining the path of potential output itself. This is the task of structural policies, including those related to infrastructure provision, education and skills, the quality and quantity of capital etc. Finally, the fiscal-monetary policy mix is important. The tighter fiscal policy is, the greater the room for looser monetary policy. However, an accommodative fiscal policy stance constrains the room for monetary policy to act as the main countercyclical policy. BIS central bankers’ speeches Our own monetary policy reactions have been very much in line with this approach. The current stance of monetary policy is accommodative in the sense that the real policy rate is negative, around minus one percent, compared with a positive pre-crisis average of around 3,5 per cent. At the same time, notwithstanding an appropriate consolidation path, fiscal policy is also relatively accommodative, and the inflation outlook is very close to the upper end of the target range, with upside risks. Our tolerance of this uncomfortable position, however, is recognition of the weak state of the economy which justifies this stance. The output gap is negative and growth is below potential and expected to remain so for some time. But the monetary policy stance is also dependent on the fact that our inflation forecast does not suggest that inflation will accelerate significantly away from the target, and that inflation expectations remain more or less anchored, albeit at the upper end of the target range. In addition, inflation appears to be driven primarily by exogenous factors, while core inflation appears to be relatively contained. The question that can reasonably be asked is whether there is room for further accommodation. Our view is that risks have increased in both directions. We have limited room for manoeuvre, despite the lower-than-expected first quarter GDP growth outcome and further downside risk to our growth forecast of 2,4 per cent. Apart from the weak global environment, the longer term structural constraints and other shorter term domestic issues outlined above have undermined confidence, both domestic and foreign, which make the outlook for growth extremely precarious. These interrelated issues are likely to continue to negatively impact on near-term growth prospects, directly and indirectly through the impact on investor confidence. These are not issues that monetary policy can solve. At the same time, there are significant upside risks to the inflation outlook coming from the exchange rate and possibly from wage settlements in excess of inflation and productivity increases. The Bank’s estimate of the pass-through coefficient from the exchange rate to consumer prices is around 0,2 i.e a 10 per cent depreciation results in a 2 percentage point increase in the inflation rate. However, this happens with a lag, and is dependent on perceptions of how permanent the move is and the state of the business cycle. To date, the pass-through from the exchange rate to inflation has been relatively constrained, particularly compared to previous periods of high volatility and currency weakness. This is probably due to low growth and relative lack of pricing power in a number of sectors of the economy. Also, it could be that the recent sharp moves in the exchange rate are seen to be excessive and a sign of overshooting. However, the longer these weaker levels persist, the greater the risk that the relatively benign impact on inflation will end. Some prices are also impacted far quicker than others: for example petrol prices where the pass-through is very quick. We have been fortunate that the impact on petrol prices has been moderated to some extent by the weaker international oil price. Nevertheless, should current levels of both product prices and the exchange rate persist, we can expect a sizeable increase in the petrol price in July. In essence, while monetary policy remains tolerant of inflation at the upper end of the target range or of temporary breaches, the increasingly risky outlook for inflation, and its possible impact on inflation expectations, does constrain further accommodation. More importantly, monetary policy cannot deal with structural constraints. All too often it seems easier to place expectations on monetary policy to respond and thereby avoid the more difficult task of dealing with these constraints. While the trade-offs between output and growth are well-understood, the bigger challenge comes from the expanding financial stability mandates. Prior to the crisis, in many countries financial stability was an implicit objective of central banks, and in many instances was conflated with the health of individual banks and the stability of the banking system. In retrospect this is quite surprising, given that monetary policy is intermediated through the financial system, and therefore a dysfunctional financial system would effectively block the transmission mechanism of monetary policy. BIS central bankers’ speeches In the early part of the 2000s there was disquiet about emerging asset price bubbles with some voices, most notably at the Bank for International Settlements (BIS) arguing that central banks should lean against these developments. The standard central bank response at the time was that, with inflation generally under control, low interest rates were appropriate. Furthermore, it was argued, central banks were not well placed to recognise bubbles, let alone prick them, but were best placed to clean up in the event of a bubble popping. Unfortunately, central banks are still cleaning up from the on-going global crisis. Having recognised that price stability is not sufficient for financial stability, the need to focus on financial stability is clear, given that the fall-out of the crisis has been so protracted and costly. Cleaning up is no longer the only option. The focus is now on macroprudential oversight, which focuses on the financial sector as a whole, rather than on individual banking institutions, which is the domain of the microprudential regulator. However, despite a broad agreement on the need for macroprudential oversight, there is still much thinking and work to be done. At the IMF conference that I referred to above, Andrew Haldane of the Bank of England argued that the thinking about macroprudential policy is more or less where the thinking of monetary policy was in the 1940s. In other words, still a long way to go! He further argued that the design features are still rudimentary, not clearly defined and poorly articulated. First, there is still no general agreement on the objective of macroprudential policy - are we concerned about protecting the financial sector from swings in the real economy or protecting the real economy from cycles and swings in the financial sector? Secondly, we have an idea of what some of the macroprudential instruments should look like, but these are not well developed, and as yet untested in many instances. Furthermore, because the efficacy of these instruments is dependent on the nature and structure of the financial system, their usefulness may differ from country to country and therefore are not necessarily generally applicable. Should we be using price-based or quantity-based instruments? Monetary policy is generally conducted through a short-term policy interest rate. At this point there is no single policy instrument that is associated with macroprudential policy in the way that the policy interest rate is closely identified with monetary policy in most countries. This is not surprising, given that financial instability could emerge in different parts of the financial system, and therefore may require different and more focused policy instruments. In fact, many of these “new” instruments are tools that were previously used as anti-inflation policies, but ultimately fell into disuse because they were too narrow in focus to deal with broader inflation. The proposed tools are largely implemented through microeconomic policies, and include regulators setting maximum loan-to-value ratios, imposing countercyclical buffers or additional capital requirements, as well as determining margin and/or reserve requirements. Thirdly, there is no general agreement on the most appropriate governance, or its relationship to monetary policy. There are two broad views on this issue and their differences have their roots in the differing views of the role of monetary policy in the lead-up to the crisis. One view, for example that of Claudio Borio of the BIS, argues that an overly narrow focus of monetary policy on price stability and a disregard for financial sector imbalances led to low interest rates and excessive leverage, contributing to high consumption expenditure and asset price bubbles. This view suggests that the financial cycle is at the core of understanding the macroeconomy, and that because the financial cycle has a lower frequency than the business cycle, a focus on inflation and the business cycle results in too short a time horizon for monetary policy. Monetary policy should explicitly take financial stability issues into consideration, either as a secondary objective or as an objective with an equal footing. This implies that the policy interest rates should be part of the macroprudential tool-kit and is likely to result in tighter monetary policy in a low inflation environment when asset prices are seen to be rising. It also creates the possibility of conflict between monetary and macroprudential policy. BIS central bankers’ speeches The alternative view, and one that appears to be evolving into the current “wisdom” or “best practice”, is that the crisis did not represent a failure of monetary policy, but rather a failure of regulation, both at the micro and macroprudential levels. Furthermore, the interest rate is a blunt instrument to deal with financial crises, and the collateral damage of excessively high interest rates could be quite high. According to this view, monetary policy and macroprudential policies have different objectives and therefore require different tools and different committees. Under such circumstances, there are possibly fewer implications for monetary policy, but clearly coordination will be required, and the potential for conflict between the two still exists. But this is true of conflicts between monetary policy and other policies such as fiscal policy. This approach does not necessarily imply that macroprudential policy should be conducted by the central bank. However, having monetary policy and macroprudential policy under one roof, (and indeed microprudential policy), facilitates coordination, but implies more responsibilities for the central bank. The approach that we have adopted in South Africa is in line with this second approach. In terms of the Twin Peaks regulatory architecture, the responsibility for financial stability and macroprudential policy has been given explicitly to the Bank. At present, this function is undertaken by the Bank’s Financial Stability Committee (FSC) which includes all members of the Monetary Policy Committee. It is envisaged that once legislation has been enacted, the current FSC will be replaced by a Financial Stability Oversight Committee (FSOC) which will have both coordination and policy formulation responsibility with regards to financial stability and the implementation of macroprudential instruments or tools. The proposed legislation envisages that the Governor will chair the FSOC, which will include the market conduct regulator as a member and the National Treasury as an observer. This additional responsibility creates both intellectual and resource challenges for the Bank. The responsibility for financial stability may have possible implications for central bank independence. As Mervyn King, the retiring Governor of the Bank of England has argued, the expansion of mandates to include financial stability makes independence harder to define. Financial stability oversight is essentially a shared responsibility with other organs of government. Furthermore, it could at times involve the use of tax payers’ money to bail out institutions in difficulty. But more generally, macroprudential policies could have highly distributive impacts. In conclusion, central banks are facing a difficult environment as the weight of expectations on them increases. The crisis has led to extraordinary measures being taken by central banks. There is little doubt that current levels of real interest rates, both abroad and in South Africa, are not the long run “new normal”. However, it is still unclear where the new long run level will be, or when the normalisation will take place, or indeed how the process of normalisation will unfold. Despite what some would like us to believe, monetary policy is not the panacea for growth. Had low interest rates been all that is needed, the global economy would be in over-drive. Monetary policy has prevented the global economy from going into free-fall, but it is no substitute for structural reforms that are needed. The new focus on financial stability will endeavor to prevent a recurrence of global financial crises, but much of this is unchartered territory – all the more so given that the crisis continues to mutate, wreaking on-going devastation and enormous hardship. This in South Africa we now have an explicit financial stability mandate, which imposes new and arduous responsibilities on the Bank. Domestically, we are facing challenges of crisis proportions that require a coordinated and coherent range of policy responses, which are largely beyond the scope of monetary and macroprudential policies alone to deal with. Since the advent of democracy, South Africa has had a growth rate that averaged almost 3,5 per cent. According to the IMF, the policies that have been implemented have resulted in a 40 per cent increase in real per capita GDP, and a drop in the poverty rate of around 10 per cent. These are significant, meaningful achievements. Notwithstanding this the recent dismal growth performance and the vulnerabilities referred to earlier mask layers of BIS central bankers’ speeches deep-rooted structural problems that manifest themselves in high levels of unemployment and massive inequalities. These in turn are caused by weak competitiveness, a poor skills profile and an educational system that, in parts, is dysfunctional, low domestic savings, low investment, uncompetitive product and labour markets and spatial distortions. South Africa’s response should be focused on three strands. Firstly, as a country, we require clear actions to stabilise the labour relations environment. Secondly, the country has to take steps to address some of the areas of short term vulnerability. Thirdly, a clear programme of reform is required to boost medium to longer term growth. Much more important than the precise elements of a strategy is for government to be decisive, act coherently and exhibit strong and focused leadership from the top. There is clear recognition that South Africa faces significant challenges; what is required is decisive leadership from all role players that consistently demonstrates a coordinated plan of action to address them. This will go a long way to restoring confidence, credibility and trust. The Bank will continue to focus on its expanded mandate and stands ready to play its part in such a coordinated national effort. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the FM Top Companies awards function, Johannesburg, 26 June 2013.
Gill Marcus: Celebrating what is good about South Africa and its economy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the FM Top Companies awards function, Johannesburg, 26 June 2013. * * * Ladies and gentlemen, Thank you for inviting me to address the FM Top Companies awards function. It is an honour to be part of a tribute to the best companies in our country. It is appropriate that, at a time when much of the economic news is gloomy, we hold our heads high and celebrate what is good about our country and our economy. South Africa has a sound economic foundation and hundreds, if not thousands, of firms and business leaders that are outstanding in any context. It is a major source of strength that South Africa has a large number of companies that continue to grow, innovate, employ people and generate revenue and export earnings for our country. It is even more impressive that in times of very difficult and uncertain economic conditions, both globally and locally, many firms are performing so well. You and your firms are a significant reason why we can proudly say that while our economy faces many challenges, it is also highly resilient. We are here today to recognise these firms and their achievements. The economic environment is a difficult one. The world is in its sixth year of crisis: a crisis that has repeatedly mutated, shifting its epicentre from a sub-prime crisis to systemic banking crisis; a liquidity, fiscal deficit and sovereign debt crisis. Measures taken to address each of these elements have had unintended consequences. Austerity measures have contributed to an unemployment crisis of immense proportions, particularly for the young. There will probably be at least one or two more forms of the crisis before we can safely say that recovery is sustainable. And even then, as we can see in the United States where there are signs of recovery, the measures that are outlined to be taken very cautiously and with considerable conditionality, such as a tapering off of Quantitative Easing, have also had unintended consequences. As we have seen in recent days and weeks, the exchange rates of many emerging market economies have been impacted negatively by an outflow of capital. This development could well mark the start of a new mutation of the ongoing global crisis. If things do not get any worse it will probably still take a number of years before the world is back to more normal growth and output gaps are fully closed. Even then, there is debate about whether that new normal would be at a lower rate of growth than in the past. All in all, it is a very uncertain and difficult decade for individuals, companies and countries. South Africa’s weak first quarter annualised growth rate of 0,9 per cent is, to some extent, consistent with what we see happening globally and in other emerging markets and these developments have, in part, contributed towards a weaker rand exchange rate. But domestic factors have also contributed. These have to do with lost production in the mining sector, instability caused by violent and often illegal strike action and persistent capacity constraints in infrastructure, electricity in particular. The source of this vulnerability is primarily a large current account deficit, a high budget deficit, rising public debt and relatively low foreign exchange reserves as well as high household indebtedness and inflation close to the top of the target range – all suggesting limited room for fiscal or monetary support. South Africa is actively taking measures to stabilise the labour relations environment led by President Zuma who, in his budget vote speech, set out concrete steps to diffuse labour tension and ensure that labour disputes are conducted peacefully and within our legal BIS central bankers’ speeches framework. President Zuma also focused on the structural reforms that are being implemented, within the framework of the National Development Plan, to ensure higher and more inclusive growth going forward. Currently the financial markets appear to be confused about the monetary policy reaction function. This is not altogether surprising, as monetary policy is facing an extremely difficult dilemma. On the one hand, slowing growth with a downside risk, and the widening output gap should signal the need for further monetary accommodation, given the absence of significant demand pressures in the economy. These conditions have already resulted in the Bank being more tolerant of inflation at the upper end of the target range than would normally have been the case. This is consistent with a flexible inflation targeting framework. On the other hand, we are seeing increasingly strong upside risks to the inflation outlook, primarily coming from exchange rate developments. Had these pressures been simply a result of excess demand pressures, the response would have been relatively straightforward. But this is not the case. There are a number of issues that we have to consider in our decision making: to what extent is the depreciation going to be sustained? Will the currency continue to depreciate, settle at current levels or has it overshot in which case it will strengthen at some stage? This is critical in terms of the extent of the pass-through to inflation. We have observed that the passthrough thus far has been far more muted than has been the case in previous episodes of currency weakness, possibly also a reflection of the weak state of the economy. We have to assess whether the pass-through remains as low as it has been, or will we reach a stage where the margins of importers can no longer be squeezed? Furthermore, if there is a spike in inflation as a result of the depreciation, is it a one-off increase that will pass through the numbers by next year, or will it generate a depreciation-inflation spiral? Most importantly, will inflation expectations remain relatively contained at current levels? These are not easy issues to determine with confidence, and have been complicated by the strong market reaction to the suggestion that the US Fed may begin slowing the pace of its bond-buying programme. Our core mandate remains price stability, so our primary objective is to keep inflation within the target range. Currently our forecasts (and those of nearly all private sector analysts) suggest that inflation is likely to remain at the top of the band or slightly above, and then to return to within the target range. The downside risks to the growth outlook would suggest that we should tolerate inflation at these levels. However, the upside risks to the inflation outlook make further accommodation more difficult, but do not automatically imply a tightening of the monetary policy stance. This will be highly dependent on how we see the inflation trajectory unfolding in this very uncertain environment. In other words, it has become even more data dependent. There is of course always the danger that we are “behind the curve” and that we leave it too late (and this we will only know ex post). But at the same time, a sustained breach of the inflation target is not our central forecast, and the downside risks to growth imply that we would not want to be unnecessarily pre-emptive. This is the essence of the monetary policy dilemma, and requires a fine balancing act. As already mentioned, South Africa’s high quality firms are a key source of strength for the South African economy. South Africa is a vibrant, robust democracy with a sound Constitution that protects the rights of all citizens. This is essential for long term economic growth and for the fruits of that growth to be shared more equitably. There are several other economic foundation-stones which will help us navigate through these difficult times. South Africa’s macroeconomic policies are sound, clear and transparent. Our macroeconomic institutions enjoy a high degree of credibility and respect, both globally and locally. Flexible inflation targeting has helped anchor inflation expectations and has provided the Reserve Bank with some scope to support economic growth. BIS central bankers’ speeches Allow me to list at least five additional strengths and opportunities for the South African economy: • South Africa’s emerging middle class is a source of strength, contributing to rising consumption, the creation of new firms and greater social stability. • Our proximity to high growth African countries is already having a positive impact on our exports. • Our natural resources, both mineral and natural beauty, provide huge potential for investment in mining, agriculture, tourism and niche manufacturing sectors. • South Africa’s financial services sector is a recognised strength, with the country ranked in the top three in the world in the regulation of securities exchanges, soundness of our banking sector and access to financial services as part of a considered policy of financial inclusion. • The efficacy of our legal framework and the strength of our auditing and accounting capacity provide a conducive environment for the private sector to operate in. I can list many more areas where steady progress is being made. These strengths are a cause for optimism for our economy and reflect the significant potential for growth, employment creation and shared economic prosperity for all in our country. South Africa’s infrastructure programme has the potential to crowd in the private sector to expand investment and employment. Investments in electricity, renewable energy, freight rail, ports, water, roads and telecommunications will enhance the capacity of the economy, enabling faster growth as well as improve the efficiency of private firms. Two examples are worth mentioning here. First, adequate electricity provision is critical. We know that at present we cannot grow at a rate much in excess of 3 per cent without hitting against electricity supply constraints. We are also aware that certain investment projects do not get off the ground because of lack of certainty of electricity supply. Thus new energy capacity must be brought on stream as soon as possible, and on-going investment in sustainable energy capacity remains an imperative. Second, we have invested in a world-class road infrastructure in Gauteng which has already had a major impact on economic efficiencies. According to an independent study, the overall average travel time on the N1 north road section between Buccleuch and the Old Johannesburg highway has been reduced by 50 per cent to 13 minutes. The improved travel time and travel speeds come despite a 28 per cent increase in traffic volumes since the implementation of the Gauteng Freeway Improvement Programme. Furthermore, petrol consumption has also declined as less time is spent idling on the highways, not to mention improved road safety and reduced vehicle running costs. The need for and benefit of such economic efficiencies brought about through an expanded infrastructure programme cannot be overestimated. Investment in infrastructure is for the benefit of both current and future generations, and should provide the private sector with a longer term time horizon, encouraging private investment, which has been very weak over the past few years. We hope that the private sector will respond appropriately, and public-private partnerships should be promoted in the process. Growth in gross fixed capital formation is currently led by state owned enterprises, but for South Africa to reach its growth potential the private sector’s role is essential. In general, the private sector contributes around two thirds of such investment. Gross fixed capital formation as a ratio to GDP presently stands at 19 per cent, down from a high of 23 per cent in 2008, and compared for instance with that of Indonesia, a fast-growing emerging market, where it stands at over 30 per cent. South Africa’s infrastructure programme will have benefits for many sectors in the economy. Going beyond South Africa, Africa’s infrastructure investment increased from about BIS central bankers’ speeches US$10 billion in 2000 to about US$45 billion in 2010, and is set to rise to US$93 billion a year by 2020. South African construction firms are well placed to be an integral part of these opportunities in our region. In the 1960s, Korean construction firms won large contracts to build roads in South East Asia. These firms sourced their inputs from South Korean manufacturers, providing the first growth stimulus for them. Similarly, South African construction firms can grow their order books globally and use a proportion of South Africa material and capital equipment, stimulating our manufacturing sector. Long term growth requires a partnership between the public and private sectors, which requires a much longer horizon. Too often we are caught up in the paralysis of shorttermism. A long term perspective requires policy certainty, trust in institutions and confidence in the longer term growth outlook. There is increased recognition within the private sector that sustainable earnings growth requires such a longer term horizon and the chase for short term returns is not always consistent with longer term sustainable growth. At least some of our woes in the mining sector arise from a degree of short termism amongst all stakeholders in the sector. Before the era of global capital markets, mining companies were able to adjust to the volatility of commodity prices. When prices were high, they were able to accumulate cash on their balance sheets. They saved this money for times when prices would fall. More recently, shareholders penalised companies for keeping large piles of cash on their balance sheets. This resulted in large dividend payments. In turn, management took large bonuses when prices were high. Workers too demanded higher salary increases when commodity prices were high. When prices fell, mining companies made losses and there was no cushion. It becomes much more difficult for a company to raise capital when they are making losses. Similarly, management bonuses and workers’ salaries are sticky. The necessity of taking a longer term perspective does not just apply to shareholders and fixed capital investment. It also applies to human resource management. South African firms spend a lower proportion of their revenue training their staff than comparable firms in other countries. For all firms globally, staff development is a win-win investment helping to raise productivity and make work more meaningful and interesting for individuals. In a country such as ours where so many were denied adequate education, firms play a crucial role in training their staff. We need to remember that lack of education, or poor education, is the greatest exclusion there can be. In many cases, it is not the absolute salary that workers feel aggrieved about. It is the lack of a career-path and opportunities to move up the ladder that is the source of frustration. Peter Drucker, one of the fathers of theories on management, wrote in The New Realities (1989): “Management’s fundamental task is to make people capable of joint performance through common goals, common values, the right structure, and the training and development they need to perform and to respond to change”. To bring several strands of my talk together, I refer to two studies, one by the IMF and the other by the OECD, into how countries can avoid the middle income trap, which is defined as a period of slower growth or even stagnation when countries reach a GDP per capita of between US$5,000 and US$10,000 (in PPP terms). These studies suggest that to break out of this middle income trap, countries need to move from being adapters of technology to being producers of technology. Countries that move up the value chain to capture a larger share of the intellectual property or innovation succeed in breaking the trap. While South Africa’s expenditure on Research and Development (R&D) has increased in the past decade, the country still lags its peers. R&D expenditure in South Africa amounts to about 0,9 per cent of GDP, well below the 2,3 per cent average for OECD countries. In most countries, about two thirds of R&D spending is undertaken by the private sector, but in almost all cases there are strong institutional links between firms, higher education BIS central bankers’ speeches institutions and science councils contributing to both higher levels of research spending and more domestic commercialisation of the ideas and innovations. South Africa has many innovative firms that are able to compete with the best in the world. The most successful firms take a long term perspective, invest in their people and take innovation seriously. Allow me to quote Sipho Nkosi, the CEO of Exxaro: “We spend money on innovation and research and development because we believe that companies focusing on this will survive in the future and will have an advantage over those that don’t innovate.” The studies referred to also suggest that the presence of local firms that have a global footprint are critical to this process. Countries that have firms with strong global brands are more likely to move up the value chain. This is partly because so much of the value addition in the world economy today rests in research and development, innovation, branding and marketing, and logistics and distribution. How relevant is such a strategy for South Africa? On the one hand, South Africa has large numbers of poorly skilled people either unemployed or employed doing relatively low productivity jobs. On the other hand, we have sophisticated firms who operate at the cutting edge of global innovation with highly skilled staff. South Africa needs to pursue both strategies. We must grow our mining, agriculture, manufacturing and tourism sectors where we have significant comparative advantage. Parts of these sectors are also labour intensive and require relatively low skilled workers. Growth in these sectors has the potential to create millions of jobs. At the same time, South Africa needs its firms to develop brands and technologies that it can export. We are already well placed in many respects in telecommunications, banking, retail, brewing, construction and mining and we have firms with a significant global presence and strong brands. These firms generate significant export earnings for South Africa through the provision of knowledge services. For example, in 2011, South Africa exported US$7 billion worth of mining equipment and had a trade surplus of US$472 million in mining equipment. Such exports have strong backward linkages to our own manufacturing sector. By 2050, the world will need to produce about 80 per cent more food than today to satisfy growing populations and rising food consumption. Africa contains the largest proportion of underutilised arable land on the planet. This provides a huge opportunity for investment, not just in agriculture but in agroprocessing, in water management, in roads and ports and in cold storage facilities. South African firms in the agricultural and agro-processing sector have the expertise, the knowhow and the capital to invest in food production and processing on the continent. Again, there are strong backward linkages between such investments abroad and jobs back home. Ladies and gentlemen, yes these are difficult economic times. We have strong firms that significantly contribute to South Africa’s economic development. From our perspective at the Bank, we will endeavour to maintain a sound and predictable macroeconomic framework and enhance our economic environment. South Africa’s progress requires firms and businesses to become partners in development. Growing firms mean a growing economy and a growing economy is essential for firms to grow. These are mutually reinforcing developments. I am inspired by the successes of South African firms domestically, on the African continent and globally. We have high calibre business leaders who are smart, professional and innovative. We need closer ties and partnerships across our economy to raise our growth level and to make our growth more inclusive. Our appeal to you is to continue with your good work, take a longer term perspective and invest in people and technology to drive higher and more inclusive growth and reduce the unacceptably high income differentials. I am confident that through such partnership, drawing on our many strengths as a nation, South Africa will grow and continue to prosper. BIS central bankers’ speeches Again, congratulations to all the winners of the awards. Thank you. References International Monetary Fund (2013). Asia and Pacific. Shifting risks, new foundations for growth. Regional Economic Outlook, April. Jankowska, A, A Nagengast and J Ramon Perea (2012). The product space and the middleincome trap: comparing Asian and Latin American experiences. OECD Development Centre, Working Paper No.311. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the SAICA Southern Region Trainee Accountant Society, Port Elizabeth, 23 July 2013.
François Groepe: The role of the accounting and auditing profession in South Africa’s economic growth and development Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the SAICA Southern Region Trainee Accountant Society, Port Elizabeth, 23 July 2013. * * * Introduction I wish to thank the Trainee Accountant Society from the Southern Region of SAICA for inviting me to speak this evening. It is always an honour and a great opportunity to engage with different sectors of society, in particular South Africa’s young professionals who have a particularly important role to play in ensuring that this country realises its full potential, both socially as well as economically. The global economy There are signs that the global economy is recovering, however, the recovery at best remains fragile and weaker than what had been anticipated just a few months ago. The US recorded a quarter-on-quarter real GDP growth rate of 1.8% in the first quarter, somewhat lower than the earlier estimates of 2.5%, weighed down by the fiscal contraction. In addition to further fiscal consolidation, the debt ceiling debates, and the impact of rising long-term Treasury yields and mortgage interest rates in response to expectations of a tapering in asset purchases by the US Federal Reserve, also pose downside risks. Peripheral Eurozone remains mired in recession. Consequently, the euro zone contracted by 1.1% year-on-year in the first quarter of 2013, following a contraction of 0.8% in the final quarter of 2012. The IMF has reduced its forecast for Eurozone growth in 2013, by 0.2 percentage points to –0.6%, with a weaker recovery than previously forecast in 2014. The Japanese economy recorded strong quarter-on-quarter growth of 4.1% in the first quarter, but it remains too soon to assess the efficacy of the various stimulus measures that were adopted. A number of the significant emerging market economies have witnessed a slowdown, and have contributed to the most recent downward revision by the IMF of global growth by 0.2 percentage points to 3.1% and 3.8% for 2013 and 2014, respectively. Volatility in financial markets in recent days seems to have abated following the assurances given by the US Federal Reserve that it would continue to support the economy and that monetary policy would remain accommodative despite asset purchase tapering. The earlier turbulence seen, however, demonstrates that emerging and developing economies remain vulnerable to the spill-over effects of the reversal of the highly accommodative monetary policy by the advanced economies. The domestic economy The domestic economic growth outlook has weakened further following the disappointing first quarter annualised growth rate of 0.9%. Of some concern is the low growth in real gross fixed capital formation, which moderated from an annualised 4.3% in the final quarter of 2012 to 2.5% in the first quarter of 2013. The Bank has recently revised its growth forecast for 2013 lower, from 2.4% to 2.0% and for 2014 from 3.5% to 3.3%. The risk to the growth outlook is assessed to be on the downside, particularly due to the electricity supply constraints, difficult labour market conditions, particularly in the mining sector, and weaker commodity prices. Unemployment levels BIS central bankers’ speeches continue to remain sticky and have risen in the first quarter of 2013 to 25.2%. Of particular concern is the increase in the youth unemployment rate to 52.9% in the first quarter. Although targeted consumer inflation surprised on the down side in May 2013, decelerating from 5.9% in April to 5.6%, this easing in price pressures is assessed to be temporary. The Bank’s latest inflation forecast has been revised upwards, and inflation is expected to average 5.9% and 5.5% in 2013 and 2014, respectively, with a temporary breach in the target during the third quarter of 2013 when inflation is expected to average 6.3%. The upward pressure on inflation is mainly due to the continued currency weakness and higher than expected fuel price increases. The role of the SARB The South African Reserve Bank mandate as set out in the Constitution is to protect the value of the currency in the interest of balanced and sustainable economic growth in South Africa. Price stability is generally viewed as a critical element of the foundation of an economy and contributes towards achieving economic growth, development and employment creation. The achievement of price stability, in the case of South Africa, is quantified by the setting of an inflation target by government that serves as a yardstick against which price stability is measured. The achievement of price stability is furthermore underpinned by the stability of the financial system and financial markets. In pursuit of its mandate and purpose, the Bank performs the following functions: • Formulating and implementing monetary policy; • Promoting financial stability; • Issuing banknotes and coin; • Regulating and supervising the banking system; • Ensuring the effective functioning of the national payment system (NPS); • Managing the official gold and foreign-exchange reserves of the country; • Acting as banker to the government; • Administering the country’s remaining exchange controls; and • Acting as lender of last resort in exceptional circumstances. In addition to these core functions, the Bank also has a number of initiatives aimed at training young professionals, in a variety of fields. In this regard, the Bank actively supports the training of chartered accountants and is a sponsor of the SAICA Thuthuka School camps. The Bank supports the camps both financially as well as through active participation with some of our staff members participating as speakers at these camps. In addition we currently fund 10 students participating in the SAICA Thuthuka bursary scheme and the Bank is accredited with SAICA for the training of chartered accountants. In this regard, we currently have four (4) students completing their articles at the Bank. The role of chartered accountants In the most recent World Competiveness Report, South Africa performed dismally, sliding in ranking to 52nd place out of 144 countries. The deteriorating state capacity was one of the areas that contributed to the slide in the country’s ranking, and some of the more problematic areas identified included an inefficient bureaucracy, corruption and policy instability. BIS central bankers’ speeches On the positive side, we can be proud to be recognised to be at the forefront of governance and was ranked number one in the following areas: • Strength of Auditing and reporting; • Regulation of securities exchange; and • Efficacy of corporate Boards. It is therefore evident that South Africa’s auditing and accounting professionals are among the best in the world, and I do believe that accountants have an important role to play in ensuring that some of the structural challenges in this country are addressed effectively. The profession can for example make a tangible contribution in commerce and industry, but also towards the public sector by ensuring that our enterprises are capacitated to deal with the many challenges that are faced. Members can, by using the skills and aptitude that are acquired during their academic and practical training, and which include skills such as analytical ability, professionalism, integrity, understanding complexity, etc. assist in solving complex problems and challenges but also ensure that the many opportunities for innovation and advancement are fully exploited. I also would like to remind, especially the younger members of the profession, of a quote by John F. Kennedy which goes: “To those whom much is given, much is expected.” As trainees and newly qualified chartered accountants many of you have had the benefit of good schooling and tertiary education. You have further benefitted from the investment in you and opportunities created for you by this society. This privilege imposes upon you a moral obligation to plough back into both your immediate communities and our society at large by ensuring that you adhere to and promote the high ethical and professional standards of your profession. It is in this context that it is appropriate that members and aspiring members of the profession respond positively to the call of public service and that members do not only become service providers to the private sector, but that they also join the ranks of the public service in order to address the shortage of skills within that sector. In this context they have much to contribute to root out corruption, design monitoring and early warning systems so as to ensure improved service delivery, institute controls that would minimise instances of wasteful and fruitless expenditure, design reports so that politicians and officials have access to accurate and timely information and which should contribute to improved decision-making and policy outcomes. I wish to encourage members to think critically and to help shape the regulatory landscape, both locally and domestically, and to actively contribute to the debate and continuous improvement of the international standards and frameworks. Andy Haldane, Executive Director for Financial Stability at the Bank of England, in a speech to a conference in December 2011, hosted by the Institute of Chartered Accountants in England and Wales, for example, questioned the appropriateness of fair value accounting for the banking sector. He claimed that: “historically, fair value accounting principles have gained ground when the going has been good, and lost it when it has got tough. …During the downswing, fair value principles are rolled back.” Similarly, Brenton Saunders, a Director at an asset management firm, in a recent article in a local financial magazine questioned the appropriateness of full fair value accounting and the mark-to-market of reserves and resources of mining companies. I shall refrain from expressing an opinion on the appropriateness of fair value accounting, as we know that other conventions such as amortised cost valuation also have their own shortcomings, particularly when it comes, for example, to the recognition of interest rate risk. I do, however, believe that both Andy Haldane and Brenton Saunders touch on issues that are worth debating and I would like to see far more robust public discourse by a wider range of stakeholders as to both the appropriateness but also the possible unintended consequences of some of the international reporting standards and frameworks. BIS central bankers’ speeches Conclusion As we enter the sixth year of the global crisis, with several factors pointing to a prolonged period of weak economic recovery, new and fresh thinking has become more critical than ever. Add to this our list of significant structural challenges that we need to overcome domestically, and it is essential that we have all hands on deck. I believe that Chartered Accountants through their unique skill set have a very important role to play in helping us to steer the country to exploiting its full potential. I hope that you are not only up to the task but that you enthusiastically embrace the challenge. I thank you. BIS central bankers’ speeches
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Speech by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 26th Annual Labour Law Conference, South African Reserve Bank, Pretoria, 31 July 2013.
Gill Marcus: Employment and the economics of job creation Speech by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 26th Annual Labour Law Conference, South African Reserve Bank, Pretoria, 31 July 2013. * * * Dr Erich Fromm, in his 1976 book “To have or to be?” provides an analysis of the crisis of modern civilisation and, when addressing the features of a new society, wrote: “The first requirement in the possible creation of the new society is to be aware of the almost insurmountable difficulties that such an attempt must face … Those who have not given up hope can succeed only if they are hard-headed realists, shed all illusions and fully appreciate the difficulties … (the new society) would have to create work conditions and a general spirit in which not material gain but other, psychic satisfactions are effective motivations … ” Akerlof and Shiller, in their book “Animal Spirits” (2009) write: “We are facing the same problem today that we faced in the latter years of the Great Depression – business today is inhibited by uncertainty about the future, about the tolerance of an angry public, about a disaffected labour force and about what further government actions may be coming … We identified five psychological factors that we thought were of particular importance. They are confidence, fairness, corruption and bad faith, money illusion and stories …” It is almost twenty years into our young democracy, the past six of which have been seriously impacted by a global financial crisis to which there is no end in sight. And one of the hardest hitting impacts has been on ordinary people from all walks of life, who have seen their hopes for the future evaporate; millions will never work again; others will never know the dignity and independence that work brings. As the above quotes reflect, creating an inclusive society requires courage, foresight and the ability to make very tough choices. We also better understand our circumstances and challenges through stories, and it is imperative that we both tell and hear the many varied South African stories that make up the complex fabric of our society. Each year, the World Bank publishes its World Development Report covering a particular theme of development. This year, it has titled its report “Jobs”. This simple title says much about the most pressing economic issue facing the world today. The IMF, too, has released a substantive paper on Employment and Growth and recently the International Labour Organisation released its World of Work report with the theme of “Repairing the Social and Economic Fabric”. In recognition of the scale of the employment crisis and its impact on both social cohesion and longer term growth, several other global institutions and economists are focusing their attention on employment, seeking ways to tackle unemployment and underemployment. These discussions on employment occur in a global context where unemployment has increased sharply since the onset of the financial crisis. Of great concern is the fact that the number of young people who are unemployed, and the length of time that people remain unemployed, are rising. South Africa has had an unemployment crisis for the better part of three decades. A few years ago South Africa was an outlier with an unemployment rate of around 25 percent. Today there are several countries in the periphery of Europe with unemployment rates at least as high as ours – not that this is any reason for complacency or comfort. The International Labour Organisation estimates that there are about 200 million unemployed people in the world today. This figure excludes the millions more who are either underemployed or are discouraged from seeking employment. The ILO estimates that the number of unemployed people in advanced economies is likely to remain above the precrisis level up to at least 2017, a full decade after the crisis first began. In South Africa, total employment is still about 400 000 below the peak reached in in 2008. BIS central bankers’ speeches The unemployment crisis represents a massive waste of lives and resources. It has profound social implications and its effects will be with us for decades to come. Economists refer to the term hysteresis, which in this context describes the loss of skills and productivity when a person has been out of the workforce for a long period of time, thereby lowering future potential growth. Reducing unemployment on a sustainable basis is arguably the single most important economic objective at the present moment. In part, creating jobs is about raising the level of economic growth. However, it is also about addressing the structural factors that limit employment growth. My address today will try to give you a sense of how central banks think about employment and how they factor employment issues into their reaction function. I will also explore broader structural and cyclical factors relating to employment. Before concluding, I will briefly make some observations about the future of work and the likely impact of technological change. The policies of central banks are not often associated directly with employment creation. However, monetary and financial sector policies have a role to play in at least two respects. Firstly, the conventional view is that monetary policy can affect cyclical employment, but it cannot determine the longer run potential output of the economy. This is the basis for countercyclical monetary policy. However, in a recent paper, Phillipe Aghion and Enisse Kharoubbi, argue that better macroeconomic stability can actually contribute towards higher potential growth and that the absence of macroeconomic stability has a profound impact on employment rates. Our task as monetary authorities is to provide a stable environment for balanced and sustainable economic growth to occur; to ensure that investors can take a longer term perspective and that the value of earnings and savings are not eroded by inflation. Price stability is an important contribution to this environment because inflation is a regressive tax, impacting on the earnings and wealth of poor people far more than on the rich, who often have the means to protect themselves. In South Africa, high inflation contributed significantly to widening inequality in the 1970s and 1980s. Secondly, central banks also play an important role as regulators of the financial sector in a manner that contributes to the efficient allocation of resources in the economy, to prevent financial crises from occurring and to ensure that that money and credit is flowing to those who seek it. A key lesson from the financial crisis is that when the financial sector implodes, when confidence in the banking sector evaporates, the real economy is seriously affected because if money and credit are unavailable, the economy grinds to a halt. And one of the consequences is that people lose their jobs. One of the measures taken as part of a global move to create a safer and more accountable financial sector has been a series of regulatory reforms, including what is known as Basel III, which creates a framework for regulating the conduct and risk-taking of banks. South Africa sees these measures as critically important, and is in the process of introducing the so-called twin peaks model to regulate the financial sector in a more holistic manner. Beyond these important contributions to the broader economic environment, which are essential for job creation, central banks do not have the policy instruments to create jobs directly. Central banks also do not usually have the institutional authority or tools to undertake the structural reforms required to ensure that an economy grows faster or that unemployment is reduced at a faster pace. Furthermore, the room for central banks to direct credit to one sector over another or to one firm over another is limited. Fiscal policy, industrial policy and quasi-fiscal institutions such as development finance institutions are more suited to implementing such policies, which also fall within their areas of responsibility. The on-going global crisis has, since inception, mutated from a sub-prime crisis to a systemic banking crisis, a fiscal deficit and sovereign debt crisis to one that has seen countries and regions move in and out of recessions. Some measures taken to address these issues, including in some instances the introduction of extreme fiscal austerity policies, exacerbated the adverse effects of the crisis on unemployment. The latest mutation appears to be one BIS central bankers’ speeches that has impacted on emerging market economies, which are experiencing significant capital outflows, depreciating currencies, slowing growth and rising inflation. All of this impacts on local economies and jobs. Some of the rise in global unemployment is due to cyclical factors, including the austerity measures introduced following the crisis, and part of the rise is due to structural changes to the economy. It is often difficult to differentiate one from the other, especially when unemployment has been so high for so long. In the South African context, a relatively small proportion of our unemployment is cyclical; the bulk of it is structural with deep and long historical underpinnings. Drawing on reports by the IMF, World Bank, ILO and other institutions, several themes emerge. The key ones include: • What is the appropriate fiscal and monetary response to unemployment or more generally to the present state of poor economic growth? • What labour market reforms are required to support economic efficiency and productivity growth? • What labour market and other social policies can protect workers? • What other microeconomic or structural reforms are needed to raise the level of growth and employment going forward? There is general support for strong fiscal and monetary responses to cyclical downturns. Countercyclical monetary and fiscal policy can stimulate investment and employment when the private sector and households are less inclined to spend or to invest. On the fiscal side, there is strong support for investment in infrastructure and for subsidies to firms to train people rather than retrench workers. There is also increasing evidence that greater public support for research and development can contribute towards economic development and productivity growth, especially at a time when private firms are spending less on investment. Monetary policy in much of the globe has been supportive of credit extension and consumption. In most countries, including our own, interest rates are at historic lows and have been for some time. In some jurisdictions, central bank purchases of a broader range of assets, also known as quantitative easing, has provided further stimulus, enabling banks to improve their balance sheets. In general, central banks in advanced countries have tried to assure economic participants that interest rates will be kept low for some time in order to encourage investment. But there are limits to what monetary policy can achieve in this respect. As indicated earlier, monetary policy can only provide short to medium term relief and is not a substitute for necessary structural reforms. On both the fiscal and monetary fronts there are debates about the sustainability of these measures and the debate has shifted to the timing of the normalisation of such unconventional policies, and a concern about the possible unintended consequences as has been seen over the past few weeks. Labour market reforms that enable more efficient movement of workers from one sector to another are necessary because they help economies adjust to changing circumstances. They are also controversial because they reduce job security. Drawing on the work of the Spence Commission (the Growth Commission), policymakers are focusing more on protecting workers than on protecting jobs. This is a subtle distinction, but a significant one. Policies such as unemployment insurance, training vouchers and placement assistance can help workers who have lost their jobs find alternative opportunities. Policies that limit the ability to downsize or restructure are seen as inefficient and are being adjusted. Some countries have introduced innovative programmes to enable firms to keep people on their payroll, albeit at lower wages, instead of retrenching workers. These programmes are generally tied to training and re-skilling of workers. The most successful of these programmes is in Germany where a significant proportion of the workforce chose lower pay BIS central bankers’ speeches and the chance to be retrained rather than retrenchment. Many countries, including developed ones, have public employment programmes not too dissimilar to our public works programme. Other active labour market policies include matching activities for both people and firms. Several jurisdictions offer tax credits to employers to take on specific categories of workers. There is also recognition that structural reforms aimed at improving economic efficiency are needed to raise the level of employment. These policies include tougher anti-competition policies and microeconomic reforms aimed at lowering costs in key network industries. Education, training and the retraining of workers are essential to maintain long-run competitiveness and ensure higher levels of employment. After declining for decades, many advanced economies are spending more on education and training since the financial crisis, despite significant pressure to reduce public spending. South Africa’s high level of unemployment is not a new phenomenon. According to Haroon Bhorat, a labour market economist at UCT, in 1970 the number of African people in formal employment was 5.3 million. This number increased in the 1970s and early 1980s but by 1995, 25 years later, it was exactly the same at 5.3 million. This is despite the working age population almost doubling. While we cannot simply look backwards and blame our past, we also cannot simply wipe away its terrible and enduring legacy. The deep structural features of apartheid – in the form of poor quality education for black people, job reservation, curbs on trading and owning businesses, forced removals, land dispossession, dormitory townships and the homeland system – have all contributed to the situation where we have one of the highest levels of inequality in the world and over a third of adults are out of work. Since 1994, we have made steady progress in creating jobs, but clearly the rate of job creation has been too low to absorb the bulk of people seeking work. Sound macroeconomic performance combined with higher growth has contributed to rising employment since 1995. The problem has been that the increase in the labour force has outpaced the number of jobs created. South Africa’s official unemployment rate increased from 17.6 percent in 1996 to 30.4 percent in 2002, before declining to 22 percent in 2007. The legacy of apartheid has clearly resulted in a high level of unemployment, but growth since 1994 has not been as high as we would like. The rate at which an economy grows consistently is critical. While we all recognise that jobs are not automatically created when countries grow, we do know that if a country is not growing then it is extremely difficult to create new jobs, or even sustain existing ones. Government has frequently mentioned the desire to grow the economy at 7 percent a year. It takes decades for countries to make the transition from poor to advanced economies. Michael Spence, when examining this matter in his book “The Next Convergence”, says that “at a 7 percent rate of growth income doubles every decade, and that is very fast ... And even at such very high growth rates it takes well over half a century to make the full transition. What matters is sustained growth over a long period of time. Little growth spurts followed by stagnation simply lowers the average growth and prolongs the process.” It is in this context that we need to frankly assess our long term growth average, and our current growth rates, as while we are creating new jobs, they are not sufficient to absorb new entrants into the labour market, and therefore unemployment continues to rise. We also have to acknowledge that there remain deep structural weaknesses in our economy that prevent faster growth and higher labour absorption. These structural weaknesses, notwithstanding the legacy issues mentioned earlier, also include uncompetitive product markets, low levels of fixed capital investment, a low savings rate, inadequate progress in improving education and training and poor public services. Of particular concern has been the fact that the two sectors in the economy most intensive in low skilled workers, mining and agriculture, have shed jobs for much of the past twenty years. While there has been some job creation in low skill sectors such as the private security industry and the retail sector, in general most jobs have been created in skills- BIS central bankers’ speeches intensive sectors, locking out low skilled workers. Given the shortage of skilled workers, this trend has also pushed up the salaries of skilled people, contributing to rising inequality. This shift to more skills-intensive jobs is not a uniquely South African phenomenon. Globally, work has become more skills-intensive and the rates of return to education have been rising in most countries (IMF, 2013), meaning that skilled workers are capturing a larger and larger share of wages in the economy. This trend, referred to as skills-biased technological change, is also impacted by the introduction of China into the global trading system. Low skilled work has been outsourced to lower cost economies. When countries have highly skilled populations, this trend is a positive one for both productivity and employment. When workforces are insufficiently skilled to move up the value chain, then these workers get left behind. Even some developed countries, such as the US, are confronted by this problem. One of the most controversial aspects of post-apartheid policies has been the labour regime and the institutional structure of the labour market. The labour regime we have has sound intentions. Its aims are to balance the power of employers and employees following a history where workers, black workers in particular, were exploited and subjected to arbitrary dismissal. The labour regime aimed to reduce tensions in the workplace by setting up complex quasi-legal dispute resolution mechanisms. Policy has also sought to broaden access to unemployment insurance, health insurance, workmen’s compensation, maternity leave as well as training opportunities through the establishment of sectoral education and training authorities. Following the enactment of the Labour Relations Act, the number of days lost to strike action fell sharply with about one million strike days a year on average from 1996 to 2007. Since 2007 however, the number of strike days lost have increased sharply and strike activity has also become more violent. More recently, there has been a sharp increase in illegal or unprocedural strikes. Today, many labour intensive sectors are characterised by high levels of tension which are not conducive to investment, job security or employment creation. In other respects too, the labour regime has not lived up to expectations. We have not seen the dynamic growth of small and medium sized firms as one would have expected in a country at the level of development of South Africa. While collective bargaining has contributed to labour peace, it has also favoured big firms at the expense of smaller ones. New labour entrants also find it difficult to break into the labour market. While in general salaries are not high relative to other countries with a similar level of productivity, starting salaries are higher than other countries, discouraging employers from hiring inexperienced workers (OECD, 2010). Firing costs, especially for smaller firms, are also high by international standards (WEF, 2012). A major feature of the labour market regime has been the inability to more closely link pay to productivity growth. This was not what was intended. When the Labour Relations Act of 1996 was passed, the intention was for collective agreements to serve as framework agreements, covering minimum pay and basic benefits. The intention was that within these framework agreements, firms would negotiate firm-specific agreements linking salary increases to productivity gains. In practice, this is the exception rather than the rule. To introduce greater links to performance one does not have to change the law. Within the existing legal framework such agreements are possible. South Africa’s youth unemployment rate is particularly high, now above 50 percent. Programmes to encourage firms to hire young people have so far not yielded the desired results. Our view is that it is possible to incentivise firms to hire younger people without the threat of displacing more experienced workers. Several OECD and developing countries have some variant of incentive, including tax breaks, to firms to hire inexperienced workers and young people while protecting the existing workforce and older workers. Given the scale of unemployment in South Africa and the fact that most of the unemployed lack the skills to fit into most of the skills-intensive parts of the economy, it is critical that we focus on growing labour intensive sectors, including mining and agriculture. It is also critical BIS central bankers’ speeches that government expands and strengthens the quality of its public services, including the social wage, to enable low skilled workers to live meaningful lives. This requires an implicit understanding that wages on their own may not meet the desired living standards for newer workers, a controversial question given the high levels of inequality in our society. While South Africa has made praiseworthy progress in expanding access to early childhood education, school education, further education and training and university education, the quality of outcomes in the education system remains below international averages. Education provides the single most-effective route to breaking the intergenerational cycle of poverty. Lack of education is also the greatest exclusion a person can experience. It is also critical to obtaining a job and to higher productivity. Given that the economy is short of skills, importing skilled workers can be a sensible strategy because of the multiplier effects for low skilled employment. It is estimated that for each high skilled immigrant that comes into the country, between four and eight low skilled jobs are created. South Africa is faced with a difficult set of trade-offs. In general, countries get rich by moving up the value chain, by becoming more skills-intensive. South Africa lacks the skills to compete with advanced economies such as Germany and the US. On the other hand, our cost structure does not allow us to compete with poorer economies. South Africa has to therefore adopt a dual strategy of promoting growth in advanced sectors that can compete globally while also creating jobs in lower productivity sectors. Both legs of this strategy should focus on the need to raise exports in general which is the only realistic strategy to address our inequality problem on a sustainable basis. While mining will remain critical to our development prospects, the economy has to diversify to be able to create more jobs going forward. Since the industrial revolution, there have been many debates about the impact of technology on employment. The general consensus is that while technology may displace workers in some firms or industries, the productivity gains and resulting welfare benefits imply that new industries emerge and overall employment continues to rise. There could of course be huge inter-temporal factors that complicate the picture with long delays and lags between the destruction of a job in one sector and the emergence of new jobs in other sectors. There are also distributional effects which have to be considered. Well-paying jobs in the auto industry in the US, for example, may be destroyed through outsourcing or mechanisation while the jobs created in the growing services sector may offer lower pay. Furthermore, the returns that go to the developers and designers of technology now far exceed the returns to the people who assemble the products or even the people who extract the raw materials for the product. These distributional challenges arise in a global context. With a rising share of profits going to the design companies who are generally located in advanced economies, less of the value addition occurs in poorer countries. To put it differently, more of the value of the product accrues from the research, development, marketing, logistics and intelligence of the product than in any other part of the supply chain. The pace of technological change appears to be accelerating exponentially. The internet, mobile telephony, networked computing and more recently artificial intelligence have implications for the world of work and for our lives that are difficult to comprehend. Joseph Stiglitz in his 2010 book Freefall, argues that the jobs lost in agriculture at the end of the 19th century contributed to lower aggregate demand, leading to the Great Depression. This catastrophe was only resolved through the rise of manufacturing, initially prompted by the demands arising from the outbreak of Second World War. Is the unemployment we are witnessing today a result of a great dislocation of workers from manufacturing to services, or a replacement of workers – both skilled and unskilled – by artificial intelligence, or are there new work opportunities that are yet to be identified that could absorb the growing army of unemployed across the globe? BIS central bankers’ speeches These trends pose complex questions for policymakers. Should we protect certain sectors, and if so, how? Does protecting certain sectors or firms weaken the ability of the economy to transform or to innovate? Again referring to the Growth Commission report, the preferred approach is to protect people through sensible welfare safety nets and retraining opportunities rather than protecting specific jobs. It also brings back into focus the role of the public sector not only as provider of public goods such as education and research and development but also as employer in labour intensive services such as health care, transport, crime prevention and education. Does this level of unemployment not require all of us to reconsider the role and responsibility of the state in filling the gaps in services to all citizens that the private sector is not adequately meeting? Conclusion South Africa and the world face difficult challenges in reviving economic growth and creating jobs. Sensible counter-cyclical policies combined with longer term structural reforms aimed at promoting growth, employment and a more equitable distribution of incomes are the way to navigate out of this crisis. For South Africa, there is also a need to improve the functioning of the labour market, to strengthen its institutions and to walk that careful balance between hard-won rights of workers and the need to promote inclusive growth through encouraging new entrants into the workplace. From our perspective at the Reserve Bank, we will continue to contribute towards an environment conducive to creating jobs and encouraging long term investment. This implies a continued focus on price stability and the prevention of financial sector crises. It also implies policies aimed at reducing the volatility of the business cycle and of ensuring as little disruption to the macroeconomy from external shocks as we can manage. I leave you with a quote from the World Development Report on jobs: “In today’s global economy the world of work is rapidly evolving. Demographic shifts, technological progress, and the lasting effects of the international financial crisis are reshaping the employment landscape in countries around the world. Countries that successfully adapt to these changes and meet their jobs challenges can achieve dramatic gains in living standards, productivity growth, and more cohesive societies. Those that do not will miss out on the transformational effects of economic and social development.” Thank you References Aghion, Philippe and Kharoubbi, Ennis. Cyclical Macroeconomic Policy, Financial Regulation, and Economic Growth. 2013. Akerlof, George A and Shiller, Robert J. Animal Spirits: how human psychology drives the economy, and why it matters for global capitalism. Princeton University Press. 2009. Bhorat, Haroon, Decomposing Sectoral Employment Trends in South Africa, 2000. Commission on Growth and Development. The Growth report: Strategies for Sustained Growth and Inclusive Development. 2008 Fromm, Erich. To have or to be? Harper and Row. 1976. International Labour Organisation. World of Work, 2013. International Monetary Fund. Jobs and Growth – Analytical and Operational Considerations for the Fund, 2013. BIS central bankers’ speeches Organisation for Economic Cooperation and Development. Jobs Report. 2013. Stiglitz, Joseph. Freefall. 2010. World Bank. World Development Report – Jobs. 2013. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 93rd ordinary general meeting of shareholders, Pretoria, 26 July 2013.
Gill Marcus: Overview of the South African economy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 93rd ordinary general meeting of shareholders, Pretoria, 26 July 2013. * * * Dear Shareholders, Members of the Board, Deputy Governors, Ladies and Gentlemen, The past financial year has been as difficult as any since the global financial crisis began. The crisis has continued to mutate and the impact on South Africa has been compounded by domestic challenges that have at times overshadowed the global risks. The latest mutation comes in the form of a slowdown in the emerging market economies, which until recently had been the main engine of global growth. In its recent World Economic Outlook update in July, the IMF revised down its April forecasts for global growth in 2013 by 0,2 percentage points, mainly as a result of a sudden deterioration in the outlook for the emerging markets. The Brics countries featured very strongly in this downgrade: growth in China was lowered from 7,8 per cent to 7,5 per cent; Russia from 3,4 per cent to 2,5 per cent; India from 5,8 per cent to 5,6 per cent; Brazil from 3,0 per cent to 2,5 per cent and South Africa from 2,8 per cent to 2,0 per cent. The speed of this downturn is cause for concern, and illustrates that the idea that the emerging markets can decouple from the advanced economies and become an independent engine of global growth is overly simplistic. This slowdown is compounded by financial market uncertainties and turbulence that followed the announcement by the US Federal Reserve that it may begin to slow the pace of asset purchases. Long-term yields spiked in both advanced and emerging bond markets, as capital flowed out of emerging markets in particular. While the markets have calmed down somewhat following their original overreaction, this episode illustrates not only the difficulties that advanced economies will have in reversing their highly accommodative monetary policy stances in the future, but also the likely spillover effects on emerging and developing countries. Our challenge as a country will be to anticipate and reduce our vulnerability to these risks. In the meantime, however, loose monetary policy is expected to persist in most of the advanced economies as downside risks to growth continue and inflation remains largely benign with a concern about deflation rather than inflation, particularly in Japan and the United States. The Eurozone remains mired in a deepening recession, the Japanese recovery is uncertain, and the US economy, while showing signs of improving, is facing headwinds from a sharp fiscal contraction. The South African economic growth prospects have also weakened in the face of global and domestic constraints. The Bank’s most recent forecast is for growth of 2,0 per cent in 2013, rising to 3,3 per cent next year. However, there are downside risks to this forecast, particularly given electricity supply constraints. At the same time, driven mainly by a depreciating currency and rising wage and salary costs, the forecast inflation path has moved up, and a temporary breach of the target range is expected in the third quarter of this year, despite an absence of strong demand pressures. Although our forecast suggests that inflation will remain within the target range thereafter, it is uncomfortably close to the top of the target range and the risks to this forecast are seen to be on the upside. The Bank’s primary mandate remains price stability within a flexible inflation targeting framework. This means that we need to be cognizant of the state of the economy, and the BIS central bankers’ speeches policy dilemma has become more marked with rising inflation and slowing growth. Against the backdrop of a volatile currency responding to domestic and global developments, we can expect a challenging year ahead for monetary policy. As was elaborated in the Annual Report, the Bank has the responsibility to act on its expanded mandate of financial stability. This is part of a global phenomenon which has seen responsibility for financial stability and macroprudential oversight becoming increasingly the responsibility of central banks. This has raised expectations about what central banks can and should do, with the danger that expectations can become unrealistic. The move to the Twin Peaks regulatory architecture is well under way. In terms of this framework, the Bank has been given responsibility for prudential regulation of the financial sector, which will entail a move of a number of personnel from the Financial Services Board (FSB) to the Bank. In addition, the Bank has been given responsibility for macroprudential oversight. The coming year will therefore not only see logistical and personnel challenges, but also challenges of integrating our expanded mandate of financial stability with our primary mandate of price stability. An important function of the Bank is the management of the country’s official gold and foreign exchange reserves. For some time there has been a need to build up the country’s holdings of foreign exchange reserves, which were – and still are – low in comparison to IMF estimates of reserve adequacy and our emerging market economy peers. The need to accumulate these reserves was driven by the imperative to reduce the country’s vulnerability to sudden large outflows of capital, something to which our economy is prone. We have made good progress in this regard in the past 10 years, with gross gold and foreign exchange reserves increasing from US$8 bn in June 2003, to current levels of US$47 bn. Net reserves increased from US$1 bn to US$45 bn over the same period. During the past financial year, most of the moves in the level of reserves were a result of valuation changes relating to fluctuations in the gold price and exchange rate movements. Direct accumulation was limited given the weakening of the rand over the period. However, our responsibility for managing these reserves has impacted significantly on the profitability of the Bank. The financial statements presented to you today show that the Bank has recorded a loss for the third consecutive year. For the 2012/13 financial year, a loss of R1,5 billion was recorded, compared with R491 million in the previous financial year. It is important to elaborate on the nature of these losses, as they arise due to the unique nature of a central bank. The structure of the Bank’s balance sheet is intrinsically linked to the diverse responsibilities of a central bank. As has been elaborated in a recent paper published by the Bank for International Settlements, central banks pursue national welfare and not profits. It follows therefore that profitability is not necessarily a good guide for measuring success, and a focus on profitability can lead to sub-optimal policies for the country as a whole. The Bank’s activities and financial results should therefore be seen in a broader context and not within the artificial narrow confines of its balance sheet. The major source of our losses emanate from our accumulation and holding of foreign exchange reserves. When the Bank purchases foreign exchange, it injects rand liquidity into the market. Unless we neutralise this liquidity increase, it could have inflationary consequences. There are a variety of ways that we can do this through our open market operations, for example through foreign exchange swap transactions, conducting reverse repurchase transactions, or the issuing of Reserve Bank debentures. This process is known as sterilisation. However, while we are paying around 5 per cent (linked to the current repo rate) on these transactions, we earn very little on our holding of foreign exchange reserves. This is because the ongoing global financial crisis has resulted in abnormally low interest rates in the advanced economies. And it is the currencies of these countries that are held as our reserves. The cost of sterilisation and the low returns on foreign currency holdings continue to impact the financial results of the Bank. The income of the Bank is mainly derived from foreign BIS central bankers’ speeches investments and, due to the low-yielding environment this was insufficient to cover the operational costs of the Bank. In addition, the total income of the Bank decreased by R282 million compared with the previous year, mainly due to a reduction in commission on banking services. Clearly we could improve our balance sheet by not accumulating reserves or by reducing our reserve holdings. However this would not be in the interest of the country as a whole. To the contrary, our reserves are still considered to be on the low side, and over time we will need to build up these reserves further. But it is also important to point out that reserve accumulation has in fact been highly profitable for the country. As the rand has depreciated over time, the rand value of these reserves has increased quite substantially. However, in terms of the SARB Act, these revaluation gains (or possible losses) accrue to the government through the Gold and Foreign Exchange Contingency Reserve Account (GFECRA), while the current low return and cost of sterilisation accrue to the Bank. As shown in the Annual Report, the GFECRA stood at R67,6 bn at the end of the 2011/2012 financial year, growing to R125,5 bn at the end of March 2013. In this sense the artificial separation of these two components of reserve accumulation give a distorted picture, and we need to bear in mind this context of accounting conventions. We have to take policy decisions that are in the best interests of the country. A further contributory factor to the increased losses reported this past financial year relates to the Bank’s role as the sole issuer of currency in the economy. The previous banknote series had been in existence since 1992. A decision was taken to introduce a new series, and at the same time upgrade the security features of the banknotes in order to minimise counterfeiting risks. The introduction of a new currency series involves high initial fixed costs for a number of years as the stocks are built up, including buffer stocks. It is important to bear in mind that the notes and coin in circulation peaked at a level above R110 bn during the financial year, and increases at about 10 per cent per annum (compared to the peak in the previous year). In November 2012, the new Mandela banknote series was launched resulting in a R819 million increase in the cost of currency in comparison to the prior year, recognising that as we knew we were introducing the new note series, production of the old notes was deliberately kept to the minimum required so that we could draw down on the buffer stocks. In summary, the losses experienced by the Bank since 2010 are not a reflection of bad management or poor budget controls, but are the result of the exceptionally low foreign yields and the cost of issuing the new currency series. We are not driven by a profit motive and the losses arise from us performing our functions in the interest of the economy. But at the same time we cannot be complacent and use this as an excuse for uncontrolled expenditure. We therefore remain committed to containing our costs and maximising operational efficiency. At this time we would normally have expanded on some of the questions raised during the shareholder road shows held in Pretoria, Durban and Cape Town on 10, 11 and 12 July 2013, respectively. However, the questions posed this year were either specific to the persons attending the meetings or have been addressed in my earlier remarks. Unfortunately, this year’s shareholder road shows were not well attended and the Bank has decided that it will no longer hold the road shows in Durban and Cape Town unless circumstances dictate otherwise. However, the road show in Pretoria will still take place prior to the AGM each year. The general information letters that are distributed to shareholders at least twice each year, will continue. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Economics and Beyond Seminar, University of South Africa, Pretoria, 5 August 2013.
François Groepe: Structural reform to promote economic growth Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Economics and Beyond Seminar, University of South Africa, Pretoria, 5 August 2013. * * * Introduction The Bank for International Settlements’ 2013 Annual Report released in June this year argues that monetary policy has provided space and time for governments to undertake structural reforms to raise growth and productivity. The key structural reforms, they argue, relate to enhancing labour and product market flexibility and reforming the financial sector. Both the IMF, in the 2012 Article IV report on South Africa and the OECD, in their 2013 Report on South Africa raised labour and product market rigidities as the main constraints to faster economic growth and employment creation. When talking about structural economic reforms, there is generally universal agreement that we require deep structural reforms to improve our economic performance but there are a myriad of different interpretations of what is needed. There is however little consensus on which reforms are needed and should be implemented and how these should be implemented. There is furthermore a robust debate about what the key structural impediments are to higher growth and employment. This is not just the case in South Africa where the debate takes on a distinctly ideological tone, but globally too. Global economic developments Before I expand on the structural constraints to higher growth, allow me to present a short overview of the issues facing the Monetary Policy Committee (MPC) and the South African Reserve Bank (the Bank) in general. The global economic environment remains weak, with most of the major advanced economies growing below potential. While there are signs of positive economic growth and rising employment in the US, this growth is still too low to significantly close their output gap. Furthermore, a number of downside risk to their growth outlook remain, particularly in the form of further fiscal consolidation, the debt ceiling levels, and the impact of rising long-term bond and mortgage interest rates in response to expectations of a tapering of asset purchases by the US Federal Reserve. The Eurozone continues to experience recessionary conditions, with real output contracting by 1,1 per cent in the first quarter of 2013. The IMF has reduced its forecast for Eurozone growth by 0,2 percentage points to –0,6 per cent, with a weaker recovery than previously forecast in 2014. The Japanese economy recorded strong growth in the first quarter of 4,1 per cent, but it remains too soon to assess the efficacy of the various stimulus measures that were adopted. Furthermore, growth in developing countries, for some time the mainstay of the world economy, is also slowing and contributing to the recent downward revision of global growth by the IMF in the order of 0,2 per cent to 3,1 per cent and 3,8 per cent for 2013 and 2014, respectively. South Africa is affected by these international developments in three ways. Firstly, our ability to export to our major trading partners is weakened. For example, our major manufactured export sector is the motor vehicle sector and most of our car exports go to Europe. The Eurozone has just had its worst quarter for car sales in 17 years. Secondly, lower global growth lowers commodity prices. This has the benefit for lowering global inflation, but as a major commodity exporter, it affects our terms of trade and our ability to earn foreign exchange. Finally, monetary policy and changes in monetary policy in advanced economies is causing excessive volatility in the rand exchange rate. During the early periods of BIS central bankers’ speeches quantitative easing, the country was able to attract significant capital inflows. This assisted the financing of the current account deficit but it also led to a period of strength for the currency which impacted on exporting sectors. The anticipated reversal of quantitative easing have contributed to a slowdown in capital inflows and a depreciation in the exchange rate, which is likely to add further upward pressure on inflation due to pass through effects. Domestic economic developments On the domestic front, lower output from the mining sector and electricity constraints are limiting growth and contributed to the widening of the current account deficit. The Bank has recently lowered its growth projection for 2013 to 2 per cent. The official unemployment rate increased from 25,2 per cent in the first quarter of 2013 to 25,6 per cent in the second quarter of 2013. Of some concern is the increase in the youth unemployment rate to 52,9 per cent during the first quarter of 2013. The inflation outlook continues to deteriorate and is expected to be higher on average by 0,1 and 0,3 percentage points at 5,9 per cent and 5,5 per cent in 2013 and 2014, respectively. Inflation is projected to temporarily breach the target range in the third quarter of 2013, at a slightly higher average level of 6,3 per cent. This results in conflicting policy choices relating to rising inflation against the back drop of weak growth. It is however important to note that South Africa’s growth performance has lagged that of Asia and more recently a number of countries on the continent. It is imperative that the question of growth is addressed satisfactorily if we wish to tackle the triple challenges of unemployment, poverty and inequality in a cohesive and sustainable manner. This will require deep and courageous structural reform. The Monetary Policy Committee is mindful of these challenges and at the previous MPC meeting decided to keep interest rates unchanged. Our primary mandate is to keep inflation within the target band. The forecast for inflation at the previous MPC meeting was for targeted inflation to return to the target band in the 4th quarter, following a temporary breach in the third quarter of 2013. If, however, inflation remains sticky and evidence emerge of second round effects, the Bank would take appropriate measures in keeping with our mandate. At present, we are however confident that inflation expectations remain anchored, albeit at the upper end of the inflation target range, thus allowing for a continuation of accommodative monetary policy at this time. Structural reform Returning to the topic of structural reform, I shall attempt to summarise the key debates around which structural reforms are most pressing for South Africa and I shall be drawing on a theoretical framework provided by Dani Rodrik in a recent paper entitled “The past, present and future of economic growth”. Rodrik argues that for countries to raise incomes and living standards, they need to do two broad things, namely to build fundamental capabilities and to undertake structural transformation. Fundamental capabilities cover a range of issues such as macroeconomic stability, the credibility of economic and other institutions, the rule of law, quality of education, sound infrastructure and a competent bureaucracy. Investing in these fundamental capabilities often have long lags in impacting on economic growth, for example improving the quality of the education system takes a long time to feed into the performance of the economy. Structural transformation refers to the process of change in the pattern of what an economy produces, and in particular, what it exports. In order for a country to progress, it has to move up the value chain and consistently increase the complexity of its products. For example, an economy producing just apples is likely to grow by a limited amount unless there is diversification into producing processed foods from those apples. BIS central bankers’ speeches The process of structural transformation is more complex. It requires investment in capital to move up the value chain; research and development; functional financial markets; and a state capable of playing a coordinating role to address market failures to assist the progress of an economy into higher value added goods and services. Rodrik further argues that while fundamental capabilities are important, countries can achieve structural transformation in a relatively short period of time even without strong fundamental capabilities. China is a good example of structural economic change without a number of the elements that we often associate with fundamental capabilities. Despite these weaknesses in fundamental capabilities, they have been able to achieve a noteworthy level of structural transformation over the past two decades. In order to sustain the pace of development, they would have to invest in fundamental capabilities but these requirements are not mutually exclusive or sequential and the skills and attributes required to invest in one is not necessarily the same as those required to invest in others. There have also been several cases where countries have sound fundamental capabilities but have not been able to engineer structural change associated with rising incomes. New Zealand is such an example. The structure of the economy in general, in the literature, refers mainly to the pattern of what is produced. How big is the primary sector in relation to the manufacturing sector? What manufactured goods are being produced? How complex are these products? How diverse is the economy? What is the productivity level of various sectors? What are the principle exports? These are critical questions. In South Africa, the phrase ‘structure of the economy’ also has a broader distributional connotation. The question, ‘Who benefits from what is produced?’ is frequently asked. Debates often revolve around who owns what and how this has changed. It also revolves around the share of labour remuneration in GDP relative to the gross operating surplus and therefore the relative returns from growth to labour and capital. The skewed income distribution frequently features in debates about the structure of the economy. Apart from sectoral patterns of growth and the distribution of benefits that accrue from growth, there is a third area of focus when discussing structural reform in South Africa. This area relates to the efficiency or lack thereof of various markets. High unemployment is clearly the most glaring example of a mismatch in supply and demand. There are other types of market inefficiencies. Monopoly pricing, cartel-like behaviour and high cost structures, all impact on the structure of the economy and indeed all warrant attention from economic policy makers. For example, high prices in the telecoms sector impacts on costs in other sectors, thereby reducing their size and productivity. Market inefficiency impacts on the structure of the economy, for example a lack of competition often translates into higher prices and higher profits and the latter may lead to greater complacency and hence a slower pace of new product development and innovation. Profitable firms also tend to attract capital from the capital markets resulting in a situation where capital is not necessarily flowing to the most efficient or innovative firm but to the one making the biggest profits. Often, the presence of large and persistent profits is a sign of market inefficiency, and not of the quality of the entrepreneurs running the firms. According to Fedderke, Kularatne and Mariotti (2007), manufacturers in South Africa enjoy relatively high mark-ups, yet investment levels are fairly low. This pattern is evident in other sectors too, with high mark-up and large profits not necessarily translated into higher rates of fixed investment. There are of course several proposed approaches to prioritising economic reforms and these are often underpinned by ideology. Some would argue that markets are best at allocating resources and that state intervention and regulation should be removed to enable markets to allocate resources to the most efficient sector or firm within a sector. Except from general redistribution through taxation and fiscal policy; it is argued that subsidies, incentives, tax BIS central bankers’ speeches breaks or special taxes are distorting and reduce economic efficiency. This group can largely be categorised into what had become known in the 1980s as the Washington Consensus. Their prescription was privatise, liberalise, deregulate and shrink the state. Others argue that the market often fails to allocate resources efficiently and that left to their own devices, markets often end up highly concentrated and uncompetitive, with distorting effects on the economy. A classic example of this globally, is a situation before the financial crisis where the financial sector made large profits, taking on undue risks and attracted a disproportionate amount of graduates; arguably at the expense of other sectors in the economy. This group argues that there should be more state intervention and regulation to curb anti-competitive abuses by market players. A middle ground approach is to look empirically at which constraints are the most binding and to address these one at a time. If the problem is concentration, then the implementation of anti-trust legislation may assist in solving the problem. If however, the problem is government regulations that limit access to the market, such as telecoms or broadcasting for example, then a relaxation of the regulations may be deemed appropriate. In general, South Africa has not made sufficient progress in tackling our many constraints, which include a shortage of skills, infrastructure blockages, the structure of the labour market, the volatility of the currency, barriers to entry that limit, new entrants into product markets, the regulatory burden on small business and the capacity of the public service. South Africa’s track record in implementing the microeconomic reforms required to achieve structural change has been patchy. A key symptom of the problem is South Africa’s poor export performance. South Africa’s per capita export growth since 1980 has been less than 1 per cent a year, compared with rates of 3 to 5 per cent a year for countries such as Malaysia, Chile and Australia. South Africa continues to be reliant on a relatively small number of key export items – platinum, gold, coal and iron ore. Outside of the mining sector, there have only been a few export success stories; such as fruit, wine and motor vehicles, with the latter benefiting from large indirect subsidies. In general, growth in exports of these items has been insufficient to drive much higher aggregate export growth. So in addition to our poor export performance a further concern is the lack of diversification of the country’s exports despite significant resources flowing into industrial policy. We have seen growth in the services sector, which is positive. We have also seen rising productivity in the services industry and a rise in the complexity of services produced. This has enabled some economic growth and expansion of the employment. An increasing number of firms in South Africa are benefiting from the export of management services or the export of knowledge-based services. This type of exports in telecoms, retail, banking, mining and IT has provided South Africa with a growing share of service export earnings. This positive trend however, has not translated into much higher aggregate export earnings. There is considerable conjecture as to why the South African economy has not diversified its export basket more since its readmission to the global economy. Reasons forwarded include our distance from markets, inefficient logistics systems, the volatility of the exchange rate, the cost of labour in the manufacturing sector, skills constraints in the services industry, the lack of a venture capital culture and questions of economic policy certainty that detract from long-term investment. Without passing judgement on the validity of any of these specific claims this list of possible reasons provides policy makers with a list of structural impediments to faster and more inclusive growth. A recently published paper by David Faulkner and Konstantin Makrelov from the National Treasury and Christopher Loewald from the SA Reserve Bank entitled “Achieving higher growth and employment: policy options for South Africa” argues that the “core requirements for rapid and sustained growth are greater savings, investment, more productive use of capital by better skilled workers, reduction in the skill constraint and moderation in unit labour BIS central bankers’ speeches costs”. They estimate that the combined effect of reducing transport and communications costs, reducing the skills constraints, and increasing foreign direct and domestic investment, can increase potential growth to close to 8 per cent and create an additional 1,7 million jobs beyond the number that would be created without policy adjustments (by 2025). Allow me to illustrate their methodology with an example. “Transport, logistics and communications are network industries and are important determinants of an economy’s underlying cost structure and competitiveness.” Reducing these costs by 30 per cent pushes potential GDP growth up by 1,2 percentage points a year. Gross fixed capital formation increases to 26 per cent of GDP and 620 000 additional jobs are created by 2025. Another area where minor microeconomic reforms could boost growth and employment is in immigration policy. Allowing firms to hire skilled foreigners has several benefits. Firstly, it enables firms to raise productivity and to use the capital employed more efficiently. Secondly, it reduces the premium on skilled labour, lowering wages for skilled people and thereby contributing to lower inequality. Behar (2008) estimates that for every skilled worker employed, one semi-skilled job and 0,5 low skilled jobs are created. The National Planning Commission estimates that this multiplier is even higher. While South Africa has about 4,7 million unemployed people, it is estimated that there are about half a million vacancies in the economy in positions requiring skilled workers. Naturally, a country must improve the quality of its education system, but with the best will in the world, this will take time to feed into the supply of skills. Importing more skilled workers whilst addressing this constraint, would appear to be a sensible economic strategy. Except in exceptional circumstances, structural economic reforms do not occur in a neat, smooth and sequential manner. They are often the result of a laborious process of experimentation, negotiation and responses to pressure. This pressure can come from lobby groups or vested interests that do not necessarily have the interests of the broader society at heart. Pressure can also come from crises. When faced with a crisis, countries have to be bold and proactive to restore confidence. A now repeated lament from central bankers is that economic policy makers across the world have not used the present global financial crisis to address the structural reforms required to drive higher growth. Many economists ask the question ‘why does the country not introduce seemingly obvious structural reforms to boost growth and employment?’ The answer to this question is complex and relates to the power dynamic in a country. Structural reforms often have winners and losers. The losers are often diffused and dispersed, and therefore not able to mobilise to demand structural change. Conversely, the winners are often easily identifiable, powerful and well-organised. The recent debate about tariffs on imported chickens is a good example. This is however not a uniquely South African phenomenon. The Common Agricultural Policy in the EU provides huge benefits to European farmers at the expense of European consumers and producers from developing countries. This problem challenges economists and economic policy-makers to improve the analysis that they use to support their arguments and to think more carefully about how these are communicated to society. Many structural reforms are difficult to implement precisely because of the political economy of a society. The last theme that I wish to touch on today is to argue that inequality itself is a structural impediment to faster and more inclusive growth. Even after adjusting for differences in income per capita, unequal countries generally have the following features: high levels of crime, poor health outcomes, lower levels of education and low levels of trust between social partners. Probably, the single most important problem in unequal societies is that social trust is hard to build and maintain. In countries with low levels of trust, investment decisions tend to focus on short-term returns rather than on long-term rewards. This skews the economy away from fixed investment and from investments in infrastructure or research and development that have long-term payoffs. The simple explanation is that unequal countries are generally more unstable and therefore long-term investment is more risky and hence impact negatively on capital flows. BIS central bankers’ speeches To counter this phenomenon, countries need strong institutions, the consistent application of rules and legal frameworks that protect investors over the long-term. They also need policy certainty and capable public services able to collect taxes and spend it effectively. These capabilities are what Rodrik refers to as fundamental capabilities. While these capabilities are difficult to develop in highly unequal countries, they are even more critical in unequal countries to foster sustained growth and development. Conclusion South Africa’s transition from apartheid to democracy is a remarkable success story. Our challenge today is to develop an economy that is more inclusive. This requires higher levels of growth and improved employment creation. Macroeconomic policies are only part of the answer to these economic objectives. In order to achieve higher and more inclusive growth deep structural reforms are required. While there are hundreds of potential economic problems that require solutions, the most critical short run issues relate to product and labour market inefficiencies that keep insiders happy and outsiders out. Longer-term reforms include the need to improve the supply of skills and raising national savings. Implementing structural reforms are never easy. Policy-makers on the one hand need solid evidence and research to justify their actions. On the other hand, they need political will and political nous to get them through. South Africa has to build on its solid institutions developed since 1994 to embark on a new set of reforms aimed at making South Africa work for all its people. The speedy implementation of some of the key recommendations and proposals contained in the National Development Plan would be a good start. References Behar. A. 2008. “Does training benefit those who do not get any? Elasticities of complementarity and factor price in South Africa.” Economic Research Southern Africa Working Paper No. 73. Bank for International Settlements, 2013. BIS Annual Report. Faulkner D., Loewald L, and Makrelov K., 2013. “Achieving higher growth and employment: Policy options for South Africa”. SA Reserve Bank Working Paper. Fedderke J. W., Kularatne C., and Mariotti M., 2007. “Mark-up pricing in South African Industry.” Journal of African Economics 16(1):28-69. National Planning Commission, 2012. National Development Plan: Fixing the Future. Organisation for Economic Cooperation and Development, 2013. Economic Surveys of South Africa. Rodrik D., 2013. “The past, present and future of economic growth.” Working Paper 1, Global Citizen Foundation. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Opening Ceremony of the 1st South Africa-China Capital Market Forum conference, Johannesburg, 7 August 2013.
Daniel Mminele: The importance of well-developed and functioning capital markets for growth and development Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Opening Ceremony of the 1st South Africa-China Capital Market Forum conference, Johannesburg, 7 August 2013. * 1. * * Introduction Good evening ladies and gentlemen. Allow me to extend a special welcome to our visitors from China. Thank you to the Johannesburg Stock Exchange, Shanghai Stock Exchange and Frontier Advisory for inviting me to speak at this inaugural conference of the South Africa-China Capital Market Forum. This initiative bears testimony to the growing relationship between China and South Africa. In the 15 years since the establishment of official relations between China and South Africa, cooperation between the two countries has improved immensely. A number of Memoranda of Understanding (“MoUs”) have been signed, Foreign Direct Investment (FDI) has picked up, and bilateral trade between the two countries has surged. China became South Africa’s biggest trading partner in 2009 and is now the largest destination for South Africa’s exports. With respect to FDI, China is actively involved in mining, manufacturing and construction with China’s FDI presence growing from around R340 million in 2005 to roughly R50 billion in 2012. The most notable FDI transaction was in the banking sector, specifically, the 20 per cent stake that Industrial and Commercial Bank of China acquired in Standard Bank for US$5.5 billion in 2007. South Africa and China also cooperate in various international groupings, including the G20 and more recently as part of BRICS. South Africa, as you know, was invited to join the BRICS group when China was the chair and successfully hosted the 5th BRICS Summit earlier this year when it assumed chair of BRICS for 2013. Having been already allotted an investment quota, at this Summit, the South African Reserve Bank (the Bank) and People's Bank of China (PBoC) signed an agency agreement enabling the Bank to invest in China’s interbank bond market through the People’s Bank of China. South Africa was the first country on the continent to be given access to the Chinese onshore bond market in this way. As part of the growing importance of trade between our countries, this represents an opportunity to diversify the country’s foreign exchange reserves accordingly, and to invest in the world’s fifth largest bond market which continues to grow rapidly, both in depth and liquidity. Currently, the BRICS are negotiating both a Contingent Reserve Arrangement (CRA) and the establishment of a New Development Bank (NDB). The CRA is a type of financial safety net in the form of a self-managed facility through which BRICS countries can provide mutual support to each other when dealing with short-term liquidity and balance of payment pressures, and will likely take the form of a swap agreement, with an initial size of US$100 billion. The aim of the NDB is to mobilise resources for infrastructure and sustainable development projects in BRICS. Chief Negotiators have been appointed by each country and have commenced negotiations around issues such as membership; governance; capital size; structure and articles of agreement, amongst others. 2. The importance of capital markets Literature around the relationship between capital market development and economic growth goes as far back as 1873, when Walter Bagehot (followed by Joseph Schumpeter and John Hicks in the 1900s) pointed out that industrialisation in most of the developing countries was due to the availability of the financial system to mobilise BIS central bankers’ speeches productive financial capital. Today this remains a widely debated topic, with some division among economists regarding the importance of finance for growth and the causal relationship between the two. Some would argue that financial development is not important and that it is actually economic development which creates the demand for financial instruments. Others would concur with Bagehot and argue that a well-developed financial system improves the efficiency of financing decisions, supports a better allocation of resources and therefore promotes economic growth and development. Well-developed capital markets not only support growth, but the ability to diversify sources of finance helps to foster more stable growth by ensuring that shocks to the supply of bank credit do not impede growth. I would certainly lean towards the camp that argues that the financial system is without a doubt essential for economic growth. To quote the words of Former British Prime Minister Gladstone “…finance is, as it were, the stomach of the country, from which all the other organs take their tone.” Various studies conducted over the years, found that equity market liberalisation led, in some instances, to over one percentage point of additional economic growth in those countries that implemented them in the late 20th century. In addition, as long as domestic government debt remains at moderate levels, the growth of bond markets contributes positively to economic growth and provides a basis for the development of other capital markets. Such studies point out, however, that it is those countries with the highest quality institutions that benefit the most in terms of growth, that is, institutions need to be strengthened along with financial development, for without this, markets can become fragile and pose a threat to financial stability and ultimately growth. Key in this regard is good governance frameworks, transparency and accountability. Well-functioning capital markets are particularly important to a country’s long-term financing needs as they help mobilise resources and efficiently direct the flow of savings and investment inside an economy in a manner that facilitates the accumulation of capital and the production of goods and services. In a similar way, the existence of robust financial markets and institutions also facilitates the international flow of funds between countries. Deep and liquid capital markets not only help provide finance for government but also increase the benefits of financial integration and improve the resilience of countries against shocks. In the absence of well-developed financial markets, it becomes costly to raise capital, information tends to be limited and there is a lack of financial transparency, which means that information is not as readily available to market participants, and risks are likely to be perceived to be higher than in economies with more fully- developed financial systems. The G20 has recognised the importance of developing local currency bond markets and in this vein adopted an Action Plan to Support the Development of Local Currency Bond Markets (LCBMs) in 2011. The Action Plan recognized that financial deepening in general, and LCBM development in particular, could enhance the stability of the international monetary system by (i) raising capacity of economies to absorb volatile capital flows and intermediate them efficiently and safely; (ii) reducing reliance on foreign savings; (iii) attenuating external imbalances; (iv) mitigating the need for large precautionary reserve holdings; and (v) improving the capacity of macroeconomic policies to respond to shocks by allowing balance sheets to adjust more smoothly. A recent guest post by Jingdong Hua of the International Finance Corporation notes that capital markets have been a driver of China’s economy, which has displayed remarkable growth of roughly 10 per cent over the past three decades. China has introduced a number of innovative reforms to spur the development of its domestic markets, including amongst others, increasing the ceiling on its Qualified Foreign Institutional Investor (QFII) programme, and doubling the amount of domestic stocks and bonds that foreign institutional investors are allowed to buy. BIS central bankers’ speeches Some steady progress has been made over the past number of years in developing Africa’s capital markets, but these still remain shallow and illiquid and tend to be small and fragmented, owing to a number of factors including low income levels; weak judicial systems; and scarcity of human capital and financial infrastructure. The financial sector is a key driver of growth in South Africa. The South African economy has over the years steadily moved towards being a service oriented economy. As a percentage of economic output, the tertiary sector accounts for almost 70 per cent in real terms, with the finance, insurance, real estate and business services making up 34 per cent of the tertiary sector. South Africa stands out on the continent as having the most well-developed and liquid financial markets. Across emerging market countries, South Africa also compares favourably with its peers. Turnover in fixed-income securities trading on the JSE has been gradually increasing, from below R10 trillion in 2004 to a record of almost R23 trillion in 2012. Turnover on the equity market over the same period increased from R950 billion and reached R3.4 trillion in 2012. Market capitalisation on the equity market is roughly R9 trillion and R2 trillion for the debt market. There is no doubt about the many benefits that South Africa has reaped from having welldeveloped capital markets. The local currency bond and equity markets helped cushion the country during the financial crisis, helping to absorb capital inflows, reduce the dependency on foreign debt and therefore limit the adverse effects of the global crisis. The liquidity of this market, combined with investors’ search for yield in recent years, has seen non-residents become the largest investor base for government funding, holding close to 40 per cent of government bonds (a ratio similar to Poland, Indonesia, Mexico and Malaysia), from 10 per cent at the beginning of the crisis and exceeding the 28 per cent held by pension funds. The South African bond market is well developed in the sense that it is not only dominated by financial institutions and the government, but also comprised of a large number of non-financial corporates, while the maturity extends beyond 30 years. The biggest challenge in South Africa has been that of developing secondary market liquidity in the corporate bond market, while a more developed derivatives market would add to the depth of the market. Although not a typical central bank function, the South African Reserve Bank initially played an active role as participant in the development of the domestic government bond market through its various phases of development. The Bank played an active role in developing the secondary bond market in the 1990s as the sole market maker, and played a leading role in bond derivatives, inter alia to ensure continued net selling of government bonds in adverse market conditions. In the late 1990s, the Bank reduced its involvement in the secondary market, which at the time was judged to be sufficiently mature. Capital markets of course also play an important role in policy making, providing instantaneous feedback to policy makers on market expectations and perceptions of policy. Such perceptions and expectations are reflected in bond and equity risk premia. Having noted the benefits of well-developed financial systems, my remarks would be incomplete without at least briefly referring to the global financial crisis and how this may have changed the views of some on the positive impact of financial development and the role of markets. John Lipsky, former IMF First Managing Director, put it very well when he said that “…much of this reassessment is natural and sensible. However, it is fair to say that the idea that financial markets are not perfectly self-regulating does not represent a novel insight. To the contrary, there are good reasons why they are regulated universally.” In a nutshell, this highlights the importance of regulation and effective supervision in order to try and avoid a repeat of the global financial crises, which led to an economic and sovereign debt crisis, which after 6 years the world economy is still struggling to recover from. However, it is also important that regulation is appropriately calibrated, and that a defensible balance is struck between ensuring maximum benefit from capital markets through innovation on the one hand, and the need to protect markets BIS central bankers’ speeches and financial systems that may be still be in their infancy or not yet sufficiently developed on the other. Particular care needs to be taken when formulating global regulatory standards that do not appropriately take account of country-specific circumstances and may have unintended consequences. Let me now conclude by congratulating you on this important initiative, which will contribute to the further development of efficient and well-functioning capital markets in both countries, and also promote regular interaction between issuers, investors, brokers and others in the interest of growth and development. I wish you every success in your endeavours, and no doubt you will go from strength to strength in years to come. I 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 2013 Pictet annual global outlook, Johannesburg, 12 August 2013.
Daniel Mminele: Global liquidity, monetary policy and communication Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 2013 Pictet annual global outlook, Johannesburg, 12 August 2013. * 1. * * Introduction Good evening ladies and gentlemen. Thank you to Pictet for inviting me to speak at this year’s annual global outlook, which is taking place against the background of an environment that continues to be uncertain. I was requested to speak about the “Outlook for the SA economy” as your programme suggests. I have taken a bit of liberty, and hope I will be forgiven, as a lot has already been said on this matter in the last couple of weeks by my colleagues in various speeches, and the Monetary Policy Committee (MPC) meeting took place less than a month ago – so I shall only briefly touch on this towards the end of my remarks. I thought that I should discuss some topical issues relating to global liquidity, monetary policy and communication. The title of the speech we just heard – “The end of cheap dollars” – is certainly a very apt description of what the financial markets across the globe have been seized with over the past few months. “Cheap dollars” have become a feature of financial markets since the onset of the global financial crisis. Although the “Greenspan put” initially became the “Bernanke call” at the start of the global crisis, this was quickly transformed into a “Bernanke put” as quantitative easing gained traction. In addition to quantitative easing, the concept of forward guidance, whilst not completely new, gained increasing traction albeit in different forms. Across the developed world, forward guidance was used by policymakers to inject additional stimulus as interest rates reached the lower bound. Such actions signalled a change in the reaction function of central banks – that is, to keep rates low for longer. Last year, the Fed for the first time employed the practice of numerical thresholds as guidance to markets about the possible future path of monetary policy, the issue having featured prominently in deliberations at the annual Jackson Hole conference a month earlier. BoE Governor Mark Carney just last week for the first time linked the monetary policy outlook in the UK to an unemployment threshold and pledged to expand stimulus if needed. ECB President Draghi’s pledge to “do whatever it takes” within the mandate of the ECB was yet another form of forward guidance. In Japan, Prime Minister Shinzo Abe introduced an ambitious programme to deal with Japans deep-seated macroeconomic problems, which similarly has an element of forward guidance and quantative easing. Although we may now be close to the period when the Fed starts to taper its asset purchases, in the rest of the advanced world, it seems that such accommodative monetary policy is likely to stay for a while still. 2. Global economic and liquidity developments The question is whether the markets and the global economy can survive without Bernanke’s put? Or have markets become hooked on central bank money? Despite the substantial stimulus provided by central banks and fiscal authorities, the global outlook has improved only marginally and there are questions as to its sustainability. The euro zone remains in recession, and emerging market economies, which were the engines of growth through the crisis, are slowing, particularly China and economies in Latin America. On the upside, there are signs of stronger growth in both Japan and the US, although fiscal issues in the US continue to cast a shadow over and could potentially derail the recovery. It is therefore disappointing that 6 years since the start of the crisis, economic growth prospects remain relatively bleak and employment creation has disappointed. Raghuram BIS central bankers’ speeches Rajan1, Professor of Finance at the University of Chicago and soon to be Governor of the Reserve Bank of India, posed the question, what if the problem is the assumption that all demand is created equal? We know that prior to the crisis, demand was boosted by massive amounts of borrowing, and that the increase in spending came from poorer and younger families whose needs are greater than their incomes and are different from those of the rich. As lending dried up, so did borrowing, and demand for particular goods changed disproportionately. For this reason, Rajan argues that the general stimulus to demand that has been provided may not have been the most effective means to restore the economy to full employment, and instead, unlike the neo-Keynesian view, sees the only sustainable solution being to allow the supply side to adjust to more normal and sustainable sources of demand. Although the growth performance has been disappointing, one cannot say that the fiscal and monetary policies employed were fruitless, because it is impossible to know the economic situation in the absence of such policies. It seems reasonable, though, to assume, that the Great Recession may have been a little or a lot worse than a recession, and that the period of recovery may have been even longer than what is currently being experienced. There is no doubt that there was a need for the policies employed, and that authorities had to make use of all instruments at their disposal to prevent an even more severe downturn in the global economy and to prevent a collapse of the world financial system. There is also no doubt that implementing some of these policies was an experiment of sorts, and central banks have always been ready to admit that this is new territory and exits from these non-conventional and non-standard measures could be complicated, because there is no blueprint to work from when it comes to the extent to which central bank balance sheets were put to use. Whether or not policies employed thus far are the correct ones and will have any significant impact on growth going forward is a debate for another day. But it does seem clear that we have entered a period of structurally lower and more moderate growth and that it will be a long time yet before the world can enjoy the kind of growth and demand as seen before the crisis. In recent weeks we have witnessed significant volatility in financial markets. Emerging market economies in particular have been rendered somewhat more vulnerable owing to the strength of capital inflows over the past few years. Steepening yield curves, sharper than expected tightening of financing conditions and subsequent sell-off in risky assets and reversals in capital flows are risks that we probably have to contend with in the foreseeable future. This volatility reflects markets that have become reliant on cheap dollars, unnervingly so, because as we witnessed during May and June this year, the very idea or utterance from the Fed that asset purchases may soon be tapered, has seen emerging market currencies, debt prices and equities tumble. Currencies in Brazil, South Africa, Russia and India depreciated by between 7 per cent (in Russia) and 15 per cent since the beginning of May to July. On a year-to-date basis, local currency bond yields of Brazil and Turkey are over 220 basis points higher, while stock markets are lower. Jaime Caruana2 explains that the market sensitivity emanates from concerns that existing imbalances and distortions, particularly persistently high debt levels, could produce large losses once monetary accommodation comes to an end. He notes that indebtedness in G-20 economies has increased by more than 30 per cent since the beginning of the crisis, reflecting a large increase in public indebtedness, particularly in advanced economies, that has not been offset by a decline in aggregate private indebtedness. “Why Stimulus has Failed”, January 2013. Bank for international Settlements, Debt, global liquidity and the challenges of exit, 8 July 2013. BIS central bankers’ speeches A withdrawal of global liquidity would equate to a withdrawal in capital inflows to emerging markets, which would remove a source of financing for emerging markets and potentially lead to a sharp rise in term premia. The Institute of International Finance (IIF)3, however, projects that while capital flows to emerging market economies may decline, this should not be too severe. Capital flows to emerging market economies during 2013 and 2014 are projected to slow to US$1.145 billion and US$1.112 billion respectively. Such projections may indicate less appetite for emerging market assets, but certainly do not reflect any severe aversion either. The IIF notes that south-south flows could potentially offset declining flows from mature economies. But, one can only speculate about the impact of the eventual exit from unconventional monetary policy, the conflicting forces and which will be stronger. There may also be a fair amount of differentiation among emerging economies and some may be affected somewhat more than others depending on risk perceptions. Global liquidity, its measurement and its impact, under direction from the G20, is receiving greater attention from international financial institutions, precisely because of the recognition of the role that liquidity played in the global financial crisis, as a potential factor behind the pre-crisis accumulation of financial vulnerabilities. Similarly, during the crisis, spillovers from the general monetary easing in advanced economies have also created vulnerabilities, while there are also global financial-stability implications of prolonged accommodation. The Bank for International Settlements and the International Monetary Fund are studying this topic under the guidance of the G20, looking at both price and quantity based indicators, core and non-core indicators, with the objective of developing a suite of indicators that can be monitored and considered for inclusion in surveillance exercises of the IMF. 3. Importance of communication In 1981, Karl Brunner wrote, with evident sarcasm: “Central Banking… thrives on a pervasive impression that [it]… is an esoteric art. Access to this art and its proper execution is confined to the initiated elite. The esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences.” I can assure you that we have moved on a bit from those days. With this uncertain outlook and a volatile environment, communication becomes essential, and much has been said recently about central bank communications. The National Bureau of Economic Research4 highlighted the increasing importance of communication as a powerful tool that has the ability to move financial markets, enhance the predictability of monetary policy decisions and help achieve central banks macroeconomic objectives. This is because central bank communications influence short-term interest rates which in turn influence long-term interest rates and other asset prices which affect macroeconomic variables such as inflation and output. Having said that, it is also true that poorly executed communications can do more harm than good and in these instances sometimes “less is more”. Janet Yellen5 made reference to a growing body of research and experience around the topic of communication which demonstrates that clear communication is itself a vital tool for increasing the efficacy and reliability of monetary policy. She pointed out that the challenges Capital Flows to Emerging Market Economies, June 26, 2013. Central Bank Communication and Monetary Policy: A survey of theory and evidence, April 2008. Communication in Monetary Policy, April 4, 2013. BIS central bankers’ speeches facing the US economy in the wake of the financial crisis have made clear communication more important than ever before. Often, comparisons are made between the 1994 Fed rate hiking cycle and that of 2004 and many have contemplated whether we could be headed for a repeat of 1994. In 1994 the Fed hiked interest rates from 3 per cent to 6 per cent in the space of 12 months. There was significant spillover effects on global financial markets in particular as they related to a sharp decline in portfolio inflows into Latin America and the Mexican crisis ensued. In contrast, the Fed’s exit in 2004 had a much more muted impact on global markets. Nonetheless, markets reacted quite differently in the two episodes….what was the difference? The 1994 exit was unanticipated while the 2004 exit was anticipated. Expectations created and communication provided played a big role in how markets reacted. Suffice to say, of course, preparing the market and clear communication does not in and of its own ensure a smooth transition, but it can certainly help limit volatility and uncertainty. This time around, the task at hand is made even more complicated by the fact that monetary accommodation provided is much more than was provided in the past and much more creative than in previous episodes. It is clear that consistent and clear communication will be vital going forward in directing markets and ensuring that withdrawal symptoms are kept to a minimum. However, the very volatile and uncertain environment itself does present communication challenges. The South African Reserve Bank is committed to transparent monetary policy communication. At the conclusion of every MPC meeting, a statement is issued through a press conference chaired by the Governor, with all MPC members in attendance, to explain the monetary policy stance. The monetary policy statements, speeches by the Governors and senior officials as well as publications such as the Monetary Policy Review identify and discuss the balance of risks around our central forecasts in such a way that market participants and other stakeholders are in a reasonable position to form a view about our possible reaction to changing circumstances. 4. Economic outlook As I draw to a conclusion, let me now very briefly turn to the economic outlook for South Africa. South Africa’s growth outlook is inextricably linked to the global outlook. Although the recovery is somewhat stronger in certain regions, overall global growth prospects remain broadly on the downside. The extraordinary challenge facing policy makers globally is how to roll-out an ambitious programme of ensuring that the global recovery is sustainable and can gain momentum, by simultaneously implementing various initiatives while ensuring that they don’t conflict with each other. There is a need to support growth in the near-term, while also implementing credible medium-term fiscal policies, there is a need to continue the repair work to banking systems by pressing ahead with regulatory reform, which in some instances requires further deleveraging, but at the same time credit needs to flow to ensure that the abundant liquidity made available by central banks actually gets transmitted into the real economy. Alongside all these, structural reform needs to be progressed in a growth-friendly way to give us a better foundation for the future. Against the backdrop of a still difficult international environment affecting our major trading partners, as well as domestic challenges, at the time of the last MPC meeting the Bank revised lower its forecast for 2013 growth from 2.4 per cent to 2.0 per cent, while that for 2014 was revised from 3.5 per cent to 3.3 per cent. At the same time the Bank announced an adjusted CPI forecast, and expected inflation to average slightly higher at 5.9 per cent for 2013 and 5.5 per cent for 2014, with a temporary breach of the inflation target range during this quarter (Q3/2013). As we have indicated before, the challenge remains how best to manage upside inflation risks and downside growth risks. BIS central bankers’ speeches Apart from international factors, growth risks stem from relatively weak business and consumer confidence, which have impacted on private sector real gross fixed capital formation, and have also moderated household consumption expenditure, the latter also being constrained by subdued employment growth, and higher costs for electricity and fuel, and relatively high debt levels. An additional risk would be possible disruptions from strike action as part of the current wage negotiations in various sectors. Recent data releases and base effects suggest a better performance in the second quarter of 2013 when compared to the growth rate of 0.9% in first quarter, but much will depend on the performance in the subsequent quarters to improve an outlook that currently exhibits downside risks. Risks to the inflation outlook present themselves mainly through a more depreciated exchange rate of the rand, especially if such depreciation occurs very rapidly and is sustained, and possible inflationary pressures arising from excessively high wage settlements, and from higher food prices. Demand driven pressures continue to be relatively low, and the pass through from the exchange rate depreciation at this stage appears somewhat weaker than observed previously during periods of exchange rate depreciation. As regards the exchange rate, the fact that South Africa has a current account deficit and is reliant on portfolio flows has meant that the impact of global risk aversion has been somewhat more severe on South Africa than other emerging market countries, coupled with the fact that our markets tend to be more liquid and deeper than other emerging markets. However, while depreciation in the rand exchange rate poses inflationary threats, it could also improve South Africa’s outlook if it results in greater competitiveness of South Africa’s exports and an improvement in the terms of trade and current account deficit. This presupposes that the benefits arising from and exchange depreciation can be locked-in and such weakness does not translate into higher wages not matched by productivity gains, and thus higher inflation. For now, the Bank deemed it prudent to keep policy unchanged, but depending on unfolding events in the global and domestic environment, the Bank stands ready, as always, to act in whichever manner is deemed prudent, in line with its mandate, to ensure that inflation does not breach the upper end of the inflation band on a sustained basis, and results in a deterioration of inflation expectations. Let me finish by wishing you all the very best as you try to navigate these very difficult times. These are difficult times not only for you as investors, but also for us as central banks. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, to the Economics Department of the North West University, Potchefstroom, 15 August 2013.
François Groepe: The expanded research opportunities for students in economics Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, to the Economics Department of the North West University, Potchefstroom, 15 August 2013. * * * Introduction Prof. Waldo Krugell, Director of the School of Economics, Staff members of the Faculty of Commerce, Students, ladies and gentlemen. I wish to thank you for the opportunity to address you at your seminar series. Global economic developments Despite some positive developments recently, the global economic crisis continues and the recovery is best described as hesitant and fragile. In the past, the Bank has referred to the mutating nature of the crisis, with the crisis starting out as a sub-prime crisis which mutated into a systemic banking crisis, a liquidity, fiscal deficit and sovereign debt crisis, and more recently in some countries a youth unemployment crisis. The altered patterns of capital flows and the rising long-term bond and mortgage interest rates that may follow the tapering of the asset purchases programme by the US Federal Reserve and the eventual exit of quantitative easing by monetary authorities in advanced economies could well result in a further mutation of the global financial crisis. Six years into the crisis, most of the major advanced economies continue to grow below potential and unemployment, particularly in the Eurozone area has remained elevated. The level of youth unemployment is of particular concern with possibly significant long-term implications for social stability in the worse affected countries. While there are signs of positive economic growth and rising employment in the US, this growth is still too low to significantly close their output gap. The haphazard fiscal contraction and the potential headwinds that may flow from this are likely to pose a risk to the robustness and sustainability of the recovery. The anticipated exiting of quantitative easing by the advanced economies is likely to contribute to rising long-term bond and mortgage interest rates. This could bring pressure to bear on the housing recovery in the US, but will furthermore have a pronounced impact on emerging market economies, particularly their financial market asset prices and currencies may prove vulnerable. The Eurozone, after six quarters of contraction has finally emerged out of its recession in the second quarter of 2013, and recorded a growth rate of 0.3 per cent, which was slightly ahead of the median forecast of 0.2 per cent growth. This growth performance appears to be broad based on the economic outcome in core countries such as Germany and France, as well as certain of the peripheral countries such as Portugal, is positive. The recovery in the Eurozone economy is, however frail overall. The most recent IMF forecast for Eurozone growth was revised downward to –0.6 per cent, with a weaker recovery, than previously forecasted in 2014. The Japanese economy recorded strong growth in the first quarter of 4.1 per cent, which has since been revised to 3.8 per cent. Growth, however moderated in the second quarter to 2.6 per cent, (quarter-on-quarter saar). The growth in Japan is underpinned by strong consumer spending and exports and although the economic growth is stronger than in the more recent past in response to the stimulus measures undertaken, it remains too early to conclude on the sustained success and the efficacy of the various stimulus measures that were adopted. The July consumer confidence index fell by 0.7 per cent to 43.6 per cent and the proposed increase in the sales taxation is expected to act as a drag on growth. BIS central bankers’ speeches Growth in developing countries, for some time the mainstay of the world economy, is also slowing and contributing to the recent downward revision of global growth by the IMF in the order of 0.2 per cent to 3.1 per cent and 3.8 per cent for 2013 and 2014, respectively. In the immediate future, emerging market economies will have to balance possible capital outflows related to tapering with weaker currencies, rising inflationary pressures and underlying imbalances. Domestic economic developments South Africa’s economic performance is closely aligned to international economic developments due to the openness of our economy. Domestic economic growth has been disappointing, with the Bank recently lowering its growth projection for 2013 and 2014 to 2.0 per cent and 3.3 per cent, respectively. The Bank projects growth to accelerate to 3.6 per cent in 2015, but we assess the risk to the growth outlook to be on the down side in the light of the further delays in overcoming the electricity supply constraints, relatively weak business and consumer confidence levels and possible labour market developments. The low growth in real gross fixed capital formation, which had moderated from an annualised 4.3 per cent in the fourth quarter of 2012 to 2.5 per cent in the first quarter of 2013, is seen as one of the factors that underlie the weak economic growth outlook. Growth in capital outlays by private business enterprise slowed for the first time since the fourth quarter in 2011, and was mostly evident in the mining and manufacturing sectors. Gross fixed capital formation, expressed as a percentage of GDP remains low at 19.3 per cent, compared to the high of 24.6 per cent achieved in the fourth quarter of 2008. The official unemployment rate increased from 25.2 per cent in the first quarter of 2013 to 25.6 per cent in the second quarter. The youth unemployment rate has risen to 52.9 per cent during the first quarter of 2013 and is of particular concern. The inflation outlook had worsened at the time of our last Monetary Policy Committee meeting and is now expected to be slightly higher at 5.9 per cent and 5.5 per cent in 2013 and 2014, respectively. Inflation is projected to temporarily breach the target range in the third quarter of 2013, at a slightly higher average level of 6.3 per cent. The challenge that we face is how best to achieve our primary mandate of price stability against the backdrop of rising inflationary pressures and weaker growth. I should add that a sustained breach of the inflation target is not the Bank’s central forecast. The Monetary Policy Committee, whilst maintaining the accommodative policy stance by keeping the repurchase rate unchanged at 5 per cent at its last meeting in July, indicated that given the upside risk to the inflation outlook, the scope for further monetary accommodation is reduced. However, tightening of the monetary policy stance does not automatically follow, as a shift will be highly dependent on how we see he inflation trajectory unfolding against the backdrop of the prevailing uncertain environment. The Global Financial crisis and its impact on financial stability I now wish to turn to the impact of the global financial crisis, particularly its impact on South Africa and other emerging markets and the challenges it poses to financial regulation. In particular, I want to underscore the need for more research in an area which has gained pre-eminence since the onset of the global financial crisis, namely the macro prudential approach to financial regulation. There is no doubt that the global financial crisis has permanently changed the course of the global economy and has established a new normal. The severity of the 2008 financial crisis brought about the most damaging effects to domestic economies of the developed countries and possibly the longest lasting negative externalities to the world economy, in history. BIS central bankers’ speeches Although the emerging market economies performed better than the advanced economies, they were nonetheless affected through the trade and finance channels and as a consequence their growth rates too had been negatively impacted. The crisis has forced many central banks to look more closely at the build-up of financial imbalances in the wider financial system and to undertake regulatory reform which has expanded central banks’ role with regard to ensuring financial stability. The latter is known as the so-called macro prudential regulation and which concerns itself with more than just idiosyncratic risk and the soundness of individual institutions but is concerned with the soundness and stability of the entire financial system, i.e. systemic soundness. Fortunately, South Africa and its financial institutions fared well during the crisis. Our policy makers however appreciated that there was no room for complacency and decided to be proactive. Hence in 2007 the National Treasury launched a review of South Africa’s financial regulatory system. This work culminated in the Minister of Finance publishing a policy document, A Safer Financial Sector to Serve South Africa Better, also known as the “Red Book”. In terms of the reforms outlined in the “Red Book” the South African Reserve Bank would assume responsibility as macro prudential regulator, micro prudential regulator and resolution authority for the wider financial system. This means that the Bank’s previous role as micro prudential regulator of Banks (since 1990), would be expanded to include prudential regulation responsibility over the insurance sector and all financial market infrastructures, including the payment system, central clearing counterparty and trade repositories. Moreover, the Bank is also becoming the Systemic or Financial Stability Regulator. It is important to note that the Bank had been pursuing financial stability since 2001. However, it was an implicit mandate. Since 2010, the Bank has had an explicit financial stability mandate complementing its price stability objective. This, however, is in line with the mandates of most central banks around the globe. In pursuit of this expanded role, a Financial Stability Oversight Committee (FSOC), chaired by the Governor, will be established which will include representation from the Bank, the market conduct regulator and the National Treasury. The FSOC will have financial stability policy responsibility, in the same way as the Monetary Policy Committee does for price stability, and will be able to hold to account various authorities or economic agents on actions to be taken to mitigate against / reduce systemic risk. Research underpinning of the work of the SARB as systemic regulator The immediate challenge of the FSOC which is the same for other financial stability regulators around the globe, would be the further development and refinement of macro prudential frameworks. This will include both an analytical framework of looking at and overseeing systemic risks and a toolbox of measures to be considered to be implemented towards the achievement of the objective of financial stability. While the interest rate and inflation targeting are well developed frameworks for the attainment of price stability, it is less the case with the financial stability mandate or objective of central banks. This is the research challenge I want to pose to you. Charles Goodhart argues that as far as he is concerned, central banks can just focus on financial stability and abandon price stability. I wish to differ from him, but it does demonstrate the sheer size of the challenge of financial stability for the role of the central bank in the post crisis world. To date, international financial institutions like1 the Bank of International Settlements (BIS), the FSB and the IMF have been doing research on macro-prudential policy frameworks, Borio C, “Towards a macro prudential framework for financial supervision and regulation”, BIS Working papers (2008). BIS central bankers’ speeches including tools to mitigate the impact of excessive capital flows following the global financial crisis. However, a number policy and research questions remain either unanswered or not fully answered, including: • What should be the objectives of a macro prudential policy framework? • What is the toolkit of instruments – are these micro prudential or macro prudential in nature or even macro-economic or other? • What is the efficacy of such instruments? • What challenges are posed by macro prudential / financial stability regulation to the traditional understanding of central bank independence? • What are the analytical tools necessary for the identification and monitoring of systemic risk? • What is systemic risk? These are only a few of the policy questions which policy makers around the world are grappling with particularly since the onset of the global financial crisis. Clearly there is a role to be played by senior students and post graduate researchers in providing answers to these important research questions and the Bank would eagerly consider partnerships on coordinated research on these and other important research endeavours which relate to the policy mandate of the Bank. Conclusion In conclusion, although the outlook for the South African economy has weakened as reflected in the lowered forecast for growth, it is important to appreciate that it is against the stark backdrop of very sluggish global growth. South Africa continues to have much going in its favour and it is important that we capitalise on these not least the role that bright young minds like yourselves can play in leveraging your education and helping to change the world. Helping us through research to better understand some of the issues I had alluded to earlier would be such an example and could in a meaningful way contribute towards achieving greater financial stability, not only in South Africa but indeed across the globe. I thank you. BIS central bankers’ speeches
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Closing remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 2013 Emerging Markets Dialogue on OTC Derivatives Reform, Johannesburg, 12-13 September 2013.
Daniel Mminele: OTC derivatives reform – lessons from the financial market regulatory reform process Closing remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 2013 Emerging Markets Dialogue on OTC Derivatives Reform, Johannesburg, 12–13 September 2013. * 1. * * Introduction Good afternoon ladies and gentlemen. Thank you to the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) and the Federal Ministry for Economic Cooperation and Development (BMZ) for inviting me to deliver the concluding remarks at the end of the two-day workshop of the Emerging Markets Dialogue on Over-The-Counter (OTC) Derivatives Reform, as well as for sponsoring this very important and topical event. I would also like to extend my thanks to our co-hosts, namely the National Treasury, in particular Deputy Minister Nene, and the Financial Services Board through Deputy Chief Executive Officer Bert Chanetsa. Last but certainly not least, I would like to thank the many staff members from all organisations co-hosting, who have contributed to the organization and success of this event. Unfortunately, I have not had the benefit of listening to the various panel discussions and what I am sure were thought-provoking comments made by the various speakers over the last two days. Therefore, to avoid the risk of repeating what others may have said, I thought I would take a broad approach to the subject and offer some thoughts on the lessons that emerging market and developing economies can draw from the financial market regulatory reform process that has taken place over the past 5 years and how this can be applied to the OTC derivative reform process. 2. The headwinds were strong and remain strong In Washington in 2008, the G-20 committed to fundamentally reform the regulation of the global financial system. The objective was to correct the regulatory failures that in part contributed to the global financial crisis, and to build a safer, more resilient financial system that could better serve the needs of the real economy. This global financial regulatory reform process began, and continues to be undertaken, in a period which is characterized by subdued economic growth, elevated unemployment levels, and volatile financial markets. In these extraordinary circumstances, policy makers have resorted to non-conventional measures both on the monetary and fiscal policy side and have tried to balance the competing short-term need to promote economic growth and create jobs with the longer term imperative to construct stable financial systems and achieve sustainable growth paths and healthy public finances. Despite this complex and challenging environment, G-20 countries have managed to make significant progress towards meeting their 2008 commitments. Governor Mark Carney, in his capacity as the Chair of the Financial Stability Board (FSB) noted in an open letter to the G-20 dated 2 September 2013, that major progress has been made in building stronger financial institutions and more robust markets through substantially strengthened international standards. However, work on this front is far from complete. Governor Carney stated that the G-20’s objective of strong, sustainable and balanced growth requires an open, integrated and efficient global financial system. Clearly, one aspect of such a financial system is efficient and stable derivative markets that work for market participants in both the advanced economies and in emerging market and developing economies. This workshop is therefore of direct relevance to the global financial reform agenda. BIS central bankers’ speeches Our challenge is to make sure that the reforms that are proposed at the global level for derivatives markets do not have adverse unintended consequences for emerging markets, and can be implemented in ways that ensure we remain active and attractive participants in global financial markets. A “one-size-fits-all” set of regulations without consideration of timing and scope may not be appropriate and reflective of where some economies are in terms of their financial market development. In order to meet these challenges, it is important that we understand the implications of the currently proposed OTC derivative reforms and can act, collectively, in the appropriate global, regional and domestic forums to mitigate any adverse consequences and maximize their benefits for markets and our domestic and international stakeholders. The growing presence of emerging market and developing economies in the global regulatory reform process provides an opportunity to shape the outcomes of the process. 3. Expanded role and responsibilities of emerging markets and developing economies The international financial standard-setting bodies were historically dominated by the advanced economies. Today, emerging market and developing countries collectively account for about half of the global economy, it therefore is no longer feasible that they be excluded from important decisions that are made, which affect the management of the global economy and regulatory reform. As a result, following the crisis that started in 2007 the leaders of the G-20 agreed to expand the membership of the international standard-setting bodies and to strengthen the mandate and capabilities of the Financial Stability Forum, which was subsequently re-established as the FSB. This has helped these bodies to become more representative and will strengthen their role in developing and encouraging their members to implement policies in the interest of a stable global financial system. In order to enhance its effectiveness, the FSB, represented at this workshop by Mr Rupert Thorne, Deputy Secretary General, is now seeking to incorporate a broader range of participants into its activities. For example, it has created Regional Consultative Groups that bring an additional 70 countries into the policy discussion. In a similar vein, emerging and developing countries are represented on the committees of the Basel Committee on Banking Supervision, and the Basel Consultative Group was established to facilitate a broad dialogue with non-member countries. But there is no such thing as a free lunch. Those of us from emerging market and developing countries, who participate in the international standard-setting bodies, where financial regulatory reforms are discussed, now have an obligation to use our voice in these forums in a responsible manner. This means that we need to be actively engaged in meetings, be ready to take constructive positions on the various items on the reform agenda, including on OTC derivative reforms, which positions are supported by solid research, and convincing arguments. We also need to pay due regard to the concerns of both those emerging markets and developing countries that are participants in these meetings, and those that are not at the table. We have previously witnessed how putting forward well-reasoned positions can have positive outcomes. For example, South Africa, together with other emerging market and developing economies helped to bring about refinements to certain elements of the Liquidity Coverage Ratio (LCR) under the Basel III framework. Based on research, including our participation in the Financial Stability Board’s “Study of effect of regulatory reforms on emerging market and developing economies”, which clearly demonstrated the potential adverse, albeit unintended, consequences of some elements of the proposed LCR, the standard-setting bodies recognized that the LCR required refinement. The revised LCR standards were announced in early 2013 and they accommodate the concerns of jurisdictions, like ours, which have a shortage of adequate high quality liquid assets as defined. Similarly, the combined efforts of affected countries, including emerging markets, are making progress in reviewing the Net Stable Funding Ratio (NSFR) proposals, and ensuring that any unintended adverse impacts BIS central bankers’ speeches are limited. The proposed OTC derivative reforms, particularly the role of central counterparties (CCPs) in derivative markets, is another topic that runs the risk of undermining one of the core objectives of the rule-making bodies, namely global parity. Fortunately, the FSB appreciates that international regulatory standards can have unintended consequences. In this regard, I want to express my appreciation to the FSB for its most recent report on the unintended consequences of the international regulatory reforms and for their stated intention to continue monitoring the reform implementation process so that it can identify these unintended consequences. It seems to me that we can draw two lessons from these examples. First, now that emerging markets have representation and are active participants in the international regulatory process, it is possible for us to influence this process. To do so, we need to cooperate with each other. We need to collaborate and coordinate our efforts in all available regional and global forums to make our case for balanced outcomes on the existing items on the reform agenda. Fortunately, there are many opportunities for such collaboration. They include, in addition to the G-20, the FSB and the international standard-setting bodies and their outreach efforts, regional groupings such as the SADC Committee for Central Bank Governors (CCBG), the Committee of African Banking Supervisors (CABS) and the Association of African Central Banks (AACB), and emerging market and developing country groupings like the BRICS and the G-24. Second, as I have just indicated, we can only become effective participants in these forums if we base our efforts on solid research and careful preparation. This will enable us to identify those issues which have the potential to generate significant benefits or to inflict significant adverse impacts on our financial systems and countries. It will also help us to marshal our arguments and resources to effectively advocate for our positions on these issues. It is clear that workshops like the one we are now concluding are important precisely because they help us with regard to both the issues I have just mentioned. By allowing us to exchange ideas and experiences on key issues on the international regulatory reform agenda, gatherings such as this one help us identify our common concerns and the ways in which we can collaborate to address them. They also help us deepen our knowledge and understanding of these issues, and broaden our network of contacts. As I draw towards the conclusion of my remarks, let me briefly come back to OTC derivatives specifically. 4. Quo vadis on OTC derivatives reforms for emerging markets? In Governor Carney’s open letter to the G-20, the FSB highlighted the structural deficiencies in the lightly regulated OTC derivatives market, and the systemic risk this poses for the wider financial markets and the real economy. I do not propose to go into detail on the current efforts to address these deficiencies because I know that you have discussed them during the past two days. However, I wish to emphasize that although these regulatory reforms have been primarily designed to respond to the needs and dynamics of the derivative markets in advanced economies, regulators in emerging market and developing economies will be required to comply with these rules if they wish their markets to be accepted as part of the global financial system. While this is understandable and we fully intend to comply with the final rules, it is important to recognize the challenges present in our own markets. One benefit of forums like this one is that it enables participants from emerging markets to meet and exchange views on OTC derivative reforms. This is important for a number of reasons. Firstly, while, it serves the global interest to achieve standardization in derivative transactions’ contracting, pricing and documentation, it is also important to make sure that the interests of all stakeholders are adequately addressed in the ways these transactions are standardized. If emerging market and developing countries do not have opportunities to discuss these matters, with appropriate attention to all the technical details, amongst BIS central bankers’ speeches themselves, this is less likely to happen. Second, we all have a vested interest in derivative transactions that are transparent and as safe as possible. In principle, this can be most easily achieved through standardized transactions executed through central counterparties and reporting to trade repositories. In practice, however, not all countries derivative markets are big enough to support the necessary market infrastructures. As such, they would require more flexible approaches to OTC derivatives than is the case in the larger advanced economies. This suggests that there is a need to collaborate on developing regulatory proposals that are appropriate to our conditions. If we do so, and can undertake the research and preparations needed to develop the arguments to support our preferred approach, I am confident, based on past experience, they will receive a fair hearing and where appropriate, will be incorporated into the current international proposals for regulating OTC derivative markets. 5. Conclusion In many ways, financial markets in emerging market and developing countries are still developing. The benefits that derivative markets offer and the challenges they bring, therefore, are not necessarily comparable with the benefits and challenges applicable to advanced countries. In addition, the benefits and challenges associated with derivative markets in specific countries may differ due to our markets’ differing stages of development. For this reason it is valuable for us to be able to share views and exchange experiences and to learn from each other. I hope that you all felt that this workshop has contributed to this objective and that it will help all of us in our efforts to promote transparent, predictable and safe derivatives markets that meet all our needs. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Black Management Forum Young Professionals, Sandton, 27 September 2013.
