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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department Annual Cocktail Function, Pretoria, 21 April 2016.
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Daniel Mminele: Key financial market developments in South Africa Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Financial Markets Department Annual Cocktail Function, Pretoria, 21 April 2016. * * * Good evening, Ladies and Gentlemen It is once again an honour for me to welcome you to the annual cocktail of the Financial Markets Department (FMD). This cocktail is a small gesture from the South African Reserve Bank (Bank) to show appreciation for the good working relationship we have with you, our partners in the financial markets. These relationships are of critical importance to us, and we are keenly aware of the efforts you make in assisting us with our task of analysing and interpreting market events, executing our daily market operations, and the support you provide through various forums, such as the Financial Markets Liaison Group (FMLG), when it comes to formulating the rules that govern the functioning of our markets. Ensuring success in the execution of these activities is aimed at enhancing the effective functioning of our markets as well as their integrity and reputation, ultimately for the benefit of all market participants and society as a whole. Central banks have been, for a number of years now, operating in a challenging and increasingly complex environment. Not only are some central banks implementing policy measures that have never been tested before, but increasingly, authorities in different countries are facing challenges that are becoming more diverse, and the implications of measures being implemented across different jurisdictions, and the effectiveness of policies, are becoming more difficult to assess. Many central banks may indeed yearn for less interesting times, as what they believed to be temporary unconventional measures, appear to be assuming more permanent characteristics. As usual, my intent is to use this opportunity to provide you with an update on our views of key market developments. Consequently, there is no better place to start than a very brief reminder of the thoughts I presented last year. At that time, we believed there were four key factors that would dominate the outlook for our, and other emerging countries’, financial markets in 2015, namely: the pace of normalisation in US interest rates, growth and monetary policy dynamics in the Eurozone, growth developments in China (and to a lesser extent in other emerging market countries), and the outlook for commodity prices. We also highlighted our concern that volatility in financial markets was likely to increase. While this analysis seemed very reasonable in early March 2015, by the time we got to the third quarter, it had seemed that our fears may have been misplaced. Equity market volatility, as expressed by the VIX index, had declined from its highs of 21,0 in January 2015 to 12,0 in July 2015, before it increased rapidly to 40,7 in August 2015, following the devaluation of the Renminbi by the Peoples Bank of China. After this the VIX remained elevated, but nevertheless continued its declining trend. Volatility in the bond market had also subsided, albeit to a lesser extent. By and large, global markets had tracked sideways. The S&P 500 index in the US had hardly moved from the 2,100 level, and the US dollar index and Treasury bonds were range trading throughout the period. In the domestic markets, things were not much different. The yield on the benchmark R186 bond had drifted slightly weaker, from below 8.0 per cent to around 8.25 per cent, and money market yields had also drifted higher. This slight deviation from trends in the US markets was not really a surprise as the Monetary Policy Committee had raised the repo rate by 50 basis points by July and the trade weighted rand had depreciated by around 4.5 per cent. The only sign of stress at that time was in the US market with the widening of high yielding and other corporate debt relative to Treasury yields. However, this was largely seen as a reflection of the impact of lower oil prices on the earnings of oil producers. It therefore BIS central bankers’ speeches appeared as if our concerns about a possible increase in market volatility may have similarly been misplaced. But as has become such a regular feature of financial markets, things were not as benign as they seemed. The first real cracks on the global stage started to show with the sudden decline of the Chinese equity markets in June, when the Shanghai Composite Index declined by 32 per cent in less than a month, and a further 16.5 per cent by the end of August. Besides some modest weakness in our local equity market, South Africa seemed largely unscathed by these events. Unfortunately, this relative stability in our markets was not to last. As we progressed through the third quarter, domestic factors started to have a negative effect on the price formulation in local assets and the market increasingly anticipated further ratings downgrades from the rating agencies. In this vein, South African asset prices, specifically bonds and foreign exchange, weakened in the latter months of the year as market participants became increasingly convinced that further negative ratings actions were imminent. Unfortunately, they were proven to be correct. At this point, it is worth commenting on the interplay of different asset prices to get a better understanding of the nature of the market views. Here I would like to highlight the divergence in the pricing of cash interest rate assets versus their derivative counterparts. Specifically, from the fourth quarter of 2015, the spread of bond yields over swaps widened quite considerably. The benchmark R186 yield, which was trading around 15 basis points below its matched-maturity interest rate swap, weakened to nearly 30 basis points over the swap yield in early 2016. This effect was even more pronounced when one looks at longer maturity bonds. The swap spread of the 32-year R2048 bond has widened from less than 50 basis points to more than 130 basis points over the swap curve. Such pronounced weakening of bonds is of concern as the cost of funding for the government increases, but also, it seems to reflect a steady deterioration in ‘real money’ investor confidence as the bond curve has steepened sharply in relation to the swap curve. Similar price action was observed in the spread of South Africa’s foreign currency yields and credit default swaps (CDS) spread when compared to emerging market averages (such as the JP Morgan Emerging Market Bond Index in the case of bond yields). Price action in the rand appears to confirm this interpretation. For much of 2015, the rand was steady against its commodity and emerging market peers. However, by early 2016, it had depreciated meaningfully against these peers. By comparison, the JP Morgan Emerging Market Currency Index had depreciated 14,0 per cent from end-June 2015 to mid-January 2016, while the rand had declined 37 per cent against the US dollar! As indicated, the rand was not the only currency to weaken during this period. Many emerging market and commodity currencies were on the back foot in reaction to poor economic data in China. In addition, market expectations for the US Federal Open Market Committee to increase its interest rate at the December meeting had risen sharply. To some extent, with the rand being viewed as a high-beta currency, whereby it trades in an exaggerated manner to its emerging market peers, the larger sell-off in the rand was to be expected in such an environment. However, local factors played a key role as Standard & Poor’s, while affirming the country’s credit rating, had revised the outlook on the rating to negative, a move that was not generally expected by the market. In addition, the changes in the Ministry of Finance shortly after the ratings action, drew an adverse reaction from the markets and contributed to further significant depreciation. Since the low of the rand to the dollar at R16.87 on 18 January 2016, the rand has recovered considerably. By the close of business yesterday, the rand was trading at R14.21, an appreciation of 15.8 per cent against the dollar from the 18 January low. This strong appreciation in the rand was predominantly driven by global factors as the JP Morgan Emerging Market Currency Index had rallied 9.8 per cent over the same period. This rally was triggered by a more benign view in the market on the likely trajectory of interest rate BIS central bankers’ speeches increases in the US, unexpected policy stimulus in Europe and Japan, and