Gill Marcus: Challenges for young professionals in South Africa Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Black Management Forum Young Professionals, Sandton, 27 September 2013. * * * Thank you for the opportunity to address you this evening. As young professionals you are the future of this country. Some among you may well be the first in your family to have attained this level of professional education or earning potential. As professionals you are in a particularly privileged position at a time when the global economy is still trying to recover from the financial crisis that began in 2007. While millions of people around the world lost their jobs, and many have lost hope of ever getting a job again, a global skills shortage exists. This shortage is even more severe in South Africa, and without appropriate skills in the country, and without a strong and sustained global recovery from the crisis, the domestic economy will struggle to grow sufficiently to make appreciable inroads into our persistent unemployment problem. As has been well documented, the global crisis hit different countries in different ways, and how countries were affected was determined in part by policy responses as well as by different structural features. Whereas the recession in South Africa was relatively brief and shallow, in line with most emerging market economies, the recovery has lagged that of our peers. Furthermore, we were an outlier in terms of the number of jobs lost during the crisis, with almost one million jobs lost. Five years later we are barely back to the levels of employment achieved before the crisis. The official unemployment rate stands at 25,6 per cent, while youth unemployment is 52,8 per cent. It is probably true to say that the longer a young person stays unemployed after leaving school, the lower their chances are of ever getting a job and they get deskilled, demotivated and disaffected, leading to social hardships and a drain on society. It is also probably the case that if people over the age of 50 lose their jobs they are unlikely to ever work again. Most of you here this evening, as young professionals, are university graduates. You are among the fortunate ones who have been relatively protected from the fallout of the crisis. And where skills shortages are more severe, the more protected are graduates as they command a premium in the labour market. A lot will clearly depend on the type of skills and qualification, and the quality of that qualification. But globally, there appear to be mixed experiences regarding the impact of the crisis on graduate employment. There have been a number of anecdotal reports of the challenges facing graduates in finding employment. This has certainly been the case in Europe and the UK, with reports of graduates having to take on temporary and relatively menial jobs. This not only affects their lifetime earnings, but also causes a ripple effect by depriving less skilled workers of access to these jobs. According to a recent survey conducted by the Trendence Institute in Berlin, the number of applications European business school graduates expect to send out before they get their first job has increased from 28,5 in 2002 to 38; and, on average, European graduates now expect to spend almost six months looking for a job. But in Greece and Spain, where unemployment is above 25 per cent and youth unemployment double that, the expectation is ten months. There are indications that, while the crisis has no doubt had a devastating effect on unskilled and even semi-skilled workers, South African graduates appear to have fared better than their European counterparts. Recent research suggests that South African university graduates are relatively better off, but perhaps not surprisingly so. According to research conducted by Hendrik van Broekhuizen and Servaas van der Berg at Stellenbosch University, and published by the Center for Development Enterprise, the stock of South African university graduates more than doubled to about 1,1 million between 1995 and 2012, but the broad unemployment rate of graduates has remained below 6 per cent. At the same BIS central bankers’ speeches time the labour force participation rate for graduates is around 90 per cent, compared with 59 per cent for people with only a school education. However, these figures hide a racial disparity. While the number of black graduates employed has trebled over this period, the unemployment rate of black graduates has been consistently higher than that of whites, although the gap has narrowed significantly over time. The above-mentioned study shows that in 2012 the unemployment rate of black graduates was 8,6 per cent, compared with 3,0 per cent for white graduates. This is still a significant difference, and I am sure we would find this compounded by gender bias if this was to be analysed. It is perhaps also worth noting that their research distinguishes between university graduates and other tertiary education. In the latter category, the experience of graduates has not been as positive, and may well reflect the state of the economy as well as some quality constraints. They show a general tendency for unemployment of graduates, irrespective of race, to follow the business cycle, but worsening economic conditions seem to have less of an impact on graduate unemployment than on people without degrees. There is no doubt that education matters for employment prospects. According to the Quarterly Labour Force Survey, in the second quarter of 2013 the unemployment rate was 5,2 per cent for university graduates; 12,6 per cent for those with other tertiary education; 27,0 per cent for those with matric and 30,3 per cent for those with less than matric. This relatively favourable trend of graduate employment is consistent with results of the Professional Provident Society of South Africa (PPS) Professional Confidence Index Survey, which shows that graduate professionals are relatively confident about the future. The most recent survey revealed a 70 per cent confidence level when respondents were asked about the future of their profession over the next five years. However, the results show that professionals are increasingly concerned about the outlook for the local economy, with only 55 per cent feeling confident. Nevertheless, 77 per cent of respondents were confident about remaining in the country for the foreseeable future. Because the outlook for the domestic economy is intricately tied to the global prospects, it is appropriate to consider whether or not we are out of the crisis yet. There is little doubt that the global financial crisis is still with us, although it has continued to mutate. While the general global outlook seems to be a bit more positive, we appear to have moved into a new phase, which is no less risky or uncertain than previous phases. And even if things don’t get worse, they will take a long time to get better. How has the crisis mutated? What started off as a banking crisis, spurred by questionable banking practices in the advanced economies in particular, a failure of regulation in some jurisdictions and excessive household borrowing, developed into a synchronised global recession. World trade, commodity prices and asset prices collapsed, and millions of people around the globe lost their jobs. Fortunately, policy makers in the advanced economies had learned from the mistakes of their predecessors during the Great Depression of the early 1930s, and a repeat of that era was avoided. So, although things were bad enough, they could have been much worse. But the path to recovery has not been easy. Expansionary fiscal policies were soon constrained as government debt ratios became unsustainable and the crisis mutated into a sovereign debt crisis, particularly in a number of European economies, which threatened the existence of the Eurozone as a single currency area. Increasing reliance was placed on monetary policy and, as interest rates reached their zero lower bound in a number of the advanced economies, a range of unconventional policies were introduced, including quantitative easing, which is a process whereby the central bank injects money into the economy by buying government bonds or other assets. The subsequent combination of high liquidity and low interest rates led to a global search for yield, and consequently reinforced strong capital flows into emerging market economies, which had generally recovered from the recession by late 2009. Emerging markets, led by China, were seen to be the new engine BIS central bankers’ speeches for global growth, and this development was seen as a tectonic shift in the balance of economic power around the globe. However, these capital inflows created challenges for emerging market economies, as the resulting exchange rate appreciation undermined competitiveness. Some emerging markets complained about “currency wars” and various policies were implemented to stem these inflows, with very mixed success. But at the same time, stronger exchange rates did help to constrain inflationary pressures, allowing monetary policy more freedom to focus on providing some stimulus to the hesitant growth recovery. A notable structural change in the nature of these capital flows was the predominance of flows into domestic currency bond markets in emerging market economies, with nonresidents holding increasing proportions of domestic bonds. South Africa‘s experience was no different. In the pre-crisis period, the bulk of portfolio flows to South Africa were to the equity market. Since 2009 until recently, bond flows predominated and non-resident ownership of the outstanding stock of bonds increased from around 12 per cent in 2007 to around 38 per cent currently. This change in the pattern of flows reinforced the downward pressure on long term bond yields. Although this did not have the positive effect on private sector investment that one would generally have expected, it did have a significant effect on the cost of borrowing by government at a time when the counter-cyclical fiscal policy of National Treasury was relatively expansionary. These flows also helped to finance the widening current account of the balance of payments. So what has changed? We now appear to be entering a new but still highly uncertain phase of the crisis. Growth in the emerging market economies, including China, has been declining, and earlier optimism that emerging markets could decouple from the advanced economies has faded somewhat. At the same time, there are some signs of recovery in the US, which prompted the US Fed to begin to consider slowing the pace of extraordinary monetary policy accommodation it has been providing. This does not mean an imminent tightening of policy by raising short term interest rates, but rather beginning to cut back on the pace of asset purchases, currently at US$85 billion per month. The reaction to the announcement by the Fed in May that tapering would begin relatively soon took many analysts and market participants by surprise, and underlined just how nervous markets are, and how elevated the uncertainty is. What was meant to be an orderly adjustment threatened to become precisely the opposite, despite the assurances by the Fed that tapering would be done in a responsible manner. Long-term bond yields and mortgage rates in the US increased by about 100 basis points. The spillover effect on emerging markets was intense, with bond yields generally increasing by more than in the US, as bond flows reversed sharply – since May about US$20 billion has flowed out of emerging bond markets, with R17 billion net sales by non-residents in the domestic bond market between 22 May and the end of August; and emerging market currencies, including the rand, depreciated markedly across the board. Although there was a general expectation that tapering of quantitative easing would begin in September, there was a great deal of uncertainty around the pace and timing, and the period between the May and the September FOMC meeting was highly volatile. In the event, the Fed refrained from tapering in September, out of concern about the slow pace of recovery in the US labour market; the unresolved fiscal issues in the US which could lead to further fiscal contraction when the debt ceiling is reached, possibly in mid-October; and the negative impact of tight financial conditions and higher long term interest rates on the nascent housing market recovery in the US. The reaction of the markets to this surprise was dramatic, with strong recoveries in bond and equity markets, while the dollar weakened across the board. However, it is inevitable that the Fed will have to begin tapering at some stage, and markets are likely to react or over-react to any data coming out of the US that is likely to have a bearing on US monetary policy decisions. We have been given a taste of what is to come, and we are in for a difficult and BIS central bankers’ speeches volatile period ahead. This is unchartered territory, and whatever the US does is going to have spillover effects onto the rest of the world. This is why we pay such close attention to developments in the US, including who will replace Ben Bernanke when his term expires at the end of January 2014. While the news from the US appears relatively positive, the same cannot be said about the prospects for the Eurozone, where the outlook for growth is poor, despite the fact that the region as a whole emerged from recession in the second quarter of this year. A number of European countries are still experiencing negative growth and, even where growth is positive, it remains very weak. The July World Economic Outlook (WEO) update of the IMF forecasts growth of –0,6 per cent in 2013 and 0,9 per cent in 2014, with the risks still seen to be on the downside. One of the constraints facing these countries is the weak state of their banking sectors, which have not recovered sufficiently to resume lending on a large scale, and there is still very slow progress towards a banking union in the region. At the same time, fiscal consolidation continues to be quite severe in some countries and the debt ratios are still deteriorating in the peripheral countries, for example, the debt to GDP ratio in Greece now stands at around 160 per cent, and that of Italy at around 130 per cent. From a South African perspective, given our trade and investment links, this is not good news, and implies that the crisis will be with us for some time. Europe is still our major trading partner, despite accounting for a declining share of our manufacturing exports, from around 38 per cent to 25 per cent between 2007 and 2012. The importance of Europe to South Africa is further underlined by its weight as a source of foreign investment into South Africa. According to the Census of Foreign Transaction, Liabilities and Assets, published by the South African Reserve Bank earlier this month, European countries and the UK are the main sources of foreign capital to the South African economy, with the relative share unchanged at around two-thirds since 2001. However, the share of the UK has declined from 45,5 per cent in 2001 to 37,6 per cent in 2011. The recent July WEO downgraded its global growth forecasts for emerging markets, and unfortunately the BRICS countries featured strongly in this downgrade. The 2013 growth forecast for China was reduced from 7,8 per cent to 7,5 per cent; Russia from 3,4 per cent to 2,5 per cent; and Brazil from 3,0 per cent to 2,5 per cent. Although China is not an important destination for our manufacturing exports, it remains our main trading partner, mainly as a destination for our commodities. China also has an important impact on global commodity price trends, and the recent weakness in a number of commodity prices has been ascribed to the slowdown in that country. While the crisis has curtailed domestic growth, it is not the only contributory factor. After all, our emerging market peers have faced the same challenging environment and yet outperformed South Africa in the post-crisis period. The World Economic Forum (WEF) Global Competitiveness report paints a mixed picture of how South Africa stands up to international comparison. It shows that, with respect to the financial sector, we are up there with the best. South Africa was ranked first out of 148 countries for regulation of securities exchanges; first for strength of auditing and reporting standards; first for efficacy of corporate boards and the protection of minority shareholders’ interests; second for financing through local equity markets; and third for overall financial market development. This reflects well on the sector, and also on the quality of the professionals that make up that sector, including accountants, economists, etc. Many of you here this evening are part of that sector. What is important to bear in mind is that, while there is recognition of the excellence of South Africa’s financial sector, and it is a critically important asset for the country and our future development, it must serve the needs of the real economy. South Africa cannot simply aspire to be a world leader in the financial sector. We need to encourage more productive real sector investment and employment and, crucially, encourage exports, given our dependence on imports of capital goods. Unfortunately, according to the WEF, we are have slipped in the overall competitiveness ranking from 40th BIS central bankers’ speeches to 53rd, and we have been surpassed by Mauritius as the most competitive country in Africa. For years we have been somewhat complacent about being the biggest economy in Africa. With the current growth rates, we could be overtaken by Nigeria within a decade. We fare even worse when it comes to labour relations where we are ranked worst in the survey of 148 countries. This declining competitiveness is reflected in South Africa’s widening current account deficit at 6,5 per cent of GDP in the second quarter of this year, driven to an important degree by a weak export performance, which can only be partly explained by weak demand growth. Our exports have also suffered due to widespread strikes: not only do current export volumes decline, whether commodities or manufactured goods such as motor vehicles, but South Africa’s attractiveness as an investment destination suffers, and this has the potential to undermine future investment in the economy. South Africa is part of the global manufacturing supply chain, and reliability of supply is key to maintaining and improving our position in this chain. South Africa’s competitiveness is further undermined by unit labour costs rising relative to competitor countries, and a weaker exchange rate only helps improve competitiveness if not offset by wage and price increases. In order to improve our growth prospects we need a sustained increase in fixed capital formation. Having reached a peak of around 24 per cent of GDP in 2008, the ratio of gross fixed capital formation to GDP has now declined to around 19 per cent. This is well short of the 25 per cent ratio that is generally seen to be the minimum to sustain the growth rates that we require to make inroads on unemployment, and even further away from the 30 per cent aspired to in the National Development Plan. The decline in the investment ratio has been mainly a result of a collapse in investment expenditure by the private sector which, at the height of the crisis, was faced with relatively low levels of capacity utilisation and uncertainty about the future. Growth in gross fixed capital formation remains weak, at 2,7 per cent in the second quarter of 2013. Since the crisis, infrastructure expenditure by the state-owned enterprises has been the main driver of fixed investment. The emphasis on infrastructure investment is appropriate as it is likely to contribute to improved economic efficiencies and helps with the alleviation of existing bottlenecks in the economy. But the focus on infrastructure is not new, and the plans must come to fruition. But it is not only the government and state-owned enterprises that need to invest. In his book “The Next Convergence” Michael Spence, the respected growth theorist, has shown that countries which have sustained growth rates of around 7 per cent or more for 25 years generally have government and public sector investment ratios of between 5 and 7 per cent of GDP, and total investment rates of at least 25 per cent of GDP. A consistent growth rate of 7 per cent will allow for a doubling of income every 10 years, whereas a growth rate of 3 per cent will take 24 years to double incomes. Currently our problem is that private sector investment is weak, which may partly reflect excess capacity in some sectors, but also a lack of general business confidence. There are indications that private sector fixed capital formation has begun to improve, but this appears to be gradual and tentative. In the second quarter of 2013, growth of 4,4 per cent was recorded. Michael Spence sums it up appropriately as follows: “Put bluntly, growth requires investment, and that means present sacrifice for future gain. The job of leaders is in part to get everyone on board, to build a consensus behind a forward-looking vision, underpinned by a growth and development strategy that is credible. Multiple classes of participants and organised stakeholders need to be willing participants. These include labour, unions, businesses and entrepreneurs, civil society organisations, and households at various levels in the income distribution.” Unfortunately, while there is a common view that we need investment, there is no consensus around how this should be achieved, and how the sacrifices should be shared. This brings us back to where I began this evening, and that is the need for education or investment in human capital. I have on numerous occasions in the past stressed the need to BIS central bankers’ speeches improve the quality of education in South Africa and to fix the parlous state of many of our dysfunctional schools. We need to value education and, thereby, knowledge, and not simply the certificate of qualification. But we also need to ensure that the education we do receive is of value. The CDE report referred to earlier suggests that, while not perfect, the university system is turning out appropriate and good quality skills. But we also need to focus on other technical skills that are not taught in universities but are no less important to the economy. Not only does an undertrained and undereducated workforce constrain economic growth, it reinforces the cycle of unemployment and widening inequalities. As Michael Spence has noted, in a world in which knowledge and connectivity are increasingly the basis for value creation, failures in the educational system are the surest form of exclusion there is. In conclusion, the crisis is still with us, and South Africa faces a challenging future. However, the doom and gloom associated with the emerging markets is probably overstated: whereas there will be global adjustments in response to normalisation of monetary policy in the advanced economies, and this means volatility in emerging market financial markets, it is hard to see a recovery of global demand or demand from the advanced economies as being anything but good news in the medium to long term. This is what we have been waiting for. But we have to ensure that we are well-positioned to take advantage of the global recovery and minimise the impact of the uncertainty and volatility that will surely accompany such a recovery. And as professionals, all of you here this evening have an important role to play. With your personal achievements comes responsibility – to your immediate families, to those who have supported you throughout your studies, to your communities and to society as a whole. You have dreams, ambitions, and visions of the future South Africa we are all striving to build. So where is your voice, your passion, your purpose in the vibrant debate that rages as we work to build our common future? We all have the ability to exercise both reason and choice. The future will be what you make it. I wish you all well in your personal and professional lives. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Dinner in Honour of Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 1 October 2013.
Gill Marcus: Globalisation can be a force for good Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Dinner in Honour of Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 1 October 2013. * * * Your Exellencies, Ambassadors, High Commissioners, Counsels and Diplomats, good evening. Thank you for accepting our invitation to join the South African Reserve Bank this evening. If there was ever any doubt that we live in a highly integrated world, financial markets have a tendency to remind us on a daily basis of the inter-linkages between our countries. Fed chairman Ben Bernanke issues a statement on monetary policy developments in the US and financial markets around the world react. European car sales fall and platinum miners in South Africa feel the effects. Coffee drinking in China increases and farmers in Ethiopia earn more. Our world is probably more integrated today than at any point in human history. With the level of interdependence that the nations of the world have today, it is worth asking whether we have the appropriate relationships, institutions and rules for everyone to benefit from global integration, and whether we have the institutional mechanisms to protect the poor and vulnerable in such an integrated world. Globalisation has increased opportunities for all countries to become richer. Markets for goods and services have grown. Countries are not just able to exploit their present comparative advantages but are also able to use technology and innovation to change their comparative advantages, to move up the value chain, thereby raising incomes and living standards of the poor. The global financial system has also adapted to a world unimaginable a few decades ago. Capital is able to flow from savers to borrowers, seeking opportunities in every corner of the planet. The net effect of greater global integration is that about a billion people have been lifted out of poverty in the past twenty years, with over half of these in China. Ladies and gentlemen, globalisation has also increased risks and vulnerabilities for all countries, in particular for poor countries and the poor and low-skilled workers within countries. A housing loan crisis in the US eventually translates into rocketing youth unemployment in Spain. A banking crisis in Cyprus sends shares on the world’s stock exchanges lower. Curbs on the importation of gold in India impact on the earnings of Ghanaian and South African gold miners. And so, while globalisation and its tools – supply chains, technology and finance – has made a major positive contribution to development, these same tools have also made the world more complex, risky and dangerous, especially for the poor. Globalisation has also coincided with a marked increase in inequality in most major economies in the world. As capital has become more mobile, investors are able to achieve higher returns by investing in new frontier markets. On the other hand, the entry of a billion more workers into the global labour force has depressed wages for low-skilled workers. The combination of these effects is that the rich have done far better out of globalisation than the poor. While it is undoubtedly true that poverty rates have fallen, the phenomenal increase in incomes going to the top one per cent of the world’s population raises the threat of social instability, conflict and strife. How do we build a world where everyone can benefit from globalisation? How do we build a world where there is a fairer distribution of the upside benefits and the world’s poor have greater protection from threats and vulnerabilities that are inherent in a more connected world? It is in the interest of all of us to look critically at the rules and institutions that we have that govern the global economy to ensure that they are fairer and more just. BIS central bankers’ speeches In 1994, South Africa re-entered the community of nations. There were those who argued that we should re-enter the global system slowly and cautiously. But because South Africa is a low-savings economy and, therefore, dependent on foreign savings to finance investment, our re-entry into the world economy was both bold and rapid. In a relatively short period, trade barriers were significantly reduced, capital controls on non-residents were abolished and financial markets were opened up. South Africa has benefited from this strategy. In many ways, our faith in the international community has paid dividends. South Africa is able to access foreign savings, South African firms have access to global markets, businesses have access to foreign technology and government can raise capital abroad for its investments. This road, however, has not been a smooth one and we have been exposed to a number of external shocks. Shortly after the transition to democracy, we were affected by the Asian crisis and the Russian debt default, which impacted our currency. At the end of 2001, in the aftermath of the dot com bubble and the events of September 11, we faced another sharp fall in the exchange rate. When the sub-prime crisis exploded and Lehman Brothers crashed, our economy suffered too, with close to one million workers losing jobs. Economic rebalancing in China has sent commodity prices lower, with its attendant consequences on our terms of trade. Both the onset of quantitative easing and, more recently, expectations of tapering, have introduced volatility into our economy that makes macroeconomic management more difficult. The South African economy, in tandem with many other economies around the world, is growing below its potential rate of growth. While part of the reason for slow growth relates to the global economy, there are also South African-specific issues that inhibit our ability to grow faster and create jobs. Over the past year, the South African Reserve Bank has highlighted some of these issues, even though we ourselves do not have the policy instruments to deal with these issues directly. We remain of the view that higher economic growth requires both sound macroeconomic management, over which we have some influence, as well as on-going reforms to improve the education system, improve the functioning of the labour market, reduce the costs of doing business and increase competitiveness in the economy. While we remain concerned about the effects of strike action on the economy, we are encouraged that, whereas 2012 was marred by a series of unprocedural and violent strikes, so far the strikes in 2013 have largely been peaceful and legal. In addition to stabilising the labour relations environment, South Africa recognises the need to take steps to reduce our vulnerability in a world economy that remains volatile and uncertain. Sound macroeconomic management to rebuild policy space and buffers and the implementation of the new twinpeaks model of financial regulation are our highest priorities. These efforts will complement other much-needed reforms to boost growth and employment. In the implementation of monetary policy, the South African Reserve Bank faces a difficult set of challenges, given slowing growth and rising inflationary pressures. The Bank will continue to take the necessary steps to anchor inflation expectations and achieve price stability within our mandate of flexible inflation targeting. There are also a series of measures that the international community needs to take collectively to make the world a safer, fairer and more prosperous place for all. I wish to highlight three aspects. The first is accelerated reform of the global financial system. The second is continued reform and strengthening of global and regional institutions such as the United Nations, the International Monetary Fund (IMF), the African Union (AU), and the Southern African Development Community (SADC). The third is to promote regional economic integration, especially on the African continent. Five years after the collapse of Lehman Brothers, the world remains a risky place, with the financial sector still constituting a major source of fragility. Reform processes led by the Financial Stability Board, the G20 and the Bank for International Settlements are pointing us BIS central bankers’ speeches in the right direction, but progress in implementing these reforms is slow and uneven across major regions of the world. The world has a broad framework to regulate globally-systemic financial institutions but there remain gaps, especially regarding resolution mechanisms when banks fail. A major source of the crisis was the build-up of significant external imbalances. The world has made slow progress in tackling high current account imbalances across the globe, which has spill-over effects on smaller countries. The recent sell-off in emerging markets in response to talk of tapering in the US is an example of how policies in one country, especially one as powerful as the United States, have unintended consequences for other countries. Many countries continue to pursue exchange rate policies that distort trade and investment flows. Naturally, each country pursues policies that suit its own national circumstances. At times, these policies exacerbate global fragilities rather than contributing to their resolution. The world would benefit from a higher level of coordination and cooperation to limit the spill over effects of domestic interest and exchange rate policies on smaller open economies. The world also needs more robust institutions to reduce the cost of insurance for individual countries as well as to objectively enforce rules and standards, with the aim of reducing future crises. At present, there is a perception that bodies such as the IMF apply rules inconsistently, with one set of rules for developing countries and another for advanced economies. South Africa, like most other countries, is a member of the IMF and it is in our collective interest for this body to be credible, strong and responsive. The paralysis in world trade negotiations has given rise to regional trading blocs and bilateral trade agreements. Given the asymmetry in power across the world, such an approach to negotiations is always going to result in a skewed system, biased towards richer countries at the expense of poorer ones. Fair and open trade and increased market access for poorer countries to richer ones is essential to reduce the build-up of imbalances. On the African continent, more needs to be done to strengthen the African Union. Quite a number of countries do not pay their dues, resulting in the organisation being overly dependent on donors. While donations are always welcome, it cannot be right for an important continental body to be so reliant on foreign funding. A stronger African Union can play a driving role in supporting the development of infrastructure that is essential for enhanced economic growth and development across the continent. The process of establishing regional economic communities is proceeding slowly and unevenly. East Africa and West Africa have probably made more progress than we have made in Southern Africa. There remain significant obstacles to greater regional integration, especially in Southern Africa. These obstacles include hard issues such as infrastructure constraints, energy shortages and different rail systems as well as softer issues such as high tariffs, significant non-tariff barriers and numerous challenges at border crossings. Many of Southern Africa’s problems are less intractable when taking a regional perspective. Water, food and energy security, as well as adapting to climate change, are all problems that require regional solutions. Southern Africa has significant hydroelectric potential that can only be tapped in an economically viable manner if we have regional supply networks. While South Africa and several of its neighbours are water scarce and hence cannot and perhaps should not be growing certain crops, many other countries have the water resources to grow a broader range of foods and fruits and become the breadbasket for the region and beyond. It is also natural that, as countries develop, certain industries become less sustainable for higher cost producers. Given the different levels of development and per capita incomes in sub-Saharan Africa, a win-win solution could be to develop parts of the supply chain in neighbouring countries to take advantage of lower costs. The challenge with many of these ideas and options is high transportation costs and inefficient and unreliable freight logistics systems. BIS central bankers’ speeches The South African Reserve Bank is making a contribution towards regional integration in the payments area by leading a pilot project for a real time electronic settlement system, which was launched in the Common Monetary Area (CMA) in July this year. Preparations are now under way to expand it beyond the CMA into other SADC countries. Payments systems are a key piece of the infrastructure required to facilitate trade and investment. Globalisation can be a force for good. Greater economic integration has the potential to lift millions more out of poverty. To achieve these outcomes we all need to do more to make the world economy safer, less crisis prone and fairer and take the necessary steps to enhance the framework that govern our myriad linkages and interactions. We also need to focus more on building credible global institutions that help to deliver global public goods. In the realm of financial markets, solid progress is being made in developing new rules, standards and mechanisms, yet more needs to be done to ensure consistent implementation. From the South African Reserve Bank perspective, we will continue to argue for reform of the global financial system to make it fairer and invest in building our internal institutions. South Africa’s progress since 1994 has been supported by the efforts of the international community. We look forward to our continued working together to build a fairer and more just world, one in which the poor, too, can benefit from financial inclusion, economic growth and globalisation. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Ruth First Jeppe High School for Girls Memorial Trust, Johannesburg, 29 October 2013.
Gill Marcus: Inspiring young women to make South Africa more inclusive Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Ruth First Jeppe High School for Girls Memorial Trust, Johannesburg, 29 October 2013. * * * Good evening ladies and gentlemen. It is a real honour and a privilege to be asked to speak to you tonight, not just because this event honours an exceptional person, Ruth First, but also because this event supports the education and development of young women in our country. There can be no investment more important than to invest in the education of young people. And, given that the odds remain heavily stacked against women from all walks of life in our society, investment in the education of young women makes a real difference to the individual, the family and society as educating the girl child is a sure way to break the cycle of poverty and the skills shortage that is spoken about so often. Jeppe High School for Girls has a long and proud tradition of delivering education of the highest quality to girls in Johannesburg. The excellent track record of the school in maintaining a 100 per cent matric pass rate for 20 years, and ensuring that an incredibly high proportion of young women go on to university, deserves praise and recognition. I wish to congratulate the school, its head mistress and teachers, as well as the school community for this outstanding achievement. Public education of the highest standard for all children is critical for democracy to flourish, and was integral to the liberation struggle, as lack of education is the greatest exclusion there can be. I fully support and endorse the establishment of a trust that funds scholarships to support young women from less advantaged backgrounds who show academic potential. Tonight I would like to add my voice to those of many others in congratulating the young women who have won scholarships to study at this wonderful educational institution. Jeppe Girls High, through the Ruth First Jeppe Trust, has set an example of how communities can come together to provide education for all, not just the privileged few. We need many more of these initiatives so that the ugly shadow of our apartheid history is eliminated from the lives and opportunities of our children. Let me say a few words about Ruth, the inspiration for this initiative and whose life comprised multiple facets. She was an activist, a revolutionary, a woman, a mother, a journalist, a writer and an academic. In addition to these attributes, she espoused and lived a set of values that continue to shape our country today and are deeply embedded in our Constitution and our aspirations. These values include non- racialism and non-sexism, a sense of justice and fairness that puts the interests of the poor and ordinary people ahead of self-interest; the commitment and courage to not only stand for what is right, but also to stand against what is wrong. It is Ruth’s sense of justice that continues to inspire millions of South Africans today, even as we increasingly live in a world where injustice prevails and material benefit is idolised. Ruth’s struggle and our Constitution should inspire all of us to continue the fight for a more just world, where the provision of high quality public education to all children must take the highest priority. Ruth fought for a world in which all people, irrespective of race or gender, had equal opportunities, a world where children from both rich and poor families would have access to the best education and the best work opportunities. Despite all of our problems and challenges as a society, we should remain steadfast in our commitment to build a South Africa in which opportunity is shared more equally, where hard work and effort trump the shadow of history. BIS central bankers’ speeches Ruth used her education and her enquiring mind, analytical thoroughness and personal courage as tools in the struggle against apartheid and colonialism, and in working for a world committed to fairness, justice and the advancement of people. She read voraciously. She studied all manner of topics. Ruth is credited with writing books on diverse topics ranging from Mozambican migrant workers to Libyan politics. There is a Chinese proverb – Shi Shi Qui Shi – seek truth from facts, that epitomised Ruth’s work. Her ground breaking research and direct investigation into the working conditions of potato farmers in Bethal in the 1950s with the late Joe Gqabi, who was also later assassinated in Zimbabwe, led to an exposé of the prison-like conditions faced by farm workers and the consequent potato boycott. Also, it set a new standard for investigative journalism and a complete rethink on labour relations in the agricultural sector. Her detailed research into the lives of migrant workers on South African mines is still used today to understand the social and economic aspects of the migrant labour system. If only world leaders had read her writings on Libya, they would have had a far better insight into that complex society. Ruth was a committed communist; she was not a revolutionary who simply used ideology to win an argument. She looked at the facts; she analysed the evidence and came to conclusions that could be defended by the data and analysis, even when such conclusions were uncomfortable for some, especially those in leadership positions or high office. Ruth was an outstanding investigative reporter and mentored dozens of young journalists to look analytically into an issue before putting pen to paper. Our journalism profession today can learn a great deal from the rigour she applied to any story she wrote. Ruth First was also a woman who was not scared of challenging authority. Not only did she dedicate her life to the struggle against apartheid, even within the liberation movement she spoke out when she saw abuse, policies and practices she felt were unjust and unjustifiable. Ruth spoke out against the invasion by the Soviet Union of Hungary and Czechoslovakia in 1956 and 1968, respectively, even though the South African Communist Party held a different position at the time. Ruth paid the ultimate sacrifice, not only for her beliefs but because of her voice. She was killed by an apartheid government intent on keeping an immoral and unjust system of racial oppression in operation. But it was Ruth and the many millions of people who fought for justice and equality who ultimately prevailed. Apartheid has been defeated, but the struggle for a just and equal South Africa and Africa in a more caring world must continue. Ruth leaves us with many lessons that are particularly pertinent for young women today. She became a respected leader in a male dominated world. She used her knowledge, analytical rigour, voice and education to fight for justice. She worked hard to uncover the facts, analyse the data, and thereby defend her findings and arguments in a profession and world that was not entirely comfortable with such an approach. I have had the singular privilege of, though to various degrees, knowing Ruth, her mother and father Tilly and Julius, her husband Joe Slovo and their daughters Shawn, Gillian and Robyn. Having been inspired by Ruth and many other leaders of the struggle for liberation and democracy, I hope that her life will inspire young women to continue to make our world a better place. There can be no better way to honour Ruth and all she held dear than to ensure that young women be given the opportunity to receive the best quality education that there is to offer. And for that education, that search for knowledge, to be valued, and not just the certificate, important as that may be. To live such a life takes courage and, as we all assess the many and different challenges young people face now and in the years ahead, let us be inspired by what has been achieved and have the courage, determination and tenacity to build a future and a people bound together by values that would make Ruth smile. BIS central bankers’ speeches Again, I wish to thank the School and the Trust for their sterling efforts in educating our youth. Congratulations to the recipients of the scholarships on offer today. Your efforts will inspire a new generation of women to live lives that have meaning, that contribute to making our country more inclusive and just, a celebration of all that life and living has to offer in a South Africa that has been shaped by women like Ruth. I 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 Phalaborwa Chamber of Business Year-End Function, Phalaborwa, 1 November 2013.
Daniel Mminele: Reflections on 2013 and challenges ahead for South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Phalaborwa Chamber of Business Year-End Function, Phalaborwa, 1 November 2013. * 1. * * Introduction Good evening ladies and gentlemen and thank you to the Phalaborwa Chamber of Business for the kind invitation to address you tonight. This was a particularly special invitation for me, as it brings me back home, back to the place of my birth, back to a place of good memories of a happy childhood. Phalaborwa and nearby Namakgale will always be very special to me. It is indeed an honour not only to be given the opportunity to address you, but also to join you as we pay tribute, acknowledge and celebrate those who have been nominated for the various awards which will be presented tonight. In my remarks tonight, given that the curtain is slowly coming down on 2013, I thought I would look back at the year that was, reflect on where we are and also on the challenges that lie before us, both on the domestic and international front. 2. Looking in the rear view mirror For over six years now, the global economy has been operating in “crisis mode”. The global financial crisis unfolded in three phases: the US subprime crisis, leading to a severe economic and employment crisis, and then mutating into a banking and sovereign debt crisis. These events spilled over into other advanced and emerging market countries, both through trade channels, by way of declining exports, negatively impacting growth and employment, and through financial linkages, which increased volatility in financial markets and led to uncertainty and declining confidence levels. The South African real economy certainly felt the impact, being closely tied to the global economy through trade linkages, and also through financial linkages given our deep and liquid financial markets. The latter fact means that we are very often used as a proxy for other emerging market currencies, as the depth and liquidity of our markets makes it easier for investors to move in and out of South African financial markets. This fact also therefore partly explains the heightened volatility we experienced in recent years, and why volatility of the South African rand exchange rate tends to be generally more elevated than the volatility experienced with most other emerging market currencies. On the economic front, South Africa lost proportionally more jobs during the recession than any other country more directly affected. The 2011 Budget Review showed that for a 2.6 per cent contraction in output during the crisis, South Africa’s employment contracted by 7.5 per cent, which if measured as the responsiveness to a 1 per cent contraction in output, equated to –2.9 per cent. This was significantly higher than the list of 10 other countries compared. If one takes another emerging market country such as Turkey, which contracted by a much larger 12.8 per cent, employment contracted a lesser –1.8 per cent which for every 1 per cent contraction in output translates to –0.1 per cent. As accommodative and unconventional monetary policy helped bring the global economy back from the brink, and the recession ended, stronger import demand was observed from trading partners. However, South Africa continued to lag behind and did not benefit as much from the increase in global trade as other emerging markets did, with export volumes failing to return to pre-crisis levels. The euro zone debt crisis weighed on South Africa’s export recovery, exacerbated by domestic factors such as infrastructure bottlenecks and a lack of competitiveness. The situation grew decidedly worse during the second half of 2012 as our financial markets decoupled from global developments, following the tragic events at BIS central bankers’ speeches Lonmin’s Marikana mine. Wild-cat strike action spilled over to other parts of the platinum industry, later moving to rest of the mining sector, and to the transport and agricultural sectors, resulting in a significant dent in global investor confidence in the country, which contributed to sovereign credit ratings downgrades by all three major rating agencies, and ultimately resulted in a further weakening in the exchange rate of the rand and higher borrowing costs for the country. In the absence of strong support from the export sector, domestic demand became the main driver of growth, supported by low nominal interest rates, rising disposable income and increased household debt levels. Fixed investment also provided a boost to growth, although this remained far below levels one would have liked to see, especially the private sector’s contribution to fixed investment. Since 2009, South Africa’s real GDP growth lagged that of other emerging markets, averaging 3 per cent as compared to the average of around 5 per cent for emerging markets. As Phalaborwa is a mining town, and has had a long and rich history with the mining industry, allow me to say a little more about mining. The mining sector’s contribution to real gross domestic product has halved since 1995, accounting for just over 5 per cent of GDP today. This fact does not make the mining sector irrelevant to the economy, far from it. The sector is important because it generates the bulk of foreign currency earnings – exports of minerals and metals account for approximately 60 per cent of all export revenue, hence the sensitivity of the foreign exchange value of the rand to mineral and metal prices and their production. Mining accounts for approximately one third of market capitalisation on the JSE; has been a strong attraction for Foreign Direct Investment and contributes handsomely to government’s tax revenue. The mining sector has shed a fair amount of jobs in the wake of the Marikana debacle – in the period between December 2009 to June 2012, employment picked up from 488 000 to 534 000, but has since declined to 511 000 in the second quarter of 2013. Although employing just shy of 3 per cent of South Africa’s total formal and informal labour force, the mining sector indirectly employs another 500 000 people, through linkages to other sectors, such as manufacturing. Given the importance of the mining industry for our economy we can ill-afford the fractious labour relations environment and the violence we have seen. 3. Reflecting on 2013 As we entered 2013 there was a fair degree of optimism globally and locally, informed by some bold policy measures that had been taken in the latter part of 2012 and early 2013. In particular, the launch of the Outright Monetary Transactions programme (OMT) in the euro zone and in January 2013, as the US managed to avert the fiscal cliff. Both of these events provided a significant boost to confidence and helped to contain the most immediate threats to the global financial system, and thereby restored calm to financial markets. There was hope that reduced volatility in financial markets and improved confidence would eventually be transmitted into the real economy and provide for a more durable recovery. The domestic economy was expected to continue growing at a moderate pace (after a growth rate of 2.5 per cent for 2012), thanks to encouraging prospects for the global economy and improved sentiment following a successful ANC elective conference, which adopted the National Development Plan and provided some clarity in respect of policy positions around nationalisation in the mining industry. The IMF’s World Economic Outlook (WEO) released in January 2013 indicated that “Global growth is projected to increase during 2013, as the factors underlying soft global activity are expected to subside”. Admittedly, the IMF also warned about downside risks that still remained. Based on data available so far, and recent information and developments in the global and domestic economy, a stronger recovery in 2013 will unfortunately in all likelihood turn out to be rather more elusive than what we had hoped for, and this is borne out by the latest release of the WEO which has seen a downgrade of global growth forecasts. BIS central bankers’ speeches As we moved deeper into 2013, some of the headwinds identified by the IMF WEO and others as contributing to downside risks to the global outlook did indeed materialise, in particular expectations of an earlier than anticipated withdrawal of unconventional monetary policies by the US Federal Reserve. These headwinds also registered in the form of less progress being made in the eurozone on various fronts to help underpin the recovery there. More recently the picture is more promising, considering the euro zone has finally exited from a recession in the second quarter led by Germany and France, after six quarters of economic contraction. The Spanish economy exited two years of recession in the second quarter, growing by 0.1 per cent despite tough austerity measures which have brought thousands to the streets in protest. The US has been one of the more convincing bright spots when it comes to stronger underlying momentum in economic growth during 2013, although, like Japan, their fiscal outlook continues to weigh on future prospects. Slower growth rates in China, lower commodity prices, and moderating growth in emerging market economies, and generally a global economy moving at varying speeds across regions are some of the downside risks that have materialised. On the domestic front, unfortunately risks that industrial action could become more widespread and disruptive during 2013 in the wake of wage negotiations in centralised bargaining agreements that were up for renewal also did come to pass and has damaged growth prospects for 2013. A dismal growth rate of 0.9 per cent was recorded in the first quarter of the year on account of a severe contraction in the manufacturing sector which was followed by a growth rate of 3 per cent in the second quarter, but which mainly related to normalisation in the manufacturing sector, and was not reflective of improving underlying economic conditions. The third quarter of this year will be affected by the widespread strike action experienced, but hopefully this will be partly offset by more improved growth performance in advanced economy trading partner countries, as noted earlier. The rand exchange rate has been somewhat slow to act as a shock absorber or adjustment mechanism to provide support to the trade account and the Balance of Payments. South Africa’s current account deficit widened from 2.8 per cent of GDP in 2010 to 6.3 per cent in 2012. The trade deficit grew on account of increased imports related to the infrastructure investment programme, and lacklustre exports, as well as declining terms of trade. The depreciation of the rand exchange rate resulted in a deterioration in the Bank’s inflation outlook, and the targeted measure of inflation increased from just below 5.0 per cent in August 2012 to 6.4 per cent in August 2013. Still, however, there was little evidence of any demand pressures, with much of this increase driven by cost push factors. It is the improvement in growth prospects for advanced economies, in particular the US, that saw the rand again recouple with global developments on talk of asset purchase tapering. Expectations of tapering had a profound impact on financial markets of both advanced economies and emerging markets, but more particularly for the latter as it is deemed that such a withdrawal of stimulus will negatively impact on portfolio flows to emerging markets. Indeed, capital inflows retreated somewhat, and in South Africa we witnessed a pull-back especially in bond inflows. During May and June this year, we witnessed a net outflow of over R17 billion from our bond market although this was partially offset by equity inflows. From the beginning of May the rand exchange rate depreciated from R8.90 against the USD to levels of R10.40 in August. A number of central banks in emerging markets reacted quite differently to these movements, with some tightening monetary policy despite an evident slowdown in growth, others intervening in the foreign exchange market and others draining liquidity in local markets. The central bank of Brazil has since April this year, increased its policy rate by a total of 225 basis points to 9.5 per cent due to inflation pressures and to shore-up the currency and limit capital outflows, while also lifting previous taxes on capital inflows. The central bank in Indonesia increased the policy rate by 150 basis points thus far in 2013 to BIS central bankers’ speeches 7.25 per cent, but in emerging Europe we have seen various interest rate reductions.1 The People’s Bank of China (PBoC) reacted by initially tightening liquidity conditions, only to be relaxed soon thereafter to reverse a substantial increase in money-market rates and to resolve liquidity issues. Although markets have retraced following the Fed’s decision not to taper after all, it should be remembered that this is only a delay, and has helped to buy time for emerging markets to prepare as best as they can for when tapering actually takes place. Emerging markets that defended their currencies during May and June of this year through the sale of foreign exchange reserves, have rebuilt these buffers, reflecting a resumption of significant capital flows into emerging markets. Countries such as Mexico, Turkey, Brazil, South Korea and Indonesia, have in the past two months erased losses in foreign exchange holdings that totalled about US$40 billion between April and July, according to data from JPMorgan. In addition, China appears to have added about US$163 billion in the third quarter, bringing its stock of reserves to a record US$3.66 trillion.2 South Africa studied what other emerging markets were doing, but given its own particular circumstances deemed it not appropriate to tighten policy during that period, nor to implement any measures aimed at the foreign exchange market. 4. Outlook Clearly, asset purchase tapering by the Fed has been put on hold for now, but this will surely commence at some point. Is there need for alarm over emerging markets in light of tapering and is the slowdown in emerging markets really that severe? The IMF’s latest Global Financial Stability Report3 (GFSR) poses the question of what would happen if flows reversed more sharply in emerging markets? The GFSR suggests that while emerging markets may have become more vulnerable, they are also in a much better position than prevailed at the time of the 2008 crisis. In the 12 weeks following the reversal of risk sentiment during May 2012, assets under management for emerging market fixed-income funds fell by 7.6 per cent (or US$19 billion), much smaller than in 2008, when assets under management fell by 36 per cent (or US$26 billion) during the first round of the asset sell-off in September–October 2008, although the impact on local currency bond yields was similar across the two episodes. Emerging market countries have come a long way in the last two decades and are not as fragile today as they would have been in the past. Foreign exchange reserve levels are much higher; monetary policy has greater credibility and there is a better track record of managing inflation; while fiscal positions are healthier than in many advanced economies; and they are less vulnerable to sudden stops given that there are less dollar liabilities. Macro-economic fundamentals have also improved significantly and while emerging markets may be slowing, they remain the biggest contributors to global growth, and this may well be a correction to more sustainable levels of growth after period of somewhat spectacular growth. But, as we witnessed at the time of tapering talk, emerging markets did react. Exchange rates weakened, yields on fixed income instruments spiked and the equity markets sold off. It is likely that there will be a further reaction when tapering eventually becomes a reality, and while some of the effects of tapering may already be priced into markets, we cannot be sure of how much is priced in and therefore how much still needs to be reflected in asset prices. Hungary and Poland (–175 basis points), Turkey (–150 basis points) Emerging markets rebuild fx reserves after recent turmoil, Financial Times, 22 October 2013 www.imf.org, GFSR, October 2013 BIS central bankers’ speeches As I indicated earlier, South Africa’s economic performance has lagged behind other emerging market economies through the crisis, and continues to reflect lacklustre growth. The Bank has repeatedly raised its inflation forecasts and lowered the growth forecasts since the end of 2012. The 2013 forecast for the CPI inflation was raised from 5.5 per cent in December 2012 to 5.9 per cent in September 2013, while the forecast for 2014 was raised from 5.0 per cent to 5.8 per cent over the same period. Real GDP forecasts for 2013 were lowered from 2.9 per cent at the end of 2012, to 2.0 per cent more recently, and for 2014 from 3.6 per cent to 3.3 per cent. The Bank’s Monetary Policy Committee (MPC), faced with such an environment has found it prudent to keep the policy rate steady throughout 2013, as despite the rising trend in inflation, the MPC deemed inflationary pressures stemming from the demand side of the economy to be subdued, and therefore that inflation pressures largely related to supply shocks and the weaker exchange rate. However, as noted in the most recent MPC statement, the upward drift in core inflation in the absence of any obvious demand pressures would suggest that there may be emerging underlying pressures owing to lagged effects of the exchange rate depreciation as well as higher unit labour costs. Although the rand has appreciated from the levels of R10.40 during August 2013, it remains vulnerable to changes in the global and domestic environment. Furthermore, while inflation expectations appear to be anchored and relatively stable, expectations are uncomfortably close to the upper end of the inflation target range. Growth remains below potential with a widening output gap and is expected to average only 2.0 per cent in 2013 and 3.3 per cent in 2014. The leading indicator of the Bank suggests that the moderate growth rates are set to continue, while protracted work stoppages in the mining and manufacturing sectors are likely to detract from growth going forward. Consumer spending is also expected to remain modest, capped by high household debt levels, low employment creation and rising administered prices. More recently, concerns over the current account deficit have heightened, and these concerns have been propelled by the fact that South Africa’s terms of trade have deteriorated, exports have failed to react sufficiently to the weaker rand, and the global environment characterised for the best part of five years by easy liquidity, is in the process of transforming. Investors have shifted their focus to macroeconomic imbalances and have become increasingly concerned about countries with high current account and budget deficits, which rely heavily on international capital flows. Along with monetary policy slowly turning the corner in advanced economies, a fundamental reassessment of the emerging market investment case appears to be under way, as the recent impact of the announcement of the intentions of the Fed to soon embark on a withdrawal from unconventional monetary policy seems to have exposed vulnerabilities in certain countries that may have been underestimated previously. Although the recent breach of the inflation target is expected to be temporary, and we recently saw CPI inflation decelerate from 6.4 per cent in August to 6.0 per cent in September, there are significant upside risks, not least of which relate to wages and the exchange rate. In line with its mandate, the Bank continues to monitor developments carefully. Indications that inflation will deteriorate significantly or remain outside of target for a protracted period and affect inflation expectations, will require the appropriate policy response from the MPC. As we approach 2014, while there appears to be reason for optimism overall as the global recovery gathers momentum, we will have to contend with an environment that continues to be characterised by uncertainty and volatility. The extent of the impact of the exit from unconventional monetary policy measures remains unclear. Given the many uncertainties in the global environment that are beyond our control, there is little room to get wrong that which is within our control, such as focused, effective and efficient implementation of reforms and policies that will improve our competitiveness and enhance our attractiveness as an investment destination, labour representatives and employers taking full ownership and BIS central bankers’ speeches responsibility for restoring orderly industrial relations, and maintaining credible fiscal and monetary policies. In closing, may I be the first to congratulate all of you who have been nominated for this year’s awards. It is always gratifying and a special honour to have one’s hard work, efforts and contribution in your profession appreciated and recognised by peers in this manner. We thank you for your inspiration and leadership and for serving as an example to many of us. 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 Standard Bank 5th African Central Bank Reserves Management Conference, Sandton, 5 November 2013.
Daniel Mminele: Global trends and South African reserves management Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Standard Bank 5th African Central Bank Reserves Management Conference, Sandton, 5 November 2013. * 1. * * Introduction Good morning ladies and gentlemen. It is a pleasure to be here and to deliver the opening remarks this morning. I thought it may be useful, given that it is the start of the conference, to share with you some of the changes that we have been observing in the reserves management environment over the past year. I note from the agenda that many of the topics you will be discussing over the next few days are issues that we at the South African Reserve Bank have been dealing with directly over the past few years: we have just completed an external fund manager review and rolled out a new external fund management programme for the next three and a half years, in conjunction with the roll out of a new Strategic Asset Allocation (SAA). We are also nearing the end of the Systems Renewal Programme we embarked on a few years ago, and are currently at an advanced stage of a Custodian Review. My remarks this morning will focus on trends globally and then touch more specifically on what has been happening at the South African Reserve Bank in the reserves management space, before concluding with some comments on asset purchase tapering and its potential impact on reserves management. 2. Global foreign exchange reserve management I need not tell an audience such as yourselves about the explosive growth in central bank holdings of foreign exchange reserves over the past decade. The most recent data from the International Monetary Fund’s “Composition of Foreign exchange reserves” (COFER) is for the second quarter of 2013, and shows that global foreign exchange reserve holdings stood at US$11 trillion, compared to holdings of just over US$1.4 trillion in 1995. In 1995, approximately 65 per cent of foreign exchange reserves were held by advanced economies with more than 60 per cent of the allocated global foreign exchange reserves held in USD. Fast forward to 18 years later, and we find that 67 per cent of reserves are held by emerging market countries and just a little more than 60 per cent of the allocated global foreign exchange reserves are held in USD. However, the unallocated portion of reserves has grown tremendously, and this makes it difficult to compare the currency composition of reserves over time on a like-for-like basis. The Asian financial crisis in the late 1990s provided the impetus for this growth, as reserve holdings were increased to provide a form of insurance against future Balance of Payments crises. The expansion in global liquidity since the 2008 global financial crisis further provided encouragement to increase reserve holdings, as central banks tried to limit appreciation pressure on exchange rates emanating from the surge in capital inflows, and hence intervened in the foreign exchange markets and by so doing, increased their holdings of foreign currency. South Africa certainly benefitted from the abundance of global liquidity in many ways, and also used this period to build up our foreign exchange reserve levels. This was done through a combination of direct purchases (mostly related to large FDI transactions) as well as opportunistic purchases in the foreign exchange market. The Bank, together with the National Treasury, considers various formulae when assessing what should be the optimal level of reserves for a country such as ours. We look at both an adjusted Greenspan-Guidotti rule, as well as the Jean-Rancierre model, both tweaked to take into account the specifics of the South African economy. The level which is arrived at provides a guide to what would be an adequate level of reserves to hold to protect against external vulnerabilities, however, this BIS central bankers’ speeches is not considered a hard target which has to be reached at all costs. It is for this reason that we have decided to not publicly release any such indicative levels or ranges. These numbers also tend to change quite a bit from year-to-year, largely influenced by the assumptions made and various forecasts used. The costs involved in accumulating reserves are always considered alongside the benefits of higher reserves, as at some point, the costs of accumulating reserves may far outweigh the benefits to be had. The composition of reserves assets has also changed over time and reserve managers have become more comfortable with and therefore gradually moved to riskier assets. Bearing in mind the low yielding environment we found ourselves in post-2008, with increased levels and costs associated with holding reserves, asset allocation decisions were influenced towards a greater focus on returns. Reserve managers have explored different avenues to achieve this, including: • Diversification in the currency composition towards non-traditional reserve currencies such as the Korean Won, New Zealand Dollar, Australian Dollar and Canadian Dollar. However, the diversification into alternative currencies as opposed to traditional currencies remains quite small as an overall proportion of reserves, around 3 per cent, given that these non-traditional currencies markets are relatively small and have limited depth and liquidity as compared to that of the USD or EUR, for example. Nonetheless, since 2008, the share of alternative currencies in reserves assets has tripled. The IMF has started showing these currencies separately in the Cofer release, in recognition of the growing role they play in foreign exchange reserves management. • Gold has also become a popular diversification strategy, with quite a few central banks increasing their holdings of gold in recent years following two decades where central banks were net sellers of gold. In the first six months of this year central banks have bought over 180 tonnes of gold, and on average have bought between 70–160 tonnes per quarter for the last couple of years1. • Investing in new asset classes such as emerging market local currency debt; mortgage-backed securities and equities; • using more sophisticated financial instruments to mitigate risk and at the same time to enhance returns by providing protection against rising interest rates; • upgrading information technology and risk management systems to better manage risk; • up-skilling staff through training, education and knowledge transfer with other central banks and private fund managers; and • Following a more sophisticated approach to investment policy making and strategic asset allocation. Experiences across central banks in dealing with the challenges of the global environment have been quite similar, although some have perhaps been more courageous than others in terms of the avenues in which they have chosen to diversify. What we of course need to be mindful of is that as central bank reserve managers we are custodians of public funds, and at all times have to be guided by prudent strategies which implies that there must be a limit to “thinking outside the box” in the quest for higher returns. ETF Daily News, Central Bankers trust gold more than money, 25 October 2013. BIS central bankers’ speeches 3. What has South Africa been up to? In managing its reserves, the South African Reserve Bank continues to adhere to the three main objectives: capital preservation; liquidity and return, in that order of importance. Capital preservation is the most important objective as any significant erosion of capital on the reserves will not only dent the general perception of the Bank’s ability to manage its reserves, but also harm perceptions about South Africa’s external vulnerability position. Liquidity is important for the Bank to be able to meet its day-to-day foreign-exchange commitments and to manage liquidity within the domestic money market arising from its monetary policy implementation function. Finally, the return objective has become increasingly important in recent years as reserve levels have grown, and therefore there is a need to enhance returns within an acceptable and prudent risk tolerance so as to help defray the costs of accumulating and holding reserves. The Bank benchmarked and just recently completed a review of its Investment Policy (IP) and also reviewed the Strategic Asset Allocation (SAA), to take into account the current lowyielding environment and expectations of future monetary policy actions by major central banks. The review and benchmarking of the IP earlier this year proved to be very useful with much of the feedback from various central banks, the World Bank and the Bank for International Settlements (BIS) taken on board. A number of refinements were made to the IP, which largely related to improving on already well-structured governance arrangements. In order to meet the three objectives of capital preservation; liquidity and return, the Bank structured the reserves into various tranches. Prior to the rollout of the most recent SAA, the Bank had divided the reserves into 3 tranches, being the liquidity, buffer and investment tranches. However, the rollout of the new SAA saw the tranches cut down to two instead, namely the liquidity and investment tranches. This change was really just a simplification of the structure and necessitated by the various scenarios informing assumptions made using the Jean-Rancierre model and the amount of reserves which needed to be held for liquidity purposes. In essence, the structuring remains very similar, as the liquidity tranche is divided into two sub-tranches, namely the buffer tranche and working capital tranche, the latter being held largely for liquidity purposes. The Bank has employed the Jean-Ranciere model in determining the appropriate size of each tranche, and within this, has made various assumptions regarding the probability of a sudden stop in capital flows, which then dictated the amount of reserves which should be held in the liquidity tranche. In order to determine the appropriate risk profile of the portfolios located within each tranche, the Bank uses a Strategic Asset Allocation (SAA), which it reviews roughly every 3 years or when market conditions necessitate a review. The purpose of the SAA is to maximize returns for each tranche, while being subject to a very low probability of capital loss over a given investment horizon. The new SAA which was rolled out in 2013, has allowed for a diversification in the Bank’s currency exposure, while assumptions about credit risk had to be adjusted in light of the dwindling amount of AAA rated paper. For the first time in the Bank’s history, a portion of the reserves will be invested in the Chinese interbank bond market. South Africa was the first African central bank to be granted an investment quota for the Chinese onshore market. The Chinese bond market is the world’s fifth largest, continues to grow rapidly in both depth and liquidity and the onshore market provides more favorable yields. An agreement between the Bank, and the PBOC allows the Bank to invest approximately US$1,5bn or CNY9,3 billion, which is roughly 3 per cent of South Africa’s official gold and foreign exchange reserves. The Bank has also taken steps to invest in new asset classes and new currencies other than the Renminbi. The Bank will be diversifying into currencies such as the Korean Won, Australian Dollar and New Zealand Dollar. New asset classes that the Bank has begun to invest in include covered bonds and mortgage-backed securities and we have recently began trading in bond futures to mitigate the potentially negative impact of rising bond yields on the reserves as well as for more efficient portfolio management. BIS central bankers’ speeches Investing in these instruments demands better skilled staff and more sophisticated information technology and risk systems. The Bank has gained a great deal of training through external fund managers, including the two official sector fund managers, being the Bank for International Settlements and the World Bank. The Bank has been part of the World Bank’s Reserves Advisory and Management Programme (RAMP) since 2006 and through this engagement Bank staff not only received extensive training but are now also in a position to provide training and engage in knowledge transfer with other central banks within the SADC region. Being a member of the RAMP programme has greatly enhanced our efficiency in managing reserves. We also enjoy a very good relationship with the BIS, with whom we have previously partnered to host conferences around reserves management and also participate in their annual BIS Associate programme. The Bank has further made changes to the split in the proportion of funds managed internally and those managed externally. South Africa implemented its first External Fund Management Programme in 1999, mainly to build internal capacity through skills and technology transfer and for diversification purposes. As our level of foreign exchange reserves grew, especially in the period since 2004, so did the external fund management programme. In 2004, South Africa’s gross reserves amounted to approximately US$8 billion and this had grown to US$50 billion by 2011. However, with the most recent review, which took place this year, we decided that the funds under external management would be reduced, primarily because the latest SAA supported benchmarks and related portfolios that could largely be managed internally. Currently, we are at an advanced stage of reviewing the custodial arrangements we have in place, including the type of model which we would like to follow going forward. The custodial review entails: • benchmarking services received from custodians against current world custodial service standards; • reviewing the current ratings of custodians against minimum ratings standards; • reviewing services required from custodians against the Bank’s business requirements; and • determining the capabilities of Custodians to provide ancillary services such as accounting, performance attribution, settlements and risk measurement and reporting. Prior to the Custodial Review, the Bank embarked on a comprehensive systems renewal project in order to upgrade the Bank’s IT and risk management systems, so as to create a superior reserve and risk management operational platform. The two projects, the Systems Renewal and Custodian Review, of course have a direct bearing on each other. We hope to make final decisions for the Systems Renewal later this year and hopefully be in a position to start implementing whichever system is chosen by the end of the year or early in 2014. The decision regarding custodial arrangements we also hope to make early next year. 4. Asset tapering and reserves management What will keep reserves managers up at night? No doubt an important issue for reserves managers going forward is that of asset purchase tapering and the timing of policy tightening after the asset purchasing programme has been completed. The implementation of asset purchases by the US Federal Reserve in a bid to dampen yields on the longer end of the yield curve resulted in significant increases in prices of US Treasuries, and prices of other advanced economy and emerging market bonds. In such an environment, it was not too difficult for reserve managers to earn good returns as yields rallied substantially, albeit with a fair amount of volatility. But as they say, everything that goes up must come down. The mere expectation of tapering by the US Federal Reserve had a significant impact on markets, BIS central bankers’ speeches introducing significant volatility, with practically all markets selling off and a number of emerging market central banks spending some of their reserves trying to defend their currencies. With over 60 per cent of foreign exchange reserves held in US dollars, this has important implications for reserve managers, as it is clear that tapering will remove an important source of support for US Treasuries, mortgages and other asset classes. US Treasuries are the so called “risk free” assets, therefore, any rise in US Treasury yields is likely to push up yields elsewhere in the developed and developing world. Furthermore, most central banks are heavily invested in bond markets, which as we know are highly interest rate sensitive. While there has been some diversification of reserves across assets, this has been quite limited. JP Morgan2 constructed several portfolios to highlight the impact of what they call a rates crisis on different portfolios and unsurprisingly found that portfolios extending beyond the fixed income universe performed relatively well in an environment of rising interest rates, showing positive expected returns, and all portfolios that included only fixed income, performing poorly with negative return expectations. Having said this, however, the author found that even central banks whose investment universe is constrained to fixed income assets can improve expected returns through diversification into different markets, credit risk exposures, and having some portion of holdings in cash. The South African Reserve Bank is acutely aware of the risks facing the global environment emanating from asset tapering, and with this in mind made a strategic decision to diversify its currency exposure so as to help insulate the reserves from this potential rise in US treasury yields. From a more operational perspective, the internal portfolio managers are better equipped with the use of bond futures as a hedging instrument against rising yields. 5. Conclusion In conclusion, the unique financial environment that we find ourselves in has created many new challenges for us as reserve managers. With the increase in the level of reserves came a much higher level of interest and scrutiny in how these reserves are managed, especially against the rising opportunity cost of holding these reserves. At the same time the yield differential between the cost of holding reserves and the return on the reserves necessitated an increased focus on return enhancement without putting at risk a prudent approach to investing. Including some non-traditional assets in investment portfolios has meant that reserves management has become more complex, resulting in central bank reserves managers, including ourselves, needing to build capacity by up-skilling staff and investing heavily in sophisticated IT and risk management systems. While the recent impasse in US politics has passed, many of us realise that this stalemate situation will again cause undue volatility in the months ahead. For reserves managers this once again means huge fluctuations in global financial markets and unfortunately large swings in the valuation of our reserve assets. However, there can be no doubt about the need for investment processes to continue to be guided by sound investment principles and solid risk management policies and good governance and oversight structures. Conferences such as this one, which provide networking opportunities, facilitate knowledge transfer and capacity building therefore play a critical role. Looking at the agenda for the next few days, I’m sure that you will find this conference worthwhile and have a lot to take away to help strengthen reserves management operations and their oversight in your respective institutions. Anticipating the end of easy money: reserve management consideration, Robert Grava, Asset Management Strategy Group. BIS central bankers’ speeches I wish you a successful conference. 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 IIF Africa Financial Summit, Sandton, 11 November 2013.
Daniel Mminele: Underpinnings of sustainable growth in Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the IIF Africa Financial Summit, Sandton, 11 November 2013. * * * Mr Tim Adams, President and CEO, Institute of International Finance (IIF), Mike Brown, Chief Executive, Nedbank, and honoured guests, allow me to express my gratitude for the honour and privilege to present the opening keynote address of the 2nd Africa Financial Summit. 1. Introduction In May 2000, the Economist magazine labelled Africa the “Hopeless Continent”, claiming that natural disasters, mass murders, a string of wars, institutional constraints and a lack of commitment to democratic practices meant that the new millennium had brought disaster rather than hope to Africa.1 In March 2013, the Economist had a complete change of mind declaring that Africa is “a Hopeful Continent” since “African lives have greatly improved over the past decade…and the next ten years will be even better”2. It is heartening to note that negative perceptions about African economic prospects, which were the norm at the turn of the millennium, are less of an issue today. While many challenges persist, Africa has shown that there is a high level of commitment and potential to achieving economic success. In this address, I would like to take stock of some of the economic successes that African countries have achieved, highlight some of the underpinnings for sustainable growth outcomes and prospects in Africa, and then look at some of the challenges facing monetary authorities. 2. Africa’s economic successes Africa’s average growth rates have exceeded 5 per cent since 2000, double the pace of the 1980s and 1990s. Over the past decade, six of the world’s ten fastest-growing countries were from the African continent. Equatorial Guinea recorded an average growth rate of 17 per cent while the Angolan economy expanded by 11 per cent per annum between 2000 and 2009. In addition, seven other countries on the continent recorded in excess of 7 per cent per annum growth during this period.3 With the outbreak of the financial crisis in 2008, there was justifiable concern that African economies were under threat. For example, the International Monetary Fund (IMF) kept revising downwards the growth forecasts for sub- Saharan Africa (SSA) for 2009, from 5 per cent in October 2008, to 3,5 per cent in January 2009, to 1,7 per cent in April 2009 and 1,3 per cent by October. However, SSA recorded a growth rate of 2,6 per cent in 2009 which was twice the pace predicted by the IMF. In addition, the pickup in economic activity in the post crisis period also exceeded forecasts with growth averaging 5,3 per cent between 2010 and 2012. http://www.economist.com/node/333429. http://www.economist.com/news/special-report/21572377-african-lives-have-already-greatly-improved-overpast-decade-says-oliver-august. These countries included Chad, Mozambique, Ethiopia, Nigeria, Rwanda, Sierra Leone and Tanzania. BIS central bankers’ speeches Part of the explanation for Africa’s resilience to the financial crisis was related to the rise in commodity prices. In fact, the boom in commodity prices during the 2000s provided a significant boost to export revenues given that mineral exports account for over half of the continent’s total exports. Statistics from the United Nations Conference on Trade and Development (UNCTAD) show that there was almost a fourfold increase in Africa’s exports from USD149 billion in 2000 to USD595 billion in 2011. The slowdown in the traditional export markets in the advanced countries as a result of the global financial crisis was countered by the rise of emerging countries in the world economy. This facilitated the diversification of export markets which served to sustain the demand for Africa’s commodity exports. For example, the share of exports destined to the European Union (EU) and United States (US) declined from 47 per cent in 2000 to 33 per cent in 2011 while the share to the BRIC (Brazil, Russia, India and China) nations increased from around 8 per cent to approximately 23 per cent during the same period. However, there was more to it than just commodity prices. Africa has been increasingly better managed, with the improvements in governance helping to promote an overall conducive environment to growth and development. There has been a steady rise in the contribution of domestic demand to gross domestic product (GDP). Part of the explanation here is the fast-growing middle class in many African countries. Estimates by the African Development Bank (ADB) show that consumer spending by the middle class reached US$680 billion and accounted for 25 per cent of Africa’s GDP in 2008. This figure is projected to reach US$2,2 trillion by 2030. On the supply side, the rise of the services sector has been one of the defining characteristics of the structural change in African economies. Telecommunications, banking, and the retail sector have been flourishing in many countries. This has contributed to the improvement in Africa’s growth prospects, which in turn, has attracted the attention of foreign investors. The concerted efforts of policymakers to address some of the major binding growth constraints, which were previously neglected, have also played a significant role in Africa’s enhanced growth performance over the last decade. Research from the McKinsey Global Institute (MGI) show that natural resources and activities directly related to the primary sector accounted for only about a third of Africa’s growth. The World Economic Forum estimates that more than half of Africa’s enhanced growth performance can be attributed to improvements in infrastructure.4 Policymakers have devoted significant attention to addressing the growth constraints on the continent, the dividends of which have been reflected in the growth outcomes of the past decade. However, having said that, infrastructure bottlenecks still persist and further attention is needed in this area to enhance Africa’s growth prospects. The 2013 “Doing Business Report” published by the World Bank earlier this year highlights that 66 per cent of countries in Africa enacted at least one business- enhancing reform in 2012 – this is double the number of countries in 2005. The report acknowledges that nine African countries rank among the top 20 most improved in terms of business regulations since 2009. These include Benin, Burundi, Cote d’Ivoire, Ghana, Guinea-Bissau, Liberia, Rwanda, Sierra Leone, and Togo. These countries are bound to reap the benefits of these business-friendly reform measures. Foreign investors have taken note of these changes. Over the past decade Africa has increasingly been earmarked as a profitable investment destination by international investors. Foreign Direct Investment (FDI) to Africa increased from approximately US$10 billion per year in 2000 to more than US$50 billion in 2012. While the commodity price boom has played some part, the institutional and political changes coupled with the The Africa Competitiveness Report 2013. BIS central bankers’ speeches continent’s enhanced growth potential have been the main factors underpinning investor confidence in Africa5. According to UNCTAD, greenfield investment into Africa constituted approximately 10 per cent of global greenfield investment between 2006 and 2012, compared to two per cent of global mergers and acquisitions that was directed to Africa. An increasing share of the greenfield FDI flows into the continent were destined for sectors, such as metals, renewable energy, automotive equipment and financial services. Africa is also seen as an attractive FDI destination by those multinational investor groups that are keen to benefit from the intra-Africa trade opportunities that currently exist. In addition, other investors that already have operations in Africa are looking to expand their footprint on the continent, to ensure that they are well positioned to benefit from the favourable growth prospects that prevail in many countries. Investors from developing economies, particularly those from China, have significantly increased their ventures into the continent. In the post crisis period, China accounted for more than half of the greenfield FDI to Africa. It is also worth noting that intra-continent FDI has been growing at a healthy pace. In fact, the share of African countries in total FDI in the continent more than doubled between 2003 and 2012; whereas in 2003 some 8 per cent of FDI into African countries came from other African countries and 92 per cent from other continents, by 2012 the intra-African share had risen to 18 per cent. As expected, multinationals from South Africa have seized the opportunity to expand their production networks across the continent. The number of projects in Africa originating from South Africa has increased by over 500 per cent in the past decade. Between 2010 and 2013, South African multinationals made FDI investments into 18 African countries. In 2012, South Africa invested in more new FDI projects in Africa than any other country in the world. According to Ernst & Young’s 2013 Attractiveness Survey, South African FDI into Africa has created almost 46 000 jobs in Africa since 2003. The financial crisis has shown that the conventional view of a positive relationship between finance and growth cannot be taken for granted. In fact, the shallowness of Africa’s banking system has helped to insulate many African countries from the adverse effects of the financial crisis. However, financial innovation and development over the past decade has helped to significantly increase the share of the population with access to basic formal financial services and technology in many African countries. We know that capital markets can be a significant driver of economic growth. While many countries in Africa have capital markets that are small and illiquid, some steady progress has been made towards developing financial markets in Africa. Increasingly African countries are accessing international capital markets, and their ability and success in doing so has contributed towards the funding of massive infrastructure projects, which I will touch on later. The ability to issue in international markets has been made possible by an increasing number of African countries obtaining sovereign credit ratings and because of heightened interest by international investors in the so-called frontier markets, in an environment of low global interest rates. Many of the debut dollar denominated sovereign bonds issued have been done so at relatively attractive yields, which have declined over time. Nigeria for example paid a 7 per cent yield on its debut two years ago with a 10-year dollar-denominated note, while the 2013 10-year bond issue was priced to yield 6.375 per cent. Nigeria’s most recent bond issues were four times oversubscribed compared with 2.5 times in 2011. According to Moody’s6, primary issuance by African sovereigns in 2013 has already reached its highest level ever of US$8 billion. Furthermore, Moody’s is positive on sustained investor interest in the region, citing a strong macroeconomic growth outlook. Six countries in Sub- African Development Bank: Annual Development Effectiveness Review 2013. International Sovereign Issuance in Africa 2013/2014: A Rating Agency Perspective”, October 2013. BIS central bankers’ speeches Saharan Africa are expected to issue inaugural bonds in the international markets within the next few years, including Angola, Cameroon, Kenya, Tanzania, Uganda and Mozambique and given expectation that the issuance sizes could be in the region of US$500 million, may make them eligible to be included in the JP Morgan Emerging Markets Bond Index. This of course helps to raise visibility, and provides access to a larger pool of investors, while also setting a benchmark for local corporates. As financial innovation and deepening evolves on the continent, it is imperative that the regulation of the financial system keeps pace with these developments. Here the emphasis should fall on appropriate regulation – that is, striking the right balance between guiding financial markets and protecting financial systems (some of which may still be at a nascent stage) on the one side, while not stifling innovation and progress on the other.. Too much regulation would entail increased costs which could hinder further development of the financial sector. But if due regulatory attention was not given to financial innovation and development then countries could be exposed to financial sector vulnerabilities which could pose a threat to sustainable economic outcomes. 3. Regional integration There are concerted efforts to foster greater financial integration at the regional level. For example, in the area of payment systems, the SADC Integrated Regional Electronic Settlement System (SIRESS) was launched on 22 July 2013 as a pilot. There are currently 21 participants (4 CMA central banks and 17 commercial banks). This system enhances and harmonises the legal and regulatory frameworks in the region and provides an integrated regional cross-border payment settlement infrastructure, allowing inter-country payments to be effected quickly, efficiently and safely. In fact, the benefits are already starting to manifest themselves. SIRESS processed 1 780 settlement instructions to the value of R15 billion during August 2013 which was the first full month in which the system was in operation. The settlement amounts will increase quite significantly with roll-out to four more countries by April 2014 and eventually more broadly in SADC. Further developments are also envisaged. For example, the SADC Banking Association and a work group from the Committee of SADC Stock Exchanges (COSSE) are working on the business model and related agreements for the settlement of the cash leg of securities trades. Rising intra-regional trade has been a defining characteristic of globalisation over the last two decades. However, it has long been recognised that Africa is highly fragmented with poor institutional arrangements and insufficient coordination at national and sub-regional levels. These factors have undermined the role of intra-regional trade in fostering economic growth on the continent. While Africa’s intra-regional trade share has doubled from 6 per cent to 12 per cent between 1990 and 2011, this remains remarkably low in a global context, considering the spatial proximity of African countries to one another. The Treaties establishing the Common Market for Eastern and Southern Africa (COMESA), the East African Community (EAC), and the South African Development Community (SADC) provide for the establishment of a Monetary Union in each bloc. However, overlapping memberships, the slow ratification and implementation of protocols coupled with the socioeconomic policy divergences have proven to be a serious obstacle to the process of regional and continental integration. Significant progress on economic integration has been achieved in some quarters, the most notable being the long track record of the Southern African Customs Union (SACU) and Common Monetary Area (CMA). One needs to warn against overly rapid monetary union formation, however, and emphasise the importance of the context and sequencing of economic integration initiatives. As the European experience has demonstrated, a monetary union without significant elements of a fiscal union could amplify tension rather than bring harmony. BIS central bankers’ speeches In June 2011, African Heads of State and Government committed themselves to the Tripartite Free Trade Area (TFTA) which aims to remove trade barriers, develop regional value chains and create jobs in COMESA, EAC and SADC. Negotiations towards the creation of the Tripartite Grand Free Trade Area between COMESA, EAC and SADC commenced in May 2013, with the objective to conclude these negotiations by December 2014, and the Agreement entering into force at the beginning of 2015. Last month, the African Development Bank approved a grant of US$7,5 million to finance a capacity building programme in support of the TFTA. 4. Challenges for policymakers on the African continent Let me now briefly highlight some of the current challenges confronting monetary policymakers on the continent. Although our continent is diverse with differing experiences and challenges, it is possible to make some general comments. While Africa’s growth performance has been impressive in a comparative context, this has not translated into an adequate, widely spread improvement in living standards. This is evident in the continent’s progress in terms of attaining the Millennium Development Goals (MDG). Despite 15 of the 20 countries which made the greatest progress on the MDGs in 2012 being from Africa, according to the “2013 MDG Report” Africa’s rate of poverty reduction would not be sufficient to reach the target of halving extreme poverty by 2015. Structural reform across a wide range of areas has to be intensified in order to make the progress which the continent needs. In this regard reference has already been made to a number of key areas, such as infrastructure improvement and creation of a more businessfriendly environment. According to the 2013 World Economic Forum Africa Competitiveness Report, the quality of infrastructure is one of the major impediments to developing trade and improving competitiveness in Africa. The World Bank estimates that the continent’s infrastructure spending needs amount to approximately US$93 billion per year, half of which is funded by the government. There is thus a huge infrastructure funding gap which in effect dictates that efficiency gains in the use of the existing infrastructure network are essential. An area that stands central to development has not been mentioned yet; namely, education and training, where huge challenges must be faced and overcome if Africa is to blossom further through inclusive growth and development. Labour markets in many countries are characterised by frictions and strife. In this regard, there are two major challenges confronting policymakers. Firstly, over the short-term there is an urgent need for the creation of labour-intensive jobs to absorb the large number of people entering the labour market each year. Secondly, over the longer term there is need to move up the value chain in production in both the manufacturing and service sectors. This would require significant investment in education both at the school and higher education levels. Programmes directed at entrepreneurship development and other training initiatives that could provide the technical skills required to support infrastructure development are key to the attainment of sustainable growth on the continent. Where do central banks fit into the sustainable growth picture? While most of the structural reform imperatives fall outside the mandate of central banks, I believe that central banks, by keeping inflation in check and creating an environment of financial stability, can make a meaningful contribution. Economic prosperity is built on stable foundations provided by central banks taking their mandate seriously. Thinking of the dozens of countries on the African continent that had high double-digit rates of inflation 20 years ago and contrasting that with the current situation, much progress has been made. In general, while inflation rates have increased marginally over the last couple of years they remain entrenched at single-digit levels in many countries. The rise in food and fuel prices coupled with the impact of currency depreciations have been important sources of inflationary pressures in many countries. The current uncertainties in the global financial BIS central bankers’ speeches environment and their associated impact on currencies may continue to pose a major threat to inflation outcomes in many countries. Recently the issue of currency movements and its impact on competitiveness has received much attention in the general press as well as in policy and academic circles. While it may be difficult to determine the equilibrium exchange rate, it is well recognised that a significantly misaligned exchange rate or excessively volatile exchange rate leads to a misallocation of resources which eventually thwarts sustainable growth. In some countries like South Africa for example, a special effort has been made to build up the level of foreign exchange reserves – to some US$50 billion at present, from US$8 billion a decade ago – since adequate reserves contribute to investor confidence and moderation in exchange rate volatility. In some other countries the nature of the foreign exchange market and risk appetite of the authorities does, at times, allow for central bank intervention in an attempt to moderate episodes of abnormal depreciation or appreciation. The shorter-term challenge to macroeconomic policymakers on the continent is to strike a balance between controlling inflation and supporting economic growth. As pointed out earlier, growth is driven from the supply side over the long-term. The trade-off between growth and inflation can only be avoided with increases in potential output. Monetary policy can only play a facilitating role in enhancing the productive capacity of the economy. Once inflation picks up significantly and stays at elevated levels, nominal interest rates also have to rise to match inflation so that saving is sustained and a macro-economic environment conducive to sustainable growth is maintained. In this regard, countries with rising inflationary pressures and limited fiscal space will be constrained in their use of expansionary macro policies to stimulate the growth momentum. On the other hand, where inflationary pressures are contained, further monetary stimulus could be provided. 5. Conclusion In conclusion, the recent financial crisis has exposed the strains in the banking system in the advanced world. While the banking systems in many African countries are not well developed, they are stable. In general, African banks are well capitalized and have avoided being overly exposed to the sub-prime and other financial crises that have affected the world economy over the past two decades. The challenge confronting policymakers on the continent is to ensure that the hard-fought economic gains achieved during the past decade are not lost. In this regard, African central bankers are committed to ensuring that monetary policy makes a significant contribution to sustainable economic outcomes by fostering price and financial stability. But much more is required than what central banks can contribute: The challenge to Africa in general is to not only plan but also implement the structural reforms necessary to bolster the continent’s sustainable growth rate. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the Merrill Lynch 2nd Annual Fixed Income Investor Conference, Sandton, 27 November 2013.
Lesetja Kganyago: South Africa and the normalisation of world monetary policies Address by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the Merrill Lynch 2nd Annual Fixed Income Investor Conference, Sandton, 27 November 2013. * * * Introduction Since the onset of the world economic crisis, monetary policy in the major advanced economies has been extremely loose. This has been helpful in supporting economic recovery in those economies, which has had positive spillover effects for developing countries, including South Africa. In line with other emerging markets, we have also benefitted from capital inflows which have boosted growth, lowered our borrowing costs and reduced inflation, through a stronger currency. However, these trends have started to reverse following signals from the US Federal Reserve that it plans to reduce the pace of bond purchases and ultimately tightening monetary policy. Today, I will discuss what this change means for South Africa. The unmoved mover: US monetary policy The prospect of Fed tapering moved to centre stage in world financial markets on the 22nd of May, when Chairman Ben Bernanke told the US Congress that he envisioned slowing or tapering the Fed’s quantitative easing programme this year. The result was a worldwide increase in medium and longer term interest rates and outflows of capital from emerging markets, as investors responded to better rates of return in advanced economies. For emerging markets, the shock appeared most visibly through weakening exchange rates, especially in the countries with large current account and fiscal deficits. By September, this strong market reaction had achieved a de facto world monetary tightening which had only to be validated by an actual Fed decision to taper. Yet this, to the surprise of many, was not forthcoming. The reasons the Fed declined to fulfill expectations were really quite persuasive. The Federal Open Market Committee had attempted to provide forward guidance on interest rates using unemployment as its main indicator, with 7% unemployment as the guideline for ending QE and 6.5% the threshold for raising rates. By September, unemployment had fallen to 7.3%, suggesting that tapering would need to happen rather quickly if QE were to be finished when unemployment reached 7%. However, unemployment was actually an unreliable indicator of the health of the US economy. This was because most of the improvement was being achieved not through people finding jobs but through people leaving the labour force. When unemployment hit 7.3% the labour force participation rate fell to 63.2%, the lowest level since 1978. The Fed therefore seemed unwilling to reduce its stimulus when so many people remained without jobs. Furthermore, the US economy was threatened by a fiscal shock from the budget and debt ceiling standoffs, to which the Fed was reluctant to add a monetary shock. For emerging markets, delayed tapering offered some respite from currency depreciation. However, it remains inevitable that advanced economy monetary policy will start to normalize, beginning in the United States. South Africa is in some ways vulnerable to this process, and I will detail our main weaknesses and the ways in which we might be affected, before discussing the proper policy responses. BIS central bankers’ speeches Vulnerabilities Our most important vulnerabilities are the twin deficits: the fiscal deficit and the current account deficit. We are also concerned about household indebtedness and therefore exposure to higher interest rates. At the moment, South Africa is running a current account deficit worth more than 6% of GDP. In comparison with other emerging market deficit countries, our deficit is the product of both weak export and strong import performance. In Brazil and Indonesia, current account deficits have come mainly from falling prices of commodity exports, whereas in India and Turkey deficits have grown mainly because of rising imports, with exports little changed. In South Africa, export performance has been disappointing and imports have been growing at a brisk pace. To fund the current account deficit we rely on capital inflows, and as they become scarcer the deficit will have to narrow. If this is to be achieved mainly through reduced imports the consequences for growth will be severe, especially as these imports include capital goods that are crucial to investment. It is therefore urgent that we improve on the country’s export performance. Furthermore, rising import penetration in the context of an output gap suggests that the tradeable sector as a whole has lost competitiveness, not just exporters. Regarding fiscal policy, the SARB’s repo rate stands at 5%, a more than three-decade low. Although we do not provide forward guidance on rates, should the rates rise, that will add to the cost of government borrowing. National Treasury has signaled smaller deficits in the future, as fiscal policy shifts from stimulus to consolidation, but smaller deficits will still add to SA’s debt. QE made borrowing much cheaper, with SA Government bond yields unusually closely correlated with US Treasury bonds. It was appropriate to capitalize on record low rates and provide stimulus during the crisis, but these conditions are now passing. As rates rise, interest costs will consume a greater portion of GDP. Our attempts to estimate this effect point to an extra R11 to R30 billion in interest payments annually, averaged over the next four years and depending on the interest rate path. It is therefore important that fiscal policy adjust appropriately to more normal interest rates. National Treasury’s most-recent MTBPS shows that this exigency has been well-understood by the fiscal authorities, and we are confident that it charts a sustainable course for South Africa. In addition to the fiscal and current account deficits, South African consumers are also likely vulnerable to higher interest rates. As the SARB’s September 2013 Financial Stability Review shows, households have used low rates to increase their debts, driving the ratio of debt to disposable income to almost 76%. The number of consumers with impaired credit records has climbed steadily since 2008, to nearly half the total. Although South Africa’s banks are well-capitalised and therefore capable of withstanding higher default rates, this raises concerns both for consumer demand, an important driver of GDP growth, and the wellbeing of these financially vulnerable households. Will South Africa experience a “sudden stop”? Given South Africa’s vulnerabilities, the question is not if world monetary normalization will affect us but rather how quickly and dramatically it will do so. The worst-case scenario is that we suffer a sudden stop, meaning inflows abruptly cease. One helpful definition of a sudden stop offered in the literature specifies a year-on-year fall in the financial account greater than two standard deviations from the mean. Other scholars have expanded this to a fall greater than one standard deviation, with the added requirement that the decline in inflows must exceed 5% of GDP, to exclude cases where low volatility BIS central bankers’ speeches produces small standard deviations.1 By either definition, this has never happened in democratic South Africa. Indeed, some of these writers pick out South Africa as a special case, a country which has experienced large currency swings but no sudden stops. By contrast, other emerging markets have a long history of “sudden stops”, and these have often been growth disasters; Indonesia, for instance, took about a decade to recover the GDP levels it had attained before the Asian Crisis of 1998. Sudden stops have also affected advanced economies – although some of them stopped being advanced economies after suffering sudden stops. As Olivier Accominotti and Barry Eichengreen have recently argued, the economic crises in Europe after 1929 and 2009 should both be treated as sudden stops. In 1927, Austria, Germany and Hungary were running current account deficits of around 5% of GDP. In 2008, Greece, Portugal, Italy, Ireland and Spain had an average current account deficit of 6.7%.2. When foreign funders suddenly refused to finance these deficits, crises resulted. Could a sudden stop happen here? We consider it unlikely. Partly, this is because world monetary policies are likely to normalize slowly, with very low rates likely to persist for several years in the United States, the Euro Area and Japan. Perhaps more importantly, South Africa’s vulnerabilities are manageable. The literature flags three main domestic drivers of sudden stops: current account deficits, fixed exchange rates and foreign currency denominated debt. I will discuss each of these in turn. The main reason current account deficits help precipitate sudden stops is that they exert downward pressure on the currency. Additionally, as a matter of economic identities the Current Account is equal to Aggregate Demand less gross national product (GNP). If the current account deficit closes suddenly demand has to fall as quickly, unless GNP expands enough to cover the gap, which it is unlikely to do in the short term. South Africa has a large current account deficit, but this is mitigated by our currency and debt policies. When a country with a fixed exchange rate experiences capital outflows, the peg comes under pressure and needs to be defended. This normally entails raising rates sharply and selling reserves, which suppresses output, exacerbates local debt problems and often fails anyway, especially when speculators bet against the fixed exchange rate. Furthermore, an overvalued exchange rate in the context of a current account deficit just exacerbates the problem, because imports are unrealistically cheap and exports are penalized. The rand, however, is a free-floating currency. This liberates us from vain or harmful attempts to manage its value, and ensures that there is liquidity in the foreign currency market at all times. Depreciation also provides the right incentives to producers and consumers of tradeables. The floating rand acts as a shock-absorber for the South African economy and is one of our best defences against a sudden stop. Foreign currency denominated debt, from the public or private sectors, may be an even more serious problem. Ricardo Hausmann has described it as the “Original Sin” of emerging markets, by which he meant that EMs are unable to borrow long-term in local currency, leading to debt profiles riven with currency and maturity mismatches. The problem with foreign currency debt is that if the exchange rate falls, the debt burden rises. The results can be likened to a bank run, with rising debt burdens deterring foreign lenders, weakening the currency and pushing debt burdens even higher, deterring more lenders, and so forth. South Guillermo A. Calvo, Alejandro Izquierdo, and Luis-Fernando Mejía, “On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects” NBER Working Paper No. 10520, http://www.nber.org/papers/ w10520.pdf, May 2004, See Pablo E. Guidotti, Federico Sturzenegger, Agustín Villar, José de Gregorio and Ilan Goldfajn, “On the consequences of sudden stops” Economía, Vol. 4, No. 2 (Spring, 2004), pp. 171–214; Calderon, C. and M. Kubota (2013): “Sudden Stops: Are global and local investors alike?”, Journal of International Economics, Vol. 89, pp. 122–142 See http://www.voxeu.org/article/mother-all-sudden-stops. BIS central bankers’ speeches Africa’s debt, however, is mostly rand-denominated, so investors bear the currency risk. We do not suffer much Original Sin. South Africa is therefore equipped to handle a shock like the end of QE without suffering a sudden stop. Although the current account deficit should prompt depreciation, a flexible currency and rand-denominated debt protect SA. This confidence that we can avoid a sudden stop is also supported by independent measures of country vulnerability. Nomura Global Economics has recently compiled an index meant to show vulnerability to a currency crisis, meaning a shift of three standard deviations from the two year average. South Africa is comfortably within the safer group of countries, ahead even of countries like China, Israel and Chile. In September 2013 The Economist magazine produced a similar index, measuring the likelihood of a capital freeze. This showed a much more disturbing result: South Africa was revealed as the third-most vulnerable country, after Turkey and Colombia. But this bad news, it turned out, was thanks to a spreadsheet error. When corrected, South Africa suddenly moved to 16th out of 26, a much less precarious position. Thinking through the likely outcomes For these reasons, we feel reassured that a sudden stop is unlikely. This clears the way for us to think about the more plausible outcomes as world monetary policies normalise. To assist with this task, we have modeled a range of scenarios, from growth in the advanced economies to renewed recession. The headline finding for this exercise is that the end of QE is neither good nor bad, in itself. What matters are the circumstances surrounding the exit. Advanced economy central banks are most likely to end QE and raise rates as growth improves – indeed, this is the whole point of monetary stimulus and the basis for forward guidance. This outcome is good for SA as faster world growth translates into higher domestic growth. Stronger exports plus depreciation would also narrow the current account deficit. It is possible exit from unconventional monetary policies could occur with world growth still disappointing. After all, this remains uncharted territory for central banks, and we cannot assume they will definitely get the timing right, or that they will not be compelled to tighten monetary policy earlier than they would like by unacceptable increases in asset prices or inflation. In this case, growth would be weaker but a depreciating rand would still boost inflation, requiring higher interest rates (although the effect is muted by the larger output gap). A weaker currency would also shift the current account towards balance. Getting policy right How should policymakers respond to the end of QE and fast-depreciating currencies? There is a danger, during currency sell-offs, of losing focus. One mistake is to treat the exchange rate as a crucial indicator of prestige. Another may be to look back on previous exchange rate crises (such as India’s in 1991, Indonesia’s in 1997/1998 or Brazil’s in 1998), and worry about losing the last war again. It may even be that currency rates, which change throughout the working day, are reported on so intensively that they assume outsize importance. Nonetheless, the exchange rate should not dominate our thinking. For the Reserve Bank, our policy stance is clear. As flexible inflation targeters, the proper response to a weakening currency isn’t to defend its value, as the priority, but rather to target the pass-through from the exchange rate to inflation. The Bank’s normal estimate of this is 20%, meaning about a fifth of the change in the currency’s value shows up in the CPI. The scale of the pass-through varies from time to time, however, and at present it appears to be lower, probably as a consequence of reduced pricing power in a subdued economy. Although inflation moved outside the target during the third quarter it has since returned to the target band, as forecast, registering 6% in September and 5.5% in October. We have BIS central bankers’ speeches therefore not changed rates so far this year, nor have we introduced other policy measures to influence the exchange rate. This contrasts with the responses seen elsewhere. Brazil has raised rates by 225 points this year, Indonesia by 150 and India by 50 points. Central banks have also resorted to less orthodox policies including tightening overnight rates, implementing some capital controls and creating new swap auctions – essentially, opening forward books. Comparing the performance of the rand with the currencies of these other countries, we see little evidence that a more activist and experimental approach would have changed the rand’s direction in a meaningful way. Furthermore, there are advantages to our approach, not the least of which is a less volatile output, inflation and interest rates. Conclusion In essence, South Africa is not a fragile country. Rather, our system is anti-fragile, like a welldesigned building in an earthquake zone: it moves with the shocks so it doesn’t collapse. – Our monetary policy stance is clear and appropriate; – Fiscal policy is vigilant in anticipation of the normalization of interest rates; – A sudden stop is relatively unlikely for South Africa; – The end of QE is not plainly bad for SA, and could be a good thing if it heralds a return to growth in the advanced economies. 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 Old Mutual Investor and Analyst Showcase Dinner, Cape Town, 4 December 2013.
Daniel Mminele: “Does the investment case for emerging markets still hold?” Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Old Mutual Investor and Analyst Showcase Dinner, Cape Town, 4 December 2013. * 1. * * Introduction Good evening ladies and gentlemen and thank you to Old Mutual for inviting me to say a few words tonight, just as another year with its share of uncertainties and challenges is drawing to a close. The topic chosen for our discussion, namely whether or not there is still a case for investing in emerging markets (including South Africa) may have sounded incongruous two or three years ago, when emerging countries were at the forefront of the global economic recovery, and capital flows into the emerging world had resumed at a strong pace following the 2008–09 financial crisis. However, the last twelve months in particular have proved more challenging for securities markets in the emerging world, and it is the seriousness and durability of these challenges which I will try to assess tonight. 2. The changing role of emerging markets in global growth The historical case for portfolio diversification into emerging market assets has long been based on the growth outperformance of emerging market countries. As these countries grew faster than their developed counterparts, reflecting either favourable demographics, large investments in human and physical capital, strong productivity gains, better governance or a mix of these, returns on invested financial capital were expected to be elevated. In turn, this justified faster growth in prices of emerging market equities. Furthermore, as income levels converged towards those of more developed economies, support for stability-oriented policies – and, consequently, lower and more stable inflation – increasingly became the norm, enabling a reduction in the risk premium embedded in these countries’ fixed-income markets. Finally, stronger productivity gains called for an appreciation of emerging market currencies, at least in real terms, over the long run. For most of the past decade, empirical evidence supported this paradigm: For example, between 2002 and 2012, the Morgan Stanley Capital International (MSCI) index for emerging market equities outperformed its global counterpart by 300 per cent, while returns on local currency emerging market bonds were 40 per cent higher than those on US Treasuries over the period. Yet, something seems to be changing. Emerging market economic growth is still outpacing that of the developed world, but the gap is narrowing. In its October 2013 World Economic Outlook, the International Monetary Fund (IMF) projected that growth in emerging markets would slow from 4,9 per cent in 2012 to 4,5 per cent this year and pick up to 5,1 per cent next year, whereas at the same time, developed economies would accelerate from 1,2 per cent this year to 2,0 per cent in 2014. Such a narrowing, albeit a mild one, in the “growth gap” is nonetheless surprising as in the past decade or two, recoveries in the developed world generally saw the emerging economies outpace advanced economies. In a word, global recoveries used to leverage the emerging market performance, rather than undermine it. Why is this happening? It is hard to pinpoint a single cause. But, among others, the performance of exports in many emerging economies has been poor, by historical standards, over the past eighteen months, suggesting (at least in some sectors) a loss of world market share. Also, in the current year, the co-existence of strong rates of credit growth and slowing real GDP growth in several large emerging market economies has raised concerns about a declining efficiency of invested capital. Separately, efforts by Chinese authorities to rebalance economic growth towards a more consumer-oriented model has prompted BIS central bankers’ speeches expectations that growth in China will in future be less intensive in industrial commodities, with negative implications for the major exporters of these commodities. The big question is how much of the recent developments represent underlying structural changes, or whether some of these factors will prove cyclical – for instance, that exports will revive once the developed world’s recovery is more solidly entrenched. There are some issues that point to a structural component. Firstly, one tool through which developed economies are fostering economic improvement is by restoring competitiveness, be it via cost and price disinflation (as in the case of the euro zone’s periphery) or by allowing currency depreciation (like in Japan). Secondly, a difference between the current situation and the early 2000s – when the recovery saw emerging market growth outpace global benchmarks – is that the real effective exchange rates of emerging market currencies are not, on balance, as depreciated as they were at the time. Thirdly, there are increasing indications that the moderation in economic growth in the emerging world has some lasting causes, for example less favourable demographic patterns. It is significant that the IMF’s estimates for potential economic growth in all the five BRICS countries are lower, in 2013, than similar estimates made in 2011. 3. The likely impact of declining global liquidity The impact of somewhat less favourable fundamentals has, of course, been compounded by concerns that the ample liquidity made available in recent years to fight the global crisis will gradually be withdrawn, perhaps in the not-too-distant future. The announcement by the US Federal Reserve in May that conditions would probably soon warrant a tapering of its asset purchase programme – which incidentally does not equate to a reduction in global liquidity, merely to a phasing down of additional injections – quickly resulted in a sharp rise in the risk premium embedded in most emerging market assets. Since Chairman Bernanke first talked about tapering on 22 May 2013, the JP Morgan index of emerging market currencies has lost 7.5 per cent of its value versus the US dollar; the Emerging Market Bond Index (EMBI) local currency index has fallen by around 2.4 per cent at the same time as the EMBI-plus sovereign spread of US dollar-denominated debt over US Treasuries increased by close to 100 basis points; and the MSCI Emerging Market equity index has fallen by 4.0 per cent, even as the MSCI World index of global equities continued to power ahead, gaining 6.0 per cent over the period. What will happen, then, when global central bank liquidity starts declining in earnest? Admittedly, the response to tapering talk since May need not necessarily be a guide to future market moves, as the reduction in the Federal Reserve’s asset purchases is probably by now discounted to a much larger extent than it was before Chairman Bernanke spoke to Congress in May. To the extent that the Fed does not again surprise markets, but instead manages to stabilize expectations embedded in the longer part of the US yield curve, for example via the continued and effective use of its forward guidance, the impact on the global asset price constellation could be more benign than it has been so far this year. But how much is priced-in, nobody really knows. Nonetheless, the strong correlation seen since the second quarter of 2013 between the exchange rates and bond yields of emerging countries (especially those seen as the most vulnerable to a reversal of capital inflows, because of more fragile domestic growth or external account fundamentals) and US Treasury yields, does highlight the vulnerability of the former to a further backup in the latter. Notwithstanding central bank efforts at anchoring long-term rate expectations, it seems difficult to imagine that a reduction in global liquidity – at a time when non-resident demand for US bonds, in particular, has been waning – would have no significant impact on US or core European yields. International estimates of “term premiums” embedded in longer-term bond yields did suggest that quantitative easing policies had compressed these premiums to unusually low levels; in turn, as prospects for an unwinding of quantitative easing emerged, they started to normalize. Furthermore, term BIS central bankers’ speeches premiums have shown some correlation across both developed and emerging bond markets, in particular since they began to rise from May 2013 onwards. 4. The case for (still) investing in emerging markets Risks hanging over emerging market assets, however, do not mean that the case for investing in such assets is closed. First of all, while the growth out-performance of emerging countries relative to the developed world has been dwindling, this should not obscure the fact that the gap, while narrowing, remains positive, and that emerging markets remain the biggest contributors to global growth. Demographic trends, productivity gains, increases in the stock of capital remain conducive to a stronger growth performance of emerging market countries in the medium to long term. Even countries that have shown a relatively strong degree of convergence with living standards of the developed world can still out-perform the latter, as the case of Korea and Taiwan shows. Similarly, emerging countries continue to display, on balance, better fiscal or external metrics than their developed world counterparts, whether one looks at current account balances, public deficits or ratios of public and private debt to GDP. Rather than the developments following Mr Bernanke’s comments in May 2013 representing an “emerging market crisis”, as some may want us to believe, what is probably a more correct characterization of the developments is a correction or re-pricing in the wake of expected normalization of global monetary policy and uncertainty around the speed of such normalization. What seems to further underpin the emerging markets investment case is much stronger fundamentals when compared to previous episodes of emerging markets coming under pressure, such as in the late 1990s, or even more recently in 2008. Substantial progress has been made in the last two decades towards more flexible exchange rates, reserves have been accumulated on a grand scale, fiscal positions are healthier than in many advanced economies, all of these making emerging markets overall more resilient. With regard to the more cyclical component of the recent developments, without underplaying the need for structural reform in some cases, one could even draw a more constructive conclusion of current developments, namely that depreciating exchange rates, and moderation in growth patterns may actually be testimony to how responsive these economies have become, and can adjust to changes in the underlying fundamentals. Furthermore, global investors may at present be relatively under-weight in emerging-market securities, strengthening the case for out-performance of the latter over the medium term. Private surveys of US and EU pension funds do suggest that their allocation to emergingmarket debt has remained stable and relatively low, as a share of total assets under management, in recent years, even as the share of emerging market bonds in world market capitalisation continued to grow. In particular, global investor allocations to local-currency bonds of emerging market economies remain low, in part because of historical reasons of liquidity which nonetheless fade over time as emerging economies increasingly expand the size and maturity of their local bond market. That said, not all emerging countries retain sustainably stronger fundamentals than their developed world counterparts, and growing divergences within the broad emerging market bloc, coupled with the likelihood of less abundant liquidity over the next few years, suggest that differentiation between respective emerging markets could increasingly become the norm in coming years. Whereas the immediate post-recession years had seen a strong cross-correlation between the performances of different emerging market assets, as they shared common drivers in the form of liquidity injections and interest rate expectations in the world’s major economies, such correlations have already started to wane in 2013. Country differentiation gradually began to replace the proverbial “risk on, risk off” trading patterns of the earlier period. Countries with relatively weaker growth, inflation and external account metrics saw their currency, bond and equity markets under-perform those with more solid fundamentals. Therefore, it may not be helpful to lump together countries and call them “the BIS central bankers’ speeches fragile five”, when underlying dynamics in these countries could be quite different, even if they present similarities when one looks at budget deficits and current account deficits. 5. South African assets under this new paradigm This allows me to conclude with a few words on our domestic situation. Domestic financial markets have faced significant challenges since the second quarter of this year. The rand has extended a depreciating trend that began in the latter half of 2011, and lost about 12 per cent on a trade-weighted basis since early March, declining to levels last seen in late 2008, at the height of the global financial crisis. The yield on the benchmark R186 long-term bond has risen by more than 100 basis points, even as domestic short-term rates remained anchored by the absence of a change in the Reserve Bank’s repurchase rate, while the CDS spread on five-year sovereign South African debt also widened, generally by a larger amount than those of countries enjoying a similar rating to South Africa. The domestic equity market has been the exception to this rule, although this partly reflects the “rand hedge” qualities of certain sectors or stocks which, because of the dollar pricing of their outputs or the international diversification of their operations, tend to benefit from a depreciation of the currency. We cannot be under the illusion that the poor performance of domestic financial markets since the beginning of this year is a mere consequence of a less favourable international backdrop. Domestic socio-economic fundamentals also play a part in investment decisions of global buyers of South African securities. Phases of rand under-performance relative to other large emerging market or commodity-linked currencies have frequently coincided, of late, with disappointing foreign trade or current account data releases; similarly, episodes of labour disputes are often accompanied by a poor performance of the local currency and credit spreads. More generally, investors seem to query whether the growth prospects of South Africa will be sufficient to meet, over time, the economic aspirations of its citizens and, in so doing, cement public support for the stability-oriented macroeconomic policies which investors have long regarded as a “constant” of the political landscape since the advent of democracy in 1994. However, one should not so easily forget the great many strides South Africa has made on the macroeconomic front, reflected by greater macroeconomic stability and longer upswings in the business cycle since the advent of democracy. The adoption of an inflation-targeting monetary policy framework in 2000 came with many benefits – contributing to a decline in the level and volatility of inflation and nominal interest rates, improving the transparency and accountability of the central bank, and therefore also its credibility. South Africa became increasingly integrated into international financial markets, contributing to the growth and development of its own domestic financial markets and financial infrastructures in terms of sophistication, depth and liquidity, thereby helping to boost growth and improve the country’s resilience against external shocks. The policy and institutional framework similarly remain strong. It is also as a result of this underpinning for the South African investment case that, over the years, South Africa has been included in a number of bond indices tracked by international investors, such as the JP Morgan Emerging Market Bond Indices and the Citi World Government Bond Index. The strides we have made as a country are borne out by favourable rankings in a number of competitiveness reports. Overall, South Africa is ranked 53 out of 148 in the 2013/14 World Economic Forum Global competitiveness report; ranked in the top 15 worldwide in the 2012 Emerging Markets Opportunity Index; first in economic competitiveness in the Africa Competitiveness Report (taking the lead in financial market development, technological readiness, market size, business sophistication and innovation); and 39 out of 185 countries in the World Bank’s Report on Doing Business. South Africa is respected for its good corporate governance – ranking first for ethical behaviour of firms; efficacy of corporate boards and protection of minority shareholders in the BIS central bankers’ speeches Global Competitiveness Index. We perform particularly well in a number of areas: quality of institutions; intellectual property protection; property rights; efficiency of legal framework; and accountability of private institutions. These rankings are a clear indication of South Africa’s economic and financial potential. That said, there are no doubt challenges that we confront today as a country and those challenges are reflected in the somewhat weaker investor sentiment. There is an urgent need for action on structural reforms, focus on quality education and skills development; infrastructure investment; to name a few. The National Development Plan sets out a good framework for dealing with these issues and the implementation thereof would help place the country on a faster and more sustainable growth path. Tackling these challenges requires a collective effort by players inside and outside government and a realisation that trade-offs will be necessary, and that the more difficult challenges cannot be addressed in a manner that is entirely painless for everybody. What role can, and should monetary policy play in supporting investor confidence in South Africa’s fundamentals? Admittedly, it is the nature of financial markets that perceptions of risk evolve over time, resulting in at least some degree of price volatility, even in those markets perceived as among the safest. Policymakers cannot completely eliminate financial market volatility. Yet in the recent past, some emerging countries have used specific tools to try and limit the extent of such volatility. One should however remember that the structures of financial markets differ across countries, and hence a policy tool that appears appropriate in some jurisdiction may not necessarily be the most desirable one in a different country. Furthermore, empirical evidence does not, so far, suggest that the volatility of South African financial assets has meaningfully diverged from those of markets in countries where such policy tools have been implemented. It is, however, important that investors remain assured and convinced of the firm commitment of South African authorities to price stability and sustainable public finances, irrespective of the challenges that the country faces in the pursuit of sustained economic growth and development. In that respect, the Bank’s commitment to flexible inflation targeting, monetary policy transparency and predictable implementation, remain crucial to limiting any rise in financial market uncertainty and volatility. The Monetary Policy Committee at its November meeting judged that an unchanged policy rate was consistent with its mandate at this stage. In order to maintain the integrity of the inflation targeting framework, however, it would not hesitate to take appropriate action, should the medium-term inflation outlook deteriorate significantly. At the same time, a reduction in public deficits as per the framework laid out in the October 2013 Medium-Term Budget Policy Statement, together with the implementation of measures agreed upon in the National Development Plan, aimed at unlocking the country’s longer-term growth potential, would substantially assist the Bank in carrying out its mandate of price and financial stability, in the interest of sustained economic growth and development. 6. Conclusion Let me then finish by answering the question of whether there is still a case for investing in emerging markets with a “yes”. While challenges remain and headwinds in the form of uncertainties around Fed tapering, lower growth in key emerging market economies, and continued volatility are likely to be with us for some time, and the need to address certain structural challenges by emerging economies is beyond question, the much better fundamental backdrop of emerging markets and continued prospects of higher growth than in advanced economies, especially in regions such as Sub-Saharan Africa, appear to suggest that it would be a mistake to write off emerging markets. By rather adopting a somewhat medium to longer-term investment horizon with appropriate diversification strategies, and looking through some of the temporary turbulence, investors that maintain their loyalty to this asset class are likely to reap the benefits. Emerging markets appear to be adjusting both BIS central bankers’ speeches cyclically and structurally from spectacular levels of growth observed previously to more sustainable levels. This should continue to support a steady investment case. Thank you. Selected bibliography World Economic Outlook – Transitions and Tensions, International Monetary Fund, October 2013. “Reviewing the Case for EM Local Debt – Structural Strength, Cyclical Headwind”, The Rohatyn Group, August 2013. “Will DM’s Recovery be EM-friendly?” Emerging Market Macro Outlook and Strategy, Citi Research, 27 September 2013. BIS central bankers’ speeches
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Graduation speech by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Central University of Technology, Bloemfontein, 11 March 2014.
Gill Marcus: Creating the conditions for growth in South Africa Graduation speech by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Central University of Technology, Bloemfontein, 11 March 2014. * * * Good evening ladies and gentlemen. Good evening to Professor Thandwa Zizwe Mthembu, Vice Chancellor and Principal of the Central University of Technology. I am humbled by the honour you and your institution have bestowed on me tonight. While you are awarding this honour to me, I feel that this tribute is also in recognition of the efforts of many others, not just in the struggle against apartheid, but also in the on-going endeavours since 1994 to make South Africa a better place for all who live in it. Societies that are making progress are those in which the present generation enjoys a better standard of living than their parents. In many countries this can no longer be taken for granted. Slow economic growth, high levels of debt, poorly performing education systems, unacceptably high levels of long term unemployment and the rising cost of ageing societies imply that for many in the advanced world the long-standing trend of children being better educated than their parents and enjoying higher incomes appears to be slowing, or perhaps even reversing. Fortunately, South Africa is not in this group of countries and today’s generation enjoys a higher standard of living than their parents. In most families there is confidence and optimism that the children will do better than their parents. Our economy has grown steadily since 1994, with incomes per capita over a third higher than in 1994. Employment has increased, with formal sector employment having risen from about 7 million 20 years ago to about 11 million today. The global financial crisis, which emanated from the advanced economies, set us and other emerging market countries back somewhat. Despite this, employment is rising and our economy is expanding, although more slowly than we would like, and the unemployment rate, at just over 24 percent, remains unacceptably high. South Africa has also made meaningful strides in social development. School enrolment is almost universal, school completion rates amongst Africans has increased sharply, enrolment at universities has more than doubled and an increasing proportion of students are taking science, engineering and technology courses. This is very important as our economy, in line with global trends and the rapid advances of technology, has become more skills and knowledge intensive, with skilled workers earning a growing share of the economic cake. This trend poses a challenge given that the vast majority of South Africans experienced a history of inferior quality education. The efforts of this university bears testimony to efforts to broaden access to quality education. Notwithstanding the progress, greater efforts are needed to address the legacy of our past. Even though our economy has improved significantly from twenty years ago, the recent period has been difficult. The world is in its sixth year of economic crisis. While most countries are out of recession, the crisis itself has not ended. Measures taken to address the unfolding crisis had unintended consequences resulting in a constant mutation – for instance from a sub-prime crisis in the US affecting home owners and lenders to a systemic banking crisis; from a systemic banking crisis to a fiscal deficit and sovereign debt crisis in many countries in Europe; from a wave of significant capital inflows and appreciating currencies in emerging economies to where more recently emerging markets have had to deal with a reversal of these flows and depreciating currencies, at a time when many of them are also facing rising inflation and slowing growth. What is consistent through this period is that growth is slower than historical averages, unemployment is higher and in particular youth unemployment, globally, is a major challenge standing at over 50 percent in a number of countries, including our own. The International BIS central bankers’ speeches Labour Organisation projects that unemployment levels are only likely to reach pre-crisis levels by 2017, a full ten years from the start of the crisis. Ten years is a long time in the life of any person. The effects in terms of human suffering, reduced household savings, long term unemployment, skills atrophy and lost investment are likely to endure for an even longer period. The US economic recovery is still fragile and risks remain. The recovery in the US, still the largest economy in the world, is a positive factor for the rest of the world. However, partly as a consequence of higher growth, the reduction in their quantitative easing programme, whereby the Fed is reducing its asset purchasing programme by US$10bn per month, is having detrimental effects on many emerging markets and an unsettling effect on financial markets globally. Growth rates have slowed in major emerging markets such as China, India and Brazil. Many developing countries, from Turkey to Venezuela, are battling both domestic economic challenges and capital outflows. However, Africa remains a bright spot in the world economy with sub-Saharan African growth at over 5 per cent a year, providing significant opportunities to South African investors and companies. The hesitant recovery in the global economy, and particularly in Europe, is negatively affecting South Africa’s growth performance. The South African economy grew by just 1.9 per cent in 2013, far below potential of around 3.5 per cent. Although the Reserve Bank projects an improved growth rate of 2.8 percent growth for this year, it is still too low to make a meaningful dent in our unemployment rate. Demand for our main exports is growing slowly and trading conditions for most firms remain difficult. In addition to global factors, South Africa’s economic growth is also being adversely affected by a number of domestic factors including electricity supply constraints, strike action in key export sectors and infrastructure bottlenecks. In addition, the economy is constrained by persistent shortages of skilled labour that lowers our growth potential. For monetary policy, the present environment presents a dilemma of slowing growth on the one hand, but rising inflation on the other. Given the fragile growth environment, the Reserve Bank has been more tolerant of inflation at the upper end of the target range for some time. However, the recent marked deterioration of our inflation forecast led the Monetary Policy Committee to raise interest rates for the first time in six years. Notwithstanding this increase, monetary policy remains accommodative, and the MPC will continue to focus on its core mandate of price stability, but with due regard to the impact of its actions on economic activity. Economic growth needs to be driven by real investment, and currently growth in private sector investment has been relatively subdued. Government’s massive infrastructure programme is essential to eliminate bottlenecks and shortages, thereby contributing to raising long term growth and productivity in the economy. The implementation of the National Development Plan will also support growth and investment as it is focused on raising our capabilities as a country and investing in our human resources. Over the next two decades, South Africa needs to raise its productivity levels, boost exports and ensure that not only do we significantly raise the rate of economic growth, but that it is also more inclusive. There are three core challenges that today’s world faces: food, water and energy. To briefly expand on just one aspect: by 2050, the world will need to produce about 80 percent more food than today to satisfy growing populations and rising food consumption. Africa contains the largest proportion of underutilised arable land on the planet. This provides a huge opportunity for investment, not just in agriculture but in agroprocessing, in water management, in roads and ports and in cold storage facilities. South African firms in the agricultural and agro-processing sector have the expertise, the know-how and the capital to invest in food production and processing on the continent. Again, there are strong backward linkages between such investments abroad and jobs back home. It is often said that all economic progress is about moving up the value chain, producing ever more complex products. This can only be done through partnership and cooperation between BIS central bankers’ speeches the state, the private sector and our education and research communities. A major area of focus for the country is the manufacturing sector. Manufacturing is important because it is a sector where productivity levels are already relatively high and the sector is able to generate well-paying jobs for millions of people. A major obstacle to faster growth in manufacturing has been a shortage of high level technical skills. That is where you come in. This university is at the cutting edge of producing the type of skills required for our manufacturing sector to move up the value chain, to enhance productivity and grow our exports. The Central University of Technology is the home of the Centre for Rapid Prototyping and Manufacturing. This university, supported by the National Research Foundation, is investing heavily in research in ‘additive manufacturing’, also known as 3D printing. 3D printing is likely to revolutionise aspects of manufacturing, lowering barriers to entry and allowing mid-sized economies to compete more effectively with other global players. These are exciting developments and I have no doubt that this university will play a greater role in helping our country to develop its advanced manufacturing sector. In conclusion ladies and gentlemen, despite significant challenges, South Africa as a nation is in the process of determining its future; it is a country that is growing, and with that growth comes opportunities. We must continuously raise the quality of our education system; continuously keep up with the best developments globally so that we can produce young graduates who are at the cutting edge of the fields that they enter; young people who will shape the future, drawing on the extraordinary strengths of all South Africans. The future is contested terrain, and it will be determined by our vision of what that future could be and what we, together, do. It is largely in your hands now. Again, thank you for this honorary doctorate. I humbly accept it on behalf of all South Africans who are making a contribution to build a non-racial, democratic and prosperous South Africa. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Central Banks Communicators Conference Dinner, South African Reserve Bank, Pretoria, 13 March 2014.
Gill Marcus: The importance of central bank communication Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Central Banks Communicators Conference Dinner, South African Reserve Bank, Pretoria, 13 March 2014. * * * Good evening everyone. Welcome to the South African Reserve Bank. And to those of you who are from abroad, a warm welcome to South Africa. It is difficult to imagine that twenty years ago it was unlikely that a conference on communication would be held in a central bank. We have come a long way from the days when central banks were arcane institutions, shrouded in secrecy, with the markets left guessing as to what the policies actually were. Karl Brunner, the well-known monetary theorist, once referred to the impossibility of central bankers to articulate their insights in explicit and intelligible words and sentences, instead pretending this was part of an esoteric art. And when a US senator claimed that he understood a comment made by former US Fed Chairman Alan Greenspan, he replied: “If you understood what I said, I must have misspoke”. I am sure that twenty years ago, central banks communications departments, if they existed at all, were small, and communication strategies were marginal to the overall strategy of the bank. Central bank communication became increasingly important with the moves towards increased independence and evolving monetary policy frameworks, as well as because of the pivotal role that central banks played, and are still playing, during global financial crises. Communication is now at the heart of central banks, and communications strategies have, to some extent, become policy instruments. Central banks have to consider carefully not only what they communicate, but how they communicate. Central banks not only need to communicate their policy decisions and views about the future – which is always uncertain – but also have to communicate their expanding mandates, so that the public is aware of what a central bank can do, and what it cannot do. This is of particular significance since the global financial crisis of 2007/8, when increasing responsibilities were placed on the shoulders of central banks. The apparent success in dealing with the crisis has led to unrealistic expectations about what a central bank can do, and it is important that we ensure that expectations are unreasonable. If not, when we do not live up to these unrealistic expectations, as will no doubt happen at some stage, we will lose credibility even in those areas that are within our appropriate policy purview. The global trend towards independence means that central banks have to become ever more accountable. Accountability requires increased transparency, and its corollary, effective communication. But this has brought its own challenges of how to communicate and how much to communicate, and, as this conference has highlighted, practices differ around the world. More recently, the issue of accountability has been accentuated with the explicit addition of financial stability to central bank mandates in many countries, including South Africa. Macroprudential policies require more coordination with other agencies, and these policies have strong distributional effects, more so than monetary policy. This requires even more effective communication to gain societal legitimacy. Nothing can undermine independence more quickly than being opaque and unaccountable. We at the South African Reserve Bank engage on an ongoing basis with the markets, and make ourselves available, where possible, to meet with a constant stream of domestic and foreign investors in the country. But communication is not just about our interaction with the markets. We have made a conscious effort to communicate with different stakeholder groups in the broader civil society through our outreach programme. We meet on a regular basis with political parties, trade unions and business associations from different sectors of the economy. We also convene an economists’ roundtable every second month, where we meet with economists and analysts from various institutions, and discuss topical issues, including, BIS central bankers’ speeches but not exclusively, monetary policy. We find it a useful forum not only to express our own views but also to hear the views of market participants. We recognise the importance of knowing what the thinking about the Bank and our policies are. Although we are not always successful in changing perceptions and misconceptions about the Bank and monetary policy, we have found that these interactions and initiatives have helped create a greater appreciation of the challenges we face, the reasons why we act in a particular way and has reduced antagonism towards the Bank, particularly when unpopular policies have to be implemented. Such meetings are usually led by me and include a deputy governor and senior staff, with counterparties being CEOs and senior executives. The discussions often last up to three hours, which demonstrates the seriousness with which we regard such interactions. Other communication initiatives include the biennial release of our Monetary Policy Review and the Financial Stability Review; the Quarterly Bulletin; and for the past two years, we have conducted a monetary policy challenge, which is a competition for high school pupils. Coinciding with the release of the biannual Monetary Policy Review, the Bank organises Monetary Policy Forums at nine centres around the country, where members of the MPC and senior staff of the Bank engage with various stakeholders and interested members of the public. A press conference is held after each Monetary Policy Committee meeting, and is broadcast live on a number of TV stations, as well as a webcast. After the statement is read, the full MPC responds to questions from the press as well as other interested parties, who are welcome to send in questions electronically. The Governors and senior officials of the Bank are regularly invited to deliver speeches or participate in panel discussions. Over the past two years, the number of speaking engagements accepted by myself and the deputy governors has exceeded 50! Part of the challenge we face is striking the right balance between communicating effectively and over-exposure. However, despite these communication initiatives, we have a long way to go in terms of reaching the broader public. In 2011 we commissioned a survey of the attitude of the public towards the Bank. The results of the survey were gratifying in that they indicated that the Bank had a high degree of credibility in the eyes of the markets. However, 45 per cent of South Africans were unaware of our very existence! Perhaps the biggest communications challenge confronting central banks currently is the issue of forward guidance, or how to communicate monetary policy decisions. Twenty years ago, the FOMC did not announce its monetary policy decisions, or give any justification for it, and it was left to the markets to infer from the Fed’s actions whether or not there had been a change of monetary policy. Gone are the days when central banks believed it was appropriate to surprise the markets. Today’s conventional wisdom is that monetary policy predictability will reduce trade-offs, and reduce volatility in both inflation and real economic activity. In other words, communication has become a policy instrument in itself. The more recent trend has been towards explicit forward guidance. This approach was started by the Reserve Bank of New Zealand, and later adopted by Norway and Sweden, where the expected path of policy interest rates were published. During the financial crisis, forward guidance became more widespread, particularly in those countries where the zero bound had been reached, and where conventional policy options became limited. Different types of forward guidance strategies were tried, ranging from providing a bias; a vague or explicit time path for future policy changes; to indicating state-contingent indicators for future monetary policy actions. For example, both the US Fed and the Bank of England specified unemployment thresholds, but generally subject to other objectives, such as inflation and financial stability considerations. While there are good arguments for forward guidance, particularly during times of crisis, providing forward guidance to the markets has not been plain sailing, and has been challenged on both theoretical and practical grounds. As argued by Prof Marcel Fratzscher, formerly of the ECB and currently President of the German Institute for Economic Research BIS central bankers’ speeches in Berlin, there are major risks and costs from over-reliance on communication strategies. His concerns are three-fold: first, the dominance of the voice of central banks in financial markets has resulted in price movements becoming a reflection of responses to their statements and action, rather than to changing economic and financial realities. Second, central bank communications dominance could “crowd out” private sources of information or analysis, depriving the monetary authorities of an independent view of trends that sound policy-making would find helpful. And third, central banks risk losing credibility, when overcommitment to a specified path of action turns out to be a misleading assurance. He argues against central banks giving forward guidance, including announcements about when they will begin to tighten monetary policy and by how much. Rather, “they need to reintroduce true two-way risk, so that asset prices again reflect underlying fundamentals … Central bankers need to communicate more clearly how they think about risks and opportunities in the economy and financial markets, and then let private investors decide the balance of risks and reward for themselves.” Other critics have focused on the usefulness of forward guidance. Charles Goodhart, for example has been skeptical of its usefulness, particularly over longer horizons, where guidance is most needed. Specifying paths is only as good as the forecasts upon which they are based. His research shows that while central bank forecasts are very good up to two quarters ahead, they are “dire” at longer time horizons. Furthermore, he finds that existing empirical studies have failed to show that markets coordinate on the published forward guidance of central banks. His own research in fact found that in Sweden and Norway, the official path adjusts to the market rather than vice versa, except on short horizons in Sweden where a two-way relationship exists. Similarly, his review of state-contingent forward guidance concludes that while it has been largely successful in influencing the short end of the yield curve, they have no effect over longer horizons. In general, where state contingent guidance has been given, it is clear that the conditionality relates to inflation and inflation expectations remaining under control. It is more difficult to give state contingent guidance if inflation is close to the upper end of the target range and the risks are to the upside (as is the case in South Africa currently). Furthermore, many of the criticisms of the Fed and the Bank of England in particular are that the conditionalities or “knockouts” are far too general, and are easily subject to change. It would appear that at times the markets will only be satisfied if a firm commitment is given, and this can clearly not be done. Forward guidance is always conditional, and is only valid as long as nothing unexpected happens. But it always will! Fratzscher’s view is consistent with our own approach to forward guidance: that we need to communicate the risks and opportunities in the economy. That means that we as central bankers have to act in a consistent way, in line with our analysis, but bearing in mind that our assessment of risks facing the economy may change, as circumstances change. Our approach has been to give some form of qualitative guidance, where we try to indicate the nature of our reaction function, and the factors that are likely to cause us to change the policy stance. We do this through our monetary policy statements and speeches, where we identify and discuss the balance of risks around our central forecasts in such a way that market participants and other stakeholders are in a reasonable position to form a view about our possible reaction to changing circumstances. In trying to give guidance to the market, we give our view of the outlook as well as our perceptions of the risks to the outlook. But this is not always straightforward. For example, any given inflation forecast could elicit different policy responses depending on the current and expected state of the economy, our perceived risks to the forecast, the degree to which inflation expectations are anchored, and how close we are to breaching the target band. So a forecast close to the upper end of the target range could result in a preemptive tightening if the economy is operating close to or above potential and the output gap is positive. But if the BIS central bankers’ speeches output gap is negative and growth is below potential, we are likely to be more tolerant of inflation being close to the upper end of the target. However, periods of heightened uncertainty (such as we are currently experiencing) make our own forecasts more uncertain and subject to greater risk, and therefore the markets tend to be more uncertain and volatile. Under such circumstances the markets tend to demand more guidance, but this is precisely when it is more difficult to give. Our recent experience is a good illustration. During 2013, the rand depreciated significantly, in part in response to expectations of tapering by the US Fed. Given the importance of the exchange rate in the inflation process, our inflation forecasts deteriorated progressively, and the risks to these forecasts were seen to be on the upside. Our dilemma was that the domestic output gap was still negative, and other indicators of demand were relatively subdued. However, we increasingly signaled our concerns in the monetary policy statements, first by indicating explicitly that there was no room for further monetary accommodation; and then, in November, by stating that, should there be further significant deterioration in the inflation outlook, we would have to take appropriate action. At that stage, given the turbulence in global financial markets, we were uncertain about what the actual outcomes would be. But the rand depreciated from around R10 against the US dollar in November, to over R11 against the US dollar by the January meeting, in response to Fed tapering which adversely affected capital flows to emerging markets. This, together with a reassessment of the possible path of food prices, led to a marked upward revision of our inflation forecast. The risks were assessed to be on the upside and inflation was expected to breach the upper end of the target range for an extended period. This deterioration in the outlook led to an increase in the policy rate, an action that surprised the markets, despite our prior warnings. However, we felt that the move was appropriate, despite the fact that the markets in general were not expecting it. This raises the question of whether or not central banks should delay acting if circumstances change, in order to placate the markets. I would suggest not. While we do not want to surprise the markets, if we believe action to be appropriate, we need to act. It is always more difficult to signal the beginning of a cycle. But, understandably, the markets now want clear guidance about the future. Our most recent statement in January stressed the fact that further action will be highly data dependent. This reflects the increasingly volatile and uncertain nature of the current global financial market environment. The initial reaction to our decision was quite extreme, with some expectations of an interest rate cycle of in excess of 400 basis points, although that has since moderated somewhat. Some analysts have justified the initial market reaction on the basis of the previous tightening cycle in 2006–08 of 500 basis points in two years. However, the past is not always a good guide to the future. The previous tightening cycle was conducted in very different circumstances to what we are seeing today: at that stage, the South African economy was growing in excess of 5 per cent per annum, well ahead of potential; credit extension was growing at around 25 per cent; and household consumption expenditure growth was around 9 per cent. With rising inflation risks, this called for a strong monetary policy response. Today we have a very different situation, with the output gap being negative and subdued growth in both household consumption expenditure and credit extension. We would therefore expect the monetary policy response to be more moderate, given our concerns about the slow growth in the economy. I therefore indicated recently that I thought that the market expectation of a further 200 basis points increase over the coming year sounded overdone, and I still believe this to be the case. However, we also stressed that future moves are highly data dependent in the current circumstances of heightened uncertainty. We have no history of tapering or normalisation to guide us. Of course, this moderate base case is highly conditional on developments and we cannot give any unconditional commitments of future policy moves. At best we can indicate our assessment of the risks, but it is for the markets to do their own assessments. It also does not mean that there will be adjustments at every BIS central bankers’ speeches meeting or that if rates are increased, that they will be increased by the same amount. And if circumstances change, we will have to change our views. Other elements of communication of monetary policy relate to the publication of minutes and voting records. In contrast to a number of other central banks, we do not keep formal minutes. However, even the practice of releasing minutes differs quite widely. Some central banks, for example the Riksbank, release verbatim minutes about two weeks after the meeting. Others release unattributed minutes, where the flavour of the debate is given. This includes the Bank of England and the Reserve Bank of Australia. Our practice is similar to that of the ECB. We release a detailed statement on the same day of the conclusion of the MPC meeting at a press conference. The statement attempts to capture the main issues considered by the MPC, and the final paragraphs attempt to capture our perception of the risks to the outlook and conveys the stance of monetary policy. Central banks also take differing approaches to the publication of voting records. In our case, we do not publicise the individual votes, as we do not want to personalise the debate. This gives individual members greater freedom to speak their minds and change their views during discussions, and it avoids the labeling of “hawks” and “doves”. However, we do indicate if there were dissenting views, but we do not reveal who the dissenters were. It does reduce the transparency of the decision-making process, but this has to be weighed up against the advantages of allowing for more rigorous debate in the Committee. While it could be argued that revealing differences of views could reduce the clarity of the policy message, we believe that there are clear advantages to doing so. In particular it shows that there is vigorous debate among committee members; that the MPC is not subject to group-think; and that differences of views are welcomed. However, to ensure clarity and consistency of our message, we have adopted the principle of committee responsibility. So even if the decision is not unanimous, once the decision is taken, all members of the committee take joint responsibility. This reduces the possibility of mixing the messages, as all members communicate with one voice. In conclusion, communication of monetary policy decisions is still evolving. There is by no means universal acceptance of some of the recent developments globally, and there are criticisms that at times, forward guidance has introduced more volatility into the markets, and that too much guidance can encourage excessive risk-taking and delay monetary policy responses. It may also be the case that forward guidance is more difficult in emerging market economies that are more prone to volatility arising from exogenous shocks and spillover effects. Charles Goodhart has also argued that “pre-commitment, even if desirable, is not even really feasible, especially in a system of decision-making by committees, with changing membership and political oversight.” We will continue to learn from what others are doing, from their successes and their mistakes. Our communication strategy has come a long way in the past few years, but it is evolving and we need to tread carefully. Conferences such as these are important mechanisms for learning from each other, and are critical for the evolution and dissemination of ideas and experiences about what works and what does not work. As communication practitioners, I am sure that you have no shortage of topics to discuss tonight and tomorrow. Thank you again for taking the time to travel to Pretoria to participate in this conference, and at the conclusion of your deliberations travel safely back home. Thank you. References Fratzcher, M (2013): The Drawbacks of Forward Guidance. http://www.project-syndicate.org/ commentary/marcel-fratzscherthe-problem-with-central-banks – communication-strategies. BIS central bankers’ speeches Goodhart, C. 2013. Debating the Merits of Forward Guidance. In Forward Guidance. Perspectives from Central Bankers, Scholars and Market Participants, ed W. den Haan, VoxEU.org eBook, Centre for Economic Policy Research. BIS central bankers’ speeches
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 8th Risk and Return Conference, Cape Town, 13 March 2014.
Daniel Mminele: South Africa in the global regulatory context – progress, challenges and opportunities Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 8th Risk and Return Conference, Cape Town, 13 March 2014. * 1. * * Introduction Good morning ladies and gentlemen. Thank you to Incisive Media for the kind invitation and the privilege for me to deliver the opening keynote address for this 8th Risk and Return South Africa conference. This conference provides a good opportunity for dialogue and sharing of experiences as it brings together a wide spectrum of financial market participants, especially risk and investment management professionals, at a time when there are critical, wide-ranging and historic changes to the financial markets landscape. While there does not seem to be any major disagreement around the weaknesses and vulnerabilities that were exposed by the global financial crisis, there have been intense debates around how best to go about strengthening regulatory frameworks to restore confidence in financial systems. These range from appropriateness of certain regulatory standards based on country-specific circumstances (danger of “one-size-fits-all” approach), the speed and sequencing of implementation, to possible unintended consequences that could stifle innovation and development, reduce liquidity in certain markets, or affect the flow and cost of credit. I have been asked to speak on the progress, challenges and opportunities of global regulatory developments, and in particular, South Africa’s experience. The global financial regulatory reform agenda is a daunting and gigantic project for all involved, and in the limited time available this morning one is unlikely to do justice to the task. Following some remarks to set the context, I will talk about the regulatory alignment and supervisory change in South Africa, make brief comments about our regulatory architecture reform, then touch on the 2014 G20 priorities for financial regulatory reform and look at where South Africa is in relation to that. 2. From crisis to Basel III The costs of the global financial crisis were significant and included substantial job losses and depressed economic activity. The severity of it was compounded by a number of factors, including a pro-cyclical deleveraging process and weaknesses in the banking sector, such as inadequate and low-quality capital, and insufficient liquidity buffers. The interconnectedness of systemically important financial institutions (SIFIs) meant that these weaknesses and consequences thereof, quickly spread to other countries and regions. On the regulatory side, inadequate mandates, autonomy, resources and instances of regulatory capture also contributed. Shortcomings were highlighted in evaluations such as the Financial Sector Assessment Programmes (FSAP). It is not surprising then, that regulators and standardsetting bodies decided on the need for a major overhaul of the global banking regulatory framework, hence Basel III. Prior to the events of 2008, regulators were already faced with evidence highlighting the shortcomings of Basel II, including over-reliance on financial risk models to determine capital levels and the role of credit rating agencies (I see the conference programme includes the important topic of model risk). In early 2008, Basel II had only recently been adopted in some of the world’s dominant economies, with preparations underway for a comparable capital regime in the insurance industry in the form of Solvency II. Basel II.5, which focused on tougher controls on trade credit and securitisation derivatives, was introduced too late to BIS central bankers’ speeches have any mitigating effect on banking capital. Therefore, some argue that its publication essentially became a matter of course that had to be dispensed with before the framework in its entirety received renewed scrutiny. Basel III, the Basel Committee on Banking Supervision’s (BCBS)1 response to the global financial crisis, sought to improve the banking sector’s shock absorbing ability, thus reducing the risk of spill over from the financial sector to the real economy. As time passed, the complexity of the financial reform agenda increased, particularly in terms of institutions covered, instruments subject to regulation, and cross-border implications. As I indicated earlier, now that we have reached the point of implementation and monitoring, concerns are being raised around issues such as inconsistency in the domestic implementation of the new regulatory standards and their applicability to all countries, and possible “unintended consequences”, which include the economic impact of the reforms which need to be balanced against the need for financial stability. The G20, which put financial regulation high on its agenda since the first Leaders’ summit in 2008, has recognised the importance of “finishing the job”, and the focus for 2014 is to deliver on a range of outstanding reform issues, which I will elaborate on later. 3. Regulatory alignment and supervisory change in South Africa South Africa, as a member of the G20, seeks to adhere to international standards of financial supervision and regulation as far as possible, taking into account domestic circumstances. Basel II compliance by South African registered banks commenced in January 2008. As alluded to earlier, not all G20 member jurisdictions managed to meet the deadlines, leading to uneven playing fields. Alignment with Basel II played a role in sensitising South African banks and the regulator to risk and capital, complementing a pre-existing culture of responsibility and relative conservatism, and led to the practice where banks were required to hold more capital than the internationally prescribed 8 per cent. It can be argued that to some extent this stricter and more conservative approach to bank regulation in South Africa served to cushion the domestic industry from the practices that led to problems elsewhere. Basel III primarily addresses the problem of counter-cyclicality, quality and quantity of capital held at banks to absorb losses, and will introduce new standards for leverage and liquidity. Some elements of these new standards (such as the Liquidity Coverage Ratio) have already been agreed upon whilst others (such as the Net Stable Funding Ratio) are still being finalised in accordance with the agreed gradual phasing-in up to 2019. As many of you are aware, their impact is substantial and not limited to the banking industry as it flows over into the over-the-counter (OTC) derivatives market and so-called shadow banking activities. Simultaneously the role of (SIFIs) took centre-stage, with tightened capital requirements and other regulatory requirements such as resolution plans. The concept of increased capital charges for global systemically-important banks has been carried over to domesticallyimportant banks and a similar process began for the insurance industry as well as the non-bank, non-insurance financial industry. This was followed by the standard-setting bodies agreeing that SIFIs should have recovery plans and that resolution authorities should be established to implement resolution frameworks. Whilst these undertakings are easily defined in principle, the cross-border implications of resolution are proving to be very challenging. Resolution frameworks are fraught with implementation complexity and global comparability is further complicated by the significant differences between national legal systems and the intricate interaction between The Basel Committee is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability. The Committee reports to and seeks endorsement for its major decisions and work programme from the Group of Governors and Heads of Supervision (GHOS). BIS central bankers’ speeches proposed resolution- and other contingent laws. Clearly, achieving some sense of appropriate or best practice will take time and the G20 has therefore set a target that by the November 2014 Brisbane Summit, a framework for recognition of cross-border actions will be in place. South African banks are in general well-positioned to meet the Basel III requirements for higher and better quality capital as they are phased-in. There are other areas, however, which have proven to be more difficult. Compliance with the liquidity coverage ratio (LCR) presents a challenge for countries like South Africa with less liquid corporate debt capital markets and limited availability of government debt securities. The Bank has therefore provided a collateralised Committed Liquidity Facility (CLF) to assist banks where necessary in meeting up to 40 per cent of these new liquidity requirements. This facility came into effect in January 2013, two years before the Basel III compliance date. . A bigger challenge for South Africa is the Net Stable Funding Ratio (NSFR), which comes into effect in 2018, and which favours retail funding with maturity in excess of one year. Such a requirement disadvantages a banking system like that of South Africa, which while relying more on wholesale funding has nevertheless been part of a sound financial system. The Liquidity working group of the BCBS, which the Bank is represented on, is in the process of considering various options, including rule changes. However, for South Africa the availability of high quality liquid assets will continue to be an issue for a while because of structural constraints. The revised leverage ratio2 framework was published on 12 January 2014 and disclosure requirements come into effect from 1 January 2015. The Basel standard was set at 3 per cent, but subsequently jurisdictions have debated imposing the leverage ratio at far higher levels nationally, suggesting a global revision to a far more conservative level. Derivative markets, often the source of misunderstanding and occasional fear amongst regulators, were destined to bear some responsibility for the crisis. In order to tighten controls on this market, reforms are focused on the totality of the derivative system, both within and beyond the normal reach of financial regulation. The Financial Stability Board (FSB) and standard setting bodies are working to enhance the transparency of OTC transactions through requirements to trade on organised platforms, to report transactions to trade repositories, by placing central counterparties (CCPs) between the two parties to a transaction, and by setting minimum capital and margining requirements. Jurisdictions that already had these CCP and trade repository infrastructures had an immediate advantage in the timetable to compliance. Other countries, which do not have these structures in place, like South Africa, still have to establish requisite structures and appropriate rules. In this regard, as a country with a small, but stable and growing OTC market, it is important for us to ensure that differing enforcement dates and approaches, especially in larger jurisdictions, combined with cross-border application of domestic regulations, do not unduly stifle development in our financial markets. Some jurisdictions are offering their banks economically-favourable compromises to the Basel OTC derivatives capital charges, which is to the detriment of our own banks and corporate customers. Operational and legal complexities arising from jurisdictional differences, exacerbated by the cross-border nature of OTC derivatives, have not yet been resolved. In South Africa regulations for OTC derivative infrastructures are prescribed in regulations under the recently-implemented Financial Markets Act which is a critical element in our national OTC financial reform programme. As for regulatory alignment overall, I would say that South Africa has made good progress in adopting and implementing the new international standards and has been an active participant in the relevant fora in which regulatory reform efforts are being addressed. Where Measures the degree to which an institution’s capital is converted to both on- and off-balance sheet exposures. BIS central bankers’ speeches appropriate we have indicated our concerns around the uneven implementation of Basel III across different jurisdictions. 4. Regulatory architecture reform Even though South Africa’s financial system weathered the storm of the financial crisis relatively well and is generally commented upon favourably, and has received positive ratings in various surveys, South African authorities felt that there should be no room for complacency, and embarked on a wide-ranging set of reforms to make the financial sector better and safer. Our national regulatory architecture is thus undergoing significant transformation. Late last year, Cabinet approved and released for public comment the Financial Sector Regulation Bill. Once passed by Parliament, the legislation will establish two new regulatory agencies: a Prudential Authority, in the SARB; and a Market Conduct Authority that will replace the Financial Services Board. The principles behind the revised structure include integration of the banking and insurance supervisory functions, increased focus on financial stability responsibilities, expansion of supervision to financial markets infrastructures, focused conglomerate supervision, reduced potential for regulatory arbitrage and increased organisational effectiveness. These structures are widely regarded as essential to ensure the fluent supervision of a vastly changing financial landscape. Good things it is said, like Rome, are seldom designed, built and functioning in a day. The SARB, National Treasury and the Financial Services Board are engaged in thorough preparation and look forward to robust implementation of the new regulatory architecture. We trust that you, the practitioners and other stakeholders involved in our markets, will also be reaping the benefits in the not-too distant future. 5. The G20 agenda for financial regulatory reform in 2014 At the time of the Brisbane G20 Summit in November 2014, four core financial reform deliverables will be assessed which ties in with the FSB focus for the upcoming year on “completing the job”. The policy priorities needed to “complete the job” are: building the resilience of financial institutions; ending too-big-to-fail; transforming shadow banking; and making derivatives markets safer. The FSB will also undertake a review of its governance structures and submit a final report to the G-20 Leaders Summit. I will address each of these policy priorities separately, without going into too much detail, in particular in those areas I have already touched on such as the OTC derivatives market. Building the resilience of financial institutions: The outstanding reform issues revolve around the Basle III capital framework and include the finalisation of the LCR, the NSFR, capital requirements for the trading book and addressing the various methodologies followed to determine risk weighted assets. South Africa fully implemented the risk-based capital component of the Basel III framework on 1 January 2013, with the exception that the capital charge for credit valuation adjustment (CVA) risk on banks’ exposures to ZAR-denominated OTC derivatives and non-ZAR OTC derivatives transacted purely between domestic entities, was zero-rated for 2013, which exemption has been extended to 2014. The CVA exemptions have been a necessity because of the lack of a domestic CCP and a similar carve out in larger jurisdictions like Europe. Another focus area is to improve the comparability across banks of the risk weights that they use in their internal risk models. A high degree of convergence and harmonisation should be reached so as to level the playing fields. Ending too-big-to-fail (TBTF): Only a few jurisdictions (most notably the US and the EU) have made the necessary legislative reforms to implement the Key Attributes of Effective Resolution Regimes, which all G20 jurisdictions are expected to fully implement in substance and scope by the end of 2015. BIS central bankers’ speeches The earlier mentioned Financial Sector Regulation Bill establishes the Bank as the Resolution Authority for domestic SIFIs and market infrastructures, and affords certain resolution powers to the Bank. During 2012/13 the Bank focused on the development of recovery and resolution plans (RRPs, also called “living wills”) by all banks registered in South Africa. A Resolution Policy Working Group (RPWG) was established, consisting of representatives from National Treasury, the Financial Services Board and the Bank, which is to draft the Resolution Bill taking cognisance of the requirements of the Key Attributes. We hope to have this Bill finalised by the end of 2014. Strengthening oversight and regulation of shadow banking entities: The shadow banking industry has grown tremendously in recent years. The FSB’s 2013 report indicated that non-bank financial intermediation grew by US$5 trillion in 2012 to reach US$71 trillion. The assets in the shadow banking system expanded in most jurisdictions in 2012, helped by a general increase in valuation of global financial markets, while bank assets stagnated. Globally the assets of Other Financial Intermediaries (OFIs) represents on average about 24 per cent of total financial assets, about half of banking system assets and 117 per cent of GDP. A broad regulatory policy framework for strengthening oversight and regulation of shadow banking entities was endorsed by all G20 members. The framework addresses five policy areas: mitigation of risks in banks’ interactions with shadow banking entities; reducing the susceptibility of money market funds (MMFs) to runs; improving transparency and aligning incentives in securitization; dampening pro-cyclicality and other financial stability risks in securities financing transactions such as repos and securities lending; and, assessing and mitigating financial stability risks posed by other shadow banking entities and activities. Peer reviews by IOSCO of implementation on the regulation of money market funds will start in 2014. A particular issue for South Africa is that the definition of shadow banking namely, “credit intermediation involving entities and activities outside the regular banking system” – has different implications in different countries. In the case of advanced economies, it is primarily applicable to such entities as money market funds, hedge funds and private equity funds which play a large role in the financial systems of these countries. In the case of EMDEs like South Africa, these entities are less prominent and although we agree with the intent to bring unregulated or under-regulated activities into mainstream regulation, there could again be unintended consequences that require careful consideration during implementation. In South Africa the definition of shadow banking as currently stated would cover credit-extending institutions that address the financial needs of individuals and SMEs who are not adequately integrated into the traditional banking sector. Some of these institutions play an important role in deepening our financial system and advancing financial inclusion. A careful balance therefore needs to be struck between creating an enabling environment on the one hand, and ensuring appropriate market conduct provisions, protection of consumers and guarding against irresponsible and exploitative lending practices on the other. FSB Governance Review: As part of the process to enhance trust and confidence in the financial system, the FSB has proposed a review of its governance structure to ensure a comprehensive approach to representation in the FSB across all levels. South Africa recognises the value of having the widest possible participation when developing global solutions to regulation in a highly globalised financial system and supports the principle of equal and balanced representation. The development of global financial standards, principles and processes require coordination between central banks, prudential and market conduct regulators, as well as policy making institutions such as the Ministries of Finance. A representative member body, in which each participant is able to contribute effectively, will improve the FSB’s ability to develop standards and rules that are responsive to the needs of key stakeholders in the global regulatory community, and will lead to greater compliance with global financial standards. BIS central bankers’ speeches Before I conclude, let me say that completing the four remaining core reforms is quite an ambitious agenda which if rushed through could result in compromises being made and create its own challenges in the future. The fact that the leading global regulators have not reached sufficient agreement to issue joint regulations is causing divergences and market fragmentation between them. It is also having a big impact on efficiency and financial stability and is increasing the business costs for both the providers and the users of financial services. South Africa is suffering direct and indirect consequences from this situation. More impetus and direction to address the current situation of fragmentation and arbitrage and push for a higher level of coordination is required. In the past, we have stressed the importance of national discretion and flexibility and we should continue in this vein. However, the scope, substance and spirit of the global regulatory objective should still be met and demonstrated at all times. 6. Conclusion In conclusion, the task of global regulatory reform is complicated by the fact of blurring lines between banking, insurance and capital markets. Interconnectedness of markets within and across countries requires an element of harmonisation without neglecting country-specific circumstances. The other challenge is that “we are making our way as we go”, because the crisis is not over yet, and we are working on the basis of preliminary lessons without being able to fully assess the likely consequences. This calls for a collaborative effort between regulators to minimise uncertainty for financial institutions and markets, so as to allow them to structure their risk management processes, price products and embark on long-term planning. Similarly, financial market participants and institutions need to take responsibility for being responsive to, accepting and communicating to their other stakeholders the need for and benefits of regulatory reform. Standards such as Basel III will not address good day-to-day risk management within banks, or the lack thereof, including strategic risks that banks undertake in pursuit of return on equity demands from shareholders who often have a short term view of the world. And of course Basel III only covers banks and therefore the financial system as a whole will remain vulnerable until we have regulations in place for the system as a whole. I wish you a successful conference and hope that you will be able to take away useful insights to help you navigate the challenging environment. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Distinguished Speakers Seminar, European Economics and Financial Centre, London, 8 April 2014.
Gill Marcus: The outlook for the South African economy in a challenging global environment Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Distinguished Speakers Seminar, European Economics and Financial Centre, London, 8 April 2014. * * * Thank you for the opportunity to address you this afternoon. Today’s discussion takes place at a time when the UK is one of the advanced economies that is showing signs of sustained recovery from the global financial crisis. This is good news not just for the UK, but also for South Africa, which still has strong trade and investment links with your country. However, after nearly seven grueling years, we need to recognise that the global financial crisis is not yet over. Rather, we have entered a new phase, one which is moving in the right direction, but one that is no less uncertain and risky than previous phases, and which poses new challenges for emerging economies in particular. The unwinding of the extraordinary monetary policy actions of the past by the US Fed is taking us all into unknown territory, and there is no history or precedent to guide us. Emerging economies had to deal with the spillover effects of monetary accommodation in the advanced economies, and the challenges to be faced by their reversal will be no less daunting. However, while the adjustment will be difficult, I believe that emerging economies in general, including South Africa, are more resilient and better equipped to respond to such challenges than was the case in the past. One of the consequences of the unconventional monetary policies adopted in a number of the advanced economies in response to the global financial crisis was a significant change in the pattern of global capital flows. As the search for yield became more intense, emerging economies had to contend with large capital inflows. Although these flows presented opportunities, they also brought challenges in the form of appreciating exchange rates and lower interest rates, which had the potential to cause a buildup of macroeconomic imbalances, including, in some instances, excessive credit extension, asset price bubbles and widening fiscal and current account deficits. The appreciating currencies also made the products of these economies less competitive, with significant consequences for domestic manufacturing, for instance. The announcement by the US Fed in May last year that a reduction of asset purchases was likely to commence at some stage later in the year had a marked impact on these global capital flows, amid initial uncertainty about the timing and quantum of the tapering. The widely expected commencement of tapering in September did not occur, and markets overscrutinised every bit of data coming out of the US for possible indications of the start of the process. An extremely volatile period of “risk on” and “risk off” episodes ensued, particularly for those countries that had been the previous beneficiaries of the capital inflows. Indications of slowing employment growth in the US were seen as good news for emerging markets, as it implied a delay of either tapering or normalisation. As a result, emerging market exchange rates, including the rand, experienced a high degree of volatility in the face of these changing flows. As shown in a recent paper by Eichengreen and Gupta, the countries most affected were those with large current account deficits and those with relatively large and liquid financial markets which allowed for investors to be better able to rebalance their portfolios. The issue was further complicated by the fact that the markets initially conflated tapering, which related to the slowdown of Fed asset purchases, with monetary policy tightening or normalisation of short-term policy rates. It appears now that the financial markets generally accept that tapering by the US Fed will proceed at a steady pace. However, the next phase of normalisation, that of the timing and extent of the US policy rate cycle, is now the subject of intense speculation. Already we have seen the market reaction to the Fed statements following the most recent FOMC meeting, BIS central bankers’ speeches when there were indications that the timing of the first policy rate adjustment may occur sooner than previously believed. There is little doubt that this process will not proceed in a linear fashion: the outlook for the coming interest rate cycle is likely to keep changing and be affected by the ebbs and flows of data coming out of the US. The outlook may also be complicated by the monetary policy exit strategies of the UK, Japan and the ongoing challenges faced by the Eurozone. While emerging markets, including South Africa, are likely to experience periods of relative stability, as is the case at the moment, we do expect volatile periods ahead. Thus while a sustained recovery in the US is critical to ending the global financial crisis, and is good news, in the short run it introduces increased risks and volatility with consequences for growth, capital outflows, commodity prices, exchange rate depreciation and inflation in many emerging markets. But this volatile global financial market environment is not the only challenge facing us. The possibility of a slowdown in China poses further risks, not only to the growth recovery in the advanced economies, but also to emerging markets in general. Trade and investment linkages with China have increased markedly in recent years, and a slowdown could adversely affect these trends. An important channel of transmission of a slowdown is already being felt by commodity exporters through the impact on commodity prices, particularly industrial commodities. The nature of the reaction function of the Chinese authorities and possible stimulus packages is still uncertain. Complicating the outlook are the challenges faced by the Chinese banking sector, in particular the shadow banking sector, which has the potential to reinforce the slowdown. More positively, the outlook for the advanced economies appears to be improving, but already some doubts have arisen regarding the strength of the recovery following a generally disappointing first quarter. From a South African perspective, although the recovery in the UK appears to be sustained, we are particularly concerned about the slow pace of recovery in the rest of Europe, which remains an important destination for our manufactured exports. The outlook for emerging markets, by contrast, has deteriorated in recent months, and there is a risk that a generalised slowdown in these economies could undermine the recovery in the advanced economies. How has South Africa fared against this challenging backdrop? Following the initial announcement by the US Fed regarding possible tapering, the rand was one of the currencies most negatively affected. The rand was at around R9,00 against the US dollar at the beginning of May 2013, and depreciated to around R10,00 against the dollar following the initial tapering announcement. It then followed a volatile depreciating trend, reaching its weakest point of R11,39 against the dollar immediately after the January MPC meeting. Since then it has followed an appreciating, but volatile trend, to reach a recent high of around R10,50 in early April. We expect this pattern of volatility to continue, as the hesitant move towards US monetary policy normalisation proceeds, with markets being overly sensitive to any data coming out of the US. For example, last week’s non-farm payrolls data came in slightly lower than expected. This disappointing news for the US was seen as good news for emerging markets, and the rand, along with the Brazilian real, appreciated by over one per cent in response. Underlying these volatile movements in the exchange rate was the changing pattern of capital flows. During 2012, net purchases of South African government bonds by nonresidents totaled R88,6 bn, influenced in part by South Africa’s inclusion in the Citibank World Government Bond Index during the year. These flows became more volatile during 2013, in line with the on-off nature of the move towards tapering. As the markets became more certain that tapering would begin, portfolio outflows proceeded at a significant rate. Between November 2013 and January 2014, net sales of bonds by non-residents amounted to R46 bn while net equity sales amounted to R25 bn. Since then, however, the outflows have abated, and in February and March net purchases of equities to the value of R13,3 bn BIS central bankers’ speeches were recorded, alongside a small net inflow into the bond market of R250 m. While to date the current account deficit has been adequately financed through other forms of capital inflows and without recourse to selling reserves, it could create a challenge going forward. However, the rand has also been affected by a number of other idiosyncratic and global factors. These include a series of protracted strikes in the motor vehicle and mining sectors in particular; a decline in the terms of trade of just over 4 per cent in 2012 and 2013, largely in response to the slowdown in China; and a widening of the deficit on the current account of the balance of payments, which, in conjunction with the fiscal deficit of around 4 per cent of GDP is seen to have contributed to the vulnerability of the economy to the possibility of a sudden stop in capital flows. The current account deficit widened from 2,3 per cent of GDP in 2011 to 5,8 in 2013, with the trade account accounting for about half of this number. This deterioration has occurred despite the significant depreciation of the nominal effective exchange rate of the rand of over 22 per cent since the beginning of 2012. Apart from the usual adjustment lags and J-curve effects there are a number of factors that could explain the slow response. First, to the extent that the depreciation is an adjustment to the declining terms of trade, it is cushioning the mining sector, rather than being a stimulus to further output and investment. Second, the pass-through to consumer prices has been relatively constrained to date, and ironically this impedes the adjustment process as the required relative price changes have not taken place. While this muted pass-through does help to ensure that the depreciation is real, the competitive advantage of manufacturers has been eroded by sharp increases in a number of key inputs in recent years, particularly electricity. Third, our traditional trading partner countries, particularly in Europe, are still experiencing slow growth. While Africa has now overtaken Europe as the main destination for our manufacturing exports, the capacity of these countries to import could also be negatively affected by the reversal of capital flows and declining commodity prices. Fourth, protracted domestic labour disputes have impeded output and exports in the manufacturing and mining sectors, while at the same time uncertainty regarding proposed mining legislation had dampened new investment in this sector. In addition, structural infrastructural constraints, particularly relating to electricity supplies as well as transport, have negatively affected our ability to get goods to, and out of, the ports. Finally, there is the relatively inelastic nature of import demand with respect to capital equipment for the ongoing much-needed infrastructure expenditure, which we must not cut back on. There are tentative signs that we may have reached the turning point with respect to the adjustment process. The current account deficit narrowed to 5,1 per cent of GDP in the final quarter of 2013, down from 6,4 per cent in the previous quarter, and although the trade deficit widened further in January to R16,9 bn, February saw a surplus of R1,7 bn, following a R6,1 bn increase in the value of exports, and a R12,5 bn decline in imports. Net exports made positive contributions to GDP growth in both the third and fourth quarters of 2013, contributing 1,6 and 7,8 percentage points in these two quarters respectively. The fourth quarter outcome was the highest contribution to quarterly growth since the final quarter of 2007, and although net exports were still a drag on annual growth in 2013 at –0,5 percentage points, this was significantly lower than the –1,7 percentage points recorded in 2012. Furthermore, the Bureau for Economic Research’s indicators for manufactured export sales and orders rose to its highest level in 10 years in the first quarter of this year. At the same time, declining new motor vehicle sales, amid weakening consumer demand, could contribute to a reduction in imports. There has also been a response on the services account where tourism receipts have increased markedly, and we expect this trend to continue. So despite the ongoing challenges to platinum exports, we are cautiously optimistic that we may be seeing a sustained improvement in the current account. While the exchange rate has been an important shock absorber for the South African economy, some concern has been expressed regarding its volatility. We have not attempted to intervene directly in the foreign exchange market as we do not believe that such BIS central bankers’ speeches intervention would be effective, given the size of South Africa’s foreign exchange market, and our relatively low level of foreign exchange reserves of around US$50 billion. Fortunately we do not suffer some of the negative balance sheet effects that have led to a “fear of floating” in a number of emerging economies: we do not have significant currency mismatches and our corporates, banks, households and government have relatively small net foreign currency exposures. However, volatility does make it difficult to plan and make long term investment decisions. From a monetary policy perspective, our focus is not to try and influence the exchange rate, but rather to focus on preventing the second round effects of the depreciation from impacting on the overall inflation rate. As I will touch on later, the exchange rate has had an impact on inflation, and remains a significant risk to the inflation outlook. South Africa’s growth performance in the post-crisis period has been disappointing, having averaged 2,8 per cent since 2010. This can be attributed in part to the slow recovery in our major trading partners. In 2013, growth averaged 1,9 per cent, well below potential growth currently estimated to be between 3,0 and 3,5 per cent. The Bank’s forecast for growth in 2014 and 2015 is 2,6 per cent and 3,1 per cent for these two years respectively. While this is an improvement, it is still below potential, and likely to have a minimal positive impact on the unemployment rate, which currently stands at 24,1 per cent. Employment growth has been slow, and what growth there has been has mainly been in the public sector. For example, in the year to the fourth quarter of 2013, non-agricultural formal sector employment grew by 0,5 per cent or about 41,000 jobs, of which 39,000 were in the public sector. The constraints to growth are mainly structural in nature, but in the near term there are two main risks to the growth outlook. The first is the uncertainty of electricity supply. South Africa’s electricity supply has been constrained for some time, and has no doubt impacted on investment decisions in the economy. The current tight conditions on the grid are likely to be stretched going into winter, imparting a near-term downside risk to our growth outlook. However, this constraint should be relieved during 2015 due to a significant new power plant build programme that has been in place over the past few years. New capacity is expected to come on stream late in 2014, and as this gets added to the grid, the shortage should ease. A further challenge arises from the protracted strike in the platinum sector, which is now in its 12th week, with no resolution in sight. To date exports have been temporarily cushioned by the depletion of stockpiles, but it will affect the GDP growth outcome. Whether or not this strike has longer term ramifications will depend on its persistence, the nature of the ultimate settlement, and any knock-on effect on other sectors and wage settlements. However, the dispute is indicative of an urgent need to address industrial relations not only in the mining sector but in the broader economy, and requires a change in mindset from both workers and employers. We are hopeful that an acceptable settlement can be achieved soon that satisfies all parties. But in the meantime the cost to workers, financially and in terms of human suffering, and to the mining companies is enormous. There are also a number of positive developments, in addition to the significant infrastructure build programme that is already well advanced, that will underpin growth in the longer term. Last year parliament unanimously adopted the National Development Plan as the long term vision for growth and employment creation. While this is not a rigid blueprint, it provides a framework which, if largely implemented, should change the South African economy fundamentally. The key points in the NDP are to promote faster and more inclusive economic growth, to build a capable state, to promote good governance and an active citizenry and to promote collaborative partnerships across society, including between government and business. The key economic policy recommendations are to promote exports, raise competitiveness, lower the cost of living for the poor, improve skills development and improve the functioning of the labour market. Critical actions required for faster economic growth include investing in economic infrastructure to lift the potential growth of the economy and removing regulatory barriers to newer firms to promote easier entry and greater competitiveness. BIS central bankers’ speeches South Africa has already made significant strides in improving the lives of millions of people. Without going into too much detail, a report released by Stats SA last week showed that poverty levels in the country have dropped from 57,2 per cent in 2006 to 45,5 per cent in 2011. As of 2011, 32,3 per cent of the population were living below the National Planning Commission’s lower bound poverty line, compared with 42,2 per cent in 2006. The Gini coefficient, which reflects income inequalities remains high but declined from 0,72 to 0,69. The focus on economic infrastructure expenditure in the NDP is key. The recent government budget provides for capital expenditure by the major state-owned companies of almost R400 billon to be spent on infrastructure during the coming three years, the bulk of this on electricity and transport infrastructure. This should have a positive impact not only on current growth during the build phases, but also on future growth as infrastructure bottlenecks are eased. The investment outlook from the government and state-owned enterprises therefore looks positive, and should help with the crowding in of private sector investment. We are also seeing favourable signs in the construction sector, particularly in civil construction. The outlook for private sector fixed investment is also more positive, despite relatively low levels of business confidence. Having been relatively subdued during the past few years, growth in gross fixed capital formation by the private sector increased from 3,9 per cent in 2012 to 5,5 per cent in 2013. Part of this increase was related to green energy investment. This indicates that if the near-term constraints can be eased and business confidence improves, there is scope for further growth in fixed investment, and this could allow for a rotation away from consumption expenditure towards investment as the main driver of growth. In 2013, the contribution of consumption expenditure to GDP growth had declined to 1,7 percentage point, compared with 2,3 in the 2012, while the contribution of gross fixed capital formation was unchanged at 0,9 percentage points. In contrast to the mining sector, the manufacturing sector also shows tentative signs of having turned the corner following particular strike-related challenges during 2013, particularly in the motor vehicle sector. The manufacturing PMI had been below the neutral level of 50 index points for the second half of 2013 and early 2014, has now returned to above 50. We are hopeful that these green shoots will lead to a sustained recovery in the sector amid a recovery in motor vehicle exports in particular. There are also significant opportunities for South Africa at the regional level. According to the latest World Economic Outlook, economic growth in sub-Saharan Africa is expected to average 6,1 per cent in 2014 and 5,8 per cent in 2015. As I noted earlier, there has been a significant shift in South Africa’s trade patterns in recent years. In 2007, 38 per cent of South African manufactured exports went to Europe, with 25 per cent going to Africa. By 2012 the picture had reversed, with 25 per cent going to Europe, and 38 per cent going to Africa. The impact of the recession in Europe, for example, was felt particularly hard in the motor vehicle export sector. However the decline in vehicle exports to Europe in 2012 was more than compensated for by a 19 per cent increase in vehicle exports to Africa in that year. The focus of South Africa’s regional interactions has not only been on the trade side. Foreign Direct Investment in the region grew from less than US$1 bn in 1990 to almost US$40 bn in 2012. South African companies have been very active in this respect and have increasingly made their presence felt on the continent in mining, the retail sector, construction, telecommunications, agri-business and banking in particular. There is enormous potential for regional infrastructure development which will enhance the growth potential of South Africa and its neighbours. The current environment has created a difficult context for monetary policy. For some time now the Monetary Policy Committee has had to face the dilemma of a relatively subdued growth environment and a rising trend in inflation. Apart from a temporary breach of the target in July and August 2013, inflation has remained within the target range since early 2012, and the repurchase rate had been unchanged at 5,0 per cent since July 2012. Notwithstanding the unusually low level of pass-through to inflation, the exchange rate has BIS central bankers’ speeches posed the biggest upside risk to the inflation outlook. Adverse exchange rate and food price developments resulted in a deterioration of the inflation outlook in January 2014 when the forecast suggested that inflation was likely to breach the upper end of the band during the second quarter of 2014, and to peak at an average of 6,6 per cent in the final quarter of the year. Inflation was expected to average 6,0 per cent in the second quarter of 2015 and remain close to the top of the band for the remainder of the year. With the risks to the inflation outlook seen to be on the upside, this trajectory suggested the need for some monetary policy tightening. However, the difficulty facing the MPC was the slow pace of economic growth, the lack of clear demand pressures as seen in the tepid growth in consumption expenditure by households, amid subdued growth in credit extension. In the event, the MPC decided that it would be appropriate to embark on a moderate tightening cycle, starting with a 50 basis point increase of the repurchase rate in January. It was indicated that the speed and intensity of the cycle would be dependent on unfolding data, and would be consistent with our flexible inflation targeting framework. At the most recent meeting in March, the inflation forecast had improved slightly, particularly for 2015, and the MPC kept the repurchase rate unchanged. Nevertheless we re-emphasised that we are in a moderate tightening cycle, but that it does not necessarily mean that rates will be changed at every meeting or by the same amount. An important consideration for the MPC was that failure to react could have an adverse impact on inflation expectations which until now have been relatively stable and anchored, albeit at the upper end of the target range. Despite the increase in the repo rate in January, the real policy rate is still slightly negative, and well below what could be considered the neutral rate. While such an accommodative stance has been considered appropriate given the developments in the real economy, pressures from the exchange rate and capital flows, and the possible normalisation of monetary policy in the US imply that this stance cannot be maintained indefinitely. At this stage we do not have a clear view of what the longer term post-crisis “new normal” neutral interest rate will be, either in South Africa or at a global level. This is a subject of debate in most countries. We do know that some adjustment will be required, but the nature of the adjustment needs to be sensitive to the context that we find ourselves in. And the context will determine how pre-emptive or reactive we will be. This does not mean that we blindly follow US monetary policy. The impact of Fed tapering and associated capital outflows has been felt on the long term bond yields, which at one stage had increased by about 200 basis points, but have since moderated somewhat. This is not surprising, as tapering has more to do with the long end of the yield curve than the short end. Central banks can indirectly influence long term rates, but do not have the same direct control over them as they do with short term rates. As noted in a recent article in the FT by Charles Goodhart, long-term interest rates are more correlated across countries than short-term rates, and countries with flexible exchange rates are more able to set policy rates independently of the Fed funds rate. However, this independence is not complete. Exchange rate pressures may lead to inflation pressure that may require a monetary policy response. But this partial independence does mean that short term rates can be more related to domestic cyclical considerations. In conclusion, South Africa, along with many of its emerging market peers, is facing a challenging period ahead. We are facing a difficult global context, which will have significant and uncertain spillover effects on us. While the advanced economies will pay lip-service to mitigating these effects, the reality is that they are likely to conduct their policies with domestic consideration in mind. South Africa also faces a number of domestic challenges. The solutions are there, but we need the community of purpose to implement these initiatives. Education and infrastructure are key elements in the much needed structural reform agenda, but this investment takes time and there is no quick fix. It is going to be a difficult road ahead, but it needs to be done and can be done. Monetary policy will play its role, but it cannot solve the underlying structural problems. We will continue to ensure a BIS central bankers’ speeches stable macroeconomic environment and a well-regulated financial sector, within a flexible inflation targeting environment. 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 Association for African Central Bankers (AACB) Roundtable on "Cross-Border Banking In Africa - A Force for the Good?", Washington DC, 11 April 2014.
Daniel Mminele: Shaping cross-border banking integration in Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Association for African Central Bankers (AACB) Roundtable on “Cross-Border Banking In Africa – A Force for the Good?”, Washington DC, 11 April 2014. * 1. * * Introduction Good afternoon ladies and gentlemen. Thank you to the conference organisers for inviting me to deliver a few remarks this afternoon on shaping cross-border banking integration in Africa. This is an area which has seen tremendous growth in recent years, particularly with the rise of Africa-based regional lenders. I will divide my remarks into four parts: I will first reflect on the drivers of cross-border banking within the region; then highlight the benefits of cross-border banking; consider the challenges of integration and finally, consider the role of regulators. 2. Drivers of cross border banking in Africa Against the backdrop of robust growth on the African continent over the past decade, Africa has become an increasingly sought after and active destination for investment and banking activity. The year-on-year growth in Africa’s gross domestic product has consistently surpassed that of the global economy, and that of advanced economies, benefitting from high commodity prices of recent years, as well as rising domestic demand in alignment with trends of increased urbanisation and disposable income within the region 1. According to the International Monetary Fund April 2014 World Economic Outlook, Sub-Saharan Africa (SSA) is forecast to grow by over 5 per cent in 2014, up from 4.9 per cent in 2013. SSA saw substantial capital inflows in 2013 totalling US$30 billion 2, with countries such as Ghana, Nigeria and Zambia in particular benefitting from an increase in portfolio inflows, reflecting growing positive global business sentiment towards Africa. There has also been robust loan demand within the region, according to the Institute of International Finance’s survey on emerging market bank lending conditions. It would seem then that despite slowing demand for commodities from China, growth could remain supported by improved investor sentiment towards African financing and an increasingly conducive business and debtor environment in the region driving financial deepening and cross-border banking. Another reason for the rise in cross border banking, particularly in Africa, is the wide-ranging international financial regulatory reform agenda adopted after the global financial crisis. The new and stringent regulatory requirements imposed by jurisdictions such as the US and European Union on their banks have meant that these international banks are doing less business within Africa, opening up an opportunity for larger African based banks to enter new African markets. The integration process is however slow and not without its challenges, as I will elaborate on shortly. 3. Benefits of cross-border banking Growth in African cross-border banking has not been confined to South Africa’s four largest private banks. Banks from Nigeria, Morocco and Kenya, including banks such as Ecobank and the United Bank of Africa, have also taken advantage of emerging opportunities. The United Nations World Economic Situation and Prospects 2014. IMF Balance of Payments Statistics, February 2014. BIS central bankers’ speeches resulting increase in the availability of banking services to segments of the African population previously excluded from formal banking, has contributed to enhancing the culture of savings and entrepreneurship with obvious benefits for economic growth and development within the region. With this, Africa has taken significant steps towards having a relatively mature banking system and has increased the resilience of the region to systemic risk 3. The arrival of regional African banks has improved the efficiency of the banking sector in host countries. They stimulate competition, and increase the diversity of available financial services, generally at transactional lower costs, improved quality and potentially lower interest rates 4. This in turn positively affects household savings and consumption and the availability of credit to businesses, leading to gains in employment and standards of living. Furthermore, cross-border integration has the significant benefit of forcing the domestic banking regulatory and supervisory systems to modernize as larger capital flows within a country necessitate improved regulatory frameworks, technological innovation and efficient payment systems 5. These modernizations also create opportunities for greater financial inclusion, both with regard to individuals and SMEs. 4. Challenges for integration While cross border banking creates significant benefits, it also is associated with challenges which need to be considered. Unlike the Euro area, where most banks have made relatively similar progress in implementing the Basel III framework, African jurisdictions are still at varying stages of implementing the various Basel capital standards. First, operating in multiple countries creates supervisory and compliance challenges. The banks are expected to report to both home and host country supervisors who may use different regulatory standards or may interpret similar standards in different ways. In many cases, the same information is reported to different supervisors in different formats as per the relevant supervisor’s requirements, which often causes duplicate reporting or banking entities operating in different jurisdictions may have to provide reporting on potentially all three Basel standards. These differences become even more pronounced when considering the operational and business impact. Although African regulators have been notably increasing their level of training and understanding of all Basel frameworks, it remains necessary for banking groups to appoint staff members with different skills to address the various elements between the Basel frameworks, and to implement systems that have the capacity to cater for all the different regulatory and reporting requirements. This can be both time consuming and resource intensive for a bank. Second, the differences in the roles and responsibilities of home- and host-country supervisors can create challenges. More specifically, a home-country supervisor is responsible for the solvency of the banking group, while the host-country supervisor’s role is to ensure that there is sufficient liquidity to meet all obligations and to protect depositors in its jurisdiction. Such differences can lead to both overlaps and gaps in the regulatory framework applicable to a bank, thereby creating problems of regulatory coordination. One way to address these challenges is through the establishment of cross-border supervisory and crisis management groups for systemically important banks in Africa. I will elaborate further on this topic later in my remarks. Oxford Policy management. 2013. “Cross border banking supervision in SADC region”. BIS Papers No 76. Levine, R (1996): “Foreign banks, financial development and economic growth”, in C Barfield (ed), International financial Markets: harmonization versus competition, Washington DC, AEI Press. BIS central bankers’ speeches Third, these banks can become means for transmitting risks from one jurisdiction to another and thus can reduce the authorities control over their economies. This can cause authorities to introduce protective regulations that complicate cross border banking. These challenges raise the obvious question of what can be done to minimize the negative aspects of cross border banking and maximize their benefits. Clearly, the governing bodies of relevant regional economies need to agree to co-operate in creating the regulatory and policy frameworks for managing cross border banking and ensuring effective financial integration. These arrangements should then address issues of common concern to various banking groups and also provide a platform from which to discuss issues that the supervisory authority believes are hindering financial integration in the region. Examples of such issues of common concern, in addition to what has already been raised, include issues such as localisation (where banking groups are of the opinion that they require at least 75% of the voting rights and therefore shareholding, in order to effect a special resolution decision) and capital protection (where banking groups may also be concerned about future restrictions on the movement of capital within the group, including the impact of currency fluctuations). In light of the challenges I just mentioned, the cross-border integration in Africa of internationally accepted banking supervision standards, improvement of financial sector disclosure and governance practices is therefore crucial not only to ensure the appropriate and effective supervision of banking groups that are significant in an African context, but also to limit the regulatory burden and associated cost burden on banks and consumers of financial products. However, it is important to recognise that these challenges also create opportunities to promote regional financial integration. South Africa is therefore fully supportive and active on committees such as the Association of African Central Banks, SADC Committee for Central Bank Governors (CCBG), the FSB’s Regional Consultative Group for sub-Saharan Africa and the Community of African Banking Supervisors (CABS). The work of these important committees all contribute towards the development and implementation of an effective financial sector regulatory framework in Africa. Promoting cross-border banking in Africa and implementing regulatory co-ordination measures to address these concerns could have substantial benefits in promoting growth in the continent. 5. Role of regulators and international and regional forums Regulators have a particular role to play in the integration process as the success of financially integrated markets starts with the regulatory authorities ensuring that the entities allowed into their financial sector meet all the relevant requirements for access to the relevant jurisdiction. For this reason, it is important to conduct rigorous assessments to accurately determine the costs and benefits which arise from allowing a foreign bank into a jurisdiction. In order to ensure the African banking sector remains adequately integrated, with minimal negative spillover effects felt from cross-border banking in both the home and host country, regulators need to be appropriately equipped to deal with cross border banks. This requires: • Staying abreast of the latest international regulatory developments: Those of us who participate in regional and international financial standard-setting bodies have an obligation to play a pro-active role, to use our strengthened voice, be ready to take constructive positions on the various reforms and consider the views of those countries that are not at the table. This highlights the importance of the Financial Stability Board (FSB) regional outreach groups and the CABS. • Encourage progress in the implementation of the Basel Capital Accords, so as to create a level playing field, which makes it easier and more cost efficient to start-up a business in a new jurisdiction. However, implementation of international standards BIS central bankers’ speeches must be done taking into account country specific circumstances and should not be at all costs, or to the detriment of the stability of the financial system. • Maintain the emphasis on information exchange: There is already a pronounced effort to make existing mechanisms of information exchange more meaningful, such as Memoranda of Understandings (MoU) between home and host countries. This was a principal aim of the SADC Subcommittee of Banking Supervisors (SSBS) initiated in 2006 6. Unfortunately, due to differences in accounting standards, reporting requirements, off-site monitoring systems, regulatory frameworks and supervisory practices, drafting and implementing effective MOU’s is difficult and they are not always used for their intended purpose. • Efforts should be made to create databases that are useful and available to all African regulators and regional workshops should be encouraged (such as the Enhanced Data Dissemination for Africa regional workshop held in 2011). Such initiatives contribute to skills development and information sharing, and create opportunities to develop new connections between regulators and new means for coordinating and standardizing the methods for compiling, processing and disseminating data. • Supervisory colleges have proven to be highly useful in ensuring information sharing and relationship building between supervisors and are therefore valuable tools to promote. Effective consolidated supervision of an international banking group requires the home supervisor to have sufficient knowledge of the operations of the group, both domestic and foreign, so as to monitor, assess and deal with risks faced by the group. As noted by past Roundtable discussions on regional banks in Africa, Regional Economic Communities (REC), in which most Pan-African financial banking groups operate, can be very useful in this regard due to their specific focus on building supervisory capacity and strengthening cross-border regulations 7. • Ensure that existing crisis management and resolution plans are enhanced and put in place to withstand financial crises: Prompt and effective responses to potential financial distress are important to avoid severe systemic disruptions and minimise the risk of banking failures. If not properly managed, supervisory co-operation might collapse when a financial crisis hits as protection of national assets will become very important. Establishing upfront crisis management and resolution plans will facilitate robust supervisory co-operation which should withstand the pressure of a crossborder financial crisis. 6. Conclusion In conclusion, financial integration in Africa has already had a positive effect on the growth potential of the continent. It is, however, vitally important that the integration process continues to be monitored by the regulatory authorities to ensure its success and sustainability. Without an integrated regulatory authority environment, achieving a robust integrated financial system would be difficult. It is therefore important that we as regulators use all the tools at our disposal, implement new and innovative ways to communicate, share information and ensure that we develop apace with the market and its needs, because without doing so we cannot create and sustain an effective cross-border financial integration. South African Reserve Bank. Bank Supervision Department Annual Report 2012. Association of African Central Banks. 2012. Roundtable on Regional Banks in Africa: “Safeguarding and Leveraging a New Force for Financial Sector Development in Africa”. BIS central bankers’ speeches I look forward to further informative discussions on the topic, such that we all may learn from past mistakes, successes and achievements whilst also continuously striving to address the challenges in unison with one another. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the University of Limpopo, Faculty of Commerce, Sovenga, Limpopo, 6 June 2014.
Lesetja Kganyago: Policy choices in a low growth, high inflation environment Address by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the University of Limpopo, Faculty of Commerce, Sovenga, Limpopo, 6 June 2014. * 1. * * Introduction Last week in the Financial Times, columnist Wolfgang Münchau reported a conversation he had with a central banker in the 1990s, at a time when inflation targeting was first being adopted. What would you do, Münchau asked then, if you faced stagflation – low growth and high inflation? Would you raise rates and risk a recession? The banker replied that such a situation would never occur. Münchau now accepts he was right – it never happened. He shouldn’t give up so easily. South Africa finds itself at precisely this unpleasant juncture. Growth was negative in the first quarter of the year, the worst performance since the 2009 recession. Meanwhile, inflation has crept above the target, reaching 6.1% in April, and the Reserve Bank has since January forecast an extended breach of the target lasting until the second quarter of 2015. This morning, I would like to speak to you about how we got into this difficult situation, and what policy can do about it. I will mostly talk about monetary policy, because that is my responsibility, but let me say upfront that monetary policy cannot fix these problems alone. Monetary policy can help staunch the bleeding, but it cannot heal the patient. 2. Inflation Starting with inflation, a central banker, like Münchau’s nameless interlocutor, might consider high inflation and low growth to be an impossible combination because weak demand alleviates price pressures. If firms lack for customers, they are unlikely to raise prices and scare off buyers. There is substantial evidence that demand has moderated in South Africa. Credit growth has been subdued. Mortgages, the largest category of credit extension, have grown slower than inflation for several years. Unsecured lending, which expanded very briskly in recent years, is now dropping fast. Installments, which mostly fund the purchase of motor vehicles, are also slowing markedly; new vehicles sales appear to have peaked last year. Retail sales have also been sluggish, falling in March 2014 on a month-on-month basis, and retailers are expecting a poor second quarter. These indicators do not point to an overheating economy and demand-driven inflation. Why, then, do we have above-target inflation? I would like to draw your attention to two main causes, cost-push pressures and exchange rate depreciation. 2.1 Cost-push inflation Cost-push pressures impart a structural upward bias to prices. The logic is that many firms and employees enjoy limited competition, so they make high wage and price demands without risking losing jobs or customers. However, the two influence each other. When firms raise prices, costs go up for workers, who then demand higher wages. Higher wages raise costs for firms, who then raise prices, and so forth. The result is consistent inflationary pressure. There is abundant evidence for this dynamic in South Africa, but let me illustrate my point using one particular example: inflation expectations. On behalf of the Reserve Bank, the Bureau for Economic Research at Stellenbosch University measures inflation expectations by surveying three groups: businesses, unions and financial analysts. Generally, the focus is on the aggregate of their expectations. However, businesses and unions have systematically higher expectations than analysts, which is especially BIS central bankers’ speeches problematic given these actors actually determine prices and wages. In a recent paper, Alain Kabundi, Eric Schaling and Modeste Some estimated that businesses and unions have implicit inflation targets of 6.8% and 6.2% respectively, above the Reserve Bank’s 3–6% target. With expectations like these, price setters will keep inflation high despite weak economic conditions. 2.2 Inflation and the exchange rate The exchange rate affects inflation both in how it moves and in how that movement gets passed-through to consumer prices. South Africa faces inflation from both these sources, and I’ll discuss them in that order. The rand has been on a depreciating trend since the start of 2011, which accelerated markedly after May 2013 and again in January 2014. In both cases, faster depreciation was driven by international developments. In May it was “taper talk”, which surprised markets with news that the Federal Reserve might start tapering its asset-purchase programme sooner than expected. In January, it was the actual implementation of tapering. Since then, the rand has appreciated somewhat, for reasons that remain mostly international. In the United States, the Federal Reserve has settled into a predictable pattern of tapering by US$10 billion per meeting. Market sentiment now holds that rate increases remain quite distant and will be gentle when they do come, thanks to low inflation and moderate growth. Meanwhile, the European Central Bank is still moving towards looser monetary policy, rather than away from it, as is the Bank of Japan. The result has been renewed global appetite for risk, leading to currency appreciation for most of the emerging markets which had previously experienced weakening exchange rates. Domestic factors seem to have played only a supporting role in driving emerging market currency movements over this period. In South Africa, markets appear to have welcomed the responsiveness of monetary policy to rising inflation; the current account deficit also narrowed somewhat in the last quarter of 2013. But South Africa’s economic fundamentals have on the whole not changed substantially, nor have markets assessed them differently: the current account deficit remains over 5% of GDP and growth has deteriorated. It would be very rash indeed to assume that the rand’s long depreciation trend is now concluded, and that henceforth a strengthening rand will mitigate inflation. Instead, South Africa remains vulnerable to further changes in global sentiment, which could be sudden. The other aspect of exchange-rate linked inflation is pass-through. With certain prices, passthrough is quick and complete. The obvious example is petrol prices, which have exerted substantial inflationary pressure despite relatively flat international prices thanks to exchange rate depreciation. But many prices behave differently. In a weak economy, firms may choose to absorb higher import costs rather than pass them on to consumers, leading to a divergence between headline consumer prices and the exchange rate. This seems to have been the pattern from the start of 2011 until early 2014. However, at some point firms will judge that their profit margins have been eroded to an unacceptable degree, and they will start passing on these costs to consumers. We see evidence that firms are being squeezed in producer price inflation, which reached 8.8% in April, its highest level in two years. And we see evidence for higher pass-through in rising core inflation, which has picked up again after a period of stability in 2013. Our conclusion is that pass-through has risen, pushing inflation above the target. This effect cannot be expected to abate just because the rand has recovered some lost ground. If the currency begins to trade in a stable band well above its old levels, stability will not necessarily moderate pass-through; rather, it could convince firms to price in the new normal level. We should not assume that inflation will simply track the most recent movement of the exchange rate. BIS central bankers’ speeches 3. The role of monetary policy South Africa has a flexible inflation targeting framework for monetary policy. Flexibility means that inflation does not have to be within the target at all times; instead, policymakers will look through passing shocks – for example, during the temporary departure from the target in August 2013, which was driven by petrol prices. Flexibility also means avoiding abrupt interest rate movements which might destabilise the economy. But flexibility does not mean ignoring sustained breaches of the target. With inflation expected to be above 6% for about a year, and given that that the exceptional period of ultra-low world rates is ineluctably drawing to a close, the Reserve Bank has commenced a monetary policy tightening cycle, starting with a 50-basis point increase in January. In describing the revised monetary policy stance, we have been at pains to emphasise that this tightening cycle will not necessarily move rates as far or as fast as in previous cycles. There are good reasons for this. Subdued economic growth reduces demand-driven inflation. Fiscal policy has moved in the direction of consolidating deficits, which should ease pressure on capital markets. World rates are very low, and may not return to pre-crisis norms. Global inflation is subdued. We have also emphasised that monetary policy remains accommodative, despite the January hike. It is easy but wrong to confuse the change in monetary policy with its level. In real terms, the repo rate is still negative. Furthermore, since 2009, the MPC has accepted inflation closer to the upper end of the target than it might in different circumstances, so as to support the recovery. In other words, monetary policy has done a great deal to assist growth. But this is not the only message to bear in mind when thinking about the monetary policy stance. The other message is that monetary policy is not the long-run solution to South Africa’s growth problems. Over the long-run, monetary policy is effective at achieving price stability, but it can generate additional growth only at the cost of rising inflation. This is why the Bank’s core mandate is for price stability. To address high inflation and low growth, what South Africa really needs are structural reforms. And it needs them even more urgently given the paucity of alternatives: • The two growth engines which powered the economy in the late 2000s are running down. Commodity prices remain high, in comparative perspective, but South Africa’s terms of trade peaked in 2011, and will probably continue to decline as China slows and rebalances. Credit extension has also been growing quite feebly in South Africa, and although household balance sheets have improved, they are not robust enough to sustain another round of credit-driven growth. • Furthermore, the policy stimuli which have bolstered growth since the crisis now need to be slowly withdrawn. Responsible fiscal and monetary policies in the pre-crisis period left South Africa with considerable policy space to run fiscal deficits and enjoy record-low interest rates. But now debt levels are once again approaching uncomfortable levels, and as I have already said, the inflation outlook requires an interest rate hiking cycle. 4. The need for reform The above notwithstanding, South Africa does have attractive prospects for policy reform. The National Development Plan (NDP) outlines ten critical actions which we should focus on to take the country to the next level, that of a higher, labour absorbing growth path. These critical actions include: 1. A social compact to reduce poverty and inequality, and raise employment and investment, founded on partnerships with all sectors of society. BIS central bankers’ speeches 2. A multipronged strategy to address poverty and its impacts through broadening access to employment, strengthening the social wage, providing public transport and raising rural incomes. 3. Steps by the state to professionalise the public service, strengthen accountability, improve coordination and prosecute corruption. 4. Boost private investment in labour-intensive areas, competitiveness and exports, with adjustments to lower the risk of hiring younger workers. 5. An education account-ability chain, with lines of responsibility from state to classroom. 6. Phase in national health insurance, with a focus on upgrading public health facilities, producing more health professionals and reducing the relative cost of private health care. 7. Public infrastructure investment at 10 percent of gross domestic product, financed through tariffs, public-private partnerships, taxes and loans and focused on transport, energy, water and freight. 8. Interventions to ensure environmental sustainability and resilience to future shocks. 9. New spatial norms and standards – densifying cities, improving transport, locating jobs where people live, upgrading informal settlements and fixing housing market gaps. 10. Reduce crime by strengthening criminal justice and improving community environments. 5. Conclusion Looking around the world, this is something of a springtime for reform. In Mexico, for example, the government has adopted a bold structural reform package, known as the Pact for Mexico, which includes major changes in telecommunications and education policy. More recently, in India, a development platform with the promise to reverse several years of sub-par growth and high inflation is being pursued. The lesson to take from this is that we are not helpless in the face of economic disappointment, of high inflation and low growth. For monetary policymakers, with limited tools, this situation provides no attractive choices. But there are many appealing options available for other aspects of policy. For South Africa, our present predicament should be read as an invitation to embrace reform. The National Development Plan provides a compelling basis upon which to build our reform agenda. Let us begin to do the work. The contribution of the South African Reserve Bank to the National Development Plan is captured in the constitution of the Republic of SA and I would like to end by quoting “Section 224.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.” Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the South African Institute of Chartered Accountants (SAICA) Business Breakfast, Rosebank, 10 June 2014.
Gill Marcus: A perspective on the global and domestic economic outlook and the challenges facing monetary policy in the current environment Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the South African Institute of Chartered Accountants (SAICA) Business Breakfast, Rosebank, 10 June 2014. * * * Good morning and thank you for the opportunity to be with you today at this event organised by the South African Institute of Chartered Accountants. According to the World Economic Forum, South Africa was again ranked number one globally in strength of auditing and accounting standards. This ranking is a tribute to SAICA and to all of you here today. Unfortunately, these rankings while pleasing, are not enough and there is no room for complacency. While the financial sector generally compares very favourably with the rest of the world, with deep and liquid markets and our banks ranked number three in the world for soundness, the broader economy performs less favourably on many of the other measures. While the accuracy of these measures can be debated, we only need to look at the recent growth rate of the economy, –0,6 per cent in the first quarter of this year and concerns for second quarter growth amid unresolved and intensifying labour disputes, to recognise that we have enormous challenges ahead of us. While the global backdrop remains difficult as the advanced economies emerge from the very deep financial crisis of the past seven years, it is no longer the main cause of South Africa’s weak domestic economic performance. The slowdown we have experienced is domestically driven, largely self-inflicted and we cannot blame external factors alone. This does mean, however, that the solutions are in our own hands, and as a country instead of focusing on whether we are entering a recession or not, we should all be striving to restore the economy to the strong growth path that it is capable of achieving. This morning I will present a perspective on the global and domestic economic outlook and the challenges facing monetary policy in the current environment. The recent global crisis has reminded us that financial crises take a long time to repair themselves. Such crises are characterised by high levels of leverage and debt, whether households, firms or the state, and the loss of wealth associated with the start of a crisis means that it takes a long time to repair these balance sheets. The process of deleveraging implies low levels of consumption and investment by households and firms, while banks will be reluctant to lend. There are now encouraging signs that some of the advanced economies have been through this process are on a path of sustained recovery. The US economic recovery appears to be taking hold, with a clearer path of fiscal consolidation and stronger bank and corporate balance sheets. Households deleveraging has also occurred, and the housing market has shown signs of improvement. However, severe weather conditions earlier in the year resulted in a contraction in the first quarter, and it will be difficult for the economy to achieve the 2,8 to 3,0 per cent growth forecast recently by the US Fed. Nevertheless, the underlying strength appears to be there, and the market consensus is for an annual growth rate of around 2,5 per cent. The UK economy also appears to have moved to a sustained recovery path, with growth of around 3 per cent expected this year. Unfortunately, the outlook for the Eurozone, an important export market for South Africa, is much less favourable. Although the region has emerged from recession, growth is expected to be anaemic, with continuing concerns about deflation, particularly in some of the European periphery. Consequently, the ECB has taken significant measures in an endeavour to stimulate growth in the region. The German economy appears to be sound, but France has recently slowed down significantly. Although the Japanese economy recorded strong first quarter growth of 5,9 per cent in anticipation of BIS central bankers’ speeches the introduction of consumption taxes, this is not expected to be sustained, and the outlook remains uncertain with an annual growth rate expected to be around 1,5 per cent. The mixed signals emanating from the advanced economies have important implications for emerging markets, including South Africa. The abnormally low interest rate environment in the advanced economies, coupled with quantitative easing, led to an almost undiscriminating wall of money flowing into emerging markets. These flows suddenly reversed following the announcement by the US Fed in May last year that it was considering tapering its programme of quantitative easing. The initial impact on emerging market bond and foreign exchange markets was severe, particularly those markets which were relatively open and liquid, including South Africa. The uncertainty surrounding the timing and speed of tapering resulted in a highly volatile period for emerging markets. When tapering was eventually confirmed in December last year, attention then focused on the timing and speed of US policy normalisation, which is the increase of the policy rate from the zero bound to more “normal” levels. So while tapering is steadily continuing, and is expected to be completed later this year, there is a great deal of uncertainty about the outlook for short term interest rates. Any changes in perception concerning the timing and intensity of the US interest rate cycle are likely to elicit reactions in global financial markets. Thus while the recovery in the US is good news for emerging markets in that this breaks the synchronised downturn in advanced economies and that a growing US economy is critical to global recovery, it does have implications for emerging market financial markets. We are therefore in for a bumpy ride, with the prospect of a series of “risk on” and “risk off” scenarios as global risk perceptions change in response to unfolding developments. We can expect financial markets, including the rand exchange rate, to remain volatile in response to these changing perceptions. The outlook is complicated by the fact that a synchronised normalisation in the advanced economies is not expected. The Bank of England is most likely to move in line with the US, but the Eurozone and Japan are still in an easing cycle. Only last week, the ECB cut interest rates again, and announced a range of new measures to induce banks to increase lending, including measures to expand bank liquidity, and hinted at the possibility of some form of quantitative easing in the future. The ECB also indicated that this accommodative stance was likely to remain in place for a protracted period. The Bank of Japan is also likely to maintain its highly accommodative monetary and fiscal stance for some time. The bottom line is that normalisation will happen: it will not be a synchronised event, and the timing and speed of the cycle is uncertain and will be dependent on the pace of the recovery in the advanced economies. The more uneven these recoveries, the more volatile capital flows to emerging markets are likely to remain. But the era of abundant flows to emerging markets appears to be over: the volume of flows is likely to be lower and more discriminating than was the case in recent years. And of course this applies more strongly to countries such as South Africa, where sustainability of current account deficits are perceived to be an issue. These developments come at a time when emerging markets in general are slowing, and the previous optimism that emerging markets are the new epicentre of global growth may have been a bit misplaced. Despite this, emerging markets remain an important driver of global growth, but the outlook is fragile. The Chinese economy is expecting to slow to levels of between 7–7,5 per cent, growth rates that would be the envy of many countries. The slowing growth trajectory has already impacted adversely on South Africa through weaker commodity prices, and there are concerns the Chinese growth outlook could be undermined further by developments in the shadow banking sector and the housing market. South Africa’s other BRICS partners, particularly Russia and Brazil, are also facing slowing growth scenarios. More positively, sub-Saharan Africa, where South Africa’s trade and investment links have expanded, is expected to remain one of the fastest growing regions in the world, although weaker commodity prices remain a risk to the outlook. BIS central bankers’ speeches While the global environment shows signs of improvement and there are real opportunities for South and sub-Saharan Africa, there are also new challenges. It is against this backdrop that the South African economy contracted by 0,6 per cent in the first quarter of 2014. This contraction arises largely from the negative growth of 24,7 per cent and 4,4 per cent in the mining and manufacturing sectors respectively in the first quarter. The rest of the economy, excluding mining and manufacturing, recorded growth of around two per cent, and while at least positive, is still inadequate. This follows a disappointing growth outcome of 1,9 per cent in 2013, following more optimistic expectations earlier on in the year. There has been much speculation as to whether the country is headed for a recession, defined as two consecutive quarters of negative growth. To give some perspective of how bad things will have to be in order to get to this point: if zero growth in each of the remaining three quarters of the year were to be recorded, the economy would still achieve a positive growth rate of 0,8 per cent for the year. To get to a negative growth rate in the second quarter, and assuming the rest of the economy continues to grow at rates of around 2 per cent, we would have to have significant further contractions off the already low bases in both the mining and manufacturing sectors, and such contractions would have to be of similar orders of magnitude as in the first quarter. Given that the platinum strike covered more than two months of the first quarter, it is unlikely that a further contraction of that order of magnitude will occur in the second quarter. Therefore, we do not believe that a recession is the most likely outcome. Should it transpire, it would be a very grim outcome indeed. But even if a recession is avoided, it will be cold comfort if the growth rate is a weak positive number. Therefore it behoves all of us – government, business and labour – to rebuild the confidence and trust that is an imperative to change the negative trajectory that the economy is presently on. The Bank’s most recent growth forecast, as indicated in the May monetary policy statement of the MPC, is for growth for this year of 2,1 per cent, but with a downside risk. This follows a progressive downward revision of these forecasts since November last year when a growth rate of 3,0 per cent was still forecast. The main downside risks to the growth outlook were the continuing strike in the platinum sector and electricity supply constraints. The platinum mines affected by the strike account for about 40 per cent of platinum production in South Africa. The contraction in platinum output accounted for about 19 percentage points of the total mining sector contraction of around 25 per cent in the first quarter. In the meantime the strike is continuing, and even if a settlement were achieved today and workers returned to work soon thereafter, it would take weeks for normal operations to resume. It is also possible that a number of shafts will never re-open. In the meantime the costs to both workers and the mining companies continue to escalate. According to the Chamber of Mines, workers have lost R9,6 billion in wages foregone, while the companies have lost R21,5 billion in earnings. The knock-on effects of the loss of earnings go well beyond the 70,000 workers and their dependents directly affected by the strike. There are numerous accounts of how the communities and businesses in the Rustenburg area and parts of the Eastern Cape are being impacted by the loss of earnings. It also impacts on the upstream and downstream industries that are connected to the sector. While the strike has already been felt in the economic growth outcome, it has not as yet been fully reflected in the export data. The mining companies had significant platinum inventories that they have been able to use to meet their contractual commitments. However, these inventories are being depleted, and the longer the strike continues, the sooner the adverse effects on exports will be felt. The deficit on the current account of the balance of payments is often regarded as the Achilles heel of the South African economy, particularly in the light of a relatively slow export response to the rand depreciation. Some tentative positive signs in this respect was evident late last year with the deficit contracting from 6,4 per cent of GDP in the third quarter of 2013 to 5,1 per cent in the final quarter. Import compression is constrained by the fact that a large proportion of the country’s imports are capital goods related to the infrastructural expenditure programme of government. We would not want to BIS central bankers’ speeches see such imports declining as improved infrastructure increases economic efficiencies by unblocking domestic bottlenecks in the economy, and allows for future exports. Therefore, a strong export performance is essential. It is difficult enough to achieve this in the context of weak growth in the Eurozone, one of our main trading partners. But to have a concurrent decline in platinum exports is an unnecessary self-inflicted wound at a time when the mining sector should be responding positively to the rand depreciation. The platinum group metals accounted for about 8 per cent of our total merchandise exports in 2012 and almost 9 per cent in 2013, so the impact of a total cessation of exports by the three affected companies is very clear. A number of looming strikes in other sectors also threaten the growth prospects of the economy. Nevertheless, unless these stoppages turn out to be far worse than anticipated, the Bank’s base case remains one of positive growth for this year, although it may be difficult to achieve a better outcome than last year. The growth forecast of 3,1 per cent for 2015 is predicated on a more stable industrial relations environment and an improvement in the electricity supply situation, with new generating capacity coming on stream early in 2015. There are, however, downside risks to this forecast. On the positive side, government infrastructural expenditure is set to continue, and this should underpin current and future growth. The recent growth numbers also show that there is life in the construction sector, which grew by 4,9 per cent in the first quarter of 2014. In March, the real value of building plans passed increased by 13,6 per cent on the 3-month-to-3-month basis, and by 5,9 per cent on a year-on-year basis. These positive developments are also consistent with the improvement in the construction sector business confidence indices. However, the recovery needs to be more broad-based. In particular, the mining sector needs to get back to work, and the manufacturing sector needs to stay at work. This is also an imperative to ensure we retain the jobs we have, and do not have further job losses and increased unemployment. So what role can monetary policy play in this context? Unfortunately, monetary policy has a limited role in kick-starting the economy, particularly given the causes of the slowdown. Notwithstanding the interest rate increase in January, monetary policy is still accommodative and the repo rate low by historical standards, with the real repo rate being slightly negative. In effect, the 50 basis point increase simply offset the recent increase in actual and expected inflation. The problem of low growth and unemployment is therefore not high interest rates. The recent slowdown is clearly related to a fractious labour relations environment, while the unemployment rate is primarily structural in nature, and not something that monetary policy can solve. As we have stressed many times in the past, monetary policy can impact on the margin on cyclical growth and employment, but it cannot determine the potential real growth path of the economy. This is the domain of other policies that can directly influence the structural constraints on the economy. The primary mandate of the Bank remains the achievement of price stability. Inflation moved outside the target band in April, in line with the Bank’s forecast, and we expect it to remain outside the target for the next four quarters. We also see an upside risk to this forecast, with the main risks coming from the exchange rate (for reasons elaborated on above) and food prices. Other potential risks come from wage settlements should they significantly exceed productivity growth. In response to these inflation pressures, combined with the prospect of normalisation of monetary policy in the US, the MPC embarked on a tightening interest rate cycle in January, but stressed that the cycle would be moderate given the weak growth outlook. The MPC is sensitive to the fact that it risks being pro-cyclical, and it could undermine growth at the margin. This is the dilemma that monetary policy faces – that of rising inflation and slowing growth. Monetary policy decision-making in a flexible inflation targeting framework needs to be sensitive to the general state of the economy. So any given inflation forecast may elicit a different monetary policy response, depending on the economic outlook. For example, the BIS central bankers’ speeches current inflation forecast may have produced a much stronger reaction had the economy been performing much better than it currently is. In other words, in a simple Taylor rule world, the smaller the negative output gap, the stronger the interest rate response for any given deviation of inflation from the target. The monetary policy dilemma is compounded by the fact that the economy is not experiencing significant demand side inflation. Real growth in consumption expenditure by households has been steadily declining, from 4,9 per cent in 2011 to 2,6 per cent in 2013. While a contraction in consumption expenditure is not expected, we believe that it will remain constrained by a variety of factors, including rising inflation, high household debt levels, and subdued levels of credit extension to households in particular. The slow growth environment means that employment opportunities are limited, and job security is reduced. Since the 2009 recession, employment creation in the formal non-agricultural sector of the economy has been mainly by government. Private sector employment growth is likely to remain muted as long as investment confidence remains low, and government is constrained by the need to maintain its fiscal consolidation path, limiting the possibility of further significant employment creation. The issue then is, how can monetary policy deal with inflation driven primarily by cost-push pressures, and under such conditions should we not simply ignore these inflation pressures? Inflation expectations are central to price formation, and expectations of future monetary policy actions are an important element in this. If there is a view that the central bank is not concerned about inflation, it will undermine credibility of monetary policy and impact adversely on inflation expectations. Inflation expectations, as measured in the quarterly BER survey, have been relatively well anchored for some time, although at the upper end of the target range. While we can take some comfort from the fact that they have not deteriorated, these expectations are uncomfortably high, in line with the precarious level of the actual inflation rate. We would not want inflation or these expectations to become embedded at the upper end or worse, at a higher level. We know that monetary policy cannot prevent the impact effects of supply side shocks. For example, if international oil prices increase, domestic petrol prices will increase in the absence of an offsetting appreciation of the rand. But we do need to watch out for possible second round effects of these increases – that is, the extent to which increases are passed through to other prices, resulting in more generalised inflation. A similar example would be the impact of exchange rate changes. We have noted that despite the significant depreciation since 2011, pass-through to generalised inflation, while still positive, has been lower than during previous depreciation episodes. We ascribe this to the weak state of the economy, where retailers find it difficult to pass the full increases on to consumers for fear of losing market share. But there will always be a temptation on their part to try and recoup their margins. Under such circumstances, if there is a perception that monetary policy will accommodate these inflationary pressures they are likely to increase their prices. However, if there is a tightening bias in monetary policy, firms are more likely to be constrained in their price setting. There is a view that is sometimes expressed that inflation may come down more quickly than we expect, or even if it does not, and if the Bank’s forecasts are correct, inflation will be back inside the target range next year. Under such circumstances, is there not a case for ending the tightening cycle, or even to consider a cut in interest rates? Although we have been more tolerant of inflation at the upper end of the target range, given the negative output gap, we do not see the upper end of the target range as being the inflation target. Currently our forecasts, and most other forecasts, are for inflation to remain uncomfortably close to the upper end of the target range in the next two year, and we assess the risks to be on the upside. While we do not target the mid-point of the band, we would prefer to be more comfortably and sustainably within the target, as this would provide more room for monetary policy to act as need be, and better anchor inflation expectations at a lower level. BIS central bankers’ speeches We also do not believe that the current level of real interest rates is sustainable. As I have mentioned previously, there is a great deal of uncertainty surrounding the post-crisis new normal level of interest rates, both domestic and global. But in the same way that it is clear that the current abnormally low interest rates in the advanced economies cannot be sustained indefinitely, the same applies to our interest rates. As we have stressed, the timing and speed of adjustment will be data dependent, in part influenced by monetary policy developments in the advanced economies. That is not to say that we simply follow US monetary policy. A flexible exchange rate framework does give us a fair degree of monetary policy independence, but it is not absolute. This is in contrast to longer term bond yields which are more highly correlated with those in the US, and over which the Bank has no direct control. We live in a highly integrated financial world and we cannot ignore these developments. To reiterate the MPC position, the interest rate increase in January was not a one-off move. It is part of a necessary cycle to deal with the inflation risks and to normalise interest rates in the economy. However, the speed and extent of tightening will be sensitive to domestic growth considerations, and to the pace of normalisation in the US which is likely to impact on the South African economy indirectly through the exchange rate. At this point in time, we are in what we assess to be a moderate extended cycle. That means the interest rates will not necessarily be adjusted at each meeting, or move by the same amount. In this context, we are often asked if a 25 basis point adjustment is a possibility. Yes, it is. When the repo rate was in double digits, a 25 basis point change would make little impact. But at current levels of the repo rate, it is an option. Can 25 basis points make an impact? Perhaps not on its own, but seen in the context of a longer cycle, it could be part of a cumulative increase, particularly should the MPC wish to see a smoother and more gradual adjustment. The disadvantage of such a strategy, however, is that it could mean that we “fall behind the curve”, which may require even stronger moves later on. A more moderate approach, on the other hand, could allow for easier adjustment to changing circumstances, and a less volatile interest rate environment in the short to medium term. In conclusion, the domestic economy is facing enormous headwinds, many of which are of our own making, and therefore within our capability to resolve. High on the list is the currently debilitating labour relations environment, and it is incumbent on all parties to resolve these issues. All parties need to recognise their own roles in bringing about this toxic environment, and consider the significant costs to the individual workers, the affected companies and the country of not resolving these disputes. Monetary policy cannot resolve these issues, nor can it deal with structural constraints to longer term growth. Rather, the role of monetary policy is to contribute to a stable macroeconomic environment conducive to inclusive higher growth. The National Development Plan is a broad blueprint for dealing with these structural issues and the focus should remain on implementation of this plan. The South African economy has enormous potential, but it also faces significant social demands in the context of high unemployment. Let us all work together so that we get inclusive growth going again and realise the great potential we have as part of a growing region. Thank you. BIS central bankers’ speeches
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Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at a luncheon hosted by the Western Cape region of the Institute of Internal Auditors, Cape Town, 6 June 2014.
François Groepe: Impact of the global financial crisis on South Africa Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at a luncheon hosted by the Western Cape region of the Institute of Internal Auditors, Cape Town, 6 June 2014. * * * Members of the Institute of Internal Auditors and other guests, Thank you for the invitation to join you at this lunch networking event, hosted by the Western Cape region of the Institute of Internal Auditors of South Africa, and for the opportunity to address you at this event. Today, I wish to focus my remarks on the impact of the global financial crisis on South Africa, in particular with reference to the challenges it poses to financial regulation and the increased focus on macro-prudential financial regulation. In this regard, I will take you through the kinds of reforms the Bank is implementing, particularly in regard to its regulatory role and which forms part of the package of responses to the global financial crisis. Lastly, I would like to touch on the role that the auditing profession can play in support of achieving this objective. The global financial crisis There is no doubt that the global financial crisis has permanently changed the course of the global economy and has established a new normal. The severity of the 2008 financial crisis brought about significant damaging effects to both developed and developing countries. Although the emerging market economies performed better than the advanced economies, and became the engines of global growth through the crisis, they were nonetheless affected through the trade and finance channels and as a consequence their growth rates, too had been negatively impacted. In addition, the crises that started out as a banking crisis, then morphed into a sovereign debt crisis, and brought with it particular challenges for central banks and their previously welldefined mandates, for example:  Many central banks now look much more closely at the build-up of imbalances in the financial system; and  As part of its focus, regulatory reform is dealing with the central banks’ role with regard to financial stability – or macro-prudential regulation (which concerns itself with more than just idiosyncratic risk and the soundness of individual institutions but is concerned with the soundness and stability of the entire financial system i.e. systemic soundness). Rationale for a financial stability focus The ultimate objective of economic policy is to create a sustainable level of economic growth through investment, employment and production. This is best achieved when contributions are made by all sectors in the economy, including the financial sector, which historically has made substantial contributions to the levels of economic growth achieved in many advanced and developing economies. This sector is therefore important and hence there rests a responsibility on policymakers to ensure its continued health. In this regard, government has an important role to play in creating a stable environment underpinned by a legal framework that brings about certainty and supported by regulatory and supervisory arrangements that help to ensure constructive incentives for financial market participants. The central bank too has a role to play as it is tasked with the responsibility of BIS central bankers’ speeches contributing towards the achievement and maintenance of both price and financial stability. Instability in either of these carries significant costs, as we have witnessed. According to the International Monetary Fund (IMF), direct costs of banking crises in the past 15 years exceeded 10% of the GDP in more than a dozen cases. The relationship between monetary policy and financial stability is important and central banks must ensure that monetary policy actions themselves do not contribute towards financial instability. Hence, central banks have an important role to ensure that the possible formation of asset price bubbles that may threaten financial stability are kept in check. The increasing interdependence of economies and the interconnectedness of the global financial system have led to significant initiatives aimed at safeguarding financial stability, including the development of standards that are material in strengthening the global financial system. A concerted effort through various international bodies has seen agreement on common standards and principles for financial regulators and has, furthermore, resulted in central banks focusing more closely on financial stability and macro-prudential analysis. What is financial stability? Matters relating to monetary policy and monetary stability come naturally to central bankers. Monetary stability relates directly to the stability of the price level and the value of the currency and speaks directly to the mission of the South African Reserve Bank (SARB). Traditionally, the main objective of central banks – often enshrined in the constitutions of countries – has been to ensure price stability. For the Bank this responsibility is defined as “to protect the value of the currency in the interest of balanced and sustainable economic growth…”. It was commonly believed that if central banks could achieve price stability (defined as a target rate or target range of inflation), financial stability would automatically follow. This assertion was found to be incorrect! Therefore, the concept of financial stability is, in general, newer, more controversial, less quantifiable and more difficult to define. Several attempts have been made to come up with a generally acceptable definition. I will use the definition of the Bank of Canada, “…when households, businesses and financial-service firms can reliably hold and transfer financial assets, without a meaningful risk of disturbances that would undermine financial exchange fundamentally and lead to macroeconomic costs”. The SARB’s mandate of price stability has been expanded with an explicit responsibility to oversee and maintain the stability of the South African financial system. While the price stability mandate of the Bank is narrowly defined and measureable, its mandate for financial stability is much broader and is a shared responsibility with other stakeholders in the financial and public sectors. During the East Asian financial crisis in the late 1990s, however, countries with low inflation rates experienced severe instability in their financial systems as banks failed, exchange rates depreciated and financial markets experienced severe volatility. As a result many central banks focused increasingly on financial stability and it became an implicit secondary objective. In South Africa, this objective was mainly pursued through the regulation and supervision of banks, which has been the responsibility of the Bank Supervision Department within the Bank. It soon became clear, however, that sound and profitable individual banks did not guarantee a sound banking and financial system. Banks often have inter-linkages and might have significant common exposures to risks that will not be visible from the supervision of individual banks. Hence the need for macro-prudential surveillance, or the monitoring of the “prudence” of the “broader” financial system was identified and which culminated in the SARB creating such capacity for this purpose as far back as 2001. The SARB further was given the objective of contributing to the stability of the financial system in South Africa, following the global financial crisis. BIS central bankers’ speeches Following the publication of a policy document by National Treasury in February 2011 called “A safer financial sector to serve South Africa better” the SARB’s responsibility for financial stability became more explicit. This policy document eventually culminated in the Financial Sector Regulation Bill, which states that “…the South African Reserve Bank has primary responsibility for promoting financial stability…”. The Bill sets out further details to give effect to the Bank’s financial stability mandate and is expected to be promulgated during 2014. It is important to note that financial stability is a shared responsibility with other stakeholders such as the prudential and market conduct regulators and the National Treasury. Careful consideration needs to be given to co-ordinating monetary policy and financial stability objectives, which at times may result in diversion of policy choices. In South Africa, cross membership between the Bank’s monetary policy and financial stability committee structures facilitates such coordination. The Bill also recommends a single committee structure for financial stability, namely the Financial Stability Oversight Committee (FSOC), chaired by the Governor of the Bank. The FSOC’s mandate will be to continuously monitor the financial system for risks and initiate any action necessary to mitigate or remedy a risk. The FSOC thus will have a financial stability responsibility, in the same way as the Monetary Policy Committee (MPC) does for price stability, and will be able to hold to account various authorities or economic agents on actions to be taken to mitigate against/reduce systemic risk. The Bank’s expanded mandate for financial stability will not impact on its price stability mandate, which, eluded to above, is a narrowly defined, formal and explicit mandate. The Bank will therefore still be independent and free from influence in pursuing its primary objective of achieving and maintaining price stability. Given this expanded role, it will require of central banks to evolve and to face up to the increased demands for greater accountability. Central banks will need to communicate on matters relating to financial stability, manage situations where conflicts arise in the goals of monetary policy and financial stability, and moderate unrealistic expectations of what can be achieved by financial stability policies. South Africa, as a member of the Group of Twenty (G20), is committed to promoting financial stability and contributing towards strengthening the resilience of the global financial system. The role of the auditing profession in supporting financial stability There are a number of important and close linkages between the financial stability objective of the central bank and the auditing profession. As mentioned earlier, one of the four main aspects of the Bank’s financial stability mandate is to promote the robustness of the financial system architecture. This is performed through a process of benchmarking the financial architecture of South Africa against the Financial Stability Board’s twelve standards for sound financial systems. Amongst these standards are International Standards on Auditing (ISA) issued by the International Auditing and Assurance Standards Board (IAASB). As part of the Reports on the Observance of Standards and Codes (ROSC) initiative, the World Bank has established a programme to assist its member countries in implementing international accounting and auditing standards for strengthening the financial reporting regime. This enables authorities to analyse comparability of national accounting and auditing standards with international standards and to develop and implement a country action plan to strengthen the country’s corporate financial reporting regime. In addition to that, well-functioning financial markets require accurate information to ensure the efficient allocation of capital and other productive resources in the economy. Market participants need to have confidence that the system of financial exchange is transparent and fair. The market system depends on trust, and in this regard, good corporate governance is critical to ensure economic and financial stability as a breakdown in governance could significantly erode business efficiency. BIS central bankers’ speeches In a testimony to the US Congress by the then Chairman of the Federal Reserve Board in 2002, Alan Greenspan stated that lawyers, internal and external auditors, corporate boards and rating agencies often fail to detect and blow the whistle on those who breach the level of trust essential to well-functioning financial markets. This could lead to widespread misinformation to shareholders and potential investors. The question is why corporate governance checks and balances that served the world well in the past broke down during recent years. Both external and internal auditors have a key role to play in strengthening corporate governance as they are the third line of defence within the combined assurance frameworks. The Committee on Internal Audit Guidance for Financial Services in the United Kingdom has issued its recommendations for effective internal audit in the Financial Services Sector in July 2013. If implemented, these recommendations will improve the relevance of the internal audit function by repositioning the focus from testing and reporting on the internal control environment to supporting both executive and non-executive management in the effective management of key risks. The guidance for example suggests that the scope of internal audit include, inter alia: (i) The risk and control culture of the organisation This should include assessing whether the processes (e.g. appraisal and remuneration), actions (e.g. decision making) and “tone at the top” are in line with the values, ethics, risk appetite and policies of the organisation. Internal Audit should consider the attitude and assess the approach taken by all levels of management to risk management and internal control. This should include Management’s actions in addressing known control deficiencies, as well as Management’s regular assessment of controls. (ii) Risk of poor customer treatment giving rise to conduct of reputation risk Internal Audit should evaluate whether the organisation is acting with integrity in its dealings with customers and in its interaction with relevant markets. Internal Audit should evaluate whether Business and Risk Management are adequately designing and controlling products, services and supporting processes in line with customer interests and conduct regulation. (iii) Capital and liquidity risk Internal Audit should include within its scope the management of the organisation’s capital and liquidity risks. Conclusion After much discussion and debate, we have to accept that, after nearly seven very challenging years, new challenges are being faced, which poses specific risks for emerging economies in particular. Some of these challenges include the unwinding of the extraordinary monetary policy actions in the US which is largely untested territory as there is no prior history to guide us. Nonetheless, I will not delve into this topic at present as we could spend many hours discussing the various issues surrounding it. Let me stop here and thank you for the opportunity to talk to you today and to share a few ideas on the fascinating topics of financial stability and corporate governance. There is no question that good corporate governance and sound accounting and auditing standards and effective audit functions contribute significantly to sound, stable and well-functioning financial systems. 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 Financial Markets Department's Annual Cocktail Function, Pretoria, 24 June 2014.
Daniel Mminele: Recent major developments in global and domestic markets Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department’s Annual Cocktail Function, Pretoria, 24 June 2014. * * * Good evening, It is a great pleasure for me to welcome you all to the Financial Markets Department’s Annual Cocktail function. As has become tradition for this event, we would like to take stock of the major developments in global and domestic financial markets over the past year, before updating you on matters relating to the Financial Markets Department and initiatives undertaken over the past year. Tonight we will adopt a different approach, namely that I will cover the first section, and then hand over to Leon Myburgh, Head of the Financial Markets Department, to update you on departmental activities. Given recent releases of the Monetary Policy Review, the Quarterly Bulletin and speeches, I shall not comment in any detail on recent economic developments. Re-pricing of risks in international and local financial markets Those of you who were able to attend our function last year will recall that the assessment at the time was that of increasing confidence about the gradual “healing” of the global economy and financial system, and the reduction in “tail risks” that had unsettled markets for the previous two years. These improvements were at the time largely attributable to the drastic policy actions undertaken on an on-going basis by the world’s major central banks. Yet at the same time, it was already becoming evident that there was a build-up of risks, and that the impact on financial markets of the timing, as well as the pace, of the eventual and unavoidable reversal of these extraordinary measures, could be substantial. Looking back over the past twelve months, these factors became the dominant drivers of market movements, as was anticipated at the time. The gradual improvement in the major economies that was expected a year ago has continued, by and large, to materialise. Global economic growth has picked up, albeit unevenly. The underlying strength of the recovery has been confirmed in the United States, the Euro zone has emerged from recession, and there are indications that a prolonged period of deflation could be ending in Japan. The extent of the slowdown in emerging market economies appears to have been one of the main surprise developments over the last year as emerging markets were not spared the negative consequences of global risk realignment while expectations of lesser liquidity provision by the US Federal Reserve led to increasing differentiation by investors across emergingmarket assets. As you know, currencies and bonds of those countries experiencing relatively wide current account deficits, sluggish economic expansion and inflationary pressures underperformed assets of emerging markets who performed better on these metrics. Concerns about a deceleration in Chinese economic growth also affected financial assets in commodity-exporting countries, like South Africa, which had benefitted from China’s surging industrial demand in earlier years. While the global economic recovery remains broadly on track, high levels of uncertainty, vulnerabilities and fragilities remain, and the global growth outlook continues to harbour downside risks, as the first quarter of 2014 has shown. As indicated above, global financial markets developments have been mainly driven by changing expectations around asset purchase tapering by the Fed and the eventual normalisation in US policy rates. Consequently, the latter part of 2013 saw long-term bond yields increase in all major developed and emerging economies, and yield curves steepened BIS central bankers’ speeches as investors required a higher “term premium” across a broad range of fixed-income assets, while currencies of emerging market countries at times adjusted abruptly and sharply, leading to a general tightening of financing conditions. More recently we have observed an easing of financing conditions, based on expectations that monetary policy in the US will only adjust gradually. These developments are underpinned by improved communication by major central banks and further policy measures such as the ones recently announced by the ECB. This has resulted in increased risk taking in financial markets and made carry trades more attractive given reduced levels of volatility. Emerging markets have been benefiting from these developments by way of better performance of their currencies and capital inflows. Unfortunately, the increased risk taking in financial markets is not matched by increased risk taking in the real sector of the economy. In addition concerns are emerging that the extraordinarily low levels of volatility (e.g. the VIX index is below pre-crisis levels) may be providing incentives to misprice risk and thus increase financial stability risks. A further hazard going forward is the increasing divergence in monetary policy in advanced economies, with the US Fed and the Bank of England moving towards lifting policy rates as part of normalisation, when on the other hand the ECB and Bank of Japan are expected to ease monetary conditions further. Thus the current situation in global financial markets does not allow for complacency and requires policy makers and market participants to remain alert and carefully manage risks. Domestic markets within the global context Given the high level of integration with international financial markets, domestic financial market developments reflected these developments, but were also significantly influenced by South Africa intrinsic factors. The under-performance of the rand relative to other emergingmarket currencies was particularly noticeable over three specific periods. The first one occurred in May and June 2013, when the Federal Reserve first talked of “tapering” its Quantitative Easing programme. The second one, in August 2013, coincided with a rise in risk aversion towards countries with large current-account deficits and deteriorating growth fundamentals. In the third phase, from mid-December to late January this year, in addition, investors appeared to be differentiating against countries that were seen to have been slow in their policy responses to tapering and normalisation risks. This period was characterised by significant net sales of domestic securities held by non-resident investors. Of course it was not only global developments that influenced local markets, as on-going labour market disruptions added to negative sentiment, underperformance in the real economy, and a worsening Balance of Payments situation. As mentioned earlier, the last few months have brought some signs of greater stability to both global and domestic financial markets: The rand has recovered since its late January trough; the yield on the R186 benchmark government bond has declined by 64 basis points; and the JSE‟s All-Share Index has climbed to new highs, gaining 10.4 per cent on a year-todate basis, and net non-resident flows into the local currency bond market stabilised in February to April, before posting a net positive inflow of R10,6 billion in May and R8,2 billion for June (until 23 June). The levels of development, sophistication and depth of our financial markets have allowed South Africa to weather the turbulence of the past year reasonably well. However, we have to acknowledge that there are still some risks in the system, even if they are difficult to quantify. Bond yields are low relative to the averages of the past decade, and the nonresident share of government bond holdings remains very high by historical standards. Carry trade activity, which seemed to support the domestic bond market in May, is by its own nature a temporary phenomenon, even though its timing is unpredictable. These factors suggest that local yields could be vulnerable to risks of a renewed global bond selloff or a BIS central bankers’ speeches sudden spurt in risk aversion. By several metrics, finally, South African equities appear increasingly expensive. But it is important to accept that the transition period on the path of policy normalisation will not always be smooth, and not to confuse the bouts of volatility that we have experienced, and which are likely to be with us for a while, with instability in our markets. Monetary policy challenges Monetary policy in South Africa is currently facing an increasingly challenging situation, as the domestic economic growth outlook has deteriorated markedly even as inflation broke out of its target range. This deterioration is heavily influenced by supply side factors and final domestic demand has slowed in recent quarters, indicating a continued lack of demanddriven price pressures in the economy. This suggests that the current rate cycle need not match the speed and magnitude of earlier cycles. As you are aware, we entered the present rate hiking cycle in January this year when the repo rate was increased by 50 basis points to 5.5 per cent per annum in reaction to a deteriorating inflation profile, with the Bank’s inflation forecast suggesting that the upper band of the inflation target would be exceeded for an extended period. The most recent CPI print at 6.6 per cent came out above expectations, which followed recent consumer and producer price data releases signalling a growing passthrough of previous rand depreciation to prices of durable and semi-durable goods. Such a risky environment continues to call for vigilance by the Monetary Policy Committee, to ensure that any pass-through of previous rand depreciation to inflation does not become permanent, that inflation expectations do not become unanchored from current levels, but in fact improve as they are uncomfortably close to the upper range of the inflation target. As indicated by the Monetary Policy Committee, the current rate hiking cycle will need to be responsive to incoming data and information in relation to, among other factors, exchange rate developments, food price developments, labour market data and Balance of Payments dynamics. But the fact remains that inflation is uncomfortably high, and that risks continue to be tilted to the upside, and that interest rates will have to normalise in due course. In this complex environment communicating with the financial markets, which provide an important link in the transmission of monetary policy, becomes particularly important. Central banks implement monetary policy decisions mainly by transacting in the financial markets. While the past year has clearly shown the benefits of an improved level of central bank communication about likely future action, it also needs to be recognised that while policy makers in certain instances may have more data at their disposal than market participants, the information available is by no means perfect or conclusive enough to allow an analysis that could result in undertakings or even promises of future action. It is also important for market participants to realise that while feedback mechanisms between the market and policy makers are invaluable, central banks will always be careful not to allocate a disproportionate weight to market information that may be embedded in market prices such as FRA rates, and will always cross-check with other information and relevant economic variables. While at times policy makers may feel the need to correct certain impressions that may exist and are influencing market prices at particular times, or give appropriate guidance, it should not be expected of policy makers to keep commenting directly on short-run market movements, as has been suggested by some. „Running commentary‟ in this regard could unnecessarily add to volatility. Concluding remarks Let me conclude by once again thanking you for attending our event today, and also thank you for the cooperation we have enjoyed with you over the past year as both policy makers and market participants were navigating choppy waters within an increasingly complex environment. Our consultative structure in the form of the Financial Markets Liaison Group (FMLG) has matured, and I would like to thank many of you present today, who participate in BIS central bankers’ speeches the various sub-committees of the FMLG and provide us with valuable inputs to inform our work here at the central bank. The FMLG will continue to play an important role as we further develop our markets and ensure their efficiency, transparency and integrity. In this regard, we also continue to monitor global investigations around reference rates. Furthermore, we have noted with concern the recent reports from abroad regarding the investigations around alleged foreign exchange manipulations. We will continue to monitor and consult developments in this regard and consult when necessary to ensure that practices in our financial markets continue to be characterised by appropriate levels of transparency and integrity. Let me now hand over to Leon Myburgh to share with you initiatives that the Financial Markets Department has been busy with. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 94th annual ordinary general meeting of shareholders, Pretoria, 25 July 2014.
Gill Marcus: Overview of the South African economy Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the 94th annual ordinary general meeting of shareholders, Pretoria, 25 July 2014. * * * Governor’s address Dear Shareholders, Members of the Board, Deputy Governors, Ladies and Gentlemen, The past year has been no less challenging for South Africa than any of the previous years since the start of the global financial crisis, which is now in its seventh year. The slow and uneven global recovery has continued, with the United Kingdom (UK) showing the most sustained signs of recovery among the advanced economies. The earlier optimism that the US economy had finally turned the corner, following fiscal challenges in 2013, was tempered following the GDP growth contraction of 2,9 per cent in the first quarter of this year. While part of this can be attributed to adverse weather conditions, there are conflicting signals coming out of the US. Corporate balance sheets appear to be healthy, and the labour market is improving, with the unemployment rate having declined to 6,1 per cent in June 2014 from 7,5 per cent a year ago. However, the housing market has weakened recently, possibly in response to higher long term rates and the economy remains vulnerable to higher interest rates. The earlier expectation of growth of around 3 per cent appears to be out of reach for 2014, and the expectation is now closer to 2 per cent. The Eurozone emerged from recession in the early part of 2014, but slow growth is expected to persist amid tight lending criteria by banks and strong fiscal consolidation in a number of countries, particularly in the periphery. More recently France, Germany and Italy, the largest economies in the region, have shown signs of slowing and growth forecasts have been revised downwards. The risk of deflation in the Eurozone persists, and remains a particular concern to the ECB, which recently announced a further round of unconventional policy stimulus. Uncertainty still surrounds the sustainability of the response of the Japanese economy to the fiscal and monetary policy stimuli implemented during the past year. Household consumption expenditure surged in the first quarter in anticipation of consumption tax increases, resulting in a strong GDP growth performance in the quarter. Second quarter growth is expected to be negative as the higher taxes take effect. The past year has also seen slowing growth in a number of the larger emerging market economies. This followed a slowdown in China and a reversal of capital flows to emerging markets in the wake of indications that the US Federal Reserve (the Fed) would taper its bond-buying programme. Growth in China has been negatively impacted by concerns about the shadow banking system, the overheating housing market and tightening credit conditions. Its growth is now expected to be below 7,5 per cent, lower than historically, and while risks are seen to be on the downside recent data suggest that these downside risks may have dissipated somewhat. The South African growth prospects are sensitive to developments in China through the impact of slower Chinese growth on commodity prices. Latin American countries, particularly Brazil, have also felt the slowdown. Other larger emerging markets that have experienced weaker growth include Indonesia, Russia, Thailand and Turkey, while India has recently shown some signs of recovery. Global financial markets have been dominated by changing assessments of the outlook for US monetary policy. As the US growth outlook improved, the Fed hinted in May last year that it was considering reducing the amount of stimulus granted in the form of quantitative easing, BIS central bankers’ speeches which involves purchases of bonds by the Fed from the market. This created considerable uncertainty regarding the timing and speed of this tapering, and expectations in this regard kept changing in response to changing data coming out of the US. These developments impacted on emerging markets which generally experienced capital outflows and volatile exchange rates in response to changing risk perceptions. By the beginning of February of 2014, once orderly tapering was priced into the market, the focus moved to the timing and speed of interest rate normalisation. More recently, as growth prospects in the US deteriorated, consensus forecasts and guidance from the US Fed appeared to shift the expected timing of the first interest rate increase further out into the future, with a slower pace of increase. The forward guidance provided by the central banks in the advanced economies has contributed to a low level of financial market volatility, and there are concerns that this could encourage excessive risk taking and asset price bubbles. Speculation regarding the timing of US interest rate normalisation is likely to remain a source of volatility and dominate financial markets for some time to come. It is also complicated by the fact that normalisation in the advanced economies is likely to be unsynchronised, with further loosening expected in Japan and the Eurozone, while the Bank of England has indicated that the first policy rate increase could already occur later this year, but at a moderate pace. Over the period under review, the South African economy faced a very challenging environment against this global backdrop, with domestic issues compounding these difficulties. The exchange rate moved broadly in line with a number of emerging-market economies in response to tapering and capital-flow reversals. For example, between the beginning of November 2013 and the beginning of February 2014, net sales of bonds and equities by non-residents totalled just over R70 bn, but since then net purchases have totalled over R40 bn. The rand has generally depreciated over the period, although with a high degree of volatility in response to these wide swings in capital flows. However, idiosyncratic factors caused the rand to diverge from its emerging market peers at times. In particular, the rand was also influenced by the widening deficit on the current account of the balance of payments, and by a succession of protracted labour disputes in the motor-vehicle subsector and mining sectors in particular, which have undermined the country’s export and growth performance and prospects. The fraught labour relations environment contributed to the decline in domestic economic growth from 2,5 per cent in 2012 to 1,9 per cent in 2013, and the economy contracted by 0,6 per cent in the first quarter of 2014. While the monthly data for April pointed to a better second quarter outcome, both mining and manufacturing outcomes in May were again negative. With household consumption expenditure and private sector investment growth expected to slow further amid weak business confidence, the Bank has lowered its growth forecast for 2014 to 1,7 per cent. Under these circumstances, the high level of unemployment, currently at around 25 per cent, is expected to persist and employment growth is expected to remain constrained, particularly in the private sector. The need for fiscal consolidation is also likely to constrain public sector employment growth, which to date has been the main driver of employment growth since the onset of the crisis. The environment for monetary policy became increasingly complex under these conditions, with the inflation outlook deteriorating as the economy weakened. Inflation breached the upper end of the target band in July and August 2013, but as the breach was anticipated to be temporary, monetary policy did not react to it. However, in January 2014, further pressures from the exchange rate and food prices saw a significant upward revision of the inflation forecast: inflation was expected to breach the upper end of the band for an extended period of about four quarters from the second quarter of 2014 and to peak at around 6,6 per cent in the fourth quarter of 2014. In line with this forecast, inflation measured 6,1 per cent in April 2014, and 6,6 per cent in both May and June, resulting in a second quarter CPI average of 6,4 per cent. BIS central bankers’ speeches The most recent forecast of the Bank shows that inflation is expected to average 6,3 per cent in 2014, with the quarterly peak of 6,6 per cent still expected in the fourth quarter, following a slight moderation in the third quarter. The forecast average inflation for 2015 and 2016 is 5,9 per cent and 5,6 per cent respectively, with inflation expected to average 5,5 per cent in the final quarter of 2016. Inflation is expected to return to within the target band during the second quarter of 2015. Monetary policy therefore faced a difficult dilemma in the period under review, with a widening output gap, downside risks to growth, and a deteriorating inflation profile with upside risks. In response to these inflation developments and in light of the need for monetary policy normalisation over time, the Bank’s Monetary Policy Committee (MPC) decided at its meeting in January 2014 to embark on a moderate tightening cycle and raised the repurchase (repo) rate by 50 basis points to 5,5 per cent per annum. As the growth outlook deteriorated further and the inflation risks moderated slightly, the monetary policy stance remained unchanged at the MPC’s subsequent meetings in March and May. However, in the July meeting, the MPC decided to continue on its gradual normalisation path, and raised the repurchase rate by 25 basis points to 5,75 per cent per annum. The Committee remained concerned about the upside risks to the inflation outlook, and the increased risk of a wage-price spiral in the context of the current difficult labour relations environment, with the risk of double digit wage settlements becoming the economywide norm. Given the global and domestic risks to the outlook, future changes in the monetary policy stance will remain highly data-dependent. The MPC will remain focused on its core mandate of price stability, but will also be mindful of the impact of its policy actions on economic growth. Many of the problems that the country faces are not within the purview of the Bank’s mandate, nor does the Bank have the policy levers to address these issues. However, the Bank will continue to play its part in supporting the economy through these difficult times by maintaining its focus on price stability in support of sustainable economic growth. While price stability remains the core mandate of the Bank, financial stability has become part of its extended mandate, which is being formalised in the draft Financial Sector Regulation Bill of 2013. The revised Bill is expected to be tabled in Parliament later this year. Planning for the implementation of the Twin Peaks Regulatory Model is proceeding. This model locates the regulation and supervision of both banks and insurance companies within the Bank and allocates market-conduct oversight to a new authority that will replace the Financial Services Board (FSB). The envisaged changes will have a significant impact on the Bank in terms of responsibilities and resources, with a sizeable increase in personnel expected. Although we have to wait until the legislation is passed to give full effect to the envisaged changes, we have still paid attention to our financial stability responsibilities: the Bank Supervision Department (BSD) has increased its supervisory vigilance domestically and its role on the Basel Committee on Banking Supervision (BCBS); the Bank’s Financial Stability Committee (FSC) meets regularly and work is being done to develop a macro-prudential policy toolkit. This is unchartered territory and a challenge faced by most countries. Fortunately, our banks and the financial system in general have remained stable, despite the difficult global and domestic environments. Let me now turn to the Annual Report The financial statements presented to you today show that the Bank has again recorded a loss. As I explained in some detail in my address to shareholders last year, the Bank is not driven by a profit motive, but rather acts in the best interests of the country. The Group recorded an after-tax loss of R1,6 billion in the year under review, compared with the R1,3 billion loss in the previous financial year. Once again, the major source of our losses emanated from the holding of foreign exchange reserves. Net interest income earned on the country’s foreign-exchange reserves remained constrained by low global interest rates as BIS central bankers’ speeches monetary policy in the advanced economies remained highly accommodative. At the same time, costs increased, including those associated with the introduction of the new currency in 2012 which were carried over into the following financial year, and staffing costs which rose as a result of salary increases and additional appointments required due to the expanded operations of the Bank. Although the losses recorded arose from the Bank performing its functions in the interest of the economy, we remain committed to containing costs and maximising operational efficiency, and are confident that the Bank will return to profitability over the next few years. Acting on legal advice, the Bank has embarked on a formal process to regularise shareholding in the Bank. This entailed addressing correspondence to all shareholders of the Bank who hold shares in contravention of section 22 of the SARB Act. These shareholders hold, together with their associates, more than 10 000 shares in the Bank, without having made the prescribed disclosure as required by law. These shareholders were called upon to provide the Bank with an irrevocable undertaking that they would dispose of the number of shares in the Bank as may be necessary to ensure that they, together with their associates, would in aggregate hold no more than 10 000 shares. Shareholders were advised that should they fail and/or refuse to provide the required undertaking and fail to dispose of the requisite shares in the Bank, legal proceedings against them in terms of section 22 of the SARB Act would be instituted for an appropriate order to redress the matter. This order may include the disposal of shares in the Bank at a price per share and subject to such terms, conditions and restrictions as a Court may determine. This year the shareholder road show was only held in Pretoria on 9 July. As attendance in other centres has been poor in recent years, we had indicated that the meeting would be broadcast live to the Cape Town and Durban branches via video conferencing. However, as we did not receive any responses from shareholders confirming their attendance at these venues, the broadcast was cancelled. The Pretoria road show was well attended and I encourage shareholders to take this opportunity in future to interact with the executive of the Bank, outside of the AGM. Once again, the questions posed at the road show were specific to the persons attending. However, it would be opportune at this time to highlight that during the financial year 2013/14 the Group adopted new accounting standards and reclassified certain financial information. This has resulted in the comparatives being restated for the financial years ending 2012 and 2013, and therefore the need for restated statements of the financial position and profit and loss. I refer you to note 16 in the 2013/14 Annual Report for further details in this regard. You have been advised that this year the Panel selected only one candidate each for the non-executive director vacancies in the mining and labour sectors. This was due to the fact that very few nominations were received from the public in these sectors. The Bank will review how it can improve the profile of the request for nominations to ensure a greater public awareness of the process going forward. BIS central bankers’ speeches
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Remarks by Ms Gill Marcus, Governor of the South African Reserve Bank, at a press conference in connection with African Bank Limited, Pretoria, 10 August 2014.
Gill Marcus: Press conference in connection with African Bank Limited Remarks by Ms Gill Marcus, Governor of the South African Reserve Bank, at a press conference in connection with African Bank Limited, Pretoria, 10 August 2014. * * * Members of the media, Ladies and Gentlemen, Thank you all for being here today. As you are aware from our invitation, we have called today’s press conference in connection with African Bank Limited. Against the backdrop of African Bank’s parent company African Bank Investment Limited’s (ABIL’s) trading update on Wednesday, 6th August, 2014, the SARB, in consultation with the Minister of Finance, has decided to implement a number of support measures. These will further strengthen the resilience of the banking system as a whole, and, importantly, they will provide African Bank with the best chance of a viable future. As you are all aware, African Bank has received considerable media coverage for some time now. The Registrar of Banks and his team intensified their active engagement with the management and board of African Bank towards the end of 2012. The concerns they expressed particularly focussed on African Bank’s impairment and provisioning policy, their rapid credit growth, and the need for a strategic rethink of their business model. Given these concerns, regular discussions were held by the Governors with the Banking Supervision Department to ensure closer monitoring of developments affecting African Bank. These meetings commenced in May 2013, and the Governors received regular reports on measures taken by the Bank Supervision Department on the steps they required African Bank to take in addressing the concerns. At that stage, African Bank had a capital adequacy ratio of 32%, which is above the minimum requirement. The measures taken by African Bank as a result of this engagement included a higher level of provisioning for non-performing loans, a review of their provisioning policy, and a rights issue that raised R 5.5 billion in December 2013. The management was also requested to dispose of Ellerine Holdings Limited. At the initiative of the SARB, discussions were also held with ABIL’s board to appoint a specialist team to assist with restructuring options. In the six month period to March 2014, ABIL posted a headline loss of R 3.1 billion. However, they assured the market that the book written after June 2013 was significantly better and forecast that they would return to profitability in the second half of the year. ABIL’s trading statement for the third quarter released on August 6th 2014 was markedly worse than what the market expected, with an estimated headline loss for the full year to September 2014 financial year of R 6.4 billion. Ellerine Holdings Ltd, like African Bank, is a wholly owned subsidiary of ABIL. Ellerine Furnishers has been a significant drain on ABIL, requiring funding support of a minimum of R 70 million per month. The ABIL Board announced its decision to sell Ellerine and endeavoured to find a buyer. African Bank is the only South African bank exposed in this way to a furniture chain. Ellerine Furnishers was placed into a business rescue process on 7th August 2014. One of the outcomes of this is that the significant monthly financial support required from ABIL and African Bank has ended. BIS central bankers’ speeches The problems that have beset African Bank are, in our view, largely specific to their current business model, which does not include a diversified set of products and income streams, nor does it offer transactional banking services. This has made African Bank and the ABIL Group uniquely vulnerable to a changing or challenging business environment, such as currently prevails. It is against this backdrop that the decision has been taken to introduce a range of support measures for African Bank. The first important measure has been the conclusion reached by the Registrar of Banks and the decision by the Minister of Finance to place African Bank under curatorship with effect from 16.00 today, 10th August 2014. African Bank Limited’s Board has, after due consideration, advised the Registrar that it does not oppose curatorship and has taken the appropriate resolutions to facilitate the process. The curatorship provides the legal framework within which the necessary initiatives to enable resolution can take place. The Minister has appointed Mr Tom Winterboer as the curator. He will be responsible for African Bank with immediate effect, with the full authority the law confers on the curator. Tom Winterboer is the financial services industry leader for Africa and a member of the global financial services leadership team at PwC. You will be provided with his CV as part of the press pack and I would like to introduce him to you now. Mr Winterboer will be assisted in his task of securing a viable future for African Bank by a team of experts, including Mr Peter Spratt and Mr David Gard from PwC London. Mr Gard, who has been appointed as Senior Advisor, Business Restructuring, has been working with African Bank for the past four weeks. He will take particular responsibility for assisting the curator on the restructuring plan. Mr Spratt has been appointed as Special Advisor to the curator. Other members of the team will be announced by Mr Winterboer in due course. He will also ensure that there is a specific help line to answer questions that clients of African Bank may have. The curatorship is a protection procedure which gives the SARB the legal means to create the necessary space to implement a resolution plan capable of ensuring that the business of African Bank gains a secure perspective for the future as a lending institution with a transformed business model. The curatorship and resolution process will: • ensure that the regular operations and collections of African Bank continue effectively and efficiently • identify performing loans and assets to be maintained in a good bank • involve the purchase by the SARB of a substantial portion of the non- and underperforming assets and other high risk loans from African Bank in order to separate them from the good bank, and also as a first step towards resolution of the challenges associated with these assets and loans • recapitalise the new entity by a capital raising of some R 10 billion underwritten by a consortium • provide current shareholders an opportunity to participate in the recapitalisation of the new entity and thereby of good bank The measures that have been taken are, in our view, in the best interest of all stakeholders, whether depositors, shareholders, creditors, or clients. I would now like to turn to the package of proposals that will guide Mr Winterboer in his endeavours to find resolution. BIS central bankers’ speeches Firstly, I want to emphasise that African Bank continues to operate during the curatorship and that Mr Winterboer will make decisions regarding the continued granting of loans and sound banking activities generally. African Bank continues to be open for business. Secondly, retail depositors represent less than 1% of African Bank’s creditors. We are therefore able to make an unequivocal commitment to all existing retail depositors that their money is safe, and that they can continue with African Bank as their bank without fear that their deposits will be frozen or lost. They will have full access to their money in the ordinary course of business. Thirdly, the resolution will see a private/public sector partnership. A consortium has been put together by the private sector. The consortium comprises Absa Bank Limited, Capitec Bank, FirstRand Bank Limited, Investec Bank Limited, Nedbank Limited, Standard Bank Limited, and the Public Investment Corporation (PIC). The consortium has committed to underwrite a R 10 billion capital raising, and will – under the guidance of Mr Winterboer – be engaging with shareholders and other interested parties in this regard. Members of the consortium have also offered to provide management and technical support. Resolution will see African Bank split into two parts: • On the one hand a good bank, which will be recapitalised as indicated above. Let me emphasise here that the R 10 billion recapitalisation is for the good bank, which has a book value of R 26 billion net of portfolio impairments • On the other hand the bad book, which comprises a substantial portion of the nonand under-performing assets, will be housed in a vehicle with the support of the SARB in order to separate these from the good bank. As a result, the bad book will no longer form part of African Bank – the bad book currently has a book value net of specific impairments of R 17 billion for which the SARB will pay R 7 billion – collection against the bad book will be continued, and indeed strengthened: there is no payment holiday for anyone owing on a loan from African Bank Every effort will be made to ensure that collections continue with the goal of avoiding any cost to the taxpayer arising out of this measure. A claw back arrangement will be put in place for the bad book to the extent that performance exceeds expectations. The proposal for the restructuring of the liabilities of African Bank is set out below: • existing depositors, specified sundry creditors and instrument holders will be restructured and assumed by the good bank as follows: ‒ retail depositors and specified sundry creditors will be transferred at full value ‒ senior debt instruments and wholesale deposits (excluding subordinated debt holders) will be transferred at 90% of face value following the restructuring (the absolute interest rate will be based on the revised face value) ‒ all other liabilities will remain in African Bank • existing ordinary shareholders and subordinated debt holders will be afforded the opportunity to participate in the good bank • it is intended that the good bank holding company will be listed on the JSE in due course, and will include the acquisition at fair value of the various insurance entities within the ABIL Group An important aspect of the curatorship is that the curator has the discretion to suspend payments of interest. While interest continues to accrue, he is expected to suspend interest payments generally with immediate effect except for interest payments on retail deposits. BIS central bankers’ speeches We are greatly encouraged by the active and committed response by the private sector to partner us in seeking resolution for African Bank. We believe that the package that has been put together with the support of the consortium is workable and substantive. Shareholders will have an opportunity, by following their rights in the capital raising, to participate in the recapitalisation. We take the opportunity to repeat what we said in our statement last week: South Africa’s banking sector remains healthy and robust. There have been no indications that other South African banks have been affected negatively by ABIL’s trading update or African Bank’s current situation. This remains the case following today’s announcement. The role of banking supervisors is to make every effort to ensure that South Africa’s banks have adequate capital, liquidity, and leverage ratios, as well as sound governance and appropriate policies. We are, and will remain, an active supervisor. But this can never substitute for management’s role and its responsibility to manage a bank. Nor can it remove a Board’s responsibility to ensure sound policies and practices in relation to corporate governance, effective risk management, as well as the strategic direction of a bank. Notwithstanding the challenges facing African Bank, government’s policy of financial inclusion is appropriate and important. This requires sound practices, appropriate lending relating to affordability and an increased effort to provide greater access to finance for entrepreneurs as well as small and medium enterprises. This will continue to be the challenge for all of us going forward as we, together, continue to maintain the strength of the banking and financial system. Thank you and I will now take questions. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the South African Chamber of Commerce and Industry (SACCI) Breakfast Briefing, Johannesburg, 13 August 2014.
Daniel Mminele: South Africa – challenges and opportunities in the monetary policy environment and the new financial services regulatory regime Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the South African Chamber of Commerce and Industry (SACCI) Breakfast Briefing, Johannesburg, 13 August 2014. * * * Good morning, Ladies and Gentlemen. It is indeed a pleasure to address you today on some of the issues that monetary policy makers and regulators both internationally and domestically are currently grappling with. I am very grateful to SACCI for creating this opportunity for us to interact at this forum, which I gather is part of SACCI’s policy programme of engagement with policy makers, political and business leaders. Fortunately, the difficult task of choosing a topic for this address was solved for me, as the organisers have specifically requested me to focus on three issues, namely, international monetary policy trends, challenges and opportunities in South Africa’s monetary policy environment and the new financial services regulatory regime in South Africa. My address is structured accordingly. 1. International monetary policy trends As you are aware, in many countries growth considerations dominate policy concerns, both on the fiscal and monetary policy fronts. According to the IMF’s latest World Economic Outlook (WEO) Update released last month, the global recovery is expected to continue but at an uneven pace and with the outlook being characterised by downside risks. While global growth is projected to rise from 3,2 per cent in 2013 to 3,4 per cent in this year and 4,0 per cent in 2015, the most recent forecast is weaker for 2014 than what was envisaged in the April 2014 WEO. Growth outcomes for advanced countries and emerging economies for this year have been revised downwards by 0,4 and 0,2 percentage points, respectively. Despite this downward revision, it is generally accepted that the growth momentum will continue, albeit at a lower and uneven pace. Thus, raising actual and potential output will remain a priority in policy circles in many economies for the foreseeable future. Growth in the advanced world has become dependent on monetary stimulus. Financial market developments, particularly asset price movements have reflected this stimulus injection. In general this has taken the form of equity purchases rather than green-field type investments, which has in effect limited the impetus to the economic growth momentum. An additional concern has been that debt levels in many countries have continued to rise against the backdrop of subdued long-term growth prospects. Debt-to-GDP ratios now average around 275 per cent in the advanced economies and approximately 175 in EMEs.1 As Jaime Caruana, the General Manager of the Bank for International Settlements, has recently noted, the surge in debt may have supported current demand, but its impact on future income and future demand is still very uncertain.2 The rise in debt makes borrowers more sensitive to tightening in the interest rate cycle. Despite the current concerns about global growth outcomes, there is evidence of self-sustaining recoveries in some of the major economies like the United States and the See BIS, 2014. 84th annual report, BIS (page 10). See Jaime Caruana, 2014. “Stepping out of the shadow of the crisis: three transitions for the world economy”, BIS (July). BIS central bankers’ speeches United Kingdom. It is now accepted that as growth recovers, policy makers in the advanced countries will start to unwind the exceptional monetary accommodation that is currently in place in these countries. This will inevitably lead to a tightening of financial conditions and higher global interest rates in the coming years. Swings in capital inflows could result in renewed bouts of turbulence in financial markets with consequent exchange rate pressures having significant adverse implications for economic outcomes in EMEs and the global economy. For example, the IMF in the most recent “2014 Spillover Report” released on 27 July 2014, estimates that an environment of sharply tighter financial conditions alongside a further weakening of emerging market growth could reduce global output by about 2 per cent. This has brought into sharper focus the future role of monetary policy. While there is no doubt that in the medium- to long-term price stability will remain the primary goal of monetary policy, lessons learnt from the crisis clearly point to the need to give broader financial stability more prominence. Policy makers around the world are grappling with finding ways of how best to define the future relationship between price stability, macro and micro-prudential policies. Recently, there has also been a renewed interest in policy coordination at the global level as a means of reducing or containing the potential adverse spillover effects of changes in the monetary policy stance of advanced economies. Governor Raghuram Rajan of the Reserve Bank of India has been at the forefront of such calls, suggesting that central banks in advanced countries should reinterpret their mandate to consider the international spillover effects of their domestic policy actions. His argument is that in the absence of global policy coordination and cooperation, EMEs may have to resort to less optimal policy options, which include implementing macro-prudential measures such as capital controls, and excessive reserve accumulation. The IMF has also acknowledged that national policies alone may not be sufficient to address the adverse spillover effects in the global economy.3 However, the nature and timing of such policy coordination is very much still an open question. This, in effect means that, while exogenous shocks are a distinct possibility, the nature and extent of these shocks are difficult to estimate and discern. International policy coordination, while clearly desirable, gets complicated by asynchronous monetary policies, which are informed by differing economic cycles. This is a challenge confronting monetary policy formulation and implementation in many EMEs currently, and is a reality we also face in South Africa. 2. Challenges and opportunities in South Africa’s monetary policy environment As you are aware, the SARB’s monetary policy mandate is executed within a flexible inflation targeting framework. In essence, this implies that when inflation expectations are under control the SARB will tolerate temporary breaches of the upper target band of 6 per cent in the interests of containing short-term fluctuations in economic growth. The 0,6 per cent contraction of the economy in the first quarter provided strong evidence of the impact of the protracted labour strike in the mining sector. While the end to the strike in the manufacturing sector which was announced at the end of July is to be welcomed, the impact of these strikes on the second quarter growth figures and over the longer-term are still to be ascertained. The recent Quarterly Labour Force Survey (QLFS) released by Statistics South Africa shows that the official unemployment rate has increased to 25,5 per cent from the 25,2 per cent registered for the first quarter of 2014. Of particular concern is the decline of 24 000 formal sector jobs and the increase in the number of unemployed to 5,2 million people which is the highest level since the inception of the QLFS in 2008. There is little doubt that job creation and reducing unemployment remains the single most important economic challenge confronting South African policy makers. IMF, 2014. Imf Multilateral Policy Report: 2014 Spillover Report, IMF, Washington (July 2014) BIS central bankers’ speeches The prospects for employment creation have also been adversely affected by the deterioration in the growth outlook. The Bank’s most recent forecast, published at the time of our last MPC meeting, is that economic growth will average 1,7 per cent for 2014. This is approximately 1 percentage point lower than what was envisaged at the beginning of the year. The growth forecasts for the next two years was also revised downwards by 0,2 percentage points to 3,1 per cent (2015) and 3,2 per cent (2016). There is little doubt that the envisaged growth outcomes of around 3 per cent over the next two years are insufficient to make meaningful inroads into the unemployment problem that we face in South Africa. The policy challenge is to enhance the growth potential of the South African economy. In this regard, attention needs to be given to removing the structural impediments in the economy, many of which have been identified in the National Development Plan. Government’s infrastructure plans and other measures such as those directed at enhancing education and skills, and supporting small and medium enterprises are some of the proposed initiatives that need to gain traction to enhance the growth and employment potential of the South African economy. It should also be pointed out that the South African economy can ill-afford a fractured labour relations environment, which increased the tensions that resulted in protracted strikes in the mining and manufacturing sectors. Both business and labour, with government facilitation, have a vital role to play to improve the labour relations environment in South Africa. The challenge remains for organisations like SACCI and other business associations together with labour, to find means and mechanisms to urgently and adequately address their concerns in such a way that the competitiveness of South African products on the international market is not compromised. It is important to bear in mind that monetary policy cannot address structural deficiencies in the economy and influence long-term growth. At best, monetary policy can smooth out fluctuations in growth over the short-term. Currently, the MPC’s policy dilemma has been compounded by CPI inflation breaching the upper end of the target range in the wake of a weak growth performance. CPI inflation on a year-on-year basis measured 6,6 per cent over the last two months. The food and transport components accounted for approximately 41 per cent of the headline inflation rate. The SARB’s forecast as contained in the MPC statement released in July 2014 shows inflation peaking at an average rate of 6,6 per cent in the fourth quarter of this year and returning to within the target band during the second quarter of 2015. Inflation is expected to average 6,3 per cent in 2014 and 5,9 per cent in 2015. There are indications that exchange rate impacts – particularly the lagged impacts from past depreciations – are starting to feed through into consumer price inflation. The MPC is of the view that the risks to the inflation forecast are skewed to the upside. Underlying inflationary pressures have increased. Core inflation, measured as headline inflation less food, petrol and energy, has increased to 5,6 per cent in June from an average rate of 5,1 per cent for the 2013 calendar year. The Bank’s projection is that core inflation will remain at elevated levels averaging around 5,7 per cent over the next year. This does not include the impact of the recent decision by the National Energy Regulator of South Africa (Nersa) to allow Eskom to recoup R7.8bn for the under-recoveries for the Multi-Year Price Determination period, 2010–2013. The impact of this decision on headline and core inflation will become clearer once Eskom announces how this amount will be recouped. Inflation expectations as reflected in the survey conducted by the Bureau for Economic Research at Stellenbosch University have been anchored at the upper end of the target band for some time now. The average expectations of financial analysts, the trade union officials and businesses are that inflation will average 6,1 per cent in 2014 and 2015 before declining to 5,9 per cent in 2016. However, trade union officials expect inflation to increase from an average 6,0 per cent in 2014 to 6,1 per cent in 2015 and 2016. On the other hand, businesses are of the view that inflation will average 6,2 per cent in 2014 and increase by an BIS central bankers’ speeches average 0,1 per cent in each of the next two years. With regard to expectations for wage settlements trade union officials indicated 7.6 per cent for both years, whereas business people expect 7.8 per cent for 2014 and 8% for 2015. Thus, the expectations of labour and business, the price-setting agents in the economy, are of concern – they are not only at uncomfortably high levels but, also outside the upper-end of the target band over the forecast horizon. A wage-price spiral would severely compromise South Africa’s inflation and growth outcomes. Thus, while inflationary pressures may not be of a demand-pull nature, secondround price effects from supply-side shocks need to be contained. The MPC has indicated that we are in a tightening phase of the interest rate cycle. While price stability remains the primary focus of monetary policy, the Bank has indicated that this objective will be pursued in a manner so that economic growth outcomes are not unduly undermined. As we explained in the July MPC statement, monetary policy is on a “gradual normalisation path”, which will be highly data-dependent. The SARB remains committed to its mandate of maintaining price stability in the interest of balanced and sustainable economic growth in South Africa. In this regard, it is important to note that despite the 75 basis point increase in the repo rate since the beginning of the year, the real repurchase rate is still marginally negative thus ensuring that monetary policy remains supportive of the domestic economy. 3. The new financial services regulatory regime in South Africa The great recession, which began in 2008 has shown that imbalances between the real and financial sectors of the economy could increase the vulnerability of the financial system. In addition, with hindsight, we now know that such vulnerabilities may not become evident solely through the supervision of individual institutions. For this reason, macro-prudential aspects of financial stability have gained traction in policy circles around the globe. South African policymakers have also engaged in a process of reviewing and revamping the regulation of the financial sector. In February 2011, the Minister of Finance announced that South Africa would be shifting to a “Twin Peaks” model of financial regulation. At the end of last year, the National Treasury published the draft Financial Sector Regulation Bill (Twin Peaks Bill), which provides some detail around the architecture of the Twin Peaks model. In terms of the Twin Peaks model, a Prudential Authority (PA) will be established within the SARB to oversee the safety and soundness of banks, insurers, financial conglomerates and key financial market infrastructures. The FSB will become the Market Conduct Authority (MCA) and will promote integrity and efficiency of financial markets in order to safeguard the interests of South African consumers of financial services. It goes without saying that co-ordination between the two regulators will be crucial to ensure the overall stability and robustness of the South African financial system. The exact date of Twin Peaks implementation will be finalised once the necessary legislative processes have taken place. It is envisaged that the Twin Peaks model of regulation will come into effect by the end of 2014 although this is dependent on the parliamentary process and the final enactment of the bill. While the enabling legislation for “Twin Peaks” is still in the process of being finalised, some of the support measures recently announced by the SARB for African Bank were informed by the principles contained in the G20/FSB Key Attributes for Effective Resolution Regimes, which are expected to feature in the new legislation. Allow me to make a brief comment about the measures announced by the SARB last Sunday. The legal structure of curatorship will facilitate an orderly, structured, and fair approach to addressing the current challenges at African Bank in an effort to secure a viable future on the basis of a transformed business model, while ensuring minimum disruption to our financial and credit markets. The proposed solutions were developed in a collaborative process between the public and private sector. The leadership and commitment shown by South African commercial banks and the PIC in BIS central bankers’ speeches underwriting the capital raising for the envisaged “good bank” bears testimony to the strong underpinnings of our banking and financial system, the resilience of which will be enhanced by these measures. Once the necessary legislation has been enacted, the current Financial Stability Committee (FSC) of the Bank, will be replaced by the Financial Stability Oversight Committee (FSOC). This committee will be chaired by the Governor with the membership of this committee comprising the SARB, the Financial Services Board (FSB) and National Treasury as an observer. The primary mandate of the FSOC will be to monitor and assess systemic risks to financial stability and make recommendations on how to counter or eliminate these risks. In the execution of its financial stability mandate, the Bank relies as far as possible on the efficient functioning of market forces to ensure the stability of the financial system. Thus, the Bank’s action will be guided by the principle of the containment of systemic risk. Given the large representation from the insurance industry in the audience today, I would like to briefly outline some of the regulatory changes confronting the insurance industry. As you are aware, some four years ago, the FSB and the South African insurance industry embarked on the Solvency Assessment and Management (SAM) project. This project is directed at establishing a risk-based supervisory regime for the prudential regulation of both long-term and short-term insurers in South Africa. In essence, the objective is to enhance the monitoring and management of risk so as to ensure that the capital requirements are appropriately aligned with the underlying risks of an insurer. Under the Twin Peaks regulatory regime, insurance regulation and supervision will be split between the Prudential Authority in the SARB and the MCA (FSB). The Prudential Authority will supervise financial soundness and the MCA will oversee the business conduct of insurers. The SARB is currently busy with undertaking the necessary preparations for taking over the prudential regulation of insurers and insurance groups. A Prudential Authority Implementation Working Group (PAIWG) has been established to guide the implementation process of the organisational structure of the Prudential Authority as well as to facilitate a smooth integration of supervisory staff from the FSB and the SARB into the Prudential Authority in due course. The intention is that the Prudential Authority will be able to effectively assume its responsibilities once the Twin Peaks legislation has been passed by parliament. 4. Conclusion Challenges abound for South African policymakers. An uncertain international economic environment, with the possibility of adverse exogenous shocks may very well, be par for the course. While there may be little that can be done to insulate the economy from uncertain exogenous shocks, there are important domestic impediments that warrant attention. Government, business and labour have an important role to play in addressing these problems. These challenges become a little easier to address against the backdrop of a stable macro-economic environment characterised by price and financial stability. The SARB remains committed to playing a constructive role in this regard within its mandate. Thank you. BIS central bankers’ speeches
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Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Dinner in Honour of Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 2 October 2014.
Gill Marcus: Outlook for the South African economy against the background of global economic developments Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Dinner in Honour of Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 2 October 2014. * * * Your Excellencies, Ambassadors, High Commissioners, Counsels and Diplomats, good evening. Thank you for kindly accepting our invitation to this dinner, which is becoming a firm feature of the annual diplomatic calendar. We live in an interconnected world, and the lessons of the past few years show the need for cooperation and collaboration. The global financial crisis impacted in some way on most economies, and we are still feeling the effects as the recovery continues in a hesitant manner. And the nature of the recovery in smaller economies such as South Africa is shaped, to an important degree, by the speed and nature of the recovery in advanced economies. This evening I will give a brief overview of how we see the global economy evolving and then focus on the outlook for the South African economy in the challenging global and domestic context. For some regions in the world, the past year has been better than the previous one, though the recovery is far from assured or complete. The United States is projected to grow strongly, especially in the second half of this year. After gaining momentum for several quarters, Japan’s growth seems to have faltered. China has been able to maintain growth above 7 per cent despite a significant economic and political transition. The UK economy is accelerating, with unemployment rates continuing to fall. Growth has improved in India, buoyed by a new optimism since the elections. Despite lower commodity prices, growth on the African continent remains robust. Most emerging markets have weathered the turbulence caused first by “taper talk” and then by actual tapering, which is likely to conclude this month. The Eurozone is the key exception. Peripheral Europe is experiencing positive growth, albeit at a low level. The Germany economy, however, contracted in the second quarter while growth in France remained at around zero. The Eurozone remains a significant market for South African exports. Low European inflation and the risk of deflation point to weak potential GDP growth with structurally weak demand across the monetary union. After a period of relative calm in financial markets, volatility has increased recently, with the key trends being the strength of the US dollar, a weakening Euro and lower commodity prices. Considerable risks and imbalances in the global economy remain and policy makers have to remain vigilant. It is highly likely that, after a long period of a synchronised downturn in the economic performance of advanced economies, next year will be characterised by an asynchronised recovery. The US economy appears to be in the advanced stages of repair with a declining degree of slack in the labour market. While there is uncertainty about the pace at which discouraged jobseekers will return to work, there is optimism that wage and income growth will return in the course of the next year. US corporate investment is rising and the fiscal metrics look better than last year. The UK is in a similar situation, perhaps even more advanced in their recovery, evident in falling unemployment and rising productivity. It is quite likely that these two economies will begin tightening monetary policy in the first half of 2015 and while the rates normalisation process is likely to be gradual and prolonged, given continued fragility in the global economy, interest rates are likely to be on their way up. The monetary policy situation in the Eurozone is vastly different. Persistently low inflation threatens to unhinge long term inflation expectations, increasing the likelihood of deflation. Europe’s leaders recognise that higher inflation, on average, is critical to enable the economic adjustment process in peripheral Europe to continue. Last month the ECB reduced their key policy rate to 0.05 per cent and took their bank deposit rate further into negative BIS central bankers’ speeches territory. A commitment to purchase asset-backed securities from the commercial banks, designed to stimulate bank lending, was also announced. Furthermore, the ECB made it clear that if these measures did not work, they would consider more generalised quantitative easing, including the purchase of government bonds. Even though Japanese inflation is at a five year high, long term inflation expectations in Japan remain low and hence policy makers are unlikely to withdraw the current monetary policy stimulus. There is rising confidence that China’s transition away from investment and exports towards domestic consumption will be managed smoothly. Risks in the housing market and related risks in the shadow banking sector remain a concern but, to date, the authorities have managed the adjustment without significant negative shocks. China’s adjustment process does have a dampening effect on commodity prices, which impacts many emerging markets including those in sub-Saharan Africa. However, the possibility of higher Chinese consumption could provide a boost for the world economy over the longer term. Foreign investment on the African continent is diversifying towards sectors outside of mining and oil. Investment in infrastructure, housing, retail, banking, telecoms and tourism continues to accelerate, sustaining growth rates in most sub-Saharan African countries. In the year ahead global financial market conditions, in other words global liquidity, are likely to become more challenging. This should, however, be offset by improving growth prospects in the real economy. Countries with sound fiscal and monetary positions and those with higher savings rates are likely to benefit from this complex interplay of rising interest rates and improving economic performance in advanced economies. In this complex milieu, South Africa’s economic performance is disappointing. Projected GDP growth of 1.5 per cent this year will mark the fourth consecutive year of slowing growth. Global factors, in particular falling commodity prices and declining global liquidity, are contributing to our below par performance. Furthermore, lower demand for commodities from China and slow growth in Europe, our major trading partner, have affected our export performance. However, in the main, the reasons for our slow growth are domestic. The five month-long strike in the platinum sector, followed by a month-long strike in the iron and steel industry, resulted in negative spill-over effects for the entire economy. These two strikes reduced manufacturing output and depressed household consumption, which negatively impacted on the performance of retailers, contributing to the downward revision to our growth forecast. Strikes are not usually a macroeconomic issue. They tend to occur every few years and are generally settled peacefully and speedily. But in the past two years strikes appear to be longer and more violent, with an apparent breakdown in the tried and tested dispute resolution processes contained in our labour relations regime. Without assigning blame to any party for this breakdown, a fraught labour relations environment cannot be consistent with policies aimed at growing labour intensive sectors of the economy. Of particular concern are high salary settlements that are out of kilter with inflation and productivity growth. Firms often adjust to such salary increases by reducing staff numbers. About 48 000 jobs have been shed in the mining sector in the past two years and more mining companies have announced plans to reduce staff numbers. Similarly, in the past few months, the media have reported on planned retrenchments by MTN, Telkom and Ellerines. In a country with an unemployment rate of 25.5 percent, this trend has to be of concern to policy makers. The second immediate constraint on the economy has been electricity supply. Electricity production has been flat for almost six years. While energy efficiency has enabled many firms and households to continue operating with less electricity, many sectors of the economy have had to curb production. Affected sectors include construction, mineral beneficiation and manufacturing. While South Africa has successfully brought about 160 mW of renewable energy into the grid, this boost is too small to make a difference to the BIS central bankers’ speeches aggregate capacity. The National Treasury estimates that electricity shortages have cost the economy about half a percentage point of growth a year, with this figure possibly being higher in 2014. These two features, labour disputes and electricity shortages, have contributed to low levels of business confidence and investment, both of which are impacted upon by perceived policy uncertainty, particularly in areas such as mining and agriculture. Firms are reluctant to invest because they are uncertain about future demand and labour and energy costs. In turn, consumer demand is weak because firms are not investing and employment is not growing. Generally, governments break this cycle through higher public investment spending. South Africa is in the midst of a major public investment programme, focused largely on energy and freight logistics capacity. Despite positive growth in public investment, it has not been sufficient either to crowd in private investment or to lift the aggregate employment picture. In the 2nd quarter of 2014, private sector investment growth was negative for the first time since 2009. At the same time as the economy has been performing poorly the central bank has had to contend with rising inflation. Inflation was above our target range of 3 to 6 per cent for one quarter in 2013 and has been outside the range since March this year. This combination of slowing growth and rising inflation is a difficult one for central banks to manage. The picture is complicated by the fact that normally, when growth slows, imports slow, reducing the current account deficit. This time, despite slower growth, imports remain sticky. And despite an exchange rate depreciation of almost 40 per cent since 2012, export performance has remained weak. This implies that South Africa still has a large foreign financing requirement at a time when global interest rates are rising and confidence in the domestic economy is sub-optimal. Theories as to why exports have not done better given the weaker exchange rate range from poor European growth and slower demand from China to more fundamental competitiveness and structural problems in the South African economy. The reality is that both weaker growth in our key markets and faltering competitiveness in key export sectors are impacting on South African exports. The main driver of higher inflation has been the effects of currency depreciation, which in turn is due to lower commodity prices and changing monetary conditions. Secondly, higher food prices have contributed to higher inflation in 2014. While the pass through from the weaker exchange rate into generalised inflation has been more muted than in previous episodes of depreciation, there is evidence of second round effects and the Bank has expressed its concern about rising salary expectations and a wage-price spiral. The Bank raised interest rates by 50 basis points in January this year and by 25 basis points in July. Notwithstanding these increases, the policy interest rate remains close to zero in real terms. Monetary policy remains accommodative, cognisant of the weak real economy. Going forward, it is possible that inflation will return to within the target range in the first quarter of 2015, but is likely to remain close to the top of the band. Also of concern is that core inflation is rising towards the top of the target range. Upside risks to inflation include higher electricity prices, rising wages and further depreciation of the exchange rate, which could be sensitive to changes in US interest rates. The Bank has repeated that while monetary policy can be supportive of growth in the shortterm, higher trend growth requires a range of economic reforms including faster public infrastructure spending, better quality education and more effective dispute resolution mechanisms in the labour market. It is not within the realm of monetary policy alone to deal with the myriad of challenges confronting the economy. Unrealistic expectations or demanding too much from monetary policy is likely to end in a loss of policy credibility. At the same time, monetary policy should be as supportive of growth as is possible, inflation permitting. Indeed our monetary policy has remained highly accommodative, notwithstanding significant price pressures. BIS central bankers’ speeches This year saw the first significant banking failure in almost a decade. The South African Reserve Bank intervened to manage the failure of African Bank, first through requesting the Minister of Finance to place African Bank under curatorship and secondly by putting in place a package of measures that are in keeping with the Financial Stability Board’s key attributes, aimed at enabling the institution to continue to operate and to serve its customers, which it is continuing to do. The Reserve Bank acted quickly to prevent contagion to the rest of the banking sector. Not only is South Africa’s banking sector healthy, but all the major players are liquid and well capitalised. So far, we have not seen any significant adverse effects of the difficulties at African Bank on the broader financial markets or the economy, though we remain vigilant. The challenges posed by African Bank’s failure raises several policy questions that are of relevance for many countries in the world. How do we define financial inclusion in a developing country context? For many, financial inclusion refers to the ability to access credit. While access to credit is important, surely financial inclusion should also focus on enabling poor households to accumulate assets, transact efficiently and insure against the normal risks associated with everyday life. South Africa will continue to take steps to promote financial inclusion but we will not tolerate unhealthy lending practices or excessive risk-taking in the financial sector. The second policy challenge that African Bank has brought to the fore is the degree to which the financial sector and the banking system in particular is interconnected and interdependent. This is a difficult balance to strike because, from an individual bank or company perspective, inter-dependencies reduce risk. However, from a system perspective, interdependencies increase risk. We all have much to learn about how we promote financial deepening and integration but protect the system against systemic risk. As a reflection of our commitment to enhance a sound and effective financial sector, and learn from the global crisis, South Africa’s adoption of a “twin peaks” regulatory framework will be formalised in the course of the next year, with legislation setting out the roles and responsibilities of all parties in the financial regulatory architecture. This legislation draws on both international and our own experiences, creating a Prudential Authority with the Bank, and a Market Conduct Authority that will take the place of the Financial Services Board. In conclusion, the world economy is in a better position than a year ago, but the crisis is not over and significant risks remain. Global trade is rising, after stagnating for several years. Notwithstanding a withdrawal of liquidity in some advanced economies, financial flows continue to impact on emerging markets. 2014 flows to South Africa have been volatile and at an elevated price, with September seeing significant outflows such that year to date flows are negative at some R22bn. Experts are beginning to talk about prices of several commodities reaching the bottom, with the potential for a period of either stability or modest price increases going forward. These trends should support growth going forward in subSaharan Africa, particularly given the significant discoveries of oil and gas. On the other hand, geopolitical factors continue to affect growth in Europe, the Middle East and North Africa. The keenly contested Scottish independence referendum also affected market sentiment, and the political ramifications will not simply disappear even though the outcome was a victory for the “no” vote. The Ebola outbreak in West Africa will affect regional GDP growth, trade and air travel. In many countries around the world, job losses incurred during the financial crisis are likely to turn into permanent decreases in productive capacity. Global unemployment and particularly youth unemployment is still unacceptably high in almost every region in the world. South Africa remains concerned that, whereas the world came together in 2008–09 in a coordinated response to the global financial crisis, policy today is more inwardly focused and disparate, rather than coordinated and coherent. The world economy still needs a high level of cooperation and partnership in order to complete the recovery process. We still need joint activity to ensure faster growth. BIS central bankers’ speeches Our responsibilities, as leaders of our respective countries, are not just price or financial stability. While these elements are important, our collective objective is for higher economic growth, shared prosperity, greater opportunities and a better life for all our citizens. And given the prevailing economic outlook and risks, it is incumbent on all of us to get our own houses in order, take the tough decisions, make the necessary trade-offs and work together. The effort this year in the G20, under Australia’s able presidency, to increase collective growth by an additional 2 percentage points by 2018 is a good example of the kinds of measures that we need. Honourable guests, the South African Reserve Bank is proud of our track record in engaging with our citizens and other stakeholders, both local and foreign. We will continue to deepen our engagements in order to be part of a global movement for shared prosperity. You know, but we wish to repeat, that we are open to interaction and conversation with you and look forward to continued collaboration and cooperation as we work together for a shared future. As all of you know, my term as governor ends in a few weeks’ time. I would like to thank the diplomatic community for the support and cooperation that you have given, not just to me, but to the South African Reserve Bank and to South Africa in general. This singular honour, to serve as governor of the South African Reserve Bank, has enabled me to serve my country, and form friendships and ties across the world; ties that I will maintain long into the future. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the RMB Morgan Stanley 2014 Big Five Investor Conference, Cape Town, 30 September 2014.
Lesetja Kganyago: South African monetary policy and the path to normalisation Address by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the RMB Morgan Stanley 2014 Big Five Investor Conference, Cape Town, 30 September 2014. * 1. * * Introduction and context Global economic rhythms remain disturbed and economic policies of major advanced economies are moving in different directions. Much of the emerging market universe is experiencing weak economic growth and higher than comfortable inflation. US policy is slowly normalising, while Europe is taking strong remedial action in an attempt to address extremely low inflation and a protracted recession. These developments, and others, will continue to affect South Africa and test our policies. This has already been a challenging year for the Reserve Bank. We have seen a sustained breach of the inflation target. We have raised policy rates for the first time since 2008. Output contracted for the first time since the crisis. In August, African Bank was placed under curatorship. Confidence in the economy is currently weak, and all else equal, will tend to put upward pressure on inflation rates as households and firms seek price increases as a way to improve their finances. Stubborn inflation persists in South Africa in part because of this, and we need to be clear as a society that a spiral of wage-price inflation cannot substitute for productivity growth as a way to improve our incomes. We need low inflation, as a protection of the living standards of the poorest among us, to support access to finance, for financial stability – and as a means of safeguarding our competitiveness and encouraging investment and job creation. At present it is important to conserve and move to rebuild policy space, and facilitate macroeconomic adjustment away from our persistent and large current account deficit. This should be achieved by increasing exports, investment and saving, and more moderate consumption of imported goods as spending rises. Higher inflation and large twin deficits are undesirable and unsustainable. A moderation in imbalances will support sustainable longterm investment by reducing long-term costs of capital and improving confidence, enabling the economy to grow and create the jobs we need. Policy normalisation in the US will occur in a global environment that is slowly improving and which will require higher global interest rates. Our monetary policy stance will need to evolve in line with domestic priorities and take into account pressures exerted by international policy normalisation. A normalisation cycle will support the moderation in inflation that we seek to achieve and to assist in correcting macroeconomic imbalances. We can also expect, however, that normalisation will generate volatility in the short-term. Our policy framework allows for most of the volatility to remain in the foreign currency market, thereby enhancing stability in the real economy. Further dampening of volatility can be achieved by ensuring effective policy communication across monetary and fiscal domains. We have in place the right kind of macroeconomic policy framework to facilitate the adjustment to external and internal shocks, both those hitting us now and those we will experience in future. This policy framework enables policy makers and investors to see through near term volatility, keeping policy rates and adjustments minimal and efficient, and economic fundamentals more stable. This is critical to enabling public and private sector actors to keep their eyes on the real economy backdrop – the improvement in global BIS central bankers’ speeches conditions – and seek ways to strengthen our ability to take advantage of it through rising investment. Before I discuss SA policy normalisation, let me first say a few words about the global economy and its effects on South African conditions. 2. US policy normalisation The US economy has achieved critically important gains over the past year. Unemployment has fallen faster than expected and is now approaching its natural level. The budget deficit has fallen steeply since the crisis and fiscal policy has also become more predictable. New estimates of future health care costs from the CBO (US Congressional Budget Office) suggest long run fiscal prospects are much rosier than previously thought. Technology and resources, particularly the shale boom, have provided new sources of economic growth, perhaps enabling a further permanent improvement in the US trade deficit and balance of payments. Inflation to accelerate Certainly, we stand at the beginning of a long path to normalisation of US policy. But the pace of normalisation is less certain and will depend on data and how the Federal Reserve interprets inflationary pressures and the economic recovery. The productivity enhancing effects of shale oil developments will tend to weigh against rising inflation in the US. But this structural downward force on inflation may be offset by the decline in the US labour force participation rate. So far, we have seen unemployment fall sharply without generating sustained inflationary pressures. If the decline in the labour force participation rate is permanent, then, as GDP rises, there will be greater pressure on wages and prices – with falling participation the labour market tightens more quickly. Other longer term factors, like less immigration and the on-going re-pricing of labour costs in China, will also tend to give impetus to global and US inflation. It is also possible however that substantial slack remains in the US labour market. As GDP rises many discouraged workers will return to work, and part-time workers will get more hours, before we see wages and inflation rise. This is one crucial problem for the US policymakers. Another is how much inflation to accept before feeling secure enough in the recovery to raise rates. Understandably, the Fed will be reluctant to throttle an infant recovery with premature tightening. The US policy response We might conclude that it seems unlikely that the US Fed will allow inflation to rise too strongly as the real economy recovers. After all, the success of counter-cyclical fiscal and monetary efforts has depended in large part on the willingness of domestic and foreign economic agents to finance the US deficit and rise in public debt. Allowing inflation to erode the value of the debt and the income payments associated with it would undermine the effectiveness of future counter-cyclical policy efforts. These thoughts suggest that a reasonable baseline view is that as the US recovery continues, on balance inflationary pressures should creep up. Policy will respond, via a commensurate tightening from the zero lower bound over the medium term, and also through sustained fiscal deficit reduction. Smaller fiscal deficits, higher interest rates, and strong economic growth should generate a sustained rise in the US dollar against other currencies – including the rand. All things equal, US normalisation will require corresponding policy shifts in South Africa, including higher local interest rates. These predictions are reliable, but specifying just when they will be validated is harder. Will the first rate increase in the US come in mid-2015? A few months later? Will policy tighten at every meeting, and in what increments? Will markets understand the signals sent by the BIS central bankers’ speeches Fed? These uncertainties will probably generate bouts of volatility, which in turn might be misread as a trend reversal or strengthening. One possibility is of a further gradual weakening in the rand as clarity about US normalisation emerges incrementally. Another possibility is of step changes, in which markets react most strongly to occasional clear policy signals and adjust expectations of forward values for the rand and interest rates in larger discrete movements. 3. Baseline complexities This baseline for the US economy, which promises economic recovery and policy normalisation, is clouded by developments in Europe, Japan, China and much of the rest of the emerging market universe. Japan In Japan, the sustainability of the effort to push up inflation and re-ignite growth seems to be in question, in large part because of the futility of trying to use macroeconomic policy alone to address structural features of a complicated socio-economy. The three arrows strategy is currently a one arrow strategy, with structural reforms still missing and the second quarter tax hike lowering growth. The pre-tax consumption boom was more than cancelled out by the post-tax slump, leaving the Japanese economy at mid-year smaller than it was at the end of 2013. The world’s third largest economy continues to struggle for the kind of sustained growth rates that have eluded it for almost a generation. Emerging markets Emerging market economies bounced back quickly from the Great Recession, prompting much talk of decoupling from the advanced economies. Since 2010, however, growth has trended persistently lower, to the point where we now sit with a generalised EM slowdown. Meanwhile, China aside, the average large EM has experienced rising inflation and an expanding current account deficit, with monetary policy moving in the direction of tightening. The lesson is that EMs have not decoupled; instead, many of the biggest emerging markets have been contributing to global demand, using up policy space, and slowing for a lack of world growth. Now they must rebalance and restructure to ensure economic stability. What role will China play in our fortunes? We know that policymakers are trying to find a path between keeping growth strong and rebalancing away from investments and exports. We really don’t know how this process will affect us. South Africa’s terms of trade have softened by just over 6% since 2011 as commodity prices have weakened, but they remain at historically elevated levels. 1 How much further could they fall, and what impact will softer prices have on volumes demanded? Evidence suggests that iron ore, coal and other exporters cannot rely on high prices to keep profits up, but this doesn’t mean a collapse in volumes. To take one example, production of iron ore increased 114%, in volume terms, between 2005 to 2014. 2 It is hard to imagine a scenario in which these volumes collapse, although it is easy to see that firms will need to restructure to remain profitable with lower prices. The price effects of commodity prices falling in USD terms have been offset in rand terms by currency depreciation, but we should be careful about extrapolating further when structural factors supporting high volumes remain intact. Terms of trade, including gold, weakened 6.3% from 2011Q1 to 2014Q2. Excluding gold, the decrease is 7%. Physical volume production, iron, 2005Q1 to 2014Q2. BIS central bankers’ speeches It is also worth noting that South Africa’s export markets continue to shift. In particular, the African market is becoming much more important for us. 3 Europe The trajectory of Europe remains an important determinant of global macroeconomic conditions and for South African outcomes. In recent years, weakness in the European economy has meant that there have been few real benefits to SA despite major rand depreciation against the Euro. 4 As with the United States, we appear to be witnessing a seachange in European policy – although this could not possibly be described as normalisation. The question for South African monetary policy is whether these changes will offset US normalisation, fully, partially, or not at all. From a real economy perspective, a sustainably growing Europe is crucial, but this may take considerable time to materialise. It is very hard to imagine Europe returning to growth with its current institutional configuration and policy settings. The contradictions are too overwhelming. Household consumption and investment across Euro Area has and will remain weak so long as banks remain in financial distress and property values and the housing markets are depressed. Europe’s financial sector needs a clearing out of bad debt. The emphasis on fiscal austerity – clearly correct for over-indebted sovereigns – would, cumulated across Europe, weigh too heavily on growth in the absence of any other demand stimulus and an exuberantly strong currency. Germany has stood out for its strong growth in the midst of stagnation by its neighbours, but its longer-term interests cannot be served by endless stagnation in the euro area. The country seems too integral to the rest of Europe, via positive and negative spillovers, to continue indefinitely on a real depreciation-based economic strategy. It cannot declare independence from Europe. Rather, Europeans probably need to think of themselves less like we do these days – less as small open economies subjected to the vagaries of currency fluctuations and capital flows – and more like a continental super-economy if the region as a whole is to prosper. It is, perhaps, out of recognition that the old “normal” cannot go on that the ECB has moved resolutely in the direction of encouraging more coherence in Euro Area macroeconomic policy. As Europe’s inflation rate has declined, the ECB has begun urging governments to consider some easing of budget consolidation while expanding its own monetary easing programme. And the President of the ECB has emphasised that this must be accompanied by structural reforms, which would pay off now as well as later if they could be locked in alongside policy easing. This may create confidence that European governments understand their challenges and have the will to address them. The impact of ECB policy easing should be to sustain a depreciation of the Euro against the USD, both nominal and real. Cees Bruggemans has reminded us recently that when the US dollar and Euro change directions, they do so much more than analysts tend to realise and over significant time frames. 5 According to DTI data, the African share as a per cent of SA’s total trade with the world increased from 11.4% in 2007 to 19.8% in 2013. Between 2011 and August 2014, the rand depreciated by 29.7% against the Euro (compared to 32.6%% to the USD). Cees Bruggemans, “Dollar & Euro part ways,” Rex Column, 8 September 2014. BIS central bankers’ speeches As the Fed’s purchases of mortgage backed securities dwindle to nothing, the ECB will buy about 1 trillion Euros, returning its balance sheet to 2012 levels. 6 It will also buy asset backed securities. The impact of this on the rand will be to encourage depreciation against the US dollar and some appreciation against the Euro, but the net effect on the Rand’s nominal effective exchange rate will also be affected by commodity price trends. We don’t expect that the ECB’s easing programme will offset normalisation on a one for one basis. It may delay or slow the process, drawing out the global normalisation process. 4. South African monetary policy Fortunately, the direct implications of normalisation for South African policy settings at this point in time are reasonably straight-forward. Rising global interest rates will put downward pressure on the value of the currency, at least in the short term, and push up interest rates. The less responsive short term rates are to this upward pressure, and the stronger the buildup of inflationary pressures in the wake of depreciation, the steeper the yield curve is likely to get. Long-term borrowing costs will take the burden of slow policy responses to a widening interest differential and currency weakness. The real economy effects of being behind the curve with short rates will be relatively small in the near term, but working against the longer term direction I think we want to go. Lower short rates might generate somewhat more near term consumption growth for less investment growth in the longer-run. But this is a poor trade-off for us to make and one we cannot exploit. With rising inflation, more policy accommodation would significantly increase the risk of a sell-off of rand assets and pre-emptively push market interest rates across the yield curve higher than they should be given our fundamentals. Economic growth Certainly our growth and employment outcomes have been poor. After 3.0% growth in 2011 and 2.5% in 2012, the outcome for 2013 was desultory and 2014 is proving as bad. Protracted strikes have had serious economic consequences; the platinum strike is estimated to have directly and indirectly reduced annualised quarterly GDP growth by 1.6 percentage points. Up to 2011, South Africa has benefited from a sustained positive demand shock caused by a rising terms of trade. As China’s economy has cooled, the deflating commodity price bubble has generated a significant negative demand shock as the terms of trade declined by 6.7% since 2011 (and 9.4% since Q4 2010). But can we say this has much to do with monetary policy settings? Our real interest rates have averaged around –0.5% since 2009, reflecting accommodative monetary conditions. Meanwhile, household spending has slowed amid 7 greater emphasis on working down household debt levels. Lower nominal interest rates have increased cash flow to households and this is going in part to debt service and debt reduction rather than consumption and taking on new debt. This makes sense – future expected real growth in income is low relative to future potential interest payments on new debt. Improving household balance sheets will create space for future consumption growth. 8 But there are limits here too – low rates don’t The ECB is expected to auction nearly €400 billion in 2014, with €174 billion in September and €167 billion in October. An asset backed securities purchase programme will be articulated in October. With expected repayments, the 1 trillion Euros will end up resulting in roughly a 600 to 650 billion Euro rise in ECB assets. The rules of the purchases suggest that this will help to lock in low rates until some time in 2016. HCE grew by 4.9% in 2011, down to 2.6% in 2013 and about 1.7% average for Q1 and Q2 2014. Debt service cost to disposable income: 12.5% in 2008; 7.9% in 2014. BIS central bankers’ speeches encourage households to reduce debt levels faster neither do they impose a penalty on government borrowing, to speed up the process of shedding excess debt. More broadly, this debt constraint continues to have implications for economic growth. With the stock of household and public debt remaining high relative to historic norms, there is insufficient domestic investment or productivity growth, or exports, to offset the slower consumption growth attributable to our weaker terms of trade and over indebted households. 9 Low rates are also not doing much for investment in fixed capital, with gross fixed capital formation growing by just under half the pace of the 2000s and a third of the rate achieved in the six years before the crisis. 10 Of course the stronger rise in loans and advances to firms seen in 2014 so far is welcome. But we have some distance to go before we move beyond the minimal investment in productive capacity we have seen in recent years. This suggests that future growth in the economy will be handicapped unless investment becomes much stronger. For many years we took the view that the economy’s potential growth rate hovered somewhere around 4 percent. This was optimistic. Our current estimates suggest that it could be considerably lower, in part because we overestimated historical growth and in part because of the effects of the economic slowdown. Negative supply shocks explain some good part of our lower potential growth. One recent shock was the strikes I referred to earlier. Another more distant shock was the sharp rise in unit labour costs that occurred in 2008 and 2009 just as the global crisis hit. These factors have also dragged down confidence. Reversing negative supply shocks will be an important part of achieving better growth rates and reducing macroeconomic imbalances. But the role of monetary policy is limited – for instance, having no impact on building additional electricity production capacity. However, inflation differentials and cost differentials with the rest of the world continue to weigh heavily on South African competitiveness. The exchange rate has supported domestic producers, with the nominal effective rate falling 36% from the end of 2010 and the real effective rate falling 20%. But if we measure our competitiveness by unit labour costs, say against the US dollar, SA has about 20% more real depreciation to claw back. 11 Monetary policy can – by being credible and focused on the right target – reduce the extent to which domestic inflation appreciates the real exchange rate and erodes competitiveness. When a domestic real cost shock hits, the currency needs to adjust to offset the real impact, but we don’t want the currency reaction to set off an inflation spiral or entrench higher inflation expectations. With this in mind, the Monetary Policy Committee has closely monitored the trend rise in core inflation, unit labour costs, and producer prices and how rand movements interact with them. It is important that real depreciation is not offset by future upward spikes in unit labour costs or a sustained upward trend in core and consumer price inflation. Currency weakness has contributed to the sustained rise in inflation since mid-2013. Headline consumer price inflation has led this rise, drifting up from 5.0% in 2011 to 6.6% in June this year before moderating to 6.3% for July. Core consumer price inflation, excluding food, NAB, and petrol, has risen from 4.0% in 2011 to 5.3% in 2013 and 5.7% as of July 2014. Household debt to disposable income: 82.4% peak in 2008; 75.2% in 2013; 73.5% Q2 2014. Real growth rates have been just over 4% for 2011–12–13, after negative growth in 2009 and 2010. The average for the whole of the 2000s is 7.9%. SA unit labour costs have risen by about 57% since 2008, compared to 4% in the US. BIS central bankers’ speeches Other factors have weighed against the rise in consumer prices and core inflation, in particular the sharp fall in international food prices through the latter half of 2013 and the renewed deceleration in food prices we are seeing at present. But these exogenously-driven movements in food prices are only slowly impacting on core and headline inflation. We expect headline CPI to average 6.2% in the fourth quarter of 2014. The forecast for 2015 is 5.7%; for 2016 it is 5.8%. This is much higher than our main trading partners. China is 3%, the US at 1.4%, the euro area at 0.9%, the UK at 1.9%. 12 This suggests reasons for the buoyancy of our current account deficit despite what appears to be significant real exchange rate depreciation since 2011. The deficit, in turn, heightens our vulnerability to shocks, as we saw in May 2013 and again this month, when we published the information that the current account deficit for the second quarter was 6.2% of GDP. South Africa needs rebalancing, and this will be aided both by the moderation of policy stimulus, which often generates import-intensive demand, and the weaker currency, which makes foreign goods and services less attractive relative to locally-produced ones. Financial stability Finally, we should consider the implications of monetary policy developments for financial stability. The decision to put African Bank under curatorship was not a signal of concern with a weak banking system. It was a specific intervention targeted at idiosyncratic risks emanating from a small bank (which accounts for about 1.2% of total banking sector assets) emanating from its unique, undiversified and as such unsustainable business model. Critically, the terms of the curatorship as announced by the Governor on 10 August are designed to ensure that the bank remains open for business, preventing an abrupt halt to credit extension to the important segment of the market (low income earners) which African Bank serves. Such credit extension, however, is now done on much sustainable terms, given the need to improve asset quality in the banking book of the “good bank”. Given the isolated nature of the intervention, and the uniqueness of African Bank’s previous business model, the concern that higher rates will impose an unbearable burden on borrowers, with dire consequences for lenders in general is overstated. Most clients of African Bank had fixed rate loans. For the rest of South African borrowers, interest rates are rising slowly from very low levels, giving borrowers and lenders plenty of warning and space, as well as incentives, to improve their balance sheets. 5. Conclusion In 2003, the Nobel-prize winning economist Robert Lucas published an article in the American Economic Review entitled “Macroeconomic Priorities”. It was elegant, compelling, and a terrible prophecy. He argued that further attempts to smooth out the business cycle weren’t much use, because fluctuations in economic activity just didn’t cost much. Instead, the priority should be growth, because over the longer run that meant vastly more wealth. Naturally, the Great Recession devastated this argument. Lucas was not entirely right: there was still an awful lot to be learnt about depression-fighting and high costs to getting it wrong. And yet, we may perhaps have learnt the lesson too well, and focussed too much on demand management and smoothing economic fluctuations. Today, there is little policy space left to boost demand, and it is surprisingly hard even to specify where we are in the business cycle. We should take this as an invitation to shift our focus. The greater problem is not getting the These are 2014 averages from the IMF. 2015 is China 3%, US 1.6%, EA 1.2%, UK 1.9%. 2016 is China 3%, US 1.8%, EA 1.3%, UK 1.9%. BIS central bankers’ speeches output gap to zero, it is raising the economy’s growth rate. We used to think potential growth was close to 4%, and more with brave reforms. The IMF suggests it is about 2 to 2.5% and we fall short of that. We need to reorient households, firms and investors on longer-term targets, and to be clear about the policy settings needed to achieve them. The contribution from monetary policy is threefold: First, sensible and sustainable monetary policies (as well as fiscal policies) support the availability of capital for growth in South Africa, which is crucial to ameliorate our chronic lack of savings. Global financing conditions have remained benign since 2010, but as part of normalisation we should expect rising global yields ratcheting up our own borrowing costs. It is important that we seek to minimise this where possible. The more money we spend on schools and roads, and the less on paying interest, the better. It is also important that we avoid taking an overly-mechanical or short-term view of the impact of rising rates. Ultra-low world rates were the right policy response to a global economic catastrophe; rising rates are a sign of a healthier world economy, which will help to realign investment decisions around long-term growth prospects. Second, we need the exchange rate to play its part as a dependable buffer for the real economy in the face of international financial and economic shocks. With our terms of trade easing, a large current account deficit, and the global recovery firming up only incrementally, currency depreciation helps improve the balance of payments in a market-friendly way, sending the right incentives to exporters, importers and import-competing industries. Macroeconomic adjustment should and needs to occur in the direction of more exports, investment and saving, and less consumption. Meanwhile, credible monetary policy – moving back within the inflation target – will help moderate volatility and facilitate SA’s adjustment to US policy normalisation. Third, we need to be competitive, which in part means ensuring inflation does not price South African goods and services out of world markets. Monetary policy must retain and strengthen its focus on inflation. In doing so, we will push the envelope of transparency and clarity wherever possible; to help ensure that inflation expectations do not drift from the target. My concluding message to you is that we must keep our eyes on our goal: to get South Africa growing again, to create jobs, to restore our macroeconomic balances, and deliver meaningful transformation. 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 South Africa Tomorrow Investor Conference, New York City, 8 October 2014.
Daniel Mminele: South Africa’s monetary policy, developments, challenges and the road ahead Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the South Africa Tomorrow Investor Conference, New York City, 8 October 2014. * * * Introduction Good morning Honourable Minister Nene, Ambassador Rasool, the SA Consul-General in New York, Mr Monyemangene, ladies and gentlemen. Thank you to the Johannesburg Stock Exchange, UBS and Standard Bank, and the South African National Treasury for organising this second South Africa Tomorrow Investor Conference and creating an opportunity for us to interact as policy makers, business leaders and investors. We meet at a time when global financial markets are increasingly focusing on the consequences of eventual monetary policy normalisation in the world’s major economies, and emerging countries with large and liquid financial markets, like South Africa, come under the spotlight once again. At the inaugural South Africa Tomorrow Conference last year, I was able to take stock of the major economic and financial market developments that had occurred in South Africa in the twenty years since the advent of democracy. In particular, I focused on the recovery in economic growth in the decade leading up to the 2008 financial crisis, the structural changes the economy has undergone, and the growth and deepening sophistication of our financial markets. Despite the challenges which the country is currently facing, these achievements, among which was the early establishment of macro-economic policy credibility, are still being built upon, and the National Development Plan (NDP) which Minister Nene has just talked about in detail, provides a framework for ensuring further progress towards a more successful and fair economy. Yet at present, a lot of questions are being asked of policy in general and monetary policy in particular, and it is mostly on this latter point that I will focus my remarks today. SA’s monetary policy framework and post-crisis developments Last year I pointed out that the flexible inflation-targeting framework which the country adopted back in 2000 had delivered clear benefits, contributing to a decline in the level and volatility of both inflation and nominal interest rates. These benefits remain visible today. In particular, measures of inflation expectations – for example, as computed every quarter by the Bureau of Economic Research from the views of businesses, labour unions and financial analysts – appear more strongly anchored than they did in the past. Whereas these expectations used to be adaptive, responding with a lag to the actual inflation cycle, they now display a greater degree of stability, albeit currently (and of some concern to the central bank) around the upper end of the 3,0 to 6,0 per cent inflation target range. On balance, it is probably fair to say that the greater stability in inflation and inflation expectations generated over time by our policy framework has allowed the Reserve Bank to respond more flexibly to the shocks which South Africa has faced since the global financial crisis. These shocks did not require the use of “unconventional tools” of the type that several central banks in the developed world, but also in some parts of the emerging world, used at the time. The solidity of South Africa’s banking system enabled it to withstand the crisis without meaningful disruptions, and as a result, the central bank did not have to intervene in either the interbank or the FX markets to ensure their proper functioning and an adequate supply of liquidity. Nonetheless, South African growth experienced significant headwinds post crisis, with GDP contracting by as much as 1.5 per cent, in real terms, in 2009. Thanks to a subsequent period of decelerating inflation, the South African Reserve Bank was able to respond with a cumulative reduction of 650 basis points in the repo rate between December BIS central bankers’ speeches 2008 and November 2010. A further 50 basis-point cut followed in July 2012, which brought the repo rate to a thirty year low of 5.0 per cent per annum, a level that prevailed until January of this year. As the nominal policy rate was being lowered, the real interest rate eventually moved into negative territory, when compared with either actual inflation or broad-based inflation expectations as measured by the Bureau of Economic Research’s surveys. These negative real rates helped cushion the impact of the recession on both the corporate and the household sectors, limiting the impact of weaker growth on business liquidations and enabling households to gradually reduce their leverage ratio without dramatic cutbacks in consumption. Thus, the household debt-to-income ratio fell from a peak of 83.0 per cent in the first quarter of 2009 to 73.5 per cent in the second quarter of 2014, while real household consumption expenditure still grew by an annual average of 3.2 per cent over that period. Admittedly, more recently, household consumption expenditure has come under pressure, with growth rates exhibiting a declining trend since the second quarter of 2013. Recent challenges and developments The current environment in which South Africa’s monetary policy operates, however, has become increasingly more complex over the past year and a half, owing to a mix of both domestic and external factors, which have impacted growth and inflation. The country currently faces a mix of subdued economic growth and relatively high inflation, with risks skewed to the upside. In part, but not exclusively, because of supply constraints, including a lengthy strike in the platinum mining sector and delays in the completion of new powergenerating capacity, real GDP has stagnated in the first half of the current year. Real GDP contracted 0.6 per cent in seasonally-adjusted, annualized terms in the first quarter, and this was barely reversed in the second quarter. On a year-on-year basis, growth has slowed to 1.0 per cent in the second quarter, the lowest reading since South Africa exited the recession at the end of 2009. At the same time, though, inflation has drifted gradually higher and breached the top end of the 3.0 – 6.0 per cent target range in April of this year. Part of this overshoot reflected aboveaverage inflation for petrol and foodstuffs, some of which fortunately is already moderating or likely to moderate in light of lower international agricultural prices or improved domestic crops since the beginning of the year. Nonetheless, underlying prices have also been picking up, and the Bank’s preferred measure of core inflation (excluding food, non-alcoholic beverages and petrol) has climbed to 5.8 per cent as of August 2014, following a sustained uptrend from a low of 3.0 per cent in early 2011. While demand-driven price pressures remain largely absent, amid slowing final domestic demand growth and moderate expansion in credit to households, the marked and sustained depreciation in the rand’s exchange rate since early 2011 has clearly contributed to the upward trend in core consumer prices, which is of concern to the Monetary Policy Committee. Beyond the challenges posed by divergent trends in growth and inflation, the persistence of negative short-term real interest rates is not desirable from a longer-term perspective, as they could exacerbate existing, or generate new imbalances in the economy. Beyond the well-known impact that negative interest rates can have on the allocation of financial resources to different sectors of the economy, or on the price of financial assets, it also important to point out their impact on the attractiveness of savings, especially in a country like South Africa, where the low level of domestic savings remains a factor behind the elevated structural current account deficit. All in all, these factors have led the Reserve Bank to embark on a gradual policy normalisation process, though one that remains data-dependent, as it acknowledges the complex factors behind the price outlook. The Bank first raised the repo rate by 50 basis points in January 2014, a decision informed by a significant deterioration in the inflation forecast (indicating the possibility of inflation being outside the target range for an extended BIS central bankers’ speeches period), amid concerns that a sustained depreciation in the exchange rate of the rand would significantly raise the risks to the inflation outlook. Although we had generally observed a lower level of pass-through when compared to previous episodes of currency depreciation, the extent and duration of the depreciating trend meant that the risk profile was worsening. Allow me to reiterate that while the Reserve Bank does not target a particular level or range of the exchange rate, we are nonetheless mindful of the potential negative consequences of accelerated rand depreciation on the outlook for inflation, as well as broad measures of inflation expectations. The January rate hike was followed by a second increase, in July 2014, of 25 basis points, bringing the policy rate to its current level of 5.75 per cent per annum. Before I leave this part of my speech which looked at recent challenges and developments, I thought, given the audience of today, I should briefly touch on the decision during August 2014, to place African Bank Limited (African Bank) under curatorship, even if I am digressing from the main focus of my speech (being monetary policy), to which I shall return in a few moments. After an extended period of more intensive regulatory monitoring of and interaction with African Bank, and following a loss of confidence by its shareholders and funders, the Registrar of Banks placed African Bank under curatorship on 10 August 2014, as announced by the Governor. Curatorship was the most suitable legal structure while the enabling legislation for a new regulatory framework, which will include provisions dealing with resolution, is still in the process of being finalised. Some of the support measures recently announced as part of the resolution package for African Bank were informed by the principles contained in the Financial Stability Board’s Key Attributes for Effective Resolution Regimes, which are expected to feature in the new legislation. The decisive intervention led by the South African Reserve Bank helped to limit the risk of contagion to the rest of the financial system. The support measures announced, which are currently being implemented by the curator under the oversight of the Registrar of Banks, are intended to facilitate an orderly, structured, and fair approach to addressing the challenges at African Bank in an effort to secure a viable future on the basis of a transformed business model, while ensuring minimum disruption to our financial and credit markets. At the time of curatorship, African bank’s total asset size amounted to R58 billion, or 1.44 per cent of total banking sector assets. However, lessons from the financial crisis indicate that systemic risk should not only be defined with reference to the size of an institution, but also in relation to its “interconnectedness”, i.e. links to other banks, financial market participants and financial products. The proposed solutions were developed in a collaborative process between the public and private sector. The leadership and commitment shown by South African commercial banks and the Public Investment Corporation in underwriting the capital raising for the envisaged “good bank” bears testimony to the strong underpinnings of our banking and financial system, the resilience of which will be enhanced by these measures. The issues around African Bank were unique to the business model of that bank, and it would be incorrect to deduce any fundamental concerns around either the South African banking system or the business of unsecured lending. The South African Reserve Bank wishes to reaffirm that it has no concerns about the quality of South Africa’s banking system, which continues to be robust and healthy, based on good levels of capitalisation, liquidity and profitability. What the road ahead could entail Where do we go from here? Based on the Bank’s projections for growth and inflation over the coming years, and of the uncertainties that surround these projections, it would be reasonable to infer that a gradual, data-dependent, normalisation path remains appropriate. The Bank’s most recent inflation forecast indicates that CPI inflation may have peaked at 6.5 per cent in the second quarter, and is expected to average 6.2 per cent for 2014 and BIS central bankers’ speeches 5.7 per cent in 2015, before a (marginal) re-acceleration to an average of 5.8 per cent in 2016, mainly reflecting the assumption of a faster increase in electricity prices. As indicated before, the MPC sees the risks to the headline inflation forecast skewed to the upside, with possible renewed pressure emanating from the exchange rate. Core inflation is expected to remain within the target range for its headline counterpart, reaching a peak of 5.8 per cent in the first quarter of 2015 before moderating to an average of 5.5 per cent in 2016. At the same time, real GDP growth, which the Bank projects to recover to 2.8 and 3.1 per cent, respectively, in 2015 and 2016 from a subdued 1.5 per cent in the current year, probably will not be strong enough to engineer a quick disappearance of the output gap, notwithstanding uncertainties as to the actual pace of potential growth in the economy. Thus, the persistence of slack would appear to reduce the likelihood that demand-driven price pressures could emerge in South Africa within the near future. The key challenge remains implementing structural reforms that will help lift the potential growth of the economy. Many of these have been identified in the National Development Plan and form part of Government’s infrastructure investment plans and other measures, such as those directed at enhancing education and skills, and supporting small and medium enterprises. Let me touch on some of the risks we see to the inflation outlook. On the domestic front, wage settlements in several key sectors have been well above current and expected inflation rates, and there have been some worrying signs of an apparent de-linking of wage demands (as well as some actual settlements) from underlying inflation and productivity growth trends. On the external front, the Bank is extremely mindful of the potential vulnerability of the domestic capital markets, and the exchange rate, to shifts in international portfolio flows as monetary policy in some major economies, especially the US and the UK, eventually moves towards a more conventional stance. In an environment where South Africa’s current account deficit remains elevated and is only expected to narrow gradually over the next two years, the risk of abrupt swings in portfolio flows into South Africa’s capital markets cannot be under-estimated. Implications for South Africa of global financial developments The experience of the “taper tantrum”, as the episode which followed the first clear mention by the US Federal Reserve in May 2013, of the need to eventually wind down its open-ended asset purchases became to be known, illustrated the sensitivity of domestic financial markets to the global backdrop. Between the beginning of May 2013 and its lowest level at the end of January 2014, the rand’s nominal effective exchange rate depreciated by as much as 26 per cent, while over the same period, the yield on the benchmark R186 government bond increased by more than 230 basis points. Expectations of future policy action embedded in derivatives like the forward rate agreements, or FRAs, moved in sympathy, with the FRA curve quickly pricing in not just an earlier but also a speedier pace of interest rate hikes by the Reserve Bank. Part of this selloff probably represented more a re-pricing of risk at longer maturities – i.e. a higher “term premium” – rather than changes in actual expectations of future policy rates. It was indeed striking to see how strong the correlation had become, during the taper tantrum episode, between the longer ends of government yield curves in South Africa and the United States, and this, despite the meaningful differences in economic and policy fundamentals between the two countries. The depth of domestic capital markets, which were able to absorb significant net sales of SA bonds by non-residents (R68 billion from the beginning of May 2013 up to the end of last week, according to JSE data) also played a part. The renewed reduction in that “term premium” in major fixed-income markets in 2014, as policy guidance by the Federal Reserve seemed to reduce investors’ uncertainties as to the future path of US rates, probably was a key factor towards the renewed decline in South African BIS central bankers’ speeches yields and the relative stabilisation in the rand since the end of January up until August 1. Certainly, in terms of communication, central banks have progressed somewhat over the past couple of years, and particularly since the taper tantrum, the associated volatility in financial markets related to monetary policy communication, has also declined. The big question remains, however, how sustainable is the recovery that we are currently experiencing? Or are we at risk, when US policy rates finally rise in 2015, assuming the median projections of both FOMC members and market participants prove to be correct, of a repeat of the market snapback that we witnessed in 2013? It is not possible to answer this question with a great degree of confidence, for even if we assume that US policy tightening is largely “priced” into markets, the potential for a renewed rise in risk premiums exists, especially in light of the current low levels of implied volatility in a broad range of markets. Nevertheless, several factors could usher in a different scenario from that of the “taper tantrum”. Admittedly, the more the US economy continues on its “healing” path following the shock of the 2008–09 global financial crisis, the more eventual policy normalisation becomes unavoidable, and the less likely it is that the Federal Reserve would delay policy action because of, say, more elevated volatility in the US Treasury market. Nevertheless, the Federal Reserve has equally made it clear that considerable uncertainty surrounds its baseline economic outlook, and that it remained watchful of potential developments that may hinder the US economic recovery. In testimony to the Joint Economic Committee of the US Congress on 7 May 2014, Federal Reserve Chair Janet Yellen referred to some specific risks, indicating in particular that “one prominent risk is that adverse developments abroad, such as heightened geopolitical tensions or an intensification of financial stresses in emerging market economies, could undermine confidence in the global economic recovery.” Therefore, the pessimists among market participants may err in fearing that US policy normalization will proceed irrespective of global developments, and in particular, of its effect on financial conditions in both the major developed and emerging economies. At the same time, the global economic recovery remains highly uneven, and this has translated into a growing policy divergence between the major central banks. In particular, the Eurozone has in recent quarters experienced a renewed loss of economic momentum and a drift in inflation rates towards very low levels, which have prompted the European Central Bank to provide additional accommodation, first in the form of targeted long-term repo operations, and then via the announcement of a programme to acquire asset-backed securities and covered bonds on the central bank’s balance-sheet. The mix of lower Eurozone inflation and expectations of additional central bank liquidity appear to have been key in driving Eurozone government bond yields lower this year; and in turn, this may be another reason why yields on major emerging bond markets, like South Africa, have also trended lower. Provided, as the market consensus expects, that there is no quick reversal of current inflation and policy trends in the Eurozone, developments in that region may continue to dampen, in the future, the impact of US policy normalisation on flows into, and prices of, SA financial assets. Whatever the outcome and wherever we may find ourselves next year this time, I believe a lot of progress has been made by policy makers around the world, and particularly within the G20, where there is greater cooperation and greater awareness and efforts made towards understanding the impacts of policy actions across countries, in particular the spill overs and feedback loops and therefore how this might influence not only individual countries but also the global growth trajectory. Our level of crisis preparedness has also been enhanced through various global financial safety nets which have been strengthened since the crisis, Between the end of August and end September, the ZAR depreciated from 10.66 to 11.30 against the USD as strong economic data from the US resulted in the market pricing in the possibility of a more aggressive monetary tightening by the Fed. BIS central bankers’ speeches not just in terms of the IMF toolkit, but also regional financial safety nets, and more recently, the BRICS Treaty on the Contingent Reserve Arrangement, which was signed by the BRICS countries at the Fortaleza Summit in July this year. We can also be optimistic about the efforts of the G20 to lift global growth and ensure that this growth is more balanced and sustainable. As you may know, the G20 is committed to developing new measures that aim to lift our collective GDP by more than 2 per cent by 2018 above the trajectory implied by policies in place at the time of the St Petersburg Summit in 2013. We have been working hard towards this goal during 2014, and have made some headway in developing growth strategies that talk to this ambition. As indicated in the most recent communique in Cairns, preliminary analysis by international organisations such as the International Monetary Fund and the OECD indicates that measures committed to thus far by G20 countries will lift our collective GDP by an additional 1.8 per cent through to 2018, including from important positive spill overs. We also continue to focus on the need for global rebalancing and appropriate macroeconomic policies as a means to achieve strong, sustainable and balanced growth. We trust that by the time of the Leaders’ Summit in November, additional commitments made will lift this number to 2 per cent. Structural reforms will be important in lifting growth, reducing unemployment and enhancing trade. These commitments will not just end there, as there will be a process for monitoring and ensuring implementation. Conclusion To summarise, it would seem that South African monetary policy will continue to face conflicting challenges, with respect to both the economic growth and the inflation outlook, in the times ahead. A global economic recovery would normally improve the domestic economic outlook and create a more stable backdrop for domestic policy normalization, however, it is at risk from the present lack of sustained economic upswing in regions like the Eurozone or Japan. Rising US policy rates risk complicating the financing of South Africa’s current account and placing pressure on the rand, however, this upside risk to inflation could be mitigated by the very consequences of slow growth in some of the world’s major regions, mainly the pursuit of stimulative monetary policies. These conflicting challenges, and the uncertainties that surround them, call for particular vigilance on behalf of monetary policy-makers, and for a readiness to adapt one’s monetary stance to a changing macroeconomic environment. At present, the Monetary Policy Committee remains of the view that interest rates will have to normalise over time. While the balance is delicately poised with regard to the timing of any policy adjustments, and requires careful judgement to avoid pre-mature action in the wake of an already weak economic growth environment, it is similarly important that the Bank, in following a forward-looking approach to monetary management, does not allow any doubting of its preparedness to act when necessary and in keeping with the commitment to its primary objective. Thank you. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, to the South African Chapter of ACI - The Financial Markets Association, Johannesburg, 28 October 2014.
Daniel Mminele: Ethics in finance and financial markets Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, to the South African Chapter of ACI – The Financial Markets Association, Johannesburg, 28 October 2014. * * * Introduction Good evening ladies and gentlemen. Thank you to ACI and Standard Bank for the honour and privilege to address you tonight, for creating an opportunity for us to exchange views, and for ACI members to cultivate their networks of contacts in the industry. As the ACI will be celebrating its sixtieth anniversary next year, it would only be proper to recall some of its important contributions to building a culture of professionalism and best practice in financial markets, especially the foreign exchange market. As you know, the ACI has over the years taken a leading role in not only bringing finance professionals together to seek ways of addressing the more pressing issues of the day, but also in enhancing the professionalism of its members, assisting in building-up of competence via its training programmes and examinations, and quite importantly, striving for high standards of ethical conduct in the industry. And it is on this latter point that I would like to share some thoughts and impressions today. Ethics in finance and financial markets has perhaps never been as relevant as it is today, and for that reason, it may not be so much of a surprise that the International Monetary Fund, at its conference on the future of finance during the Annual Meetings earlier this month, scheduled as its first session a two-hour panel discussion on the subject of Ethics and Finance. The importance of ethics for a sound financial environment I do not need to highlight to an audience such as this one the importance of ethical behaviour in financial markets, not just from a moral point of view, but equally from a point of view of economic efficiency. In an industry where the conclusion and enforcement of contracts is based on trust – trust from the provider of capital that he is fairly rewarded for the risk of potentially losing some of his assets; trust from the borrower that he is charged a fair price for his access to capital – any breakdown in that confidence can quickly lead to incorrect pricing and in turn, improper allocation of resources. Lack of confidence in the financial system in general typically means rising counterparty risks, and prompts lenders of capital to require a higher risk premium in their investment returns, raising the overall cost of capital in the economy. In similar fashion, fears that some participants in financial transactions may prove to be “rotten apples” would force all others to pay a higher price for access to resources, even if the broad majority behave in a proper manner. In a developing country like South Africa, reluctance to lend, or demand for an elevated risk premium, for fear of fraudulent or information-withholding behaviour, can easily limit the ability of the general public to access credit and, in turn, impede the path to a more balanced and inclusive economic growth framework. Yet the developments of recent years illustrate the challenges that the industry is facing. The Libor scandal of 2012, when several banks were found guilty of colluding to misprice benchmark rates, illustrates the potential ramifications of unethical behaviour in one segment of the market. Libor is an inter-bank rate, but its role as a benchmark in the pricing of financial derivatives and corporate sector loans means it affects a far broader range of transactions than simply money market ones. Yet the manipulation of Libor was only one example of improper practices. While several global banks were fined for their involvement in the manipulation of the Libor and Euribor reference rates, others ended up paying hefty fines BIS central bankers’ speeches for infringements as diverse as inadequate underwriting and improper sales practices in the sub-prime mortgage market, material non-disclosure, illegal involvement with counterparties under US sanctions, or illegal credit card practices. Since 2010, two large US banking groups alone ended up paying total fines of US$52 billion and US$36 billion, respectively, while a European banking group paid fines of as much as US$9 billion. The fines imposed on global banks since 2010 have been the most severe ever applied by US authorities. Closer to the interests of a professional body like the ACI, the last couple of years have seen the uncovering of several cases of foreign exchange market manipulation, resulting in the dismissal of employees and in criminal prosecutions – potentially larger consequences for the guilty parties than in incidences of interest rate manipulation. The high publicity surrounding these cases has not been without negative impact on the financial industry’s reputation with the general public; and it is of concern that surveys of public trust in business and institutions, like the 2014 Edelman Global Trust Survey, continue to place banks as the least trusted of the major business sectors. Reasons for the drift and corrective measures put in place A lot has been written about the reasons for this apparent “drift”, over the past decade or so in the financial industry’s standards. In 2011, already, the US Financial Crisis Inquiry Commission listed several governance issues as key factors behind the global financial crisis, including: failure of accountability and ethics; lowered lending standards; and a lack of regulation of OTC derivatives. 1 Indeed, the increasingly complex nature of financial products transacted between financial counterparties in the run-up to the 2008–09 global financial crisis may have, to some extent, caught both senior executives of companies and their senior risk managers “napping”. Or, possibly, the warnings of risk managers may have simply been ignored, with their reports coming low down the list of urgent matters, as the primary focus was on outperforming the competition in generating short-term profits. As long as business was growing and new structured products were bringing in additional customers and raising returns on equity, the risks underlying these products – and the extent to which investors understood that risk – may not have been of sufficient concern to the parties involved. A general environment of booming credit growth, at a time when the combination of stable and low inflation together with solid GDP growth led many observers to theorise about a structural decline in macroeconomic and market risk, probably added to overall complacency, together with what is now regarded as the lax underwriting standards of the time, and the insufficient capital requirements imposed on banks. The changing nature of the financial business may also have contributed to the problem. In the debate on ethics and finance hosted by the IMF on 12 October, which I referred to earlier, Bank of England Governor Mark Carney spoke of how finance, over time, became much more transactional rather than relational – in a word, the growing number of intermediaries tended to break the connection between the original service provider and the end-customer, which had earlier formed the basis of trust-building in the industry. Furthermore, as the number of intermediaries grew, so did the size of financial companies through the wave of mergers and acquisitions that followed the deregulation of the 1980s, resulting in what some have described as a “dilution of culture” in many institutions. An institution spanning many businesses, countries and continents, as per the “financial supermarket” model that increasingly prevailed from the mid-1990s, made the creation of a common culture and set of values difficult. In many instances, companies began operating “in silos” and even senior staff often lacked sufficient knowledge of the different businesses See Report of the US Financial Crisis Inquiry Commission, January 2011. BIS central bankers’ speeches in which they were involved. Finally, one cannot ignore the issue of incentives in the financial industry, especially the system of employee compensation, which at some stage heavily rewarded sales volume and short-term profits at the expense of risk awareness and longerterm prudential analysis. There is no doubt that regulatory authorities and financial institutions alike have become more aware of the need for correcting the excesses of the past. Back in 2010, the Seoul Summit of the G-20 committed to “core elements of a new financial regulatory framework (…) as well as measures to better regulate and effectively resolve systemically important financial institutions, complemented by more effective oversight and supervision.” This included the endorsement of Basel III rules on banking supervision, which, among others, raised the quality and quantity of bank capital and liquidity, and constrained the build-up of leverage and maturity mismatches. Separately, since the global financial crisis, several pieces of legislation have strengthened prudential regulation and supervision of the industry. In the United States, for instance, the Dodd-Frank Wall Street Reform and Consumer Protection Act gave regulatory agencies increased powers of oversight towards systemically important institutions, while incorporating stricter rules on executive compensation and corporate governance. The Volcker Rule, introduced as an amendment to the Act, was specifically aimed at shielding bank customers from risky behaviour by banks, by seeking separation of retail banking from investment banking and proprietary trading activities. At the same time, financial institutions have themselves taken steps to avoid a repeat of past crises, including a comprehensive review of their corporate culture and practices, with greater emphasis on the need to prioritize customer service. A September 2013 survey of 382 respondents from Europe, Asia-pacific and North America by the Economist Intelligence Unit showed that nearly all of the respondents felt that ethical conduct was just as important as financial success to their firm, and that 67 per cent had taken steps to make staff more aware of the importance of ethical conduct. Furthermore, 63 per cent had introduced or strengthened a formal code for ethical conduct, and 43 per cent had introduced financial or career incentives for respecting that code of conduct. 2 Another approach followed by financial institutions was to hire high profile corporate governance specialists that have knowledge of compliance issues in order to transform their institutions, and help them to quickly step up to the required standards of compliance and conduct. If there is one area in which banks are not cutting costs, it is in the area of risk management and compliance. This is a positive step insofar as it brings governance closer to the coal face; however, there are also concerns that these actions, if not undertaken properly, can weaken the enforcement institutions by creating a false sense security, and achieve little more than increasing salaries for compliance officers. Limits to what regulation can achieve With the ambitious efforts on the part of regulators to up their game as well, specialist skills have also been recruited from the markets into official institutions. Yet the extent to which regulators can enforce more ethical standards in the industry, and avoid a repeat of the excesses that contributed to the global financial crisis, may have its limitations. The first problem resides with the ability of regulations to envisage all possible infringements. In a world where financial innovation has been moving fast, and new and more sophisticated products continue to be developed, there is always the risk that unethical market participants remain one step ahead of regulatory authorities, in the same way as unethical athletes and sport physicians attempt to be one step ahead of anti-doping agencies. And indeed, new transgressions in the recent past have been committed after the promulgation of legislation See “A Crisis of Culture: Valuing Ethics and Knowledge in Financial Services”, a report from the Economist Intelligence Unit, 2013. BIS central bankers’ speeches aimed at curbing improper practices – providing evidence that legislation will not completely prevent the occurrence of improper or fraudulent behaviour. The second issue is one of finding the optimal degree of regulation. While the events of the past decade have clearly demonstrated the limits of “light touch” regulation and reliance on the market’s ability to self-regulate, there may equally be a risk that too much regulation will stifle financial innovation, result in elevated compliance costs that will be passed through to the end-customer, and limit the willingness of institutions to provide funding to all but the most creditworthy borrowers. Furthermore, “top-down” regulation brought about by international bodies like, for example, the G-20, may not be appropriately tailored to all jurisdictions in which they would apply. It would be undesirable, for instance, for regulations initiated in response to developments witnessed in the world’s largest economies to end up stifling financial development in an emerging country like South Africa. A push for elevated regulation may also easily break the fragile consensus achieved by most countries in the aftermath of the global financial crisis: In recent weeks, for instance, the Bank of England’s Prudential Regulation Authority has expressed strong reservations about EU proposals on the role of bonuses on bankers’ remuneration. At the same time, acknowledgement by financial institutions of the need to encourage more ethical behaviour by their staff is no guarantee that practices will indeed change. Speaking last week to a workshop on reforming culture in the financial industry, Federal Reserve Bank of New York President, Bill Dudley, stressed that supervisors will need to see evidence of measures taken yielding results in the form, among others, of more open and routine escalation of issues, reduced frequency of unchecked problems, and improved image of institutions with the general public. 3 What remains of concern is that not everybody is convinced that tougher standards are in their own best interest: For example, the Economist Intelligence Unit’s survey of financial industry participants, which I cited earlier, also found that 53 per cent of respondents felt that career progression at their firm would be difficult without being flexible on ethical standards, and that only 37 per cent thought that better ethics would mean better financial results for their institutions. Such continued shortfalls emphasise not just the need for stronger and more effective selfregulation in the industry, but also the role that professional bodies like the ACI can and should play in areas like the development of conduct rules for its members, and in educating finance professionals to better understand the complexity of today’s financial world and the risks emanating from that complexity. In adapting to these needs, the ACI Model Code is being developed as an online exam (separate module) that can be incorporated into individual bank and institution compliance processes. The Code will be updated annually and staff will keep current with the Model Code by completing the exams annually to ensure compliance and adherence to the etiquette of the market rules of engagements. On the regulatory front, the ECB has been given the lead role in work to strengthen codes of conduct for currency markets. Work on new standards were top of the agenda at a meeting of regulators in Sydney in May 2014, which brought together eight central bank committees charged with keeping tabs on the currency market. The meeting followed suspensions or firing of more than 40 dealers following claims that senior bankers used client order information improperly to manipulate prices. The ACI has already proven its ability to contribute at the highest level to the new regulatory process: In recent months, for example, the ACI has been leading the solution agenda for the European Central Bank, the Reserve Bank of Australia and the Bank of Canada, who have See “Enhancing financial stability by improving culture in the financial services industry”, Remarks by William C. Dudley, President of the Federal Reserve Bank of New York, at the workshop on “Reforming Culture and Behaviour in the Financial Services Industry”, Federal Reserve Bank of New York, New York City, 20 October 2014. BIS central bankers’ speeches all signed up to the Model Code it has developed. The New York Federal Reserve and Bank of England both have their own set of rules, but an agreement on the new principles could tie all closer together. On the particular point of US policy enforcement, it may be worth noting that the Securities and Exchange Commission (SEC), in an attempt to stamp out unethical and unlawful behaviour, has been providing huge incentives for whistle-blowers by giving them recordbreaking rewards for successful prosecutions of untoward behaviour. Is this indicative of weakness or, in instances, even a failure of the self-regulation model? Would bodies like the ACI have improved the situation by being more proactive? Whatever the case maybe, there is a need to step up, probably in both self-regulation and actual regulation of market participants in order to bring fairness to the market place. Bodies like the ACI have no doubt a big role in delivering to this objective, with the recent engagement by ACI around the FSB Benchmark Consultative Document being a good example. South Africa’s experience – looking for a pro-active approach Before I conclude, allow me to provide some detail about South Africa’s efforts in trying to keep ahead of the pack when it comes to entrenching and maintaining ethical market conduct, and also highlight the current and envisaged role and contribution of the ACI in this regard. For quite a while, the local chapter of ACI has been engaged in consultations with the Financial Services Board to ensure that the current regulatory exams are adequate for ACI accreditation. The process is has not been finalised yet, however, the Financial Services Board has embarked on an initiative to get this done as soon as possible. Through its participation in the Foreign Exchange subcommittee of the Financial Markets Liaison Group (FMLG), the ACI played a constructive role in ensuring that we could complete the project around the South African Rand Fixing page, which is now being published on the JSE website. Publishing it on third-party systems such as Bloomberg and Reuters is still work in progress. Although the JSE currently maintains the governance around the fixing, and given that the rand fixing is such a critical issue in the domestic market, market participants on various occasions have expressed the urgent need for a Code of Conduct for Rand Fixing participants. At the June 2014 FMLG meeting, it was proposed that the ACI Model Code could be used for this purpose, but further work is required to establish whether the Model Code in its current form would fully meet the requirements of the domestic market. I would therefore like to acknowledge and convey my appreciation the ACI’s participation in the substructures of FMLG and its involvement in efforts to improve the functioning of the South African financial markets. We look forward to continuing to work with the ACI, and the FMLG can certainly leverage off the ACI’s global linkages as part of our efforts to make the foreign exchange and money markets safer, more liquid and more transparent. Another much applauded effort by the ACI is the extension of its coverage to the settlements area by providing customized learning programmes. The more competent these officers are, the greater their effectiveness in the implementation of the segregation of duty principle. The SARB has taken advantage of the training provided by arranging such training in-house for our own staff. South Africa’s escape (by an large) of the financial crisis should not leave room for complacency, and it is with this awareness that the South African Reserve Bank is engaging in an ongoing dialogue with the financial industry in order to “batten down the hatches” and contribute to the review and enhancement of codes of conduct for the different markets, and to generally ensure that our markets meet best practice standards. It is also within this context that we announced yesterday that the SARB and the Financial Services Board will conduct a review of foreign exchange trading operations of authorised dealers. This review is intended to confirm and, where appropriate, strengthen the level of BIS central bankers’ speeches adherence to best practices in foreign exchange dealing, minimise the risk of manipulating benchmarks and sharing confidential client information, so as to enhance the transparency, efficiency and integrity of the foreign exchange market. As indicated earlier, regulators in a number of jurisdictions have been investigating banking institutions over various improper practices. We have no evidence of widespread malpractices in the South African foreign exchange market, nor are we dealing with any specific allegations, but felt that given the broad-based nature of investigations in other jurisdictions, which also involve trading in emerging market currencies, it would be prudent to obtain comfort that foreign exchange trading practices are in line with best practice. Conclusion In conclusion, while a lot of work remains to be done, it is nonetheless very encouraging to note that key steps have been taken by regulators and financial institutions alike to tighten behavioural standards in the industry. It is equally encouraging that South Africa, while largely sheltered from the global financial crisis, is embarking on measures to limit the risk of such crises occurring locally in the future, including strengthening market conduct regulations as part of the move to a twin peaks system of regulation. Nonetheless, the future evolution of the financial industry will bring new challenges for regulators and professional bodies alike. I will only mention a few potential examples here. Much has been written, for instance, about the growing role of non-bank institutions in financial intermediation, and indeed, one potential consequence of stricter regulation of banks may be to shift a greater share of transactions towards the non-bank sector. Extending codes of good behaviour and governance to a broader swathe of financial market players will be a continuing task for regulators and professional bodies. Another example is the changing world of information technology, and how it can bring new players into the financial system. Will internet and cellular telephony companies become the major providers of financial services in the next twenty years, as more people complete financial transactions on their mobile phones? Similarly, will the main centres of financial transactions migrate towards regions and countries which up to now, like China and India, have been held back by the low liquidity of their markets and the existence of capital controls, even though their share in the world economy has been growing fast? It is too early to answer, but these may be just examples of new, non-bank institutions and new major financial centres that will over time, play a larger role in global financial transactions. As such, they will have to join in the endorsement of codes of good practice, if the industry and indeed the world economy are to continue on the path to greater and safer prosperity. I therefore encourage the ACI to keep up the good work, to continue building your organisation and being a constructive partner in the continuous effort of building a professional culture that is characterised by adherence to the highest standards of ethical conduct. Thank you. BIS central bankers’ speeches
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Opening address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Biennial Conference of the Bank "Fourteen Years of Inflation Targeting in South Africa and the Challenge of a Changing Mandate", Pretoria, 30 October 2014.
Gill Marcus: Fourteen years of inflation targeting in South Africa and the challenge of a changing mandate Opening address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Biennial Conference of the Bank “Fourteen Years of Inflation Targeting in South Africa and the Challenge of a Changing Mandate”, Pretoria, 30 October 2014. * * * It gives me great pleasure to welcome you all to the biennial conference of the South African Reserve Bank. The theme this year is “Fourteen Years of Inflation Targeting in South Africa and the Challenge of a Changing Mandate”. Lessons from history tell us that nothing is static, that societies and economies evolve, as do policies and policy frameworks. When things appear to be going well, it is often difficult to imagine that this will not continue or that the status quo will change, or how indeed it will or can change. During the so-called “great moderation” of the mid-2000s, when global inflation was low, the battle against business cycles was seemingly won, and inflation targeting, or some variant thereof had gained widespread acceptability, it was hard to envisage what would come next, and what would cause us to reconsider the adequacy of the framework. Little did we know that very soon, in the wake of the global financial crisis, we would be asking the question whether inflation targeting was enough, and if not, how should the framework be modified or augmented, and should central bank mandates be expanded? The global financial crisis was a salutary reminder that nothing is static, that central banks largely deal with the unknown future, and that we have to adapt to changing and unexpected circumstances. However, there is still an intense debate about whether monetary policy should change, and how it should change. The aim of this conference is to provide a platform to debate these issues rigorously, and we are indeed privileged to have a high-level line-up of recognised authorities in the field, both international and local, to stimulate these discussions. Although the focus of the conference is more about the future, the topic does imply some assessment of the framework, and I will attempt to provide brief reflections of the past 14 years of inflation targeting in South Africa. I will also reflect on global developments in monetary policy and in particular in respect of the expanding mandates of central banks and how these developments relate to our domestic circumstances. Has inflation targeting been a success in South Africa? It is hard to say in the absence of the counterfactual, but there are a number of indicators that suggest it has been a positive experience. One way of looking at it is to compare the pre- and post-inflation targeting period outcomes. While this approach gives us some indications, the causal relationships may be unclear, and the different periods were subject to different shocks which may distort the picture. Nevertheless, the data does show that inflation targeting has been consistent with an average inflation rate lower than in the previous decade, and accompanied by lower volatility and lower nominal and real interest rates. Similarly, growth outcomes have been more favourable, which undercuts the argument that is sometimes made that inflation targeting is inimical to growth. We have adopted a flexible inflation targeting approach, conscious of the trade-off between short-term inflation variability and output variability. This approach has been appropriate both in dealing with exogenous shocks, as well as responding to periods of slow growth, as is currently the case. While growth does have a positive weight in the MPC’s objective function, and consideration is given to the real economy in making monetary policy decisions, we believe that monetary policy, whatever the framework, does not impact significantly on long term potential output growth. BIS central bankers’ speeches Looking at some of the comparative data, we see that in the 10 years before inflation targeting was adopted, inflation averaged 9,7 per cent, and this declined to 6,3 per cent in the full inflation targeting period, while average GDP growth improved from 1,6 per cent to 3,3 per cent. The average nominal policy rate declined from 15,5 percent to 8,5 per cent, while the average real policy rate declined from 5,7 per cent to 2,2 per cent. If we simply look at the period from 2010, inflation has averaged 5,3 per cent, real GDP growth 2,6 per cent, the repo rate 5,5 per cent and the real repo 0,3 per cent. The volatility of all these variables is also lower in the inflation targeting period. Other positive indicators are the increased contracyclical nature of monetary policy (as noted inter alia in work by Ben Smit and Stan du Plessis), as well as the relative stability of inflation expectations, albeit, in the last three years, at the upper end of the target range. This topic will be explored further in the presentation by Alain Kabundi. But it has not all been plain-sailing, and as the averages suggest, inflation has not always been within the target range. Despite the improved outcomes during the inflation targeting period, there have been significant divergences of inflation from the target range, particularly in 2002–03 and 2006–08. However, these deviations were primarily a result of exogenous shocks, and therefore “justifiable” in a flexible inflation targeting framework. Such deviations, if communicated and responded to appropriately, should not undermine the credibility of the framework. These shocks have been primarily in the form of significant exchange rate changes, and global oil and food price increases. A criticism sometimes leveled at inflation targeting is that the response to such supply side shocks could lead to pro-cyclicality of monetary policy. Our approach has been to try to “see through” the first round effects of such increases, and focus on the possible impact on inflation expectations and the emergence of second-round effects. Depending on the extent to which inflation expectations are anchored, we could also take a more flexible approach by, for example, extending the policy time horizon. However, this is often easier said than done as a lot depends on the nature and duration of the shock, which is not always easy to discern ex ante. For example, the oil price increases in January 2004 from around US$30 per barrel, were initially expected to be temporary. Prices did not reverse, but then settled in the US$60US$70 per barrel range for some time. From the beginning of 2007, oil prices began to increase almost persistently, but our own forecasts, based to a large extent on market forecasts at the time, kept underestimating these increases. Oil price increases continuously surprised on the upside, resulting in almost continuous upward adjustments in the Bank’s inflation forecasts. Each forecast round produced a higher trajectory, and a higher oil price assumption. As these increases fed quickly through to headline inflation, coupled with accelerating global food prices and a depreciating currency, disentangling first and second round effects became increasingly difficult. It may be relatively easy to see through a temporary shock or a once-off permanent shock, but dealing with a continuous or persistent one-sided shock is more challenging, particularly in the emerging market context. One approach to dealing with exogenous shocks would be to target core inflation, which would strip out volatile supply side shocks. Most countries target headline inflation, but some use a measure of core inflation for operational purposes. While we have paid increasing attention over the years to a measure of core inflation, and we publish our forecast for this measure alongside our forecast for headline inflation, we have kept the main emphasis on headline inflation for ease of communication. We have, however, found core inflation to be a good indicator of the underlying inflation pressures excluding some exogenous and volatile components and exogenous shocks, and therefore a useful policy guide. Whether or not policy should focus primarily on core inflation is an issue that will be addressed by Stan du Plessis, and I am sure it will generate some interesting debate. A related challenge to the inflation targeting framework has been dealing with large exchange rate changes which were primarily responsible for the deviations from target experienced in 2002–3 and to some extent in 2014. Although pass-through from the exchange rate to CPI has declined significantly over the period, it remains an important driver BIS central bankers’ speeches of inflation. The rand is prone to overshooting in both directions, at times for extended periods, and is vulnerable to terms of trade swings. In addition, because of the openness and depth of the South African foreign exchange market, the exchange rate is sensitive to changes in risk perceptions in global financial markets and associated changes in capital flows, an issue highlighted in Shakill Hassan’s paper. Reacting to exchange rate movements has the potential to confuse the signals about the objectives of monetary policy and the commitment to the inflation target, particularly when a conflict between the objectives arises. However, while an inflation targeting framework requires exchange rate flexibility, it is generally accepted that some intervention is not inconsistent with the framework, as long as the motives are fully communicated and understood, and that precedence is given to the inflation objective when a conflict between the objectives arises. Changes in the exchange rate could have inflationary impacts, but reacting to them could pose a challenge for communication, particularly when a currency depreciation has been accompanied by a tightening of monetary policy. We have tried to emphasise that such a reaction is to the potential inflationary impact of the exchange rate change and not an attempt to target the exchange rate itself. The exchange rate is one of a number of determinants of inflation, so any response to an exchange rate change would have to be assessed in conjunction with the simultaneous impact of changes in other variables, some of which may be offsetting. The response to exchange rate changes would depend on the nature of the shock, where monetary and portfolio type shocks would require different interest rate responses. The reaction of the exchange rate to interest rate changes has also been uncertain: during the mid-2000s, when equity capital flows dominated in South Africa, lower interest rates encouraged growth sensitive inflows, and currency appreciation. The impact of the exchange rate has become even more relevant given increasing evidence of monetary policy spill-over effects from advanced economies. In particular, low interest rates and quantitative easing in the US and associated capital flows (and reversals) have impacted on the rand, with attendant consequences for inflation and inflation expectations. In this regard, domestic monetary policy has had to respond to both domestic factors and changes or potential changes in policy globally. The issue of spillover effects will be taken further by John Taylor, while Vivek Arora highlights the diverse response of emerging markets to shocks. Inflation targeting, however, has not been without its domestic critics and political economy challenges. There has been a lot of resistance to the framework from sections of the labour movement in particular, where the idea of a long run trade-off between inflation and employment persists, and, not surprisingly, opposition has tended to intensify during upward phases of the interest rate cycle. This animosity is problematic, as societal buy-in and public support are considered to be important prerequisites for the successful implementation of the framework. Nicola Viegi, for example, argues in his paper that a lack of a strong response of wages to labour market conditions is likely to undermine the efficiency of the framework. Initially, inflation targeting was introduced without much prior publicity, public education or consultation beyond the Bank and the National Treasury. In retrospect, we could have embarked on a more aggressive education campaign to underline the benefits of low inflation, the limits to what monetary policy can do with respect to growth, and why a flexible inflation targeting framework is not necessarily inimical to growth. There was, and still is, a widely held view that monetary policy can do more for structural growth and employment than it can in reality. To counter this, during the past few years, we have engaged in intensive stakeholder consultations and instituted an “outreach programme” where we meet regularly with political parties, trade unions, business federations and civil society to discuss our view on the economy in general and on monetary policy in particular. Communication with the public has become an integral part of our overall strategy. It has taken time to develop a modus BIS central bankers’ speeches operandi for communicating with the public, and this remains an area of constant evolution and refinement. Unfortunately, although the animosity towards inflation targeting has declined significantly, almost 15 years after the implementation of the framework, and despite our communication initiatives, the views of some segments of society have not changed much. For example, following the 25 basis point increase in the repo rate in July, the Cosatu response was one of “bitter disappointment”, laying the blame for low growth at the door of “conservative monetary and fiscal policies”, despite a slightly negative real policy rate and a fiscal deficit of 4.5 per cent of GDP. Communication has another dimension that relates to transparency of policy decision-making and forward guidance, which is more about future policy actions rather than communication about what monetary policy can and cannot do. Although transparency and communication, which is the corollary to accountability, is not unique to inflation targeting, there is no doubt that it is integral to the framework and most countries, including South Africa, have made great strides in increasing this aspect over the past two decades. Alan Blinder has appropriately referred to this process as the “quiet revolution in central banking”. But there are disagreements around the limits of this transparency, particularly around the issue of forward guidance. Although forward guidance, in the form of setting the path for policy rates, predated the crisis, (in New Zealand, Sweden and Norway), as monetary policy reached the zero lower bound in a number of the advanced economies forward guidance of some form became more common-place, although the nature of the guidance often differs across countries, and has been changing in the US and UK in particular. The debate is now whether or not such guidance has been useful, and whether or not it should continue once interest rates normalise. Although we have chosen not to give guidance in the form of an explicit path, we have moved in the direction of being more open, but prefer to provide a more generalised form of guidance, to act consistently and allow the market to deduce the appropriate policy path. Along with a number of other features of inflation targeting or monetary policy, central bank communication is likely to continue to evolve particularly given the increased demand for greater public accountability. Since the crisis there has been some questioning as to whether inflation targeting is enough to ensure price and financial stability and should there be any adjustments to the framework and policy mandates. In general, most conclusions are that some variant of inflation targeting is appropriate, and that long run price stability should remain a key goal of monetary policy. But beyond that there are disagreements. In particular, there are concerns that the low inflation environment and the narrow focus on inflation contributed to the financial crisis: that the period of low interest rate volatility lowered perceived risks, and encouraged increased leverage and lending. Economists at the BIS, for example, were warning that credit cycles tend to be longer than business cycles, and that failure to focus on the former could lead to excessive leverage and the emergence of asset price bubbles. The conventional response at the time, as typified in Chairman Greenspan’s Jackson Hole address in 2003, was that central banks could not recognise asset price bubbles, and therefore should not lean against them, but should rather clean up after the bubbles had popped (Bill White’s so-called “lean or clean” debate). It is now generally accepted that a narrow focus on inflation to the exclusion of asset prices is not sufficient. However, a number of unresolved issues remain, one being whether or not monetary policy should lean against asset prices. For example Claudio Borio at the Bank for International Settlements, proposes extending the time horizon for monetary policy to take the financial cycle into account. Alternatively, should interest rates remain focused on monetary policy, and macroprudential tools be used to deal with asset price excesses? And if macroprudential tools are used, should this be done by the central bank, or by a separate agency? There are very different views still on this issue. A Brazilian proposal by da Silva and Minella is to integrate a focus on credit gaps into the monetary policy framework. By BIS central bankers’ speeches contrast John Taylor argues for a return to a rules-based approach rather than trying to finetune sectors of the economy over the cycle while Lars Svennson highlights the output costs of “leaning against the asset price winds” with monetary policy. Our approach is one of separation of goals and instruments, that the repo rate will maintain its traditional role as the main monetary policy instrument, while macroprudential tools will be used for financial stability purposes. This toolkit is being developed, and the Bank closely observes how different instruments are being used in varied circumstances by other central banks. This does not mean, however, that interest rates could or should not be used in combination with macroprudential tools should the need arise. The Bank’s experience during the pre-crisis period, when we did not have a focused macroprudential approach, is instructive. During the period 2003–2006, the economy was growing at rates above potential, with an average growth rate of around 5,5 per cent, at a time when the potential growth rate was estimated to have been around 4 per cent. The exchange rate was appreciating, partly in response to the commodity price cycle; annual growth rates in credit extension were around 30 per cent; real household consumption expenditure growth was around 9 per cent; and house price growth was in excess of 30 per cent. Had we had a macroprudential focus, such a combination of settings would have been a cause for concern, and may have elicited a policy response through higher interest rates. However, over that period, inflation was steadily declining and threatening to fall below the lower end of the target range when it reached a low of 3,1 per cent, which could have required a further easing of monetary policy. There was perhaps a failure on our part to recognise this as a broader financial stability risk, and to react either with a tighter monetary policy stance, or with macroprudential tools. Similar settings would probably result in a different response today, given our explicit financial stability mandate. How effective our macroprudential policies will be in solving financial stability issues and dealing with situations such as those described above is, however, still an open question. The expansion of central bank mandates to include financial stability explicitly could have implications for central bank independence. Central bank independence is not absolute, however, and independence relates mostly to monetary policy at the operational level. The inflation targeting framework lends itself well to the separation of instrument and goal independence, in that generally central banks do not have goal independence (as the target is usually, but not always, set by government), but, in order to prevent the so-called political interest rate cycle, central banks have independence to pursue the mandate given to them. But, as I have stressed on a number of occasions in the past, we are not independent of the economy or society that we live in, and therefore we have to take a number of factors into consideration when making decisions. However, compared to financial stability, monetary policy decisions, while not easy, are more straightforward and better understood by the public. These decisions generally involve the use of one tool (the interest rate), although quantitative easing has complicated this argument, and there is a clear objective, even if there is some weight on output variability in the Bank’s objective function. However, a financial stability mandate is more complicated. It generally involves government, particularly when public funds are involved, in crisis resolution and the policy tools are more directed at particular sectors, and therefore may be more politically sensitive as the distributional impacts are more apparent than in the case of monetary policy. Furthermore, challenges for communications are likely to arise if interest rates are used for both monetary policy and financial stability purposes. And, as a recent IMF paper has argued, financial stability is difficult to measure but crises are evident, so policy failures are observable, unlike successes. To quote from the paper, “central banks would find it difficult, (even ex post) to defend potentially unpopular measures, precisely because they succeeded in maintaining financial stability.” And any perceived failures on the financial stability front have the potential to undermine monetary policy independence through a general loss of credibility of the central bank. BIS central bankers’ speeches A final issue is the debate around the optimal level of inflation. In particular, is the 2 per cent inflation target norm in advanced economies too low? Olivier Blanchard at the IMF mooted this in 2010, but the idea persists, and was recently raised again by Paul Krugman. The argument relates to a fear of deflation, the dangers of a low inflation trap, and the economic costs of deflation. But it does not undermine the basic tenet that long run price stability remains at the core of central bank mandates. Rather, it appears to be a call for a moderate upward adjustment to what would be regarded as the advanced economy norm for price stability. This debate, however, is not really that relevant in South Africa or many emerging market economies where structural features, price setting behaviour and vulnerability to exogenous shocks has generally required higher inflation targets. These structural features include factors such as the weight of administered prices in the inflation basket, the weight of volatile elements such as food, vulnerability to terms of trade changes, particularly in the case of commodity producers, and the impact of exchange rate volatility on the exchange rate. Although our inflation target of between 3 and 6 per cent is higher than the advanced economy norm, this does not mean that there have not been times when there have been calls to raise the inflation target, even from the current high level, in order to bring about a looser monetary policy stance. Our current level of inflation and our target are not close to the low inflation trap, and our view is that a higher inflation target would merely raise inflation expectations, and actual inflation would then likely increase. The end result would be higher nominal interest rates, and because of possible higher inflation variability and other risk premia, we could end up with higher real interest rates as well. In conclusion, inflation targeting is not as straight-forward as its name suggests. There are many contentious issues, and the challenges facing emerging market economies are different to those of the advanced economies. We are extremely fortunate to have a strong line-up of international and local experts on this topic to provide us with their thinking on this important policy question and to stimulate discussion. There is also keen interest and participation in the conference, with a wide range of delegates, and I am sure you will all be active participants in the discussions. I am particularly grateful to our international visitors who have undertaken the long journey to be with us, and we hope that you will enjoy your stay with us and will have time to gain an appreciation of our country beyond the confines of the central bank and monetary policy. Thank you. BIS central bankers’ speeches
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Introductory remarks by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the launch of the September 2014 Financial Stability Review, Johannesburg branch of the South African Reserve Bank, Johannesburg, 29 October 2014.
Lesetja Kganyago: South Africa’s September 2014 Financial Stability Review Introductory remarks by Mr Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, at the launch of the September 2014 Financial Stability Review, Johannesburg branch of the South African Reserve Bank, Johannesburg, 29 October 2014. * * * Members of the press, guests and colleagues, welcome to the release of the September 2014 edition of the Financial Stability Review. The Financial Stability Review has been published semi-annually since 2004 which makes this year its tenth anniversary. In addition to its primary objective of price stability, the Bank also oversees and maintains financial stability. In pursuit of this mandate and to 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. Through the publication of its Financial Stability Review the Bank endeavours to communicate its assessment of potential risks to financial system stability. The Bank also strives to enhance the understanding of, and encourage informed debate on these complex and challenging matters related to financial stability. South Africa is in the process of reforming its financial-sector regulatory architecture by implementing a twin peaks model of financial regulation. Under this approach, supervisory roles will be streamlined between the Bank and the Financial Services Board. The Financial Sector Regulation Bill, 2013, gives primary responsibility to the Bank for promoting financial stability. In terms of this Bill, a newly created Prudential Authority within the Bank will be responsible for the prudential supervision of banks, insurers, financial conglomerates and financial market infrastructures. The Financial Services Board, in future to be known as the Financial Conduct Authority, will be responsible for consumer protection through its marketconduct regulation and supervision. The Bank transformed its Financial Stability Unit into a fully-fledged Financial Stability Department with effect from 1 April 2014, and elevated the status of the Financial Stability Committee which has been in existence since 2000 to include deployment of macro prudential tools. The Financial Stability Review is currently being revamped in line with the explicit financial stability mandate of the Bank and global best practice. The revamped publication will report in more detail on financial stability policy decisions once the new architecture is in place. The Financial Stability Department is in the process of developing a toolkit of macro-prudential policy instruments in addition to further refining its monitoring framework for financial stability, developing a top-down stress testing model and preparing policy proposals for the development of a resolution framework for the systemically important financial institutions and markets in South Africa. The definition of financial stability has also been refined to the following statement: “Financial stability refers to a financial system that is resilient to systemic shocks, facilitates efficient financial intermediation and minimises the macroeconomic costs of disruptions in such a way that confidence in the system is maintained.” This edition of the Financial Stability Review covers the six-month period ending June 2014, but also takes into account some events up to the point of publication. It consists of three main sections. The first section provides a reassessment of financial stability risks that were identified as potential risks in the March 2014 edition of the Financial Stability Review. In the second section the main financial stability developments and trends over the period under review are analysed from a global and domestic perspective. The final section provides a review of the developments in the domestic and international financial and regulatory environment. This edition also includes three boxes on the following topics: BIS central bankers’ speeches - The curatorship and resolution of African Bank; - Debt ratings - Shadow banking in South Africa; and The South African banking sector remained sound with adequate levels of capital, increased levels of high-quality liquid assets, good asset quality and profitability that compares favorably with other jurisdictions. The sector’s total capital adequacy ratio of 14,6 per cent remained well above the regulatory requirement of 10 per cent. The soundness of the banking sector was achieved despite a deteriorating domestic economic growth outlook and the first significant bank resolution in almost a decade when African Bank Limited was placed under curatorship in August 2014. The SARB managed the resolution of African Bank Limited in a speedily and decisive manner, limiting the potential risk of contagion to the rest of the banking sector. As part of this process the Bank put in place a package of measures which are in line with the Key Attributes of Effective Resolution Regimes of the Financial Stability Board (FSB), enabling the institution to continue operating. Although the intervention of the Bank managed to avoid systemic risk materialising and there were no significant adverse effects on the rest of the banking sector, the broader financial markets and or the economy, some limited spillovers did occur. The limited contagion to other parts of the financial system occurred mainly as a result of the wholesale nature of African Bank Limited’s funding model. Coordinated interventions by the authorities, regulators and the private sector contained these spillovers and ensured the continued stability of the financial system and the banking sector in particular. Although household debt, as a percentage of disposable income, has been improving consistently since reaching a peak in the first quarter of 2009 and the ability of households to service their debt has remained strong given an extended period of low interest rates, the household sector is now faced by a rising interest rate cycle and higher cost of living. Household wealth has increased strongly, however this was mainly as a result of a significant increase in the valuations of financial assets, possibly leaving consumers in a financially vulnerable position. House prices in South Africa are fairly valued at present and do not present any risks to financial stability. Equity market valuations, on the other hand, are currently at fairly elevated levels and a sudden and sharp correction in equity markets could reveal vulnerabilities that could have certain indirect negative effects on the financial system. South Africa has been participating in the FSB’s monitoring exercise of non-bank financial intermediation activities, or shadow banking as it is commonly known, since 2012. Although their share of total financial assets increased to about 18 per cent in the fourth quarter of 2013, non-bank financial intermediaries currently provide only about 11 per cent of total credit extension in the South African financial system. The optimistic outlook for some advanced economies continues to diverge from the more subdued growth outlook for EMEs amid persistent concerns over country-specific weaknesses. While leading indicators are pointing to the global recovery gaining strength in the second half of 2014, some constraints from both the fiscal and the monetary sides, as well as slow progress with structural reforms in some instances, remain a risk to a sustainable global recovery. A prominent exogenous risk to domestic financial stability is the effect that monetary policy normalisation in advanced economies and the US in particular could have on EMEs, including South Africa. Although normalisation has been discounted to an extent and forward guidance allows markets to anticipate policy moves better, the timing and magnitude of interest rate increases and their effects on capital flows and financial markets remain uncertain. Another important global development, not reported on in the FSR, is the results of the European Central Bank’s comprehensive assessment of bank balance sheets and stress testing announced recently. Twenty five banks failed the assessment and need to raise BIS central bankers’ speeches €25 billion of new capital. Twelve banks have already covered their shortfalls in the year to September. The ECB expects the in-depth review of the largest banks to boost public confidence in the banking sector. Apart from implementing a twin peaks financial regulation framework in South Africa, several other initiatives are reported on in this publication, aimed at improving the robustness of the domestic financial infrastructure. On 4 July 2014, the National Treasury published for public comment a policy document and proposed regulations on OTC derivatives. These regulations form part of a broader package of global regulatory reforms aimed at making derivatives markets safer and strengthening the resilience of the financial system. Other initiatives include the introduction of a Global Legal Entity Identifier system and the adoption of the Committee on Payment and Market Infrastructures (formerly CPSS) and International Organization of Securities Commissions (IOSCO) Principles for Financial Market Infrastructure. The South African financial system continues to be resilient in the wake of a volatile and uncertain global environment and a degree of domestic economic concerns. Although the current conjuncture is uncertain and several challenges remain, the financial system remains sound. I have briefly highlighted the key issues raised in the Financial Stability Review. More detailed analyses are available in the publication itself, and some will be covered in the presentation by my colleague, Dr Hendrik Nel, highlighting some of the analyses that were conducted by the Financial Stability Department. I trust that you will find these stimulating and relevant to the current environment and invite you to provide comment as part of the process of on-going debate on financial stability. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the 18th conference of the Association of African Banknotes and Security Documents Printers (AABSDP), hosted by the South African Bank Note Company (SABN), Cape Town, 17 November 2014.
François Groepe: Improving the security and cost-effectiveness of banknotes Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the 18th conference of the Association of African Banknotes and Security Documents Printers (AABSDP), hosted by the South African Bank Note Company (SABN), Cape Town, 17 November 2014. * * * Good day ladies, gentlemen and fellow central bankers, a warm welcome to South Africa, welcome to the Mother City and the 18th Conference of the Association of African Banknotes and Security Documents Printers (AABSDP). Cape Town is one of the most beautiful and well-known cities in the world – it is rich in history, art, culture, nature and I sincerely hope that you will enjoy your stay. Its fame, and that of South Africa, has been lifted by the extraordinary courage and dignity of one man, Nelson Mandela, and I am proud that our new currency pays homage to this great man. I have been informed that we have more than 300 delegates attending the Conference, representing 80 organisations around the world, of which more than 25 central banks are represented and various government institutions, such as printing works and mints. From the outset we have aimed to invite a broad spectrum of people as possible and I am delighted that we have succeeded in this endeavour. The theme of this Conference this year is top of mind in the Security Printing Industry today, as well as for Central Banks – that of improving security and cost effectiveness of banknote production and circulation which, if done successfully will contribute to efficiencies in the cash management cycle. Following the Great Recession, most central banks had either their mandate expanded or their mandate was more explicitly defined to include financial stability. The supply and availability of cash is a critical component of financial stability because a shortage of physical cash can lead to socio-political instability which may result in spill-over effects. Hence, it is important that central banks approach and treat cash management with the same diligence as they treat their monetary and financial stability mandates, as it does not stand separate from those mandates, but in fact is a key component of those mandates. Central Banks are continuously confronted with new developments in the design, production, circulation and destruction of banknotes. The participation of various and new stakeholders in the banknote lifecycle, trends in substrate choice, features and banknote life expectancy, heightened demands for improved productivity and efficiency and emerging threats from counterfeiters all add to this challenge. Banknotes remain the most important contact point for Central Banks with the public and therefore they play a key role in the reputation and public perception of the central bank. The quality of banknotes in circulation also poses a reputational risk for the central bank and in fact for the country. Poor quality banknotes cannot be used by the people to pay for example their parking tickets where the pay-station will not accept poor quality banknotes. Furthermore, poor quality banknotes, would lead to jamming of automatic teller machines but also increases the risk of counterfeiting. These are but three examples of why it is important that the quality of banknotes in circulation should be efficiently and effectively monitored and controlled by the central bank, irrespective of the degree to which off-sorting may have been privatised within a particular country. The type of substrate to be used remains a very topical subject within the industry. Central banks from both large and small economies have challenged the long accepted wisdom over security and the longevity of banknotes. The longer a banknote lasts, the more value the BIS central bankers’ speeches central bank will obtain from that particular note order. Given the size of orders, even a small improvement in percentage terms can mean a substantial improvement in profitability. During the Conference we will be debating this at length. Among our speakers, we have the Bank of Canada, they recently changed their notes from paper to polymer and will share their experiences with us. The demand for cash is increasing and so is the cost of transporting and processing the cash. Central banks increasingly recognise the need to revisit nationwide arrangements for distribution and consider the role of the private sector; however, outsourcing brings with it its own risks. Whether sorting is carried out in-house or outsourced, central banks are under increasing pressure to improve efficiency. During the course of the Conference some of the presenters will focus on the different cash management systems employed by central banks. Another challenge, facing the industry, is the forecasting of the demand banknotes. It seems that there is no simple method to do this calculation. In South Africa, as in many other countries, the demand for currency is showing an increasing trend. In 2012, the demand for currency increased by 11 per cent with approximately R110 billion (US$ 10.6 billion) worth of notes in circulation as at the end of the year. Central banks, therefore, are faced with challenges to either reduce the volume of cash produced; or reduce the cost of producing the cash, while at the same time enhancing the security and durability of the currency. A new challenge for central banks is the requirement that all key business areas should be included in effective contingency plans. High profile incidents around the world have highlighted the importance of central banks having in place, considered and tested plans, to deal with outages due to everything from supplier problems to natural disasters. Generally, central banks source their banknotes from one, or a small number of international companies. Currency managers need to weigh-up the importance of price against considerations, such as time of delivery, quantity of order and quality of product. They also need to consider if more than one supplier for, say ink, could be beneficial for operational risk concerns. Procurement from external suppliers is expensive, complex and may span several years. As with any outsourcing arrangement, production and quality, a standard needs to be monitored. The impact of technical innovations for the distribution of cash or payment mechanisms is developing at a rapid pace, especially for the under-banked. The use of mobile phone technology to transfer money is becoming a popular method due to efficiency and the lower cost associated with this payment mechanism. A further consideration by central banks is the cost that security features add to the banknote production process. We all appreciate the need for security features to avoid the counterfeiting of banknotes, but the question is at what cost and whether these costs can be optimised? These issues will be presented and debated upon during the next few days by all the participants and hopefully assist central banks with their deliberations in this regard. The objective is, through the diverse nature of attendees at this Conference, to improve the understanding of the issues for those involved in providing and managing banknotes; coins and other secure documents and at the same time improving the understanding of the consumers’ needs by the suppliers. The Conference has set out to achieve this with a mixture of presentations, workshops and panel discussions that touch on the latest developments and technologies in the industry and allow adequate time for discussion and dialogue. You are all encouraged to seek answers by asking questions and discussing the issues. The overall aim is to improve understanding through education – Africa has some catching-up to do, compared with the rest of the world. This is our attempt to start that ball rolling strongly in the field of banknotes, coins, ID and other security documents and to position this great continent as a producer, as well as a user of such products. BIS central bankers’ speeches It is our sincere hope that you will gain in knowledge and establish contacts and relationships that will continue into the future; but most of all our hope is that you will enjoy having an enjoyable time. 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 of America Merrill Lynch Fixed Income conference, Johannesburg, 28 November 2014.
Daniel Mminele: Normalising monetary policy in an uncertain world – the outlook for monetary policy in South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bank of America Merrill Lynch Fixed Income conference, Johannesburg, 28 November 2014. * * * Introduction Good morning ladies and gentlemen. Thank you to Bank of America Merrill Lynch for inviting me to address you on the issue of monetary policy normalisation in an uncertain world. This must be the single-most important issue that central banks around the world have been grappling with for quite a while now. We are now in the sixth year post the global financial crisis (GFC). Six years seems rather instructive, because this is approximately the amount of time of that Reinhart and Rogoff originally suggested it would take to recover from the financial crisis.1 There is now a fairly strong consensus view among economists across the world that the US has paid its dues and set itself up for a period of economic growth and subsequent monetary policy normalisation. In the case of the US, normalisation is generally taken to mean that the Federal Reserve (Fed) will stabilise the size of their balance sheet, raise the Federal Funds rate and allow the yield on US treasury bonds to move more freely. As a consequence of the US’s favourable interest rate and growth differentials vis-a-vis the rest of the world, the US dollar is likely to continue to strengthen as capital flows back to higher yielding opportunities in the States. Although normalisation and the consequent moves to higher policy and bond rates are probably one of the most expected and anticipated consensus trades that the collective market has ever anticipated, two things remain uncertain – namely timing and the degree of adjustment, both in the US and elsewhere. In a normalising yield environment in the US, most investors expect emerging market (EM) currencies to come under pressure – particularly of those EMs running large (twin) deficits and vulnerable to capital flow reversals. South Africa is unfortunately part of this latter group of countries. If this is not challenging enough, we are also faced with stagflation – i.e. low growth and high inflation. On the one hand US policy normalization suggests that we need to tighten policy, but on the other hand raising rates carries the risk of weakening our own already weak recovery. Consequently, the combination of an uncomfortably high current account and fiscal deficits requires a pragmatic and balanced policy response that will contribute to a more sustainable growth path for our economy. In an effort to do justice to the topic I was asked to address today, I will try and assess how we got into this unpleasant juncture, and what policy can do about it. But let me first say a few words about monetary policy in major advanced economies and its effect on South Africa, given just how important a swing factor this is for our policy considerations. Carmen M. Reinhart and Kenneth S. Rogoff examined the evolution of real per capita GDP around 100 systemic banking crises. They found that on average, it takes about eight years to reach the pre-crisis level of income; the median is about 6½ years. See American Economic Review Papers and Proceedings, May 2014; Recovery from Financial Crises: Evidence from Episodes* http://www.nber.org/papers/w19823. BIS central bankers’ speeches Diverging policies global monetary policies We know that the onset of the global financial crisis saw a synchronised response by central banks across the world. There was a coordinated effort to loosen monetary policy to cushion the world economy against what would probably have been a devastating collapse. These accommodative policies have indeed succeeded in helping to protect against a protracted global recession, and have also underpinned a global economic recovery. However, the pace and extent of recovery has been uneven, which has resulted in diverging policies across the major developed economies. After a disappointing start to the year, the US economic performance has been better than expected in recent quarters. The weather-related contraction of the first quarter was followed by a strong rebound in growth in the second quarter, with the strong momentum maintained into the third quarter. The economy is estimated to have grown at a better-than expected 3,9 per cent in the third quarter, with leading indicators such as the PMI pointing to strong growth in the final quarter of the year. The job market has also improved considerably, with the unemployment rate declining to 5,8 per cent in September, the lowest level since June 2008. In line with this stronger than expected performance of the economy, the Fed concluded its quantitative easing programme in October and this has raised expectations of a policy rate hike in mid-2015. The pace and timing of normalisation of policy rates, as repeatedly stated by the Fed, will largely depend on the economic and inflationary developments and the Fed’s interpretation thereof. With a lot of slack still remaining in the US labour market, one would expect the Fed to be cautious to not impede the recovery by moving too soon and too aggressively. Inflationary pressures are also expected to remain largely contained by a strong dollar and lower energy costs. The Fed will therefore face a less difficult trade-off between above-target inflation and consolidating growth. As such, the base case appears to one of a gradual normalisation of the Fed’s policy rate. The UK recovery also appears to be on track, with the economy growing 2,8 per cent in the third quarter and the unemployment rate falling faster than expected, reaching 6 per cent at the end of the third quarter. Although the Bank of England has maintained its asset purchases at £375 billion and interest rates at 0.5 per cent, sentiments are slowly shifting with some policymakers starting to vote for a policy rate hike. However, with the decline in the inflation rate to below the 2 per cent target, faltering growth in Europe, and soured trading and financial relations with Russia, a delay in policy normalisation appears likely. In contrast to the positive developments in the US and the UK, growth in the euro area and Japan has stalled, with policymakers in these countries indicating their willingness to take strong remedial action to mitigate against a protracted recession and extremely low inflation. The outlook for the euro area has deteriorated over the year, with growth forecasts by the European Commission having been revised downwards in November, from 1,2 and 1,7 percent to 0,8 and 1,1 per cent for 2014 and 2015 respectively. More worrying has been the shift of the weakness from the periphery to the core, notably France and Germany. The euro zone is also battling with extremely low inflation, with CPI growing by a meagre 0,4 per cent in October, uncomfortably close to deflation and far below the ECB’s target of close-tobut-below 2 per cent. The ECB has responded to these challenges by cutting its policy rate further in September and introducing a new stimulus plan2 involving the purchase of investment-grade asset backed securities issued by the non-financial private sector as well as covered bonds of the financial sector. And we have had strong indications from policy makers again during this week that should these measures prove to be insufficient, the The ECB expects that the purchases of asset-back securities and covered bonds under the new programme, together with the targeted longer-term refinancing operations (announced in June 2014), would increase the size of its balance sheet by roughly 1 trillion euros to 3 trillion euros, a level last seen in early 2012. BIS central bankers’ speeches Governing council will consider in the first quarter of 2015 whether to embark on a sovereign bond purchase programme. Japan’s economic performance has also disappointed, with the hike in the value-added tax (VAT) partly to blame. Pre-emptive buying ahead of the VAT increase in the first quarter of the year resulted in a positive performance, but this was followed by contractions in the second and third quarters, pushing the Japanese economy back into recession. Furthermore, although inflation is above the 2 percent target, this is largely due to the VAT increase and inflation is expected to fall in the early months of 2015. In response to recessionary conditions and still muted inflation, the Bank of Japan (BOJ) responded by raising its monetary expansion programme in October by an additional ¥10–20 trillion to ¥80 trillion (an equivalent of just under US$700 billion) per year. Clearly, we are seeing a divergence of policy in the major advanced economies. This suggests that central banks need to weigh the spill-over effects of tightening policy in the US against accommodative policies in Europe and Japan in determining their own monetary policy trajectories. Our sense is that the impact of US tightening will dominate, but that it would be tempered somewhat by ECB and BOJ stimulus plans. However, it is clear that global financial conditions have become less hospitable for countries with large external financing requirements. This process has already delivered a bumpy ride for South Africa, as it has for some other countries. Impact of normalisation on South Africa Like most emerging markets, South Africa benefited from the massive liquidity injection into the global financial market following the Great Recession. Inflows of capital meant that the current account deficit was comfortably financed, while it also resulted in significant appreciation of the rand. This in turn helped to contain inflation, allowing room for accommodative monetary policy over a fairly extended period. However, these trends started to reverse in May 2013 in anticipation of US monetary policy normalisation, following indications to that effect from the Fed. This saw a widespread depreciation of emerging market currencies, which intensified with the actual implementation of the US Federal Reserve’s asset purchase tapering programme starting from January 2014. The rand depreciated quite sharply in line with emerging market currencies, with the weakness exacerbated by a widening current account deficit. The rand weakness contributed to rising inflationary pressures, with inflation breaching the 6 per cent target in April and reaching 6,6 per cent in May and June before retreating to 5,9 per cent in September and October. The moderation in food and petrol prices contributed to lower inflation outcomes in recent months. In particular, the abrupt and significant decline in international oil prices to below US$80 per barrel in November has had a positive impact on the medium term inflation outlook. The Bank’s latest inflation forecast reflects an improved outlook, with headline inflation now expected to average 6,1 per cent and 5,3 per cent in 2014 and 2015 respectively, compared with the previous forecast of 6,2 per cent and 5,7 percent. However, there is a lot of uncertainty around the sustainability of the decline in oil prices, while the exchange rate also continues to pose upside risks to the inflation outlook, as it still remains vulnerable to changing perceptions about global monetary policy normalisation, and the large current account deficit. As we have indicated previously, wage settlements that are de-linked from inflation and underlying productivity trends also pose an upside risk to the inflation outlook. Furthermore, the Bank remains concerned about the elevated level of core inflation which remains close to the upper target level. Domestic growth outlook also remains weak. The economy contracted by 1,6 per cent in the first quarter and grew by a marginal 0,5 per cent in the second, with much of this weakness due to prolonged strikes in the mining and manufacturing sectors amid already weak global conditions. Growth improved to 1,4 per cent in the third quarter, however this was off a low base. The Bank revised its growth outlook for 2014 downwards to 1,4 per cent, as BIS central bankers’ speeches announced after our most recent MPC meeting last week, compared with 1,5 per cent previously. The 2015 and 2016 projections were also downgraded from 2,8 per cent and 3,1 per cent respectively to 2,5 per cent and 2,9 per cent. Domestic growth prospects remain constrained by short-term and long-term structural supply factors such as strike activity, rising input costs and electricity shortages, as well as slowing consumer demand. Falling commodity prices and weak economic conditions in the country’s major trading partners also add to this subdued outlook. The combination of uncomfortably high current account and fiscal deficits (in the face of global monetary policy normalisation), high inflationary pressures, and weak domestic growth pose a challenge for both monetary and fiscal policy. These have required a balanced policy response in an effort to ensure a sustainable growth path for our economy. So how is South Africa doing? Let me quote you a paragraph from last week’s Economist magazine: “It was great while it lasted. In a golden period from 2003 to 2010 …. economies grew at an annual average rate of close to 5%, wages rose and unemployment fell, … people were lifted out of poverty and the middle class swelled…. But now the growth spurt is over. What some worried would be a ‘new normal’ of expansion of 3% a year is turning out to be far worse. The …economy will on average grow by only around 1.3% this year.”3 No, in this case the Economist is not referring to South Africa – the quote is actually for the Latin American region. But it is very much also our own story. Indeed, the ongoing emerging market slowdown serves to remind us of the protracted nature of previous crisis episodes, including the 1997–1998 Asian crisis and the 2008–09 world financial crisis. However, there are limits to similarities among EMs, which may lead to differentiation when assessing countries. For example, South Africa’s export performance relative to a number of peers remains poor – irrespective of whether they are commodity exporters (Australia), or have also experienced significant exchange rate depreciation (India, Turkey), or both (Brazil and Chile). The fact that South Africa has grown its exports less than its peers, implies that the domestic economy is suffering from something more than weak global demand and declining commodity prices. South Africa’s weak performance is also visible in the country’s declining share of world exports, which declined from around 0.7% of world merchandise exports to 0.55% over the last 10 years. Perplexingly, SA’s portion of global exports has remained roughly stable since 2011, at about the level last attained at the height of the Great Recession, despite pronounced currency depreciation over that entire period. With global growth – particularly in the EU, our largest trading partner – under severe pressure, we increasingly relied on the domestic non-tradeables sector to prop up domestic growth as it would have been difficult to ramp up exports. Unfortunately not all growth is equal. The quality of growth matters at least as much as the quantity of growth, and there are reasons to believe SA’s non-tradeable growth in the postcrisis years has been of inferior quality. It has been driven by consumption, not investment, which has been financed by debt, meaning it reduces future consumption and investment The Economist, “The great deceleration: The region’s economies have slowed far more abruptly than anyone expected” 22 November 2014. See http://www.economist.com/news/americas/21633940-regions-economieshave-slowed-far-more-abruptly-anyone-expected-great-deceleration. BIS central bankers’ speeches capacity. Furthermore, the growth has been based on large quantities of imported inputs, resulting in an unsustainable current account deficit. Credit growth to the private sector appears sustainable and consistent with macroeconomic fundamentals. Since the first quarter of 2011, credit extended to households increased by 22.3 per cent (or 4.9 percent when deflated with headline CPI), slightly less than the 6% increase in GDP over the same period. Household credit has weakened quite significantly in recent months, with growth slowing to an annual rate of 3,7 percent in September compared to 7,5 percent in the same month last year. However, the moderate overall increase in credit could be masking several unwelcome developments. For instance, “good credit” extended for mortgages increased by much less than other categories, notably instalment sale credit (mostly used for vehicle financing) and unsecured credit. With credit extended to households shifting from relatively low interest (and lower margin) mortgages to more profitable (higher margin) categories, it is not surprising that the real value added in the financial sector also increased by a cumulative 9.5 percent since 2011q1 – on par with the real growth recorded in the retail sector. In fact the retail and finance sectors together contributed almost 60 percent of GDP growth since 2011q1 – significantly larger than their 37 percent share in GDP. The growing size of the non-tradeables sector may also explain a weakening economy-wide response to a weaker real exchange rate. Potential growth has slowed Another reason why South Africa has so far experienced a relatively weak recovery from the 2008–09 recession, relates to faltering potential growth. According to the OECD, “estimating potential growth rates is always an imprecise exercise, and all the more so for a country (such as SA) with such a high rate of inactivity and where the responsiveness of wage and price inflation to changes in unemployment is low. In addition, in recent years the task has been further complicated by uncertainty over the extent to which electricity supply limitations have constrained potential output growth in South Africa”.4 Replicating work by Borio, Disyatat, and Juselius (2013, 2014) at the Bank of International Settlements (BIS), which incorporates financial cycle characteristics into the estimation, some estimates suggest that South Africa’s potential growth rate declined from 4 per cent in 2007 to around 2½ per cent in 2013, compared to earlier estimates which suggested that current potential growth rates was around 3 to 3½ percent5. This development is not unique to South Africa as several studies show that potential growth may have been over-estimated in many emerging market economies. Monetary policy response The operating environment for South Africa’s monetary policy has become increasingly complex, with growth and inflation dynamics being influenced by a range of global and domestic factors, which call for delicate trade-offs in terms of policy settings. Recent developments suggest that the period of relatively low volatility has come to an end. Market participants and policy makers now have to grapple with the possibility or risk that the lift-off of rates in US may occur sooner than they anticipate, while in Japan and the Eurozone more easing seems to be on the way, while risks assigned to geo-political risks, which the OECD (2013), OECD Economic Surveys: South Africa 2013, OECD Publishing. See http://www.oecdilibrary.org/economics/oecd-economic-surveys-south-africa-2013_eco_surveys-zaf-2013-en. Anvari, V., R. Steinbach, and N. Ehlers (2014). A semi-structural approach to estimate South Africa’s potential output. South African Reserve Bank Working Paper WP/14/08. BIS central bankers’ speeches market seems relatively relaxed about, may intensify. All these factors are likely to increase volatility. Recent experience has shown us how sensitive our domestic market are to the international backdrop. Against the background of South Africa’s elevated current account deficit, which is expected to only correct slowly, the risk of abrupt swings in capital flows cannot be under-estimated. This environment calls for continued vigilance from policy makers, and preparedness to respond to the fast-changing economic and financial markets environment, and readiness to act to changes one’s monetary policy stance when deemed appropriate. It also calls for ongoing dialogue, exchange of information and appropriately calibrated communication in order to strengthen policy credibility. As you are aware, we embarked on a gradual, datadependent, policy normalisation process at the beginning of this year, which will continue, but will also take account of the unfolding situation as it affects the inflation trajectory and growth dynamics. More recent developments on the inflation front have been encouraging and resulted in an improved headline inflation forecast, which gave the MPC some flexibility in the short-term, while it expressed concern about sticky core inflation, and reiterating that the need to over time realign our real interest rates better with our emerging market peers remains. As indicated in our MPC statement last week, the timing of future interest rate increases will be dependent on a range of factors, including the evolution of inflation expectations, the timing and speed of normalisation of monetary policy in the US and the state of the domestic economy. As we have said before, while monetary policy should and in South Africa will play its role within the confines of its mandate, a concerted effort is needed by other key role players in agreeing and effectively implementing the necessary structural reforms that will deliver higher trend growth. Thank you. BIS central bankers’ speeches
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Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Tenth Basel Committee on Banking Supervision-Financial Stability Institute High-level Meeting for Africa on "Strengthening Financial Sector Supervision and Current Regulatory Priorities", Cape Town, 29-30 January 2015.
François Groepe: Recent developments in the African region Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Tenth Basel Committee on Banking Supervision–Financial Stability Institute High-level Meeting for Africa on “Strengthening Financial Sector Supervision and Current Regulatory Priorities”, Cape Town, 29–30 January 2015. * * * Introduction Good morning ladies and gentlemen. Thank you for inviting me to the Tenth BCBS-FSI High-level Meeting for Africa and to share my views on the recent developments in the African region. I will provide you with a brief overview of possible risks for the African region that are associated with a new round of quantitative easing in developed economies. I will also discuss the impact of low oil prices on sovereign and corporate debt issuance, and global growth and the implications of these developments for the region. I shall conclude by giving an update on regulatory developments. Despite a strong performance by the US and UK economies, the global economic growth outlook remains mixed, with the growth prospects having deteriorated in a number of the other advanced economies, with Japan in a technical recession and the Eurozone remaining weak amid the possibility of deflation. The lower oil and other commodity prices have had a significant and divergent impact on recent macroeconomic developments, with deteriorating prospects in some emerging markets contributing to the lowering of the IMF’s 2015 global growth forecast by 0,3 percentage points to 3,5 per cent with notable downward revisions made to Brazil, China, Nigeria, and Russia. Growth in China is expected to moderate to 6,8 per cent in 2015 and although Africa remains one of the high-growth regions, weaker commodity prices pose downside risk to the outlook. Currency devaluations and the potential impact on the African region The global increase in liquidity, resulting predominantly from capital injections by the Bank of Japan and the European Central Bank (ECB), could have negative spill over effects to sub-Saharan Africa and emerging market economies (EMEs) in general. Concerns over losses in the export market as a result of a strengthening of domestic currencies could give rise to attempts at currency devaluations in some developed economies and encourage monetary policy easing in the context of a subdued inflation outlook environment, specifically in industrialised nations. The announcement of further large-scale asset purchases by the ECB and the Bank of Japan precipitated the weakening of the euro and the yen, respectively, amidst expectations of monetary policy normalisation in the US. Already, Denmark and Canada have cut interest rates, while the proponents of interest rate increases in the UK are retreating. Subsequent to the ECB’s announcement to fend off deflation threats through an asset-purchase programme, the Swiss Franc appreciated strongly, increasing the risk of falling exports and a possible contraction. In Asia, the advent of Abenomics raised concerns that China could respond in an effort to protect its exports market share and with its growth easing to 7,4 per cent for the fourth quarter in 2014, the lowest in 24 years, devaluation of the Chinese yuan may be considered a possible policy option. BIS central bankers’ speeches In summary, the further quantitative easing may in the short term increase global liquidity and lead to capital inflows to emerging market economies, but this may be accompanied by increased currency volatility on the back of dollar strength and in some countries weaker growth. Currency devaluations flowing from quantitative easing in external markets may also have a negative impact on countries that export to those countries. Currency risk, sovereign and corporate downgrades For the sub-Saharan African region, the past five years of highly accommodative monetary policies in the US, Europe and Japan have stoked the currency risk associated with the increase in sovereign debt issuance. The persistent search for high-yielding securities presents an additional dimension of risk for African countries. Backed in recent years by comparatively stronger regional growth, African nations are now able to issue billions of dollars in sovereign bonds, prompting the IMF to issue a warning that too much debt in the region could derail the best economic period observed in this generation. The uptick in borrowing in the region lifted public debt to a ten-year high of 35 per cent of GDP in 2014. Although such debt levels are much lower than in Europe and some Asian countries, the associated currency risk is significant. The cost of servicing a US dollar-denominated Eurobond, issued by an African state may look cheaper than that of a debt issue in local markets, but if the relevant country’s currency declines, the cost of foreign borrowing could increase, thereby exerting unwelcome pressure on national budgets. This risk is more pronounced in oil-exporting countries that draw a significant portion of government revenue from their energy sectors. As an illustration, Russia’s credit rating has been downgraded to below investment rate for the first time in a decade. A number of oil producing countries on the African continent, too will need to adjust to the falling oil prices and declining fiscal revenue by cutting fiscal expenditure and possibly raising taxes. The risk of sovereign downgrades, on the back of deteriorating fiscal and external balances could also extend to the corporate sector and may spill over to vulnerable non-oil producing countries. Yields on corporate bonds, issued by the energy sector, have risen sharply since June 2014. The prospect of defaults due to over-lending to the energy sector is a possibility that cannot be ignored. Unless oil prices rebound significantly to enable borrowers to refinance their debt on more favourable terms, the cross-sectional risks of multiple exposures of different industries to the energy sector would be propagated through the financial system. Consequently, share prices of oil-listed companies, along with those that provide services to the energy sector, could be negatively impacted. The impact of low oil prices on the interconnectedness of financial institutions – a risk for global growth The obvious similarities between the transmission mechanism of the 2006 fall in US house prices and the fall in the price of oil since June 2014 have prompted some analyst to predict that the correction in the oil price could lead to a plunge in stock markets, with subsequent negative spill over effects to the global economy. The global financial crisis had its roots strongly embedded in the procyclical risks that were amplified and propagated over time by the highly leveraged US housing market. Accordingly, a sharp fall in US house prices led to bankruptcies of major financial institutions that had significant exposures to the real-estate market. As companies filed for bankruptcies and the risk of default increased in the financial markets, refinancing of existing debt became increasingly difficult. The shutdown of the US commercial paper market made it difficult for corporates to borrow money over the short-end of the yield curve, resulting in an BIS central bankers’ speeches unprecedented financial meltdown and significant job losses as economic activity came to a halt. Through different financial institutions’ interconnectedness, a well-contained and relatively limited exposure to the US real-estate market soon spilled over to the global financial system, with negative consequences for regional growth in Africa. While the origins of the crisis might have been procyclical, it is essentially the distribution of risks during the 2007–08 crisis that amplified the losses incurred. In less than a decade, since the crisis, we now have another highly leveraged sector – the US shale oil industry – that capitalised on the rise in the price of oil that started almost ten years ago. Banks’ lending to the energy sector of billions of dollars could pose a systemic risk to the global financial system as the exposure was seen as low-risk and the pricing of risk by lenders might have been less robust during the upward swing in oil prices. Resultantly, the plunge in oil prices has stoked concerns over growth of particularly oil producing countries, fuelling fears about deflation and intensifying scrutiny of capital spending across the energy sector, with companies set to slash their exploration and development budgets. Some estimates put the figure of possible losses related to halting exploration projects at US$1 trillion. Moreover, low oil prices are a major threat to high cost oil producers. For as long as prices remain below US$50 per barrel, a number of those oil producers will struggle to break even. This could trigger a new wave of bankruptcies and defaults with concomitant negative spill over effects to the financial sector. It is evident that although low oil prices could boost consumption its impact on growth could be mixed, with oil exporting countries particularly negatively impacted by these developments in the form of deteriorating fiscal and external balances. This will furthermore result in a sharp decline in the flows into sovereign wealth funds and given the fiscal deficits could result in significant sell off by these funds. The lower oil prices may also accelerate the build-up of deflationary pressures and possibly result in stagflation becoming more entrenched in certain economies. The impact of low oil prices on revenue projection in the African region Some sub-Saharan African countries are particularly at risk from the fall in oil prices, with oil exports accounting for 40–50 per cent of GDP for Gabon, Angola and the Republic of the Congo and 80 per cent for Equatorial Guinea. In Angola, the Republic of Congo and Equatorial Guinea, the oil industry accounts for 75 per cent of government revenue, while in Nigeria oil still accounts for more than 70 per cent of the national budget, leaving public institutions exposed to the ebb and flow of global energy prices. Cheaper oil is complicating Ghana’s efforts to reduce its significant trade and budget deficits. In August 2014, it requested a US$500 million bailout from the IMF. In order to meet bailout terms, Ghana is taxing oil at the pump; however, the fall in oil prices may exacerbate its difficulties in meeting its debt obligations. Most oil exporters need oil prices to be considerably above US$57, the projected price for 2015, to cover government spending, which has increased in recent years in response to rising social pressures and infrastructure development goals. Furthermore, vulnerability to currency risk increases if the borrower is dependent on the exports of one or two commodities for revenue. East Africa is set to emerge as a global supplier of oil and gas within the next decade due to the recent major oil and gas discoveries in Mozambique, Tanzania, Kenya and Uganda. Kenya and Uganda alone are estimated to hold 4 billion barrels of crude oil, while Tanzania and Mozambique claim reserves of 200 trillion cubic feet of natural gas. With the promise of unprecedented petro-revenues possible, host governments are working on bold, detailed and BIS central bankers’ speeches comprehensive local content policies as they eye the next phase. All these plans could be jeopardised if oil prices do not rebound in the medium term. Lastly, the fall in oil prices has negatively affected revenue projections of oil-exporting countries and their currencies’ exchange rates. While emerging market currencies generally track inflation differentials over the long run, large moves in the crude oil price have directly affected exporters’ currencies in the short-term, because of a perceived diminished value in export flow revenue. Regulatory, supervisory and financial stability matters Turning to regulatory and financial stability matters, the global financial crisis has necessitated, among other things, a serious regulatory reform agenda in order to address the excesses of the period leading up to it; anchor future economic growth and ensure a sound regulatory and financial stability framework. The current overhaul of the global regulatory system is broad and covers a range of relevant financial issues. Some of the key themes thereof include addressing the too-big-to-fail (TBTF) problem of systemically important financial institutions (SIFIs), building resilient financial institutions, reducing the opacity of the over-the-counter (OTC) derivatives markets, mitigating the impact of shadow banking on financial stability, enhancing financial benchmark transparency and promoting the convergence of accounting standards. Within each of these themes there are a number of regulatory initiatives, such as the regulation and resolution of SIFIs under the TBTF problem and Basel III and proposals for a basic capital requirement for insurers to strengthen the theme of building resilient financial institutions. This list, although not exhaustive, suggests the significant scope and amount of the work still ahead. Compounding the problem further are the implementation and monitoring processes, such as FSAPs and related peer reviews to assess progress made with the implementation of internationally agreed regulatory standards by member jurisdictions. Given the extensive range of regulatory reforms currently under way, South Africa has since last year been calling for a consolidation phase where emphasis should be placed on the adoption and implementation of agreed international regulatory standards and greater understanding of the impact of new regulatory reforms on emerging market and developing economies (EMDEs). This call was firstly made to avoid unacceptable, uneven, and differing implementation of these new standards, thereby creating regulatory arbitrage opportunities globally, and secondly out of concern for the impact of the cost of new regulatory developments on EMDEs. Also, given the nature of “Tenth BCBS-FSI High-level Meeting for Africa” meeting, we need to alert global regulatory authorities and standard setters that there is a possibility of a widening gap between regulatory standards in advanced economies and those in sub-Sahara Africa, where a number of countries are only now implementing Basel II. South Africa, as a member of the G-20 and the FSB, is able to participate and, hopefully, influence formulation of policy, but unfortunately a number of our peers on the continent are not as fortunate as us and hence are denied this opportunity. South Africa, therefore, welcomes the recent decision by the FSB to allow opportunities for non-FSB members to contribute to this process and it supports the monitoring processes that have been put in place. We furthermore welcome the decision not only for the reasons highlighted above, but also so that we can obtain an independent assessment of the progress that South Africa has made in this regard. Recent domestic developments On 1 January 2013 South Africa implemented the Basel III framework. The implementation period for several of the Basel III requirements that were incorporated into the domestic banking regulations commenced on 1 January 2013 and includes transitional arrangements, BIS central bankers’ speeches which will be phased in until 1 January 2019. The purpose of the transitional arrangements is to afford banks sufficient time to meet the higher standards while still supporting lending to the real economy. South Africa underwent an FSB peer and thematic review in 2013 and recently participated in an IMF/World Bank Financial Sector Assessment Program (FSAP), which was finalised towards the end of 2014. The purpose of FSAPs is to assess the stability of member jurisdictions’ financial systems as a whole, and not that of individual institutions. FSAPs are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Overall, the assessment of South Africa’s financial sector and the supervision and regulation thereof was positive, with the report noting a high level of compliance and strong supervision, but found that the financial sector operated in a challenging economic environment and some gaps were identified. Regarding the implementation of a twin peaks model of financial regulation, South Africa decided in 2011 to change its regulatory architecture into a twin peaks regulatory system. The original 2011 policy document on the twin peaks model set-out key proposals aimed at enhancing financial stability, consumer protection, and financial inclusion. 1 In terms of the twin peaks model, the approach will change from regulation by institution to regulation by objective. In this new approach, the South African Reserve Bank (SARB) will be responsible for the prudential oversight of banks, insurers, financial conglomerates, and financial market infrastructures and it will also become the Resolution Authority. The current Financial Services Board will be re-named the Financial Sector Conduct Authority (FSCA) and will be responsible for the market conduct of all financial services institutions, including banks. Under the planned twin peaks approach, there will be opportunity to streamline the supervision of the financial system between the SARB and the yet-to-be-formed FSCA. There will be a phased approach to the implementation of a twin peaks model, starting with the enactment of relevant legislation to establish the relevant regulators. In December 2014, the National Treasury (NT) released, for public comment, the cabinet-approved second draft of the Financial Sector Regulation Bill to give effect to the establishment of the necessary regulators, their powers and responsibilities. It is noteworthy that chapter 6 of this proposed Bill deals with coordination, cooperation, collaboration, consultation and consistency between regulations, a matter raised in the 2014 FSAP report. South Africa, as it seeks to strengthen its financial system and regulatory framework, is willing to learn from all relevant stakeholders, whether here or abroad, and adopt these lessons to domestic circumstances. Conclusion It is clear that the slump in oil prices poses risks to financial system through its possible impact on stock market developments. The highly indebted US shale oil producers are possible trigger points and should be monitored. There is a risk that losses may intensify in the derivatives market. These negative developments can affect global growth, which could remain weak in a deflationary environment, forcing central banks to inject more liquidity into their respective economies in an attempt to revive economic activity. Finally, while low oil prices are generally positive for consumers and business confidence, an extended period of low oil prices could pose a number of risks for global financial stability. I have also highlighted the scale of the global regulatory reform process under way and some of the challenges in this regard. Given the growing complexity and interconnectedness of the See the policy document titled, A Safer Financial Sector to Serve South Africa Better (commonly referred to as the Red Book), released by National Treasury in February 2011. BIS central bankers’ speeches global financial system, it is imperative for regulators in individual jurisdictions to cooperate and coordinate their efforts in the interest of a more robust global financial system. It is in this spirit that I wish you well as you share your experiences, ideas and insights at this meeting. BIS central bankers’ speeches
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Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Fedusa Collective Bargaining Conference 2015, Muldersdrift, 17 February 2015.
Lesetja Kganyago: Monetary policy and South Africa’s economic objectives Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Fedusa Collective Bargaining Conference 2015, Muldersdrift, 17 February 2015. * * * Good morning ladies and gentlemen. Thank you for inviting me to address you today as you prepare to participate in collective bargaining across a range of industries. In particular, I would like to thank Mr. Koos Bezhuidenhout, the President of Fedusa and Mr. Dennis George, General Secretary of Fedusa. The South African Reserve Bank has enjoyed a healthy and productive relationship with your Federation for many years, a relationship I wish to continue. You have asked me to address the pertinent question of whether monetary policy is still supportive and accommodative of South Africa’s economic objectives. My emphatic answer to the question is yes, monetary policy is still accommodative and supportive of South Africa’s economic objectives. In elaborating on this short answer, I will discuss three broad issues. Firstly, what is the mandate of the Bank in achieving South Africa’s economic objectives? Secondly, I will explain in an historical context why monetary policy at the present moment is highly accommodative; and thirdly, I will discuss some of the longer term policy challenges confronting workers and the South African economy in general. This third part of the answer will provide some context, both in answering your question and points for you to ponder as you prepare for the next round of collective bargaining. The Constitution mandates the Bank to protect the value of the currency in the interests of balanced and sustainable growth. The value of the currency in your pocket is its buying power. Our aim is to maintain the buying power of each rand you earn or have saved. We do this by aiming to keep inflation low. Hence our primary mandate is price stability. The Bank also plays a key role in regulating the financial sector with the aim of maintaining financial stability. We do this to protect workers and the economy from shocks that may arise in the financial system. Why do we pursue price stability and how does this objective fit into South Africa’s overall economic objectives? Indeed, you may legitimately ask, what does balanced and sustainable growth mean and is low inflation a prerequisite for balanced and sustainable growth? These are critical questions in understanding South Africa’s economic policy architecture. There are very few things that economists generally agree on. The necessity of price stability for the sound functioning of an economy is one of the few elements of economics that most economists agree on. With about two hundred years of evidence and hundreds of countries as natural experiments, countries with low and stable inflation generally grow faster and more sustainably over a longer period of time than countries with higher inflation or erratic price changes. Since these conversations take place not only here in South Africa, but also in other parts of the world, allow me to quote Mark Carney, the Governor of the Bank of England addressing the 2014 Trade Union Council congress in the UK: “By maintaining price and financial stability, we put in place the foundations for sustainable job creation and income growth. Stability gives workers the confidence to invest in skills or to change jobs. And it gives firms the confidence to hire new workers, invest in new equipment, introduce new products and pursue new markets. We need workers with the right skills and we need companies taking strategic initiatives to grow productivity. That productivity is needed to ensure real wage increases over the medium term.” BIS central bankers’ speeches These words although referring to the UK economy, they could be easily applicable to the South African economic situation as well. We pursue price stability not because it is good for government or for the financial sector. We pursue price stability because it is good for workers, for job creation and for poorer sections who lack the means to hedge or to protect themselves against inflation. It is true that there can be short term economic and indeed employment benefits from more accommodative monetary policy. It might be the case that if we lowered interest rates substantially, for a short period of time, consumption and possibly employment would rise. If, however, the economic conditions do not warrant such policy, then the effect will be temporary. Worse still, the effect could be to raise employment for a short period of time only to lower it by much more a few quarters down the road. South Africa, under apartheid, had a history of boom bust episodes. So yes, it is possible to increase employment with monetary policy and monetary policy has a special role to play to support employment during economic downturns. Monetary policy, however, cannot affect the level of employment over the longer term. Monetary policy is only one aspect of economic policy. Together with fiscal policy and exchange rate policy, form our macroeconomic policy stance. Our priority for macroeconomic policy is to provide a stable environment for business and workers to pursue growth, employment and investment opportunities. If we do our job well, we create a foundation for sustained prosperity. Without such a foundation, sustained wealth creation by households is unlikely. Despite its fanciness, macroeconomic policy has little influence over the level of potential or trend growth. Therefore, we actually play little role in the size or speed of wealth accumulation or employment creation. Other policies, policies ranging from education to broadband connectivity, economic regulation to agriculture, trade policies and the quality of infrastructure (especially electricity provision) all play a role in determining the speed limit or potential growth of an economy. It is important for policy makers, such as ourselves, to understand the limits of our powers, but it is also important for South Africans to understand the limitations of, in this case, monetary policy. Most countries, including our own, have independent central banks because it could sometimes be in the short term interests of governments and even firms to borrow from tomorrow to deliver goods today. Naturally, a key role of the financial sector is to intermediate between savers and borrowers, including between generations. However, some economic actors have the power to borrow more from future generations than they have the capacity to repay. Governments do this by running unsustainable budget deficits. Firms could pursue short term profits but leave society with longer term costs; such as with events that led to the financial crisis. The task of the Reserve Bank is to dissuade governments, firms and households when they attempt to borrow too much from tomorrow. Because this is sometimes a politically difficult task, our Constitution assigns this role to an independent central bank. Government has a set an inflation target of between 3 to 6 percent. They set this target because, at the time that it was set, this target was broadly in line with the inflation rates of our major trading partners. It is important that we keep our inflation rate broadly at these levels. If we fail to do so, it means that we are losing competitiveness. Some unions and indeed some workers argue that inflation doesn’t matter. Whether inflation is 5 percent or 20 percent, they say, I’ll still get an inflation-related salary increase at the end of the year, so I am okay. This is patently untrue and I will illustrate with an example. If inflation is 20 percent a year, it means that prices rise by about 1.5 percent a month. Each month, the purchasing power of your salary is eroded by 1.5 percent. By the twelfth month, just before your salary increase, you would have lost a major part of the buying power of your monthly salary. Let’s assume that at the end of each year, you receive a 20 percent salary increase. After five years, your purchasing power has been eroded by a cumulative 40 percent; even though you BIS central bankers’ speeches think you are doing fine because you receive an annual salary increase equal to inflation. Now let’s assume that inflation averages 5 percent a year for those five years. After 60 months, the cumulative loss of purchasing power is about 10 percent; a loss nonetheless, but a far smaller one. This simple example illustrates that higher inflation is not good for workers, even if your salary gets topped up by inflation each year. Lower inflation is more conducive to rising real incomes. Lower inflation begets lower interest rates; higher inflation begets higher interest rates. Having made the case for low inflation, let me also argue that the Reserve Bank is not populated by inflation nutters. Within our mandate, we have been tolerant of periods of higher inflation when we think that higher inflation would be temporary or has been caused by an external shock. There have been several periods in the 15 year history of inflation targeting where inflation increased either because of once-off shocks to the price of fuel or food or because of a sharp exchange rate movement. Our pattern has been to see through the first round effects of such shocks and to respond only if we think that there is a likelihood of second round effects (that is, a feed through into more generalised inflation) or if we think inflation would be permanently higher as a result of the shock. In 2013, inflation breached the target band for one quarter. We did not raise interest rates. In 2014, inflation breached the target for much of the year. Over 2013 and 2014, the rand depreciated by over 40 percent. Notwithstanding the breach of the inflation target and the risks of an even longer breach posed by the exchange rate; we raised rates by a modest 75 basis points. That demonstrates the benefits of our flexible inflation targeting framework. The SARB has been accommodative, without compromising our primary mandate. In historical terms, South Africa’s interest rates are lower in real and nominal terms than at any point in our recent economic history. It is true that there were periods during the late 1970s and 1980s when real interest rates were negative. In our view, negative real interest rates for such a long time structurally damaged the savings performance of the economy. In 2008, when the impact of the global financial crisis became evident, we reduced interest rates sharply to 5.5 percent. In 2009, inflation spiked to over 11 percent, leaving real interest rates highly negative. As the crisis abated, real interest rates increased, but remained negative for several years and only in late 2014 did they become positive. In our view, this was the correct response to the global financial crisis. It helped mitigate the effect of the crisis on workers and on firms. Together with counter-cyclical fiscal policy, monetary policy helped to support the recovery. But real interest rates cannot remain negative for ever. They were a specific response to an economic crisis. Over time, interest rates will have to normalise. It is unsustainable to provide savers with negative returns while enabling borrowers to borrow at artificially low rates forever. As pointed out earlier, the long period of negative interest rates in the 1980s structurally damaged South Africa’s savings performance; a trend we are yet to truly recover from. Workers of the world have not had a good millennium. In general, workers have seen increased job insecurity and depressed wage growth, while younger workers have found it hard to break into stable, formal employment. There are three broad factors that explain this negative situation for workers. Firstly, the fall of the Berlin Wall and China’s embrace of the global trading system saw over a billion workers enter the global economy. This greater competition amongst workers depressed wages for most workers around the world. Secondly, work has become more skills intensive, implying higher rates of return for skilled workers and, in many cases, falling returns for lower skilled workers. These pressures were partly offset by lower-priced goods from China and from an abundance of credit for workers. Then came the financial crisis; a direct result of global imbalances and an excess of credit in advanced economies. Since the financial crisis, employment gains have been modest whilst income growth has stagnated. Increased globalisation and financial integration has increased the returns to capital, further pressurising workers’ wages. BIS central bankers’ speeches While South African workers have had to bear the consequences of these global trends, the picture in South Africa has some interesting nuances. In general, workers’ wages have increased in real terms throughout this millennium; albeit at a slower pace than profit growth. In South Africa, the bulk of these global adjustments have been placed on young workers, new entrants and those with minimal skills. Unlike in many other countries, workers’ wages in South Africa did not fall during the global financial crisis. In SA, the burden on the crisis was felt on vulnerable workers and on new entrants into the labour market. Most of the one million or so workers who lost their jobs in 2009 were young, unskilled and new entrants into the workplace. In many ways, we traded better pay for fewer jobs, a trade-off that has significant social consequences for the present unemployed and for future generations. Unemployment is South Africa’s single biggest challenge. It is simply unsustainable to run an economy when fewer than half of all adults are in employment. The inevitable social strains will quickly undermine even the best of policies and drag the country down. South Africa’s unemployment challenge is neither new nor under-analysed. We know what the problems are and we know what to do about them. The National Development Plan provides a comprehensive diagnostic analysis of our challenges and a plan to remedy these flaws. In the main, key structural rigidities in the economy include poorly functioning labour markets, uncompetitive product markets, a poor skills profile, spatial development patterns that exclude the poor and a low savings ratio which makes us heavily reliant on foreign capital flows, which are often fickle and short-term in nature. These structural rigidities occur on top of already high levels of poverty, inequality and unemployment; the major legacies of apartheid. South Africa’s recovery after the financial crisis was in line with the global recovery. Economic growth recovered to 3.0 percent in 2010 and to 3.2 percent in 2011. Since 2011, our economy has slowed again. There is an international and domestic dimension in explaining this slowdown. Globally, the recovery began to falter in late 2011 with Chinese growth slowing, commodity prices falling and Europe re-entering recession territory. Europe and China are our two largest export markets. Slower growth there and in particular falling demand for commodities has impacted on our growth levels. Since its peak in 2011, the platinum price has fallen by 35 percent, coal prices by 49 percent and iron ore prices by 63 percent (in dollar terms). Added to this mix, the past three years have seen unprecedented volatility in global financial markets, impacting on the rand exchange rate and on capital flows to emerging markets. Depending on whether it is a risk on or risk off day in the markets, the rand could strengthen or weaken by over a percentage point in a day. In addition to these global factors, domestic growth has been weak because of our own owngoals. Lengthy and sometimes violent strikes, electricity supply constraints, perceived or real concerns about economic policies and a slow breakdown in trust between major social partners have deducted from growth and investment. In 2012, the Marikana strike and its consequences knocked exports as well as confidence; confidence in our ability to manage our social stresses. In 2013, the motor industry strike and related strikes in the automotive component sectors and transport sectors knocked over 0.5 percent off our growth. In 2014, the five-month-long platinum strike and the four week manufacturing sector strike knocked over one percentage point off our GDP growth. While electricity constraints have become more binding in recent months, the lack of supply capacity has cost us foregone investment for much of the past five years. National Treasury estimates these costs to be about 0.3 to 0.4 percentage points of GDP a year, and this was before load-shedding resumed in December 2014. Lower electricity capacity for the next three to four years is a major reason behind the Bank’s downward revision to GDP growth for 2015 from 2.5 percent to 2.2 percent. We hope that business, labour and government can join together to manage the electricity constraint in a manner that does least damage to the economy. BIS central bankers’ speeches Strike activity and a slow breakdown in trust between major social partners have impacted on business confidence and hence on investment. Add to this weak consumer demand, and it appears as though the economy is in a rut: weak demand leads to low investment, weak investment means no growth in employment and household incomes. How does one break out of such a rut? There is little space for macroeconomic policy in this context. Fiscal policy, having been used successfully to offset weak demand for six years has reached its limits. A failure to consolidate the fiscal position would leave the country vulnerable in the face of another global shock, and if the country’s credit rating is further downgraded, would raise borrowing costs for the entire economy. Fortunately, in the 2014 MTBPS, the Minister of Finance outlined a clear path towards fiscal consolidation in South Africa. Monetary policy is constrained by the fact that inflation has either been close to or above the target band for a significant period over the past two years. In the absence of macroeconomic policy space, which has to be gradually rebuilt, faster employment and economic growth can only come about through selling more to the rest of the world or through implementing the well-known structural reforms outlined in the NDP to get us to a higher growth path. The lower oil price does provide us with a shot in the arm. It will boost the economy through greater discretionary spending amongst households and through a lower imported fuel bill. If however, because of the tighter electricity constraints, the economy cannot supply the additional goods demanded, the benefit to the economy may be smaller than we think. The lower oil price provides an opportunity for households to pay down debt. Furthermore, even though the lower oil price provides a boost to consumers, lower prices for our key export commodities such as coal, iron ore and platinum mean that South Africa loses out on valuable export earnings. Because the prices of both imported oil and exported commodities have fallen, the net positive effect for South Africa is still positive, but minimal. The benefit from the lower oil price, even if it is to be realised, is likely to be temporary, for two reasons. Firstly, unless oil prices continue falling, the lower oil price provides a once-off reduction in inflation. We do expect the oil price to recover, and so it has recently, rising by over 25 percent from its low point in January. We expect oil prices to recover further, even though we do not think it would go back up to $100 a barrel anytime soon. The second reason why we think that the benefit from the lower oil price is only transitory is that price setters in the economy do not appear to be using the lower oil price and lower inflation in the present to lower price expectations about the future. Put bluntly, even though inflation in January came in at 5.3 percent and the February number is likely to dip below 4 percent, average wage settlements are still in the realms of 8 percent. Similarly, many price setters for goods and services are not passing on the benefits of lower prices to consumers. A classic example is taxi fares. Do they ever come down when petrol prices fall? Another example is retailers, who are quick to adjust their prices in response to rising distribution costs when the fuel prices rise, but not so quick to reduce them when fuel prices fall. The reason why these prices remain high even with lower cost structures suggests that there is a lack of adequate levels of competition in some of these industries. If however, we can dream; and lower fuel prices are passed on to consumers and lower prices are reflected in lower nominal salary settlements, then inflation could be structurally lower than it has been. This would give the Monetary Policy Committee serious food for thought and in general would imply lower rates or at least a more gradual normalisation of interest rates. It could be a win-win-win scenario. If only we could dream! The South African economy is in a difficult space. We are negatively impacted by global developments, especially in Europe and in China. Combined with domestic concerns that I have outlined earlier, we do not anticipate robust economic growth or employment creation in the medium term. We hope we are wrong. It is possible for South Africa to enter a virtuous cycle of rising confidence, rising investment and stronger growth fuelling employment gains; BIS central bankers’ speeches leading to still higher levels of confidence. It will require strong leadership across the economy to create such a virtuous cycle. Let me turn more directly to the challenges of collective bargaining. Wage negotiations and the process of wage setting are important in the central bank’s thinking because wages are a key price in the economy. You would have often heard central bank governors decry periods when salary settlements are in excess of inflation and productivity growth. I would like to make clear what the Bank’s thinking on this matter is. We are not opposed to workers receiving real salary increases. Firstly, we feel that there should be an equitable sharing of productivity gains between workers and investors. An unequal sharing of such gains in either direction is unsustainable. Secondly, there must, especially in the South African context, be an appropriate sharing of productivity gains between workers and senior managers. Thirdly, productivity gains should be shared between existing workers and new additions to the workplace. If existing workers take all the productivity gains, then there is little scope to increase employment. The trend in recent years in South Africa has been for workers to receive salary settlements in excess of inflation and productivity gains. Firms respond to this situation by reducing staff numbers. This is clearly an unsustainable and undesirable development. The simple point that successive Reserve Bank governors are making is that in general, lower inflation enables larger real salary increases and higher productivity leads to higher incomes, higher investment and more employment. In conclusion ladies and gentlemen, I would like to leave you with a lesson from John Nash, who won the Nobel prize in economics for his work on game theory. His simple lesson is as follows: In a one shot game, a player may win by cheating or by deceit (withholding information from an opposing player). However, in a game with multiple rounds, the best strategy to survive and win is by always being trustworthy and by cooperating. If you have to approach wage negotiations as a one-shot game, you could probably win by taking the most reckless or deceitful strategy. However, in the world where there are repeated rounds, the best strategy is to build trust by being open about one’s intentions and building a cooperative relationship. It is about taking a long view. I appeal to you as you enter into this round of bargaining by taking a long view. This call is not just to workers but also to the employers and other price setters in the economy to take a long view; as such an approach is in our collective best interest. Thank you. BIS central bankers’ speeches
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Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at The Webber Wentzel Leadership Network, Johannesburg, 4 March 2015.
François Groepe: Recent economic and regulatory developments Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at The Webber Wentzel Leadership Network, Johannesburg, 4 March 2015. * * * Introduction Good morning, ladies and gentlemen. Thank you for inviting me to the Webber Wentzel Leadership Network, which is aimed at reinforcing your firm’s dedication to the future of South Africa and underscores the role that young professionals should play in the advancement of our country’s democracy. I look forward to sharing my views on the recent international and domestic economic developments, as well as changes to the financial regulatory architecture. International economic developments We have entered the seventh year since the start of the Great Recession, and despite the significant elapse of time, the global recovery can be characterised as uneven. Global economic growth decelerated significantly to an annualised rate of 3,4 per cent in the final quarter of 2014 compared to the 4,6 per cent recorded in the third quarter. This slowdown can largely be attributed to the slower growth recorded in both advanced economies, as well as a number of the large emerging market economies, such as China and India. The US economy, after expanding strongly by 5,0 per cent in the third quarter of 2014, slowed to 2,2 per cent in the fourth quarter. Overall economic activity expanded by a solid 2,4 per cent during 2014, which represented a notable improvement in economic conditions following the contraction of 2,1 per cent in the first quarter of 2014. Although the US unemployment rate ticked up marginally to 5,7 per cent, this could be attributed to the slight improvement of 0,2 percentage points in the labour force participation rate to 62,9 per cent and which can broadly be interpreted as an improvement in labour market conditions. Although headline CPI inflation has declined to –0,1 percentage points and Personal Consumption Expenditure inflation stands at 0,2 percentage points (year-on-year), it is likely that monetary policymakers will look through the oil price shock. Core Personal Consumption Expenditure inflation is at 1,3 per cent and services inflation is at 2,1 per cent, very close to the US Fed’s 2 per cent goal. Wage growth ticked up to 2,2 per cent in January. It is anticipated that the Federal Open Market Committee will commence with the process of interest-rate normalisation during the course of this year, despite its use of the term “patient” during its January statement, and market participants are eagerly anticipating the March statement to analyse it for any change in the language used. Although lift-off is possible towards the middle of the year, it will be data-dependent. And as the timing risk of a lift-off is asymmetric (i.e. the perceived risk of tightening too soon outweighs the risk of tightening slightly too late), there is a chance that lift-off may be delayed to the second half of this year. Should the so-called lift-off occur earlier than the market expects, market volatility is likely to heighten, despite the committee’s guidance that normalisation will be at a slow and gradual pace. The UK economy expanded by a briskly 2,6 per cent in 2014, despite growth slowing to 2,2 per cent in the final quarter of 2014 compared to the 2,6 per cent registered in the third quarter. In the euro area, economic growth remains pedestrian despite accelerating from 0,4 per cent in the third quarter to 1,6 per cent in the final quarter of 2014, which helped to push growth to 0,9 per cent for 2014. Growth for 2015 is projected at 1,3 per cent, but with downside risk. BIS central bankers’ speeches Although the immediate risk of a Grexit has receded, following an agreement to a four-month extension to its EU/IMF bailout programme, significant risks remain as some €10 billion in loan, bond and interest repayments is due in the next few months. Preliminary headline inflation registered –0,3 percentage points in February 2015, which is marginally better than the –0,6 percentage points reported for January, due to the lower energy prices, thus raising the spectre of deflation. The European Central Bank announced in January 2015 that it would embark on an open-ended monthly asset purchase programme of some €1,1 trillion in total. This seems to have partly stabilised inflation expectations in the euro area. Unemployment in the euro area continues to improve marginally and is now at 11,2 per cent. Japanese growth returned to positive territory in the fourth quarter of 2014 on the back of brisk growth in net exports. Despite this, growth for 2014 registered zero per cent. Headline inflation in January amounted to 2,4 per cent, but when allowance was made for the effect of the increase in consumption taxation in April 2014, consumer price inflation was merely 0,4 per cent and hence some way off the 2 per cent target that has been set by the authorities. The Bank of Japan increased its quantitative and qualitative easing programme to approximately ¥80 trillion per annum in October 2014. Earlier this year, the IMF lowered its global growth forecast for 2015 and 2016 to 3,5 per cent and 3,7 per cent, respectively. This was mainly due to a more bearish growth outlook for certain emerging market and oil-exporting economies, as well as the euro area and Japan. China’s real output decelerated from 8,3 per cent in the third quarter to 7,2 per cent in the final quarter of 2014 while its growth for 2014 registered 7,4 per cent, its slowest expansion in more than two decades. The impact of unconventional monetary policy on emerging market economies The global increase in liquidity, following the launch of widespread quantitative and qualitative easing programmes, or the unconventional monetary policy, by several advanced economies played an important role in preventing the Great Recession from degenerating into a Great Depression, and more recently, has been used to counter the possible unanchoring of inflation expectations in the face of deflationary conditions. The transmission of global financial conditions and shocks across borders seems to have intensified following the implementation of the unconventional monetary policy in advanced economies. This is as a result of increasing global trade and integrated financial markets. The channels by which these shocks are transmitted to emerging market economies are the interest-rate channel, the exchange-rate channel, and changes in asset prices. The interest-rate channel, and especially the yield curve, has been a key transmission channel of extraordinary monetary accommodation in advanced economies. With the decline in global interest rates to near-zero and the consequent easing of financial conditions, the term premium was compressed, which prompted investors to rebalance their portfolios towards higher-yielding assets in emerging market economies. Higher interest rates and relatively stronger growth in emerging market economies acted as a pull factor on capital flows. International financial and monetary conditions were therefore the trigger for flows into the bond markets of emerging market economies, or what Hyun Song Shin terms as the second phase of global liquidity, bringing economic benefits, but also making these economies more vulnerable to external shocks. Investors drew scant little distinction between the riskiest high-yield corporate bonds and the emerging market sovereigns while excessively accommodative monetary policy in advanced economies prevailed. However, with increased expectations of normalisation of policy rates and the end of the asset purchase programme in the US, the high-yielding emerging market economies’ securities has lost their appeal somewhat. BIS central bankers’ speeches A further channel of transmission for quantitative easing has been through exchange-rate movements. Capital inflows, particularly portfolio inflows, to emerging market economies have resulted in the appreciation of some emerging market economies’ currencies. However, according to the IMF, the overall impact on emerging market economies was generally positive. It further argues that the positive spill-over effects from the relatively stronger demand in advanced economies, as well as from the lower costs of capital, cheaper sovereign financing and higher equity prices, outweighed the negative effect of currency appreciation. Some of the positive net effects of quantitative easing on emerging market economies were, however, reversed following the “tapering” announcement in May 2013 which triggered changes in US policy expectations. Some evidence suggests that the announcement has likely reduced market participants’ risk appetite for investing in emerging market economies. Indeed, many emerging market economies experienced a sharp withdrawal of private capital inflows and increased financial market volatility. The impact has, however, increasingly become differentiated among economies. Countries with stronger fundamentals, deeper financial markets and a tighter stance on capital flows and macro-prudential policies, prior to tapering, seems to have experienced less volatility. South Africa was among the emerging market economies strongly affected by the US Fed’s tapering announcement. As in other emerging market economies, portfolio inflows slowed from May 2013 and turned to outflows in the second and fourth quarters of 2013 and again in the third quarter of 2014. The exchange rate of the rand has also been volatile. Although some of this volatility can be explained by the changing expectations of the timing of the first US interest-rate increase, domestic idiosyncratic factors were also at play, including weak growth projections, large twin deficits, a sizable share of foreign holdings in rand government debt and downgrades of South Africa’s credit ratings. The flexible exchange-rate system and robust macro-prudential policies in South Africa have, to some extent, served as a buffer in offsetting some of the negative spill-overs. Market perceptions of a possible delay in US normalisation, coupled with the European Central Bank action, have changed global market risk sentiment and improved the prospects for capital flows to emerging markets over the short-term. This, however, is likely to be temporary in nature. The third transmission channel of unconventional monetary policy has been through the increase in asset values, both through the liquidity effect and by lowering the rates used to discount future streams of earnings. This has occurred both in advanced, as well as in emerging market economies. Since the US Fed embarked on the first round of quantitative easing, the US equity market, as measured by the S&P500, has gained over 232 per cent. The equity market in South Africa gained 236 per cent over the same period in rand terms. However, even though foreign equity flows slowed somewhat since the taper tantrum in May 2013 and the actual tapering commencing in January 2014, the JSE has continued rising and equity valuations at about 17,3 times forward price-earnings ratio are firmly above their longterm trend. While South Africa has experienced significant volatility in its exchange rate, as well as a surge in asset prices, there is little evidence to suggest that this has had a significant impact on the domestic credit cycle. The credit-to-GDP gap, which was in line with the positive levels of the credit-to-GDP gap of most advanced economies during the build-up phase of the global financial crisis, is currently below its long-term trend in South Africa. Recently, Christine Lagarde, the MD of the IMF, argued that even if the process of interestrate increases by the US Fed is well-managed, it may result in excessive volatility in financial markets and trigger a reversal of capital flows, particularly from vulnerable emerging market economies as investors reassess their perception of risk. South Africa, with its large budgetand current-account deficits, remains vulnerable to capital outflows and a weakening of the currency. BIS central bankers’ speeches The impact of low oil prices on the global economy The similarities between the transmission mechanism of the 2006 fall in US house prices and the fall in the price of oil since June 2014 have prompted some analysts to predict that the correction in the oil price could ultimately lead to negative spill-over effects to the global economy. The US shale gas and oil industry is highly leveraged, and capitalised on the rise in the price of oil that started almost a decade ago. Banks’ lending to the energy sector of billions of dollars could pose a systemic risk to the global financial system. The exposure was seen as low-risk and the pricing of risk by lenders might have been less robust during the upward swing in oil prices. The recent precipitous plunge in oil prices from approximately US$115 to US$60 has stoked concerns over growth of particularly the oil-producing countries, fuelling fears about deflation and intensifying scrutiny of capital spending across the energy sector, with companies set to slash their exploration and development budgets. Some estimates put the figure of possible losses related to halting exploration projects at US$1 trillion. Sustained low oil prices could further trigger a wave of bankruptcies and defaults with concomitant negative spill-over effects to the financial sector. A number of sub-Sahara African countries are particularly at risk from the fall in oil prices, with oil exports accounting for 40–50 per cent of GDP for Gabon, Angola and the Republic of the Congo, and 80 per cent for Equatorial Guinea. In Angola, the Republic of Congo and Equatorial Guinea, the oil industry accounts for 75 per cent of government revenue, while in Nigeria oil still accounts for more than 70 per cent of the national budget, leaving public institutions exposed should low oil prices persist for some time. Although low oil prices could boost consumption, their impact on growth could be mixed, with oil-exporting countries particularly vulnerable and they may be negatively affected by these developments in the form of deteriorating fiscal and external balances. This may further result in sovereign wealth liquidating some of their investment holdings. The lower oil prices may also accelerate the build-up of deflationary pressures in certain advanced economies. Domestic economic developments Although the South African economy expanded at a brisk annualised rate of 4,1 per cent in the final quarter of 2014, growth for the full year was a disappointing 1,5 per cent and represents the second-lowest growth rate recorded over the past sixteen years. The real output during 2014 was severely affected by the industrial action in the platinum, as well as steel and engineering sectors, and supply-side bottlenecks such as the interruptions to the electricity supply towards the end of last year. Although mindful of the impact that monetary policy may have on economic growth, the Bank has to remain focused on its primary objective of price stability without being oblivious to growth dynamics. Similarly, monetary policy does not cure all ills, and South Africa needs to be alive to the structural reforms, albeit painful, that may be required to place the country on a firm path to balanced and sustainable growth. These reforms extend beyond labour market reforms and according to the IMF’s 2014 Article IV Consultation Staff Report, they should include increased product market competition, as it would help to reduce the wage-productivity gap by lowering the cost of living and enhancing productivity. The current-account deficit improved during the second half of 2014. It improved from a deficit of 6,2 per cent in the second quarter to 5,8 per cent in the third quarter of 2014. This can be attributed to mineral exports improving in the second half of the year, following the crippling platinum strikes in the first half of 2014, improved terms of trade due to the sharp decline in the international crude oil prices, and a more competitive rand exchange rate. BIS central bankers’ speeches Headline CPI inflation decelerated to an annual rate of 4,4 per cent in January 2015, down from 5,3 per cent in December, and is now below the mid-point of the inflation target range. Consumer goods price inflation slowed markedly from a year-on-year rate of 4,8 per cent in December 2014 to 3,0 per cent in January 2015. Similarly, non-durable goods inflation decelerated sharply to 2,5 per cent in January 2015 from 4,8 per cent in December 2014, as a result of the sharp decline in fuel prices, which resulted in transport contributing 0,7 percentage points to the 0,9 percentage points decline in headline CPI inflation. Services price inflation remained sticky in January and moderated only slightly to 5,8 per cent from 5,9 per cent in December 2014. Headline CPI, excluding food and non-alcoholic beverages, petrol and energy – the most popular measure of core inflation – accelerated marginally to 5,8 per cent in January 2015 from 5,7 per cent in December 2014. The underlying measures of CPI remain stable, but elevated, which points to fairly persistent underlying inflationary pressures. The most recent rally in international crude oil prices resulted in a rebound in the petrol price of 96 cents per litre at the beginning of March 2015, which on its own may add approximately 0,6 percentage points to headline CPI. Although the more benign headline CPI outlook has given the MPC some room to pause in its process of interest-rate normalisation, it had emphasised that the bar for further accommodation remains high and, as indicated, would require a sustained decline in the inflation rate and sticky inflation expectations. Regulatory, supervisory, and financial stability matters Following the Great Recession of 2008, the Bank’s mandate of price stability has been expanded in line with most other central banks’ in the world, to include the additional responsibility of overseeing and maintaining the stability of their financial systems. The Bank shares this mandate for financial stability of the South African financial system with other stakeholders in the financial and public sectors. National Treasury published a policy document in February 2011 titled A safer financial sector to serve South Africa better, which outlined government’s decision to shift to a Twin Peaks model of financial sector regulation. The Twin Peaks model of financial regulation represents a move away from a fragmented regulatory approach (based on the institution or activity) towards a regulatory and supervision model based on objectives. It is envisaged that, once fully implemented, the Twin Peaks system of regulation will focus on a more harmonised system of licencing, supervision, enforcement, customer complaints, an appeal and review mechanism, and consumer advice and education. National Treasury published the second draft of the Financial Sector Regulation Bill in December 2014. This bill proposes to confer upon the Bank the responsibility for financial stability and the oversight of market infrastructure and payment systems. It further proposes the establishment of two regulators, namely a Prudential Authority within the Bank and a new Financial Sector Conduct Authority. The Prudential Authority would supervise the safety and soundness of banks, insurance companies, and other financial institutions, while the market conduct authority would supervise the way in which financial services firms conduct themselves and treat their customers. This reform forms part of the current broader overhaul of the global regulatory system which aims to address the too-big-to-fail problem of systemically important financial institutions, building resilient financial institutions, reducing the opacity of over-the-counter derivatives markets, mitigating the impact of shadow banking on financial stability, enhancing financial benchmark transparency, and promoting the convergence of accounting standards. Within each of these themes there are a number of regulatory initiatives, such as the regulation of systemically important financial institutions under the too-big-to-fail problem, Basel III and proposals for a basic capital requirement for insurers to strengthen the theme of BIS central bankers’ speeches building resilient financial institutions. This list, although not exhaustive, suggests the significant scope and amount of the work still ahead. Adding to this burden are the implementation and monitoring processes, such as the Financial Sector Assessment Programme and related peer reviews to assess progress made with the implementation of internationally agreed regulatory standards by member jurisdictions. On 1 January 2013, South Africa implemented the Basel III framework. The implementation period for several of the Basel III requirements that were incorporated into the domestic banking regulations commenced on 1 January 2013, and includes transitional arrangements, which will be phased in until 1 January 2019. The purpose of the transitional arrangements is to afford banks sufficient time to meet the higher standards while still supporting lending to the real economy. South Africa underwent a peer and thematic review by the Financial Stability Board in 2013, and recently participated in an IMF/World Bank Financial Sector Assessment Programme, which was finalised towards the end of 2014. The purpose of such programmes is to assess the stability of member jurisdictions’ financial systems as a whole; they intend to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance their resilience to shocks and contagion. Overall, the assessment of South Africa’s financial sector and its supervision and regulation was positive, the report noting a high-level of compliance and strong supervision but finding that the financial sector operated in a challenging economic environment, identifying some gaps. Conclusion It is clear that although the global recovery has started to gain momentum, particularly in the US and the UK, it is multispeed and there are a number of downside risks to the global economic growth outlook. Although the slump in oil prices can be described as equivalent to a tax reduction of approximately US$1 – 1,5 trillion and is viewed by most analysts as net positive for global growth, the positive and negative shocks are asymmetric, and certain oilexporting countries will be severely affected should oil prices remain at current levels for an extended period of time. Many of these countries may be downgraded by rating agencies and may experience significant capital outflows, particularly if the US economy recovers more strongly and if lift-off happens sooner or at a faster pace than markets may have anticipated. This may elevate global financial stability concerns. Further risks to the global economic outlook include a possible disorderly Grexit and the risk of deflation, should inflation expectations become unhinged in the euro area and in Japan. On the domestic front, growth continues to disappoint, and potential growth is likely to be constrained due to the electricity load-shedding. The inflation outlook, although materially better, remains sticky, with inflation expectations remaining close to the upper-end of the target. It has, however, provided some room for pause, but the bar for an interest reduction is high, as previously stated. The scale of the regulatory reform process under way is probably the most significant overhaul of the financial regulatory architecture since the 1970s. Despite its ambitious scale, the Bank is preparing itself to embrace this expanded mandate in its quest to promote, maintain, and ensure a more stable financial system. That will hopefully allow all of us to sleep more soundly at night, knowing that our savings and investments are safer. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department's Annual Cocktail Function, Pretoria, 3 March 2015.
Daniel Mminele: Policy implications of some key market developments Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department’s Annual Cocktail Function, Pretoria, 3 March 2015. * * * Introduction Ladies and gentlemen, good evening. Thank you for attending this year’s Financial Markets Department cocktail function. It has almost become tradition for me to take stock of major global and domestic market developments that occurred during the past year, and to briefly reflect on their implications for South Africa. In the past, we also used this event to brief you, our partners in financial markets and other stakeholders, on key projects undertaken, changes and innovations introduced in the Financial Markets Department. This year, though, I would like to take a slightly different approach. Rather than providing a detailed review of operations over the past year, I will look at what I think are potential challenges that market participants and policymakers are likely to be confronted with in the period ahead. Given the time constraints, I will focus on the policy implications of some key market developments. You will, however, not be deprived of information about recent developments and activities of our Financial Markets Department. I have the pleasure of announcing the launch of the newsletter called FMD update, copies of which will be available tonight. The newsletter will also be available on the Bank’s website. What has not changed and will not change is the importance of central bank interaction and communication with the markets, especially in light of the new views on the role of forward guidance in its various forms. Forward guidance, in more formal or less formal ways, appears to have graduated from what was essentially a crisis-fighting instrument to now being advocated by some as part of the standard toolkit of central bankers, even in normal times. Recent experience has shown how sensitive financial asset prices have become to changes in signals over future policy. We therefore continue to value our ongoing interaction with yourselves as market participants, as you are in essence part of our transmission mechanism of monetary policy. Monetary policy divergence, the stronger US dollar, and global imbalances But let me get back to market issues and policy. One of the key trends observed over the last few quarters has been the steady appreciation of the US dollar against the backdrop of divergent monetary policies in advanced economies. At first glance, such a recovery in the US currency seems consistent with the improvement in US economic prospects. US GDP growth continues to outpace that of the eurozone and Japan, and most economists agree that ‘the healing process’ of balance sheets in the private and public sectors, a necessary adjustment following the global financial crisis, is more advanced in the US than in some of the other advanced economies. In view of these improvements, and of perceptions that the US economy is likely to prove fairly resilient to foreign-exchange appreciation, market participants have discounted earlier rate hikes in the US than in other major blocs, and widening yield and forward rate differentials have favoured the US dollar. As you are aware, the actual timing for a lift-off in US interest rates remains the subject of much debate and speculation. Conversely, the resulting currency depreciation in regions like Europe, Japan and Latin America is seen as growth-enhancing and also assisting, in some cases, with warding off the risk of deflation. BIS central bankers’ speeches The marked appreciation of the US dollar may, however, revive other concerns. We have seen a very strong correlation between the stronger dollar and weaker commodity prices. While this is in part a logical consequence as the US dollar is the currency of denomination for trading in many commodities, the firming in the US currency appears to have contributed to an unwinding of long speculative positions in commodity futures, which has possibly exacerbated the overall price decline. Some have argued that the risk that such an unwinding of positions could extend to other financial assets through portfolio rebalancing effects should not be underestimated. Hence, it may not be a coincidence that the stronger dollar was accompanied by a rise in financial market volatility, a subject I will address in more detail later. Finally, it may be worth asking whether the stronger dollar and stronger US growth will not, as has already happened in earlier decades, exacerbate current-account imbalances or result in widening global imbalances, at a time when external surpluses in the eurozone and China are rising again and the US trade deficit is drifting wider. How has this affected South Africa? A corollary to the rising US dollar has been depreciating emerging market currencies, including the rand. The downward trend of the rand versus the US dollar continued in 2014. At R11,71 to the US dollar as of 2 March, the bilateral exchange rate is approximately 7,0 per cent weaker than a year ago and only marginally stronger than the low of R11,87 reached at the height of the 2008 global financial crisis. However, compared with other emerging market currencies, the rand was certainly one of the betterperforming currencies against the US dollar and has regained some of the ground it had lost in earlier years. Yet, unlike previously, this weakening of the rand against the US dollar has not resulted in depreciation on a trade-weighted basis. In fact, the effective exchange rate has been relatively stable since the beginning of 2014. On 2 January 2014, the TWI was at a level of 68,3 while on 2 March 2015 it was virtually unchanged at 68,4. For 2015, up to and including 2 March, the rand has appreciated by 2,1 per cent on a trade-weighted basis. This is explained by the fact that while there has been a marginal depreciation against the US dollar of close to 2 per cent, the rand has appreciated by 6,3 per cent against the euro. This reconfiguration in currency markets arising from the stronger US dollar, which happens to coincide with easing policies in other parts of the world, has led some observers to highlight the risk of new currency wars. Any currency wars which inhibit international trade will affect economies highly dependent on exports and will certainly trigger uncertainty, with an adverse impact on capital flows to emerging market economies. It is for this reason that the G-20 agenda argues against the use of competitive devaluations as a deliberate policy measure. The volatility of domestic bond yields Another important development over the past year has been the decline in long-term South African bond yields, even as the rand continued to weaken against the US dollar. For example, while off its late-January lows, the yield on the R186 bond is still about 130 basis points below early-2014 levels. The current yields are nevertheless still substantially higher than the levels that prevailed prior to the ‘taper tantrum’. Before bond yields started rising to the current levels of 7,66 per cent, the R186 bond traded at 7,04 per cent towards the end of January. The strong bond market rally in January was due to market participants having scaled down their expectations for interest-rate hikes compared with what they projected in early 2014 due to the oil price having declined sharply, to the point that domestic inflation was no longer expected to exceed the upper end of the target range over the forecasting period, and real domestic GDP growth having also fallen short of earlier expectations. Furthermore, non-residents were net buyers of domestic bonds to the value of more than R9,1 billion. Bond yields reversed course as non-residents started selling domestic bonds (approximately R13,7 billion in February). There were also rising concerns and uncertainty as to the sustainability of the low oil price. There were indications that broad measures of longer-term inflation expectations – as depicted by the BER survey – had not declined significantly, at BIS central bankers’ speeches least not as much as market measures like break-even inflation expectations, which was a key factor behind the decline in long-term bond yields in January. The Bank will continue monitoring the international and domestic factors driving bond market volatility. Increased volatility would be a source of risk as it could undermine capital inflows and put pressure on the balance of payments. In that respect, it may be worth reflecting on, in particular, what the relationship should be between long-term interest rates and the price of oil. Indeed, a decline in oil prices should depress the inflation rate in the short term but at the same time provide a boost to real GDP growth, and as a result need not have a big impact on long-term inflation expectations. A strong rally in longer-term bonds on the back of lower oil prices may be justified in places like the eurozone, where market participants fear that even a few months of negative headline inflation readings might entrench deflation; yet one cannot make a similar case in South Africa. After all, more likely, the decline in long-term SA bond yields was influenced by the strong correlation between domestic and foreign term premiums, especially with the US. However, this pattern highlights the vulnerability of domestic yields to any sudden steepening in global yield curves. Causes of the recent uptrend in volatility While global long-term yields are still below the average levels that prevailed in the second half of last year, most indicators of financial market volatility, especially in the fixed-income and currency markets, have tended to move higher in recent months. Furthermore, at least compared to the period of relative stability around mid-2014, these indicators seem prone to swings that are both more frequent and bigger in magnitude. In a word, volatility seems to be getting more volatile. Some commentators argue that this volatility is driven by, among others, geopolitical events, uncertainties about the timing and pace of US rate rises, tensions arising from needing to find sustainable solutions for Greece, and doubts about how successful QE will be in the eurozone. These factors have a significant bearing on this rise in volatility. Rising volatility in several financial assets seems to have been correlated with higher oil price volatility as a result of the drop in crude prices, which may sound a bit counterintuitive as lower oil prices typically bring about a better growth/inflation mix in the world’s largest economies. While demand and supply factors are responsible for the over US$50 per barrel decline in the price of Brent crude, we do not have a full understanding of the drivers of the oil price decline. In fact, there are indications that financial factors, while not dominant, did have some bearing on oil price movements. Or was the oil price decline seen as a harbinger of deflation in some regions? It could also be a reflection of deeper structural economic weaknesses that will complicate the task of policymakers, and thereby challenge the valuation of many asset prices. Only time will tell. At the same time, the side effects of regulatory changes introduced in recent years, and in particular limitations on banks’ proprietary trading, appear to have reduced the willingness of established primary dealers to hold sizable inventories of fixed-income securities, and to continue to make markets in the less liquid issues. As a result, turnover has tended to decline relative to amounts outstanding in many of these markets. At a time when fund managers (both private and public) have tended to diversify their portfolios and hold larger quantities of these less liquid issues, the risk of a sudden plunge in liquidity, and subsequent sharper price swings, may rise should asset managers be required to substantially reduce their positions in a relatively short period. Yet, while these constraints to market liquidity are likely to be a sign that new regulations could be having unintended and undesired side effects, they should not be used as an excuse to put on hold the search for greater fairness, transparency and ethics in financial markets, both internationally and at home. In a world where both the size and the complexity of financial transactions keep increasing, yet where a growing number of intermediaries and BIS central bankers’ speeches trading technologies mean a decline in the personal relationship between buyers and sellers, the need for trust, strong culture and appropriate values becomes even more important. This requirement is illustrated by recent findings on collusive practices in reference rate setting and foreign-exchange markets over recent years, which resulted in huge financial penalties for the institutions involved. In the absence of trust, acceptable norms and values, market participants would require additional risk premiums to protect against the risk of unfair pricing, implying, in the long run, restrictions in access to credit, suboptimal returns for savers, and overall constraints to economic growth and development. In South Africa, the Bank has spearheaded several initiatives in recent years with respect to strengthening codes of conduct for Jibar and foreign-exchange markets, and, more recently, a push to enhance transparency in the broader money market. Yet professional associations and their members still need to play a key role, at home and abroad, in enforcing greater and more efficient selfregulation. Concluding remarks – implications for the Bank’s policy What does this all mean as we go deeper into 2015? The big themes that we saw in the closing stages of 2014 are still with us. In addition to domestic growth and inflation trends, the outlook for South African financial markets, similar to other emerging market economies, will likely be dominated by four factors, namely: the pace of normalisation in US interest rates, growth and monetary policy dynamics in the eurozone, growth developments in China (large and to a lesser extent in other emerging market countries), and the outlook for commodity prices. These developments appear to have set the tone for higher volatility in global markets and a possibly more challenging environment for emerging market economies, especially those whose private and public entities have borrowed heavily in US dollars in recent years and in some instances have invested in oil-related activities. While shock changes to sentiment seem to affect markets more (as exhibited by this heightened volatility), the ability of the market to absorb such events still seems to be intact, but spill-over effects could be more pronounced. Policymakers will have to deal with the increasingly complex nature of various cross-currents that characterise the current environment. Such factors of uncertainty require a high degree of vigilance from monetary authorities, even as inflation falls lower than we expected a few quarters ago. Although it is clear that policymakers globally have been given some reprieve as a result of the decline in oil prices, there still exists much uncertainty as to its drivers and its sustainability, which makes us vulnerable to a correction or reversal in prices from current levels. In such an environment, it is important to remain vigilant and not to declare early victories because of what appear to be temporary dynamics around headline inflation outcomes, but to continue to be guided by a forward-looking approach over the medium term. Amid such new developments and uncertainties, the Bank will continue to abide by its mandates of price and financial stability. The Bank is cognisant of how the oil price decline has significantly changed the near-term inflation outlook, however, the former’s long-term impact on both growth and inflation will depend on how persistent the decline is. Consequently, the Bank has made moderate downward revisions to its core inflation forecast, projecting average rates of 5,5 per cent in 2015 and 5,1 per cent in 2016, versus rates of 5,7 per cent and 5,3 per cent, respectively, at the time of the November MPC meeting. Furthermore, several factors may preclude the normal positive boost that a marked oil price decline typically provides to a country’s growth-inflation mix, highlighting the uncertainties surrounding these forecasts. The currency remains a major factor of uncertainty, for while the rand’s real effective exchange rate is relatively low by historical standards and showed signs of stabilising last year, the persistence of a structurally large current-account deficit, coupled with the uncertainties I mentioned earlier about market liquidity and volatility and asset price BIS central bankers’ speeches valuations, highlight the risk of reduced portfolio inflows, even outflows, and further currency depreciation. At the same time, on the wage front, the continued rigidity in wage demands and settlements, at a time when labour conflicts have risen and productivity has slowed, raises doubts as to the extent that a temporary, oil-driven drop in inflation can feed into a more benign wage-price spiral. Finally, on the real economy side, the country’s well-publicised power supply constraints, while limiting the growth benefits of the oil price drop, raise questions about the extent to which potential growth, and the output gap, may be trimmed over the next few years. Such factors of uncertainty require a high degree of vigilance from monetary authorities, even as inflation falls lower than we expected a few quarters ago. The more benign projected inflation path, in an environment where growth in credit and property prices does not signal any build-up in financial imbalances, gives the Bank some room to pause in its interest rate normalisation process. Yet, risks related to currency moves, capital flows and overall financial market volatility will have to be closely monitored in coming quarters. BIS central bankers’ speeches
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Continuous Linked Settlement (CLS) Reception to mark ten years of inclusion of the South African rand in the CLS, Johannesburg, 17 March 2015.
Daniel Mminele: Ten years of inclusion of the South African rand in the CLS Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Continuous Linked Settlement (CLS) Reception to mark ten years of inclusion of the South African rand in the CLS, Johannesburg, 17 March 2015. * * * Good evening, ladies and gentlemen. It is an honour for me to make a few remarks on this occasion of the CLS Reception to mark ten years of settlement of the rand in the CLS system. I am particularly pleased that the CLS delegation to mark this key milestone is led by none other than the Chairman of the CLS Board, Mr Kenneth Harvey. We welcome you and your colleagues to South Africa, and thank you for coming all the way. The CLS is one of those mission-critical systems that can be compared to the plumbing system of a building. Just as most of us never think about the plumbing of a building and take for granted that it is there and works, the CLS also runs very much in the background of the foreign-exchange market. It is only when there is a leak or a pipe bursts that we realise how important plumbing is. In the context of the CLS, if a big pipe bursts and cannot be fixed quickly, this can result in major disruptions to the foreign-exchange market, with potential rapid spill-over effects to the rest of the financial system, which at worst could bring about financial instability on a global scale. As many of you will know, the CLS plays a fundamental role in the foreign-exchange market, where it operates the largest multi-currency cash settlement system to mitigate settlement risk for the foreign-exchange transactions of its members and their customers. In its offering, the CLS mitigates settlement risk through the provision of its unique payment-versuspayment settlement service which has direct links to the real-time gross settlement (RTGS) systems of the currencies it settles. In addition to mitigating settlement risk, the CLS also contributes to streamlining and standardising foreign-exchange operations, helping to reduce costs. A foreign-exchange settlement usually requires potentially large cash funding liquidity to settle the obligations of settlement members. These values are materially reduced in the CLS system through the multilateral netting of the obligations between member banks to deliver best-in-class liquidity management. As regulatory requirements for larger liquidity buffers increase, the benefits from multilateral netting at an industry level have become increasingly important. Before I briefly share with you how our participation in the CLS has grown over the years, allow me to go down memory lane for a short while. Foreign-exchange settlement risk – being the risk that originates from a situation where, in a foreign-exchange trade, one party has irrevocably paid a currency and the counterparty subsequently fails to meet its side of the deal by not delivering the other currency on time – captured the attention of regulators as a major source of systemic risk following the spectacular collapse of Bankhaus Herstatt in Germany in 1974. The creation of the CLS goes back to regulatory concerns around the collapse of Bankhaus Herstatt. In March 1996, the Committee on Payment and Settlement Systems (CPSS) at the Bank for International Settlements (BIS) published the so-called Allsopp Report titled Settlement risk in foreign-exchange transactions – a strategy for addressing foreign-exchange settlement risk. This report called for action from the private sector to address settlement risk in the foreign-exchange market. The response of the private sector led to the establishment of the CLS and the launch of the CLS system with 39 members and seven currencies: the BIS central bankers’ speeches Australian dollar, Canadian dollar, euro, Japanese yen, Swiss franc, UK pound sterling, and US dollar in September 2002. Since then, the system has evolved to the current state where foreign-exchange transactions in 17 currencies are settled with a peak volume to date of over 2 million transactions per day and a peak value of more than US$10 trillion per day. In its evolution, the CLS added four more currencies in September 2003: the Danish krone, Norwegian krone, Singapore dollar, and Swedish krona. In December 2004, a further four currencies were added to the settlement service, namely the Hong Kong dollar, Korean won, New Zealand dollar, and South African rand. The currencies of Israel and Mexico were implemented on the system in 2008. Joining the CLS in 2004 was a major achievement for South Africa given the stringent eligibility criteria. In briefing Parliament at the time about the risk management, liquidity, and efficiency benefits of the CLS system, then Minister of Finance, Mr Trevor Manuel, put it rather succinctly, and I quote: “The inclusion (…) demonstrates that the South African payment system provides for global best practice, and would foster domestic and international investor confidence in the integrity and robustness of the national payment system.” Back in December 2004, our central bank joined the CLS Cooperative Oversight arrangement led by the Federal Reserve Bank of New York, as the regulator of the CLS Bank, in order to ensure that, in the settlement of the rand in the CLS system, our domestic policy objectives continued to be met. We also joined the CLS Operators Forum, also led by the Federal Reserve Bank of New York, to ensure the coordination of relevant actions by all real-time gross settlement system operators that are linked to the CLS system. In all these cooperative arrangements, there is an appreciation of regular interaction as well as frank and constructive engagement with CLS management and executives. Before I conclude, let me share some information on our participation in the CLS system. In 2004, when we joined the system, two of our banks, namely Absa and Standard Bank, became settlement members. These banks had obtained direct access to the CLS system in terms of submitting their foreign-exchange trades. Absa has, however, since become a member of the Barclays Group and its membership has thus been terminated. It is now a submitting branch of Barclays in the CLS system. At the time, we had six Rand Nostro service providers, namely Absa, Calyon, CITI, FirstRand Bank, Nedbank, and Standard Bank. These banks provide services to CLS members in terms of either receiving rands that are purchased and settled through the CLS system or funding rands that are sold and settled through the CLS system. In terms of rand settlement members, they are in a position to receive and fund rands for their own account. As far as rand settlement in the CLS system is concerned, during 2005, an average of R83 billion worth of rand trades were settled in the CLS system on a daily basis. To settle these trades, the average daily liquidity requirement that needed to be paid into the CLS system through the SAMOS system amounted to only R6,2 billion. This resulted in a liquidity efficiency of 7,5 per cent. By 2009, the average values of rand trades that were settled in the CLS system on a daily basis had grown to R163 billion. To settle these trades, the average daily liquidity requirement that needed to be paid into the CLS system through the SAMOS system amounted to only R9 billion. This resulted in a liquidity efficiency of 5,5 per cent. More recently, during 2014, the average values of rand trades that were settled in the CLS system on a daily basis amounted to R411 billion. To settle these trades, the average daily liquidity requirement that needed to be paid into the CLS system through the SAMOS system amounted to only R8.7 billion. This resulted in a liquidity efficiency of 2,1 per cent. Thus, in the ten years of South African participation in the CLS, the average daily value of transactions settled has increased fivefold, with only a 40 per cent increase in pay-in values. From these statistics it is evident that while our market is benefiting from the risk BIS central bankers’ speeches management mechanism provided by the CLS system, there are also huge benefits that we gain from the liquidity efficiency. Among the many things highlighted by the global financial crisis was the realisation that there are certain critical, systemically important systems in the international payment and settlement environment which deserve special attention going forward. The CLS is one of them, and in this vein we in South Africa remain committed to building on our good relationship with the CLS and other fellow regulators as well as relevant international bodies, such as the Committee on Payments and Market Infrastructures (CPMI), to ensure the we continue to strengthen the system further so as to reduce the potential for systemic disruption and financial instability. As you may be aware, we are also actively engaged in implementing cross- border settlement arrangements and systems within the Southern African Development Community (SADC), and our experiences from working with the CLS are proving quite useful. To our stakeholders in the South African national payment system, the CLS Group, and, last but not least, my colleagues at the South African Reserve Bank and other regulators, all the best for the next ten years and more! BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Tenth Annual International Operational Risk Working Group (IORWG) Conference, Cape Town, 22 April 2015.
François Groepe: The South African economy, policy mandates and international central bank cooperation Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Tenth Annual International Operational Risk Working Group (IORWG) Conference, Cape Town, 22 April 2015. * * * Introduction Good evening ladies and gentlemen. I wish to extend a warm and hearty African welcome to you and I hope that you will thoroughly enjoy tonight’s gala dinner. It is my privilege and honour to host this gala dinner on the occasion of the Tenth Annual International Operational Risk Working Group (IORWG) Conference. I wish to personally thank the co-chairperson, Ms Donna Brenner, for supporting the South African Reserve Bank’s (SARB) bid to host this important conference in this wonderful city. I, furthermore, wish to express my sincerest gratitude to all the delegates and their spouses, many who have travelled from abroad for gracing us with your presence and contributing to the debates and the discussions. The SARB has enjoyed a long and beneficial relationship with the IORWG and all its member central banks and it is my wish that this conference will further cement the strong and mutually beneficial bi- and multi-lateral relationships that have been built over many years. Before we proceed with dinner, I would like to share with you some thoughts about the South African economy and our policy mandates and the importance of international cooperation among central banks. South Africa and the global economy South Africa is a small open economy with a population of 54 million and a GDP of some USD 350 billion. This equates to a GDP per capita of USD 5 900 and USD 12 100 on a purchasing power parity basis. The tertiary sector has expanded rapidly over the last decade or two and now accounts for nearly two thirds of the economy. One of the huge challenges the country faces is structural unemployment, which is around 24 per cent with youth unemployment as high as 50 per cent. In order for the country to keep unemployment levels stable, the economy needs to grow at approximately 3 per cent per annum. The country’s economic recovery after the global financial crisis was initially broadly in line with the global recovery with economic growth registering at 3,0 per cent and 3,2 per cent in 2010 and 2011, respectively. Since 2011, the economic recovery has slowed with growth slowing to 2,2 per cent and 1,5 per cent in 2013 and 2014, respectively. Growth for 2015 is projected at 2,2 per cent and is notably lower than the pre-crisis growth rates. In recent years the lower growth rates was attributable to significant supply side constraints and disruptions. The most recent electricity load shedding has become a more pronounced drag on real output and unfortunately is likely to be a binding constraint over the short to medium term. South Africa’s current account deficit has improved slightly from 5,8 per cent of GDP in 2013 to 5,4 per cent in 2014. Although this is often described as a vulnerability, it is somewhat mitigated by the fact that the public debt to GDP ratio is manageable at approximately 45 per cent, a fairly small percentage of the public debt is foreign denominated and lastly, the country’s net international investment position, (i.e. external financial assets minus liabilities) stood at only –R438 billion in the final quarter of 2014. BIS central bankers’ speeches The South African Government released the National Development Plan some two years ago. This plan offers a long-term perspective on how to eliminate poverty and reduce inequality by 2030 by, inter alia, growing an inclusive economy, building capabilities, and enhancing the capacity of the state. Should significant aspects of this plan be successfully implemented over the next decade or so, it will contribute positively towards lifting the potential growth rate of the economy and causing unemployment and poverty levels to drop in a meaningful way. The slow growth rate referred to above, however, has not only been impacted by domestic idiosyncratic factors only. Certain exogenous factors, such as the moderation in emerging market economies growth rates, weaker external demand and lower commodity prices have certainly contributed to the more pedestrian growth outcomes. The unprecedented extent of unconventional monetary policy adopted by the advanced economies and the subsequent commencement by the US on the path towards monetary policy normalisation has led to significant spill-over effects. This is as a result of the extent of global trade and the integration of financial markets and has contributed to the high levels of volatility seen in the foreign exchange markets. The rand/dollar exchange rate has depreciated by 4,96 per cent since the beginning of this year, but has appreciated by 7,25 per cent against the euro and hence, on a trade weighted basis the rand had been relatively stable. The volatility in the foreign currency exchange markets is likely to persist and will be amplified should the timing of the so-called lift-off differ from market expectations, or a Grexit occur. The emerging market economies are likely to be affected significantly by these developments and countries with weak macro-economic fundamentals and indicators in particular are likely to be most vulnerable. The role of the SARB in the economy The Constitution mandates the SARB to protect the value of the currency in the interest of balanced and sustainable economic growth. We strive to achieve this objective within a flexible inflation targeting framework as it is widely believed that price stability is a necessary pre-condition for balanced and sustainable growth. The global financial crisis has, however, demonstrated that price stability in, and of its own, is not sufficient to ensure that financial stability is achieved. This resulted in the Bank’s mandate of price stability being expanded to include the additional responsibility of overseeing and maintaining the stability of the broader financial system. South Africa has opted to shift to a Twin Peaks model of financial sector regulation which represents a move away from a fragmented regulatory approach (based on the institution or activity) towards a regulatory and supervision model based on objectives. In terms of proposed legislation, the Bank will house the Prudential Authority, which would supervise the safety and soundness of banks, insurance companies and other financial institutions, while the market conduct authority would supervise the way in which financial services firms conduct themselves and treat their customers. These reform forms part of the current broader overhaul of the global regulatory system, which aims to address the too-big-to-fail problem of systemically important financial institutions, building resilient financial institutions, reducing the opacity of over-the-counter derivatives markets, mitigating the impact of shadow banking on financial stability, enhancing financial benchmark transparency, and promoting the convergence of accounting standards. The importance of international dialogue and ERM frameworks for central banks The increased connectedness of the world, within which we operate, has necessitated closer cooperation and coordination within the central bank community. The need for this has once again been highlighted by the global financial crisis and the subsequent attempts to not only BIS central bankers’ speeches restart the global economy but also to undertake an ambitious global regulatory reform agenda in order to address and avoid the excesses and imbalances that led to it. This illustrates the importance of collaboration between central banks. Without strong international leadership and active collaboration it would not have been possible to progress the overhaul of the global regulatory system to the extent that had been achieved. The expanded mandate of central banks may in the longer-term lead to demands for greater accountability and potentially attempts to curtail their independence. It is, therefore, important that central banks are proactive in further improving accountability and transparency and to ensure that their governance standards are beyond reproach. Central to such a governance framework is the risk management policy framework. This conference provides a platform for collaborating, sharing experiences and thoughts and addressing common challenges together. It provides a useful opportunity to leverage and learn from the experiences of how best to ensure that the risks, that inhibit achievement of our objectives, are properly identified and mitigated. It is generally accepted that central banks were late movers into the area of true Enterprise Risk Management (ERM), due to the strong emphasis on financial risk management. It soon became apparent that this is not sufficient and that operational risk management had to be brought into sharper focus. It is important that central banks move to the next phase which would require a greater appreciation of the importance of integrating all risk management across a central bank’s operations in the mould of a true ERM approach. This will assist in ensuring that strategic risks, policy risks, and reputational risks are holistically integrated with operational risk management. The IORWG has played, and I believe will continue to play, a vital role facilitating this broadening of the risk management frameworks within the broader central bank community. I have further been encouraged by the fact that many of you are appreciative of the need to move in that direction. There is no doubt that there may be some resistance to the expansion of the risk management frameworks to cover policy risks within central banks. I am, therefore, proud that I am able to share with you that South Africa has recently expanded its risk management framework to cover policy risks and we have completed an assessment of monetary policy risks. We further envisage incorporating financial stability policy into our risk management framework once we have implemented the proposed financial regulatory architecture reforms. In the light of what I have said, I hope you would forgive me for being so bold as to suggest that the IORWG may wish to consider changing its name to better reflect this structural shift. It may choose to consider replacing the word OPERATIONAL with ORGANISATIONAL in the IORWG acronym. Conclusion Central banks have many functions and operations that underlie their primary goals. Enterprise risk management is a key assurance activity that allows central banks to pursue their mandates effectively and efficiently. This is vital given the escalation in the challenges that they face such as the growing threat of concerted cyber-attacks to name but a single example. I, therefore, challenge you to take forward the many themes covered here this week and to continue to collaborate in the cooperative spirit you have shown in the past to find ways to meet the threats facing us all. Your institutions, your countries, your fellow countrymen, in fact the whole world will thank you for assisting your institutions in realising their mandates in support of economic growth, keeping prices stable, achieving and maintaining financial stability and keeping unemployment levels in check. Thank you for your attention, and enjoy the rest of the evening with us in this lovely setting. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the J P Morgan Investor Seminar at the 2015 International Monetary Fund/World Bank Group Spring Meetings, Washington DC, 19 April 2015.
Daniel Mminele: The monetary policy outlook for South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the J P Morgan Investor Seminar at the 2015 International Monetary Fund/World Bank Group Spring Meetings, Washington DC, 19 April 2015. * * * Good morning, ladies and gentlemen. Let me start by thanking J P Morgan for the opportunity to share some thoughts on South Africa’s monetary policy outlook. As you are aware, heightened uncertainty is one of the defining characteristics of the monetary policy environment in many emerging-market economies (EMEs). However, while uncertainty is at the heart of monetary policy formulation, it is the escalation in the level of uncertainty that presents the major challenge for monetary policy formulation in many countries in the current environment. Recent global economic developments have put a spotlight on the extent of these uncertainties. Take, for example, the developments in oil prices – are they transitory or permanent? How about the path of US interest rate normalisation? Will it happen in June or in September? Will it happen at all this year? These uncertainties have rendered the conduct of monetary policy increasingly complex, given that economic forecasts could vary significantly depending on which assumptions are used. Let me begin by briefly outlining the recent economic developments in South Africa. This will provide the context to discuss the monetary policy outlook and challenges facing South African policy makers in the short to medium term. Much as they have a significant bearing on developments in South Africa, I will not dwell too much on global economic developments, since these have received much attention here in Washington D.C. following the publication of the IMF’s April 2015 World Economic Outlook and Global Financial Stability Report last Tuesday. Recent economic developments in South Africa In line with developments in many other EMEs, policy formulation remains challenging in South Africa. The key the challenge is the difficulty in lifting economic growth. Electricity constraints – which are expected to persist for some time – have compounded other structural bottlenecks (such as inadequate education and skills, low level of investment, competitiveness and productivity challenges) and these remain the most critical impediments to the growth outlook. As a result, there has been a downward revision of short-term potential output to between 2,0 and 2,5 per cent from the pre-crisis levels of 3,5 to 4,0 per cent. The growth rate for 2014 was 1,5 per cent and, based on the most recent South African Reserve Bank forecast, which has downside risks attached to it, an increase to 2,2 per cent is projected for 2015. This is far from the levels of around 4,0 to 5,0 per cent needed to arrest the large unemployment problem in South Africa. The year-on-year inflation rate, as measured by the consumer price index (or CPI) for all urban areas, registered 4,4 and 3,9 per cent in January and February 2015 respectively, which is well within the inflation target range of 3 to 6 per cent. This improved trend in inflation was, however, mainly due to lower petrol prices. Recent oil price and exchange rate developments have dampened the inflation outlook. Moreover, core inflation, which excludes food, electricity and petrol prices, remained near the upper end of the inflation target range, measuring 5,8 per cent in both January and February 2015. This is an indication that underlying inflationary pressures persist. BIS central bankers’ speeches The Bank’s inflation forecast released at the time of the most recent Monetary Policy Committee (MPC) meeting last month, indicated that inflation was projected to average 4,8 per cent in 2015, an upward revision from the forecast of 3,8 per cent in January 2015. Additionally, inflation expectations, as reflected in the Bureau for Economic Research survey conducted during the first quarter of 2015, showed that all respondents expect inflation to return to levels around the upper end of the target range in the next two years. The rand/dollar exchange rate has exhibited significant volatility lately, which was in line with developments in some of the other emerging-market currencies. Since the beginning of this year to the end of March, the Rand depreciated by about 5,0 per cent against the US dollar, and traded in a wide band between R11,54 and R12,52. This weakening of the rand against the US dollar has, however, not resulted in depreciation on a trade-weighted basis as a result of it having appreciated against the euro by 7,3 per cent since January 2015. Given the Euro’s larger weight of around 30 per cent when compared with 13,7 per cent for the US$, the nominal effective exchange rate has been relatively stable since the beginning of 2014. The current-account deficit registered 5,4 per cent of gross domestic product on an annual basis in 2014 compared to 5,8 per cent for 2013. More recently, the current-account deficit shrank from 5,8 per cent of GDP in the third quarter of 2014 to 5,1 per cent in the fourth quarter. It remains uncertain whether this improvement represented normalisation from earlier strikes affecting exports, and thus would be temporary, or whether this will be the start of a more sustained compression. While the current-account deficit has been comfortably financed so far, the global capital flow environment remains challenging, particularly against the backdrop of uncertainties surrounding the tightening of US monetary policy. The flexible exchange-rate system has so far been able to cushion some of the adverse effects and should continue to do so, assuming an orderly and continued well-communicated normalisation of US monetary policy. The domestic monetary policy outlook for 2015 Notwithstanding monetary policy tightening in 2014 which saw the repo rate increasing by a cumulative 75 basis points, monetary policy remains relatively accommodative and appropriately takes into account the weak state of the domestic economy. At our most recent meeting of the MPC in March interest rates were kept unchanged, with the committee, however, noting that the near-term inflation outlook had deteriorated, as it is subjected to upward pressure from the partial reversal of the recent petrol price declines, emerging upside pressures on food prices because of drought conditions, and the high risk of further electricity tariff increases. This underscores that the timing of future interest rate increases would depend on the evolution of domestic and external factors and our understanding thereof. Let me now discuss some of the domestic and global factors that will have a bearing on the domestic outlook and policy response going forward. On the international front, I will concentrate on the three developments that have been receiving increasing attention in policy circles, namely developments in the price of oil, divergent monetary policy in advanced economies, and the impact of a stronger US dollar. Oil price developments As you are aware, there has been a significant decline in the price of Brent crude oil, reaching a low of around US$45 per barrel in January 2015. While this oil price decline was expected, the extent and speed of the decline caught many market analysts and policymakers by surprise. As the IMF has pointed out, both demand and supply factors are responsible for the decline. While the role that speculation played in driving down prices is uncertain, the appreciation of the US dollar has also contributed to lower commodity prices in general. BIS central bankers’ speeches Lower oil prices have had some direct positive impacts on the South African economy through reductions in the oil import bill. While overall net positive, there are also negatives to the decline in the oil price. A number of our export partners in Africa, such as Angola and Nigeria (which are oil-exporting countries), have been severely affected by the decline in oil prices. Reduced export revenues and growth in these economies will adversely affect their trade with South Africa. Added to this has been the generally weak global growth outlook, particularly in some of South Africa’s major trading partners, including the eurozone and China, which also offsets the positive impact arising from the decline in oil prices. Furthermore, a lower oil price may strengthen disinflationary pressures in places like the eurozone and Japan, further weakening their growth prospects 1 with adverse implications for countries like South Africa which are reliant on these export markets, although we are encouraged by the most recent assessment of the outlook for the eurozone and Japan as contained in the April 2015 WEO. On balance, for an oil-importing country like South Africa, the positives of an oil price decline outweigh the negatives. However, we cannot afford to be complacent. In South Africa, the risk to the inflation outlook is tilted to the upside for a variety of reasons. Firstly, oil price developments are uncertain. Secondly, while expectations of US monetary policy normalisation appear to have been moved out, any surprises to the contrary could increase the already high volatility in financial markets, and particularly in foreign-exchange markets. Finally, the current decline in inflation rates as a result of the recent oil price movements, in effect, means that inflation outcomes in a year’s time will be subject to strong adverse base effects. The policy challenge is to ascertain the future path of oil price developments – this is a formidable task! It is uncertain whether the lower price levels that we are currently experiencing are transitory or permanent. Put differently, could oil prices increase again as quickly as they went down? While there seems to be consensus that we would not return to the most recent peaks, unfortunately, these questions do not lend themselves to easy and clear answers. According to IMF’s World Economic Outlook Update, January 2015, despite substantial uncertainty about the evolution of supply and demand factors, futures markets suggest that oil prices will rebound but remain below the level of recent years. Experience to date does, however, show that futures prices have been poor predictors of spot prices on the oil market. It is clear that although policymakers have been given some reprieve as a result of the decline in oil prices, we know very little about their drivers and their sustainability, and we therefore remain vulnerable to a disorderly correction or reversal in these prices. In the South African context, the exchange rate is also an important factor influencing the net impact of oil prices on its economy. Rand depreciation has offset some of the benefits of the decline in international oil prices. Thus, oil price developments and uncertainty regarding their future path will continue to pose a major challenge to monetary policy formulation in South Africa. Monetary policy divergence in major advanced economies Asynchronous monetary policy developments in the major advanced and emerging markets will characterise the monetary policy landscape in 2015. The Federal Reserve is expected to gradually start hiking rates in the near term given the robust recovery in the US, and the Bank of England is also expected to start tightening policy. In both cases there is increased uncertainty as to when the hiking would start. World Bank, Global Economic Prospects, January 2015. BIS central bankers’ speeches The implication for South Africa is that rising global interest rates are among the factors that increase interest rate differentials, potentially leading to capital outflows which would put downward pressure on the value of the currency, at least in the short term; this would most likely generate some inflationary pressures. On the other hand, the €1,1 trillion stimulus package currently being implemented by the European Central Bank and further large-scale asset purchases announced by the Bank of Japan in November 2014 suggest that the euro area and Japan are likely to maintain highly accommodative policies given their generally weak growth performance. To the extent that the ECB’s quantitative easing is successful in stimulating growth, this will affect South Africa’s exports positively. However, as Europe and Japan start to grow, we will face another bout of spill over from their normalisation, although for South Africa the extent of the impact is likely to be less pronounced than that brought about by US policy normalisation. Policy divergence in major economies creates uncertainty for us as we attempt to understand the spill over effects and how best to respond to these new developments. At a global level, there is broad consensus on the need for some level of policy coordination to mitigate these uncertainties. However, the evidence to date shows that this is in many respects “easier said than done”. Containing adverse spill over effects of domestic policy actions remains a major challenge at the global level. US dollar appreciation Since October 2014, the dollar has appreciated by more than 5 per cent in effective terms. While this appreciation remains modest from a historical perspective, signs point to the possibility of further appreciation in the future for a variety of reasons. Firstly, history suggests that a drop in oil prices is often accompanied by a rise in the US dollar. Secondly, the stronger dollar could reflect the relative strength of the US economy and the expected rate hikes. Thirdly, geopolitical risks have promoted a return to “safe haven assets” and US Treasury bonds in particular. Lastly, the expansion of dollar credit outside the US since the crisis could add to the appreciating pressures in the future. The impact of a stronger dollar on emerging economies is not as clear-cut as one may expect. Other factors being constant, a stronger dollar implies the depreciation of other currencies. To the extent that the dollar strength is a result of stronger US growth, other countries’ exports – and thus growth – would benefit from increased demand from the US and from a more competitive domestic currency. South Africa’s benefit from this channel is, however, likely to be somewhat limited given the US share of our exports: 8,2 per cent in 2013 compared to 20,5 per cent for the euro area. Then there is the issue of the impact of rand depreciation on inflation outcomes. There is evidence that the pass-through of exchange-rate depreciation to inflation may have declined in recent times, but the adverse impact of currency depreciation on inflation outcomes cannot be ignored, especially if the depreciation occurs over an extended period. Additionally, over the past year, South African long-term bond yields have been declining, even as the rand continued to weaken against the US dollar. For example, while off its late-January lows, the yield on the R186 bond is still about 130 basis points below early-2014 levels. The current yields are nevertheless still substantially higher than the levels that prevailed prior to the “taper tantrum”. In addition, it is important to note that while the rand has depreciated against the dollar, it has appreciated against the yen and the euro. The South African economy would face new challenges should a strong dollar persist and a tightening of monetary policy in the US materialise while growth in the euro area remained weak. Rising interest rates in the US would have an adverse impact on borrowing costs, while a weaker euro would limit external demand for South African exports, Europe being a major trading partner for the country. BIS central bankers’ speeches Other domestic concerns Monetary policy will also be influenced by various domestic factors in South Africa going forward. I will focus my attention on two of these challenges, namely the current-account and fiscal deficits. South Africa’s “twin deficit” South Africa’s “twin deficit” remains a source of vulnerability. The persistence of these deficits – in the face of global monetary normalisation and weak domestic growth prospects – poses a serious challenge to both monetary and fiscal policies. In addressing the fiscal deficit, the 2015 Budget announced in February entails a fiscal package which reduces the expenditure ceiling and raises tax revenue over the next two years. Policymakers are aware that stabilising debt at a sustainable level, while necessary and inevitable, will be challenging in the face of subdued economic growth outcomes. The high current-account deficit is another source of vulnerability. Since the global crisis, weak domestic growth and the sustained depreciation of the rand have failed to significantly narrow the deficit. In addition to better external demand, reducing the level of this deficit by, among others, addressing export competitiveness is a challenge that South Africa needs to address. As pointed out earlier, the fall in oil prices has and will provide some benefits to the trade and current account, but this will be partly offset by lower commodity prices which have accompanied the decline in oil prices. In the context of the large external financing requirement serving as a “pull” and extraordinarily loose monetary policy in many advanced economies serving as a “push”, nonresident demand for bonds and equities has been financing most of the current-account deficit. However, as evidenced by the “taper tantrum” in May 2013, our large financing need as well as reliance on portfolio flows make South Africa vulnerable to changing risk sentiments in the market at a time when the weak growth outlook, geopolitical risk factors, and a stronger dollar may negatively affect capital flows to EMEs. So far in 2015, nonresidents have remained net sellers of bonds, but net buyers of local equities. This is broadly in line with the trend in other emerging markets. Mitigating these risks is South Africa’s limited exposure to foreign-denominated debts and our free-floating exchange-rate regime. Moreover, to the extent that a portion of the currentaccount deficit is attributable to infrastructure and investment programmes, these are likely to generate a positive rate of return for the South African economy in the medium to long term. Conclusion The list of challenges I have focused on is not exhaustive. Nonetheless, from this brief and selective review, it is apparent that South Africa’s economic policy environment, like that of many other emerging markets, will be challenging. Clearly, South Africa’s immediate priority is to strengthen the growth momentum. Unfortunately, the role of monetary policy is limited in this regard as monetary policy cannot address structural deficiencies in the economy and influence long-term growth. While monetary policy should and will play its role within the confines of its mandate, a concerted effort is needed by all role players in agreeing and then effectively coordinating and implementing the necessary structural reforms, including addressing the electricity challenges facing the country. This requires a strong, constructive, and thus effective partnership between Government, business, labour and civil society organisations. The MPC is of the view that inflation risks are skewed to the upside. Having indicated previously that, while not on a pre-set course and being data-dependent, interest rates will have to normalise over time, earlier this year we felt that short-term dynamics allowed for a pause on the interest rate normalisation path. There is now reduced flexibility in this regard BIS central bankers’ speeches and the recent deterioration in the inflation outlook will require the MPC to carefully assess when it will be appropriate to adjust the policy rate further. The forecast horizon is fraught with uncertainties, which calls for heightened vigilance, decisive policy action, and clear communication. It requires us to sharpen our analytical tools to better understand, and strengthen our capacity for forecasting, policy analysis and implementation. 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 INSEAD Alumni Association Dialogue, Pretoria, 28 May 2015.
Daniel Mminele: The globalised nature of central banking Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the INSEAD Alumni Association Dialogue, Pretoria, 28 May 2015. * * * Introduction Good evening, and welcome to the South African Reserve Bank. INSEAD is internationally recognised for excellence in business education. It is not only one of the largest business schools in the world; INSEAD also has a strong tradition of promoting diversity, with close on 90 different nationalities being represented in each annual intake. I gather that the South African Alumni Association has 580 members who have attended both MBA and executive level courses at INSEAD. It is a pleasure to host and participate in this Dialogue with you this evening, particularly in light of the fact that many of you are in senior and executive positions in large companies and hence are important stakeholders in addressing the challenges confronting our country today. The world has become increasingly globalised. This is clearly evident in economic indicators on capital movements and foreign direct investments, international trade, technology transfers, and the expansion of cross-border activity of multinational firms. Thus, global considerations are always on the radar screen of policymakers, especially those in small open economies like South Africa. In the case of monetary policy, factors such as oil price developments, capital flows, global inflation trends, and exchange-rate developments are some of the considerations that have a bearing on policy stance determination. However, knowing that many of you would have read our MPC statement of last week, my remarks today will not focus on policy, at least not directly. I would rather like to use this opportunity to talk about the globalised nature of central banking. In essence, my remarks will focus on how the financial crisis of 2007/08 as well as the role of international forums (such as the G-20, the International Monetary Fund, and BRICS) in responding to the crisis, have impacted on the work of central banks. This will also provide the opportunity for me to share with you the involvement of the South African Reserve Bank in these international forums, which complements the interest-rate setting mandate of the Bank. Monetary policy before and after the crisis Much has been written about how globalisation might impact on the work of central banks and whether it weakens the effectiveness of domestic monetary policy. Some have argued that globalisation does indeed dilute monetary policy’s effectiveness through its impact on the structure and functioning of markets, while it also pitches global factors as more prominent drivers of domestic outcomes. Others have pointed to the benefits emanating from risk-sharing and reduced volatility in financial markets, as globalisation, helps to increase liquidity in financial markets, for example. As with everything, one could argue equally for both sides on the costs and benefits of globalisation, but, needless to say, impacts will differ across countries and regions depending on, among others, the level of development of their financial markets, the openness of their economies, and the credibility of their monetary and fiscal authorities. Of importance for a policymaker is understanding the influences and risks associated with globalisation and ensuring that the risks are adequately accounted for in policy formulation and implementation. BIS central bankers’ speeches Lucas Papademos, a former Vice-President of the European Central Bank, has argued that globalisation in general does not fundamentally undermine the effectiveness of monetary policy in preserving price stability. He has acknowledged the positive effects of financial globalisation on the efficiency of financial markets, on global risk-sharing and, ultimately, on economic growth worldwide, but he has also admitted that the global financial crisis revealed a number of weaknesses in the globalised financial system, where tensions in one segment of the market in one country can rapidly spread across other markets and countries. 1 The global financial crisis certainly elevated the subject of globalisation and its impact on the world of central banking. We now have first-hand knowledge of how financial globalisation in particular can alter the monetary policy landscape and influence the nature and magnitude of spillovers and spillbacks. Certainly, the world of central banking has undergone dramatic changes since 2007: unprecedented reductions in policy rates to the zero lower bound and beyond, and the utilisation of balance-sheet policies in non-traditional ways, which have become the norm in some advanced economies. These actions had repercussions for financial markets through increased capital flows, among others, with emerging markets bearing the brunt of these developments. We are now being reminded that emerging markets should prepare themselves for the possibility of further market dislocations given the prevailing environment of divergent policy settings, with the Fed and the UK on paths of monetary policy tightening while the euro area and Japan are likely to maintain a loose policy stance for the immediate future. Besides influencing monetary policy, the crisis also revealed that central banks could no longer see themselves purely as overseers of monetary policy but that this mandate had to be broadened to explicitly include financial stability. As the Bank for International Settlements has put it, “the global financial crisis has shaken the foundations of the deceptively comfortable pre-crisis central banking world”. 2 The conventional wisdom which held prior to the crisis has proved inadequate. It is now generally accepted that price stability alone is insufficient for macroeconomic stability. In addition, we now know that there is no neat separation between monetary and financial stability functions, and that if each central bank looks after its own economy, this does not automatically lead to an appropriate global monetary stance. Further, interest-rate policy alone is not enough. The regulation and supervision of financial institutions needs to go beyond a microprudential perspective towards a macroprudential orientation, with central banks playing a key role in this process. It was the financial crisis which brought to the fore the need for greater global cooperation, not only among advanced economies but also in emerging-market economies who would prove to be the drivers of global growth during the crisis. It was for this reason that the prominence of the G-20 was raised to that of a Leaders’ Summit in 2009. There was clear recognition that there needed to be greater inclusivity to effectively mitigate the damage of the financial crisis, which had clearly highlighted the vulnerability and the interlinkages of the global financial system. The international response Let me now turn to the work undertaken by the international forums in which the Bank is an active participant (including the G-20, BRICS, and the Bank for International Settlements), Globalisation and central bank policies, a speech by Lucas Papademos at the Bridge Forum Dialogue, 22 January 2008. BIS Working Papers No. 353, Central banking post-crisis: what compass for uncharted waters? by Claudio Borio. BIS central bankers’ speeches with the objective of ensuring that outcomes reached are in the best interest of not only the global economy but also emerging markets, South Africa, and the region. Since the onset of the crisis, the G-20 assumed a leading role in trying to address the consequences thereof in an effort to reduce the negative repercussions for the global economy. This entailed, inter alia, the G-20 taking the lead in addressing the shortcomings of the global financial system, enhancing financial safety nets, and, together with the Basel Committee on Banking Supervision, ensuring a more sound and stable financial and regulatory framework. The G-20 played a prominent role in shaping the elements of the work programme of the International Monetary Fund, or the IMF. Let me highlight some of the initiatives that the IMF undertook in response to requests from the G-20. Firstly, the IMF’s lending capacity was boosted to ensure that it would comfortably meet the ever-increasing financing needs of countries hit by the global financial crisis, thereby strengthening global economic and financial stability. The G-20 agreed in April 2009 to increase the borrowed resources available to the IMF by up to US$750 billion, tripling the total pre-crisis lending resources of about US$250 billion. In April 2010, the IMF Executive Board adopted a proposal on an expanded and more flexible New Arrangements to Borrow, or NAB, under which the NAB grew to approximately US$560 billion. This included 13 new participating countries and institutions, including a number of emerging-market countries that made significant contributions to this large expansion. In April 2012, the International Monetary and Financial Committee 3 (IMFC) and the G-20 Finance Ministers and Governors jointly agreed to further enhance the IMF’s resources through a new round of bilateral borrowing. This round included 35 agreements totalling US$385 billion. South Africa participated in all these initiatives and contributed US$2 billion to the 2012 initiative. The IMF, together with the G-20, revamped its lending framework to provide greater emphasis on crisis prevention tools. For example, the Flexible Credit Line was introduced in April 2009 and enhanced in August 2010 as a lending tool and form of insurance for countries with very strong fundamentals; qualified countries can have upfront, large access to IMF resources, with no ongoing conditions given the strength of their policy frameworks. The Precautionary and Liquidity Line was also designed to meet the liquidity needs of member countries with sound economic fundamentals but with some remaining vulnerabilities. In an attempt to strengthen its credibility and legitimacy, the IMF undertook to reform its governance structure and, in April 2008 and November 2010, agreed on wide-ranging governance reforms to reflect the increasing importance of emerging-market countries. However, the latter reforms have unfortunately not been implemented yet and continue to await ratification by the US. Nonetheless, the 14th General Review of Quotas will double the IMF’s permanent resources to US$656 billion. In recent years, the IMF has undertaken major initiatives to strengthen surveillance to respond to a more globalised and interconnected world. These initiatives include revamping the legal framework for surveillance to cover spillovers, a greater analysis of risks and financial systems, stepping up assessments of members’ external positions, and responding more promptly to concerns of member countries. All these changes were introduced with input from the G-20, and South Africa, as a member of the G-20, actively participated in these discussions and decisions. The IMF Board of Governors is advised by two ministerial committees: the International Monetary and Financial Committee (IMFC) and the Development Committee. The IMFC has 24 members, drawn from the pool of 187 governors of the IMF. The IMFC discusses matters of common concern affecting the global economy and advises the IMF on the direction of its work. BIS central bankers’ speeches In the area of financial regulation, the G-20 has worked closely with the Basel Committee on Banking Supervision and other standard-setting bodies to agree on and implement key regulatory reforms, including ensuring resilient financial institutions, ending the “too-big-tofail” approach, addressing shadow-banking risks, and making over-the-counter derivative markets safer. Basel III was endorsed by the G-20 in November 2010. The task of developing new standards was complex and time-consuming, requiring cross-border cooperation to ensure consistency on a multitude of issues between central banks, ministries of finance, regulators and supervisors, international organisations, and financial standardsetting bodies. While the Basle III rules have been agreed upon, the next phase of a timely, full, and consistent implementation is just as important to ensure level playing fields between jurisdictions and financial institutions and to address any unintended consequences of the reforms. Due to the globalised nature of the financial system, it will be important to continue analysing the effects of individual jurisdictions’ policies on each other to understand the positive and negative spillovers. The participation of the South African Reserve Bank The Bank has a particular role to play in ensuring the stability and resilience of South African financial institutions and markets, thus contributing to and promoting globally stable financial systems. The Bank fulfils this responsibility on an international, regional, and domestic level. Similarly to many other jurisdictions, South Africa is also reforming its domestic financial regulatory architecture and arrangements. In addition to regulating and supervising the banking sector and overseeing the national payment system, under the proposed Twin Peaks model of regulation the Bank will also be responsible for the prudential regulation of the insurance sector and other types of financial market infrastructures, and will fulfil the function of the resolution authority. While the Bank readies itself to take on more regulatory responsibilities on the insurance side, South Africa, through its current supervisor, the Financial Services Board, is already a respected partner in the International Association of Insurance Supervisors, having been one of the seven co-founders in 1994. Financial regulatory standard-setting bodies such as the Financial Stability Board and the Basel Committee on Banking Supervision have expanded their governance structures to be more representative and to reflect the globalised nature of the financial system. This includes considering the particular role of central banks as direct financial supervisory authorities, or where they act in an advisory role to their governments. As mentioned earlier, the Bank is actively engaged in the activities of international financial standard-setting bodies as well as the activities of the G-20 forum and the IMF. To name but two examples, in 2009 the Bank formally joined the membership of the Basel Committee on Banking Supervision and of the Committee on Payments and Market Infrastructures (formerly known as the CPSS: the Committee on Payment and Settlement Systems). Through National Treasury, South Africa has been a plenary member of the Financial Stability Board since 2010, and in early 2015 was allocated a second seat along with five other emerging-market countries at the plenary table. The Bank has assumed the position of an additional plenary member and, together with National Treasury, can use this opportunity to influence the agenda to focus on issues that especially affect emerging markets. It should, however, be clear that even before the Bank formally became a member of the above-mentioned bodies, it continuously followed and, where appropriate, aligned its own policies and procedures with the guidance and principles issued by these international standard-setting bodies. South Africa’s membership of these international standard-setting bodies is accompanied with the requirement that we comply with the standards developed by these bodies. This compliance process includes annual IMF Article IV consultations, IMF / World Bank Financial System Stability Assessments (FSSAs) and Reports on Observance of Standards and Codes (ROSCs), peer reviews by other G-20 member countries on our Framework for Economic Growth, Financial Stability Board country peer reviews, and the Basel Committee on Banking Supervision process to determine the adoption of Basel III capital and liquidity BIS central bankers’ speeches standards for banks through the Regulatory Consistency Assessment Programme (RCAP). The Financial Stability Board released its review on South Africa in 2013, the IMF completed an FSSA and three ROSCs in 2014, and the Basel Committee on Banking Supervision has almost completed its RCAP on capital and liquidity compliance. In the G-20 forum, there is much discussion, analysis, and sharing of views on monetary policy spillovers, particularly in the current environment of increasingly divergent monetary policies by some of the advanced countries. Other topics that have received attention within the G-20 context have included oil price developments, investment spending, and tax reforms. These issues are discussed at ministerial and governor level, and these discussions certainly help in creating greater awareness of policy actions and a better understanding of the spillover and spillback effects that countries could be subjected to. The overarching focus of discussion at the G-20 more recently has been how individual member countries can devise growth strategies which would contribute to the objective of increasing global growth by an additional 2 per cent over the next five years. These strategies are continuously evaluated to ensure that they remain applicable and implementable, and they are also peerreviewed to ensure that countries adhere to their commitments. In addition to our involvement in the Basel Committee on Banking Supervision, the Governor attends the bimonthly meetings of the Bank for International Settlements, which provides a forum for governors and senior officials to share country experiences and to discuss the outlook for the global economy and financial markets. The Bank also participates in the Meeting of Governors from major emerging-market economies. In today’s interconnected world, having such a forum to discuss issues and challenges specific to emerging-market economies is extremely valuable. Furthermore, in many instances, the Bank is the only representative from the continent and is thus able to provide an African perspective on some of the economic challenges confronting the global economy. The Bank’s interactions are not limited to international bodies but include regional bodies and less formal but equally important engagements, such as with home- and host-country supervisors through supervisory colleges and crisis management groups. To promote regional financial integration, the Bank is fully supportive of and active on committees such as the Association of African Central Banks, the SADC Committee for Central Bank Governors (CCBG), the Community of African Banking Supervisors (CABS), and the Financial Stability Board’s Regional Consultative Group for sub-Saharan Africa. The work of these important committees contributes towards the development and implementation of an effective financial sector regulatory framework in Africa, and promotes growth and development on the continent. Being in the privileged position of participating in the development of international standards and principles brings with it certain responsibilities. Those who participate in international and regional financial standard-setting bodies have the obligation to play a proactive role, to use our strengthened voice, to be ready to take constructive positions on the various reforms, and to consider the views of those countries who do not sit at the table. The Bank is fully committed to fulfilling this responsibility in all its engagements. As you are aware, South Africa is also part of the BRICS grouping of countries. We meet ahead of G-20 meetings to exchange views on issues affecting the global economy. In addition, these countries have committed themselves to supporting one another and undertaking collaborative initiatives that will benefit BRICS as a group. In this regard, BRICS has agreed to the establishment of the Contingent Reserve Arrangement (CRA), which BRICS leaders agreed to in July 2014. The CRA is a self-managed arrangement, the purpose of which is to serve as a financial safety net, complementing existing international monetary and financial arrangements. The initial size of the CRA is US$100 billion; South Africa contributes US$5 billion and is eligible to receive US$10 billion in support. The CRA is made up of swap arrangements between the BRICS countries and will be used to forestall short-term balance-of-payments pressures, provide mutual support, and strengthen financial BIS central bankers’ speeches stability. The CRA is beneficial to South Africa as it adds a layer of financial support in times of crises. Currently, the BRICS central banks are negotiating the Inter Central Bank Agreement which operationalises the CRA; this is set to be finalised before the next BRICS Summit in Russia in July 2015. Conclusion The recent crisis has highlighted the importance of effective cooperation and coordination by central banks as well as the benefits of improved information-sharing between financial supervisors and central banks. The experiences of the past few years have highlighted the need to deepen our understanding of how globalisation affects both monetary policy and financial stability. This, in turn, facilitates a better assessment of the potential systemic implications of financial shocks, which should assist policymakers in addressing market tensions faced by individual institutions. Through forums such as the G-20, the IMF, and BRICS, much work has been undertaken to strengthen the global economy and the global financial system, and to better identify, understand, and manage risks. South Africa and the Bank, as an active participant in these international forums, always strive to ensure that the interests of the country and of the continent are represented in discussions on the global economy. Allow me, in closing, to leave you with a plea. You have all been privileged to attend one of the world’s leading business schools and have come back equipped to assume the important roles you occupy in your respective companies. With the release of the most recent unemployment figures earlier this week, which in no small measure have to do with education and skills levels, I would encourage you, if you are not already doing so, to get involved in coaching and mentorship programmes to share your insights, expertise, and experiences. We celebrated Africa Day on Monday. With the vast potential and opportunities that our continent offers, which need good business leadership to partner with governments and the public sector, would it not be nice to add, somewhere in the near future, an African INSEAD campus to the locations in Europe, Asia, and the Middle East? Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Actuarial Society of South Africa (ASSA) 2015 Investment Seminar, Cape Town, 27 May 2015.
François Groepe: Recent international and domestic economic developments and changes to the financial regulatory architecture Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Actuarial Society of South Africa (ASSA) 2015 Investment Seminar, Cape Town, 27 May 2015. * * * Introduction Good day ladies and gentlemen. Thank you for inviting me to this seminar and I look forward to sharing my views on the recent international and domestic economic developments, as well as changes to the financial regulatory architecture. Global outlook The global environment facing South Africa remains challenging and fraught with a high degree of uncertainty. Developments in the US, in particular, continue to have spill-over effects on emerging markets in general and South Africa in particular. While it is clear that monetary policy normalisation will (and should) take place, the timing of the initial “lift off” is still uncertain, and dependent on domestic developments in the US, not least in the labour market. This makes each data release a source of volatility, with good news in the payrolls data generally being interpreted that it will bring forward the expected commencement date of the normalisation process. Perhaps of greater importance than the “lift off” itself is the question of the future path of interest rates. The US Fed has gone to great pains to communicate a gradual path, but the “dots” (the interest rate forecasts of the individual members) that illustrate this are subject to a high degree of dispersion and change from meeting to meeting. This reflects the high degree of uncertainty. However, uncertainties in the US economy abound. The economy appeared to be well on the road to recovery in the second half of last year, but the first quarter data disappointed, following an advanced estimate growth rate of 0,2 per cent. The general expectation is that this was due to temporary factors, but risks still remain that it could portend a more general extended slowdown. Furthermore, there is still uncertainty regarding the improvement in the labour market: in particular, whether the improvement is a result of a decline in labour force participation rates, which could reverse should the improvement in the economy be sustained. Finally, there is still a great deal of uncertainty about whether potential growth rates will return to pre-crisis levels or settle at a lower level, and this is likely to have implications for the longer term neutral rate of interest. The Eurozone appears to be improving following a weak few quarters, with positive growth impulses from the weaker euro and lower oil prices. The partial reversal of the oil price suggests that this impulse may be waning. It does however appear that the quantitative easing by the ECB is bearing fruit, but the question remains as to whether the region can sustain the recovery without this support. A question mark also remains regarding the possible contagion effect from the Greek debt crisis. The market reaction to date suggests that this is more contained, unlike the more generalised crisis in 2011 when risk premia on all peripheral Eurozone bonds widened significantly. The Chinese economy continues to focus on rebalancing away from investment to domestic consumption. This has resulted in a downward revision of growth targets, but has also meant that demand for commodities is not as strong as it was previously. While a growth rate of 7 per cent would seem unattainable for South Africa, it is relatively low by recent historical standards for China. BIS central bankers’ speeches Domestic outlook The spill overs on to South Africa from these developments are significant. The US impact is through the exchange rate and long term bond yields, which are highly correlated with those in the UK. The Eurozone is an important destination for South Africa’s manufactured exports, so a slow recovery is bad for the manufacturing sector, while the (until recently) weaker euro means that the competitive advantage from a weaker rand is undermined. Although the African continent, which has been growing quite robustly, has emerged as one of the main destinations of South Africa’s manufactured exports, there are downside risks to the continent’s growth prospects given the decline in oil and other commodity prices. The slowdown in China has had a marked impact on global commodity prices, resulting in a deterioration of South Africa’s terms of trade, which was only reversed to some extent with the collapse of international oil prices since late last year, but even this windfall has reversed somewhat. So all in all we are indeed facing a challenging international environment. However, it would be wrong to suggest that the subdued outlook for the domestic economy is purely a function of global developments. Domestic factors are also important, and some of them are of our own making. Real GDP for the first quarter of this year slowed down to 1.3 per cent compared to the 4.1 per cent (qqsa) recorded for the final quarter of 2014. This is against the backdrop of the sluggish growth rate of 1,5 per cent for 2014 and which is well below the Bank’s estimate of potential output of between 2,0 and 2,5 per cent. The weak outcome last year was partly due to the impact of protracted strikes in the mining and manufacturing sectors during the year. The Bank estimates the negative impact of these strikes to be in the order of around 1,2 percentage points of GDP. Hopefully, prolonged work stoppages will not be a regular feature each year. The question we need to ask ourselves is why the growth prognosis is so weak. Some of it has to do with the global economy, as I outlined earlier. Secondly, there are binding constraints coming from the electricity supply uncertainties. Our estimate of growth tries to incorporate some element of the impact of load shedding on output. There are two elements here: one is the impact of longer term constraints which hamper new investment, and which is reflected in the overall lower potential output; the other is the impact of load-shedding on existing capacity and therefore on current output. We estimate this latter factor to be in the order of magnitude of around 0,5 percentage points of GDP. Load-shedding appears to have contributed to a general low level of business confidence, as evident in the various confidence indices, but also evident in the very low growth in private sector gross fixed capital formation. In 2014, gross fixed capital formation contracted by 0,4 per cent, driven mainly by the 3,4 per cent contraction in investment by the private sector, which accounts for just under two thirds of capital formation. On a more positive note, in the second half of the year growth was positive, a reversal of the strongly negative trends observed in the first half of the year. However, supply side constraints and low confidence are likely to constrain stronger growth. It is worth noting that the more favourable fixed investment outcomes observed in 2013 were mainly related to renewable energy projects. The main driver of growth in recent years has been the consumption expenditure by households. However, the contribution to growth in 2014 declined by one percentage point to 0,8 percentage points. While we would prefer to have investment-driven growth, even consumption has been relatively subdued for some time, declining to 1,4 per cent in 2014 compared with 2,9 per cent in 2013. A further concern has been the recent sharp drop in consumer confidence, which, according to the FNB/BER survey reached a level of –4 in the first quarter of the year, compared to an average of +5. Factors undermining consumer confidence include the partial reversal of the boost to consumption provided by lower petrol prices; the increase in the marginal tax rate in the February budget; high levels of household indebtedness despite some deleveraging; and continued weak growth in credit extension to households. Employment growth trends are also not supportive in this respect, and although wage growth remains relatively high, the positive net impact on consumption could be offset to some extent by the negative impact on employment from relatively high wage growth. BIS central bankers’ speeches Inflation is currently well within the inflation target band of 3–6 per cent. However, the focus of monetary policy is not current inflation, which is something that we cannot do anything about, but rather on the inflation trajectory over the relevant policy horizon, i.e. the time period over which monetary policy can have an impact on inflation and which is around 12–18 months ahead. Headline CPI inflation accelerated to 4,5 per cent in April, which is at the mid-point of the target range. The main drivers of the annual increase were housing and utilities (1,3 percentage points), miscellaneous goods and services (1,1 percentage points) as well as food and non-alcoholic beverages (0,8 percentage points). On a monthly basis Headline CPI inflation increased by 0.9 percentage points, up from the recent low of 3,9 per cent in February and which is mainly attributable to the previous decline in the petrol price, which has largely been reversed. As we noted in our monetary policy statement last week, inflation is expected to accelerate in the coming months, and is expected to rise to 6,8 per cent on average for the quarter thus temporarily breaching the upper end of the headline inflation target range during the first quarter of 2016. The CPI inflation rate is expected to average 6,1 per cent and 5,7 per cent in 2016 and 2017, respectively. Core inflation is forecast to average 5,4 per cent and 5,2 per cent in the outer two years with the persistence in this measure largely being attributed to high levels of wage growth, currency depreciation and inflation expectations that are anchored at the upper end of the target range. There are a number of upside risks to this outlook. The main one emanates from the exchange rate, given the rand’s sensitivity to imminent US Fed monetary tightening. South Africa, along with other emerging markets with wide current account and fiscal deficits are seen to be particularly vulnerable. However, there is a great deal of uncertainty in this regard. How much is already priced in to the exchange rate? Will any weakening be a temporary overshoot? To what extent is this offset by QE in the Eurozone and Japan? We should also recognise that domestic factors also play a role, including the persistently wide current account deficit, weak growth outlook and uncertainty arising from the binding electricity constraints. And finally, in this regard, there is uncertainty regarding the degree of passthrough from the depreciation to inflation. We have seen far more muted pass-through in the past few years, than during previous episodes of rand depreciation and the Bank estimates that actual pass-through could be about half of what is assumed in the forecast model. The uncertainty is whether this represents some form of structural change, or whether it is cyclical – in which case it will increase when growth picks up – or whether some inflexion points exist, beyond which inflation will accelerate. A further issue relates to electricity prices. There is some uncertainty following the application to Nersa for a 25 per cent increase in electricity tariffs. The Bank’s model previously incorporated an increase of around 13 per cent, effective from 1 July 2015, but should a higher increase be granted, we will see further upside pressure on inflation. The above backdrop provides a difficult challenge for monetary policy. It is clear that the main pressures on inflation are supply side shocks, rather than demand pressures which are easier to deal with through monetary policy. At the same time, the growth outlook remains highly constrained. We, however cannot simply ignore supply side developments, as in so doing we could allow inflation expectations to become unanchored. Furthermore, the MPC is concerned about the persistence of the medium term inflation outlook at heightened levels and the significant upside risk to this outlook, which includes electricity tariff increases, the exchange rate and the level of wage settlements. Our focus is therefore sharply on possible second round effects of these shocks to see if it spills over into more generalised inflation. Monetary policy has been accommodative, which has been appropriate in light of the weak real economy. We are however in a hiking cycle and the deteriorating inflation outlook may necessitate policy action as the window for an unchanged stance has narrowed. The pace of normalisation will however be influenced by the data. BIS central bankers’ speeches Regulatory reforms As you are no doubt aware, the Bank’s mandate has been broadened to more explicitly include financial stability. Following the global financial crisis, it became clear that price stability is a necessary, but insufficient condition for financial stability and it has now become a more explicit mandate of central banks in many countries. While the price stability mandate of the SARB is clearly defined and measureable, its mandate for financial stability is much broader and is a shared responsibility with other stakeholders. National Treasury published a policy document in February 2011 titled A safer financial sector to serve South Africa better, which outlined government’s decision to shift to a Twin Peaks model of financial sector regulation. The Twin Peaks model of financial sector regulation represents a move away from a fragmented regulatory approach which was based on the institution or activity towards a regulatory and supervision model based on objectives. It is envisaged that, once fully implemented, the Twin Peaks system of regulation will focus on a more harmonised system of licensing, supervision, enforcement, customer complaints, an appeal and review mechanism, and consumer advice and education. National Treasury published the second draft of the Financial Sector Regulation Bill in December 2014. This bill proposes to confer upon the Bank the responsibility for financial stability and the oversight of market infrastructure and payment systems. It further proposes the establishment of two regulators, namely a Prudential Authority within the Bank and a new Financial Sector Conduct Authority. The Prudential Authority would supervise the safety and soundness of banks, insurance companies, and other financial institutions, while the market conduct authority would supervise the way in which financial services firms conduct themselves and treat their customers. This reform forms part of the current broader overhaul of the global regulatory system which aims to address the too-big-to-fail problem of systemically important financial institutions, building resilient financial institutions, reducing the opacity of over-the-counter derivatives markets, mitigating the impact of shadow banking on financial stability, enhancing financial benchmark transparency, and promoting the convergence of accounting standards. Within each of these themes there are a number of regulatory initiatives, such as the regulation of systemically important financial institutions under the too-big-to-fail problem, Basel III and proposals for a basic capital requirement for insurers to strengthen the theme of building resilient financial institutions. The Bank’s main activities in the financial stability arena currently include developing and implementing recovery and resolution plans for systemically important financial institutions, introducing a macroprudential toolkit of policy instruments to contain risks associated with imbalances in the financial system, and applying a top-down stress testing framework to the banking sector in South Africa. Although the Bank’s financial stability mandate is distinct from its price stability mandate, careful consideration is continuously given to the interaction between the Bank’s monetary policy and financial stability objectives. This coordination is facilitated by cross-membership between the Bank’s monetary policy and financial stability committee structures. The main risks from the global and domestic environments that might impact the stability of the domestic financial system and that are monitored continuously in terms of possible mitigating actions include the possibility of severe electricity supply disruptions, volatility and risk aversion in global financial markets, a protracted period of slow growth in the euro area, low growth in the domestic economy and the escalation of global geopolitical tensions. These possible scenarios of potential threats to financial stability are rated according to the likelihood of occurrence and the expected impact on the domestic financial system. The results are captured in a risk assessment matrix and published in the latest Financial Stability Review which was released at the end of April. This publication is aimed at analysing these BIS central bankers’ speeches potential risks to financial stability and to stimulate debate on pertinent financial stability issues. Conclusion It is clear that although the global recovery has started to gain momentum it continues to be erratic and there are a number of downside risks to the global economic growth outlook. The recent partial rebound in the price of crude oil has ameliorated some of the benefits arising from its earlier sharp decline. A further risk is a possible Grexit and other geopolitical risks. On the domestic front, growth continues to disappoint, and the medium term growth outlook is likely to be constrained due to the binding electricity constraints. The inflation outlook has deteriorated to uncomfortable levels recently with inflation expectations remaining close to the upper-end of the target and with further notable upside risk to the outlook. The scale of the regulatory reform process under way is probably the most significant overhaul of the financial regulatory architecture in the last few decades. Despite its ambitious scale, the Bank is making good progress in preparing itself to take up its new responsibilities as set out in the Financial Sector Regulation Bill. Thank you! BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the SWIFT Regional Conference, Cape Town, 5 May 2015.
Lesetja Kganyago: Africa is rising – seizing the opportunity Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the SWIFT Regional Conference, Cape Town, 5 May 2015. * * * Chairperson, distinguished delegates, ladies and gentlemen; It is an honour for me to welcome you all to Cape Town, South Africa on this occasion of the SWIFT Regional Conference. “Africa is rising – Seizing the Opportunity” this is the theme for this year’s conference. I think that you will agree that this theme is appropriate, as Africa is blessed with abundant resources and although we face several challenges, these are far outweighed by the many opportunities that the continent offers. We acknowledge that taking advantage of these opportunities require strong political will and pan-African cooperation, however, the numerous regional integration initiatives taking place all over the continent are testimony that this is indeed possible. This is the 22nd SWIFT African Regional Conference (ARC) and the delegates include policy makers, industry leaders and the broader financial community from across the African continent. The typical African Regional Conference attracts up to 500 delegates from around 40 countries, and is a unique forum for networking, education, discussion, and debate – all within a collaborative environment. I believe that discussions in the next three day will focus, inter alia, on how intra- Africa trade and economic growth can be boosted, a look at how the African securities markets are evolving and the growth plans of African corporates as they expand across the continent. The conference will also focus on leveraging the role of technology innovations in Africa to benefit the financial industry and support sustainable growth objectives of the continent. From the payment system environment, we are aware that intra-Africa payments have in the past mostly been facilitated through correspondent banking arrangements, as has been the standard for cross border payments globally. In practice, intra-Africa payments are effected through correspondent banking relationships with banking partners normally located within the USA or in Europe. Most of these correspondent banking arrangements are still used extensively today, but are proving to be inadequate and inefficient. Across the continent, several regions have launched initiatives to facilitate more efficient transacting mechanisms within their respective regions. The advantage of these initiatives is that transacting parties now have more control over their payments, within the region. Concerns have been raised about the general reduction in correspondent banking relationships, and related financial services globally. The drivers of the reduction in correspondent banking relationships are not clear, but we surmise that regulations relating to AML/CFT and the increase in the number of cross-border money remittance or transfer companies could be contributing factors to this declining trend. In the case of the money remittance companies, it can be argued that global banks may have concerns about the high risks of uncertainty in facilitating transactions with unknown/nonvetted clients, especially those in EMDE’s 1, in terms of the AML/CFT 2 rules. This raises the potential for fines and reputational risks for these banks and therefore reduces the appetite for exposure to specific jurisdictions by banks participating in this environment. There are Emerging Markets and Developing Economies (EMDEs). AML – anti money laundering; CFT – counter terrorist financing. BIS central bankers’ speeches also potential downsides to decreased cross-border transactions. For example, it is a wellknown fact that money remittances attract high costs, and it is therefore likely that small companies would be more affected by the reduction in global correspondent activity. In both instances, it would be the poor and smaller commercial entities that would be most vulnerable if correspondent banking activities are not replaced by more efficient and reliable alternatives. Regional solutions, implemented in the payment system environment, will go a long way to address constraints that may be introduced by the reduction of correspondent banking services, as well as to bring overall efficiencies in the execution of intra-regional cross border payments. I would now like to share with you developments relating to three of these regional initiatives as examples. In 2000, five countries of West Africa (Gambia, Ghana, Guinea, Nigeria and Sierra Leone) established the West African Monetary Zone (WAMZ). At the same time they also set-up the West African Monetary Institute (WAMI). Liberia joined in 2010. The objective of the countries was to establish the West African Monetary Zone (WAMZ) as a monetary and customs union with a common currency. Initially they proposed to introduce a Single Currency in 2003, but subsequently agreed to launch the new single currency in 2015. As these countries are represented at this conference, you will benefit from updates on progress made with this initiative. The main objectives of WAMZ were agreed as: • the promotion of trade integration in the region; • trade and financial facilitation; • harmonisation of legislation and statistics; and • payment systems and macroeconomic convergence. The WAMI was established as the main body responsible of the creation of the Common West African Central Bank and the Single Currency of the WAMZ. In east Africa, the East African Community (EAC) has been established as a regional intergovernmental organisation of the Republics of Burundi, Kenya, Rwanda, the United Republic of Tanzania, and the Republic of Uganda. The vision of the EAC is to foster a prosperous, competitive, secure, stable and politically united East Africa. Their mission is to widen and deepen economic, political, social and cultural integration in order to improve the quality of life of the people of East Africa through increased competitiveness, value added production, trade and investments. The Treaty for the establishment of the East African Community was signed on 30 November 1999 and come into force on 7 July 2000. The Republic of Rwanda and the Republic of Burundi became full members of the community with effect from 1 July 2007. From a payment system perspective, the region has achieved the goal of implementing an integrated payment infrastructure to facilitate the ease of flow of payments among the participating member counties known as the East Africa Payment System (EAPS). The EAPS is a secure, effective and efficient funds transfer system that enhances efficiency and safety of payments and settlement within the EAC region. The systems operates on a real time gross settlement basis by utilising the linkage between the various partner states’ Real Time Gross Settlement (RTGS) systems using SWIFT (Society for Worldwide Interbank Financial Telecommunication) messaging network for safe and secure delivery of payment and settlement messages to each other. The EAPS also facilitates cross border transactions that is essential for boosting intra-regional trade among the East African countries. Some of the benefits of EAPS: • real time funds transfers, safe and efficient transfer of large value payments BIS central bankers’ speeches • finality and irrevocability of payments • increased accessibility as EAPS is available in all the commercial banks’ branch networks, and • same-day settlement. This initiative is indeed a success that is worth celebrating. The Southern African Development Community (SADC) was established as a development coordinating conference (SADCC) in 1980 and transformed into a development community in 1992. It is an inter-governmental organisation whose goal is to promote sustainable and equitable economic growth and socio-economic development through efficient productive systems, deeper co-operation and integration, good governance and durable peace and security among fifteen Southern African member-states. In the process of driving its development objectives, the region adopted a Regional Indicative Strategic Development Plan. In support of this plan, central banks within the region working in collaboration with the banking community launched a payment system integration project that culminated in the implementation of the SADC Integrated Regional Electronic Settlement System (SIRESS). According to the latest data, the implementation of the SIRESS system has resulted in 43 per cent of eligible intra-SADC cross-border South African Rand payments for the participating nine countries being settled through accounts that regional banks hold on the SIRESS system, instead of via the normal cross-border correspondent banking system. At this relatively ‘early’ stage of SIRESS (implemented July 2013), the high percentage of crossborder transactions being settled via the SIRESS system in real time is significant, and it could in future have an even more significant impact on correspondent banking activity within the SADC region. I take great pride in being able to share with you that SIRESS has reached the ZAR 1 trillion settlement mark in the last week of April 2015. We also recognise that the emergence of regional solutions such as SIRESS, requires regional authorities to resolve possible concerns that may arise from regulatory requirements within their business process flows to ensure that matters such as AML/CFT and exchange controls, where they exist, are taken care of. It is my hope that the development of these initiatives will lay a solid foundation for facilitating trade and investment in Africa. Leveraging of current infrastructure, efficient securities market solutions and future infrastructure solutions may contribute to facilitating the ease of investment in the continent. The regional initiatives are also paving the way for the achievement of the integration agenda of the whole continent and I hope that in undertaking the separate regional initiatives, open standards are adopted to facilitate the ultimate integration of these regional infrastructures. What Africa needs is to get the various regional systems to interact with each other so that settlement can take place seamlessly across the region. I also note that with the aim of leveraging the hands-on experience with projects in Africa, one session in this conference will look at the rapid growth of the regional payment systems and how lessons learnt from these projects could be replicated in other regions. The regulatory session should explore how, taking a proactive stance in coping with new financial regulations, moving quickly to adopt global best practice in the various fields of compliance and addressing of issues relating to regulatory capital requirements can lead to competitive advantages. It is also with interest that I gather that for the first time, the 2015 ARC will host an African round of the SWIFT Innotribe start-up challenge. Innotribe is a laudable initiative that offers an opportunity for bringing innovative ideas to the fore and fostering discussions that would enable practical solutions to emerge out of those ideas. The start-up challenge will bring together young African financial technology companies from across the continent, introducing them to venture capitalists and investors. The winners will proceed and compete in the grand BIS central bankers’ speeches finale at the Sibos 2015 conference scheduled later this year in Singapore. Our continent will surely reap benefits from these initiatives and I encourage you to ensure that you are part of the growing ARC community in 2015, and that your industry discussion will be fruitful. It is clear from the programme that the organisers have put together a full and well thought out programme. I hope you will benefit from this 22nd ARC and in this spirit I wish you well as you share experiences and meet new colleagues. Thank you BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, on the occasion of the release of the 14th UASA South African Employment Report, Johannesburg, 30 April 2015.
François Groepe: South Africa’s structural unemployment challenge – the most important issues to be addressed to place South Africa on a sustainable growth path in an effort to reduce unemployment levels Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, on the occasion of the release of the 14th UASA South African Employment Report, Johannesburg, 30 April 2015. * * * Chairperson, ladies and gentlemen, I am pleased to be part of the proceedings of the day, as we gather here for the release of the 14th UASA Employment Report. This publication has grown in stature over the years and has earned itself a place amongst various high-level publications informing on the state of the South African labour market. This morning, I shall focus on the most important issues to be addressed to place South Africa on a sustainable growth path in an effort to, amongst others reduce the unemployment levels. South Africa counts, among its key challenges, its high level of structural unemployment which is exacerbated by the levels of poverty and inequality in the country. These challenges, in turn, give rise to a host of other socio-economic and socio-political challenges. Earlier policies, such as the Accelerated and Shared Growth Initiative (ASGISA) (2006), as well as the more recent long-term vision for South Africa, as captured in the National Development Plan first released in 2012, highlight the requirement for economic growth in excess of 5 per cent on a sustained basis to meaningfully make inroads towards reducing the high levels of unemployment. Prior to the global financial crisis in 2008/09, some progress had been made in reducing overall levels of unemployment in the country as strong global and local economic growth resulted in higher levels of output leading to increased demand for labour. South Africa, in fact, had experienced one of its longest periods of uninterrupted economic growth – 55 quarters of growth averaging between 3 and 5,6 per cent annually. As the global economic growth recovered after the financial crisis, albeit hesitantly and unevenly, South Africa lagged behind, growing at rates well below its potential, which had been negatively been impacted by strained relations and industrial action, but also by structural deficiencies such as the electricity load shedding. While South Africa has performed well in managing to largely contain inflation, within the inflation target range, and no doubt assisted in part by the lower international food and oil prices, the country has been less successful in matching levels of growth as experienced in other developing countries. Within the BRICS partnership, South Africa is the smallest economy in terms of its gross domestic product and population size and had both the lowest levels of average growth and employment over the past decade. Of some concern is the fact that South Africa continues to experience levels of inequality that are ranked amongst the most elevated in the world. All these indicators require a renewed focus on both the basic drivers of development, such as education enhancement and interventions that directly address structural barriers to growth and employment. Broadly speaking, any effective solution should not only focus on stimulating growth in key industries, but those industries that are lagging should actively be engaged through appropriate policies. Such policies should improve the micro-foundations of economic growth, which include education and skills training, industrial and trade policy, labour market policies and competition policy. Along these lines the National Development Plan (NDP) has as its central focus the elimination of unemployment, poverty and inequality by 2030. Within this Plan, nine main challenges are being highlighted, namely: BIS central bankers’ speeches • The elevated levels of unemployment; • The standard of education, which for a large proportion of learners is arguably of an undesirable quality; • Infrastructure, which is not always optimally located, and which at times is undermaintained and insufficient to foster higher growth rates; • Spatial patterns which exclude the poor from the benefits of development; • An economy is that could be described as overly and unsustainably resource intensive; • A widespread disease burden that is compounded by the challenges faced by the public health system; • Public services that are uneven and often of in certain circumstances of inadequate quality; • The corruption levels that is perceived to be wide spread; and • The perception that exist regarding the divisions within the broader society. The NDP provides a useful framework by which these issues can be addressed in a systematic and structured manner as government actively pursues its implementation. The challenge remains the alignment of medium-term and short-term planning by government in its efforts to effectively implement the NDP. The adoption by cabinet of the Medium Term Strategic Framework for 2014 to 2019 for each outcome of the NDP is clear evidence of the government’s commitment towards the successful implementation of the NDP. The key pillars of the Medium Term Strategic Framework comprise the following: • Infrastructure programmes must lead to a crowding in of productive investment as government spending boosts the demand for goods, leading to increased private demand for new output sources, such as factories; • Growth and employment of the productive sectors of our economy should be supported; • Red tape and the unintended consequences of regulation should be reduced; • Skills planning, to address the needs of the economy, should be improved; • The level of employment in agriculture should be increased; • Growth and investment should be supported by sustainable fiscal policies; • Strong partnerships, with business and labour, should be built and workplace conflict should be reduced; • Public Employment Programmes should be scaled up; • Economic opportunities for historically excluded and vulnerable groups should be expanded; and • Investment in research, development and innovation should be supported. Returning now to the NDP, as part of a broader development agenda, business investment is being identified as a cornerstone to create 11-million jobs and eliminate poverty in South Africa by 2030. It sets a target of reducing the unemployment rate from its current level of 25 per cent to 14 per cent in 2020 and to 6 per cent in 2030 and to increase the labour force participation rate from 54 per cent to 65 per cent. Per capita income is also envisaged to increase from around R50 000 to around R120 000 per year. BIS central bankers’ speeches The NDP suggests that some labour regulations be relaxed in an effort to encourage business enterprises to employ more easily, as well as lower entry-level wages to facilitate a higher uptake of young people in the jobs market. Some of the proposals in this Plan will no doubt fall within the area of public discourse on possible contestation and will require continued intense negotiations among all social partners in an effort to reach broad consensus in order to secure its implementation. The Plan takes a pragmatic and broad-based approach to the challenges that South Africa faces in eradicating unemployment. The role that the Plan sees for government’s intervention is permeated with a willingness to work with the private sector, as the plan leans towards less regulation of the economy. The Plan envisages small and expanding companies creating around 90 per cent of the new employment opportunities in the economy in the next 20 years. This will place South Africa in step with global employment trends. Small firms would benefit from bold proposals to drastically reduce so-called “red tape” and improve employment and practices and procedures. The NDP strives towards an economy that will be more enabling for business entry and expansion, with a focus on credit and market access. Cognisance is taken of the fact that any inclusive growth strategy that does not harness the creativity, innovation and competitiveness of the private sector is unlikely to succeed. Regulatory reform and support being advocated by the Plan has the intention to boost mass entrepreneurship. The topic of strained labour relations is also addressed, indicating that it is inconceivable, that the economy will evolve into a more labour-intensive structure if tensions between employers and labour persist. Ways need to be found to reduce the probability of the occurrence of lengthy strikes, such as those experienced during last year. These tensions need to be dealt with in a transparent and honest manner and not only by amending labour legislation, in order to be conducive of enhanced labour absorbing growth. As the social partners, re-establish trust among themselves, it will go some way towards the process of reinforcing their social pact. Central to the propositions made in the NDP related to the jobs market, is the statement that over a 20-year horizon wage growth needs to be linked to productivity growth as it is not feasible to sustain a labour absorbing path, unless both are growing in tandem. In an effort to enhance the labour absorption rate of the economy, the Plan has already led to a reduction in the initial cost of employing young labour-market entrants, through the implementation of the Employment Tax Incentive, Act no 26 of 2013 which came into effect on 1 January 2014. This initiative compliments government’s measures to create jobs for young workers and those in special economic zones through offering tax incentives to employers to encourage the employment of these workers. This initiative, according to the Minister of Finance, had led to 200 000 young people being employed, which is significantly in excess of government’s initial expectation of 70 000 within six months of implementation. Furthermore, newly introduced changes to labour legislation, in general, hold the promise of improving the functioning of the labour market, as it better addresses discrimination, and advances the approach of equal pay for work of equal value. These changes will not only benefit young people, but will result in a more equitable labour relations environment in general. Over and above the focus on the jobs market, the NDP also advances some frank recommendations in areas such as education, health and the public sector, as part of the creation of a nurturing and enabling environment for business to prosper. A set of integrated actions is being proposed to address the issue of inefficiency and other challenges related to public service delivery. To improve educational outcomes, the Plan directly confronts issues, such as teacher performance, appointment procedures and accountability. The challenges in public health management are also addressed and in building a capable state, detailed recommendations are made on professionalising the public service. Some areas of Government, where improvements have occurred, such as the South African Revenue BIS central bankers’ speeches Service through an improvement in operational procedures, management and delivery systems should be emulated by other organs of state. An initiative worth mentioning in terms of already improved processes in the public sector is the introduction of an e-portal on 1 April 2015 that will reshape the South African government supply chain processes, particularly as it relates to government tenders. It is envisaged that the public will eventually be able to see all tenders, bidders and their prices quoted, as well as minutes of bid committee meetings. Over and above the e-portal, a national database of all approved and compliant suppliers and an “online shop”, where government departments will place orders of less than R500 000, will be established. Initiatives such as these are laudable and will contribute towards increased efficiencies in service delivery which is essential for improved growth prospects. The focus within the NDP on the eradication of corruption from the system is most welcome, in taking cognisance of the fact that for state officials to act in a corrupt fashion, requires a willing counter party from the private sector is necessary. The introduction of the government’s new tender process, as already mentioned, will go a long way in exposing and limiting possible corruption within the system. The NDP recognises the need for increased fixed investment in the economy and has set a target of raising the level of gross fixed capital formation from around 20 per cent of GDP currently, to as high as 30 per cent by 2030. Inarguably, well-planned and appropriate infrastructural development is conducive to higher levels of economic growth and job creation. The NDP clearly distinguishes between investment that generates immediate financial returns, such as in airports and power stations and those projects where financial returns are far less measurable, such as in schools and hospitals. The role of business in increasing the overall level of fixed investment in the country will most appropriately lie in the area of fixed investment where financial returns are more evident, through public private partnerships. International experience has shown that private sector participation in infrastructure provision is most successful in the transport and energy sectors. The participation of the private sector contributes to effective cost containment through the profit motive, improves efficiency and leads to more sustainable jobs through more ambitious skills transfer initiatives. An area, in which the private sector can excel, given appropriate incentives, is that of research and development which could act as a driver of competitiveness and job creation. A number of large R&D projects have already shown feasibility and have the ability to develop into new industries, creating substantial opportunities for increased employment, foreign revenue income, beneficiation and competitiveness. Many infrastructure investment projects can act as an attractive asset class for private investors, due to the predictable nature of returns, thereby providing a low risk investment profile. Infrastructure investment projects may provide a means whereby a consistent real return over inflation can be attained through a low volatility investment vehicle. Private sector funding is, however, subject to policy certainty so that private investors can be assured that they will be able to realise a return on their investments. The NDP proposes that Regulatory Impact Assessments be done on all new regulations, and that an expert panel be appointed to prepare a comprehensive regulatory review for smalland medium-sized firms in an effort to assess whether special conditions are required for such entities. To this end, a new unit is being created in the Presidency to carry out thorough impact assessments of both new and existing legislation and regulations within a Social Economic Impact Assessment System that will ensure alignment with the NDP and reduce the risk of unintended consequences. The continued drive towards the establishment of a viable renewable energy sector in South Africa should be supported and is an example of an area in which small businesses could rapidly gain traction, as countries become more inclined to embrace a Green Growth development approach, as we enter the so-called Solar Age. BIS central bankers’ speeches The proper implementation of the NDP will be conducive to an increased level of entrepreneurship in the economy, as the ease of doing business improves. The obvious outcome of such a process will be the creation of more sustainable jobs. Small businesses generally have the capacity to attract those who are low to moderately skilled and are, therefore, best placed to recruit from among the significant pool of unemployed workers. The NDP is already facilitating the bringing together of various stakeholders in the economy within an environment of common purpose. The NDP thus constitutes a powerful and integrated development agenda for the state and the whole of South Africa, and for the Plan to succeed it should continuously be translated into action plans, with clear milestone along the way, within realistic time frames. To yield relatively swift results, in terms of improved growth, the following two focus areas deserve mentioning. The first is a better integration of the South African economy with that of Africa. This will indeed be beneficial through boosting interregional trade, investment and capital flows, and allow the domestic economy to tap into the more vibrant growth rates being experienced in the rest of sub-Saharan Africa. It is estimated that an effective integration with the sub-continent could add as much as 1,5 per cent to South Africa’s growth rate. Furthermore, South Africa should capitalise on its comparative advantages, related to physical, financial and telecommunication infrastructure to attract international firms with the aspiration to gain a foothold in Africa. A study, recently conducted by the World Bank, identified three areas of opportunity to improve this country’s export competitiveness, namely, boosting local competition by opening South African markets to domestic and foreign entry; promoting deeper regional integration in goods and services within Africa; and alleviating infrastructure bottlenecks. This brings us to the second factor which would meaningfully enhance South Africa’s growth potential, namely the forceful implementation of the R1 trillion infrastructure expenditure programme of government. Through multiplier effects, and in terms of job creation, especially with regard to the promotion of low-skilled jobs, economic growth can be materially enhanced. Several studies have shown that investment in economic infrastructure has the potential to act as one of the most effective policies in terms of promoting economic growth. Employment is created during the construction phase of such infrastructure projects, as well as during the operational life thereof. Moreover, the key driver of private sector investment is public sector investment as it inspires both business and consumer confidence. A combination of these two driving forces has the potential to easily boost South Africa’s growth to rates well in excess of current levels, putting this country on a higher road to economic prosperity, thus hopefully reducing unemployment levels, poverty levels and the degree of inequality. I further believe that it will positively contribute to further restore the dignity of our fellow South Africans. South Africans at times can tend to be fairly pessimistic. The challenges we face are immense, but not dissimilar in scale and extent to those faced not only by developing economies but also developed economies. I however choose to be optimistic and do believe that we have many factors that do count in our favour and am convinced that with the right policy choices we can go a long way towards successfully addressing the triple challenges of structural unemployment, poverty and inequality. I 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 Annual Conference of the Bureau for Economic Research, Johannesburg, 12 June 2015.
Daniel Mminele: Global monetary policy normalisation and South African financial markets Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Annual Conference of the Bureau for Economic Research, Johannesburg, 12 June 2015. * * * Introduction Good morning, ladies and gentlemen. It is a pleasure to address you at this Annual Conference of the BER, and thank you to the BER for inviting me. Let me take the opportunity to express our appreciation for the work that the BER has been doing over the years: a research house that has built a local and international reputation for excellence since its establishment in 1944, making it one of the oldest economic research institutes in South Africa. The BER also contributes towards sound monetary policy by conducting the quarterly inflation expectations survey on behalf of the South African Reserve Bank, which, as you know, is an important piece of information for an inflation-targeting central bank. It has been approximately seven years since the global financial crisis began – more or less the period which Reinhart and Rogoff 1 predicted it would take the global economy to recover from the crisis and set the scene for monetary policy normalisation. The global economic environment continues to be characterised by various global headwinds, not least of which is the return to “normal”. My remarks this morning will focus on the period after the global financial crisis, what it means for South African financial markets, and the resulting policy implications. I will also briefly touch on how international forums are dealing with the uncertainty and volatility created by divergent monetary policy. After the global financial crisis, or the GFC Reflecting on the post-GFC period, the first thing that comes to mind is the set of spill-over effects from almost seven years of extremely loose and accommodative monetary policy in advanced economies. Monetary policy developments in advanced economies – and the associated robust capital inflows to emerging markets chasing higher yields – supported financial market asset prices, lowered borrowing costs, and, for a while, created pressure on the US dollar to depreciate. However, policymakers at the time already warned that this unprecedented monetary accommodation was unchartered territory which created its own challenges, such as the so-called “currency wars”, and that ultimately the tide would turn and potentially have even more severe implications for emerging-market economies. Indeed, the turning point came on 22 May 2013, when the then-Chair of the Federal Open Market Committee, Ben Bernanke, announced the intention of the US Federal Reserve to start scaling down its quantitative easing (or QE) bond buying programme. The reaction to these remarks became known as the “taper tantrum”, a period marked by the sharp repricing of risk and unusually high market volatility. This “taper tantrum” was the likely consequence of an unanticipated turning point in US monetary policy amid one-sided market positioning accompanied by very low implied volatility, as expressed in options prices. Carmen M. Reinhart and Kenneth S. Rogoff, Recovery from the crisis: evidence from 100 episodes, American Economic Review Papers and Proceedings, May 2014. BIS central bankers’ speeches The “taper tantrum” is behind us and the US QE programme has since come to an end, but vast uncertainties have re-emerged in recent months, firstly with regard to the timing and pace of the Fed’s rate hikes, and secondly because both the European Central Bank and the Bank of Japan have embarked on more aggressive QE programmes of their own. These divergent monetary policies by three of the world’s largest central banks, and the resultant “complex forces” that the International Monetary Fund refers to in its latest Word Economic Outlook 2, have already had a significant impact on global financial markets. The uncertainties over the Fed’s rate-hiking cycle are captured by the divergence in the views expressed by market participants and the Fed’s policymakers. As of a few days ago, market-based estimates, as reflected by fed fund futures, are for a 25 basis points (bps) increase in the US policy rate in the fourth quarter of 2015 or at least by December, followed by another 75 bps in both 2016 and 2017. It is worth noting that the divergence between the estimates of the Federal Open Market Committee and markets has narrowed in recent months, reflecting more or less consensus for a 50 bps hike by December 2015 or early 2016. The divergence in the following two years, however, is large, at around 75 and 125 bps for 2016 and 2017 respectively. This reflects considerable misalignment and a possible underestimation by market participants of the extent and pace of the Fed’s hiking cycle. Such misalignments are not surprising as the Fed has started to extricate itself from explicit forward guidance and is moving to communication that indicates greater data dependency in policy decisions during an uneven economic recovery. Just a few days ago, in its annual review of the state of the US economy, the IMF suggested that the Fed wait until 2016 to raise interest rates, cautioning that the central bank’s credibility was at stake and that there was too much uncertainty to justify a much-anticipated lift-off. What should we understand by “monetary policy normalisation”? Monetary policy normalisation implies the removal of extraordinary policy measures that had been implemented to deal with a particular economic episode. In this sense it refers to a path taken to return to a more “normal” monetary policy setting, although no qualification is made as to what exactly constitutes “normal” in the post-GFC world. Furthermore, it should be noted that monetary policy normalisation in the aftermath of the GFC will most likely differ from previous cycles. During rate-hiking cycles, a key concern for global markets is the path of US bond yields, as these tend to have knock-on effects on other markets. In this regard I would like to mention some factors which could constrain and/or prevent abrupt and unexpected increases in US Treasury yields – or, in other words, which could smooth the normalisation path. Firstly, most central banks have adopted some form of forward guidance as part of their normal monetary policy toolkit, and although this may at times have contributed to volatility in markets because of the highly uncertain environment in which communication takes place, the aim remains for central banks to be as transparent as possible in terms of the policy outlook and attendant risks so as to avoid spells of excessive volatility associated with unanticipated policy adjustments. The second important dynamic is that the longer end of the US yield curve is also interrelated with the Fed’s balance-sheet dynamics. The Federal Open Market Committee has indicated that it will consider the cessation of reinvestments of maturing securities only after it starts hiking the policy rate. In the meantime, it will not sell any securities. Until such time as the Fed has signalled that it will cease to reinvest bond maturities, the Fed will have no direct impact on the net supply of bonds in the market. World Economic Outlook, April 2015. BIS central bankers’ speeches Thirdly, there is debate on how much the “equilibrium” interest rate has declined structurally in the US, contributing to the downward pressure on the long end of the yield curve. Fourthly, the declining trend in eurozone bond yields has in the past also played a significant role in driving US Treasury yields lower. This was evident during the eurozone crisis of 2011/12 and again in 2014 when the European Central Bank stepped up liquidity-provision measures and ultimately implemented QE earlier this year. As a result, the 10-year Bund traded below 1,0 per cent in late 2014 and even closer to 0 per cent earlier this year. This pulled US Treasury yields lower as investors switched out of low-yielding eurozone bonds into more attractive yielding US Treasuries. Interestingly, during the past week we have seen Bund yields exerting upward pressure on US Treasuries when the Bund yields went above 1,0 per cent for the first time since September 2014. Aside from divergent monetary policy, financial markets have in recent months also been affected by a variety of uncertainties in the global environment. These include the still relatively low oil prices, the possibility of Greece exiting the euro area and its likely impact on the latter’s already-weak economic performance, the changing Chinese growth model and therefore slower economic growth, and the US dollar appreciation as markets get ready for the Fed’s lift-off. Although markets have, to some extent, priced in the lift-off by the Fed, there remains considerable uncertainty regarding the timing and extent thereof. South African markets and global monetary policy normalisation As financial markets and systems became more integrated in recent years, the monetary policy cycles of major economies also became increasingly important for emerging-market economies. The impact from US monetary policy normalisation could transpire through two channels: firstly the real channel (trade), and secondly the financial channel. The real / trade channel implies that US policy tightening is associated with an acceleration in economic growth, with subsequent spillovers for emerging-market economies. South Africa is unlikely to directly benefit to any significant degree from this channel, given that the US portion of our exports is only approximately 8 per cent compared to 21 per cent for the euro area. The financial channel is much more important for us, whereby US policy tightening triggers a reallocation in financial assets, for example, in South Africa’s case, portfolio outflows with a subsequent impact on the various asset classes. Let us take the “taper tantrum” as another example. Similar to other emerging-market economies, portfolio inflows into South Africa declined in the aftermath of the “taper tantrum”. Reserve Bank statistics show that total portfolio inflows reversed from R85 billion in 2012 to an outflow of R55,5 billion in 2014, comprising R13,4 billion equity inflows and R68,9 billion bond outflows. More recent data from the Central Securities Depository 3 reveal that, in the first half of 2015 to date, non-residents bought R19,0 billion worth of equities but sold R1,6 billion worth of bonds, amounting to total inflows of R17,4 billion. South Africa’s vulnerability to US policy tightening is augmented by our dependence on external financing to deal with the current-account deficit. It is well known that South African bonds – and those of countries such as Brazil, India, and Mexico – have a strong correlation with US Treasuries. This correlation was clearly evident during the “taper tantrum” when the 10-year US Treasury yield increased from 1,63 to almost 3,0 per cent and the South African 10-year benchmark bond increased from 6,58 to almost 8,0 per cent between May and August 2013. In 2014, South African bond yields also adjusted (downwards) in line with US Treasuries despite various negative domestic developments, including rating downgrades and the deprecation of the rand, which under normal conditions would have driven yields higher. As the US policy rate hike was believed Strate data. BIS central bankers’ speeches to be getting closer, the persistent strength of the US labour market, as reflected by the closely watched non-farm payrolls data, drove US Treasury yields significantly higher. Over the past four months, 10-year US Treasury yields have increased by approximately 75 bps, which is quite large given the current soft US economic backdrop. This was mirrored by a 140 bps increase in the comparable R186 domestic bond yield. The importance of the US interest-rate cycle for South Africa is also apparent in terms of funding costs for both the sovereign and domestic corporates. With reference to the former, the external funding costs – as reflected by JP Morgan’s Emerging Market Bond Index (or EMBI) – the spread for South Africa over US Treasuries has increased to 216 bps due to domestic factors but also in anticipation of US tightening, from 170 bps a year ago. The funding costs for domestic banks have, on the other hand, been negatively influenced by a further dynamic in the aftermath of the GFC, namely more stringent global financial regulations which are being implemented locally. With the upcoming introduction of the Net Stable Funding Ratio, the spread to Jibar on 5-year floating-rate NCDs issued by commercial banks increased significantly across all maturities, in some cases more than double the levels seen around mid-2013, as banks are forced to issue longer-term instruments. There is a general view that financial regulatory reform may have had certain unintended consequences, such as limitations on banks’ proprietary trading reducing the ability of Primary Dealers to hold sizeable inventories of securities, which have contributed to less liquidity in the markets. This lower level of liquidity introduces new risks that could amplify negative spillover effects in stress situations. The foreign-exchange market, however, is probably the market that may suffer a more pronounced impact from global monetary policy normalisation. This risk was illustrated during the 2013 “taper tantrum” when the rand – together with the currencies of certain other emerging-market economies perceived at the time to be most vulnerable (such as Brazil, India, Indonesia, and Turkey) – depreciated by more than 10 per cent against the US dollar 4. The period that followed was characterised by increased differentiation between emergingmarket economies. As such, countries that implemented appropriate macroeconomic policies, with a reasonable reform agenda to improve economic potential, have been more resilient. The popular narrative tends to focus on the rand-dollar exchange rate. Given the outlook for the normalisation of monetary policy in the US, the US dollar has surprised with its appreciation since mid-2014. The US currency has appreciated by 26 per cent on a tradeweighted basis 5 to reach US$1,05 against the euro, a level that was only expected towards the end of 2015 amid actual US tightening 6. This was the largest appreciation ever in the runup to an interest-rate tightening cycle in the US. The dollar’s appreciation was triggered mainly by the European Central Bank announcing the Targeted Long-term Refinancing Operations 7 and speculating on full-scale QE, which implied increased monetary policy divergence. The outlook for the US dollar will, to a large extent, depend on two fundamental factors: the pace of widening interest-rate differentials and the performance of the US economy relative to its major trading partners. But there are also other factors which could contribute to future May to August 2013. Mid-2014 to mid-March 2015 (Since then, however, the US dollar has depreciated by about 5 per cent until 5 June 2015.) Market analysts’ models were showing that the US dollar performance was consistent with an actual 100 bps increase in the US policy rate. This new form of Long-term Refinancing Operations, amounting to EUR400 billion, was designed to provide funding to banks at 10 basis points above the main refinancing rate for as long as four years, subject to meeting certain loan criteria. BIS central bankers’ speeches US dollar appreciation, such as safe-haven buying due to geopolitical developments or Greece exiting the euro. Historical patterns since the early 1970s show excessive US dollar appreciation during the periods coinciding with the two aforementioned fundamental variables, such as during 1983–84 and the late 1990s. Therefore, actual US policy normalisation could result in further weakness in the rand against the dollar, and could also negatively impact on portfolio flows by reducing the willingness of fund managers (a large share of them having US dollar liabilities) to hold unhedged positions in South African bonds and equities. At the same time, a weaker exchange rate would probably raise implied rand volatility, adding to overall risk aversion and weak sentiment towards rand-denominated assets. Allow me to point out, however, that, unlike previous episodes of rand depreciation, the nominal effective exchange rate of the rand has been reasonably stable since the beginning of 2014, and, relative to baskets of commodityexporting or large emerging-market economies, the rand has regained some of the ground it had lost in earlier years. Nonetheless, exchange-rate developments continue to pose the single biggest risk to South Africa’s inflation outlook. Sharp movements in the rand-dollar exchange rate have translated into large swings in the Reserve Bank’s inflation forecasts. Between the Monetary Policy Committee (MPC) meeting at the end of 2014 and its subsequent meeting in March, inflation forecasts had changed substantially, initially reflecting a significant improvement as a result of the decline in oil prices, then changing to a less favourable outlook in March owing to adverse exchange-rate developments. Such swings complicate the task of monetary management. For South Africa, the favourable impacts of a weaker currency on the current-account deficit have not been forthcoming, which is a concern in the current international environment of volatile capital flows. While there has been some narrowing in the current-account deficit in the fourth quarter of 2014, it is unclear to what extent this represents the beginning of a sustained compression of the current account after a long period of real exchange-rate depreciation. Furthermore, a stronger US dollar tends to dampen commodity prices, with adverse implications for commodity producers like South Africa. Although a number of emerging-market economies have been able to reduce their policy rates in response to the favourable impact from oil prices on inflation, this could be thwarted by developments in currency markets. This in an environment where economic growth for emerging markets has slipped to its slowest pace since 2009 as countries battle to deal with the combined impact of a stronger dollar and weaker commodity prices. Another frequently discussed challenge is that of foreign-currency corporate borrowing in US dollars and the impact of the stronger dollar on debt-servicing and refinancing risks. For South Africa, this does not present a significant risk, given the relatively low foreign liabilities of local companies and banks. However, should this have ramifications for other emerging markets, the effects could very well spill over to South Africa. It is clear that we cannot afford to be complacent, as the risks related to global monetary policy developments remain high given the globalised nature of the world economy. This is unchartered territory; the risks are tilted to the upside, with significant implications for financial stability. On the positive side, we should remember that the beginning of the US monetary policy tightening cycle will not necessarily be bad for the world, in particular for South Africa and other emerging-market economies, as it would indicate that the US economy is in better shape and therefore supports the global recovery. In addition, without QE in the euro area, world GDP would be less positive and slow growth more persistent, and while exchange-rate impacts are not positive for inflation, they are positive for emerging-market economies’ growth, while QE is likely to dramatically reduce deflation risks in the euro area. Let me turn to the international efforts being made to understand the current paradigm and galvanise global policymakers to work towards more coordination while putting in place regulation aimed at strengthening the financial system against future crises. BIS central bankers’ speeches Strengthening cooperation among global policymakers It has become clear that, in this increasingly interconnected global economy, the determination of optimal domestic policy in large economies needs to consider the impact on other economies. For some, policy actions can and do have significant spillovers and spillbacks. Analysing these issues provides policymakers with a more comprehensive and thorough understanding of the challenges we ourselves face but also that others face, and helps us to better position domestic policy and communication at a level that is appropriate and calibrated to these risks. The G-20 Finance Ministers and Central Bank Governors have lengthy discussions about many of these issues. Just last year, we introduced what is called a “Scenario Analysis” into discussions, whereby international organisations calibrate various scenarios informed by recent developments and issues that are of critical importance to policymakers, such as developments in monetary policy globally, commodity price developments and so forth. The Bank for International Settlements (or the BIS) conducts a great deal of research on similar issues, particularly as they pertain to the work of central banks. BIS meetings provide central bank governors with the opportunity to further share their views. It would not be sufficient for the G-20 to focus on the risks facing the global economy without taking into consideration global financial safety nets. As you will know, many changes were made to the IMF toolkit following the GFC, recognising that it was simply not enough to have facilities which kicked in only once countries were in trouble, but that there was a need for precautionary facilities as well as liquidity facilities. Similarly, the BRICS countries signed the Contingent Reserve Arrangement Treaty in July 2014, which is a reserve-pooling arrangement to serve as a precautionary instrument that the BRICS countries can use in the event of short-term liquidity pressures. Mutual support will thus be provided, financial stability will be strengthened, and the treaty will complement and strengthen the global financial safety net and existing international arrangements. Our work on global financial safety nets continues and remains an important agenda item for the G-20. Conclusion The GFC has significantly transformed the environment in which monetary policy operates. While uncertainty is always part of monetary formulation, it is the ever-escalating level of uncertainty in the aftermath of the GFC that has presented the major challenge for policy formulation in the current environment. What, then, are the implications for monetary policy in South Africa going forward? As indicated earlier, the main risks stemming from global monetary policy normalisation are embedded in the exchange rate of the rand and bond yields, and in their resultant impact on portfolio flows, particularly in the context of South Africa’s twin deficits. Any significant weakening of the exchange rate in reaction to US monetary policy tightening could cause inflation to diverge even further from target, which may lead to second-round inflationary pressures. In addition, domestic risks to the inflation outlook persist, including electricity tariffs and wage settlements. We at the South African Reserve Bank are mindful of our mandate and are committed to achieving our inflation target in the interest of sustainable and balanced economic growth. The MPC has indicated that the balance of risks to our inflation outlook continues to be tilted to the upside, and that recently inflation risks have increased, which suggest that an unchanged monetary policy stance cannot be maintained indefinitely. The current environment calls for continued vigilance from policymakers and preparedness to respond to the fast-changing, domestic and global, economic and financial markets environment. As indicated previously, the MPC therefore stands ready to adjust the monetary policy stance when deemed appropriate. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Sake24 Economist of the Year Presentation, Johannesburg, 18 June 2015.
Lesetja Kganyago: Role of the forecast in monetary policy decision making at the South African Reserve Bank Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Sake24 Economist of the Year Presentation, Johannesburg, 18 June 2015. * * * Good evening ladies and gentlemen. It is an honour for me to be the keynote speaker at this event, which recognises economists for their forecasting abilities. Those of you here this evening will understand better than most the difficulties involved with forecasting: that it is not an exact science, and at times it is more akin to being an informed “best guess”. Forecasting is difficult. Inevitably we are dealing with an unknown and unknowable future. But whether we are policy makers or making long term investment decisions, we have to take a view of the future. As monetary policy makers, our time horizons are long. Our policy instruments act with a lag, with interest rate decisions taken today only having their full impact on inflation in about 18 to 24 months time. In my remarks to you this evening, I will expand on the role of the forecast in monetary policy decision making at the Bank. We recently announced that in the interest of increased transparency, we will publish the assumptions underlying our forecasts as of the July MPC meeting. Although it is not my intention to reveal the assumptions this evening, I will make some general comments about the importance of these assumptions, and the process we adopt in arriving at them. Although the inflation and growth forecasts are an integral part of the monetary policy-making process, it is important not to overstate their role. We do not, and should not, mechanistically use the forecast when making decisions. A great deal of subjective judgement goes into the process. Models are simplified approximations of reality; they are not reality. But they do provide a useful basis for discussion of the policy stance. Contrary to what some people believe, inflation targeting is not a simple framework that requires a predictable or mechanistic reaction to deviations of expected inflation from the target. A flexible inflation targeting regime, for example, allows for temporary deviations of inflation from the target. How far and for what period such expected deviations can be tolerated depends on prevailing circumstances, the expected trajectory of inflation, as well as on our assessment of the risks to the forecast. So deviations under conditions of weak growth may entail different outcomes than deviations under conditions of strong domestic demand. Similarly, a given inflation trajectory can elicit different policy responses at different times depending on how the MPC members assess the risks to the forecast. A forecast with a strong upside risk could see a very different policy response to one with a strong downside risk. Such considerations make it difficult for us to give a simple answer to the often asked question as to what period of time are we prepared to tolerate a deviation of (forecast) inflation from the target. The answer is generally, that it depends. It depends on how confident we are that inflation will return to the target; on how we see the risks; on the state of the economy; on how comfortably to within the target range inflation is expected to return, and how sustained this is expected to be; and how well anchored we judge inflation expectations to be. If inflation expectations are not well anchored, even short term deviations of inflation from target could cause inflation to accelerate away from the target. Conversely, well anchored inflation expectations could allow for a more extended deviation of inflation from the target. So our tolerance of deviations from the target depends on our assessment of these various factors. Past history may be a guide to our reaction function, but it would be important to control for these various factors. These factors would also play an important role in BIS central bankers’ speeches determining the strength and amplitude of the interest rate cycle. The need for well thoughtthrough judgement complements the different kind of rigor provided by model-based assessments. Forecast error can come about for various reasons, including model specification uncertainty; structural changes in the economy or unexpected events that are not adequately accounted for in the model; or faulty exogenous assumptions that are put into the model. These exogenous assumptions play an important role in determining the forecast. If the assumptions are not credible, the value of the forecasts deteriorates. The exogenous assumptions of the Bank’s core model include the international oil price; international commodity prices; global inflation and global growth; government consumption expenditure growth; administered price increases; the real effective exchange rate; and the policy interest rate. Some assumptions are generally more important than others, and some may be of greater interest at different times, depending on the extent of their current and expected movements. For example, the oil price assumptions would be of greater interest at times when real oil price trends change direction, such as recently experienced. The assumptions of the model can have a significant impact on the longer term forecast trajectory, as we have to take a view of the behaviour of these variables over a two to three year time horizon. Given the importance of the assumptions, a lot of time is spent deciding on them, and these discussions are an integral part of the MPC process. In fact, it is through the assumptions that the MPC members take ownership of the forecast, by making the final decision about the assumptions. To briefly describe the process: the modelling team, in conjunction with the various units in the Bank, will analyse the relevant data, and bring proposals to a meeting with the MPC members. Each assumption is then discussed and the reasons interrogated, and where deemed appropriate, the MPC members may require a change in the assumptions. Of course it is possible that MPC members may have differing views. Under such circumstances the majority view will prevail, but such differences will ultimately be reflected in the balance of risks to the forecast. Our assumptions are benchmarked against various external forecasts. For example, our assumption of world growth is based to a large extent on our trading partner growth forecasts generated by the IMF. These forecasts are then used to derive a global growth assumption weighted by the shares of these countries in South Africa’s international trade. Our assumption of government consumption expenditure is based on National Treasury budget projections. The international oil price assumption is more challenging. Some central banks simply use the prevailing futures prices, while recognising the shortcomings of this approach. Apart from trying to get an understanding of the oil market dynamics, we also look at the forecasts of various oil analysts and institutions in order to get an idea of the consensus view, and we benchmark our decision against that. However,the divergence between the highest and lowest forecasts is often quite wide, particularly during periods of oil price volatility, reflecting the high degree of uncertainty in the market. Often the assumptions change marginally or not at all. But the challenge emerges when we have to take a view on variables during periods of high volatility. For example, between 2011 and 2014, the international oil price was relatively stable, and our assumptions changed marginally, if at all, from meeting to meeting. During the second half of 2014, very few analysts expected prices to fall as much as they did. Indeed, during June of that year, geopolitical risks were posing an upside risk to these prices. As prices began to decline from August, we initially had incremental downward adjustments to the near-term oil price assumption, but the longer term assumptions were relatively unchanged. By January it became clear that oil prices were likely to remain lower for longer, resulting in a more substantial downward revision over the entire forecast period. However, we did not believe that the price would remain at the levels of around US$45 per barrel, and we also assumed an upward trend over the forecast period. To date our assumptions have been more or less BIS central bankers’ speeches in line with actual outcomes. But changes in supply and demand conditions in international oil markets could require adjustments to these assumptions, with implications for the longer term inflation forecast. A similar situation, but in the opposite direction, faced the MPC during the 2006-08 period of rising oil prices. At that time the market price continually surprised on the upside, (ultimately reaching around US$150 per barrel), until the global financial crisis took the oil price on the downside of the roller coaster ride to levels of around US$35 per barrel. Under such conditions, it is always difficult to know whether prevailing trends will persist over the forecast period, or if prices will stabilise or indeed decline. But we have to take a view, and whatever we decide could have a marked bearing on the inflation trajectory, given the 5,7 per cent weight of petrol in the CPI basket. The other important and volatile assumption in the model is the exchange rate. Again, we have to try and look through short term volatility and focus on longer term trends. In order to take account of movements between the currencies of South Africa’s major trading partners, (for example the recent sharp depreciation of the euro against the US dollar), we focus on the effective or trade-weighted exchange rate. Given the difficulties in forecasting the exchange rate, we make a simplifying assumption of a constant real exchange rate over the forecast period. This implies a change in the nominal effective exchange rate in line with South Africa’s inflation differentials against its trading partners. We generally set the starting point at the prevailing index level, unless the MPC assesses this level is to be significantly out of line, in which case it may be set at a level deemed to be more appropriate. The focus of our discussions then becomes assigning the balance of risks to this forecast. We also look very carefully at different exchange rate scenarios, to get an idea of the sensitivity of the forecast to various alternative exchange rate outcomes. Administered prices, apart from petrol, are generally fairly predictable, particularly where multi-year price determinations exist, as in the case of electricity tariffs. However, the recent application by Eskom for a significant tariff review has increased the upside risk to the forecast. While we would not be surprised if some of the Eskom request is acceded to, the quantum and timing is uncertain. Given these uncertainties, the MPC decided to assign a higher upside risk to the forecast, and wait for the outcome of the Nersa decision, due at the end of June, before changing the electricity price assumption. But in the meantime, we have analysed the impact of a number of scenarios on the inflation forecast. A scenario where the full 25 percent increase is granted to Eskom would increase inflation over a year by about 0,5 percentage points. Perhaps the most contentious assumption is that of the policy interest rate. There is no unanimity among central banks as to how to deal with this issue. Broadly, there are four different approaches. The first approach is to assume an unchanged policy rate over the forecast period. While this allows us to assess the implications for inflation of an unchanged policy stance, it has the drawback that it is unrealistic during periods of regular changes to the policy rate. The second approach allows for an endogenously determined interest rate path- one that would be consistent with achieving the inflation target over the forecast period. A third approach would be to incorporate the MPC’s subjective view of the interest rate path over the forecast period. This approach is also used as a means to provide forward guidance to the market, and has been adopted for some time in some countries including New Zealand, Norway and Sweden. However, there is some risk that the public interprets this as an unconditional commitment to a particular interest rate path. A look at the so-called Fed “dots” (which represent the expectations of individual FOMC members of future policy rates) reveals a fairly wide dispersion of views among FOMC members, but also shows how these views can change from meeting to meeting. Similarly, the New Zealand experience with publishing a forward path shows how significantly the expected path can change between meetings. This has led Charles Goodhart to argue that forward guidance of this nature may be more useful over short periods than over longer time horizons. BIS central bankers’ speeches The fourth approach is to adopt an exogenous market-based interest rate path. This path is also subject to change, and therefore prone to some of the same problems as the previous alternative. The benefit of approaches that do not assume a constant interest rate is that they give some sense of the effect of policy on inflation. Our current approach is to assume a constant interest rate path in our core model, but the MPC is provided with alternative forecasts based on a market-based interest rate path. Furthermore, we have developed a General Equilibrium Model, which generates an endogenous interest rate path, and the results are also presented to the MPC at each meeting. However, only the forecasts of our core model are published. At this stage, we continue with the practice of assuming an unchanged path, and providing qualitative guidance to the market. This includes specifying the risks to the forecasts, and signalling, when appropriate, our view of the interest rate cycle. It is important to emphasise that any signal, whether quantitative or qualitative, should not be seen as an unconditional commitment to specific actions. The use of a non-constant interest rate assumption remains a subject of discussion in many central banks, and we will continue to work on the utility of moving to such an approach. Our forecasts are continually changing, at times marginally, at other times more markedly. This should not be surprising: the underlying assumptions often change in unpredictable ways, sometimes significantly, and this requires a change in our assumptions. We also benchmark our forecasts against forecasts of other institutions and analysts, and as seen in the various regular consensus surveys, those forecasts are subject to change as well. Once a year, we undertake an assessment of our forecasts, including a comparison of the accuracy of our forecasts relative to those of financial market analysts. Generally our forecasts have compared favourably on this basis, and the results are published once a year in a box in the Monetary Policy Review. Our inflation forecasts this year have been subject to quite significant changes, mainly due to changing assumptions of some of the underlying variables, For example, our inflation forecast for 2015 changed from 3,8 per cent in January, to 4,8 per cent in March. Factors that were central to these revisions included the unexpected increase in the Road Accident Fund levy in the petrol price; changes in the international oil price; and the impact of the drought on spot prices of maize and wheat and their possible implications for food prices later in the year. As set out in the May MPC statement, our latest forecasts suggest that inflation will average 4,9 per cent in 2015, 6,1 per cent in 2016 and 5,7 per cent in 2017, with a peak of around 6,8 per cent in the first quarter of next year. While the headline forecast deteriorated only somewhat compared to that of the March MPC meeting, the upside risks to the forecast were assessed to have deteriorated quite markedly. And should these risks transpire, we could see a more significant change in the forecast by the next meeting. Further depreciation of the exchange rate, an expected increase in electricity tariffs, and higher-than-expected wage settlements, have the potential to worsen the inflation outlook. Moderating downside risk arose primarily from risks to GDP growth. Our latest forecast is for growth of 2,1 per cent and 2,2 per cent in 2015 and 2016 respectively, rising to 2,7 per cent in 2017. This growth forecast assumes an easing of the electricity supply constraint by 2017. Hopefully there is not too much downside risk to this assumption! In conclusion, given the inherent difficulties with forecasting, the best we can do is to ensure that we continue to develop our suite of models, and keep up with the latest international advances and trends. Although we can continually increase the sophistication of our models, a model will never be a perfect representation of the economy, and the assumptions will always be subject to change. And given the risks to the forecasts, policy decisions will inevitably require a degree of subjective judgement. I would not want to forecast the winner of this competition, but I wish all of the finalists the best of luck and heartiest congratulations to the winner. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 95th annual ordinary general meeting of shareholders, Pretoria, 31 July 2015.
Lesetja Kganyago: Overview of the South African economy Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 95th annual ordinary general meeting of shareholders, Pretoria, 31 July 2015. * * * The Bank has come through yet another difficult year, and the coming year looks no less challenging. At the global level, the past year has been dominated by the expectation of a sustained recovery in the United States and United Kingdom. Despite negative growth in the US during the first quarter of this year, partly due to adverse weather conditions, recent positive labour market trends appear to have remained resilient, and there are increased signs that the recovery will be sustained. Although growth in the Eurozone remains relatively weak, it has emerged from a recession and there appear to be some positive responses to the significant monetary policy stimulus implemented by the European Central Bank since earlier this year. The past few weeks were dominated by renewed concerns about the sustainability of Greek debt and the possibility of Greece leaving the eurozone. The near term risks from this crisis appear to have been averted for now, but the longer term sustainability of the Greek debt burden remains a concern. Growth in Japan remains positive but very slow. The outlook for emerging markets deteriorated over the past year, with negative growth rates in both Brazil and Russia, and a slowdown in China, as the economy rebalanced away from domestic investment towards consumption. While there has been a general expectation that China would at worst experience a soft landing, i.e. growth of just under 7,0 per cent, recent developments including the bursting of the Chinese equity market bubble, and systemic risks to the financial markets and the property market, increase the downside risks to the outlook. The growth moderation has already contributed to the persistent decline in commodity prices that began in 2011, and accelerated in the past two months. The adverse effect on South Africa’s terms of trade was ameliorated somewhat by the sharp decline in international oil prices that started in the middle of last year. Although growth in African economies remains relatively robust, oil and other commodity producers face an increasingly difficult outlook. Uncertainty regarding the pace and timing of US policy interest rate normalisation continued to dominate global financial markets and the pattern of global capital flows. The changing outlook regarding domestic US growth, labour market trends and inflation caused a great deal of volatility in financial markets. Although an increase in the policy rate is expected sometime this year, the exact timing is still uncertain, as is the pace and timing of future increases. Monetary policy in the UK is also expected to be tightened later this year or early next year. By contrast, monetary policy in Japan and the eurozone remains highly accommodative, and is expected to remain so for some time. Changing expectations with respect to monetary policy stances in the advanced economies are likely to keep emerging-market currencies relatively volatile, as capital flows respond to these developments. The rand was particularly vulnerable to changes in risk perceptions, having depreciated by about 10 per cent on a trade-weighted basis during the financial year under review. Since April 2015 it has depreciated by a further 4,5 per cent. However, domestic factors also contributed to this depreciating trend. These included the persistently wide current-account deficit of around 5 per cent of GDP, the strained labour relations environment, and the weak growth outlook. The past financial year was particularly difficult for the domestic economy, which had to contend with a protracted strike in the platinum sector followed by a strike by metal workers. The downward pressure on growth was exacerbated by the resumption of regular electricity load-shedding by Eskom, which is expected to continue for some time. BIS central bankers’ speeches The outlook for the economy remains subdued following a growth rate of 1,5 per cent in 2014. The Bank forecasts economic growth of 2,0 and 2,1 per cent in 2015 and 2016, rising to 2,6 per cent in 2017 when the electricity supply constraint is expected to ease to some extent. Growth in private-sector gross fixed capital formation remains weak but it improved somewhat in the second half of 2014 and the first quarter of 2015, following a contraction in the first half last year. Household consumption expenditure grew by less than 2 per cent amid low credit extension to households, weak employment growth and a sharp decline in consumer confidence. Headline inflation, which had exceeded the target for five consecutive months during 2014, returned to within the target range of 3 to 6 per cent in September and has remained within the range since then. In the wake of the international oil price decline, inflation reached a low of 3,9 per cent in February 2015 and has been increasing steadily since then, and measured 4,7 per cent in June. The Bank expects inflation to temporarily breach the upper end of the target range during the first two quarters of 2016, with upside risks and pressures from the weaker exchange rate as well as food and electricity prices. Wage settlements in excess of inflation and productivity increases are expected to contribute to the persistence of inflation at the upper end of the range. Core inflation is expected to remain within the target but uncomfortably close to the upper end of the range. Monetary policy had to contend with the continued dilemma of trying to balance rising risks to the inflation outlook (driven to a large extent by supply-side shocks) and a weak economy. A tightening monetary policy cycle commenced in January 2014 with a 50 basis point increase, followed by a further 25 basis point increase in July 2014. This move was prompted by a combination of rising inflation risks and the need to normalise the real policy rate, which had been negative for some time. The lower oil price also allowed for a pause in this cycle. The Bank’s Monetary Policy Committee (MPC) emphasised the likely moderate nature of the cycle given the negative output gap, and that further moves would be highly data-dependent. In its most recent meeting earlier this month, the MPC decided to continue on its path of gradual policy rate normalisation, amid continued upside risks to the inflation outlook. Consequently, the repurchase rate was increased by 25 basis points to 6,0 per cent per annum. The Bank remains committed to achieving its primary mandate of price stability but will continue to conduct policy in a manner that is sensitive to the fragile state of the domestic economy. Progress towards operationalising the financial stability mandate of the Bank continued in line with the Twin Peaks Regulatory Model which expands the responsibility of the Bank for prudential regulation and supervision beyond banking, and locates the Prudential Authority within the Bank. The Financial Sector Regulation Bill, which is expected to be tabled in Parliament during 2015, assigns to the Bank the responsibility to maintain, promote and enhance financial stability. The Bill gives effect to the policy framework for macroprudential regulation and supervision and further provides for interaction and coordination between the Prudential Authority within the Bank and other financial sector regulators. Once passed, the Bill is expected to have significant resource and personnel implications for the Bank. In the year under review, the Bank continued to develop its capacity to oversee and monitor the broader financial sector with the adoption of a macroprudential surveillance approach. At the microprudential level, the past year saw the first significant bank failure in South Africa in over a decade when African Bank Limited was placed under curatorship. In cooperation with National Treasury, the Bank and the private sector, the issue was resolved and prevented systemic spillovers, which includes the application of bail-in provisions. This was in line with the Key attributes of effective resolution regimes of the Financial Stability Board, which South Africa has undertaken to adhere to as a G-20 member country. African Bank Limited remains under curatorship and, once it is restructured, it is anticipated that the resulting “Good Bank” will be relisted in the foreseeable future. Let me now turn to the Annual Report. BIS central bankers’ speeches The Bank remains committed to complying with best practice in terms of integrated reporting, insofar as it is practical for a central bank to do so, taking into account the overriding legislation and confidentiality requirements. The 2014/15 Annual Report reflects a holistic account of all relevant and material financial and non-financial information, which will enable stakeholders to evaluate the performance and impact of the Bank’s operations and the implementation of its mandate. We have again this year enhanced the look and feel of the printed annual report and produced an interactive and easy to navigate HTML version on the website. We hope that you have enjoyed reading the report. I am pleased to report that, having made losses in the previous five financial years, the Bank has returned to profitability. I should emphasise, however, that the Bank does not have a profit-maximising objective and that its operations are conducted in the broader interests of the country, in pursuit of its mandate and responsibilities. The Group recorded an after-tax profit of R0,63 billion compared with a loss of R1,3 billion in the previous financial year. This improvement in the financial position of the Bank was attributable mainly to unrealised profits due to declining global bond yields and the depreciation of the rand against major currencies, which increased the rand value of the interest earned from investing the country’s foreignexchange reserves. Operating cost increases were attributable mainly to the higher cost of producing new currency, higher staffing costs, as well as the change in the actuarial assumptions related to post-retirement benefits. This year the shareholders’ Roadshow was held only in Pretoria on 14 July, as there were no timeous confirmations received from shareholders who wished to participate in the event at the Cape Town and Durban branches via a video conference facility. Unfortunately, we have found that the interest from shareholders in attending the Roadshow meetings has diminished over time and accordingly we have decided that we will no longer hold the Roadshow events prior to the AGM each year. However, I encourage shareholders to communicate with the Bank via email or post when necessary and we will always respond to your enquiries and the Bank will continue to correspond with the shareholders where there are significant developments which would be relevant to them. In addition, the Bank holds Monetary Policy Forums twice annually in Pretoria and in various centres around the country and you are welcome to attend those meetings. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Thomson Reuters Economist of the Year Awards JSE Limited, Sandton,11 August 2015.
Lesetja Kganyago: Issues confronting monetary policymakers in South Africa Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Thomson Reuters Economist of the Year Awards JSE Limited, Sandton,11 August 2015. * * * Good morning, ladies and gentlemen, and thank you for the opportunity to deliver the keynote address at this prestigious awards ceremony. This competition is about forecasting a number of economic variables. Predicting the future is difficult at the best of times, and with the economic environment becoming increasingly turbulent, forecasting is becoming that much more difficult. It is also a challenging time for policymakers; in the face of heightened uncertainty, our decisions become more datadependent than usual. This makes it more difficult for analysts to forecast policy moves. We interact with market participants and other interested parties on a regular basis to help them understand our thinking on various issues.In the recent past, a number of questions have repeatedly come up, and in my address to you today, I will focus on three of these interrelated questions. First, how should monetary policy respond to changes in the exchange rate, particularly when driven by terms-of-trade shocks? Second, given the importance of US policy normalisation in our communication, does this mean that the Bank follows global interest rates in making policy decisions? And finally, how does the Bank think about inflation expectations? Responding to exchange-rate shocks Since the beginning of 2014, when the Bank started the tightening cycle, the rand has depreciated by about 18 per cent against the US dollar and by about 6 per cent on a tradeweighted basis. For some time, we have been indicating that the rand exchange rate is one of the main upside risks to the inflation outlook. However, this does not mean that we target the rand in any way: the rand is but one of a number of determinants of inflation acting simultaneously, sometimes in different directions and with varying intensities. Monetary policy actions do not attempt to influence the exchange rate but rather focus on the overall inflation outlook. A complicating issue recently has been the fact that the traditional pass-through relationship from the exchange rate appears to be lower than during previous episodes of rand weakness. Time will tell whether or not this is a cyclical phenomenon which may be reversed at some stage, or whether it is of a more structural nature. A number of factors have impacted on the rand, and I will highlight three broad categories. First, some domestic developments have impacted negatively on growth and risk perceptions. These include the protracted strikes in the mining and manufacturing sectors last year as well as the deteriorating growth prospects, aggravated by electricity load-shedding. These factors have contributed to the widening of the current account of the balance of payments. Second is the prospect of US policy normalisation and its implications for the pattern of global capital flows. Expectations about the timing of the first move have kept changing as conflicting data regarding the strength of the US economic recovery emerged. Good news for the US economy proved to be bad news for emerging- market currencies, and vice versa. That the Fed will tighten is not a debate. The question is one of timing. One would expect that the markets would have discounted this to some extent, but uncertainty still remains regarding the starting date as well as the speed and extent of the cycle. The continuing changes to the socalled ‘Fed dots’, which reflect the expectations of interest-rate changes of individual members of the Federal Open Market Committee (or the FOMC), indicate just how uncertain this process is. The third broad category to have affected the rand is the ongoing precipitous decline in commodity prices. Commodity prices have been on a persistent downward trend since 2011, reflecting a deterioration in South Africa’s terms of trade and contributing to a persistent BIS central bankers’ speeches current-account deficit. This deterioration was reversed briefly with the decline in the international oil price in the second half of 2014. However, in the past two to three months, we have seen a further sharp decline in commodity prices in international markets. For example, since the beginning of May, platinum prices have declined by about 17 per cent, iron-ore prices by 5 per cent (and about 20 per cent since January), gold prices by 8 per cent, and copper prices by 15 per cent. Clearly, these developments, if sustained, pose a downside risk to South Africa’s growth outlook, apart from their impact on the current account and the exchange rate. Offsetting this to some extent is the fact that international oil prices have also moderated significantly over the period, having declined from the recent highs of around US$65 per barrel in May to the current levels of around US$50 per barrel. I should point out, however, that South Africa is not alone in this respect. While a number of idiosyncratic shocks have impacted on the rand, the currencies of other commodity producers have also been affected, in some cases more so than the rand. Since the beginning of the year, for example, during which time the rand has depreciated by about 9 per cent against the dollar, the rand remains more or less unchanged against the Australian dollar and the Russian ruble, but has appreciated by about 8 per cent against the New Zealand dollar, by about 17 per cent against the Brazilian real, by about 2 per cent against the Chilean peso, and by about 3 per cent against the Canadian dollar (although there was generally a good deal of volatility between these two periods). Monetary policy reactions have differed; over this period, monetary policy has been tightened in Brazil, unchanged in Chile, and loosened in Australia, Canada, and New Zealand. The question is how monetary policy should react to different categories of shocks. Textbooks distinguish between portfolio shocks and terms-of-trade shocks (apart from standard domesticdemand shocks). The challenges posed to the rand by the US policy uncertainty clearly fall into the category of portfolio shocks. Here, literature tells us that policymakers should respond to these shocks by tightening monetary policy. In an inflation-targeting framework, the tightening would depend on the extent to which the weaker exchange rate was expected to impact on inflation rather than acting to protect the exchange rate per se. The role of inflation expectations (and monetary policy credibility) would be central to this. Reaction to a terms-of-trade shock is less straightforward, as it would also depend on whether it was a decline in an export price (for example the gold or platinum price), which would in itself have less impact on domestic prices, or whether it was an increase in import prices (for example oil prices), which do impact more on domestic inflation. In general, a terms-of-trade deterioration driven by a decline in export prices implies a decline in domestic incomes which can be disinflationary. A fall in export prices may be accompanied by currency depreciation which moderates the impact of the decline in export prices on demand and inflation. A policy response would need to try and ‘see through’ the first-round effects of the change in the exchange rate. However, again, much depends on the extent to which inflation expectations are well anchored. Where countries have inflation under control, a response to depreciation and negative termsof-trade shocks can be more supportive to economic activity. Other commodity producers – like Australia, Canada, Chile, and New Zealand – have low levels of inflation and minimal upside risks to inflation. However, the Australian response could be assisted to a significant degree by the fact that the Prices and Incomes Accord between government and the trade unions, implemented during 1983 and 1996, had broken the back of inflation, and that inflation expectations were well anchored at that time. This is policy capital that Australia has and it could stand them in good stead this time around too. By contrast, the risks to South Africa’s inflation are on the upside, inflation is uncomfortably close to the upper end of the target range, and inflation expectations are at elevated levels. Textbooks may be clear, but reality is a bit more complicated. It is very difficult to disentangle the impact of the various types of shocks when they are happening simultaneously, as is currently the case in South Africa; it is also difficult to know whether these shocks are once-off or likely to persist for some time. It is easy enough to ‘look through’ a once-off shock, but when BIS central bankers’ speeches the shock is of a protracted or continuous nature, it is a lot more difficult to manage. Furthermore, it is not straightforward assessing the extent to which inflation expectations are anchored, an issue that I will return to in a while. Global interest rates and domestic monetary policy A related question is: does the fact that we are concerned about the impact of Fed normalisation mean that we simply follow global interest rates in conducting monetary policy? The simple answer is: no. For a start, it is difficult to talk about a global interest rate when interest rates in the US and the UK are expected to increase in the near future but those in the eurozone and Japan are expected to remain close to the zero bound for a much longer period. With respect to the US rate, the correlation between US and South African long bond yields is much stronger than at the short end. Our decisions on short-term interest-rate changes are focused primarily on the domestic inflation outlook which can include the extent to which expected changes in US rates are assessed to impact on the overall inflation outlook through the exchange-rate channel. In this respect, there are conflicting views in the market about the way in which we should react to a change in the US interest rate: pre-emptively or reactively? On the one hand, we are told that by acting reactively and delaying the adjustment, we will have to act more aggressively later, ultimately leading to a much higher rate. Implicit in this argument is that inflation would be higher than if we had acted pre-emptively. On the other hand, critics of our recent rate increase argue that by moving pre- emptively we will be starting from a higher repo-rate level when the Fed action begins, which will affect short-term growth. To some extent, we have tried to chart a middle road between these two views. Our primary mandate is to maintain price stability in the interest of balanced and sustainable economic growth. This implies assessing the impact of our policies on inflation, output, and employment under current conditions. For this reason, our monetary policy tightening cycle has been moderate, and this approach remains our base case – although it is, of course, highly datadependent. We have not observed a knee-jerk reaction to every adverse move in inflation, particularly among pressures driven by supply-side shocks. But at the same time, completely ignoring the risk of second-round effects could entrench inflation expectations at higher levels and could require stronger action later, with consequences for output. Monetary policy and inflation expectations The issue of inflation expectations has cropped up a number of times this morning. Inflation expectations are potentially an important determinant of actual inflation outcomes: to the extent that price-setters set prices on a forward-looking basis, they will have some notion in their minds as to what future inflation is likely to be. Similarly, wage negotiations generally revolve around expected inflation outcomes. In fact, an objective of an inflation-targeting framework is to anchor longer-term inflation expectations within the target range, and this will not only help to maintain inflation within the target, but will also make expectations resilient to temporary shocks to the inflation outlook. This requires monetary policy credibility, which means not only transparency and clear communication, but also demonstrated commitment to act appropriately to keep inflation under control. All this seems relatively straightforward. However, there are a number of complicated issues and questions which make the interpretation of measured or implied inflation expectations extremely difficult, particularly for policy purposes. First, in reality, it does not necessarily follow that inflation expectations are always correct or that they will be self-fulfilling. Related to this: what do we do when inflation expectations diverge from our own forecasts, which already have inflation expectations incorporated into them? This relates to a second issue: whose expectations should we give most weight to, particularly when there is a divergence between the expectations of different categories of respondents? Do we simply look at those of pricesetters? BIS central bankers’ speeches Third, it is sometimes the case that inflation expectations are formed not on a forward-looking basis but rather on the basis of backward-looking or adaptive expectations. Under such circumstances, published expectations may not be useful predictors of future inflation. It also comes as no surprise that when inflation outcomes have been relatively stable, inflation expectations are also stable. Under such conditions, unless we know how expectations are formed, we cannot be certain if stable expectations are indicative of well-anchored forwardlooking expectations or if they are simply telling us what has happened in the past. Fourth: what is the appropriate time horizon for assessing expectations? As Adam Posen has pointed out, anchored expectations do not necessarily mean unchanging expectations, and short-term inflation expectations should be expected to vary over the business cycles and in the face of shocks to the economy. For this reason, more attention should be given to longerterm expectations. If monetary policy does have credibility, longer-term expectations should not be impacted by shocks that affect short-term expectations. The Bank uses a number of sources for trying to assess expectations. The broadest is the inflation expectations survey conducted by the Bureau for Economic Research, or BER, on a quarterly basis. It surveys analysts, business people, and trade unionists, asking what their inflation expectations are for the current year and for the next two years. Since mid-2011, respondents have also been asked to give their expectations of inflation in five years’ time. Household expectations are also polled, but only for the current year. In addition, there are the surveys that poll financial market analysts on a monthly basis, including the Reuters econometer survey and the Bloomberg survey. The break-even inflation rates, derived on a high-frequency basis from the inflation-linked bond market, give us some indication of the views of bond market participants. We generally assume that the expectations of the economic analysts are the most forwardlooking of the three groups surveyed by the BER. Economic analysts tend to rely on forecasting models similar to our own, and it is not surprising that their forecasts are often quite similar to those of the Bank. But although their forecasts are useful for us to benchmark against, analysts are generally not price-setters in the economy. The same would apply to the break-even inflation rates, which often diverge quite significantly from those of the analysts. (I should point out that we often get confusing or conflicting information when distinguishing between the expectations implicit in the 5-, 10-, and 20-year bonds.) Over the past few years, average inflation expectations, as shown in the BER surveys, have been relatively stable but deteriorated slightly in the latest survey. Average expectations have been close to or, at times, slightly above the upper end of the target range, although there is generally a variation between the different groups. The expectations of both business and labour are often above those of the analysts, although over time there has been some convergence between the three groupings. Research by the Bank suggests that the expectations of business and labour respondents tend to be more adaptive. So trying to make sense of the different expectations is often quite difficult, and they cannot always be taken at face value. Furthermore, for reasons mentioned earlier, the Bank focuses less on near-term expectations than on longer-term expectations. It should not come as a surprise if shocks to the economy (for example oil price shocks) cause near-term expectations to change. But focusing on the longer term can also be a challenge as the signals are not always clear. For example, in the most recent BER survey, short-term expectations deteriorated; over the two-to-three-year time horizon inflation expectations improved, on average; but over a five-year horizon they deteriorated. A two-year horizon is consistent with the lag between a change in the policy rate and its full impact on inflation (our models show an 18-month distributed lag for the full effects of an interest-rate change to be felt). Since 2012, the average five-year inflation expectation measured each quarter has varied in the narrow range of 5,8 per cent and 6,2 per cent, with the latest reading at 6,0 per cent following two consecutive months at 5,8 per cent. This is concerning as it is uncomfortably close to or at the upper end of the inflation target range. At this stage, we still do not have a clear view of how inflation expectations are formed, BIS central bankers’ speeches particularly over longer-term horizons. We would like to think that inflation expectations are well anchored because of the credibility of the Bank, but we also recognise that these could be a reflection of past inflation. The persistence introduced by the wage-bargaining process and relatively low levels of competition in parts of the product markets means that inflation expectations matter and can be self-reinforcing. We will therefore continue to monitor the various measures, mindful of these caveats, and focus on the longer-term trends. Final thoughts In conclusion, I have tried to convey a sense of how the Bank thinks about some of the issues confronting monetary policymakers. Unfortunately, models and textbook prescriptions generally work more smoothly than what we have to deal with in the real world. In reality, we deal with imperfect information and uncertainty regarding inflation expectations formation, apart from having to cope with an increasingly uncertain future. The global economy is entering unchartered waters, with the prospect of normalisation in the US and a slowdown in China impacting on commodity prices. The truth is that South Africa, along with other emergingmarket economies, is likely to face an increasingly turbulent time ahead. While theoretical models can help to guide us, we cannot react in a mechanical way and ultimately have to rely, to a certain degree, on subjective judgment. I wish all the finalists the best of luck and heartiest congratulations to the winner. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the 18th Southern African Internal Audit Conference, hosted by the Institute of Internal Auditors South Africa, Johannesburg, 18 August 2015.
François Groepe: Lessons to be learnt from progressive economies Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the 18th Southern African Internal Audit Conference, hosted by the Institute of Internal Auditors South Africa, Johannesburg, 18 August 2015. * * * Chairperson, ladies and gentlemen. Thank you for inviting me to participate in the 18th Southern African Internal Audit Conference, hosted by the Institute of Internal Auditors, South Africa. In my address this morning, I will spend some time discussing the lessons learnt from progressive economies and applying them to South Africa. Economies, and the factors affecting them, have generated much interest in our attempts to deepen our understanding of the most appropriate and efficient ways of organising the economy in an effort to optimise the allocation of scarce resources. At the outset, it must, however, be emphasised that the management and allocation of resources within an economic system does not happen in isolation or in some abstract manner. Factors such as culture, values, education, technology, social and other institutions, political structures and legal systems all provide content and context and set the backdrop and parameters in which the different economies function. In this regard, Douglas North writes, “It is the admixture of formal rules, informal norms and enforcement characteristics that shape economic performance… And economies that adopt the formal rules of another economy will have very different performance characteristics than the first economy because of different informal norms and enforcement”. 1 There are clearly different schools of economic thought, with their own analytical frameworks, which in turn has a bearing on both the analyses of economic imbalances and the policy prescripts to remedy them. Despite certain reservations raised by some economist it can be argued that the United States (US) economy has made huge strides during the 20th century in growing to become the world’s largest economy and arguably one of the world’s more successful economies. One of the outcomes of this achievement was the establishment of a large middle class population following the Second World War. Despite this strong economic performance, inequality has widened more recently. The average income of the top 1 per cent of the population in the US had increased by more than 250 per cent during the preceding two decades, while the income of most other Americans had stagnated. This may have contributed to President Obama pronouncing that, “growing inequality is the defining issue of our time”. He declared that it was a tipping point for the middle class in the US and all those aspiring to gain access into the middle class. For an economy or any society to thrive one would need to acknowledge and redress both economic and political inequality. Measures of economic equality include, among other things, growth in gross domestic product per capita and a reduction in unemployment. The World Bank defined sustainable economic development as a situation under which extreme poverty is reduced to such an extent that the number of people making a living on less than US$1,25 per day will eventually be lowered to less than 3 per cent of the total global population by 2030. Furthermore, prosperity should be promoted by improving the living standards of the bottom 40 per cent of the population in all countries. The latest World Bank Report indicates that growth in per capita income has taken place during the past decade, more specifically in the African region. Progress made is apparent in the world’s middle North, D.C (1993) “Economic performance through time” Prize lecture in Economic Sciences in memory of Alfred Nobel, December 9, 1993. BIS central bankers’ speeches class, which is showing steady growth. According to Organisation for Economic Co-operation and Development (OECD) estimates, five billion people would have moved into the middle class, with about two-thirds residing in Asia, followed by the Middle East, Africa and Latin America. The shift towards the middle class is therefore expected to occur mostly in emerging markets, which supports the objective of inclusive growth. The South African Institute of Race Relations estimates that the South African middle class realistically constitutes around 10 per cent of the total population. Efforts to expand and grow this number may, however, come under strain unless the South African growth trajectory can be lifted to the 5 per cent target set in the National Development Plan. To judge the progressiveness of countries, from which lessons can be learnt, it is prudent to construct a continuum, from non-progressive countries on the one side to progressive countries on the other. Consistent with such an approach, the IMF expressed an opinion on the status of economies that could be used to place them on such a continuum, while also indicating what is required for these countries to become progressive. It is worth noting that countries such as Canada and Singapore were rated as countries with solid growth, whilst Mexico has been acknowledged for undertaking significant structural reforms. Bolivia, interestingly has seen per capita income tripling over the past couple of years whilst Namibia has grown strongly. Poland is demonstrating that its macroeconomic policies are proving to be highly conducive towards growth, followed by New Zealand at the progressive side of this continuum. These countries are displaying good governance structures and the prudent management of national resources. The following principles generally contribute towards establishing a progressive economy: • Economic growth is essential, but it must be sustainable and inclusive, resulting in good-quality jobs and improve the living standards of the citizens of the country. Growth without this prerequisite will fall short of creating a prosperous society and will not be sustainable in the long run. • High-income countries generally face challenges in terms of rising inequality due to technological progress, which has increased the wage dispersion in favour of higher-skilled workers. To address these matters, concerted efforts should be introduced to promote increased investments in human capital. Flexibility in the labour markets can contribute towards an enhance absorption of labour combined with appropriate social support systems. The environment should also receive attention to guard against environmental degradation. • Developing economies face challenges to realise inclusive growth and should pursue policies that allow for the absorption of lower skilled labour. This can be done by investing in skills training that aligns the abilities of workers with the requirements of the labour market. Adequate social protection systems should also be put in place. In South Africa, despite the transformation of the economy during the past two decades, there are still too many citizens struggling to make ends meet and who are reliant of the social grant system. Drawing on the latest round of Article IV consultations by the IMF, various good practices by progressive countries are referenced within their reports. Without referring to specific countries, the following general guidelines can be considered as good practice towards the development of a progressive economy: • Raising labour productivity and increasing labour force participation would improve longer-term economic prospects by boosting potential growth. • Increased access to financing for start-ups and the reduction of administrative barriers for new businesses could assist in expanding an economy’s production frontier. BIS central bankers’ speeches • Maintaining a flexible exchange rate is essential, both as a buffer against external shocks and to facilitate adjustment towards domestic sources of growth to reduce external imbalances. Furthermore, it is considered as advantageous to implement a broad-based set of policy actions when required, rather than incremental actions when confidence levels need to be shifted to a higher level. • Pursuing structural reforms in a country should never be considered a trivial matter, as it can be a very challenging undertaking to balance the interests of different groups. It should, therefore, be approached in a circumspect manner. Fiscal sustainability should always be a key consideration in any undertaking towards the creation of a progressive economy. Governments should always address weaknesses in public infrastructure, including through new institutions, to enable better planning and coordination at the local level. Competition, in especially the services sector, should be encouraged as this will increase the overall level of productivity in an economy. • Another prerequisite for a thriving economy is the establishment and maintenance of good industrial relations within the labour market towards an equitable distribution of income between the various constituencies. Quality education and training through apprenticeship programmes, as well as immigration policies aimed at accommodating scarce skills, have the tendency to alleviate skills mismatches in a country. Reduced regulatory burdens and increased competition through trade liberalisation assist in the reduction of the wage-productivity gap by lowering the cost of living, and contributing to enhanced productivity. A dedicated focus on research and development has proven beneficial to the advances made by progressive economies. The pursuance of regional free-trade arrangements is also helpful to harness the benefits of the dynamism of an adjacent region, when applicable. Government procurement practices should ideally be characterised by simplified bidding procedures, high levels of transparency, and standardised contracts that reduce costs with a focus on value for money. Performance-based budgeting practices generally also improve the impact of government programmes. Experience in progressive economies has shown that a predictable legal framework is paramount to broad-based and inclusive growth, as it raises confidence in practices and processes and most importantly creates a strong degree of legal certainty. Comprehensive and regular evaluations of programmes being implemented should be undertaken to ensure the efficiency of execution. If found that the implementation procedures of such programmes need to be revised, or that implementation should be abandoned in totality, the necessary institutional leeway should be available to effect such changes. A sound financial system supported by comprehensive macro-economic and microprudential policy measures, and well capitalised banks with solid liquidity buffers, contribute materially to sustainable growth within an economy. Moreover, authorities should strive towards the strengthening of their macro-prudential toolkits to better adhere to their financial stability mandates. Some of the global regulatory reforms undertaken is aimed to ensure an even greater degree of transparency and include efforts to reduce potential conflicts of interest and the risks associated with moral hazard. Executive compensation remains firmly on the agenda, not only because of equality considerations, but because in certain instances it may give rise to excessive risk taking. An argument that the high levels of executive compensation is justified due to the value created for shareholders must also be closely examined against the exogenous factors, such as the liquidity overhang caused by the unconventional monetary policies pursued by many of the advanced economies. Creating an enabling environment for small- and medium-sized enterprises, which are major sources of employment, should be part of any policy transformation attempt. BIS central bankers’ speeches Academic research generally concludes that political freedom, strong institutions and quality regulation are significant contributors to economic growth. Effective, fair and accountable governments boost public confidence, raising the level of satisfaction among citizens. Likewise, citizens’ access to public officials to voice their concerns is correlated with a higher state of well-being. It is worth noting the most recent findings by the Institute for Management Development responsible for the publication of the World Competitiveness Yearbook. The 2015 Yearbook indicates that SA occupies position 53 in terms of its competitiveness within a group of 61 countries surveyed. The Yearbook ranks a mix of 61 industrialised and emerging economies in terms of ability to create and foster an environment sustaining competitive enterprises. Country data are evaluated based on specific criteria, categorised in terms of four competitiveness factors, namely government efficiency, business efficiency, economic performance and infrastructure. South Africa’s economic performance has improved by seven places to position 49 in 2015, following an improvement in international trade and attaining the lowest cost-of-living index that topped the world rankings. Government efficiency though is indicated to have dropped to position 40 in 2015, after having been at position 32 two years earlier. This is mainly attributable to the poor performance of public finance, a weak institutional framework and business legislation. The performance of businesses’ efficiency also deteriorated further in 2015, as a result of a decline in productivity and efficiency, a further deterioration in labour market conditions, deteriorating management practices, and poor attitudes and values in the business sector. The ranking of technological infrastructure, health and environment infrastructure also deteriorated. The report states that business efficiency requires high productivity in order to thrive and, in the absence of that, it is difficult for an economy to be competitive. According to the report, it has been empirically proven that business efficiency and productivity have been the main drivers of the competitiveness gains in the US, with that country remaining the most competitive economy in 2015. In dealing with our own challenges regarding competitiveness, it is important that we continue to pursue fair access to markets and more balanced global trade. Furthermore, although protectionism appears to be an attractive policy response against a backdrop of low growth and a structural current account deficit, it should be approached with a degree of circumspection as an important lesson to be taken from economic history is that the period that followed the Great Depression was marked by an outbreak of protectionist trade policies. These policies led to a sharp contraction in global trade in the 1930’s, beyond the economic collapse itself, and a lacklustre rebound in trade despite the eventual worldwide economic recovery. 2 It is also worth acknowledging that trade protectionism often fails to adequately address the underlying challenges of competitiveness, or the lack thereof, within an economy and it may even lead to a decline in the degree of competiveness as its could lead to higher input costs and hence contribute to price inflation. Lastly, it is unlikely to restore external balance if external demand is weak. The International Monetary Fund (IMF) has developed sustainable growth indicators which focus on policy, democracy, and governance as the drivers of growth. The policy component encapsulates economic policies, while the governance component relates to accountability. This approach by the IMF enables a link between economic growth and the role of the South African Reserve Bank (the Bank) and bodies, such as the Institute of Internal Auditors, in fulfilling their respective mandates. The contribution by the Bank enhances institutional capacity in the economy as it serves the South African society through maintaining price and financial stability in the interest of Eichengreen, B and Irving, D.A (2009) “The slide to protectionism in the Great Depression: Who succumbed and why?” NBER Working Paper No. 15142. BIS central bankers’ speeches balanced and sustainable growth. In the policy sphere, it conducts monetary policy to contain price inflation. In doing this, the Bank assists in maintaining and improving competitiveness, protecting the purchasing power of the currency and, thus the living standards of all South Africans. Furthermore, this provides a favourable environment for employment creation through balanced growth. In addition, the Bank also has the mandate to oversee and maintain financial stability which is a distinct and separate policy objective from price stability. We can feel very proud that South Africa was ranked first out of 144 countries ranked in the Global Competitive Index Report for our Strength of our Auditing Standards and Reporting, second for Accountability and third for the efficacy of our corporate boards. This is meaningful as the internal and external auditing profession forms an integral part of the international and domestic institutional capacity. These professions contribute to both the moral and legal frameworks that maintain and uphold ethics and standards, while forming an important line of defence in upholding good governance in both the public and private sector. The auditing profession contributes to a credible and thriving business environment, while acting as the custodians of international standards for professional conduct. Lastly, the comfort that investors get from the auditing professions, promotes investment and thus ultimately economic growth and therefor makes a difference to people’s standards of living and hence their quality of life. I wish to conclude my talk this morning, by quoting former President, Nelson Mandela, when he said “There is no passion to be found playing small - in settling for a life that is less than the one you are capable of living”. I hope we all would continuously strive towards a life that is nothing less than the one we are capable of. More importantly, I hope that we would all take hands and work tirelessly to create a future for our country that is reflective, not only of the rich endowments we enjoy as a country, but a future that is reflective of our true and full potential as a nation. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the public workshop on the discussion paper titled "Strengthening South Africa s resolution framework for financial institutions" Cape Town, 15 September 2015.
François Groepe: Strengthening South Africa’s resolution framework for financial institutions Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the public workshop on the discussion paper titled “Strengthening South Africa’s resolution framework for financial institutions, Cape Town, 15 September 2015. * * * Introduction: addressing ‘too big to fail’ After the global financial crisis of 2007/08, and the severe and lingering consequences thereof on the global economy, one of the key items on the agenda of the G-20 (the Group of Twenty Finance Ministers and Central Bank Governors) was to address the ‘too big to fail’ problem. During the past couple of decades, financial sectors have outgrown the size of their national economies and have expanded beyond their national borders. The individual balance sheets of large, global financial conglomerates are now larger than those of most economies. For example, the balance sheet of JP Morgan Chase amounted to US$2,6 trillion in 2014 – larger than the gross domestic product, or GDP, of all but the six largest economies in the world1. Moreover, the activities of these large financial institutions are highly interconnected, and the services they provide are inseparably integrated into the modern financial system and the global economy. Unlike non-financial corporates, which can be liquidated in the event of failure even if they are large, the failure of a single large financial institution can disrupt the functioning of the whole financial system and the economy so that the ultimate cost of the failure far exceeds the initial losses that caused the failure. 1 This is what had forced governments to intervene in past financial crises, and what came to be known as the ‘too big to fail’ problem. The ‘too big to fail’ problem is not only a global phenomenon. In South Africa, banks’ total assets amount to some R4,4 trillion. This approximates to 125 per cent of South Africa’s GDP of about R3,7 trillion. The assets of long-term insurers amount to about R2,4 trillion, and those of self-administered pension and provident funds to R1,7 trillion2. These are just some examples to show how important financial institutions have become in our own economy, and how exposed the system has become to the consequences of a failure of one of the significant financial institutions, especially since the financial system is highly concentrated and interconnected. Even if government were willing to support these institutions in the event of failure, such an intervention would bring a huge burden on the public purse. We are fortunate that our large financial institutions are all in a healthy financial condition and well managed, with a very low probability of failure. However, this is also the best time to prepare for the unlikely event of failure. 2 Lessons from the financial crisis for resolution The global financial crisis as well as the way in which both governments and central banks had to act to contain the effects thereof has taught us important lessons. The list of lessons is extensive, but I will highlight a few that have a particular bearing on resolution and on what we are attempting to achieve with a strengthened resolution framework. China, France, Germany, Japan, United Kingdom and United States (data from the International Monetary Fund and the World Bank) All amounts quoted from the June 2015 Quarterly Bulletin BIS central bankers’ speeches i. Implicit support leads to moral hazard. If banks believe that they will not be allowed to fail (i.e. that they will be ‘bailed out’), they tend to take greater risk. Similarly, if bank managers and executives are rewarded on the basis of profitability without facing the consequences of excessive risk-taking, it creates skewed incentives. This did not happen in South Africa on any large scale, which helped to protect us from the worst of the crisis, but it certainly happened in other parts of the world, with devastating effects. ii. Implicit support leads to a mispricing of risk. If investors believe that banks will be bailed out and will therefore not be liquidated, they basically believe that their investment risk profile is similar to that of the sovereign. An effective resolution framework should promote market discipline by ensuring that investors and creditors price for the risk of the institution in which they invest, without relying on a government bailout and hence an implicit subsidy. iii. Markets overreact in a crisis. An effective resolution framework should enable authorities to prevent excessive losses that arise from fire sales, frozen markets, excessive volatility, additional collateral requirements, margin calls and early termination rights. iv. Early intervention and corrective action reduce the losses resulting from failure. The cost of a failure can be significantly reduced if authorities have the power and the tools to intervene while the financial institution is still solvent. Once the market loses confidence in the ability of an institution to recover, its failure becomes a self-fulfilling prophecy. iv. Planning and preparing for resolution is important. Although the reason for a possible failure cannot be predicted, and although the likelihood of failure could be very small, proper planning always puts authorities in a better position to successfully manage an orderly resolution. Being caught unawares – without the necessary information, resolution tools and/or cooperation agreements – may cause delays during which asset values and market confidence are eroded and possibly destroyed. v. It is not only banks whose failure can cause a financial crisis. The failure of nonbank financial institutions can have equally devastating effects on financial stability, as was clear from the failure of Lehman Brothers, AIG and others. Authorities therefore need tools to deal with the failure of various kinds of financial institutions, as well as of financial groups. vi. Financial failures cause hardship for ordinary people. Financial crises can result in job losses, financial losses, and an inability to conclude transactions. An effective resolution framework should contain safety net arrangements to protect the most vulnerable citizens from severe hardship as a result of a financial failure. vii. Cooperation and coordination among regulators and other authorities is essential to achieving an orderly resolution, especially if a financial group operates in various jurisdictions. Coordination arrangements should be supported by appropriate legislation. The international response Various international standard-setting bodies, including the G-20 and the Financial Stability Board (FSB), have made significant progress in developing and promoting the implementation of enhanced regulatory standards to increase the resilience of the financial sector to shocks. BIS central bankers’ speeches South Africa’s own regulatory framework is undergoing significant changes as a result of this response, with the introduction of Basel III, … (SAM), over-the-counter (OTC) derivatives market reforms and the Twin Peaks regulatory framework, to name but a few. However, even the most effective regulatory framework cannot completely rule out the possibility that financial institutions and financial groups may fail. Therefore, significant attention has been given to the development of new standards for resolution. G-20 member countries have committed themselves to the objective of implementing measures which will allow large financial institutions fail in a way that critical economic and financial functions continue uninterrupted and without taxpayer money while maintaining the financial stability of the sector. To achieve this objective, the FSB has developed a set of new international standards that G-20 member countries have to implement in order to make it possible to resolve the failure of large, complex and interconnected financial institutions, which often operate in multiple jurisdictions, without having to provide public support and without interrupting the provision of critical functions. Drawing on lessons learnt during the global financial crisis, the FSB developed the Key attributes for effective resolution regimes (Key attributes), which describe the minimum set of legal powers, processes and governance arrangements that countries should have in place in order to achieve the orderly resolution of failing financial institutions. G-20 member countries have to comply with these Key attributes from 2016. The second thematic peer review on resolution, conducted by the FSB in May 2015, showed that G-20 member countries have made progress in implementing the Key attributes. In the European Union (EU), the Bank Recovery and Resolution Directive (or BRRD) was introduced, which contains the full range of resolution powers. The BRRD is being incorporated into national legislation by EU members. In the United States (US), the DoddFrank Act introduced all but one of the Key attributes powers. Six jurisdictions have all but two or three powers. Most jurisdictions have reported that they are planning and implementing reforms. Significant progress has also been made in the areas of recovery planning and resolution planning, in particular with regard to global systemically important banks (G-SIBs). South Africa’s response As a G-20 member, South Africa is committed to implementing the framework contained in the Key attributes. But this is not merely an exercise to comply with international standards; rather, this is seen as a key element of a resilient financial sector that can withstand shocks and continue to serve the economy and all its stakeholders, even in the event of a systemic disruption or failure. A thematic peer review conducted by the FSB in 2013 and a comprehensive review of South Africa’s resolution framework in 2009/10 under the auspices of the World Bank’s First Initiative Programme revealed gaps in a number of areas where South Africa’s resolution powers did not comply with the Key attributes. These gaps were confirmed in the findings of the International Monetary Fund (IMF) in its 2014 Financial Sector Assessment Programme (FSAP) for South Africa. Our current framework for dealing with failed financial institutions is fragmented across various pieces of legislation and regulations. In general, there are inconsistencies in dealing with different kinds of financial institutions, inadequate powers for ‘business rescue’ practices that would be appropriate for financial institutions, and some implicit assumptions and beliefs that drive activities in the financial sector but that would not always be possible or realistic. Table 1 in the paper contains a more complete assessment of South Africa’s existing resolution framework against the Key attributes, and highlights the gaps that the new framework should address. The new resolution framework is intended to rectify the inconsistencies; to clarify the position of investors, depositors, policyholders and creditors in the event of a failure; to ensure the fair BIS central bankers’ speeches and transparent allocation of losses with appropriate safeguards; to put measures in place for the funding of resolution actions; to provide protection where it is most needed; and to introduce the tools necessary for maintaining financial stability and ensuring the continuation of critical financial services. The key elements of an effective resolution framework The discussion paper sets out the key elements of an effective resolution framework, as it could be applied to South Africa. It is important to understand that the term ‘resolution’ is not a synonym for ‘liquidation’, ‘curatorship’ or ‘administration’, the latter terms representing South Africa’s current arrangements for dealing with failed financial institutions. Resolution in the context of the Key attributes is a new concept that requires a paradigm shift. Going forward, resolution is about earlier intervention, preserving value, restoring confidence, and preventing ‘fire sale’ losses. Going forward, resolution is about allocating losses where they are due without necessarily having to liquidate, and about being able to rectify malpractices, structural problems and mismanagement while there is still a chance for recovery. Going forward, resolution is focused at maintaining critical functions rather than rescuing legal entities. Going forward, resolution is about protecting broader financial stability instead of protecting only particular groups of creditors or depositors. The intention is to establish a new, strengthened framework for resolution by drafting and promulgating a Special Resolution Bill. The main objective of this Special Resolution Bill will be to maintain financial stability in the event of an institutional failure. I will highlight the main elements of the new framework, each of which is discussed in detail in the paper itself. i. The paper introduces the concept of a ‘designated resolution institution’, applicable to any financial institution whose failure would disrupt financial stability. The Special Resolution Bill will apply to all banks and to systemically significant non-financial institutions. The Bill will potentially (but not necessarily) apply to financial groups from the level of the ultimate holding company; this will be determined by the structure and operations of each financial conglomerate. ii. The South African Reserve Bank will be the Resolution Authority, in line with its financial stability mandate. However, appropriate consultation and coordination requirements as well as appropriate governance and accountability arrangements will be in place. iii. Resolution plans and resolvability assessments will become a legal requirement in terms of the Special Resolution Bill, and the South African Reserve Bank will be able to share these plans or parts thereof with other regulators, if required. iv. A deposit guarantee scheme will be established as part of the new resolution framework. A panel of experts is currently conducting a research project to finalise detailed proposals on the design features of the scheme. v. The South African Reserve Bank, as the Resolution Authority, should have the ability to share information with other regulators and enter into agreements to facilitate the execution of an orderly group-wide resolution strategy. vi. The Special Resolution Bill should provide for pre-resolution powers which should be available to the Resolution Authority in order to facilitate ongoing resolution planning, the operation of the deposit guarantee scheme, and cross-border cooperation. In addition, the powers needed in a resolution process are also needed to implement the resolution strategy. The powers proposed in the paper should be available to all institutions but may not be equally appropriate to all institutions in all BIS central bankers’ speeches circumstances. The powers used should be proportionate to the nature and systemic significance of the institution being resolved. vii. The point at which an institution is put into resolution (the ‘point of resolution’ or POR) will be triggered if the institution is no longer able to meet its minimum prudential requirements or is judged to be no longer viable, if recovery options have become depleted or ineffective, and if no private-sector solution seems likely or feasible. These criteria are applicable to all financial institutions, not only to banks. viii. The paper proposes a number of new stabilisation powers, namely the ability to establish a bridge institution, to transfer assets and liabilities, and to ‘bail in’ within resolution (the so-called ‘statutory bail-in’). The paper also proposes a creditor hierarchy for financial institutions that will facilitate bail-in in a way that no creditor or investor will be worse off in resolution than they would have been in liquidation. Bailin is the tool available to the Resolution Authority to recapitalise a failed institution or a bridge institution, and to allocate losses to shareholders, creditors and investors outside of liquidation. Bail-in can contribute to greater market discipline and better pricing for risk, provided that the conditions for and the hierarchy of the instruments that are potentially subject to the bail-in are fair, transparent and well understood. Conclusion I trust that you will find this workshop interesting and useful to understand what we are aiming to achieve with a strengthened resolution framework. We depend on your valuable input on the proposals presented in the discussion paper to ensure that we design a framework that will serve our financial system better into the future. I foresee likely changes to the policy proposals once we have processed all the comments and inputs. We look forward to receiving your honest and constructive opinions to help us achieve the best possible outcome. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the AHI conference on "The role of business in local government and local economic development", organised by the George Business Chamber, George, 9 October 2015.
François Groepe: The role of small business in the economy Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the AHI conference on “The role of business in local government and local economic development”, organised by the George Business Chamber, George, 9 October 2015. * * * Introduction It is an honour and a great pleasure for me to speak at the AHI conference, not least since I firmly believe that small business plays a critical role in a thriving economy. When viewed through an evolutionary lens, small business can make two indispensable contributions to an economy. Firstly, it is an integral part in the renewal process that pervades and defines a market economy as it plays a crucial role in innovation that supports technological change and productivity growth. In the second instance, small business is an essential conduit whereby millions of people enter the economic and social mainstream of a society, and is particularly adapt at creating opportunities for women, immigrants and minority groups.1 The domestic and global economy Current economic conditions and trends to a large extent shape the environment within which business has to function. Allow me therefore to highlight a number of key developments that have a bearing on our business environment. Ever since the onset of the global financial crisis and the failure of Lehman Brothers in September 2008, the world economy has been struggling to regain robust growth momentum. Advanced economies have generally recorded subdued performance, with activity in the euro area and Japan particularly sluggish. This disappointing state of affairs has continued notwithstanding expansionary monetary and fiscal policies. Ultra-stimulatory monetary policies, with policy interest rates close to zero, have been sustained in the United States, the United Kingdom, the euro area and Japan for more than half a decade. Financial markets are awaiting the first upward movement in the US policy rate with bated breath and which is likely to be within the next six months. Growth in developing economies has been stronger than in advanced economies, as may be expected. China in particular has played an important role to ameliorate the slowdown in the advanced economies’ growth rate in the aftermath of the global financial crisis, and with its high propensity to invest in commodity-intensive capital projects has lent strong support to commodity markets. Recently, however, economic growth in China has started to decelerate while at the same time the composition of domestic expenditure has begun to shift from commodity-intensive investment to less commodity-intensive consumption. This structural shift has acted as a drag on commodity prices. The South African Reserve Bank estimates that the price of a basket of South African export commodities like gold, platinum and coal has declined by 20 per cent in US dollar terms over the past 12 months to September 2015. South Africa’s economic growth has disappointed in recent years. In 2014, real gross domestic product (or GDP) growth registered 1,5 per cent and the latest projections estimate that real GDP growth in 2015 will also be around 1,5 per cent. This falls short of the estimated population growth of 1,6 per cent, The slow growth outcomes have been registered despite expansionary monetary and fiscal policies, and mainly relate to a number of structural impediments in the Zoltan, J. (ed.) 1999. “Chapter 1: The new American revolution”. In Are small firms important? Their role and impact. New York: Springer Science + Business Media. BIS central bankers’ speeches South African economy, such as the electricity constraints; the small pool of skilled labour and certain infrastructure bottlenecks. Several sectors experienced contractions in output volumes in the second quarter of 2015. In the case of agriculture, this was the result of drought which reduced the size of the maize crop by about 30 per cent from that of the previous year. The electricity sector suffered from a lack of capacity as unplanned maintenance disrupted supply, resulting in numerous instances of load-shedding. This in turn contributed to a reduction in manufacturing and mining output, exacerbating the impact of already lustreless domestic and global demand. As could be expected in an environment of slow growth, employment creation has also been weak recently. For instance, underlying employment in the formal sectors of the economy has declined by 0,3 per cent over the year to the second quarter of 2015, taking out the distortion arising from the election-related 130 000 temporary government employees added to the second-quarter 2014 base level of employment. Employment declines have been concentrated in the goods-producing part of the economy while services employment has been more stable. Overall, unemployment remains elevated at around 25 per cent of the workforce. The international price of oil have more than halved since mid-2014 causing inflation outcomes in South Africa to have been favourably affected, with the most recent reading of the consumer price inflation rate, at 4,6 per cent, quite close to the midpoint of the 3–6 per cent inflation target range. However, due to base effects, 12-month inflation is expected to pick up notably in the coming months and to exceed 6 per cent in 2016. This does not leave much room for complacency in monetary policy as prices are known to be sticky and inflation expectations remain stubbornly entrenched around the upper end of the inflation target range. The South African Reserve Bank continues to be in a tightening cycle and has raised the repurchase rate by a cumulative one percentage point since early 2014 to its current level of 6 per cent. Despite this tightening, monetary policy remains broadly accommodating, with the real repurchase rate remaining close to 0 per cent. The public sector has, over the past six years, stepped up its capital expenditure to alleviate the bottlenecks in the economy – a welcome development. South African households have simultaneously raised their consumption expenditure. Both capital and consumption spending have a high import content, directly or indirectly, with the result that imports have been elevated. At the same time, exports were held back by certain structural impediments, as well as by deteriorating export prices. Accordingly, the deficit on the current account of the balance of payments has exceeded 5 per cent of GDP since 2012. These large deficits reflected a considerable depreciation in the real (i.e. inflation-adjusted) effective exchange rate of the rand since mid-2011, when the rand traded at less than R8 to the US dollar. However, the deficits have continued to be financed by savings from abroad as non-residents continue to invest in South African assets. Only more recently, in the second quarter of 2015, has the deficit on the current account narrowed to 3,1 per cent of GDP – an improvement due to a number of factors, which include a reduction in industrial action, additional exports met by drawing down inventories, the lower oil price, and the impact of the sustained lower exchange value of the rand. In the banking sector, conditions have remained stable, with the banks adequately capitalised. Overall credit extension growth in the banking sector remains slow, consistent with the state of the economy. Loans to businesses are growing at a moderate double-digit rate, with brisk increases in lending to firms engaged in green energy projects. Loans to the household sector are also growing, albeit at a low single-digit pace, with microlending activity particularly weak. Following a long period of negligible growth, the pace of increase in mortgage credit has started to firm in recent months. With global interest rates still relatively low, share prices continued to rally. On the JSE, share prices reached record highs in the second quarter of 2015 but have subsequently receded as growth projections for China weakened which in turn contributed to the Chinese share market correcting from the exuberant levels previously reached. Further contributing factors included BIS central bankers’ speeches softer commodity prices and expectations of an imminent increase in US interest rates. Despite the downward correction, South African price-earnings ratios still seem to be on the demanding side when compared to historical trends. South African house prices have continued to rise over the past year, but at a subdued single-digit rate. Ever since the onset of the global financial crisis, South Africa’s public finances have been growth-supportive. Caution about the upward trend in government debt has prompted authorities to adopt a programme of gradual reduction in the deficit, both through capping expenditure and through raising additional revenue. This has been somewhat complicated by the weakening in international commodity prices and the subdued domestic and global economy, resulting in downward pressure on tax collections and the extension of the original fiscal consolidation timeframe. Small business in the economy “Small business” is difficult to define. In South Africa’s National Small Business Act, passed in 1996, the definitions provide for “micro enterprises” to have fewer than 5 employees, “very small businesses” to have 6 to 20, “small businesses” to have 21 to 50, and “medium businesses” to have fewer than 200 employees.2 Government has recently raised the status of its small business initiatives with the creation, in 2014, of a department dedicated to this cause: the Department of Small Business Development, under the political leadership of Minister Lindiwe Zulu, with an annual budget of approximately R1 billion. Previously, programmes dealing with small business development fell under the Department of Trade and Industry and the Economic Development Department. Estimates of the contribution of small, medium and micro enterprises (SMMEs) to the economy vary. In terms of contribution to GDP, an estimate of 52 to 57 per cent has been quoted by the Deputy Minister of Trade and Industry, Elizabeth Thabethe, who put the number of SMMEs in South Africa at 2,8 million and their contribution to employment at 60 per cent. Moreover, looking ahead, the National Development Plan projects that, by 2030, no less than 90 per cent of new jobs will be created in small and expanding firms. Small business, furthermore forms part of the backbone of a thriving society. In order to survive, it has little choice but to be versatile, innovative and entrepreneurial as SMMEs seldom have a monopoly. Hence, SMMEs are often subjected to fierce competition with scant opportunities to extract rents. This, by necessity brings out the best in them. Innovation Innovation is not the exclusive domain of small business as many forms and kinds of innovation require economies of scale, large investments in research and development, and the ability to bear out long periods to gestation and regulatory approval. But there are numerous examples of small businesses that have sufficient talent to produce significant and bankable innovations. Being nimble, lean and hungry supports executional excellence, as is borne out by the garage innovators of Silicon Valley and the swimming-pool equipment innovators of South Africa. South Africa, however does have some way to go on the innovation front. The IMD3 World Competitiveness Yearbook 2015, for instance, shows that South Africans register very few patents. With the 2 211 patent applications filed by South Africans in 2013, the country comes out at number 49 out of 61 countries in the “patent applications per capita” category of competitiveness measurement. Total expenditure on research and development at 0,73 per This is a rough approximation because the National Small Business Act in fact provides for different numbers depending on the industry, and also introduces turnover and total asset value criteria. Institute for Management Development. BIS central bankers’ speeches cent of GDP puts South Africa at number 46 out of the 61 countries ranked by the IMD, with Israel topping the list with 4,2 per cent of GDP. South Africa also lags on the number of computers per capita criterion – at 195 computers per 1 000 people, it occupies place number 53 out of 61, with the US leading the way at a ratio of 1 111 per 1 000 people. Incidentally, on the overall competitiveness scoreboard, the IMD ranks South Africa 53rd out of the 61 countries ranked. Of the BRICS countries, only Brazil, at number 56, is below South Africa. The US, China and Singapore occupy the first three places. Entrepreneurship Significant changes in relative prices signal great entrepreneurial opportunities. An example is the sharp reduction in the relative prices of information technology as well as communication goods and services, the huge opportunities which they created, and the impressive way in which entrepreneurs – worldwide – have responded to these opportunities. In South Africa too, our IT entrepreneurs continue to scale new heights. An opportunity which is worthwhile bearing in mind relates to the big changes in the exchange rate of the rand, i.e. the relative price of producing goods and services locally rather than elsewhere. A domestic wine exporter selling a bottle of wine for US$5 would have pocketed R37 five years ago; today they would realise R69. The entrepreneurial response – expanding exports and substituting imports – is probably initially muted due to what the academic literature attributes to lags in both consumers’ and producers’ responses and imperfect competition. Given the state of the world economy, the probability of a strong recovery in the international prices of South African export commodities in the near term seems low, which should assist the real exchange rate of the rand to remain relatively competitive. In addition, entrepreneurs can use hedging strategies to lock in the advantages of a certain set of relative prices for lengthy periods; for example, in South Africa there is an active market for forward cover in foreign exchange, with outright forward transactions against the rand fluctuating at around US$1,7 billion and swap transactions at around US$13 billion per day. I am therefore confident that the adjustment towards external balance will gain further momentum and it is supported by the fact that export volumes have risen more briskly than the pace of global growth in the first half of 2015. To incubate entrepreneurship, South Africa needs bold improvements in the education and school system. Interestingly enough, South Africa’s total public expenditure on education as a percentage of GDP, at 7,0 per cent, puts the country in the third-highest position among the 61 countries ranked, with only Denmark and Iceland above it. However, the amount spent per capita gives a dramatically different result, pushing South Africa down to the 42nd position on the IMD ranking. Education outcomes in South Africa do however show room for further improvements in support of enhancing the small business sector as well as in the interest of long-term economic growth and developments. The role of the South African Reserve Bank (the “Bank”) The Bank is responsible for monetary policy in South Africa. It has been given the task of protecting the purchasing power of our money in the interest of balanced and sustainable economic growth and development. Apart from ensuring price stability, it also plays a key role in maintaining an environment of financial stability. Since 2000 the task of protecting the purchasing power of our money has been given clearer definition, with government adopting an inflation-targeting framework. The target has been set at 3 to 6 per cent, and the Bank has instrument independence to do what is necessary with its repurchase rate to ensure that inflation remains inside the target band. In doing so, the Bank is mindful of the lag between changes in the repurchase rate and inflation, and of the need to avoid unnecessary volatility in output. BIS central bankers’ speeches Since 2002, when the inflation target became effective, the targeted rate of consumer price inflation has averaged 6,1 per cent to date. In the preceding two decades, consumer price inflation averaged 12,3 per cent. Furthermore, the more gradualist approach facilitated by the adoption of flexible inflation targeting can be inferred from the range within which the banks’ prime lending rate fluctuated over the respective periods. Under inflation targeting, the prime rate has ranged between 8,5 and 17 per cent per annum. In the two decades prior to that, it ranged between 9,5 and 25,5 per cent. Small businesses often lack the financial reserves and facilities of the large business sector. Accordingly, large swings in interest rates and inflation can be far more crippling to the SMME sector. It follows that keeping inflation low and stable, and therefore being in a position to prevent sharp swings in interest rates, is the contribution that the Bank can make to the financial health of the country and of SMMEs in particular. This is complemented by the role of the Bank in making sure that the financial system is safe and sound, while allowing for the orderly entry and exit of financial institutions. Conclusion In conclusion, let me firstly emphasise that the current environment is testing for small businesses. With agricultural output and mineral commodity prices down, the spending power arising from agriculture and mining-based communities and enterprises is under considerable downward pressure. This also triggers various multipliers and accelerators in the economy, working in reverse gear and extending the pain to other sectors, capital expenditure and the like. Secondly, every opportunity should be grasped and, as indicated above, the depreciated external value of the rand may be one such opportunity, bringing about more attractive relative prices of exports and import-substituting goods and services. Agile businesses that can respond appropriately stand to benefit. Thirdly, to grow the number of small businesses in the country the education system has an important role to play by raising the level of skills among the workforce and empowering potential entrepreneurs to realise that potential. Finally, the growth and indeed the flourishing of small business is key to our future. The South African Reserve Bank is conscious of its enabling role as the provider of a stable platform for price and financial stability in this regard. With its commitment to well-contained inflation that feeds into less volatility in interest rates and maintaining an environment of stability in the financial system, the Bank hopes to provide small business with at least one less thing to worry about. References Zoltan J. (ed) 1999. Chapter 1: “The New American Revolution” in Are Small Firms Important? Their Role and Impact. Springer Science + Business Media, New York. Institute for Management Development. 2015. IMD World Competitiveness Yearbook 2015. Institute for Management Development, Lausanne, Switzerland. Maye, M. 2014. Small Business in South Africa: What the Department of Small Business Development Can Do to Stimulate Growth. Southern African Catholic Bishops’ Conference Parliamentary Liaison Office. Occasional Paper 35. Cape Town. September 2014. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the New York Investment Conference, New York City, 5 October 2015.
Lesetja Kganyago: South Africa’s robust macroeconomic framework Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the New York Investment Conference, New York City, 5 October 2015. * * * South Africa has sailed a considerable distance over the past two decades. Perhaps the most critical macroeconomic markers over that distance were the efforts made in the late 1990s to establish fiscal credibility, the adoption of an inflation-targeting monetary framework, and the adjustment to a market-determined exchange rate. My good friend and colleague, the Minister of Finance, Nhlanhla Nene will address the first. All three of these fundamental macroeconomic policy achievements are essential to understanding where we are now. And they are critical to thinking through why our policy stance and institutions will continue to support the economy through the adjustment needed in the face of major global forces beyond our control. I would like to discuss the latter two achievements – monetary policy and currency flexibility – for these are central to the remit of the South African Reserve Bank but also because they are essential to keeping our particular ship afloat in present times. For South Africa, the policy adjustment in response to the Asian, Argentinian and Russian crises of 1998–2001 marked a clear break from the past. We effectively gave up on the idea that a good way to support the economy was to closely manage the currency in an effort to hit multiple goals. Perhaps the most difficult part of this shift in thinking was the recognition that efforts to manage the currency really did impose major costs on the domestic economy. It was the acceptance of the Mundell trinity in the context of an ever more volatile global financial environment and awareness of massive built-up liabilities. The outcome of this new thinking was the construction of a system which is sensitive to the dangers while welcoming the opportunities of global capital mobility. I believe they make us more resilient in the face of shocks, dramatically lowering the chances of a crisis. Moreover, they complement the diversity of the South African economy; currency adjustment in response to bad weather facilitates the moderation of imbalances in a way that encourages economic growth. It is not the growth we saw prior to the crisis – pumped up by high commodity prices, too rapid credit extension and excessive consumption. It is more patient growth, harder won, built on productivity growth and a greater focus on non-traditional (commodity) exports. And while a range of other emerging markets has adopted similar approaches to these common problems, the quality and credibility of our approach sets us apart. In the wake of the Asian crisis In developing robust macroeconomic structures, the crucial adaptation for South Africa was the shift to floating exchange rates. When we embarked on the era of policy reform and economic renewal in the 1990s, you could argue that the choices were difficult. You couldn’t fix exchange rates, but unfixing them could be disastrous. As Paul Krugman wrote at the time, and I quote: Nobody who looks at the terrible experiences of Mexico in 1995 or Thailand in 1997 can remain a cheerful advocate of exchange-rate flexibility. It seems that there is a double standard on these things: when a Western country lets its currency drop, the market in effect says “Good, that’s over” and money flows in. But when a BIS central bankers’ speeches Mexico or a Thailand does the same, the market in effect says “Oh my God, they have no credibility” and launches a massive speculative attack.1 One of the accomplishments of emerging-market macroeconomic policy after 1998 has been burying that double standard. Emerging markets can build their own credibility, and this was best seen by the steady rise in capital flows into these countries through the 2000s and the expansion of investment analyst capacity to understand them better. For South Africa, the period of integration with the world economy in the 1990s coincided with a steady fall in the price of major commodity exports. The rand was overvalued and needed to adjust downwards. It trended steadily weaker over the following decade, with periods of overshooting in 1996 and 1998. The South African Reserve Bank attempted to support the currency and failed. In the process, a large net open forward position in US dollars was created. This liability carried the potential for severe economic outcomes in the event of ongoing depreciation and meant that it had to go, but preferably as part of a new monetary framework. Inflation targeting, with its clearer policy anchor, implied dismantling the system of currency support and giving up on managing the exchange rate at all. The initial test of the new framework was the sharp fall in the rand in 2001, in which intervention was avoided. The currency reached what remains an all-time low, in real terms, but then rebounded. Critical to this was the recognition that the rand’s fall was part of a Dornbusch overshooting dynamic and that forecasts for inflation showed it moderating in the wake of the depreciation. This built credibility of the new monetary policy framework. Over the following decade, the rand shifted its trajectory away from trend depreciation. Capital flows into South Africa, which had been quite weak and uneven through the 1990s, became much stronger and steadier. Large capital flows meant large current-account deficits, of course, but these were appropriate for a country with investment needs in excess of domestic savings. The boom of the 2000s era came to an end with the global crash of 2009. The rand depreciated dramatically but then, over the next two years, recovered strongly. It was helped by stimulus in China, which boosted commodity prices, as well as by quantitative easing in the United States, which encouraged capital flows into emerging markets. These forces, however, could not be permanent. Our terms of trade peaked in 2011 and have since fallen by 8 per cent. Meanwhile, world monetary conditions began to tighten, starting with the “taper tantrum” of May 2013. In line with these developments, the rand followed a downward trend for about four years. As before, our policy was not to intervene. Maintaining a flexible exchange rate provides the economy with a number of benefits. One is the insulation from price shocks. In South Africa, as with many commodity exporters, terms of trade have deteriorated. But the impact is cushioned because production costs are denominated in rands whereas export prices are denominated in dollars. Our dollar-price index for South Africa’s commodities is down 41,0 per cent since 2011. The rand-price index has actually increased slightly, by 4,8 per cent. And the advantages are not limited to commodities. Rand depreciation makes the tradeables sector more competitive, creating the right import and export incentives – which are especially important in the context of substantial current-account deficits. In the context of a struggling global economy, it is not very surprising that our own current-account adjustment has been slow, but we do expect it to be better than previously elevated levels. A flexible exchange rate also insulates the economy from some shocks. If you don’t need to target a fast-moving variable like an exchange rate, then policy doesn’t need to react and transmit the shocks that hit the currency on to the real, domestic economy. As an illustration, Paul Krugman, Latin America’s swan song (http://web.mit.edu/krugman/www/swansong.html). BIS central bankers’ speeches let me remind you that the rand has depreciated by 16 per cent against the dollar so far this year. We have raised our policy rate by 100 basis points over an 18-month period. In 1998, before the adoption of inflation targeting, the rand also depreciated by 16 per cent and we hiked rates by 690 basis points in a period of six months. Lower pass-through from the depreciation to inflation has also helped to moderate potential policy responses. Of course, floating exchange rates are dangerous if domestic borrowers have run up large, unhedged foreign-currency debts. Where this is the case, the monetary authority may end up facing only bad choices. One is to use foreign currency to prop up the domestic currency to protect the economy, but this has clear limits and typically fails. The alternative is to step back and let sectors of the economy adjust on their own to the new currency level, implying much higher financing costs. The clear differentiator for South Africa against many other emerging markets is that this particular policy dilemma doesn’t feature in our decision-making process. Renouncing the “forward book” and allowing the “fear of floating” to wear off over time has limited the extent of foreign-currency borrowing, encouraging the development of our own capital markets and reducing a major risk for non-resident investors in rand assets.2 When a country adopts a floating exchange rate, the reasons for holding foreign reserves also change. The goal is no longer managing the value of the currency. Instead, reserves serve to bolster the national balance sheet, reassuring investors that the country has access to safe, liquid resources even in extreme situations. The use of reserves is therefore very different. The reserves provide insurance, a guarantee that markets will be able to price exchange rates. The fact that emerging markets have accumulated many more substantial reserves than they held, for instance, in the 1990s or early 2000s, suggests that markets will be able to function in more orderly ways, and that large, long-term investors will feel comfortable trading in those markets. Monetary policy The exchange-rate policy fits within the broader policy of inflation targeting. Inflation targeting provided us with a policy goal more realistic than the previous eclectic approach to policy, because we could hit it. That goal was also more meaningful for citizens, because we could focus on protecting the buying power of regular consumers in domestic markets – as opposed to, say, trying to hold down the costs of holidays in New York. These approaches to policy have served us and others well for more than a decade. But just because we replaced a bad policy with another that returned better results doesn’t mean that monetary policymaking has become easy or obvious. This is a challenging period. It is worth discussing our policy response. The most straightforward decisions for an inflation-targeting central bank are those when inflationary pressures are coming from the demand side. In these circumstances, monetary policy acts to hold growth closer to its potential level. The primary mechanism is clear: by raising the costs of borrowing and rewarding saving (which is deferred consumption), central banks moderate the level of economic activity, returning it to a non-inflationary level. However, South Africa has rarely enjoyed such straightforward conditions. Instead, inflationary pressures from the supply side have dominated. The standard accusation levelled at inflationtargeting monetary policy which responds to these shocks is that it is procyclical and therefore wrong. But I think that this charge misses the subtlety of the inflation-targeting response, with its emphasis on flexibility and the primacy of second-round effects. Take the current period as an illustration. Guillermo Calvo and Carmen Reinhart, Fear of floating (http://www.nber.org/papers/w7993.pdf), November 2000. BIS central bankers’ speeches In recent years, emerging markets have been buffeted by two kinds of shocks. The first was falling commodity prices, caused in particular, if not exclusively, by slowing and shifting growth patterns in the Chinese economy. The second was portfolio shifts, occasioned mainly by changes in US monetary policy. Both of these shocks have caused emerging-market currencies to depreciate. In South Africa, that depreciation has been marked. Since 2011, when our terms of trade peaked, the rand has fallen against the dollar and on a trade-weighted basis. This has been a persistent source of inflationary pressure in the South African economy. Literature emphasises the importance of the origin of a shock. A terms-of-trade shock is likely to reduce net exports and thus aggregate demand. This lowers the output gap – offsetting the depreciation with some disinflation. By contrast, a sustained portfolio shock has little effect on aggregate demand and provides no offset to the inflationary consequences of the currency’s fall.3 Central banks are supposed to respond to currency depreciations caused by portfolio shocks but not necessarily terms-of-trade shocks. However, as the Governor of the Central Bank of Chile, Rodrigo Vergara, recently reminded us, output gaps do not appear to explain much about the currently observed inflation, particularly in emerging markets.4 Currency depreciation, by contrast, is a clearer source of inflationary pressure. So what are emerging-market central banks to do? Our answer is to go after the so-called second-round effects, ensuring that inflation corresponds to the target over the medium term. First-round effects, either directly through the higher cost of imported goods or indirectly through those costs feeding into other goods and services, are relatively hard to control. Under flexible inflation targeting, we have some leeway to look through these shocks. But when wages and inflation expectations shift away from the inflation target, we are required to act. We are also inclined to do so pre-emptively, before expectations stray from the target, potentially requiring greater efforts to be shifted back downwards. Our tools for addressing these forces are our communications strategy and the policy rate. These instruments affect inflation in several ways. By convincing price and wage setters of our commitment to the target, we prevent them from assuming higher levels of inflation in the future and from creating a self-fulfilling prophecy. Higher rates which lower the output gap put downward pressure on inflation. It is also possible that higher rates will appreciate the currency, although, as I have said, this is not a policy goal. The extent of any policy response is proportional to the challenge. In South Africa, we have adjusted the repo rate by a cumulative 100 basis points since January 2014. In real terms, it remains close to zero, as it has since the crisis – a very low level from a historical perspective, and also quite accommodative relative to other countries. The adjustment has been smooth, without large increases or abrupt changes of direction. During this period, headline inflation has made temporary departures from the target range, but core has remained within the target range. Longer-term inflation expectations have stayed close to the top of the target, and we watch them very closely for signs of breaking away. If longer-term expectations were clustered at the midpoint of the target range, we could look beyond near-term volatility. But a small margin of safety has made this more difficult. Christopher Ragan, “The exchange rate and Canadian inflation targeting”, Bank of Canada Working Paper 2005–34 (http://people.mcgill.ca/files/christopher.ragan/ER-FinalBankofCanadaWP.pdf), November 2005. Rodrigo Vergara, Inflation dynamics in LATAM: a comparison with global trends and implications for monetary policy (https://www.kansascityfed.org/~/media/files/publicat/sympos/2015/econsymposium-vergararemarks.pdf?la=en), August 2015. BIS central bankers’ speeches We expect our gradual tightening cycle to accomplish our primary mandate: controlling inflation as defined by our inflation target while showing due concern for growth. Debt dynamics Minister Nene has already spoken about the fiscal aspects of macroeconomic policy. I now turn to aggregate debt dynamics and in particular private-sector debt. In the years before the Great Recession, South Africa’s debt-to-GDP ratio declined markedly due to robust growth and booming revenue collection. Yet, despite the space created for fiscal stimulus and accommodative macroeconomic policy settings – and very high commodity prices – growth persistently disappointed, and has slowed steadily since 2011. As the Bank for International Settlements and other observers have argued, emerging-market debt is a worrying fault line in the world economy.5 This is partly the old foreign-currency story, in which a stronger dollar and tighter monetary policy in the US render debt burdens unsustainable. It is also a debt-accumulation story, in which growth is accomplished through greater leverage. The concern is that, as the boom ends, it will become obvious that productivity growth has been stagnant and the returns on investment will be too low to service the debt incurred – widespread attempts to deleverage will then further weaken aggregate demand, setting off a vicious cycle. This dynamic can be exacerbated by the coincident slump in commodity prices. In the press, this scenario – of financial and commodity cycles moving in opposite directions simultaneously – is typically introduced with Warren Buffett’s axiom that you only discover who’s been swimming naked when the tide goes out. I am happy to tell you that South Africa is wearing a swimming suit. In fact, the peak of our financial cycle came before the Great Recession. This is something we have in common with advanced economies – although our overall debt levels are closer to emerging-market averages. Since the crisis, private-sector borrowing appetites have been broadly muted. Households have deleveraged gradually, reducing debt relative to incomes. When it comes to firms, as the International Monetary Fund has recently noted, South Africa is one of a few emerging markets where corporate debt stocks have declined since 2007.6 One lesson from this is that South Africa does not have a burgeoning private-sector debt problem which could soon be revealed as an important vulnerability. Another lesson is that episodes of rapid debt accumulation, even when they do not end in crisis, commonly give way to extended periods of weak growth. From a private-sector perspective, this is not a useful depiction of South African conditions, even if it is accurate for other emerging markets. In short, there is little impeding corporate borrowing from a balance-sheet view in the South African economy, and households have made decent progress in reducing their own debt levels. This is likely to continue in a moderate way over the next year. In the short run, there is a strong case for countries with macroeconomic space to use it in a countercyclical way, restoring growth. Many emerging markets have done this. Unfortunately, growth in emerging markets has also been slowing for five years, ever since the post-crisis rebound in 2011. Permanent stimulus is not countercyclical. One of my greatest concerns is that we let the fear of slow growth scare us into a deeply uncomfortable macroeconomic position in which monetary policy accepts stagflation. See, for instance, the Bank for International Settlements (http://www.bis.org/publ/qtrpdf/r_qt1412.pdf), December 2014, pp. 20–21. International Monetary Fund, World Economic Outlook, “Chapter 3: corporate leverage in emerging markets: a concern?” (http://www.imf.org/external/pubs/ft/gfsr/2015/02/pdf/c3.pdf), September 2015. BIS central bankers’ speeches quarterly review In South Africa, our inflation target is 3–6 per cent. We do not want to let that become a policy of 6 per cent plus whatever shocks appear. Inflation higher than that of our trading partners affects our competitiveness. It erodes incomes, especially those of the more vulnerable members of society. Over the medium term, extra inflation does nothing for growth.7 These are important lessons, too easily overlooked when the focus is on the latest data and the short run. Concluding thoughts In the past, emerging-market crises tended to centre on currency crises. Prominent examples include the Tequila Crisis of 1994, when Mexico devalued the peso, and the Asian crisis of 1997/98. Given these experiences, it is not difficult to imagine the Fed tightening, generating further volatility and creating expectations of more emerging-market crises.8 But emerging markets are in better shape than they used to be, in particular because they have flexible exchange rates. South Africa, perhaps more than other emerging markets, has developed a robust track record of enabling the currency to carry the brunt of the adjustment to global volatility. Importantly, the low level of foreign-currency liabilities helps to reduce the risk of a sudden sharp crisis and cannot act as a complicating factor in policy decisions. Currency adjustment helps the market to find its balance again but also, importantly, works in the direction of the unwinding of macroeconomic imbalances. In other words, in the current conditions of weakening commodity prices, currency adjustment works in line with fundamentals. This helps the real economy to find its own balance and rebound. Relative to other emerging economies, let alone the developed markets, our private and public debt levels remain low, a clear advantage as the global economic recovery strengthens further in coming years. In South Africa, our task is to maintain our robust macroeconomic architecture, work through the structural reforms necessary for raising potential growth, and ensure that we remain at the forefront of emerging markets. Our macroeconomic policy framework remains sensitive to the challenges of global policy normalisation and flexible enough to take advantage of the few opportunities underlying the difficult global conditions of our times. Thank you. As discussed in Andrew Haldane, How low can you go? (http://www.bankofengland.co.uk/publications/Pages/speeches/2015/840.aspx), 18 September 2015; see also Robert Shiller, Why do people dislike inflation? (http://www.nber.org/chapters/c8881.pdf), 1997. See, for instance, Nelson D. Schwartz, “Watching the Fed, and remembering the Tequila Crisis”, New York Times (http://www.nytimes.com/2015/09/19/business/economy/if-rates-rise-global-markets-fear-effects-of-anyaftershocks.html?_r=0), 18 September 2015. BIS central bankers’ speeches
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Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the STRATE, PASA and GIBS Conference, Johannesburg, 29 September 2015.
François Groepe: Game changers in financial markets – regulation, innovation and cybersecurity Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the STRATE, PASA and GIBS Conference, Johannesburg, 29 September 2015. * * * Introduction Good day, ladies and gentlemen. I would like to thank the organisers of the STRATE, PASA and GIBS Conference for inviting me to give this keynote address. I look forward to sharing my views on the developments that can be considered game changers that may affect financial markets and shall focus primarily on regulation, innovation and cybersecurity in this context. A game changer can be defined as “a newly introduced element or factor that changes an existing situation or activity in a significant way”. 1 Another way of thinking about game changers may be in terms of what the well-known Austrian-born economist, Joseph Schumpeter, called “creative destruction”. Schumpeter, writing on economic and social evolution in his work Capitalism, socialism and democracy in 1942, wrote: The opening up of new markets, foreign or domestic, and the organisational development from the craft shop to such concerns as US Steel illustrate the same process of industrial mutation – if I may use that biological term – that incessantly revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of creative destruction is the essential fact about capitalism. Inventive economists have since adopted this term to describe the disorderly manner in which the free market delivers progress. The disruptive nature of innovation is essential for both progress and prosperity, and the theory of “creative destruction” gives us some insights into understanding this phenomenon and the evolutionary changes that follow in its aftermath. Disruptive innovation brings opportunity in the form of productivity gains, for example, but it also brings challenges such as increased cyber-threats and vulnerabilities stemming from the greater degree of interconnectedness and, in the latter case, increased risks of contagion. Regulation, by necessity, has to keep pace and respond to the changing environment. Unfortunately, regulators often play catch-up due to the speed of technological change and innovation as well as their lagging ability to fully understand the technology and the risks that it may give rise to. Despite this, regulators should promote an environment that is conducive to technological change and at the very least not become a hindrance or frustrate innovation as it supports economic development and growth. In this regard, the OECD opines: One of the important lessons of the past two decades has been the pivotal role of innovation in economic development. The build-up of innovation capacities has played a central role in the growth dynamics of successful developing countries. These countries have recognised that innovation is not just about high-technology products and that innovation capacity has to be built early in the development Merriam-Webster dictionary. BIS central bankers’ speeches process in order to possess the learning capacities that will allow “catch-up” to happen … Ultimately a successful development strategy has to build extensive innovation capacities to foster growth. 2 1. Regulatory developments affecting financial markets The most recent global financial crisis has impacted negatively on the global economy and financial markets, and has revealed significant deficiencies in the policy frameworks of many countries. In an attempt to address these deficiencies, the G-20 has called for financial markets and regulation to be reformed, with the objective of making financial systems more resilient. This initiative has accelerated the rate of reform, with governments putting increasing pressure on regulatory authorities to adhere to and implement international best practice and standards. Activities offered by financial service providers in the financial system are highly interconnected, and these services are inseparably integrated into both the domestic and the international economy, which means that regulatory authorities had to take note of the way in which these markets are developing and the role they play within the broader global context. The magnitude of the financial system and regulatory reform has been unprecedented. The reforms have focused mainly on the banking, insurance and financial markets and providers of financial services, as well as on the infrastructure supporting these sectors. As regulatory frameworks develop and reforms are implemented, new aspects to financial regulation come to the fore. Previously, regulators were mainly concerned with the supervision of banks and the oversight of payment systems. Now they have to contend with a much broader universe (which includes non-bank participants in the financial markets) and consider shadow-banking, how it affects the financial system and financial stability, and how to regulate these activities. The focus, however, is no longer narrowly on prudential regulation. In this age where we are confronted with a society that is well informed and digitally connected, that proactively engages in consumer activism and that places great emphasis on values such as fairness, the spotlight shines brightly on issues such as market conduct, transparency and calls to “level the playing fields”. It is indeed so that regulation and liberalisation happen in cycles, and periods of deregulation are often followed by periods of re-regulation. Given the devastating effects of the most recent global financial crisis, the astronomical social costs resulting from it, and the perceptions around the role that financial engineering and technology alongside deficient supervision and regulation played in the run-up to the crisis, we have inevitably been catapulted into an epoch of re-regulation. Regulators and economic agents alike face a number of challenges at this point in time. These include: 1. International standards have been developed – for markets, regulators and participants – to assist with the management of risks and even behaviour. Whether they are encapsulated in the new Basel III requirements for capital or liquidity, or in the Principles for financial market infrastructures, or in the codes of conduct, these standards are introducing requirements that require adherence. Non-compliance with these standards is likely to lead to hefty penalties. There is a strong demand for participants to be accountable and responsible, and to incur liability if they are not playing by the rules. This has resulted in numerous large financial-sector firms being slapped with fines running into billions of dollars. 2. Standards are inextricably linked to the next point, which is governance arrangements and remuneration. Governance arrangements have been a focal point for some time OECD Directorate for Science Technology and Industry, 2012, Innovation for development. BIS central bankers’ speeches now, and recent events in international markets have highlighted the importance of good governance and of ethical behaviour from all stakeholders. The global financial crisis has also refocused the attention of regulators on the remuneration structures of management and other individuals participating in financial markets and systems. This, in some ways, can be related to what economist describe as the “agency problem” and which under certain conditions may result in risk-shifting. This is a key area of focus of reform in attempts to promote the soundness of the financial sector in particular, hence governance arrangements and remuneration continue to be intensely discussed at various international regulatory forums. 3. “Shadow-banking” and “new (non-bank) participants” have come into sharp focus since the global financial crisis due to their role in the run-up to the global financial crisis and in financial regulatory arbitrage. Efforts to regulate these entities will intensify. This is likely to draw criticism from certain quarters but is entirely justifiable. The reason is that shadow-banking has the potential to transform the financial environment, to open up markets, to promote financial inclusion, to reduce frictional costs, and so forth. Hence, the further development of shadow-banking should be encouraged, simultaneously mitigating any risks that these entities may pose to the financial system and ensuring that the playing fields are level. 4. Financial market infrastructures (or FMIs), resolution and cross-border issues constitute a further challenge. Central banks have traditionally fulfilled the role of lender of last resort to commercial banks. The global financial crisis has shown that central banks may need to reconsider this function and consider the role of FMIs. Financial markets are interconnected and integrated internationally, creating a further challenge for central banks as they need to consider the position and cross-border transactions of global FMIs. 5. Conduct has already been raised in terms of standards, codes and governance. As much as financial market participants must come to terms with the fact that there are now a multitude of regulators to contend with, regulators need to consider the mandates of other regulators and agree on arrangements or memorandums of understanding to work with one another to create an enabling environment for a safer financial sector. It is also vitally important that regulators do not merely regulate because that is their mandate. It is vital that the impact of regulation is properly assessed ex ante and that careful consideration is lent to the possible unintended consequences and the economic costs of unnecessary regulation or so-called “red tape”. Regulators should strive towards smart and effective regulation as opposed to simply issuing more regulations. 2. Innovation and financial markets Regulators should not inhibit innovation. However, as custodians of financial stability, central banks in particular are tasked with the safety and efficiency of financial systems, and should act appropriately to address any risks that may emerge. Electronic trading in South African bonds During 2012, the Bond Market Development Committee, under the auspices of the Financial Markets Liaison Group, embarked on an initiative to enhance liquidity in the South African bond market. The Bond Market Development Committee, chaired by National Treasury, and in consultation with the World Bank and bond market stakeholders, has made considerable progress and is currently at an advanced stage of the development of an electronic trading platform; it is envisaged that the platform will be introduced before the end of this year. BIS central bankers’ speeches The initial phase will, however, include only government bonds; it will be expanded to corporate bonds at a later stage. Initially in the electronic trading platform, primary dealers will be the only “price makers” while the rest of the market will be “price takers” but with full access to trading and pricing information. In addition to the general benefits of enhanced market transparency, credit risk management and trading, the electronic trading platform also aims to improve liquidity by expanding this platform to include other market participants complying with the requirements as market makers, in addition to the primary dealers. Competition among market makers is paramount to supporting liquidity at an instrument level and to minimising transaction cost. The introduction of the electronic trading platform will enable National Treasury and the South African Reserve Bank to monitor market-making activities in the secondary bond market, which could result in the enhanced monitoring of liquidity conditions. Enhancements to over-the-counter trading In response to the recommendations of the G-20 and the subsequent Principles for financial market infrastructures, the South African Central Securities Depository, known as STRATE, is in the process of addressing the lack of transparency and risk management in over-the-counter (or OTC) instruments. To address these concerns, the Financial Markets Act was promulgated and regulation was passed to include the clearing through a central counter party and to record all the financial transactions of OTC derivatives contracts in a Trade Repository. Collateral optimisation In collateral markets, “collateral optimisation” has become a key objective. Not only do banks invest in systems that optimise the way in which their collateral can be utilised, but vendors and central securities depositories now also provide these services to their clients. These smart systems have built-in intelligence which optimises the way in which the collateral is applied and will substitute assets if required. An example is the Clearstream collateral management system, which is gaining momentum globally. The speed of transactions The need for faster services, trading, transactions and payments is stimulated by a generation demanding access and speed, accommodated by the proliferation of new technologies, growing familiarity with technology, and expectations of real-time satisfaction if not gratification – not only in financial market transactions and payments, but also in communication, services, social media and entertainment. Participants in financial markets have created systems which enable the “trawling” of financial markets to detect opportunities within markets and then to transact on these opportunities within milliseconds – also termed “high-frequency trading”. Not only do these transactions take place within seconds; the system development and innovation within financial markets makes it possible to transact from anywhere in the world 24 hours a day, seven days a week. Blockchain technology Blockchain technology, another example of the recently trending phraseology, enables the ordering (grouping) of various transactions in an inexpensive decentralised manner by making use of a number of servers. These transactions are not only limited to near-real-time payments but can also include financial market transactions and information relating to the settlement thereof. Blockchain has the ability to reduce transaction costs, as it takes away the requirement for intermediaries and is completely decentralised. BIS central bankers’ speeches Blockchain is still in its infancy and while regulators and markets are still trying to get to grips with the concept of Bitcoin, newer or more innovative technologies are already on our doorstep. 3. Cybersecurity The developments in cyberspace are a cause of concern for regulators, financial market participants, business and informed consumers. With the interconnectedness of systems and the ease of Internet access, regulators need to understand the cyber-threats that the financial system is exposed to. Nearly every week one reads about the latest victim of a cyberattack, and the targets range from banking systems through consumer information held by retailers to social media facilitators and even governments. The rapid developments in technology and the cyber-world have opened the doors to a new and uncharted frontier. Companies and countries alike are trying to get to grips with this latest threat and to find ways in which to mitigate the risk while protecting their information and reputation at the same time. Governments, central banks, financial service providers and companies are expanding their cyber-protection capabilities. This means there is a growing demand for the limited technical skills available in this environment. The focus is, however, not only on prevention. In responding to security breaches, one has to respond with agility and speed while trying to limit the damage done and importantly to ensure continuity of service. Conclusion In conclusion, I would like to revisit the idea of a “game changer”. A game changer can be the discovery of something as small as a molecule or the invention of something that transforms the way in which we communicate, like mobile telephony. The way in which one looks at game-changing innovations will alter the way in which one sees the world and will affect one’s strategies and business plans. Game changers can be perceived as opportunities or threats, and both the number and the frequency are likely to increase in the future. No country can afford to have a myopic view and narrow national focus when it considers the game changers in financial market developments. Equally, regulators cannot afford to be left behind and only react to the changes in financial markets. Regulators must work alongside all stakeholders and not only the incumbents to try to understand the disruptive innovations and the policy implications thereof. It is important to emphasise the point of incumbents, as Rajan and Zingales eloquently set out the role that incumbent coalitions play in financial system developments but also underline how such coalitions may hold back financial sector development. 3 Lastly, regulators need to be agile and forward thinkers and appreciate that their role extends beyond simply regulating. Their role is to help facilitate progress with the ultimate objective of improving the quality of peoples’ lives. Thank you. Rajan, R. and Zingales, l., 2003, ‘The great reversals: the politics of financial development in the twentieth century’, Journal of Financial Economics 69, p. 5–50. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Conference of the Industrial Development Corporation (IDC), Sandton, 19 October 2015.
Lesetja Kganyago: The global economy and South Africa’s challenges Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Conference of the Industrial Development Corporation (IDC), Sandton, 19 October 2015. * * * Good morning and thank you for the opportunity to address you at this important milestone in the history of the Industrial Development Corporation. South Africa’s industrial development was initially shaped by mining, but linkages to the rest of the economy spurred the growth of the manufacturing sector. Today, industrial development is still seen as central for economic growth and employment creation in the country. However, South Africa’s manufacturing sector is currently facing significant short-term as well as longerterm challenges. Fifteen years ago, the sector accounted for about 18 per cent of GDP, but today its share is 12,5 per cent, with the finance, real estate and business services sector now the single largest sector at almost 20 per cent. Since the global financial crisis in particular, South Africa’s global competitiveness has been deteriorating, as reflected in the country’s declining share of world trade. Longer-term constraints to industrial development include the pace of global technological change, the changing nature of global value chains, the lack of appropriate skills, logistics and infrastructural deficiencies as well as rising input costs, to name but a few. These issues will be discussed in some depth by the panels during the course of the day. My address this morning will attempt to set the scene by focusing on the current global and domestic contexts as well as the challenges that these pose to future industrial development. No discussion about competitiveness is complete without reference to the exchange rate, which is often too easily seen as either the cause of or the potential panacea for South Africa’s competitiveness woes. Given its volatile behaviour, the exchange rate is an important focus of monetary policy, and I will make some comments on this issue as well. The global economic outlook Allow me to begin with the outlook for the global economy that has not fully recovered from the global financial crisis. While emerging-market economies recovered relatively quickly from the crisis, recovery in the advanced economies has been hesitant at best. In the past four years or so, we have seen a familiar pattern: one of optimism at the beginning of the year that the global economy will improve, only for these hopes to be disappointed quite early on in the year. More recently, however, there have been convincing signs that some of the advanced economies are well on the road to recovery, particularly the United States and the United Kingdom. But even in these economies forecasts have been scaled down somewhat, particularly after the very weak first quarter in the US. Nevertheless, growth next year is expected to be in line with, or to exceed, estimated potential output growth. Labour-market developments in both economies have been favourable, with the unemployment rate falling to 5,1 per cent in the US. Nevertheless, there is still uncertainty about whether these trends will result in an increase in labour-market participation, which would cause the unemployment rate to increase. And while these economies are improving, it is unlikely that their recovery will be sufficient to take the rest of the world along with it, as the US is no longer the locomotive of global growth that it used to be. This positive prognosis is not generalised to all the advanced economies, with the euro area in particular still facing significant challenges. While there have been signs of a more sustained recovery in the region recently – particularly in countries such as Ireland, Italy and Spain – growth in the German economy has disappointed. The Greek debt crisis seems to have been averted for now, but the general view is that any re-emergence of the crisis is unlikely to have a systemic impact. The slow pace of recovery in the region is expected to result in a BIS central bankers’ speeches continuation, or even an expansion, of the monetary stimulus from the European Central Bank. The outlook for Japan also remains quite uncertain. The favourable first-quarter outcome was followed by a contraction in the second quarter, and the economy remains dependent on monetary policy support as it battles to get out of its deflationary trap on a sustainable basis. While recovery in the advanced economies remains patchy but positive overall, the lack of synchronisation in the global recovery is even more pronounced when we look at the outlook for the emerging-market economies. The post-crisis view that emerging markets would replace the advanced economies as the epicentre of global growth has been shaken, despite their important initial role in leading the global recovery. Central to the risks to the outlook has been the slowdown in China, where growth rates have declined persistently in recent years as the economy rebalances away from investment-led growth to a more consumption-led focus. The implications for much of the emerging market and the developing world have been profound, but given the increasingly important role of emerging markets in global economic prospects, the risk of spillbacks to advanced-economy growth prospects has been significant as well. There are conflicting views as to the extent of the slowdown, the ability of the Chinese authorities to counteract it, and the impact on emerging markets of a rebalancing of the Chinese economy. Despite these concerns, the latest IMF growth forecast for China, as published in the October World Economic Outlook, is unchanged since the April forecast, with growth of 6,8 per cent forecast for this year (compared with a forecast of 7,3 per cent in April last year) and 6,3 per cent for 2016. This follows growth of 7,7 per cent and 7,3 per cent in 2013 and 2014 respectively. A number of other forecasters are, however, not as optimistic. To some extent, this slowdown is to be expected, as the previous stellar rates of growth were unsustainable, particularly as the Chinese economy grows off a larger base. Furthermore, previous growth was predominantly driven by unsustainably high investment ratios in excess of 40 per cent of GDP. Previously, the government policy response to the slowdown was to stimulate investment in the industrial sector and infrastructure. Given the new focus, there is uncertainty about the nature and efficacy of possible policy responses to the current slowdown. Furthermore, if the authorities do manage to engineer a soft landing and persist with a more consumption-led path, there is a great deal of uncertainty as to what the implications of a more services sector-oriented economy would be for emerging markets and commodity prices. To date, while the measured growth slowdown appears to have been moderate, the impact on other economies has been quite strong. The main impact for South Africa and a number of other economies (not only emerging markets) has been on commodity prices. This is not new; this trend began in 2011 already, but accelerated around the middle of this year. Since the beginning of 2012, for example, platinum prices have almost halved and iron-ore prices are down by about 25 per cent. The IMF estimates that the weak commodity price outlook will subtract about 1 percentage point annually from the average growth rates of commodityexporting countries from 2015 to 2017, and in energy-exporting economies the impact is expected to be more than double this amount. These developments are reflected in the recent economic performance of Brazil and Russia, both of which are experiencing recessions, India being the only one of our BRICS partners with a strong growth outlook. Although African economies have been experiencing relatively strong growth, some downside revision has been seen in response to commodity-price developments. Apart from commodity prices, another global factor impacting on South Africa is the prospect of monetary policy tightening by the US Federal Reserve, which has had a significant impact on capital flows to emerging markets. The recovery in the US has prompted expectations of a tightening of monetary policy, and this process effectively began with the phasing out of quantitative easing during 2013. The focus then became the timing and extent of policy interest-rate increases, but successive growth disappointments, very low inflation and uncertain labour-market developments delayed the expected commencement. The everchanging views on the timing of the so-called ‘lift-off’ have contributed to the uncertainty and volatility in emerging-market exchange rates, with every data point overly scrutinised. For example, the weak US retail data, released last week following worse-than-expected payrolls BIS central bankers’ speeches data, resulted in a sharp weakening of the dollar as expectations of an interest-rate increase were moved out. That the Fed will tighten is inevitable. The question is one of timing. But the associated uncertainty has affected the financial conditions in many emerging markets, particularly those with current-account deficits. Furthermore, the start of interest-rate normalisation will not do away with uncertainty completely, as the focus will then move to the next meeting. While the Fed has signalled its intent to follow a very moderate path of interest-rate increases, the socalled ‘dots’, which represent the expectations of FOMC members of future interest-rate moves, have changed significantly from meeting to meeting, reflecting uncertainty even among policymakers. Emerging markets have therefore been facing a double negative in terms of capital flows: capital which had previously been chasing relatively higher yields and higher growth in emerging markets is now reversing, with the prospect of interest-rate increases in the US. In addition, the lower growth associated with the slowdown in China and declining terms of trade have also contributed to a reversal of capital flows towards the advanced economies. But at the same time, concern about the slowing global economy and its possible spillbacks to advanced economies has also weighed on the Fed’s decision making. Do these developments point to an impending crisis in emerging markets? Some commentators point to parallels with the Asian crisis in 1998/99. The outlook is challenging, but I would not characterise it as a crisis. Emerging markets in general are better equipped today to meet the challenges posed by terms-of-trade deterioration and capital-flow reversals. Macroeconomic frameworks are far more robust, and exchange rates are more flexible to act as a shock absorber to these changes. That is not to say that it will be without pain. Unfortunately, capital flows which could help to cushion the adjustment to deteriorating terms of trade are drying up precisely when most needed. Some adjustment will have to take place, and the exchange rate is an important part of this process. Furthermore, there are differences between emerging markets which will determine how they are affected by these developments. For example, countries with sizeable current-account deficits will have a different reaction to capital-flow reversals than those with surpluses. And while non-commodity exporters will benefit from lower commodity prices, particularly emerging markets in Asia, these economies are already experiencing a decline in their manufactured exports to China. The domestic economic outlook These developments provide a challenging backdrop for the South African economy going forward. Apart from the impact of lower commodity prices, the continued slow growth in the euro area and further risks from a slowdown in Africa constrain the growth in our manufactured exports. In addition, the persistent current-account deficit needs to be financed at a time when capital flows to emerging markets are declining. South Africa’s growth outlook is extremely fragile. Following the disappointing quarter-onquarter GDP growth outcome of 1,3 per cent in the first quarter of this year, growth surprised on the downside when a contraction of 1,3 per cent was recorded. Of concern was the fact that it was broad-based across sectors, with only the finance, real estate and business services sector showing reasonable performance, recording growth of 2,7 per cent. At the heart of this low growth is the weak growth trend in gross fixed capital formation. This is particularly true of the private sector, and reflects in part the persistently low levels of business confidence. Total gross fixed capital formation contracted by 0,4 per cent in 2014, with the private sector contracting by 3,4 per cent and public corporations increasing by a mere 1,6 per cent. In the second quarter of this year, private-sector growth was barely positive at 0,1 per cent, the same as that of public corporations. The main area where there has been some growth in private-sector investment in recent years has been with respect to renewable energy. While this is a welcome development, we need more broad-based investment. The weak BIS central bankers’ speeches public-sector investment growth reflects the slow pace of infrastructure expenditure growth, which is central to any industrial development strategy. One of the main constraints to investment is of course the uncertainty of electricity supply. This has both short- and long-term impacts. Load-shedding affects output immediately, and is reflected in the weaker current GDP growth outcomes. But of greater concern is the longerterm impact that electricity supply constraints have on potential output growth, as forwardlooking investment plans are delayed or even shelved because of the lack of guarantees of electricity supply. This constraint has contributed to the decline in our estimate of potential output growth to 1,8 per cent. Clearly, if we want a vibrant and expanding industrial sector, we need to have investment as well as an adequate and reliable supply of electricity. Unfortunately we cannot solve this overnight. The production-based sectors of the economy have been particularly weak, and face a difficult outlook. The agricultural sector is beset by drought, which resulted in a contraction of around 17 per cent in the first two quarters of this year. The mining sector contracted at an annualised rate of 6,8 per cent in the second quarter, and monthly production data indicate that the third quarter is also likely to disappoint. The manufacturing sector has also experienced two consecutive quarters of contraction, of 2,4 per cent and 6,3 per cent, and the outlook is also constrained although a further contraction is not expected in the third quarter. The Bank’s forecast for growth has recently been revised down by half a percentage point in each year of the forecast period, to 1,5 per cent in 2015 and to 1,6 per cent and 2,1 per cent in the subsequent two years. This weak outlook is consistent with the Bank’s leading indicator of economic activity, which has exhibited a more pronounced downward trend in recent months. Apart from the continued electricity supply issues, growth is expected to be constrained by weak private-sector investment and subdued growth in household consumption expenditure amid low levels of both business and consumer confidence. Competitiveness and the exchange rate One of the main themes of today’s discussions is that of competitiveness. Competitiveness has a number of different dimensions, one of which is the exchange rate, and it is perhaps appropriate for me to say a few words about this, as the exchange rate is of course also of importance from a monetary policy perspective. Between 2009 and 2011, the rand experienced a strong recovery from the global financial crisis in the wake of strong commodity-price increases and inflows of capital seeking higher yields. This created stress for parts of the manufacturing sector, in terms of both exports and import competition. Not surprisingly, the Bank came under pressure from parts of this sector to weaken the exchange rate. However, since 2011 the rand has followed a relatively volatile depreciating trend, driven by various factors, including the terms-of-trade deterioration, idiosyncratic domestic factors, bouts of global risk aversion (related in particular to the eurozone crisis) and, more recently, the partial reversal of capital flows in anticipation of higher interest rates in the advanced economies. However, the response of both the manufacturing sector and exports to the weakening exchange rate has been disappointing, although in recent months we have seen tentative signs of current-account adjustment, both through higher export volumes and through lower import volumes. The current-account-to-GDP ratio has been declining steadily for the past four quarters and measured 3,1 per cent in the second quarter of this year, from a peak of 6,2 per cent in the second quarter of last year. In the second quarter of this year, the trade account recorded its first surplus since the final quarter of 2011. Despite these more favourable developments, we expect the current-account deficit to average in excess of 4 per cent of GDP this year and the next. There are a number of reasons why we would expect a slow current-account response. First, from a competitiveness perspective, it is the real exchange rate that is of relevance: that is, the nominal exchange rate adjusted for inflation differentials (although there are debates as to BIS central bankers’ speeches what the appropriate deflator should be). Because our inflation has generally been higher than that of our trading partners, the real depreciation has been lower than that of the nominal effective exchange rate. Since July 2011, the nominal effective exchange rate has depreciated by almost 40 per cent, compared to a real depreciation of around 20 per cent. We also need to bear in mind that the real exchange rate is a very broad macroeconomic measure, but companies and sectors have different import intensities and different cost structures, so firmor sector-specific real exchange rates may differ markedly. Second, the global environment is important. Slow growth in our major trading partners will dampen our export potential as income elasticities are higher than price elasticities. As outlined earlier, our major trading partners are experiencing subdued or declining growth, consequently constraining demand for our manufactured exports. Third, intermediate goods (including fuel) and capital goods account for about 80 per cent of imports, and these are often tied to capital investment projects. This imparts a degree of rigidity to import volumes. Too often in the past was current-account compression achieved through declining investment expenditure, with adverse implications for employment and growth. Fourth, there are lags in adjustment, and manufacturers will want to be certain that the more competitive position will be sustained. Fifth, strikes and labour disputes have periodically affected exports adversely, as was the case in the platinum sector in 2014. Sixth, for commodity exporters, the exchange rate acts as a cushion for lower commodity prices but it does not necessarily provide an impetus to higher export volumes. Seventh, there is the possibility that the increased role of global value chains may have weakened the relationship between the exchange rate and trade in intermediate products used as inputs into other economies’ exports. This issue is discussed in depth in the latest IMF World Economic Outlook. Although the main finding is that the bulk of global trade is still conventional trade, this issue may be relevant in a number of sectors. This may be of particular relevance to the motor industry in South Africa. Finally, we also need to look carefully at some of our own domestic policies that have the potential to undermine our exports or to counter the favourable impact of depreciation. So how does the Bank view the exchange rate, and should we try to intervene in the interest of competitiveness? Monetary policy is concerned about the exchange rate because of its potential impact on inflation. As we have outlined in our monetary policy statements, the exchange rate remains one of the main risks to the inflation outlook despite the fact that the pass-through has been relatively muted compared with previous episodes of rand weakness. However, this does not mean that we try to act against rand weakness. Rather, our reaction to exchange-rate changes is focused on the potential inflationary impact of exchange-rate depreciation in conjunction with a range of other variables that may be concurrently affecting inflation, both positively and negatively. Similarly, we do not try to explicitly lean against rand strength, although we did take advantage of such conditions in 2009–2011 to continue with our policy of accumulating international reserves. However, the view that we prefer a strong rand to a weak rand is not well-founded. Ideally, what we would like to see is an appropriately valued stable exchange rate, one that is not a significant issue for inflation. However, that is in an ideal world. In reality, the exchange rate is buffeted by a number of fundamentals which require adjusting to; in South Africa’s case, these fundamentals include commodity-price changes and capital flows. Over time, we have learned the hard way that trying to ‘lean against the wind’ in the face of markedly changing fundamentals can be both futile and expensive, and any success in this respect is likely to be short-lived at best. That is not to say that we will never get involved, particularly in the event of liquidity drying up in the market. That said, let me be clear: no amount of central bank intervention, no matter how well intentioned, can prevent an exchangerate adjustment from aligning with fundamentals. The best contribution that the Bank can make BIS central bankers’ speeches to competitiveness is to ensure that inflation is contained to the extent possible during periods of rand weakness to ensure that the depreciation is real. It is then up to the relevant sectors to take advantage of the increase in competitiveness. Conclusion In conclusion, the domestic economy is facing a challenging future. While the global economy is a constraint, it is important that we do not focus on that only and ignore the very real domestic impediments to growth as well as the opportunities. It is too easy to sit back and bemoan the fact that we are hostage to global developments. There are things that can be done, many of which are clearly spelled out in the National Development Plan. We often hear about a focus on infrastructure, but we always seem to under-deliver in this respect. If South Africa wants to develop its industrial sector, it needs to improve its infrastructure apart from electricity. There also needs to be policy coherence and less regulatory uncertainty. If we are to succeed in reducing unemployment, we must have a growing, competitive economy. Competitiveness is not simply about the exchange rate; it is a multidimensional concept. These dimensions include the quality of goods and services produced, reliability of delivery, reliable and appropriate infrastructure, appropriate technologies, appropriate and sufficient skills, the ease of doing business, and the minimisation of red tape. Our financial sector is regarded as one of the most efficient in the world, and we have a sound legal framework. We need to build on these strengths, but we have to be proactive if we don’t want to fall further behind. These are some of the issues that will be discussed during the course of the day, and I look forward to the deliberations. 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 Economist Annual Investment Agenda Conference, Johannesburg, 20 October 2015.
Daniel Mminele: South African monetary policy amidst an uncertain and volatile global economic backdrop Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at The Economist Annual Investment Agenda Conference, Johannesburg, 20 October 2015. * * * Good morning ladies and gentlemen. Thank you to the Economist for the invitation to deliver the welcome keynote address at “The Investment Agenda Johannesburg 2015”. The first part of the title of the Investment Agenda, “No Man Is An Island”, is taken from a poem of John Donne. To quote a little further from that poem: “No man is an Island, entire of itself; every man is a piece of the Continent, a part of the main…” This expression can be related not only to our personal lives, but lends itself particularly well to the world of financial markets and economics. Each part of the economic and financial system, while separate, is driven by similar factors with many interdependencies. For example, the global financial crisis of 2008/09, started off as a crisis in the housing sector, but quickly broadened to money markets and other areas of the financial sector. In addition, the crisis was not contained but spread from the US to other advanced economies (AEs) and ultimately to emerging markets (EMs). It had serious ramifications for economic growth, employment and inflation, and ultimately elicited strong responses from both fiscal and monetary authorities. Some have argued that these responses sowed the seeds of other crises, citing the European sovereign debt crisis, and more recently, the increasing talk of a possible EM crisis on the back of a credit crunch fears as capital flows decelerate or reverse. In my remarks today, I would like to delve a little into the global economic environment, particularly as it pertains to monetary policy as a source of financial volatility and the more recent developments in China and how this is impacting on Africa. I will then conclude with a few remarks on monetary policy in South Africa against this backdrop. Global monetary policy Monetary policy has been one of the dominant topics in financial circles over the past few years. The current nuance of concern is how the conduct of monetary policy in AEs is influencing financial market developments and the spillover effects to EMs. I am sure you have been inundated with information on this topic. However, please indulge me a little since, after all, it is a source of substantial uncertainty and volatility in financial markets and is most certainly a factor of significant concern for monetary authorities, including the South African Reserve Bank (SARB). The SARB is one of 23 monetary authorities worldwide to have tightened monetary policy during the course of 2015 thus far. It is interesting to note that with the exception of Iceland, the remaining 22 countries with tighter policy stances are developing economies, for the majority of which the policy stance is intended to try and suppress inflationary pressures, particularly second round effects, rather than suppressing domestic demand per say. In fact, inadequate or subdued demand is a feature that most of these economies share at the moment. The conundrum of balancing inflation and growth concerns is nothing new to central bankers, but our nous is certainly being tested presently. However, this tightening bias is hardly a global trend as 45 other monetary authorities have in fact eased their policy stance this year. This is the first time since the onset of the financial crisis that such a divergence has existed in the global monetary policy environment. If we narrow our focus to the two largest global economies, potential policy divergence in the near future is a stark reality that policymakers will have to face. Since the inception of the BIS central bankers’ speeches ECB at the turn of the century, the policies of the ECB and the Federal Reserve have generally been complementary. Today, as the world awaits the first change in the Federal Funds Target Rate in seven years, the ECB by contrast is only in the first half of an ambitious quantitative easing program. Much has been said about these two moves and the unprecedented nature thereof, but I am not quite sure that we fully understand the exact implications of this development going forward. The SARB has mentioned in the past that whilst the timing of the first movement by the Fed is significant, the timing and magnitude of future hikes are just as important. After all, the latest “dot plots” of the FOMC suggests that participants consider the appropriate long-term nominal interest rate to be at between 3 and 4 per cent, which is a fair distance away from the current policy stance. On the other hand, there are indications that the ECB could expand its current QE program, potentially both in terms of scope and duration. This highlights the uncertainty around the current environment, where spillovers from divergent policy between the two largest global players might imply that each could pull harder in opposite directions in order to achieve the desired effect in their respective economies. This implies that potentially the policy challenge will entail larger and more unpredictable spillovers into the global real economy. Naturally this has implications for the domestic financial environment. The exchange rate of the rand against the US dollar has been mentioned time and again as a significant risk to the domestic inflation outlook with implications for the pace of domestic policy normalisation. Whilst part of the Fed’s normalisation may have been priced into the domestic currency, it isn’t at all clear by how much. Furthermore, it is important to note that the domestic policy response isn’t as simple as responding to each Fed hike, as some analysts sometimes seem to suggest. Instead the implications and spillovers of Fed rate hikes have to be viewed alongside other domestic and global factors, which have a bearing on the domestic economic outlook and the mandate of the SARB. The euro area as a region remains our largest merchandise export destination and hence, a recovery in euro area domestic demand is in our mutual interest. However, should the ECB expand its QE program – which appears increasingly likely – and in so doing, cause another round of euro depreciation, this could be to the detriment of our exporters. However, in this case the impact on the rand might actually be secondary to the financial market volatility that these spillovers might create. A week from now the FOMC will emerge from their penultimate meeting of the year and may take the decision that will end months of speculation and set the wheels of normalisation in process. A decision that may serve to heighten or reduce volatility in global markets and such a decision rather than providing certainty may merely push the focus to the timing of the next rate hike. Alternatively, the FOMC could continue in the current holding pattern and take the familiar „wait and see‟ approach that most AEs are adopting, which again may also induce more volatility. It’s almost a matter of „damned if you do, and damned if you don‟t‟. Whichever decision the Fed takes, clear communication will be vital in influencing the market impact, something that has received increasing attention in monetary policy since the financial crisis. China adds another dimension Amidst this highly uncertain monetary policy backdrop, China has added another twist. According to the IMF 1, China’s economy is expected to slow to 6.8 per cent in 2015, from 7.4 per cent last year. This slowdown is in line with the government’s target of around 7 per cent and reflects progress in addressing vulnerabilities, particularly a much needed moderation in real estate investment. This is also nothing new, as we have known for some World Economic Outlook, IMF, October 2015. BIS central bankers’ speeches time that China is slowing and that a rebalancing towards consumption-led growth and what the People’s Bank of China (PBoC) has termed the „new normal‟ is under way. What this entails is growth of around 6 to 7 per cent over the next 5 years, significantly lower than the double digit levels that we had become accustomed to. What was of note however, was the recent market correction of share prices, following a period of extraordinary growth whereby equity prices in China grew by almost 160 per cent between mid-June 2014 and 2015. The correction in the stock market resulted in an outflow of capital, exacerbated by the double devaluation of the renminbi in August. Chinese authorities undertook a number of measures to stabilise markets, including a cut in the benchmark interest rates and regulatory reserve requirements, relaxed rules on margin financing, a restriction on short-selling, pledging central bank liquidity support for the China Securities Finance Corporation and initiating a share buyback programme for state-owned enterprises. It is also speculated that the PBoC spent over US$90 billion defending the currency in August alone 2. However, the IMF and PBoC do not believe that the stock market correction will derail the ongoing adjustment to a slower yet more balanced growth path. It is generally agreed that this adjustment is preferable to relying on an unsustainable growth model of excessive credit and investment, which could lead to large vulnerabilities in the fiscal, real estate, financial, and corporate sectors. In line with the above mentioned slower growth forecasts, recent indicators such as the manufacturing PMI, point to weaker growth for the remainder of the year. As imports continue to fall faster than exports, China will likely record a large trade surplus. China’s current account surplus on the other hand, has come down from heady levels of around 10 per cent of GDP, to current levels of around 2.7 per cent of GDP. Indeed, the recent article in the Economist titled “The Great Fall of China”, asserts that this is not the hour of China’s crisis and that the financial tumult is misleading. While questions remain about true health of the Chinese economy, this sentiment of China not being in crisis was also borne out in discussions at the recent the IMF/World Bank Annual Meetings in Lima, Peru. The Asian Development Bank also noted a number of reasons to remain optimistic despite the slowing growth outlook, notably a growing services sector and resilient consumption amongst others. Deutsche Bank, in a recent article 3 notes that a “hard landing” scenario in China is not on the cards and interpret recent evidence as pointing to, at worst, a gradual decline in growth such as has been evident over the past couple of years. Deutsche Bank argues that while China’s credit/GDP ratio is rising, the inherent advantages of a current account surplus, high net foreign assets (13 per cent of GDP) and low external debt burden (about 10 Per cent of GDP) offer a significant counterweight to the risks of a crisis posed by a high credit/GDP ratio. Therefore, it is unlikely that there would be a „sudden stop‟ of international capital, such as the kind that in the past has triggered crises. In addition, it is argued that China doesn’t need to import capital to sustain credit growth, neither are banks in China likely to voluntarily suspend financing to borrowers. What does this all mean for Africa? The current low level of commodity prices has had a significant impact on some commodity exporters. If we take oil as an example, Nigeria as an oil exporter has seen a dramatic slowing in growth to 2.4 per cent in the second quarter of 2015 from 6.5 per cent a year earlier. The oil market accounts for more than 90 per cent of foreign exchange earnings and about 70 per cent of government revenues in Nigeria. The central bank has spent reserves and more recently implemented capital controls to defend the currency. It is also worth noting that the IMF has significantly revised downwards the sub-Saharan Africa growth outlook for 2016, from 5.1 per cent in July, to 4.3 per cent in the October 2015 World Economic Outlook. http://www.brookings.edu/blogs/order-from-chaos/posts/2015/09/21-chinese-currency-devaluation-dollar Global Economic Perspectives, A hard landing in China? Deutsche Bank, 5 October 2015. BIS central bankers’ speeches While China is Africa’s largest trading partner, it does not follow that because China slows, that it is all doom and gloom for Africa. We should remember that Africa’s average growth rates have exceeded 5 per cent since 2000, double the pace of the 1980s and 1990s. With the outbreak of the financial crisis in 2008, Africa remained resilient as borne out by strong growth numbers. While it is true that the boom in commodity prices during the 2000s provided a significant boost to export revenues, this was only part of Africa’s broader growth performance. There has been a steady rise in the contribution of domestic demand to gross domestic product (GDP), owing to a fast-growing middle class in many African countries. On the supply side, the rise of the services sector has been one of the defining characteristics of the structural change in African economies. Telecommunications, banking, and the retail sector have been flourishing in many countries. This has contributed to the improvement in Africa’s growth prospects, which in turn, has attracted the attention of foreign investors. The concerted efforts of policymakers to address some of the major binding growth constraints, which were previously neglected, have also played a significant role in Africa’s enhanced growth performance. In the 2015 World Bank Doing Business Report SSA was reported to have accounted for the largest number of regulatory reforms, making it easier to do business in the past year. Over the past decade Africa has increasingly been earmarked as a profitable investment destination by international investors. Foreign Direct Investment (FDI) to Africa increased from approximately US$10 billion per year in 2000 to more than US$50 billion in 2012. The institutional and political changes, coupled with the continent’s enhanced growth potential have been the main factors underpinning investor confidence in Africa. Africa is also seen as an attractive FDI destination by those multinational investor groups that are keen to benefit from the intra-Africa trade opportunities that currently exist. In addition, other investors that already have operations in Africa are looking to expand their footprint on the continent, to ensure that they are well positioned to benefit from the favourable growth prospects that prevail in many countries. It is also worth noting that intra-continent FDI has been growing at a healthy pace. In fact, the share of African countries in total FDI in the continent more than doubled between 2003 and 2012; whereas in 2003 some 8 per cent of FDI into African countries came from other African countries, by 2012 this share had risen to 18 per cent. Thus, given the aforementioned successes and progress made in Africa, particularly on the investment front, there should not be an overly negative impact on Africa as a result of these global developments. However, given the increasing concern around tightening financial conditions on account of the global developments that I discussed earlier, it is incumbent upon us on the continent to work harder to counter persistent misconceptions and investor scepticism when it comes to investing in Africa, especially in infrastructure. We need to market project opportunities better and leverage off initiatives such as the World Bank’s Global Infrastructure Facility. To quote the 2015 Ernst & Young attractiveness survey: “We remain confident that, despite economic headwinds, the „Africa rising‟ narrative remains intact and sustainable.” Some challenges to monetary policy formulation in South Africa So where does the SARB stand amidst this complicated global backdrop? Monetary policy in South Africa is being conducted against the background of a global economy experiencing a deceleration of growth, a rotation from AE to Ems as drivers of growth, a transition in China to a new growth model, and amid uncertainty over the timing and scale of US interest rate hikes, and increased volatility in financial markets. Like many other emerging market central banks, monetary policy in South Africa has also faced the dilemma of sharply slowing growth and rising inflation. The domestic growth outlook has deteriorated significantly, as reflected by the SARB‟s downward revisions. At the beginning of the year growth for 2015 was revised lower from 2.5 per cent to 2.2 per cent, BIS central bankers’ speeches and more recently to 1.5 per cent. In its October 2015 WEO, the IMF downgraded South Africa’s growth forecast for 2015 to 1.4 per cent, a downward revision of 0.6 percentage points from its previous forecast. The IMF forecast for 2016 was revised downwards by 0.8 percentage point to 1.3 per cent. South Africa’s second quarter economic performance reflected a contraction in growth, with the weakest performances recorded in the primary and secondary sectors of the economy, although the tertiary sector also witnessed a slight moderation. Consumer demand is weak and the outlook is one of a constrained consumer given a backdrop of slow employment growth, declining disposable income growth and rising inflation. Confidence indicators for business have also deteriorated. Growth will remain constrained by global developments as well as low confidence levels and domestic bottlenecks such as limited electricity supply. On the upside, South Africa’s wide current account deficit of the past few years has narrowed for four consecutive quarters. This can, in part be attributed to temporary factors, but there is also some indication that both import and export volumes are responding to the depreciation of the rand and the weaker economy. How global headwinds, including China’s slowdown may alter this outlook, remains to be seen. As you know, the SARB targets inflation within a flexible framework, which allows for temporary breaches of the target being tolerated under certain circumstances. The inflation forecast has been somewhat erratic, impacted by the combination of a weaker exchange rate on the one, hand and falling oil prices on the other. However, the rand exchange rate remains the one of the biggest upside risks to the inflation outlook. The ZAR has fluctuated in a range of between R11.30 and just over R14,00 against the US dollar since the beginning of the year, depreciating to a historic low of R14.16 against the US dollar, but more recently we have seen some correction. On a year-to-date basis, the rand is almost 12 per cent weaker against the US dollar. This is in the mid-range of other EMs currencies, some of which have depreciated by over 30 per cent (such as Brazilian real) and others by around 3 per cent (such as the Indian rupee). The most recent inflation forecasts point to an average inflation rate of 4.7 per cent in 2015. Temporary breaches of the target are expected in the first quarter, and again in the final quarter of 2016. Much of this is due to base effects. For 2017, inflation shows a slow downward trend. The SARB Monetary Policy Committee (MPC) remains on a gradual normalisation path and is of the view that monetary policy remains accommodative. The MPC has to achieve a fine balance between realising its core objective, and not unduly undermining growth in the shortterm. While we have raised the policy rate in July 2015 by 25 basis points, bringing the cumulative increase in the policy rate since the first upward move in January 2014 to 100 basis points, in real terms monetary policy remains accommodative as pointed out in our recent MPC statement, released in September 2015. The current environment requires policy makers to remain vigilant and to carefully analyse incoming data, and not hesitate to act if the risks of a more persistent breach in the inflation target materialise and inflation expectations become unanchored, thus posing a threat to inflation outcomes over the medium term. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Bureau for Economic Research, Cape Town, 22 October 2015.
Lesetja Kganyago: South Africa’s growth performance and monetary policy Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Bureau for Economic Research, Cape Town, 22 October 2015. * * * Introduction Thank you for inviting me to address you today. South Africa’s growth rate has been declining persistently since the post-crisis rebound of 2011. The Bank’s 2015 forecast has GDP growth at 1,5 per cent, the lowest level since 2009. We expect next year to be only slightly better, at 1,6 per cent. These narrowly positive growth numbers are disappointing, not least because they fall well below the 5,4 per cent growth described in the National Development Plan as the rate necessary for meaningful progress against unemployment and poverty. I would like to talk to you today about this low growth problem – and about the role of monetary policy. Boom and bust, recovery and relapse It is perhaps worth reminding ourselves how we arrived at the present circumstances. The current post-crisis era of low growth was preceded by a large boom. The South African economy expanded continuously from the end of 1998 to the middle of 2008, its output increasing by almost half. Real GDP, on a per capita basis, grew from R44 000 to R54 000. 1 This partly reflected marked structural improvements in the country: a much better fiscal situation, a switch to inflation targeting, and South Africa opening to world trade and financial flows. But, in the mid- to late-2000s, these structural improvements coincided with powerful cyclical forces. Soaring terms of trade and robust borrowing sent growth levels to well above potential, understood as the rate of expansion which does not accelerate inflation. The economy overheated as prices for labour and capital resources were bid up and export prices increased continuously. Moreover, sustained growth in house prices revealed an asset price bubble which had developed in response to low credit costs. The domestic economy was on an unsustainable trajectory. Rising global food and oil prices – pushed upward as part of the commodity price bubble – added to domestic inflation and prompted greater efforts to slow the pace of fiscal spending growth and a tightening monetary policy stance. 2 This acted on credit extension and started to slow lending. It was in these slowing conditions that the Great Recession hit in 2008, following the bankruptcy of the Lehman Brothers. This was an exogenous shock; it was not obvious that it had much to do with South Africa, but it had a major impact on how we have had to reconsider the potential growth rate of the economy. What was our potential growth given the scale of the pre-crisis commodity and house price boom and the post-crisis collapse in global trade? What has been the impact of our electricity constraint? The search for our own ‘new normal’ has been an increasingly difficult problem for policymakers in recent years and will continue for some time as the economy continues to adjust to the series of shocks that have hit over the past decade. In 2010 rands. The National Credit Act also came into force at this time. BIS central bankers’ speeches When the crash hit, South Africa had the leeway to conduct countercyclical policy. National Treasury had fiscal space to keep aggregate demand up as foreign demand evaporated, running significant budget deficits. 3 The initial impact on public debt levels was low as a result of the small fiscal surpluses in the last years of the boom. 4 Monetary policy could also be loosened as inflation was receding rapidly: declining from nearly 9 per cent in 2007 and 2008 to 6 per cent by the end of 2009 and 3,5 per cent by the end of 2010. Vigorous stimulus measures helped output rebound in 2010 and 2011, with growth rates reaching around 3 per cent. Other emerging markets enjoyed similar vigour, and often more. China’s growth was in double digits for both years. Brazil was close to 8 per cent in 2010, Russia over 4 per cent. The financial press was filled with speculation of decoupling: the idea that emerging markets could grow by themselves even if developed economies were in crisis. The vision was attractive but misleading. Emerging markets were actually on the verge of a slowdown. Within a few years, China’s growth would be under 7 per cent, and Brazil and Russia would be in recession. From this perspective, 2011 looked like the last year of the boom. But it did not seem that in real time. In South Africa, with potential growth estimated at 4 per cent, the economy seemed to be operating below its normal level even with growth over 3 per cent. The problem got worse from 2012 as growth fell further from this goal. The output gap – the accumulated distance between potential and actual growth – kept growing. Inflation was similarly uncooperative. We experienced breaches of the inflation target around the end of 2011 and the start of 2012, and again in mid-2013. The case for looking through these breaches was compelling. Each of them could be traced to specific supply shocks, from food or administered prices. The departures from the target were temporary. Core inflation remained within the target range. Inflation expectations were elevated but highly dispersed and reasonably stable. For a flexible-inflation-targeting central bank facing persistently sub-par growth, there was a robust case against responding to these price developments. But that did not make the choice free. The policy had costs. And the benefits disappointed. One of these costs was shifting to a much higher level of core inflation. When headline inflation first exceeded 6 per cent, the top end of the target range, towards the end of 2011, core inflation was at 3,9 per cent. 5 From that point, it tracked steadily upwards to a peak of 5,8 per cent in late 2014. It did so in line with repeated, if temporary, deviations of headline inflation from the target range. Headline inflation averaged 5,8 per cent between 2012 and 2014. In these circumstances, it is unsurprising that other, less volatile prices adjusted to that level. 6 Another cost was the consolidation of inflation expectations around the very top of the target range. As I have already mentioned, average expectations have been fairly stable around the top of the target range for several years now. But focusing on a simple average conceals useful information. Medium-term expectations have converged strongly over the past four years, revealing something near a consensus that South African inflation will be around 6 per cent over the longer term. This is not because of shocks, which cannot be foreseen with any clarity several years out. This is because the 6 per cent is perceived as the normal level. What of the benefits? The goal of cutting rates to historically low levels was to close the output gap as inflation was easing. Growth did not accelerate; it slowed persistently: from just over 3 per cent in 2010 and 2011 to slightly over 2 per cent in 2012 and 2013, and a mere 1,5 per cent in 2014. Very low The consolidated government balance, as a percentage of GDP, moved from a surplus of 1 per cent in 2007/08 to a deficit of 3,9 per cent in 2014/15. Over the period, total gross loan debt as a percentage of GDP rose from 26,6 per cent in 2007/08 to 46,2 per cent in 2014/15. Core inflation is defined here as headline minus food, non-alcoholic beverages and energy costs, including petrol. For example, services inflation has averaged 6 per cent since the beginning of 2012. BIS central bankers’ speeches interest rates did not encourage rapid credit uptake in the private sector. Households were overextended from the pre-crisis boom. They benefited from lower borrowing costs, which facilitated debt repayment and permitted some income to be directed to spending. But they did not show much appetite for new debt, except in some relatively small sectors of the overall household credit market. 7 Corporate finances have been in better shape than households’, but businesses also responded unenthusiastically to very low rates. Private sector investment has been weak. 8 In fact, the strongest movements in credit to corporates have occurred over the past two years, during which we have gradually raised rates. Meanwhile, the output gap did narrow – but not because growth had picked up. Rather, it was because potential growth had slipped lower. And the inaccuracy of our output gap estimates did not come as a surprise. It is a well-established fact that output gaps are very difficult to estimate, especially in real time. The phenomenon itself is unobserved. There is no single, agreed method for its determination, and competing methods yield varying results. So policymakers do not accept output gap estimates uncritically. In real time, we thought in late 2013 that the output gap may have widened to as much as -3,5 per cent. Since then, we have repeatedly re-estimated the gap. Our latest measures suggest that the gap may have been closer to –0,5 per cent at that time in late 2013. An intensifying slowdown This background matters as we contemplate the accumulating evidence of a further growth slowdown, both in the world economy and domestically. In China, there are new fears of worsening growth. Of course, we have known for some time that China had to slow from double-digit growth rates. We have also known that it was unlikely to need continually expanding quantities of commodities, particularly industrial commodities such as coal, iron and copper. What we have not known is whether this slowdown would be abrupt or gentle. Market assessments have recently shifted, to some extent, away from the benign, gradual scenario. Commodity prices have tumbled as a result; the Bloomberg commodity index fell to levels last seen during the Great Recession in 2008. There were two triggers for this shift. One was the inflation and subsequent collapse of the Shanghai stock exchange bubble. The second was a devaluation of the renminbi. Exactly what these events mean for China’s growth trajectory remains unclear. The IMF’s forecasts have not changed from the April to the October edition of the World Economic Outlook: 6,8 per cent for 2015 and 6,3 per cent for 2016. Bloomberg consensus forecasts have finally edged down, in the third quarter of the year, with the median for 2015 now at 6,8 per cent and for 2016 now at 6,5 per cent. That median, however, was constant throughout the period of market turmoil, suggesting that markets remain unsure of the GDP data. It is often argued that forecasts for China’s economic growth remain anchored at too high a level. The debate is very active. It is even possible that the data are understating growth by undercounting the services sector and overemphasising the industrial sector, which is plagued by overcapacity. All we really know is that uncertainty over China’s prospects spiked in the second half of this year. Along with falling commodity prices, this has fuelled speculation about a possible third chapter to the world economic crisis, with emerging markets taking their turn after the US and the UK, in 2009, and the euro area, in 2011. These events also affect the advanced economies. The US Federal Reserve declined to raise the Fed Funds Rate recently, despite repeated signals that this course of action was likely. Two Fed governors have since publicly suggested that rates will not rise at all in 2015, Household debt to disposable income remains relatively high, at around 78 per cent. Since mid-2010, private sector investment has averaged 3,1 per cent – a full 6 percentage points lower than its 2001–2008 average. BIS central bankers’ speeches although rising rates remains the baseline expectation. 9 Headline CPI inflation was once again negative in the US in September, although this was once again seen to be temporary. The deflation risk is higher in the euro area, which has faced more outright deflation than the US and continues to have more risks weighted in that direction. Sinking inflation forecasts have prompted a renewed discussion of the possibility of expanding Frankfurt’s programme of asset purchases. The fact that the Fed cannot raise rates yet is a sign of global weakness and the European Central Bank must do even more quantitative easing. Domestic news have also been discouraging. The FNB/BER Consumer Confidence Index is at Great Recession levels. The Barclays PMI has spent much of the year below the neutral level of 50, including through August and September. Our composite business cycle leading indicator has trended lower this year, and is now at levels last reached in late 2009. Unexpectedly, the economy contracted in the second quarter of the year, shrinking by 1,3 per cent, with negative contributions from agriculture, mining and manufacturing. But this number should not be treated as cast in stone. GDP estimates are necessarily uncertain. We are often reminded of this by the US, where the practice is to release preliminary estimates of growth followed by second and final versions – and then sometimes a revised estimate after that. In the first quarter of this year, for instance, US growth was described as 0,2 per cent, then –0,7 per cent, then –0,2 per cent and finally – I hope – 0,6 per cent. Similarly, calculations of South African output are not straightforward. The second quarter of this year is a particularly striking example. The estimate of South Africa’s GDP growth taken from the demand side gave a different verdict to the supply-side version. The demand-side number was positive. The gap or residual required to reconcile the demand- and supply-side versions was 2,2 per cent of GDP. This is very large and suggests that revisions to the secondquarter number will be significant. Our forecasts, like those of others in the market, showed weak but positive outcomes for that quarter, and it is possible that these will turn out to be somewhat less wrong than seen at first sight. We do anticipate growth to be positive in the third quarter, but this is scarcely comforting. Growth will remain very low over the next few years. Our best judgment is that potential growth for 2015 has fallen all the way to 1,8 per cent. And with actual growth expected to be 1,5 per cent, the output gap will increase somewhat. Policy and the problem of stagflation Let me turn now to our current policy stance. In this environment of weak economic growth, we are sometimes encouraged, as the monetary policy authorities, to try and do more for growth. This is a valid and important contribution to policymaking, so I would like to spend a few minutes explaining the monetary settings we have in place now and why we think these settings are supportive of growth. The inflation outlook is not favourable. We expect headline inflation to average more than 6 per cent in the first and fourth quarters of next year, and just less than 6 per cent in 2017. This forecast faces sizeable risks, especially from currency depreciation as well as wage and price determination processes. With weak commodity prices and US monetary policy normalisation coming closer, we cannot be complacent about the exchange rate and its potential inflation consequences. Furthermore, we confront medium-term inflation expectations bunched around the top of the target range. The risk of positive inflation shocks feeding into higher expectations and price setting remains very high. Lael Brainard, Economic outlook and monetary policy (http://www.federalreserve.gov/newsevents/speech/ brainard20151012a.htm), 12 October 2015; Binyamin Applebaum, “A 2nd Fed governor opposes raising rates this year, breaking with Yellen”, New York Times (http://www.nytimes.com/2015/10/14/business/economy/a-2ndfed-governor-opposes-raising-rates-this-year-breaking-with-yellen.html?_r=0), 13 October 2015 BIS central bankers’ speeches Were the forecast more favourable or were inflation expectations anchored firmly within the target range, monetary policy would enjoy greater freedom of action. If wage and price setting in the economy were more attuned to weak demand and the usefulness of lower inflation, we would have more policy space. But we do not have that space. It has been eroded trying to get growth back up to potential. Now we have to contend with significant risks of a sustained breach of the inflation target range. For this reason, we entered a tightening cycle in January 2014, which has so far brought the repo rate 100 basis points higher, to 6 per cent. The real rate has been slightly negative and is now about zero, relative to an historical real rate averaging around 3 per cent. This gradual and limited rise, occurring over nearly two years, has shown due concern for growth while maintaining our attention on a rising inflation rate. Some voices say that this is a mistake: that we should let inflation go and focus on the output gap. This advice is problematic on several levels. As economic literature has repeatedly demonstrated and as our experience has once again demonstrated, the output gap is an unreliable measure. 10 It is a poor guide for policy at the best of times. It is an even worse reason to depart from the guidelines entirely. It is possible that cutting rates would boost shortterm growth, but we saw little evidence of that before the commencement of the tightening cycle. We should also note that with potential growth so low and structural constraints binding, additional monetary accommodation is likely to generate more inflation. Rigidities in product and labour markets mean insiders would push wage and price demands higher, limiting the gains we think could be achieved with looser policy. The stickiness of expectations has been particularly obvious lately, with oil prices suppressing headline inflation all year but mediumterm expectations apparently unmoved. Evidently, inflation expectations are not only backward-looking, suggesting that expectations are already stickier than they should be. A more sustained and general rise in inflation expectations would be difficult and expensive to reverse. By anchoring expectations within a credible inflation-targeting regime, we prevent inflation creeping higher. This is a valuable objective. Additional inflation would hurt people who lack the power and privilege to protect the real purchasing power of their wages and savings. Higher inflation is also a medium-term threat to competitiveness. World inflation is currently unusually low. A number of major economies are close to deflation. This expands our inflation differential with our trading partners and competitors. The floating currency offsets the problem but not in a reliable or permanent way. Instead, whenever nominal exchange rates stabilise, the inflation differential helps the real exchange rate to appreciate. To defend the inflation-targeting framework and emphasise the costliness of inflation is not to ignore growth. Indeed, monetary policy in South Africa remains extremely accommodative. Interest rates have gone up but they are not high, nor are they climbing rapidly. The repo rate is still close to zero in real terms. This is a low level from a historical perspective. It is also low compared to peer countries. Monetary policy can be so supportive of growth precisely because of the flexible-inflation-targeting regime. We have the leeway to look through shocks and focus on second-round effects. For instance, we do not need to try and control the exchange rate, a difficult task at which we have traditionally failed. Rather, we can respond to the potential for depreciation to feed into inflation, and specifically wages and inflation expectations. This is why, for all the shocks buffeting the economy, not least a large depreciation of the rand, we have adjusted the repo rate just a quarter of a percentage point this year. Conclusion South Africa’s growth has slowed steadily since 2011, despite expansionary fiscal and monetary settings. These policies were designed to restore growth to its potential. Unfortunately, our potential growth rate has declined. We anticipate that growth will start to See, for instance, Matin et al., “Potential output and recessions: are we fooling ourselves?”, International Finance Discussion Papers 1145 (http://dx.doi.org/10.17016/IFDP.2015.1145), 2015 BIS central bankers’ speeches improve over a two- to three-year horizon, as potential rebounds. One important change will be a relaxing electricity constraint as new sources of supply feed into the grid. Improving world growth will also tend to support the domestic economy, and it is in this context that we need to be sure that inflation or other obstacles do not deprive us of market access or competitiveness. Over the next few years, monetary policy will contend with high inflation. We are not in the position of the major economies in Europe, North America and Asia, which are having trouble lifting growth and also in generating inflation. Our problems are more prosaic, and are unlikely to require major revisions to the textbooks. In keeping with the flexible-inflation-targeting framework, monetary policy will be set to keep inflation within the target range over the medium term. Fortunately, the credibility of our regime will help us to do this in a way that is also supportive of growth. 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 National Asset-Liability Management Africa Symposium, Johannesburg, 29 October 2015.
Daniel Mminele: The impact of diverging monetary policies on emerging markets Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the National Asset-Liability Management Africa Symposium, Johannesburg, 29 October 2015. * * * Good morning, ladies and gentlemen. It is a pleasure and privilege to have been invited to deliver the keynote address at this sixth Annual National Asset-Liability Management Africa symposium, which judging from the topics, promises to be an exciting event. Unfortunately, other commitments will not allow me to spend more time with you as I will have to leave immediately after this address. There is, however, strong representation from the South African Reserve Bank, and my colleagues will be able to share with me later some of the insights I am going to miss. As financial market participants, we all realise the challenges and risks stemming from a low growth and low interest rate economic environment amid a changing financial landscape and turbulence in financial markets. My remarks this morning will focus on the years since the global financial crisis (GFC), specifically in relation to monetary policy in advanced economies (AEs) and resulting spillovers and policy implications for emerging market economies (EMEs), with particular reference to South Africa. I will touch on how these monetary policy developments have impacted capital flows and investment positions in EMEs. Monetary policy developments after the global financial crisis Although the “taper tantrum” is behind us and the Fed’s QE programme came to an end in September 2014, vast uncertainties have re-emerged. Firstly, the timing and pace of Fed’s rate hikes became more uncertain as we moved deeper into 2015, following the soft patch in the US economy, and as inflation kept falling short of expectations. Secondly, the global environment and specifically financial markets began experiencing some renewed turbulences due to a possible Greek exit and country specific developments in EMEs. One example of such country specific events were the mounting concerns regarding the slowdown in the Chinese economy and its impact on commodity prices, commodity-exporting countries as well as global growth. The unease about the slowdown in China appears to have been further fuelled by various policy measures implemented by Chinese authorities to restore confidence during the sharp sell-off in their equity market, as well as the unexpected devaluation of their currency, which at the time seemed to have created even more policy uncertainty. Thirdly, in contrast to the Fed’s expected monetary policy tightening path, some other major central banks have embarked on further policy easing, exacerbating the so-called monetary policy divergence. In the early part of this year, the European Central Bank (ECB) announced their long awaited QE programme of approximately EUR1,1 trillion, while the dovish stance at last week’s policy meeting reinforced expectations for further easing. In Japan, the recent economic contraction and renewed deflation fears fuelled speculation that the Bank of Japan (BoJ) could announce more QE. In addition, various central banks in AEs reduced their policy rates in 2015, for example Canada, Australia (both by 50 bps), New Zealand (75 bps) while Sweden and Switzerland moved further into the territory of negative interest rates. China also started easing monetary policy since November 2014, reducing their benchmark policy rates on six occasions and the reserve requirement ratio four times. The latest easing by China happened as recently as last week, reflecting the Chinese authorities’ concern about future BIS central bankers’ speeches growth expectations and the overall health of the economy. Surprisingly, this resulted in broad EM weakness with losses being registered on both equity and currency markets. Perhaps this reaction is a reflection of increased risks to the Chinese economic outlook. The GFC set the tone for monetary policy implementation and liquidity provision to significantly influence balance sheet dynamics in AEs (and in order to restore dysfunctional interbank markets). In EMEs, however, this phenomenon was less apparent, with only the PBOC active in this regard. This was because, as EM central banks did not face the “zero lower bound” constraint, they could still use traditional policy tools (such as policy rates) to respond to external shocks. In addition, many EM countries recovered more quickly from the GFC than their AE counterparts, further reducing the need for exceptional policy measures. Nonetheless, the expansion of the balance sheets of major central banks has not been without effect on emerging markets, and has at times complicated the task of the latter’s central banks. Ample global liquidity triggered capital flows into EM countries, in many cases encouraging public and private leveraging and fuelling credit growth. Such developments would typically prompt a policy response in the form of higher interest rates. However, with interest rates differentials with AEs a key driver of portfolio flows and currency appreciation, some EM central banks found themselves facing increasingly complex challenges. Despite the current delay in the Fed’s expected monetary policy normalisation path, the Fed and the Bank of England (BoE) are expected to be the first AEs to increase their policy rates. Against this background, it still appears that monetary policy paths will differ amongst major central banks, in terms of the trend, timing and pace, adding to the uncertainty in global financial markets. These diverging monetary policy paths create a challenging environment in which central banks have to operate in order to attain a balance between macroeconomic challenges and policy choices. One of these possible choices could be a revision of monetary policy mandates due to changes in inflation trends. Over the past few decades, inflation targets in AEs have steadily fallen to an average of around 2 per cent. In EMEs, inflation fell at a faster pace to an average of around 4,0 per cent, however, with a fair degree of dispersion. This fall in average inflation targets has mirrored the fall in inflation itself. Yet, at present inflation is undershooting those targets, on average by around 1,5 percentage points, in an environment of the zero lower bound constraint. Some economists feel that a way of loosening this constraint would be to revise inflation targets upwards. For example, raising inflation targets to 4,0 per cent from 2,0 per cent would provide 2 extra percentage points of “room to manoeuvre”. That is roughly the order of magnitude some researchers1 have suggested might be desirable. For EMEs, however, the picture is somewhat more challenging, as domestic developments, in particular currency depreciation, have been key to inflation developments and outlook. US monetary policy normalisation and treasury yields Despite the positive growth impact of monetary policy accommodation over the past seven years, considerable vulnerabilities have also emerged during this period, especially for those EMEs that did not introduce the appropriate policy adjustments. Those economies could be vulnerable in the wake of tighter financial conditions. Although the spill-overs or intensity of the transmission channels of monetary policy normalisation will, amongst others, depend on country-specific factors, the global environment has also become more integrated and complex. In addition, the last couple of months have brought more issues to the fore, for example the impact of lower commodity prices on commodity exporting countries and heightened market volatility, which could make the Ball, L (2014), “The Case for a Long-Run Inflation Target of Four Percent”, IMF Working Paper 14/92, and Blanchard, O, Dell’Ariccia, G, and Mauro, P (2010), “Rethinking Macroeconomic Policy”, IMF Staff Position. BIS central bankers’ speeches monetary policy adjustment process even more complicated and painful. Against this background, domestic imbalances or weak policies could aggravate risks and challenges in the adjustment process. Given that the Fed, as alluded to earlier, is expected to tighten policy first amongst the major central banks, let me spend some time on the impact of the imminent US monetary policy normalisation on EMEs. Monetary policy normalisation implies the removal of extraordinary policy measures that had been implemented to deal with a particular economic episode. In this sense, it refers to a path taken to return to a more “normal” monetary policy setting, although no qualification is made as to what exactly constitutes “normal” in the post-GFC world. During rate-hiking cycles, a key concern for global markets is the path of US bond yields, as these tend to have knock-on effects on other markets, and this is one of the three financial channels of spill-overs to EMEs. Before I discuss the possible effects of US monetary policy tightening on EMEs, I would like to mention some factors which could constrain and/or prevent abrupt and unexpected increases in US Treasury yields. These are important to note as they may influence expectations about the extent of the impact of US tightening on EME economies. Firstly, some central banks like the Fed initially adopted a form of forward guidance as part of their normal monetary policy toolkit. Although this could have at times contributed to volatility in markets because of the highly uncertain and changing environment in which communication takes place, the aim remained for central banks to be as transparent as possible in terms of the policy outlook. The FOMC is also clear on the gradual normalisation path, as also alluded to by the previous Fed officials like Ben Bernanke ahead of the 2004 tightening cycle2. Gradualism in monetary policy also reflects the Fed’s desire to keep bond-market volatility in check – in Greenspan’s words, to “not create discontinuous problems with respect to balance sheets and asset values”. The second important dynamic is that the longer end of the US yield curve is also interrelated with the Fed’s balance-sheet dynamics. The FOMC has indicated that it will consider the cessation of reinvestments of maturing securities only after it commences hiking the policy rate. In the meantime, it will not sell any securities. Until such time as the Fed has signalled that it will cease to reinvest bond maturities, the Fed will have no direct impact on the stock of bonds in the market. Thirdly, there is debate on how much the “equilibrium” interest rate has declined structurally in the US, contributing to the downward pressure on the long end of the yield curve. Lastly, monetary policy in other AEs can also influence the demand and supply for core sovereign assets and therefore the global trend in long-term interest rates. For example, the declining trend in Eurozone bond yields has in the past also played a significant role in driving US Treasury yields lower. This could help explain the observation that US bond yields have not increased significantly along with expected future increases in US policy rates during 2014, a phenomenon reminiscent of the 2004–2006 US tightening cycle. This was also evident during the Eurozone crisis of 2011/12 and again in 2014, when the ECB stepped up liquidity-provision measures and ultimately implemented QE. As a result, the 10-year Bund traded below 1,0 per cent in late 2014 and even closer to 0 per cent earlier this year. This pulled US Treasury yields lower as investors switched out of low-yielding Eurozone bonds into more attractive yielding US Treasuries. Although some economists/analysts still believe that a Fed lift-off is possible before year-end, there remains considerable uncertainty in the broader market space regarding the timing and extent thereof. This was reinforced by the FOMC decision not to hike at the September meeting amid concerns about global developments and their impact on the US, as well as the likelihood Bernanke Ben, Gradualism, Remarks at an economics luncheon co-sponsored by the Federal Reserve Bank of San Francisco and the University of Washington, 2004. BIS central bankers’ speeches that inflation could dip even lower in the near future. The Fed, however, reserved the option of raising rates by year end and some FOMC members have indicated a belief that such a hike will be necessary. Therefore, the debate continues as to when conditions will warrant a lift-off. The statement from the FOMC after the conclusion of its most recent meeting yesterday suggested that the committee has downgraded its assessment of global risks and has left the door wide open for a possible move at its next meeting in December. Monetary spill-overs to emerging-market economies As financial markets and systems became more integrated in recent years, the monetary policy cycles of major economies also became increasingly important for EMEs. The impact from US monetary policy normalisation could transpire through two types of channels: firstly the real channel (trade), and secondly the financial channel. The real/trade channel occurs when US policy tightening is associated with an acceleration in US economic growth, with subsequent spill-overs for EMEs. However, the US economy is not expected to accelerate meaningfully; rather, US policy normalisation will consist of reducing an unusually large, and eventually no longer necessary, degree of stimulus. In contrast to the trade channel, the much more dynamic financial channel is very important for countries like South Africa, whereby spill-overs function through three sub-channels, i.e. changes in interest rates (or yields), exchange rates and portfolio flows, which could also influence domestic credit conditions as well as other asset prices. In terms of the interest rate channel, it is well known that South African bonds – and those of countries such as Brazil, India, and Mexico – have a strong correlation with US Treasuries, albeit inconsistent at times. This correlation was clearly evident during the “taper tantrum” when the 10-year US Treasury yield increased from 1,63 to almost 3,0 per cent and the South African 10-year benchmark bond increased from 6,58 to almost 8,0 per cent between May and August 2013. In 2014, South African bond yields also adjusted (downwards) in line with US Treasuries despite various negative domestic developments, including credit rating downgrades and the depreciation of the rand, which under normal conditions would have driven yields higher. In 2015, however, as the initial US policy rate hike was believed to be getting closer, 10-year US Treasury yields increased to around 2,50 per cent, which was mirrored by a 160 bps increase in the comparable R186 domestic bond yield. Earlier this month, however, following disappointing US payrolls data for September and other international data, the 10-year US Treasury dipped to below 2,0 per cent again, followed by a 40 bps decline in domestic bond yields. The importance of the US interest-rate cycle for South Africa is also apparent in terms of funding costs for both the sovereign and domestic corporates. With reference to the former, the external funding costs – as reflected by JP Morgan’s Emerging Market Bond Index (or EMBI) – the spread for South African bonds over US Treasuries peaked around 460 bps by late September due to domestic factors but also in anticipation of US tightening and general risk aversion, from 350 bps a year ago. EMEs in general have experienced varying degrees of vulnerability during 2015, largely owing to negative country-specific factors, which include political uncertainty in Turkey and increasing concerns about the economic outlook for Brazil. Standard and Poor’s (S&P) downgraded Brazil’s sovereign credit rating to sub-investment grade in September 2015. Domestic funding costs for banks in South Africa have, on the other hand, been negatively influenced by a further dynamic in the aftermath of the GFC, namely more stringent global financial regulations which are being implemented locally. With the upcoming introduction of the Net Stable Funding Ratio, the spread to Jibar of floating-rate NCDs issued by commercial banks increased significantly across all maturities, in some cases more than double the levels seen around mid-2013, as banks are forced to issue longer-term instruments. There is a general view that financial regulatory reform, while necessary, may have had certain unintended consequences, such as limitations on banks’ proprietary trading, reducing the BIS central bankers’ speeches willingness and ability of Primary Dealers to hold sizeable inventories of securities, which have contributed to less liquidity in the markets. This lower level of liquidity introduces new risks through an increase in market volatility that could amplify negative spill-over effects in stress situations. Another frequently discussed challenge is that of EMEs’ foreign-currency corporate borrowing in US dollars and the impact of the stronger dollar and higher yields on debt-servicing and refinancing risks. The total US dollar exposure from both bank loans and debt securities has been growing rapidly over recent years to approximately USD3,3 trillion, according to the BIS. For South Africa, this does not present a significant risk, given relatively low level of foreign liabilities of local companies and banks. However, excessive US dollar appreciation could have ramifications for highly indebted emerging markets, resulting in increased volatility and a selloff in EM assets. This might very well spill over to other EMEs, including South Africa. The second sub-channel, the foreign-exchange market, is probably the market that may suffer a more pronounced impact from global monetary policy normalisation. This risk was illustrated during the 2013 “taper tantrum” when the rand – together with the currencies of certain other EMEs perceived at the time to be most vulnerable (such as Brazil, India, Indonesia, and Turkey) – depreciated by more than 10 per cent against the US dollar3. The period that followed was characterised by increased differentiation between EMEs. During recent months, however, correlations across markets in EMEs have increased, perhaps suggesting a lower degree of investor differentiation. Against this background, currency-market volatility has increased to levels that prevailed during the Eurozone sovereign debt crisis, while EM currencies on average depreciated by 14 per cent4. The popular narrative tends to focus on the rand-dollar exchange rate. Given the outlook for the normalisation of monetary policy in the US, the US dollar has surprised with the magnitude and speed of its appreciation since mid-2014. This was initially triggered by the ECB’s announcement of the Targeted Long-term Refinancing Operations in June 2014, amid heightened speculation of full-scale QE, which implied increased monetary policy divergence. In the meantime, expectations of the Fed’s hiking cycle were also escalating, and by March 2015, the US currency had appreciated by 26 per cent on a trade-weighted basis5 and reached US$1,05 against the euro, a level that was only expected amid actual US tightening6. This was the largest appreciation ever in the run-up to an interest-rate tightening cycle in the US. The outlook for the US dollar will, to a large extent, depend on two fundamental factors: the pace of widening interest-rate differentials and the performance of the US economy relative to its major trading partners, although other factors – such as portfolio reallocation – can at times temporarily dampen the importance of these two factors, as occurred in 2014. Therefore, actual US policy normalisation could result in further weakness in the rand against the dollar, and could also negatively impact portfolio flows by reducing the willingness of fund managers (a large share of them having US dollar liabilities) to hold unhedged positions in South African bonds and equities. This speaks to the third sub-channel, namely portfolio flows. Similar to other EMEs, portfolio inflows into South Africa declined in the aftermath of the “taper tantrum”. Reserve Bank statistics show that total portfolio inflows slowed from R85 billion in 2012 to R50 billion in 2014, comprising mostly bond inflows of around R37 billion. More recent 3 May to August 2013. According to the JP Morgan EM currency index, comprising Brazil, Chile, China, Singapore India, Hungary, Mexico, Russia, Turkey and South Africa. Mid-2014 to mid-March 2015 (Since then, however, the US dollar has depreciated marginally, but traded generally sideways.). Market analysts’ models were showing that the US dollar performance was consistent with an actual 100 bps increase in the US policy rate. BIS central bankers’ speeches data from the Central Securities Depository7 reveals that, in the year-to-date, non-residents bought R20,1 billion worth of equities and R861 million worth of bonds, amounting to total inflows of R21,0 billion. South Africa’s vulnerability to US policy tightening is augmented by our dependence on external financing to deal with the current-account deficit. South Africa is, however, not alone in this episode of asset reallocation away from EMEs, whereby portfolio inflows in 2015 are expected to fall below 2008 levels, according to the Institute of International Finance8. This, however, reflects a “lengthening drought” in capital flows, rather than a sudden stop. Has divergence in monetary policy impacted investment positions in EMEs? In the wake of the GFC, investors piled into EM equities and debt amid abundant liquidity, low interest rates and low growth in AEs. These inflows, however, did not always reflect domestic economic fundamentals, whilst the EM outlook also became increasingly uncertain over the past four years. As a result, a major concern with the Fed’s upcoming tightening cycle is that global investors will further reallocate portfolios away from EM assets and back towards the US given better growth prospects, rising yields and the perception of a more secure investment environment. A weaker exchange rate for South Africa would probably raise implied rand volatility, adding to overall risk aversion and weak sentiment towards rand-denominated assets. Although the nominal effective exchange rate of the rand was reasonably stable during 2014, relative to baskets of commodity-exporting or large EMEs, it depreciated by about 10 per cent on a tradeweighted basis during 2015 to date due to the combination of domestic and global developments already discussed. For South Africa, the favourable impact of a weaker currency on the trade account have not been forthcoming for a few years now which is rather problematic in an international environment of volatile capital flows. While there has been some narrowing in the currentaccount deficit since the third quarter of 2014, it remains to be seen to what extent this represents the beginning of a sustained compression of the current account after a long period of real exchange-rate depreciation. Furthermore, a stronger US dollar tends to dampen commodity prices, with adverse implications for commodity producers like South Africa. In the second quarter of this year, however, the current-account deficit narrowed to 3,1 per cent of GDP from 6,2 per cent in the same period last year. While this narrowing is attributed in part to temporary factors, there appears to be some evidence that both export and import volumes are responding to the depreciation of the rand and the weaker economy. I have to add though that larger service receipts contributed to a narrowing of the current account. However, the Bank expects this process of adjustment to remain slow, with the export response inhibited by a number of factors including, inter alia, headwinds from the slowing global economy and electricity supply constraints. Although a number of EMEs have been able to reduce their policy rates in response to the favourable impact from oil prices on inflation, this could be thwarted by developments in currency markets. This, in an environment where economic growth for emerging markets has slipped to its slowest pace since 2009 as countries battle to deal with the combined impact of a stronger dollar and weaker commodity prices. In this regard, the domestic economic outlook has also deteriorated even further as reflected by the surprise economic contraction in the second quarter of the year. Although domestic developments contributed, the downside risks to the global economic outlook have also increased on the back of a slowing Chinese economy. Strate data up to 20 October 2015. Capital flows to emerging markets, October 2015. BIS central bankers’ speeches On the positive side, we should remember that the beginning of the US monetary policy tightening cycle will not necessarily be bad for the world, in particular for South Africa and other EMEs, as it would indicate that the US economy is in better shape and therefore supports the global recovery. In addition, both the consensus and FOMC projections suggest that the Fed will not move to a restrictive stance anytime soon, but rather that it will merely reduce the degree of policy looseness. Finally, while policy normalisation in the US may well reduce the flow of US-based capital to EM assets, prospects for additional stimulus in the Eurozone and Japan, as well as capital outflows from China, could result in greater investments into EM from these regions, counter-balancing to some extent the impact of US tightening. In summary, recent experience makes it quite clear that changes in AEs’ monetary policies have been a key driver of developments and sentiment towards EMEs and market volatility, as the years of low interest rates and unconventional monetary policy have seen increased international exposures to EMEs. Conclusion In conclusion, it would appear that policy challenges and, specifically, the “divergence” between the major central banks will continue to have major bearings on emerging economies in the foreseeable future. Market strains have eased over the past few weeks, in part because of growing indications that the Federal Reserve would take the risk of a further deterioration in financial conditions in consideration before any policy decision. Nonetheless, the consensus view remains that while lift-off has been delayed, it will still happen in the not-too-distant future; and its impact on global portfolio flows and EM assets remain highly uncertain. So does the impact on the world economy and global financial markets from current or potential stimulus in the Eurozone, Japan and China. Against, this background, it is clear that central banks cannot afford to be complacent, as the risks related to global monetary policy and macroeconomic developments remain high given the globalised nature of the world economy. This is unchartered territory, and the risks of further market turbulence are tilted to the upside. In light of possible implications for financial stability and resilience, and for domestic price developments, central banks – and the South African Reserve Bank among them – will have to exert continued and utmost vigilance. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Credit Suisse Africa Conference, Cape Town, 6 November 2015.
François Groepe: African central banks and monetary policy challenges Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Credit Suisse Africa Conference, Cape Town, 6 November 2015. * * * Introduction Good morning, ladies and gentlemen. Allow me to express my pleasure at being invited to deliver the opening address at this year’s Credit Suisse Africa Conference. The theme chosen for this address – “African central banks and monetary policy challenges” – is particularly relevant today, seeing as financial market participants grapple with volatile markets informed by a fluid economic and monetary policy environment. The context is a highly interconnected world where spillover and spill-back risks are evident, and which brings about new challenges. In my speech, I will look at some of these global challenges and how they have shifted over the past few years, then focusing on their particular relevance for African nations and, in turn, looking at the ways in which African central banks can deal with their policy implications. I will briefly highlight the experience of the South African Reserve Bank in that respect, and discuss how increased cooperation between regional central banks can help to strengthen the way in which we navigate these challenging times. A more challenging world environment Despite the elapse of nearly seven years since the height of the global financial crisis, a fullyfledged global economic recovery remains elusive, and new challenges continue to appear. The recovery process that began in some segments of the world economy has started to tentatively bear fruit. Banks in the United States and, increasingly, in the eurozone have seen sufficient improvements in their balance sheets to allow for the resumption of positive credit growth. At the same time, financial conditions have improved sufficiently for corporate entities in these regions to resume hiring, a necessary condition for a consumer recovery. Furthermore, in Europe, a mix of central bank initiatives and political will to hold the European construct together has handed most peripheral countries markedly lower borrowing costs and has created room for them to escape from their double-dip recession. The global growth outlook, however, continues to vacillate and has once again deteriorated somewhat recently. In its October 2015 World Economic Outlook, the International Monetary Fund downgraded its global GDP growth forecasts by 0,2 per cent to 3,1 per cent and 3,6 per cent in 2015 and 2016 respectively. The 3,1 per cent global growth forecasted for 2015 is materially lower than the 3,8 per cent forecasted a year ago. This downward revision is mainly as a result of the downscaling of the growth projections for the emerging economies. The downwardly revised growth outlook for emerging-market economies is mainly attributable to the relative slowdown in China which faces overcapacity in its traditional industries, a property oversupply, an erosion of its competitive advantages, and elevated levels of debt. Other large emerging-market economies are, however, also feeling the strain, in particular those which have a high degree of dependence on commodity exports. Furthermore, investor risk aversion towards emerging-market assets has been rising against a backdrop of market uncertainties about the timing and impact of US policy rate normalisation coupled with concerns about the economic slowdown in Asia and the impact of lower commodity prices. This has contributed to significant capital flow reversals from BIS central bankers’ speeches emerging-market economies, and the Institute of International Finance has recently projected that emerging markets will see net capital outflows this year for the first time since 1988.1 Why these developments matter to Africa These international developments are highly relevant for sub-Saharan Africa. At the time of the global financial crisis, regional growth was relatively sheltered from adverse developments in the major economies. Regional GDP, for instance, continued to grow by 4,1 per cent in 2009, whereas most of the advanced economies and some emerging-market economies were in recession. The lack of depth in most African financial markets as well as the limited linkages between their banking systems and those of the advanced economies had in part explained Africa’s relative resilience. However, Africa appears to have become more vulnerable to global developments since then. The exposure of sub-Saharan economies, particularly to China – which is now a key contributor to the global slowdown – has continued to increase over recent years.2 The region’s exports to China have grown, on average, by around 25 per cent per year between 2000 and 2014, far outpacing the growth rates of less than 10 per cent for exports to the US and the EU. According to the IMF, China in 2014 accounted for more than 20 per cent of exports in about 15 sub-Saharan countries, including Angola, the DRC, South Africa and Zambia. Interestingly, exports to the other BRICS economies also increased over the past decade, by close to 20 per cent on an annual basis. But China’s relevance for African economies is not limited to trade links. According to the United Nations Conference on Trade and Development (UNCTAD), China is now the largest developing foreign investor in Africa, and official Chinese data indicate a doubling in the stock of foreign direct investment to Africa between 2009 and 2012, to US$21 billion. The sharply lower commodity prices equally hold significant implications for Africa. Despite some diversification of their economies over the past decade or so – in particular into the services sectors such as retail, finance and mobile telephony – the export base of countries in sub-Saharan Africa remains highly dependent on commodities. The IMF has identified 15 countries in the region, beyond its eight oil-exporting countries, where non-renewable resources represent more than 25 per cent of exports. In nine of those, the share exceeds 50 per cent – and these calculations exclude agricultural commodities, on which many poorer African nations remain heavily dependent.3 The negative impact of the lower commodity prices is not limited to lower domestic income, tax revenues and employment in the mining sector, but is equally likely to result in the curtailment of drilling and extraction investment projects. The region, however, is likely to continue growing above trend in the near future. The IMF forecasts sub-Saharan GDP growth of 4,3 per cent in 2016, up from the estimated 3,8 per cent in the current year but still below the 5,25 per cent average growth rate of the past five years. The most recent projections of the World Bank similarly show a moderate recovery in 2016 and 2017. There are, however, some downside risks to these forecasts, such as the impact of adverse weather conditions on the agricultural sector and the possibility that ongoing public spending on infrastructure may be curtailed due to deteriorating public finance metrics in several countries. See ‘Capital flight darkens economic prospects for emerging markets’, Financial Times, 1 October 2015. See ‘Linkages between China and sub-Saharan Africa’, Global Economic Prospects, World Bank, June 2015. See ‘Dealing with the gathering clouds’, Regional Economic Outlook for sub-Saharan Africa, International Monetary Fund, October 2015. BIS central bankers’ speeches Indeed, the more challenging external environment for African countries occurs at a time when these countries’ external and budget balances have been deteriorating. The IMF forecasts that, in 2016, 30 of the 45 sub-Saharan countries will have a current-account deficit in excess of 5,0 per cent of GDP. The region’s external shortfall is expected to be as high as 5,5 per cent of GDP, compared with the low of 0,7 per cent in 2011 and net surpluses in the years before the global financial crisis. Equally, the average budget deficit for the region is estimated to have risen to 4,2 per cent of GDP this year, up from 1,8 per cent three years ago; as a result, the public-debt-to-GDP ratio is likely to have reached its highest level since 2005. The re-emergence of the ‘twin deficit’ phenomenon in many African countries may prove of particular concern at a time when global financing conditions have deteriorated and the credit spreads of most emerging sovereigns widen this year, in particular among subSaharan issuers. Many African countries have taken advantage of the low yields in developed countries to increase their issuance of foreign currency-denominated Eurobonds in recent years. Such issuance has helped these sovereigns to tap into international investor demand for yield and reap the rewards of earlier efforts to improve their creditworthiness. However, it has also increased their external debt burden as most of the region’s currencies have come under pressure. The trend towards currency depreciation that was witnessed throughout most of the emerging world has not spared sub-Saharan Africa. Since the start of the year, for example, the currencies of countries such as Angola, Ghana, Kenya and South Africa depreciated by between 10 and 25 per cent against the US dollar. In the case of others, like Zambia, the currency-value loss has been close to 50 per cent. These currency developments have complicated the servicing and refinancing of external debt, and have also contributed to a rise in inflationary pressures in some countries, offsetting the positive effect of lower oil prices in this context. For the sub-Saharan Africa region as a whole, the IMF now forecasts average inflation to accelerate to 6,9 per cent this year and to 7,3 per cent in 2016 compared to 6,4 per cent in 2014. How central banks can respond to the challenges A situation where real economic growth slows but inflation accelerates is not one that central banks particularly relish in having to contend with. Central banks’ mandate of inflation targeting, be it direct or indirect, requires them to be responsive to any build-up of price pressures, especially if it could result in the un-anchoring of inflation expectations. This is particularly relevant where inflation remains sticky at the upper end of the inflation target range. Yet at the same time, a slowdown in economic growth – at least in the event that it is demand-driven and results in a negative output gap – means that the central bank has to be mindful not to exacerbate the cyclical moderation by unduly tightening monetary policy. Procyclical monetary tightening can negatively impact on economic growth and employment, and over time could contribute to financial instability. It is worth noting that the nature of the inflation pressures faced by African central banks may itself be changing. A recent IMF study showed that while, in the past, inflation cycles tended to be heavily influenced by domestic supply shocks, the role of foreign exchange, money supply and domestic demand shifts has gradually increased over time.4 It is therefore likely that demand shocks (global, regional and local) matter increasingly more for inflation rather than supply-related ones. Ever-increasing trade and financial integration has been beneficial to growth and development in sub-Saharan Africa over the past decade or two; it has also brought greater dependency on and responsiveness to international economic and financial See ‘On the drivers of inflation in sub-Saharan Africa’ by Anh D.M. Nguyen, Jemma Dridi, Filiz D. Unsal and Oral H. Williams, Monetary Fund Working Paper Series WP/15/189, August 2015. BIS central bankers’ speeches trends, and with it also the need for greater cooperation and exchange of information among African countries, including their central banks. So how should central banks in Africa respond to these new challenges? First of all, there is no “one size fits all” policy response. Because of the structural differences between African countries – such as their oil exporter/importer status, the diversification of their production, the degree of development of their respective financial sectors, and the health of their public finances – they are not equally vulnerable to the current global challenges. As mentioned earlier, the outlook for both growth and inflation in the region’s member states shows significant divergences. The IMF, for example, forecasts that inflation in several countries – mostly members of the CFA zones but also some oil importers, like Kenya – is expected to remain muted, or even to decline, in 2016. Several other countries, however, including many of the largest economies of the continent, are likely to see inflation drifting higher or remaining around uncomfortably elevated levels. Nonetheless, common themes may be emerging. In an environment of weakening growth in key trading partners such as China, of lower commodity prices and of potentially challenging global liquidity conditions, exchange rates are likely to remain under some kind of pressure. But this need not be a negative development. In many ways, provided that a country’s external debt remains moderate, depreciated exchange rates act as an automatic stabiliser against an external demand and/or terms-of-trade shock. It is nevertheless the responsibility of central banks to ensure that such depreciation does not result in a lasting price spike or in an un-anchoring of inflation expectations. This can be a particular risk in Africa, where a large share of consumer goods is imported, and at a time when food prices – a large portion of the CPI basket in many regional economies – are increasingly sensitive to global, rather than domestic, developments. According to the IMF’s latest Regional Economic Outlook for sub-Saharan Africa, a key factor behind the improved growth performance of sub-Saharan Africa in recent years has been an improved policy environment. Gains in the quality of policymaking and sounder macroeconomic management can ill-afford to be reversed. In some countries, the challenge for policymakers has been compounded by the relaxation in public spending policy – in particular civil service wage settlements – in recent years. This is certainly not an unusual or a surprising development as it is reasonable to affect some degree of redistribution when economic growth and improved fiscal revenue allows for it given the skewness of income and wealth distribution in many of these countries. It is, however, of great importance that such efforts be undertaken in a sustainable manner and not at the cost of discarding fiscal discipline, as a lack thereof could exacerbate inflation pressures and weigh on investor sentiment, thus complicating the task of monetary policymakers. Admittedly, this possibly points to the limitations of the role that central banks can play in dealing with the current global and regional challenges. Other economic agents, in particular fiscal policymakers, have a key role to fulfil alongside monetary authorities in ensuring that the path to sustained growth and development in Africa is not derailed. Appropriate countercyclical fiscal policies, which prioritise investment in infrastructure and human capital over current spending, would go some way in assisting central banks in executing their mandates. It is worth noting that many central banks’ mandates have been expanded to now explicitly include financial stability. This may not have been a major focus area in the past for most African central banks due to the region’s relatively low credit depth and its lack of large, sophisticated financial markets. But the rapid development of the financial sector, the growing interconnectedness of the countries’ banking systems, and the gradual opening of their capital markets has necessitated an increased focus on financial stability. The IMF recently found evidence of linkages – in particular in the case of sub-Saharan Africa countries – between lower commodity prices and financial stability metrics, such as non- BIS central bankers’ speeches performing bank loans, returns on equity, and ratios of liquid assets to deposits. Despite these linkages, it is evident that a growing financial system which is well regulated and supervised is likely to result in better allocation of capital to different economic sectors, the facilitation of entrepreneurship, stronger job creation and, overall, the promotion of sustainable economic development. Dealing with challenges – the experience of the South African Reserve Bank The global challenges described above, and the questions of how to deal with them, have not spared the South African Reserve Bank. South African growth has slowed due to various external factors, not least due to the worsening terms of trade on the back of softer commodity prices. It is worth noting that commodity exports continue to represent about 60 per cent of South Africa’s external trade but trade is increasingly shifting to other emerging-market economies, for example export shipments to China and the other BRICS countries have risen from 2,6 and 3,0 per cent in 2005 to 9,6 and 5,2 per cent in 2014 respectively. These external factors have been compounded by domestic supply issues, prominent among which were electricity constraints, prolonged strikes in the mining and manufacturing sectors as well as skills shortages and uncertainties in certain fields of policy, such as the mining and agricultural sectors. The South African Reserve Bank forecasts GDP growth of 1,5 per cent this year and 1,6 per cent next year, which is substantially lower than the post-recession high of 3,2 per cent in 2011. The Bank further estimates that a part of this deterioration may be structural and that potential economic growth has slowed from around 3 to 3,5 per cent in 20105 to about 1,8 per cent this year. Inflation continues to remain of some concern, even as growth slowed and the persistence of a negative output gap seemingly dampened the pass-through effects of currency depreciation to headline CPI inflation. Core consumer price increases have remained relatively elevated against a background of prolonged currency depreciation, above-inflation wage settlements and administrative price increases. Furthermore, the Bank projects that headline inflation will exceed its target range for two quarters in 2016 before declining to 5,7 by the fourth quarter of 2017. The South African Reserve Bank has also been closely monitoring the broad-based measures of inflation expectations, in particular the Bureau for Economic Research’s surveys of analysts, businesspeople and trade unions, which have shown greater stability over the past three to four years yet have remained anchored around the upper limit of the Bank’s inflation target range. With inflation expected to overshoot its target range for two quarters in 2016, the Bank has been wary of any possible un-anchoring and/or an upward drift in these expectations. As a result, it stands ready to tighten policy further should such adverse developments occur. The Bank’s Monetary Policy Committee has repeatedly indicated that it sees itself in a gradual tightening cycle. So far, interest rates have increased by 100 basis points, to 6,0 per cent, since January 2014. The sluggishness of economic growth and the persistence of a negative output gap inform our view of the gradualism of the current normalisation cycle. Nevertheless, the core mandate of the Bank is price stability, which means that the Bank remains vigilant and stands ready to act against any build-up of inflation pressures which may result in a persistent deviation from the inflation target range. See ‘A semi-structural approach to estimate South Africa’s potential output’ by V Anvari, N Ehlers and R Steinbach, South African Reserve Bank Working Paper Series WP/14/08, November 2014. BIS central bankers’ speeches Cooperation and the role of the Association of African Central Banks Before concluding, let me return to the importance of cooperation between the respective central banks on the continent, and in particular allude to the work undertaken through the Association of African Central Banks, the AACB. As the economic, banking and financial inter-linkages between African countries multiply, the mutual understanding of our financial systems and the exchange of information on risks associated with, among others, cross-border bank lending can be of paramount importance to limit the risks of contagion through the continent of any future shock. In this respect, the role of the AACB, which has provided African central banks with a mechanism for cooperation and a forum for discussion since 1965, is likely to continue to grow in the coming years. I would like to highlight the role which the South African Reserve Bank in particular is playing in leading the recently established working group on cross-border banking supervision. Our initial interaction with colleagues from other African central banks makes us confident that the working group will be able to formulate sufficient methods to improve cross-border supervision. Indeed, we anticipate that, over time, this working group will become the preferred platform where experiences are shared, ideas are discussed, and, ultimately, the effective supervision of cross-border banking operations is strengthened. The sharing of knowledge and the more effective use of skills and resources will no doubt be key, in the longer run, to improving the supervision of continental banking groups. Conclusion In conclusion, I would like to emphasise that sub-Saharan Africa has shown promising gains in economic growth and diversification, human development and policy governance over the past decade. It will be the task of all stakeholders, central banks included, to ensure that these gains are built upon in coming years, even as the global environment becomes more challenging. Allowing for the necessary adjustments of financial variables, like exchange rates, without endangering financial stability; keeping inflation stable without putting undue strain on fragile economic growth; and ensuring cooperation between the continent’s regulatory institutions to allow for the development of cross-border financing while keeping risks in check are among the major challenges of the coming years. I have no doubt that, despite these challenges, the African Renaissance will continue to gain traction and that the next decade or two will see significant overall improvements in all developmental and economic metrics. Thank you. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Bank of America-Merrill Lynch Investor Conference, Johannesburg, 27 November 2015.
François Groepe: The challenges for domestic monetary policy amid US policy normalisation Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Bank of America-Merrill Lynch Investor Conference, Johannesburg, 27 November 2015. * * * Introduction Ladies and gentlemen, good morning. I am grateful to the Bank of America-Merrill Lynch for the invitation to address this fourth edition of their annual Fixed Income Investor Conference. I think that the subject of my speech is a matter that is widely debated. In my address today I will highlight the different channels through which United States (US) monetary policy shifts can affect South Africa’s economic, price and financial variables, and how this is likely to impact on domestic monetary policy. The global rate environment may be changing There is no denying the impact that the prolonged period of near-zero US short-term interest rates has had on global economies and financial markets. The target for the federal funds rate has now been at zero to a quarter of a per cent for as long as seven years. Since the end of the Second World War, episodes of low US interest rates had not seen rates fall so low for such a long period. Furthermore, the policy response to the Fed was not limited to a near-zero Fed funds target: sizeable purchases of government and agency debt by the central bank, together with “forward guidance” regarding the future path of interest rates, were implemented with the stated aim of lowering interest rates across the whole yield curve. These unconventional policy tools were also not limited to the US. Over time, central banks in the eurozone, Japan and the United Kingdom, among others, moved to a combination of very low policy rates and asset purchases. The extent to which these measures reduced long-term interest rates in advanced economies and encouraged capital flows towards emerging markets remains a point of debate. Other factors no doubt were at work. These include moderating inflation and slower potential growth in the developed world and, in the immediate years after the global financial crisis, more attractive fundamentals in emerging countries. Nonetheless, various academic studies suggest that unconventional tools, via their effect on term premiums, may have depressed 10-year US yields by as much as 50 to 100 basis points.1 As for capital flows to emerging markets, it may be no surprise that the era of very accommodative policy in the developed world coincided (according to data of the Institute of International Finance) with inflows in excess of US$ 1 trillion per year from 2010 to 2014, a level that had only been exceeded once before the global financial crisis.2 This backdrop, however is likely to change soon. The Fed’s FOMC has, of late, repeatedly expressed its confidence in meeting its dual target of full employment and a return of inflation towards its targeted levels. Addressing the House of Representatives on 4 November, Chair Janet Yellen remarked that “if we were to move, say in December, it would be based on an expectation, which I believe is justified, that – with an improving labour market and transitory factors fading – inflation will move up to 2 per cent.” In the wake of recent Fed communication We can refer, among others, to “The macroeconomic effects of the Federal Reserve’s unconventional monetary policies” by Eric M Engen, Thomas T Laubach and David Reifschneider, Finance and Economics Discussion Series 2015–005, Washington, DC: Federal Reserve Board, 2015. See “Capital flows to emerging markets”, Institute of International Finance, 1 October 2015. BIS central bankers’ speeches and US labour market data, financial market participants are now discounting an approximate 65 per cent probability of a hike in the Fed funds future on 16 December. By the end of next year, market participants see Fed funds around 0,75 to 1,00 per cent, while the median projection of FOMC members currently lies at 1,4 per cent. Why does it matter for South Africa? On its own, a slow and gradual normalisation of US monetary policy need not be negative for South Africa, or indeed for the emerging world as a whole. The reasoning being that if the Fed is considering a “lift-off” in its policy rate, it is because in their view the US economy has recovered sufficiently from the legacies of the global financial crisis, and that it can continue growing at a steady and sustainable pace without further need for unusually large accommodation. Secondly, the normalisation path is likely to be very gradual. Nonetheless, because of the role that US policy played in encouraging inflows to emerging markets in particular and “risky” assets in general, many people are awaiting the prospective US rate “lift-off” with elevated nervousness. Volatility has risen across a broad range of assets; the rand, together with other major emerging currencies, has come under pressure; and some observers have asked the question whether the South African Reserve Bank (SARB) needs to “shadow”, or even pre-empt the Fed in raising interest rates. Before I go more into detail on that subject, let me repeat an important point: the SARB does not have an exchange rate target; it has an inflation target. Furthermore, both theory and experience do show that in the case of the latter, domestic interest rates need not respond to policy rate changes in the US as they would in the event of a dollar peg. If one targets the dollar exchange rate, the interest rate differential with the US is key to sustaining the target. However, if one targets inflation, the role of US rates becomes indirect. In fact, one could see two main reasons why a rise in US interest rates could justify a similar move in a country like South Africa: first, if the US move reflects an inflationary acceleration in the US economy that looks set to be replicated in South Africa; and second, if the US rate increase affects capital flows to South Africa to the point that the rand depreciates significantly and raises prospective domestic inflation. The first argument can be dismissed in the present situation. As I previously indicated, the Fed, if it begins to raise interest rates in the coming months, will not do so because of a strong, potentially inflationary acceleration in US gross domestic product (GDP) growth. It will do so to ensure sustained US growth through a gradual reduction in the degree of monetary accommodation. The FOMC’s median projection does not see US GDP growth deviating substantially from the current trend in the next two or three years, and most official and private forecasters share that view. In addition, historical experience seem to indicate that while major cycles in the US economy, including the last recession, influence those in South Africa, there is much less correlation between GDP trends in the two countries during moderate growth cycles, as is now the case. Therefor the “growth transmission channel” will have a limited role. “Push and pull” factors and portfolio flows The “capital flows” transmission channel is of much bigger concern at present. In recent years, a lot has been written about the “push and pull” factors that drove private capital flows, and in particular portfolio flows, from developed to emerging economies. On the “push” side, as I alluded to earlier, the mix of very low policy rates, quantitative easing and forward guidance by key major central banks, including the Fed, created an incentive for large investment funds to “search for yield” in other destinations. On the “pull” side, in the first few years following the global financial crisis, a combination of rising commodity prices and a stronger economic recovery in emerging economies, relative to their advanced economy counterparts, enhanced the attractiveness of these countries as an investment destination. BIS central bankers’ speeches Yet, just as some of the “push” factors look set to recede with the beginning of US monetary policy normalisation, the “pull” factors attracting capital towards emerging markets have been equally waning. The Reuters-CRB index of commodity prices has fallen by nearly 50 per cent since its peak in April 2011; in real terms, adjusted for US inflation, it is back to levels last seen in 2001. Such a large-scale adjustment, unsurprisingly, has led to a marked slowdown in commodities exporters’ growth. Yet, even those emerging countries that are net resource importers have experienced a loss of economic growth momentum, in part because of growing economic and financial interconnections within the developing world. In 2011, the growth differential between the emerging and developed world was as high as 4,6 percentage points; in 2015, according to International Monetary Fund (IMF) projections, it will be as low as 2,0 percentage points, the narrowest gap in 15 years. International capital flow data are already highlighting the impact of these developments on cross-border funding. In a report released last month, the Institute of International Finance (IIF) projected that non-resident capital flows into emerging economies would fall to only US$548 billion in 2015, down from US$1,305 billion two years ago, with bank lending and bond portfolio flows likely to account for the bulk of the decline. At the same time, the IIF projects that private residents of emerging economies will increase their investments in the developed world, resulting in the developing world being a net exporter of capital for the first time since 1988.3 The vulnerabilities of South Africa Recent experience indicates that South Africa is not immune to the risks I have just outlined. The rand has depreciated by around 17 per cent against the US dollar since the start of the year. Whilst the rand is not an exception, it is nonetheless underperforming, on average, its emerging-market peers. Indeed, despite some improvement over the past year or two, our current-account deficit still appears likely to remain elevated, at around 4,2 per cent of GDP in 2015, and around 4,6 per cent next year. With the balance of foreign direct investment flows in deficit, on average, over the past year and a half, this means a continued reliance on portfolio inflows to ensure a smooth financing of the current-account deficit. Generally, portfolio flows into South African assets do not behave differently from those into other major emerging markets. IIF Portfolio Tracker data show a positive correlation of 56 per cent in the current year, and indeed since 2010, between net non-resident flows into South Africa and into emerging markets as a whole. Non-residents became net sellers of South African bonds and equities in the last three months, coinciding with an underperformance of the domestic bond market and renewed rand weakness. We have noted that for emerging markets as a whole, there seems to be an increased correlation between the performance of local-currency bonds and the exchange rate. This observation also applies of late to South Africa, providing further evidence of the linkages between bond flows and currency trends. Furthermore, the same data also show that in the past few years net flows into South African securities have become increasingly sensitive to shifts in the US yield curve. Since the “taper tantrum” of May 2013, months when 10-year US Treasury yields rose by more than 10 basis points coincided with net non-resident outflows from South African bonds, whereas other months saw net inflows. Equally, the period since May 2013 has seen, on balance, a negative correlation between US Treasury yields and the performance of the rand, in contrast to what prevailed in the immediate years after the recession. At that time, rising US yields may have been perceived as signalling a stronger global recovery. Nowadays they appear reflective of tighter global financial conditions, with negative implications for the South African rand. The risk of a negative “feedback loop” between US yields, outflows from domestic bonds and rand depreciation is therefore real. Op. cit., page 2. BIS central bankers’ speeches The challenges of a slowing South African economy The prospective normalisation of monetary policy in the US, with the possible implications I have just described, comes at a challenging time for South Africa and for monetary policy. On the one hand, underlying inflation trends and inflation expectations are already relatively high, and the potential for sizable portfolio outflows and ensuing currency depreciation clearly poses an upside risk to the inflation outlook. On the other hand, the domestic economy is weak, and policy tightening could aggravate such weakness. There is indeed no denying that the South African economic growth outlook is more challenging than a year ago. At present, the SARB is projecting real economic growth of 1,4 per cent in 2015 and 1,5 per cent in 2016. At the time of the November 2014 MPC meeting, these forecasts stood at 2,5 per cent and 2,9 per cent respectively. We are a far cry from the 4,8 average growth rate seen in the five years prior to the global recession, or even from the growth rate that prevailed in its immediate aftermath, when it averaged 2,8 per cent between 2010 and 2012. Adding to the challenge for monetary policymakers is that such a slowdown in growth reflects a mix of structural as well as cyclical factors. These include slowing growth in some of South Africa’s major trading partners, such as China; the negative shock from falling terms of trade; and the moderate rise in the tax burden that has weighed on disposable income growth and, especially in the last few quarters, consumer demand. These developments, coupled with domestic constraints such as reduced and uncertain power supplies, labour market disruptions, and relatively high transportation and logistics costs, have in turn undermined the supply side of the economy. In particular, they constrained private-sector fixed investment, which measured 13 per cent of GDP on average in the first half of this year, down from a peak of 15,4 per cent just before the 2008–09 recession. The SARB estimates that short-term potential real GDP growth in South Africa has slowed to 1,8 per cent this year, from an estimated pace of 3,25 per cent around 2010. Hence, the country probably has a narrower negative output gap than was assumed a few years ago. Still, some slack persists in the South African economy, a pattern that is confirmed by other indicators such as capacity utilisation in manufacturing, which has actually been declining throughout the current year. Under normal circumstances, one would expect such slack to generate disinflationary pressures and call for an accommodative monetary policy stance to close the output gap. This is particularly the case in situations where fiscal policy is constrained, because of rising debt levels, in its ability to support the economy, as is currently the case in South Africa. However, monetary policy has already been accommodative for several years, at least judging by the level of real short-term interest rates, which remains unusually low. Furthermore, the impact of such accommodation has not been felt as much as previous cycles would have suggested. In addition to the absence of demand pressures, the relatively subdued growth in money and credit extension, and the lack of significant gains in property prices over the past few years, suggest a lack of appetite among private agents for new borrowing. Most probably, the elevated degree of households’ leveraging at the time of the recession has acted as a constraint on their willingness and ability to respond to the sharp decline in interest rates. It is also noticeable that non-resident capital inflows into South Africa have not, in recent years, fed into the kind of fast domestic credit expansion that one saw in several Asian or Latin American economies. The South African Reserve Bank’s policy response I have already emphasised that the SARB does not target the exchange rate. Amid weaker economic growth, and with the currency depreciating for many reasons, several of which are independent of our domestic environment, raising interest rates aggressively in an attempt to prevent currency depreciation could quickly become a futile, if not counter-productive approach. The IMF recently highlighted in its latest issue of the World Economic Outlook that BIS central bankers’ speeches currency depreciation can play a welcome role as an absorber of shocks, including terms of trade shocks. This is the case, of course, as long as the depreciation does not spill over into lasting and more broad-based price pressures, or threaten the stability of a country’s financial system. The risk of price pressures is where the main focus lies for the SARB. Admittedly, financial stability is also an integral part of our mandate and focus. But at present, the latest rand depreciation does not pose immediate threats to financial stability. Due to prudent financial management by both the public and private sectors, South Africa’s foreign currencydenominated external debt represented less than 20 per cent of GDP as of the second quarter of 2015, even though it has risen in recent years.4 It is true that foreign debt issuance by South Africa’s corporate sector has increased quite significantly in recent years. However, it has not reached the levels seen in some other emerging countries, particularly in Asia. Furthermore, the banking sector’s foreign assets and liabilities remain relatively low, at 14 and 10 per cent of the banks’ total balance-sheets respectively, which means banks enjoy a positive “buffer” of net foreign assets. The most pressing concern for South Africa, however, would be a sustained, currency-induced overshoot of the 3 to 6 per cent inflation target, which could in turn “unanchor” broader-based inflation expectations from their current levels. These inflation expectations, as measured by the quarterly Bureau for Economic Research survey of analysts, trade unions and business leaders, have recently displayed greater stability than in the early years of the inflationtargeting era. However, they are anchored around the upper end of the inflation target, implying limited “margin for error” in the event of a severe or prolonged price shock. In addition, wage demands typically remain well in excess of the inflation target, and could very conceivably rise in the event of a lasting overshoot of that target, prompting an unfavourable wage-price spiral. Over the past couple of years, there has been evidence of a reduced exchange rate passthrough to inflation compared with previous cycles of rand depreciation. Core inflation – that is, headline inflation excluding food, petrol and energy – has actually slowed in recent months, from a high of 5,8 per cent in February 2015 to 5,2 per cent in October. Financial market participants have been cognisant of these encouraging developments, as shown by the relatively muted reaction of domestic bond yields to this year’s rand depreciation. This lower inflation pass-through of currency depreciation to consumer prices is not unique to South Africa. It has been observed in other emerging countries. Possibly, the lack of dynamism in demand around the world, the difficulties economies are experiencing in closing output gaps, and the very low inflation rates in the world’s major economies are reasons why the transmission channel of imported to domestic prices has been unusually muted. But perhaps because it is not yet well understood, this lower observed pass-through may indeed require increased vigilance. After all, the reaction of domestic prices may not be lower, but merely delayed. Central banks cannot afford any form of complacency. For this reason, the SARB’s MPC had to consider the optimal strategy on how to deal with an inflation path that looks set to remain mostly within target, but with clear and elevated risks of amongst others a more durable overshoot. The MPC could have taken advantage of the recent, moderately positive trends in core inflation to delay a hike in the policy rate and instead wait to assess potential market, currency and portfolio flow developments around the likely start of US policy normalisation. But, such an approach would have carried the risks of a further upward drift in inflation expectations and risks and, eventually, second-round effects that would have required an even stronger policy response. In light of the fragility of domestic economic growth, such delayed but more aggressive responses are best avoided. This measure excludes rand-denominated liabilities held by non-residents, which are also counted into the broad definition of external debt. BIS central bankers’ speeches Conclusion To conclude, let me again restate that the timing and speed of eventual US policy normalisation may be uncertain, but unless the US economy again experiences a durable loss of momentum, which is in nobody’s interest, it appears unavoidable. The best that emerging-market central banks can do is to be ready to respond to any potential negative side-effects on either price or financial stability. Some factors may play in our favour: because of the Fed’s concern about generating undue volatility in global financial markets, the general framework of future normalisation has been clearly laid out and, hopefully, well understood by markets. Consequently, one would also hope for a lesser reaction of financial asset prices, when US rates eventually rise, than at the time of the “taper tantrum” in 2013. Nonetheless, in light of the large degree of leverage in the world’s financial markets, and of still-stretched valuations in some categories of assets, relative stability of financial asset prices is far from guaranteed. Higher market volatility, at least relative to a few years ago, may become the norm. The SARB will continue to closely monitor any impact of such volatility on domestic market and economic variables, and react accordingly, if needed. Thank you. BIS central bankers’ speeches
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Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Institute of International Finance (IIF)-First National Bank (FNB) Africa Financial Summit, Johannesburg, 4 November 2015.
Lesetja Kganyago: African economic and financial development in challenging times Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Institute of International Finance (IIF)-First National Bank (FNB) Africa Financial Summit, Johannesburg, 4 November 2015. * * * Introduction Ladies and gentlemen, good afternoon. Allow me to first thank both the Institute of International Finance and First National Bank, our hosts, for inviting me to address this latest instalment of the IIF-FNB Africa Financial Summit. I am particularly honoured to join the impressive list of speakers and panellists. I have been asked to deliver the keynote address yet I do not want to pre-empt the debates that will follow. So, I will first try to summarise some of the challenges that our continent is facing. And, looking at the Reserve Bank’s own experience in the South African context, I will speak about implications for how Africa’s financial systems and its developing capital markets can best address these challenges and sustain progress in developing the continent. New global challenges for the African continent There is no denying that Africa is facing a more challenging global backdrop than in recent years; my colleague from the Bank of Tanzania, Governor Ndulu, as well as this morning’s panellists have already discussed some of these challenges. I will not dwell on them in detail, but would like to emphasise three key points. First, global growth again is disappointing. We heard last month how forecasters at the International Monetary Fund, or IMF, again downgraded their outlook for world economic growth: it is expected to reach 3,1 per cent this year, down from the 3,8 per cent expected a year ago. This decrease in expected growth is in keeping with the times, but it raises the concern about whether the weak growth is structural. Earlier this year, the IMF highlighted how medium-term growth expectations (five years ahead) had been steadily revised down since 2010, in both advanced and emerging economies.1 The fact that potential growth rates are falling makes explicit our global problem and the apparent inability of the world’s economy to fully recover from the global financial crisis of 2008. Rather, over the years, the crisis seems to have “morphed” from one of real-estate bubbles and lax underwriting standards, mostly in the US, to one of unsustainable debt burdens in the periphery of the eurozone, and now to one of excess corporate leverage and deteriorating macroeconomic conditions in several regions of the emerging world. Policy responses appear uncoordinated between regions, addressing some immediate problems but also fuelling imbalances and exposing policy contradictions elsewhere. Looking at the mix of slowing growth and high private-sector leverage in emerging Asia, in particular China, some observers wonder whether the world may face a repeat of the 1997–98 Asian crisis. Such concerns may prove excessive: in contrast to 1997, Asian sovereigns are financially more solid, with stronger reserve buffers and – a point I will return to later – more flexible exchange rates, which have limited the build-up of external International Monetary Fund, “Where are we headed? Perspectives on potential output”, World Economic Outlook, Washington DC: International Monetary Fund, April 2015. BIS central bankers’ speeches imbalances. Nonetheless, the era of lofty growth rates in Asia, driven by the fast expansion of China’s industrial sector, is most probably over – and this is a factor that African countries will have to take into account as their terms of trade weaken and export volumes decline. My second key point relates to the first, insofar as it deals with the outlook for commodity prices. When expressed in inflation-adjusted terms, the composite indices of commodity prices (like the Reuters-CRB index) are back to levels seen in the early 2000s, providing evidence – in case there was still doubt over the matter – that the commodity “super-cycle” of the last decade has by now truly reversed. It is likely true that other factors have exacerbated the decline in commodity prices: the rise in supply and financial factors, including the strength of the US dollar. However, a central driver of that decline has been the slowdown in demand from key marginal importers, the largest being China. It seems sensible to me to take at face value the Chinese authorities’ aim to rebalance their economy away from investment, and for that reason it would be unwise for African commodity exporters to bank on a strong price rebound in coming years. Finally, I would like to emphasise the potential challenges arising from the eventual normalization of monetary policy in the US. We know the debate remains open as to when this normalization will actually start and that the forecasts are for a gradual normalization. However, I fear we have been lulled into complacency by the years of abundant liquidity and a “search for yield”. Even a gradual unwinding of easy financing conditions will create greater competition for funds globally. The timing is not good. Sub-Saharan African countries have increased their funding needs by and large, and the potential for needs to increase is high as countries try to sustain spending even as growth, terms of trade and financing costs deteriorate. South Africa has not been immune to these challenges. With world demand sluggish and commodity prices declining, we have seen a loss of 9 per cent in our terms of trade between the third quarter of 2011 and the second quarter of 2015. The current-account deficit widened to as high as 5,8 per cent of GDP in 2013. And, while we saw a significant narrowing since (to as low as 3,1 per cent of GDP in the second quarter of this year), the Reserve Bank still expects a fairly large external shortfall in the next two years, worth close to 4,5 per cent of GDP. Net direct investment flows not far from zero, the country remains highly reliant on net portfolio inflows for the smooth financing of that deficit. Our statistics show a continued solid net portfolio inflow in the first half of the year, but JSE data paint a more challenging picture in the past two or three months, coinciding with renewed downward pressure on the currency. Currency implications and how to deal with them Downward pressure on the rand, as on many other emerging and African currencies, should not come as a surprise. When portfolio flows dry up (or reverse), the ex ante financing of large current-account deficits becomes problematic. What is more of a debating point, however, is how to deal with such currency depreciation. Back in the 1990s, many emerging countries opted for more or less stringent systems of fixed exchange rates (crawling pegs, hard pegs, currency boards), generally in the hope that such systems would help to get rid of perennial high inflation, bolster international policy credibility, and provide a strong basis for increased foreign investment flows. At first, fixed exchange rate systems did bring about some decline in inflation. However, they equally allowed the build-up of imbalances as they prevented the adjustment of relative prices to terms of trade, external demand shocks, and different productivity growth rates. In addition, they encouraged speculative, “hot money” inflows which aimed to benefit from positive interest rate differentials while the fixed exchange rate held. Eventually, as the experience of the 1997–98 Asian crisis or the 2001 Argentinian default showed, most peg regimes had to be abandoned before policy credibility was restored – though not without a significant BIS central bankers’ speeches rundown of official reserves, a severe inflationary shock, and a need for painful austerity measures. While we never had a formal fixed exchange rate regime, South Africa experienced some version of these problems in the early years of our new democratic dispensation. As South Africa reintegrated into the world economy, with import tariffs and capital controls significantly reduced, the prices of our major commodity exports declined, resulting in intense downward pressure on the real exchange rate of the rand. With inflation volatile and still high, the Reserve Bank intervened to stem the depreciation of the currency. But these attempts resulted in the country running a large net open forward position in US dollars – the same development that had triggered large-scale economic and financial turmoil in some Asian countries in 1997. It was only when South Africa moved to an inflation-targeting regime in 2000 and let the market determine the value of the currency relative to macroeconomic fundamentals that the sustained downward pressure on the currency eased. The contradiction between policy effort and macroeconomic fundamentals was removed, and slowly these also started to improve. Gradually but steadily, inflation moved downwards. Inflation expectations became more stable. And the Reserve Bank was able to wind down its forward position and rebuild a proper reserve buffer. Currency depreciation has always been trickier for economies that are more dependent on few export lines and require greater currency stability to keep inflation in check. For this reason, historically, many economies in Africa used currency pegs of one sort or another. Many have now moved away from that approach, opening up a channel that might help to address external shocks. With commodity prices falling, sub-Saharan African economies face a potential worsening of their internal relative price balance between tradables and nontradables.2 Assuming that inflation falls with declining export prices, moderate currency depreciation will help economies to rebalance and resume growth. Where inflation is persistent and economic growth weak, however, currency depreciation can exacerbate the stagflation and has less clear policy implications. It seems sensible to allow floating currencies to absorb external shocks, to maintain policy stances that do not worsen imbalances, and to move towards the microeconomic reforms and network infrastructures needed to help export diversification and sustain investment by the private sector generally. The experience of the Reserve Bank and reserves management The depreciation of South Africa’s currency has been in line with that of commodity exporters and other emerging markets, and substantial. So far this year, the rand has depreciated by 16 per cent against the US dollar. While the pass-through of such depreciation has been more muted than in previous cycles due to weak economic growth and moderate food price inflation, the Reserve Bank has nonetheless been closely monitoring any second-round effects from that depreciation. Aware of the risk that already-high inflation expectations are moving higher and of the overall loose stance of monetary policy, the Bank has raised interest rates by a cumulative 100 basis points since January 2014. The stance supports the economy while mitigating the risk of higher inflation. This represents a welcome contrast to the pre-inflation-targeting era when policy was tightened (by 690 basis points) and large US-dollar liabilities built up in an effort to more directly target a sharply weaker exchange rate. Our approach to the currency has been qualitatively different. In agreement with National Treasury, we unwound US-dollar liabilities and built a positive reserve position over time, with the objective of bolstering the national balance sheet and ex ante reducing the risk of The International Monetary Fund (IMF) has recently projected that the region’s terms of trade will drop by about 14 per cent in 2015. BIS central bankers’ speeches financial and/or liquidity crises. Our official reserves remain rather low by most metrics and by overall emerging-market standards. For African countries now facing lower commodity prices and a more challenging global financial environment, the quality of a nation’s external balance sheet seems of paramount importance. African central banks have slowly rebuilt reserve buffers over the last few years, but they remain relatively low by overall emerging-market standards. And as the global environment continues to worsen, policymakers need to focus more on the prudent management of external liabilities in order to maintain investor confidence. The growing role of financial stability Let me now say a few words about the role of financial stability and about the growing importance of stable, healthy and well-capitalised banking systems – as my colleague, René van Wyk, will no doubt discuss in greater detail in the next session. It was partly thanks to the prudent management of banks’ external exposure, on both the asset and the liability side, that South Africa was able to weather the shock from the 2008–09 global financial crisis without suffering severe domestic banking stains and, consequently, limit the duration and depth of its recession. Similarly, it was in part thanks to our prudent supervision of South Africa’s banks and their prudent management of risks that we weathered the global financial crisis as well as we did. In the recent past, South African banks have taken active steps to comply with the pending Basel III regulations, increasing in particular their ratio of liquid assets to short-term liabilities as the liquidity coverage ratio, or LCR, was phased in from 1 January 2015. For sub-Saharan Africa as a whole, issues of financial stability were mostly subsumed by the extension of financial services, reflecting in part the lack of depth in the credit markets in many countries of the region and hence the limited role that bank lending has played as a policy transmission mechanism and driver of inflation. However, things have been changing in that domain too. Credit growth has been particularly strong in several countries of the region in recent years, and while credit deepening is a welcome development, it also, if unchecked, carries risks. The IMF, in its Regional Economic Outlook for sub-Saharan Africa released on 27 October, points out that episodes of unusually high credit expansion tend to be associated with increases in financial risk and that phases of falling commodity prices are often linked with a deterioration in banks’ financial heath, such as a higher rate of nonperforming loans or a decline in the returns on banks’ equity.3 Chances and pitfalls from growing capital markets Admittedly, the financing of the economy, including in the emerging world, has long ceased to rely solely on banks, and capital markets have grown in the sub-Saharan African region in the past decade or so. In an environment of ample central bank liquidity and low returns on financial assets in the developed world, governments in the region have been able to take advantage of greater investor appetite for “frontier” markets. From negligible levels prior to 2009, sovereign bond issues in sub-Saharan Africa rose to more than US$6,0 billion in 2014.4 Similarly, the number of countries rated by the major agencies rose from only 4 in 2003 to 17 in 2014. By 2014, the stock of outstanding sovereign bonds in the region had risen to around US$18 billion, though it is still small at 1,1 per cent of regional GDP. International Monetary Fund, “Where are we headed? Perspectives on potential output”, World Economic Outlook, Washington DC: International Monetary Fund, April 2015. J E Tyson, Sub-Saharan Africa international sovereign bonds: investor and issuer perspectives, Overseas Development Institute, January 2015, available at http://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/9435.pdf. BIS central bankers’ speeches Furthermore, development in African capital markets has not been limited to sovereign bonds. Global flows into the region’s equity markets, while still very small compared to other regions, nonetheless grew in importance relative to the size of the recipient economies. The flow of capital into Africa is critical to its ongoing development. Access to capital has been greatly enhanced and a more competitively priced supply is currently offered, moving away from a reliance on official-sector financing. However, to ensure that benefits to borrowers are maximised, it is important that financing be transparent and that risk be fairly priced. Furthermore, where lending is overly risk-averse, the development of corporate bond, equity or even venture capital markets can facilitate the expansion of a private, mediumsized business sector. Finally, over time, as financial markets grow across the continent, one can equally expect to see increased cross-border portfolio and direct investment flows within sub-Saharan Africa, helping to facilitate regional economic and financial integration. These gains in hand, we need to be mindful of the risks associated with external portfolio financing. A tightening of financial conditions in the developed world can easily prompt international fund managers to reduce their exposure to frontier markets. What is then a small portfolio adjustment for a large US- or Europe-based fund, however, can result in significant price action on a small and relatively illiquid sovereign debt market. Rising foreigncurrency external liabilities equally expose a sovereign’s balance sheet to currency depreciation, limiting the benefits I described earlier of foreign-exchange adjustment as a “shock absorber”. In that respect, an increased focus on developing local-currency bond markets and on equity financing may present a solution to the risk of excessive foreign-currency leveraging. In South Africa, the existence of a large and liquid domestic government bond market, with long-maturity instruments, has limited the rise in foreign currency-denominated debt, even as our country has experienced large current-account deficits. The ratio of foreign-exchange debt to GDP stood at 26,8 per cent by the first quarter of 2015, up from 12,2 per cent in 2010. Had South Africa not been able to attract foreign capital inflows into rand-denominated bonds and equities, this ratio would have risen further. In sub-Saharan Africa, however, growth in local-currency bond markets has been stymied by the absence of a large and diversified domestic investor base, undeveloped secondary markets, and the lack of liquidity of many instruments.5 In most cases, moreover, the issuance of local-currency bonds has been limited to the sovereign. Where local bond financing consists mostly of domestic banks, the buying of government securities will tend to crowd out finance for a large number of private businesses and/or for much-needed infrastructure projects. In this respect, it would be desirable to see the growth in domestic securities markets occur alongside an expansion of the domestic investor base through incentives for longer-term savings via life insurance products, pension and provident schemes, and mutual fund investments. A deep domestic investor base can also act as a ‘buffer’ when non-resident investors reduce their investments. In South Africa, for example, yields on ten-year rand government bonds have increased by only 30 basis points since the start of 2014, even as (according to data from the JSE) non-residents sold domestic bonds to the tune of R60 billion over the period. If sub-Saharan Africa is to see a healthy expansion of both international and domestic investments in its securities markets, the region requires a strong governance structure, proper regulation and supervision, and adequate reporting and auditing standards in these markets. We should not underestimate, for instance, the impact on South Africa’s ability to See, for instance, M Mecagni et al., “Issuing international sovereign bonds: opportunities and challenges for sub-Saharan Africa”, Departmental Paper 14/02, Washington DC: International Monetary Fund, 2014. BIS central bankers’ speeches attract and retain foreign investments from our strong performance in this respect. Indeed, in the 2015 Global Competitiveness Report published this September by the World Economic Forum, South Africa continued to score first, among 140 countries, on criteria such as “financing through local equity market” and “strength of auditing and reporting standards”. We came second in the regulation of our securities exchanges and third in the protection of minority shareholders’ interests. Conclusion In conclusion, let me emphasise that the new challenges which our continent is facing, while real, are not insurmountable and, if properly handled, need not preclude continued solid economic growth in the years ahead. Major progress has been made in a range of areas that are critical to long-term economic development, not least of which was attaining a much more sustained level of macroeconomic stability across much of the region. This has been built on steady improvement in policy formulation and institutional development, but also on some favourable trade winds. These are now changing direction as commodity prices fall, so it is essential that policymakers double their efforts to sustain foreign interest in our economies and encourage diversification. Central to this effort, it seems to me, must be supporting financial and capital market development, deepening what we already have, and building robust regional linkages between our markets. Thank you. BIS central bankers’ speeches
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the African Central Bank Reserves Management 2020 Conference, Arusha, 1 December 2015.
Daniel Mminele: Challenges today – opportunities tomorrow Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the African Central Bank Reserves Management 2020 Conference, Arusha, 1 December 2015. * * * Good morning, ladies and gentlemen. It is indeed a privilege to have been invited to deliver the keynote address at this prestigious African Central Bank Reserves Management Conference. I would like to thank the Bank of Tanzania, Allianz Global Investors, and the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) for affording me the opportunity to share some thoughts regarding the challenges and opportunities we face in managing official reserves. Thank you also for creating this valuable opportunity to discuss and swap notes on best reserve management practices. The ever-changing landscape in the financial markets poses significant and exciting challenges for reserves managers, but change can also bring new opportunities, which could require a rethink in the way that central bankers manage official reserves. As is always the case with change, new risks also emerge. This is even the case when considering only the primary objective of capital preservation, for which historically there were seemingly simple solutions. In the not so distant past, there was a clear formula for achieving capital preservation by placing deposits with AAA– rated counterparties or buying highly rated government bonds. However, holding government bonds in the current environment may not necessarily guarantee capital preservation. For instance, in countries such as Germany, negative yields prevailing in the short to medium maturity notes actually guarantee not being able to achieve capital preservation. How to deal with negative interest rates is just one of the challenges we face as reserves managers. Judging by the structure of the agenda and the speakers for this conference, I have no doubt that many other issues will be unpacked, to help enhance our understanding as we grapple with these extraordinary economic circumstances that have created today’s trying conditions under which reserves managers have to operate. In my remarks this morning, I will touch briefly on the global economic and financial markets context; then talk about recent developments in reserves management, and the challenges currently facing central bank reserve managers. Before exploring, towards the end of my remarks, possible opportunities stemming from this changing global landscape, as we cast our eyes out to 2020, I will briefly share with you how we at the South African Reserve Bank (SARB) have been thinking about and approaching these challenges. Recent economic and market trends Due to the global financial crisis in 2007 and 2008, there was coordinated global easing in monetary policy in an effort to boost the global economy. Given the severity of the crisis, it is probably fair to say that investors and other market participants had believed this would remain the policy stance for a protracted period. But the game changer came in May 2013 with what is now commonly referred to as the ‘taper tantrum’, when the then Fed Chair, Ben Bernanke, indicated that the authorities may consider reducing the pace of asset purchases. This was the starting point of markets needing to adjust to a world of diverging monetary policies. Since then, the Federal Reserve has entirely ceased with its asset purchases by slowly reducing its monthly purchases to zero from December 2013 to October 2014. Subsequently, the debate shifted to the timing of the rate hiking cycle. While the United States (US) has BIS central bankers’ speeches shown sound economic performance amid resurgent domestic spending, and indications by the monetary authorities of the need to reduce the accommodative stance in interest rates, the market chose to focus on the lack of consumer and wage inflation. Consequently, there was a divergence between the indication from Fed officials and the market pricing about the expected path of interest rates, adding uncertainty and volatility to the market. More recently, labour market statistics and Federal Open Market Committee (FOMC) communication has seen the market move to bring forward its rate hike expectations, with the chance of a December hike now priced at around 74 per cent. During this period of uncertainty in the US markets, the European Central Bank (ECB) embarked on quantitative easing with consequential negative interest rates. On 18 November 2015, Germany issued 2-year bonds at a record low of –38 basis points! The spread of the US 10-year yield over the equivalent maturity German bond is now trading around 175 basis points, close to its historic high of 190 basis points. At the same time, China’s process of transitioning to a more domestic, consumption-driven economy from one that is investment-led and relies heavily on exports, was a major factor in slowing down its overall economic growth. We are all acutely aware that this slowdown adversely affected commodity prices and export-driven countries, which has severe repercussions for emerging-market economic growth, including on the African continent. In addition, the falling oil prices, partially due to downward revisions to Chinese growth expectations, contributed to keeping inflation tame and adding to the deflation dilemma in some developed markets. Today, we therefore face divergent monetary policies, with the US on the verge of increasing interest rates, likely to be followed by the United Kingdom next, while the Eurozone and Japan are set to continue with looser monetary policies. This dichotomy presents reserves managers with a clear dilemma: investments in US treasuries may produce negative returns during an interest rate hiking cycle. At the same time, with reserves generally reported in US dollars, non-US dollar investments are expected to underperform in response to an expected stronger US dollar. This is of course adding to the complexity faced in global policy-making and investor decision-making. Trends in reserves management With the investment environment clearly becoming more complicated, it may be useful to review recent trends in reserves management, both globally as well as on the continent. According to International Monetary Fund (IMF) data, global foreign-exchange reserves (excluding gold and Special Drawing Rights (SDR) increased from US$2,5 trillion to US$8,3 trillion, or 332 by per cent, in the ten years to 2014. Over the same period, total foreign-exchange reserves in Africa increased from US$81,9 billion to US$271,8 billion, or 331 per cent. This sudden increase in reserve accumulation did not happen in isolation. The increased globalisation of economic relationships brought with it the requirement for holding additional reserves. This as many of the reserves adequacy metrics will involve the ratio of either trade data or debt levels to gross domestic product. Consequently, as economies open up, so their required reserve holdings need to increase. Such strong growth in reserve holdings brought with it a number of changes in reserves management practices. According to the April 2015 HSBC Reserve Management Trends Survey, conducted in association with Central Banking Publications, central banks continue to focus on diversification into non-traditional markets, such as Australia, Canada, Scandinavia and, recently, China. Central bank respondents to the survey expect that the Chinese Renminbi will reach 10 per cent of global reserves by 2025. In terms of asset classes, more than 20 per cent of central banks are either investing now or considering investment into emergingmarket bonds and equities. Furthermore, more than 10 per cent of the respondents indicated that either they are investing now or considering investment into exchange-traded funds. BIS central bankers’ speeches Interestingly, the survey also points out that about 70 per cent of central banks are active in, or considering, securities lending. Based on our interactions with colleagues in other central banks on the continent, the recent focus among African reserves managers has been on: (i) formalising the investment decision processes; (ii) introducing the use of bond futures for efficient portfolio management; and (iii) investigating the viability of including Chinese bonds, onshore and/or offshore, into their reserves portfolios. Work currently under way under the auspices of the Committee of Central Bank Governors of the South African Development Community (SADC) indicates convergence in reserves management practices in this sub-region of Africa. The initial research results show that reserve management activity in the region is governed by proper policies and guidelines, and nearly all central banks have adopted strategic asset allocation (SAA) frameworks. It also notes that there is a general approach of using tranching when constructing reserve portfolios. The SAA framework determines tranche sizes where relevant. Most central banks invest in cash, cash equivalents and fixed income instruments, with the US dollar and the euro being common currencies in all portfolios. Challenges facing reserves managers With that contextual backdrop, and before moving on to discuss some of the challenges faced by reserves managers, it is worth reflecting on one of the consequences of the global financial crisis that we are still grappling with today. This is the deterioration in the credit quality of the reserve currencies. Since 2008, using Standard & Poor’s ratings, we have seen the Japanese government debt being downgraded from AA to A+ and the US drop from AAA to AA+. Within Europe, while Germany has remained AAA-rated, France was downgraded from AAA to AA and peripheral European countries such as Spain (from AAA to BBB+) and Portugal (from AA- to BB) saw an even more dramatic drop in their ratings. This narrowed the high-grade investment universe, requiring, in some instances, adjustments in investment guidelines to accommodate these changes. With issuers consequently falling outside the traditional investment universe, finding yield-enhancing assets became more difficult. These challenges persist and with the continued subdued global economic growth outlook are unlikely to go away anytime soon. Moving on to developments that are more recent, and with reference to my earlier discussion on diverging monetary policies, the key challenges that reserves managers have been facing since the latter part of 2013 have been around the ongoing uncertainties on the timing of the rise in US interest rates and the negative yields in Europe. This has required reserves managers to take stock of their SAA as well as review their tactical strategies. For central banks with low reserves, the SAA tends to be set along the currency patterns of their foreign trade and external debt. While debt obligations tend to be dollar based, trade patterns can vary more significantly. I remarked earlier that all SADC central banks have euros in their portfolio, which reflects the importance of this region to the continent. However, central banks typically invest in maturities up to three-years, and this part of the German yield curve has negative yields of around 40bps. For countries with larger reserve holdings, there are opportunities to enhance returns through lengthening the maturity of investments or adding credit risk to the portfolio. However, such strategies in turn bring additional market and credit risk to the portfolio, potentially coming into conflict with the overarching objective of capital preservation. With expectations of higher interest rates in the US, the dollar has strengthened and investors have started to shy away from investing in commodities, including gold. According to Bloomberg, the amount of gold held in exchange-traded funds has dropped from 2,633 tonnes in late 2012 to 1,494 tonnes in November 2015. There has been a striking correlation between the gold held by these funds with the dollar price of gold. Gold holdings in these funds are still substantially higher than pre-2008 levels and therefore there is a risk BIS central bankers’ speeches of further unwind. For South Africa, the decline in the gold price has seen the dollar value of gold holdings decline from US$ 7,1 billion in September 2012 to US$ 4,6 billion at the end of October 2015. Another consequence of the global financial crisis was a significant tightening in the regulatory framework. The new regulatory environment (introduction of Basel III and DoddFrank) in financial markets has raised concerns about liquidity, especially in fixed income markets. The concerns stem from the fact that many global investment banks and market makers are adjusting their balance sheets, and consequently their business operating models, in order to comply with these new regulations and deal with the associated costs structures. As reserves managers, we should be acutely aware of how market liquidity develops so that we are confident that we will be able to convert assets into cash when required. The risk is that it is exactly in crisis times when central banks may need to tap into reserves, and it is in crisis times that market liquidity tends to disappear. Finally, we should not overlook the role of technology, which is another challenge reserves manager are dealing with. With the growing complexity of the investment environment reserves managers are required to enhance their analytical skills and capabilities, but the increasing cost of technology could stand in the way of a proper assessment of the long-term benefits of such essential investment. This is particularly important for central banks diversifying into new assets classes across various currencies and instruments. It is essential for reserves managers to invest in prime technology in order to receive an optimal riskadjusted return and reduce the probability of negative returns. At the SARB, we are keenly aware of the benefits and risks associated with new technology, a subject I will return to in a moment. The South African Reserve Bank’s response to these challenges One of the steps the SARB took when thinking about how best to deal with expected higher rates in the US was to include the use of bond futures in its investment guidelines in order to provide an efficient way to protect the internally managed bond portfolios invested in the US and other major markets. Secondly, the SAA was diversified to allow investment into currencies of some of the high credit-rated and liquid bonds from markets with low debt to gross domestic product (GDP) ratios. For the SARB, this meant fixed income investments in Canada, Sweden, South Korea, and China. The diversification into the Chinese onshore bond market was a result of a strategic view on the long-term outlook for the role of China in the global economy and its economic relations with South Africa. The Chinese bond market also offered good yields together with diversification benefits that have proved to be very valuable. In addition to the diversification of our currency universe, the SARB included high-rated covered bonds and mortgage-backed securities in the SAA in order to diversify the sources of return and reduce the negative impact of rising rates on the overall portfolio. Other strategies employed by the SARB to reduce external vulnerability and ensure access to foreign exchange in times of stress included negotiating swap lines with the Peoples Bank of China (PBoC) and the Contingent Reserve Agreement among the BRICS nations. Lastly, the SARB is making considerable investments in improving technology by acquiring new systems and staff capacity so as to future-proof the reserves management function. We have undertaken a comprehensive review of our system architecture used in the management of gold and foreign-exchange reserves. To this end, we have decided to replace our existing IT system with a new one, more appropriate to our current and future needs, so as to enhance the reserves management value chain. BIS central bankers’ speeches Potential opportunities for reserves managers What opportunities does the current environment provide when we think about the next five years or so? Firstly, the prospect of higher rates in the US will provide an opportunity for reserves managers to invest in higher yielding but safer investments. The indication by the FOMC that it intends to raise rates at a measured pace should help manage the risk of negative portfolio returns. As central banks tend to invest in short maturity bonds with a duration of three years or shorter, a ‘sweet spot’ may exist in that when rates are expected to increase modestly, longer maturity investors may shorten durations in order to avoid losses, keeping the short end of the yield curve somewhat supported. As the bulk of global reserves are held in US dollars, there is no doubt that after some initial mark-to-market losses, higher rates will in due course increase the yield in the portfolio. Here it becomes important for reserves managers to focus on the investment horizon, and not on annual financial accounting outcomes. After the global financial crisis, bond yields in the developed economies became highly correlated as these countries added stimulus to their economies in order to avoid, among other things, deflation. Consequently, risk adjusted returns of portfolios invested in advanced economies were depressed owing to the loss of diversification benefits. The current diverging monetary policies may in future provide diversification benefits, which will improve the riskadjusted returns of the overall portfolio of reserves. Furthermore, African countries have improved in respect of overall political and economic stability, thus providing possible opportunities for long-term stable investments. As these countries provide both hard and domestic currency investments, the weaker exchange rates could now be providing entry points for reserves managers who may want to diversify their investments and benefit from the higher yields. Likewise, the devaluation of the Chinese Renminbi in recent years may have created an opportunity for reserves managers to enter the market at a more favourable exchange rate. With the Chinese authorities taking steps to support economic growth and recent measures announced to further internationalise the Renminbi, the Renminbi is likely to become more attractive. The most recent reforms have certainly made things a lot easier for central banks in particular. In this light, and with the Renminbi set to be included into the IMF’s SDR basket from October next year, following approval by the IMF executive board yesterday, central banks and other official institutions are likely to include this currency into their reserves portfolios (or increase current holdings). An opinion piece by Jukka Pihlman in yesterday’s Financial Times pointed to the potential significant demand for Renminbi, estimating that even a conservative one per cent reallocation of global reserves each year would result in inflows of about USD80bn annually. Amid the lack of allure of traditional government bonds, which could be in play in the foreseeable future, alternative instruments and assets, such as equities, could feature in future SAAs. Some research has shown that improved capital preservation, while generating somewhat higher returns, is on offer from equities relative to bonds. But any broad based moves into equities will be highly country-specific. Concluding remarks There can be no doubt that the game has changed for central bank reserves managers. The fast changing world and investment landscape is requiring of reserves managers to adapt to a playing field that is characterised by high levels of uncertainty and volatility, resulting in the need to reconsider investment strategies on a more frequent basis. This will necessitate SAA processes that are vigilant and rigorous. Old and trusted assets are not yielding returns and some are even eroding capital. New instruments and assets that fall within the familiar and accepted investment universe are not plentiful. BIS central bankers’ speeches Reserves managers must keenly evaluate factors such as investment time horizons, what constitutes and acceptable risk-return balance, what role alternatives should play alongside traditional asset classes, and whether our traditional benchmarks still fit it in with new strategies. However, at all times reserves managers must also remember that they are custodians of public funds, and have to be guided by prudent strategies, which implies that there must be a limit to “thinking outside the box” in the quest for ever higher returns. Dealing with these challenges will certainly require human capital that is appropriately skilled, and equipped with the right technology. Conferences such as this one present a unique opportunity to share experiences, and transfer skills and knowledge among African central banks, as it brings together central banks with private-sector players, and development institutions, a uniquely powerful combination. I understand that the conference is the culmination of two years of work involving members of the East African Community. I would encourage the organisers to find ways of sustaining this momentum. Finally, I trust that you will leave Arusha with better insights and an improved network of contacts in the central banking community to help you navigate the future as you strengthen reserves management practices in your own environments to the benefit of your respective central banks and countries. Enjoy the rest of the conference. 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 European Economics & Financial Centre (EEFC), London, 12 January 2016.
Daniel Mminele: Recent economic and monetary policy developments in South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the European Economics & Financial Centre (EEFC), London, 12 January 2016. * * * Your Excellencies, distinguished guests, ladies and gentlemen. Thank you to Professor Scobie and the Board of the EEFC, and I am truly humbled by the invitation to participate in the Distinguished Speakers Seminar Programme. Let me start by thanking the European Economics and Financial Centre for the good work they are doing in seeking to forge closer links between theorists and practitioners in economics and finance. I guess when it comes to monetary policy, that’s where the art and the science meet. Your work reminds me of the quote that is attributed to Yogi Berra that “In theory there is no difference between theory and practice, in practice there is.” The practice of monetary policy has been undergoing significant changes, and it will be interesting to see how much of all that ends up being embodied in the theory. The New Year is typically a time for reflection and as such I thought it appropriate to start by reflecting on some of the recent international economic developments. I will then focus on South African economic developments and end with a consideration of some of the issues that will warrant attention in the monetary policy sphere in the year ahead. International economic developments and outlook Over the past year, the global economy has struggled to gain traction. Unfortunately this has been an all too familiar theme in the aftermath of the global financial crisis. According to the IMF, world growth for 2015 is expected to have slowed to 3.1 per cent, from 3.4 per cent in 2014, reflecting a weaker than anticipated recovery in advanced economies and, more significantly, broad-based weakness in emerging market economies. The IMF expects growth to pick up in the coming year, to 3.6 per cent with downside risks continuing to dominate. 1 A further slowdown in China and other emerging markets (EMs), tightening financial conditions and lower commodity prices could provide significant headwinds to growth going forward. The volatility in financial markets in the first week of 2016, influenced to a large extent by ongoing concerns about Chinese growth and uncertainties about the policy response of authorities, served as a reminder that many investors remain very nervous about the road ahead. Then there is the issue of geopolitical risks, which unfortunately have also shown signs of escalating of late. Global growth in 2015 was driven by the advanced economies and in particular by the sustained recoveries in the United States and United Kingdom. The US experienced higherthan-expected growth in the third quarter, which, together with robust domestic private demand and job creation, allowed the Fed last month to finally embark on its much anticipated lift-off as part of policy normalisation. Market participants viewed the Fed’s statement following the December FOMC meeting as somewhat dovish, reinforcing the gradual prospective path of normalisation. Furthermore, as demonstrated by the FOMC’s “dot plots” over the last few FOMC meetings, the range of the projected target federal funds rate has narrowed, signifying a more clearer and coherent path of normalisation. Such perceived moderation of the Fed’s expectations, together with ample advance notice through its communication strategy, no World Economic Outlook, IMF, October 2015. BIS central bankers’ speeches doubt helped markets digest the dreaded “first hike in the cycle” (the first increase in the Fed funds target in almost ten years) without major price swings. In Japan and the euro area, however, growth remains weak and fragile. The euro area expanded by an annualised 1.2 per cent in the third quarter, and indicators ranging from business confidence to credit growth are showing increasing signs of upward normalization. However, concerns over a lack of pricing pressures 2 prompted the ECB to lower its deposit rate and extend its QE programme last month. On the other hand, even as Japan avoided a technical recession in the third quarter, inflation remains well below its 2 per cent target level. Going forward, it is anticipated that growth in advanced economies will strengthen on the back of supportive fiscal and accommodative monetary policies and lower commodity prices. However, weaker growth in emerging markets and resultant feedback loops, harbour downside risks. Emerging market growth continued to disappoint in 2015, with the slowdown in China, recessions in Brazil and Russia and weak commodity prices dominating the outlook going forward. China continues to rebalance its economy, and according to the IMF is expected to have grown by 6.8 per cent in 2015, and achieve growth of 6.3 per cent in 2016. 3 Monetary policy continues to support the economy, with the People’s Bank of China reducing the policy rate by 165 basis points in 2015, and new fiscal measures announced in 2015 should help shore up demand and avoid a hard landing. Meanwhile the Chinese financial markets have gained in prominence in the past few years, which is why the turbulence over last week warrants particular attention. The Chinese authorities’ decision to implement and then remove the 7 per cent “circuit breaker”, which was triggered twice in the week, was a significant development and may suggest that financial market volatility may well be something that we have to live with for the time being. On a more positive note, India’s strong growth momentum continues. The IMF expects India to grow faster than China for the first time since 1999, forecasting GDP growth of 7.3 per cent in 2015 and 7.5 per cent in 2016. Indeed, India’s economy grew by 7.4 per cent, year on year, in the third quarter, making it the world’s fastest growing major economy for that quarter. In Russia, third quarter data suggests that the pace of contraction, and the impact of declining oil prices and political sanctions may be slowing. Prospects for Brazil, however, remain challenging, with the economy contracting by 4.5 per cent, year on year, in the third quarter. Meanwhile the 10.7 per cent year on year increase in consumer prices recorded in December confirmed that Brazil missed their inflation target for the first time in more than a decade. Political challenges have weighed heavily on consumer and business confidence, while cutbacks in public investment and government spending will impinge on the growth prospects in the near-term. Closer to home, the growth momentum is slowing in sub-Saharan Africa (SSA). Since achieving growth of 5.0 per cent in 2014, the region is forecast to grow by 3.8 per cent in 2015, and 4.3 per cent over the coming year. 4 As you are aware, the region is dependent on commodity exports and as such has been hard-hit by the decline in commodity prices and the slowdown in global trade. Oil exporters, such as Nigeria and Angola, have been severely affected, with growth for this group of countries expected to drop from 5.9 per cent in 2014, to 3.6 and 4.2 per cent for 2015 and 2016 respectively. The further unexpected decline in oil prices that we have witnessed since the beginning of the year does not bode well for growth prospects and may result in actual outcomes being worse than current forecasts. Yet even for oil-importers, reduced demand for raw materials has meant that the benefits of cheaper energy imports have been offset by the general decline in commodity prices, which have decreased Inflation in the euro area stands at only 0.2% y/y in both November and December 2015. World Economic Outlook, IMF, October 2015. All data on sub-Saharan Africa from the Regional Economic Outlook for sub-Saharan Africa, IMF, October 2015. BIS central bankers’ speeches by approximately 40 to 60 per cent between January 2013 and August 2015. In several African countries, the decline in prices of commodity exports has also led to a deterioration in both external and government balances, which had already been stretched by ambitious public infrastructure programmes and some relaxation of government spending discipline. In an environment of higher US interest rates, international diversification of investments is less forthcoming with a result that many countries in the region have found that external financing has become more difficult, or at least more costly. This has been the case of middle-income countries on the African continent, such as Ghana and Zambia, where tighter financing conditions as well as supply constraints are expected to weigh down on growth. Other countries, however, face fewer of the aforementioned constraints, such as Kenya and Senegal, and are expected to see an acceleration in economic activity, supported by public investment and private sector activity, respectively. For lowincome countries in the region, the outlook is more favourable, mainly as a result of robust infrastructure investment and private consumption driving growth. On average, this group of countries is expected to grow by 6.0 per cent in 2015, which while impressive, is still roughly three quarters of a percent lower than was forecast by the IMF in October 2014. This downward revision highlights the challenging headwinds facing the region. In the context of persistently low commodity prices, less favourable financial conditions, currency pressures, and external and fiscal vulnerabilities, risks to the outlook for sub-Saharan Africa remain on the downside. On the inflation front, global inflationary pressures are subdued. In advanced economies, lower commodity prices and weak growth have led to lower inflation, and even deflation in some cases. Core inflation is expected to remain soft in advanced economies over the next two years, 5 reflecting persistent slack and lower import, particularly energy prices. In emerging markets the picture is more mixed. In Latin America, countries such as Chile, Colombia, Peru and Brazil have raised interest rates, as currency depreciation has led to a rise in inflation, and inflation expectations in some cases. However, in other emerging markets, particularly in Asia, policy rates have been eased in order to support growth. Overall, despite significant currency depreciations faced by emerging markets, inflation pressures in general remain fairly contained mainly as a result of weak demand. Moving to the economic outlook for 2016, one issue that is likely to dominate the policy landscape is the tightening of international financial conditions and the impact that this may have on emerging markets. In the aftermath of the financial crisis, extraordinarily accommodative monetary policies in the advanced economies and the search for yield, combined with the relative strong growth performance of many emerging markets, drove strong capital inflows into emerging markets. However, as you are aware, there has been a turning of the tide. This is in response to both the beginning of monetary policy normalisation in the US, as well as the weakening fundamentals in many EMs. For example, the IIF expects non-resident inflows to emerging markets to have reached US$ 548 billion in 2015, below the levels recorded in 2008/2009, and for net capital flows to EMs in 2015 to have been negative. As a share of emerging market GDP, capital inflows are estimated to have fallen from a high of 8 per cent in 2007 to 2 per cent for 2015. 6 China accounts for a large proportion of these outflows, with the IIF estimating capital outflows of over $500 billion from the country in 2015. The market turbulence experienced in September and October 2015, as well as in the past week, also highlight the manner in which developments in China, and fears of a crisis in emerging markets, will influence financial market conditions. Whilst the announcement of the initial Fed rate hike removed one source of uncertainty, other potentially more disruptive risks persist. Economic Outlook, OECD, November 2015. Capital Flows to Emerging Markets, IIF, October 2015. BIS central bankers’ speeches Despite the weakness and uncertainties that exist in the outlook for advanced economies, developments in emerging markets are likely to prove crucial for the global economy in 2016. Between the 1980s and present, emerging markets and developing countries’ share of global GDP growth (in PPP terms) has doubled to over 70 per cent. 7 The growing importance of emerging markets to the global economy implies that a faster slowdown in China, or a protracted slowdown in EMs in general, could threaten the fragile global recovery. Recent research by the World Bank indicated that on average, a one percentage point decline in growth in BRICS countries could lead to a reduction of global growth of 0.4 per cent over the next two years. 8 At the same time, EMs face significant headwinds in the form of monetary policy divergence in the advanced economies, weaker commodity prices, dwindling policy buffers and a weak global growth and trade outlook. Further dollar appreciation and an increased sensitivity of EM yields to US rates not only pose risks to growth and inflation in many emerging markets, but also to financial stability, through balance sheet exposures. Policy makers globally need to commit to policies aimed at boosting both actual and potential output, in order to support a strong, sustainable and balanced global recovery. Looking to the near-term, demand management measures also have a role to play in supporting growth outcomes globally. In many advanced economies, negative output gaps and low inflation trends allow for a continuation of accommodative monetary policies, and in some instances for more expansionary fiscal policies. In many emerging markets, however, the scope for both monetary and fiscal easing has narrowed, as policy makers look to manage rising vulnerabilities. In many cases cyclical policies need to move in sync with structural reform measures aimed at boosting potential growth in the medium-to-long term. Globalisation and interconnectedness are key features of the world economy. Thus, exogenous influences are an integral part of policymaking today. This includes, inter alia, the spillover risks generated by policy decisions in large key economies such as the US or China. To further support global growth, there is therefore a need for continued global cooperation, and well calibrated communication, in order to mitigate the negative spillovers national policies may generate. South African economic developments and outlook 2015 was a challenging year for the South African economy. Despite consecutive contractions in the primary sector in the second and third quarters, we avoided a technical recession in the third quarter. The economy registered annualised growth of 0.7 per cent in the third quarter, driven by a rebound in the manufacturing sector. Growth continues to be constrained by certain cyclical elements, such as weaker global trade and commodity price declines, as well as more idiosyncratic factors. Electricity shortages, although easing somewhat as more generating capacity has come online, continue to constrain production in some of the energy intensive sectors of the economy. In addition, the recent drought, said to be the worst in decades, has had a severe negative impact on the agricultural sector, which may worsen in coming quarters. Indeed initial crop estimates indicate that South Africa will likely need to import a significant amount of grain this year. Looking to the year ahead, as at November last year the Bank’s projections for growth was 1.5 per cent for this year and 2.1 per cent in 2017 as electricity constraints ease, but the risks remain skewed to the downside. The slowdown in China and persistently low commodity prices are expected to have a negative impact on the mining sector, which, while contributing only 5 per cent to GDP has accounted for more than 60 per cent of South Africa’s export revenues over the past decade. Internal estimates by the Reserve Bank indicate that the drop in commodity prices between June and November 2015 could take a quarter of a percent off real IMF WEO database. Global Economic Prospects, World Bank, January 2016. BIS central bankers’ speeches GDP growth in 2016. 9 With regard to manufacturing, the Barclays Purchasing Managers’ Index fell sharply in November from 48.1 to 43.3 index points – the lowest level since August 2009, suggesting a constrained outlook for the sector. Furthermore, business confidence remains low, with the SACCI Business Confidence Index for December 2015 declining by 3.1 index points to 79.6, when compared to the month prior. The 2015 annual average of the Business Confidence Index is at the lowest level since 1993. Unsurprisingly, in light of the weak growth prospects for the South African economy, and low levels of business confidence, growth in gross fixed capital formation has remained subdued. After reaching a five-year low in 2015, private sector fixed investment growth has since picked up slightly. The SARB expects private sector fixed investment growth to reach 1.6 per cent in 2016, from 0.4 per cent in 2015, with electricity shortages and weak demand for commodities being among the main factors responsible for this subdued outlook. 10 On the demand side, the financial position of households remains under pressure, despite some gradual deleveraging since the global financial crisis. Consumer expenditure growth remains weak as a result of a moderation in real income growth and low levels of consumer confidence. Real spending on durable goods contracted in the third quarter of 2015 – the first contraction since the second quarter of 2009. Credit extension to the household sector has been weak over the last few years, and is likely to remain so in the future, given the subdued growth and employment prospects South Africa faces over the short- to medium-term. Unemployment remains high, at 25.5 per cent. With electricity price increases and last year’s personal tax increase further constraining consumer income growth, the Bank projects household consumption growth to be below 2 per cent for 2015 and 2016. According to the World Bank, structural impediments have been putting a brake on emerging market growth, with declining potential growth, on average, accounting for a third of the slowdown in EMs since 2010, South Africa being no exception. 11 Our estimates suggest that potential output growth for 2015 in South Africa was around 1.8 per cent, the lowest since the transition to democracy, and a significant decline from the 4.0 per cent level in the pre-crisis period. 12 However, monetary policy has a limited role to play in boosting potential growth. Structural policies are needed to boost the productive capacity of South Africa and promote the steady growth that is needed to make a meaningful dent in our unemployment figures. The Infrastructure Development Act and Employment Tax Incentive introduced by government are meant to address some of the structural impediments in the economy. Like other emerging markets, South Africa has felt the impact of tighter international financial conditions. Data shows that portfolio flows into South Africa and into emerging markets as a whole have followed the same trend since 2010. Consequently, South Africa’s recent experience of capital outflows and currency pressures has displayed similarities with the rest of the emerging world. Between September and November, non-resident sales of equities amounted to R25.9 billion, while net bond sales amounted to R5.9 billion. We have also observed that, in recent years, capital inflows have been increasingly sensitive to shifts in the US yield curve; while the rand, since May 2013, has been negatively correlated to US Treasury yields. Given these experiences, the lift-off in the US suggests that were higher Fed funds rates to push longer-term US yields higher, South Africa could anticipate tighter financial conditions and further pressure on the rand. Indeed, immediately following the announcement, the rand Monetary Policy Review, SARB, November 2015. Monetary Policy Review, SARB, November 2015. “Slowdown in Emerging Markets: Rough Patch or Prolonged Weakness?” by T. Didier, M. Kose, F. Ohnsorge and L. Ye, World Bank Policy Research Note PRN/15/04, December 2015 Monetary Policy Review, SARB, November 2015. BIS central bankers’ speeches fell against the dollar, although it subsequently rallied somewhat, and government bond yields rose. While some volatility was expected, the relatively muted market response in South Africa and elsewhere is encouraging, and suggests that the rate hike was mostly priced in by the market. Continued clear communication by the Fed will be instrumental in containing the potential negative spillovers of US monetary policy to emerging markets going forward. Rand depreciation remains a significant source of risk for the South African economy. While many peer emerging market currencies have also faced currency depreciation and volatility, the rand has, on average, underperformed. Since the beginning of last year, the rand has depreciated by 44 per cent against the US dollar, 48 per cent against the Yen, and 31 per cent against the euro. Furthermore, since the end of 2015, the rand has also lost ground against other emerging market currencies. It is clear that both external and internal developments have been driving the rand weaker. Tighter global financial conditions as the beginning of Fed normalization approached, uncertainties regarding the rebalancing in China and the consequent decline in commodity prices, have played a part – unfortunately, these factors may well persist into the coming year. Domestically, weaker growth prospects and perceptions around political events such as the cabinet reshuffle resulted in volatility in the local financial markets increasing sharply just before year-end. Markets initially reacted extremely negatively to the developments, with local assets experiencing severe selling pressure. The exchange rate of the rand touched what was then a historic low of R16.05 against the US dollar, the benchmark R186 government bond yield reached its highest level in seven years of 10.62 per cent on 11 December, while the country’s 5-year CDS spreads also widened substantially by 72 basis points relative to emerging market peers. Part of this selloff was later reversed, but the impact of this on investor sentiment, as well as local business and consumer confidence may linger. This is particularly true in the context of recent sovereign credit downgrades. The seemingly persistent current account deficit, which currently stands at 4.1 per cent of GDP, remains another source of vulnerability. Despite a drop in the price of oil and the depreciation of the rand, the current account deficit widened in the third quarter of last year, after benefiting from a temporary positive trade balance in the previous quarter. Despite recording a small net inflow of foreign direct investment in our financial account in the third quarter of 2015, portfolio flows dominate, and this makes us vulnerable to changing risk sentiments in the markets. In terms of the trade account, despite the depreciation in the currency, slower growth in export volumes and the decline in commodity prices have meant that South Africa only experienced marginal growth in the nominal value of merchandise exports. At the same time, the value of merchandise imports rose by 3.6 per cent in the third quarter of 2015, driven by a boost in the quantity and price of imports, as a result of the weaker rand. Intermediate and capital goods account for approximately three quarters of South Africa’s imports, and as such our demand for imports remains relatively price-inelastic. Furthermore, key export sectors, such as mining and manufacturing, have been unable to fully exploit the benefit of a weaker rand due to electricity constraints and labour disputes, not to mention the impact of lower international commodity prices and demand. Our external vulnerability is however mitigated somewhat by our level of reserves, measured in terms of import cover, which increased from 4.8 months in June to 5.2 months in September. Relatively low levels of foreign-denominated debt also limit the financial stability risks that can arise as a result of currency depreciation. Foreign debt of government remains low, at 9.8 per cent of total gross loan debt of national government, and 4.8 per cent relative to GDP as of the end of the third quarter. Furthermore, South Africa’s proportion of total foreign debt as a percentage of GDP is also relatively low, at 41.6 per cent. Unlike in some other EMs, the issuance of international debt by non-financial corporates, while having picked up over the last couple of years, does not present a significant financial stability risk, as many of these corporates are commodity exporters or other multinationals likely to have hedged their foreign currency assets and liabilities. BIS central bankers’ speeches As outlined in the most recent Medium Term Budget Policy Statement (MTBPS), and echoed by Finance Minister Gordhan, South Africa remains committed to a path of fiscal consolidation. The budget deficit for 2014/2015 was 3.6 per cent of GDP, and is expected to reach 3.8 per cent in 2015/2016, before narrowing to 3.0 per cent in 2018/2019. Implementing the fiscal sustainability measures as detailed in the most recent Policy Statement, in conjunction with the structural reforms needed to address impediments to growth, are all crucial in these times and this is something that the authorities are cognisant of and remain committed to achieving. While South Africa is currently facing some headwinds, the fundamentals underpinning the South African economy, such as the strong macroeconomic policy framework and the strength of institutions, provide the platform from which to successfully implement structural reforms that will lift both potential and actual growth and enhance resilience to external shocks. The South African monetary policy outlook Over the past year, the South African Reserve Bank has faced the policy challenge of rising inflationary pressures amid weak domestic growth and significant external headwinds. The deterioration in the inflation outlook over the past year prompted the SARB to raise the repo rate by 25 basis points in July and again in November 2015. Looking ahead, domestic constraints, exchange rate developments, the domestic drought and tighter financial conditions pose significant risks to the inflation outlook, and will continue to inform the monetary policy stance of the Bank in 2016. Headline inflation for 2015 is expected to have averaged 4.6 per cent, on the back of low oil prices, well within the target band of 3 to 6 per cent. However, the SARB forecasts show that inflation will pick-up over the next two years, averaging 6.0 per cent for 2016, with two breaches of the target, in the first and last quarter of the year. This anticipated rapid acceleration in headline inflation is as a result of base effects from the fall in fuel prices in 2014, coupled with rising food price inflation, which is forecast at 6.0 per cent for 2016, and fairly sticky core inflation, which I’ll return to in a moment. I should add that these forecasts were presented to the MPC in November of last year, and that following the recent developments, they are currently being revised in preparation for our next MPC meeting later this month. According to the latest inflation expectations survey in the fourth quarter of 2015, average headline CPI inflation expectations of analysts, business people and trade unions for 2016 increased marginally by 0.1 percentage points to 6.2 per cent, respectively. Average expectations for 2017 increased by a more substantial 0.3 percentage points to 6.2 per cent, driven largely by trade unions who raised their forecast by a noticeable 0.4 percentage points to 6.3 per cent. This uptick, while marginally above the upper target limit, nonetheless suggests that the risk of a “de-anchoring” of inflation expectations, from the upper end of the 3,0–6,0 per cent target range, where they had stabilized in recent years, cannot be overlooked. Furthermore, break-even inflation rates reflect elevated longer-run inflation expectations, with implied inflation rates from five- and ten-year bonds averaging 6.5 per cent over the past year. Despite weak growth and the lack of demand pressures, inflation in South Africa remains elevated partly because of structural rigidities in product and labour markets. 13 Product markets in South Africa are highly concentrated and are characterised by high and inflexible prices, which reduces the sensitivity of corporate pricing power to the business cycle and thus adversely impacts on inflationary pressures. Wage growth in many industries is not strongly correlated to productivity growth, and the shortage of skilled workers in the tertiary sector means that average salary expectations – at 7.1 per cent for 2016 – remain above current and expected inflation. This of course has implications for core inflation and is part of the reason that it hasn’t slowed as much in 2015 as we would have hoped. After averaging 5.6 per cent Monetary Policy Review, SARB, November 2015. BIS central bankers’ speeches in 2014, core inflation is expected to have only moderated to 5.5 per cent in 2015, which coincides with the Bank’s forecast for this year. As the MPC has clearly noted in its statements, the currency remains a key source of risk for inflation in South Africa, despite some recent evidence of weaker pass-through. Rand depreciation is a major factor underpinning inflationary pressures in so far as they increase the domestic prices of imported goods. Commodity price movements also lead to a negative demand shock, which serves to offset inflationary pressures somewhat. Recent indications suggest, however, that the transmission of import prices to domestic prices has been more muted in South Africa and other emerging markets. In our case, this could be explained by a lack of demand pressures, represented by a negative output gap, which is forecast at –1.8 per cent of GDP for 2015. 14 However, it is unclear as to whether this trend will continue, or if the full impact of the pass-through is merely delayed, and policy makers must thus remain vigilant. Earlier in 2015, there were signs of a relatively benign path for the exchange rate, as it held up well against the yen and euro. However, as the year progressed and the rand weakened across the board, inflation risks heightened and prompted the decision to resume the hiking cycle in July 2015. In general, the MPC aims to see through the first round effects of exogenous shocks. However, in the context of prolonged currency depreciation, the first and second round effects are harder to disentangle. As such, the Bank decided to increase the policy rate to minimise the risk of second-round effects and the need for a stronger reaction in the future. But the impact of a weaker currency is not limited to its effect on inflation. The currency impacts on real output through two channels, namely, trade and income. With regard to the former, theory states that currency depreciation will boost net exports, as exports become relatively cheaper in the world market. However, as a result of the prevailing structural constraints, the potential benefits from depreciation to exporters and import-competing firms have not fully materialised. As far as the income effect on growth is concerned, currency depreciation, and the ensuing rise in inflation, will lead to a decline in real wages and real disposable income, all else being equal. This in turn would negatively impact on real household expenditure and real GDP growth. While some may question our decision to further raise rates in November given the weak growth outlook, the income channel highlights the growth enhancing effect of keeping inflation under control. The SARB decided to raise rates in July and November 2015 in order to prevent potential second-round inflationary effects from occurring and to anchor long-term inflation expectations, which remain uncomfortably close to or above the upper band of the inflation target. In general, risks to the inflation outlook for 2016 remain tilted to the upside and have recently deteriorated further. Rand depreciation, electricity tariff increases, and the impact of the drought on food prices are expected to outweigh the impact of lower oil prices. Nevertheless, the Bank has made it clear that any future decisions will be data dependent and driven by the developments in the inflation outlook. It may be useful to comment on this concept of data dependency, which some have argued was violated in the wake of our most recent policy adjustment in November 2015. We think of “data” in the broader sense of all pieces of information on a collective basis that in our judgement may have a bearing on the inflation trajectory in the medium term, rather than only in a narrower sense of looking at individual economic indicators as they are released. The latter would invariably embed a “behind-the-curve bias”, which, given the lags with which monetary policy works, would be contrary to the principle of needing to adopt a forward looking approach to monetary policy formulation, and also reduce policy flexibility. Monetary Policy Review, SARB, November 2015. BIS central bankers’ speeches Conclusion In conclusion, there is no doubt that South Africa, as an emerging market economy, remains vulnerable to global economic and financial markets developments and currency pressures these uncertainties generate, as well as a number of domestic challenges to both growth and inflation outcomes. The opening weeks of 2016 suggest that the conduct of monetary policy in South Africa will be further complicated. Therefore utmost vigilance remains the order of the day, and risks will require close monitoring as we move deeper into 2016, and preparedness to take decisive action within our flexible inflation targeting framework if the key mandate of price and financial stability comes under threat. Given the recent escalation of risks to the inflation outlook, including since the last meeting of the MPC, the MPC will need to assess very carefully whether the current monetary policy stance remains appropriate. Thank you. BIS central bankers’ speeches
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Address by Mr Kuben Naidoo, Deputy Governor of the South African Reserve Bank, at the FEDUSA Leadership and Collective Bargaining Conference, Muldersdrift, 19 February 2016.
Kuben Naidoo: Monetary policy in South Africa Address by Mr Kuben Naidoo, Deputy Governor of the South African Reserve Bank, at the FEDUSA Leadership and Collective Bargaining Conference, Muldersdrift, 19 February 2016. * * * Distinguished guests, ladies and gentlemen I would like to thank the Federation of Unions of South Africa (FEDUSA) for the opportunity to address the delegates of its annual Leadership and Collective Bargaining Conference. I am honoured to be part of a programme with such an illustrious group of speakers and panellists. This year’s theme, ‘Decent work and decent life for all’, is particularly relevant when one considers the challenging economic backdrop in South Africa and in many other developing countries. It is wonderful to be able to debate the broad set of pertinent issues that are outlined in this programme. I believe that we can tackle South Africa’s economic challenges through open dialogue and engagement across all spheres of our society. Today, I will address one specific economic challenge: that of monetary policy formulation. I will frame the monetary policy debate with an assessment of the global and local economy before concluding with some remarks on the upcoming round of wage bargaining. Global prospects The world economy is once again experiencing a period of slowing growth, only this time the key areas of weakness are found in the emerging markets. Some argue that eight years after the onset of the global financial crisis we are still not out of it yet. What started off as a subprime crisis in the United States became a crisis for the global financial system, morphing into a government debt crisis in Europe and now, potentially, a crisis for the emerging markets. The International Monetary Fund (IMF), estimates that global economic growth slowed to 3,1 per cent last year, down from 3,4 per cent in 2014. This was driven by a considerable slowdown in emerging market growth to a six-year low of 4 per cent from 4,6 per cent in 2014. Meanwhile, gross domestic product (GDP) growth in advanced economies increased marginally to 1,9 per cent last year. The slower pace of economic expansion in China played a major role in the weaker performance of emerging market economies last year. Emerging market growth was constrained through the channels of slower export growth into China, lower commodity prices, currency weakness, and financial market volatility. These factors, along with domestic challenges, saw emerging market economies like Brazil and Russia suffer recessions in 2015. Looking ahead, the IMF expects a modest rebound in emerging market growth this year. However, it warns that the risks to this outlook are skewed to the downside due to geopolitical uncertainties, China’s shifting growth model, and the possibility of escalating financial market volatility. Advanced economies continued on a path of recovery last year, albeit at a mixed pace. The US and the UK appear to be leading the recovery, while Japan and the euro area find themselves in an earlier phase of their economic upswings. The ongoing improvement in US economic activity and employment prompted the US Federal Reserve (Fed) to lift the benchmark US interest rate last December for the first time in nine years. The Fed is expected to continue on a gradual path of interest rate normalization over the medium term. As publicand private-sector borrowing costs in many parts of the world are referenced off US interest rates, a rising US policy rate threatens to push up the cost of capital globally. A second symptom of the impending US hiking cycle is that it has seen the dollar strengthen substantially against most other currencies since mid-2014. This has been driven by a flow of capital into BIS central bankers’ speeches the US and, to some extent, out of emerging markets. Meanwhile, in Europe and Japan, central banks are aggressively easing policy in an attempt to fight off deflation and low growth. Global economic growth has persistently disappointed since the financial crisis hit in 2009. This is due, in part, to high levels of indebtedness, excess capacity as well as weak fixed investment growth in many parts of the world. However, these challenges are being exacerbated by longer-term trends such as falling productivity growth, the technological displacement of jobs, and a downshift in global trade. While these trends present both opportunities and challenges, it appears as if emerging market economies are most at risk in the current environment, especially from an employment perspective. In an increasingly globalized world, it is important for South Africa to improve its competitiveness so that we can grow our export base and avoid increased import penetration. Domestic prospects Let us turn now to an examination of the domestic economy. As Governor Kganyago pointed out in the statement of the Monetary Policy Committee (MPC) last month, GDP growth is expected to come in at only 0,9 per cent this year. If the forecasts of the South African Reserve Bank (SARB) are correct, economic growth in 2016 will be the weakest in seven years. South Africa, like other commodity-exporting nations, is facing a terms-of-trade shock as a result of the persistent decline in commodity prices since 2011. This has been exacerbated by periods of protracted labour unrest and electricity supply shortages. More recently, the severe drought conditions have begun to weigh on activity in the agricultural sector. At an aggregate level, corporate profit growth in the third quarter of 2015 (known as the gross operating surplus) was at its lowest level on record at 0,3 per cent year-on-year. This was due to declining profitability in agriculture, mining, and manufacturing. Pressure on corporate income suggests that investment, consumption, and hiring by the private sector will be muted in 2016. SARB’s leading indicator of economic activity has declined on a year-on-year basis for the past 12 months. This supports our view that the risks to the growth outlook are skewed to the downside. Meanwhile, the inflation outlook has also deteriorated. After averaging 4,6 per cent in 2015, inflation is expected to accelerate to 6,8 per cent in 2016 and 7 per cent in 2017. The elevated inflation trajectory is largely as a result of multiple supply-side shocks which are expected to feed into consumer prices over the forecast horizon. These include a sharp depreciation of the exchange rate, a spike in domestic maize prices, and above-inflation electricity tariff increases. The domestic drought conditions have forced South Africa to import maize, which means that the depreciated exchange rate is now a determinant of the local maize price. As a result of this double whammy, food inflation is expected to reach 11 per cent this year. Even the sharp drop in the international oil price is unlikely to provide much reprieve to consumers as the rand’s depreciation means that petrol prices are likely to be slightly higher this year than in 2015. Persistent weakness in the South African economy poses very real risks to employment and investment growth over the longer term. Ultimately, this means that the collective gains in prosperity which we as a nation have achieved are at risk of being eroded. Monetary policy Against this difficult economic backdrop, the Reserve Bank must continue to execute its mandate of protecting the value of the currency in the interest of balanced and sustainable economic growth. Protecting the value of the currency means that we aim to maintain its purchasing power. The purchasing power of the rand is influenced by inflation. As inflation rises, one is able to purchase fewer goods for a given number of rands. Therefore, we aim to protect the purchasing power of the currency by attempting to keep inflation low. We have an inflation target range of 3–6 per cent, which informs our policymaking.The Reserve Bank is BIS central bankers’ speeches also responsible for regulating parts of the financial sector. Regulation of this nature helps to reduce the risk of financial crises, which over the long run is likely to result in improved economic performance. Furthermore, financial regulation can promote fairness as financial sector stress tends to weigh disproportionately on the most vulnerable in our society. While protecting the value of the currency is, of itself, an important objective, it also serves a greater overarching purpose: that of providing a stable foundation for sustained economic growth. This is because most economic activity takes place on the basis of trust in the value of a currency, not just today, but also in the future. People are far more likely to save for the future if they are confident that the purchasing power of their savings will at least be maintained over time. Similarly, companies are more likely to enter into long-term contracts with each other if they are confident that inflation will not materially reduce the value of the contract once the job is completed. By providing stakeholders with a credible inflation target range and a commitment to maintain inflation within that target range, we are making the business environment more predictable and ultimately more efficient over the long run. This is an indirect benefit of a sound monetary policy framework. To put it differently, a large body of literature shows that monetary policy can directly affect economic growth and employment only in the short run. For example, if the Reserve Bank maintains an interest rate that is artificially low, we may be able to temporarily boost GDP growth and employment. However, this will come at the cost of rising inflation and significant uncertainty about future inflation outcomes. Over time, this uncertainty may result in inflation expectations rising, which can lead to an inflation spiral as wage demands and price increases continuously rise to match future inflation expectations. The cost of bringing inflation back into the target range once inflation expectations have become dislodged is high. It would require aggressive policy action in a short space of time. As such, the temporary benefits associated with an overly accommodative monetary policy would be quickly eroded and replaced by a more difficult and uncertain operating environment for business and consumers. It would, therefore, be short-sighted of the Reserve Bank to overlook inflation and consider only shortterm economic growth in its decision making. Instead, what we try to do is balance the need for stable economic growth and low levels of inflation. We are cognizant that the current interest rate hiking cycle will have a short-term detrimental impact on the economy. However, the cycle thus far has been gradual and shallow by historical standards. This measured approach to monetary policy tightening reflects the difficult balancing act that we currently face. The Reserve Bank operates within a flexible inflation-targeting framework, which allows us a degree of discretion in responding to inflation target breaches. If we expect a breach to be temporary or to be caused by an external shock, we may opt to look through such an event. An external shock could be a once-off food price increase or a depreciation of the exchange rate. In the case of such a shock, we may look past the first-round impact and act only if we see evidence of second-round effects (that this, if the shock feeds through more broadly into inflation). For example, in both 2012 and 2013 inflation briefly breached the 6 per cent level. The breaches were temporary, so we were able to look through them and leave interest rates on hold at that time. The inflation outlook has unfortunately deteriorated since then, which has called for higher interest rates. Last month, the MPC opted to lift the repurchase rate, or repo rate, by 50 basis points. This was due to a revised inflation forecast, which sees headline inflation remaining above the 3–6 per cent target range throughout the forecast period. Our inflation forecast was revised higher in January due to the multiple supply-side shocks that I referred to earlier. While we are able to tolerate a single external shock for a limited period of time, we cannot tolerate multiple simultaneous shocks that are likely to keep inflation elevated for two years. Shocks of this nature raise the risk that inflation expectations for the coming years will recalibrate to a significantly higher level. BIS central bankers’ speeches Our monetary policy response going forward will depend largely on how surveyed and implied inflation expectations play out over the course of this year. We use the Bureau for Economic Research survey of inflation expectations among trade unions, financial analysts, and business people as a guide. But a crucial indicator of implied inflation expectations is the level of actual wage settlements in the economy. Wage settlements that are above inflation and productivity growth threaten to undermine employment and pose a significant upside risk to the inflation outlook. Settlements of this nature may force the Reserve Bank to adopt a tighter monetary policy stance in order to curtail their second-round inflation impact. I would like to emphasise that monetary policy is only one aspect of our country’s macroeconomic policies. The aim of monetary policy is not to drive growth directly, but rather to contribute towards a stable macroeconomic environment. Growth can and must be raised through better education; sound public institutions; healthy relationships between government, business and labour; and a legal and policy environment that provides incentives for long-term investment and employment growth. While we encourage these policies, they fall outside of the direct mandate of the Reserve Bank. We call on all in society to pull together in support of these economic reforms as they will boost confidence in our economy and facilitate longerterm prosperity. Concluding remarks We are acutely aware of the high levels of inequality in our country and the need for the fair sharing of profits between the owners of labour and capital. I would therefore appeal to all stakeholders in the upcoming round of wage bargaining to take a view on what is good not only for existing workers today, but also for society at large over the longer term. In conclusion, I would like to thank FEDUSA, in particular General Secretary Mr Dennis George and President Mr Koos Bezuidenhout, for the healthy relationship that we have had over many years. FEDUSA has always been willing and able to engage in robust and at times difficult discussions with the Bank on our policies, our work, and our approaches to fighting inflation. As Mahatma Gandhi once said: “Honest differences are often a healthy sign of progress.” We look forward to ongoing engagement in these difficult times. South Africa’s problems are complex and can only be solved by honest dialogue between all parties who are committed to making South Africa a better place. Thank you. BIS central bankers’ speeches
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Opening address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the G-30 Forum on Banking Conduct and Culture, Pretoria, 18 February 2016.
Daniel Mminele: Conduct and culture in the banking and financial sectors Opening address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the G-30 Forum on Banking Conduct and Culture, Pretoria, 18 February 2016. * * * Governor Kganyago (SARB), Governor Sithole (Central Bank of Swaziland), Deputy Governor Mlambo (Reserve Bank of Zimbabwe), Deputy Governors, Groepe and Naidoo (SARB), Second Deputy Governor Sullivan (Central Bank of Seychelles), Sir David Walker (Vice Chair of the Group of Thirty Steering Committee), Dr Stuart Mackintosh (Executive Director of the G30), Ms Maria Ramos (Chief Executive Officer of Barclays Africa), the leadership of banks and other financial institutions, panel members, and esteemed delegates. It is a privilege and an honour for me to welcome you, on behalf of South African Reserve Bank (SARB), to this Forum on Banking Conduct and Culture, which we are co-hosting with the G30 and Barclays Africa. The G-30 has, over the years, played a significant role in bringing together members of the banking, financial and regulatory community to discuss issues of common concern and examine the choices available to market practitioners and policymakers. Given the enormous trust deficit that has built up since the global financial crisis, the topic of conduct and culture is of great importance and highly relevant to the global banking and financial sector. Bankers have always had a delicate relationship with the societies they serve. It would appear that, at any point in time, it is almost a national sport across the globe to take a swipe at bankers. Mark Twain famously said: “A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.” And J M Keynes asked: “How long will it take to pay city men so entirely out of proportion to what other servants of society commonly received for performing social services not less useful or difficult?” We would be terribly misguided to treat the current wave of discontent and deep mistrust as just another wave that will eventually subside. The most recent global financial crisis, from which almost nine years later we are still struggling to recover, shook the very foundations of our financial system and almost caused its total meltdown. In a nutshell, the crisis was about failures in conduct, culture, and supervisory practices. The consequences are with us today in the form of multiple-agency and jurisdictional investigations, litigation, and massive penalties, the number and sizes of which are becoming difficult to keep pace with. The task at hand, to which our deliberations here today are meant to contribute, is to see how we can restore confidence and trust in the leadership and staff of banks and other financial institutions, in the effective and efficient functioning of financial markets, and lastly but not least in the ability of regulators to give the right level of comfort around their supervisory practices. Trust is the most essential prerequisite for a healthy and useful banking and financial system. Global regulatory standards for banking which were refined and adopted following bank failures and other financial stresses in the system, including rules such as Basel III, can help explain how financial disasters transpire and in their construct seek to address the risks, but of course only after the event. Yet these rules are not always effective in pinpointing institutional weaknesses, particularly those of a behavioural nature. The role of individuals, but also of groups or networks of staff both within and outside the employee boundaries of banks, has come to the fore as a determinant of corporate culture, which in turn has led to isolated action in some instances and institutional action in others that have eventually led to the compromise or even complete demise of banks. Inappropriate behaviour has increasingly set the tone for organisational interactions within markets, or regions, among both collaborating BIS central bankers’ speeches and competing banks. This phenomenon was especially evident among banks in the United States that issued sub-prime mortgages; only one example of improper practices. Banking regulation has historically been formulated by global agreement with the intent of setting minimum standards of risk mitigation for banks through the application of common measurement processes. To support these metrics, standard-setting bodies, in particular the Basel Committee on Banking Supervision, have introduced principles for risk management and governance which have focused more on the technical attributes of organisational risk-taking than on individual or collective behaviour. While the ‘second pillar’ of Basel III – with its enhanced coverage of all material risks and inclusion of corporate governance, culture, and values in the supervisory process – is encouraging, it appears that the rules repeatedly fail to address the organisational integrity of banks and bankers, and this has become the next frontier for ensuring the stability of domestic economies and the global financial system. It is not an objective of regulatory oversight to stifle effort, reward, or innovative behaviour. However, in the interest of global financial stability and to ensure the longevity of the role of banking in financial systems, it has become critical that guidelines are developed to address integrity within banks as well as between banks and their clients, counterparts, and competitors – guidelines which are globally relevant, robust over time, and aspirational, and which influence behaviour across society. The new frontier for standard-setting, however, comes with challenges. In the normal course of risk management, internal targets and banking rules take the form of a plethora of financial measures, numbers, statistics, and technical financial analysis, which form the primary toolset. The challenge is that these rules are a necessary precondition, but not a sufficient one. They help to guide compliance, which tends to speak to the letter of the rules, but seem insufficient in guiding culture, which goes further to also include the spirit of the rules. The current charge requires the establishment of codes which are normative for individual and corporate behaviour. This is challenging from at least two perspectives. The one is systemic: the legal paradigms of modern society protect individual rights, privacy, and autonomy. The other is practical: it is dramatically time-consuming to observe and analyse behaviour for noncompliance with codes. This also has the potential to create inordinate distrust, and this should not be overlooked by regulatory authorities. Allow me to touch on the initiatives currently underway in South Africa, which will help in strengthening market conduct and culture. Enhancing market conduct and culture in the banking and financial sectors: the Twin Peaks reforms South Africa is in the throes of one of the most significant reforms to the financial regulatory landscape since the 1980s: the introduction of the Twin Peaks model of financial regulation, the heart of which includes a proposed new approach to market conduct regulation. As most of you will know, the plan is to establish a Prudential Authority (PA) and a Financial Services Conduct Authority (FSCA). The reform process is an important opportunity to develop and enhance South Africa’s market conduct regulatory framework. The soon-to-be-created FSCA, which will replace the current Financial Services Board (FSB), will be given the task of being an integrated market conduct regulator in the financial sector, with the following statutory objectives: • Promote the fair treatment of financial customers. • Enhance and support the integrity and efficiency of the financial system. • Develop financial literacy and capability. • Assist in maintaining financial stability. For financial institutions, treating customers fairly means: BIS central bankers’ speeches • Pay due regard to the interests and needs of customers. • Do not engage in unfair business practices. • Be transparent, and fully disclose all risks and rewards. • Solve eventual problems in a timely and effective manner. In the context of the Twin Peaks proposal, the expectation is that customers’ interests should be at the heart of how firms in the banking and broader financial sector do business. Customers should expect to obtain financial products and services which meet their needs from firms that they can trust. Meeting their reasonable and fair expectations should be the responsibility of firms, not of the regulators, whose role should rather be to create a conducive regulatory environment and, through their supervisory activities, encourage good conduct. It is important to emphasise that the proposed Twin Peaks reforms are not an adverse judgement on the country’s current regulatory architecture. Rather, they are aimed at making continuous improvements to the regulatory framework which helped the domestic financial sector weather the storm of the global financial crisis better than many other countries. The Twin Peaks reforms answer the following question: “How can we do better in what we are already doing very well?” The Financial Sector Regulation Bill provides for a broad mandate and scope for the FSCA to ensure improved market conduct outcomes in the South African financial sector. This mandate includes powers to issue conduct standards for product design, marketing, distribution, and disclosure. It also places an important onus on governance arrangements within financial institutions in order to ensure that such arrangements deliver on expected market conduct outcomes in support of the objectives of the FSCA. Clearly, organisational culture is at the heart of improved market conduct outcomes for financial institutions, as it is ‘the tone from the top’, so to speak, that has the greatest impact on how a financial institution treats its customers, contributes to financial integrity, and ensures market efficiency. Furthermore, the culture and approach to risk taking, particularly for material risk takers in regulated institutions, are a critical consideration from both a prudential and a market conduct perspective. The Financial Stability Board has done much work in this area, specifically on the development of remuneration principles, malus and clawbacks for material risk takers. South Africa, as a member of the Financial Stability Board, subscribes fully to these principles. As such, both Twin Peaks authorities envisage having powers aimed at influencing the governance arrangements in regulated entities in order to ensure adequate risk outcomes from both a soundness and a consumer protection point of view, including through remuneration arrangements. Failure to manage conduct risks can expose a financial institution to a variety of other risks which, if not managed properly, can threaten its solvency and sustainability. The regulatory regime for market conduct therefore provides a framework for the identification and management of conduct risk as a complementary framework to prudential regulation. This is part of the motivation for rigorous coordination and cooperation arrangements between the PA and the FSCA envisaged by the Financial Sector Regulation Bill aimed at ensuring that all risks are holistically managed within an overarching financial stability policy framework. Strengthening conduct in wholesale OTC markets Another initiative has been the development of a code of conduct for South African wholesale over-the-counter (OTC) financial markets in a collaborative effort between regulators and key market participants. I will return to this aspect later. Against the background of various investigations undertaken in many foreign jurisdictions in relation to foreign exchange market manipulation, the SARB and the FSB launched a review BIS central bankers’ speeches of the foreign exchange trading operations of South African authorised dealers in October 2014. As the rand is a globally traded currency, the aim of the review was to establish whether there may have been any spillover into our markets in relation to any misconduct or malpractice. It is important to note that, unlike in other jurisdictions, the South African review was not informed by whistle-blowing or any allegations – or indeed concrete evidence – of any misconduct. We had no evidence of widespread malpractice in the South African foreign exchange market but felt that, given the broad-based nature of investigations in other jurisdictions (which also involved trading in emerging market currencies), it would be prudent to obtain comfort that our foreign exchange trading practices were in line with best practice. It was therefore a proactive step on the part of South African regulators. The Foreign Exchange Review Committee established for this purpose – chaired by former Senior Deputy Governor James Cross, who is with us today – released its report in October 2015. The committee reported that it had found no evidence of manipulation or serious misconduct in the domestic foreign exchange market during the period covered by the review, but that there was scope for improvement in relation to governance and conduct. The committee also recommended that legislation be enhanced to give market conduct regulators wider powers to strengthen enforcement. South African regulators are in conversation with each other on how best to give effect to the implementation of the recommendations. There was also the recommendation that a group of senior market professionals and compliance officers form a Financial Markets Standards Group, akin to the FICC Market Standards Board in the United Kingdom or the Treasury Markets Practice Group in the United States. In December 2015, the FSB began interacting with the Acting Chair of the FICC Market Standards Board, seeking opportunities to discuss possible future cooperative arrangements. Early in the process of the review, it became apparent that South Africa would benefit from a unified code of conduct for wholesale OTC financial markets, and the decision was made to draft such a code in collaboration with market participants and other stakeholders, referencing a number of codes used in major international financial centres. The code is overarching and does not substitute market- or product-specific codes. Where applicable, the latter codes will be appended to the OTC code as subsidiary guidelines which contain detail relevant to each market and/or product. Following the conclusion at the end of last year of the first round of public consultation, the SARB has reviewed the comments and has begun engaging with fellow regulators and stakeholders on a revised code. It is envisaged that this process will be completed in the coming months. The OTC code aims to ensure that the highest levels of professionalism and integrity are maintained in the South African financial markets. The code is also intended to serve as a template to assist authorities in supervising conduct in financial markets. The code will be a living document which will continually benefit from evolving best practice, including international codes such as the upcoming Global Code of the Bank for International Settlements (BIS). Conclusion In conclusion, while much work remains to be done, it is nonetheless very encouraging to note that key steps have already been taken by regulators and financial institutions alike to strengthen behavioural standards in the industry. It is equally encouraging that South Africa, while largely sheltered from the global financial crisis, is embarking on measures to limit the risk of such crises occurring locally in the future, including strengthening market conduct regulations as part of the move towards a Twin Peaks system of regulation. Nonetheless, the BIS central bankers’ speeches evolution of the financial industry will bring new challenges for regulators and professional bodies alike. In an industry where the conclusion and enforcement of contracts is based on trust – trust from the provider of capital that he/she will be fairly rewarded for the risk of potentially losing some of his/her assets; trust from the borrower that he/she will be charged a fair price for access to capital – any breakdown in that confidence can quickly lead to incorrect pricing and, in turn, improper allocation of resources. A lack of confidence in the financial system generally means rising counterparty risk, requirements for higher risk premiums, and raising the overall cost of capital in the economy. Without sound values and proper conduct, we will not be able to restore trust, and this will affect confidence. And when there is little or no confidence, there are risks to stability, growth, jobs, and development. 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 JP Morgan Investor Seminar, Washington DC, 16 April 2016.
Daniel Mminele: Outlook for monetary policy in South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the JP Morgan Investor Seminar, Washington DC, 16 April 2016. * * * Good morning, Ladies and Gentlemen Thank you to JP Morgan for the opportunity to again participate in this seminar, which takes place on the margins of the International Monetary Fund and World Bank Spring Meetings. I have been requested to give you an update on the monetary policy outlook for South Africa. Those of you who joined us last year may recall that I talked about heightened uncertainty complicating the conduct of monetary policy. If anything, the environment has become more complex for policymaking in both emerging and advanced economies, South Africa being no exception. Let me start by reiterating the primary mandate of the South African Reserve Bank (SARB), which is to achieve and maintain price stability in the interest of balanced and sustainable economic growth. It should be noted that price stability is pursued within a flexible inflation targeting monetary policy framework, with the target band for headline consumer price inflation being 3 to 6 percent. In practice this implies that the SARB will tolerate temporary breaches of the inflation target in the interest of smoothing out short-term fluctuations in economic growth. However, a persistent breach of the inflation target range will require a policy response to achieve sufficiently low inflation that promotes competitiveness and provides an enabling environment for sustainable growth and employment creation, in addition to protecting the purchasing power of the currency. Last month, the monetary policy committee (MPC) stated that the upside risks to the inflation forecast, coupled with the protracted period of the expected breach of the inflation target range, was the primary motivation for increasing the repo rate by a further 25 basis points to 7 percent, bringing the cumulative increase to 200 basis points since the beginning of the tightening cycle in January 2014. Let me now turn to some of the factors that have and are likely to influence the monetary policy outlook. Global economic developments The World Economic Outlook (WEO) that has just been released by the International Monetary Fund (IMF) has confirmed recent observations that the global recovery remains weak. I can afford to be brief on some of the details given that the WEO has enjoyed wide coverage over the last couple of days. Global growth is forecast to reach 3.2 percent in 2016 and 3.5 in 2017, representing, yet again, a downward revision to the growth outlook. The growth outlook for most advanced countries (AEs) is notably weaker and the same can also be said for the emerging market economies (EMEs), with the exception of emerging Asia. For some time, the global recovery has been underpinned by the performance in emerging markets with the expectation that the global growth momentum will gain traction as the pace of recovery in advanced countries picked up. Unfortunately, these expectations have not been fully realised. Emerging market economies, which currently make up around 58 percent of global gross domestic product (GDP), still continue to account for a significant portion of world growth. However, the economic performance across emerging markets as a whole is uneven and generally weaker. With the exception of India, most major emerging market economies have had disappointing growth outcomes as depicted by the recent recessions in Brazil and Russia and the slowdown in China. BIS central bankers’ speeches Of concern, is that the global recovery is not only weaker, but that the deterioration in the global environment over the last year has been accompanied by greater downside risks. The drop in commodity prices, uncertainty in financial markets, volatile capital flows, subdued external demand and geopolitical influences, coupled with the refugee crisis, have been some of the major headwinds adversely impacting global economic developments. Unfortunately, these factors will continue to have a bearing on the economic outlook for both emerging market economies and the global economy as a whole. Given the globalised nature of EMEs – South Africa included – this implies that international influences, although of an exogenous nature, will form an integral part of the policy landscape in emerging economies. Global inflation pressures remain subdued with both current and projected inflation rates below target in most advanced economies. These developments, combined with below potential growth have prompted expansionary monetary policies in a number of advanced economies, which are very likely to persist over the forecast horizon. In contrast, inflationary pressures have been rising in a number of emerging economies, mainly on account of currency depreciation rather than as a result of rising international price pressures. South African inflation outcomes have also been subjected to more prominent exchange rate pressures recently, an issue I will come back to later on. So in general, global inflation remains at modest and subdued levels and, with oil prices projected to remain at low levels, international cost pressures are unlikely to pose a major risk to inflation outcomes across the globe. South Africa’s economic outcomes and outlook Recent indicators show that real economic growth in South Africa slowed marginally to an annualised rate of 0,6 percent in the fourth quarter of 2015 from 0,7 percent in the third quarter resulting in a growth rate of 1,3 percent for 2015 as a whole. In fact, there has been a steady deceleration in South African real GDP growth over the last five years from 3 percent in 2011 to 1,5 percent in 2014 and 1,3 percent in 2015. The growth rate in 2015 was the lowest in the past 17 years barring the contraction in 2009. In general, both domestic and external factors have been responsible for the lacklustre performance of the South African economy. Inter alia, these have included, muted domestic and external demand conditions, domestic supply-side constraints (most notably electricity supply constraints), a decline in international commodity prices, and the effects of the drought on agricultural output and prices. Of particular concern is the poor performance of the agricultural sector given its impact on both growth (output) and inflation (prices). As a result of the worst drought in decades, this sector contracted in all four quarters of 2015 resulting in an annual contraction of 8,4 percent for 2015 as a whole. The decline in international commodity prices has had a strong bearing on South Africa’s export and growth outcomes. For 2015 as a whole, the US dollar price of the basket of South African non-gold export commodities declined by approximately 21,5 percent following the decrease of 9,4 percent in 2014. Despite a marginal quarter-on-quarter improvement in the terms of trade, South Africa’s trade deficit widened in the final quarter of 2015. When combined with the larger shortfall on the services, income and current transfer account, the deficit on the current account of the balance of payments increased to 5,1 percent of GDP in the fourth quarter of 2015 from – 4,3 percent and –3,1 percent in the previous two quarters respectively. The SARB has officially identified November 2013 as the upper turning point in the business cycle, implying that the South African economy is now officially in a downward phase of the business cycle. In addition, subdued business and consumer confidence levels do not augur well for growth outcomes going forward. The SARB’s most recent forecast shows GDP growth of 0,8 percent for 2016, significantly down from 1,5 percent projected in November 2015 and 2,9 percent in November 2014. The recently released WEO is more pessimistic, BIS central bankers’ speeches forecasting 0,6 percent growth for the South African economy in 2016 and 1,2 percent in 2017. The SARB forecasts for 2017 have also been revised down to 1,4 percent and 1,8 percent in 2018. The most recent estimates by the SARB indicate that potential output growth of the South African economy has declined from 1,9 percent to 1,5 percent for 2016, and from 2,1 percent to 1,6 percent for 2017. With lower growth outcomes, the output gap is expected to remain negative over the forecast horizon. The policy challenge is to ensure that the economy is not trapped in a cycle of persistent low growth. South African policymakers are fully aware that we have to avoid the risk of becoming trapped in what Christine Lagarde, the MD of the IMF, has termed the “new mediocre”. The budget, which was tabled in February, reinforces the need to provide support to economic growth, albeit against a background of deteriorating prospects for tax revenue collection. The budget sets out to accomplish this through a path of more rapid fiscal consolidation. In the main, the budget focuses on containing administrative expenditure (most notably salaries) while maintaining investment and other core expenditure items at levels that will be supportive of economic growth. The package of tax measures that have been introduced in the 2016 Budget has also spread the additional tax burden over several revenue sources so as to limit the adverse short-term impact on growth. As a ratio of GDP, the deficit of national government is projected to narrow from 4,2 percent in the 2015/16 fiscal year to 2,9 percent by fiscal 2018/19. It is noteworthy that the budget sets out a more rapid adjustment path than what was envisaged in the 2015 Medium Term Budget Policy Statement in October last year. These projected outcomes are commendable in the current circumstances, and if implemented effectively, will contribute to dampening inflationary pressures and impact favourably on investor confidence and South Africa’s credit rating metrics. South Africa’s inflation outcome and outlook The trajectory for the year-on-year inflation rate as measured by the consumer price index (CPI) has increased significantly over the last three months. Consumer inflation measured 7 percent in February, up from 6,2 percent in January and 5,2 percent in December 2015. On a month-to-month basis, headline CPI increased by 1,4 percentage points between January 2016 and February 2016. Headline CPI inflation for February exceeded both the Reuters and Bloomberg consensus forecast of 6,8 percent for February 2016, mainly as a result of an acceleration in food price inflation. Following sharp increases in agricultural food prices in earlier months as a result of the severe drought conditions, food price inflation increased markedly by 1,8 percentage points to 8,8 percent in February 2016 – the highest level since August 2014. Food price inflation at the producer level registered 9,0 percent in February, significantly up from the 7,8 percent recorded in January. Agricultural food prices on the other hand has also followed a similar trend, increasing by 27,2 percent in February as compared to 25,9 percent in January 2016. These increases are expected to impact consumer prices with a lag. In addition, current indications are not encouraging for the expected agricultural output for the coming season. According to the most recent estimates (February 2016), the agricultural land or area under cultivation will be approximately 26 percent smaller than last year. Further, maize which has an important direct and indirect impact on overall food inflation will have to be imported in the coming year in order to meet the annual domestic and commercial consumption of roughly 9,6 million tons. The SARB forecasts as at the March MPC meeting – which did not consider the February inflation numbers – showed that annual CPI food price inflation was expected to peak at 11,6 percent in the final quarter of 2016 as compared to the forecast of 11,3 percent at the beginning of 2016. Food price pressures, which have intensified in recent months pose a significant upside risk to inflation. BIS central bankers’ speeches Inflation is now expected to average 6,6 percent and 6,4 percent in 2016 and 2017, compared to the 6,8 percent and 7,0 percent forecasted at the beginning of the year. It is expected to peak at 7,3 percent in the fourth quarter of 2016 and only return to within the target range during the fourth quarter of 2017. This represents a protracted breach implying that underlying pressures remain elevated. Let me now turn to a discussion of some of the underlying inflationary pressures in the economy. The SARB’s forecast shows that core inflation will breach the upper end of the target range in the second quarter of 2016 for four consecutive quarters, with a peak at 6,5 percent in the latter half of 2016. Core inflation is expected to average 6,2 percent in 2016, and 5,7 percent and 5,2 percent in the next two years, respectively. Average inflation expectations have remained undesirably close to the upper target level of 6 percent despite inflation outcomes at times being close to the midpoint of the target range during 2015. Inflation expectations as measured by the Bureau of Economic Research (BER) at the University of Stellenbosch at the end of 2015 revealed that average headline inflation expectations over the forecast horizon (i.e. one and two years) had shifted above 6 percent. More recently, the BER survey presents a more mixed picture. In the survey conducted during the first quarter of 2016, the expectations of analysts increased significantly, while those of business representatives and trade unions have moderated for both years. However, average expectations are unchanged at 6,2 percent for 2016 and 2017 while inflation is expected to average 6,0 percent in 2018. The short-term expectations of economic analysts, as reflected in the Reuters Econometer survey in March, show that the median expectation for 2016 and 2017 was 6,4 percent and 6,3 percent respectively, with inflation returning to within the target range to average 5,6 percent in 2018. In addition, market-based measures of expectations over the longer run (5 to 10 years) indicate that break-even inflation rates remain at elevated levels. More recently, while these rates have declined to around 7 percent from 8 percent in December, they are significantly above the average level for 2015 and the upper inflation target level. While there is little evidence of a deterioration in longer-term inflation expectations, they are anchored at elevated levels. So in essence, inflation expectations over the forecast horizon, as well as over the longer term, are uncomfortably close to the upper target level and this has been one of the factors considered by the MPC at its most recent meeting in March 2016. Of particular significance for monetary policy has been the movement in the value of the rand. There has been a steady depreciation in the currency over the last five years. The rand depreciated by approximately 30 percent against the dollar in 2015, reaching historical lows in December 2015 mainly as a result of an adverse market reaction to domestic political developments associated with changes in the finance ministry. While the rand exchange rate has recovered from the lows experienced in December 2015, it remains volatile and vulnerable to domestic and external developments. While exchange rate pass-through to inflation has been low in recent years, the sustained and substantial depreciation in the currency was identified by the MPC as a significant threat to inflation outcomes over the forecast horizon. However, the recovery in the exchange rate in recent weeks is welcome, and if sustained, will favourably influence the risk profile associated with the inflation trajectory over the forecast horizon. Conclusion Currently, the policy dilemma is one of trying to address the deterioration in the inflation outlook against the background of a weakening growth outlook. Inflation is currently outside the inflation target range and the latest forecasts suggest it will return to within the target band only in late 2017. Inflationary pressures are underpinned by supply-side shocks, mainly related to exchange rate and food price movements. Some of the inflation risks previously identified materialised earlier and more forcefully than anticipated. Under these circumstances, monetary policy cannot afford to be complacent and should strive to manage BIS central bankers’ speeches inflation expectations to ensure that these shocks do not result in second-round impacts and a generalised increase in prices. The overall monetary policy stance continues to be supportive of the weak economy with the necessary policy tightening having proceeded at a moderate pace, showing sensitivity for the weak growth environment while seeking to counter mounting inflationary pressures in the economy. It is, however, worth reiterating that over the long run South Africa’s growth prospects are best served by keeping inflation within the target range, and not by looking to exploit a temporary trade-off between growth and inflation. In these times of uncertainty and volatility, the SARB will remain focused on its mandate and continue to be a beacon of stability by implementing its policy framework in a forward-looking, consistent, transparent, and as far as possible, predictable manner. Thank you. References South African Reserve Bank. 2016. Quarterly Bulletin, South African Reserve Bank, Pretoria March 2016. South African Reserve Bank. 2016. Monetary Policy Review, South African Reserve Bank, Pretoria, April 2016. International Monetary Fund, 2016. World Economic Outlook, IMF, Washington. April 2016. BIS central bankers’ speeches
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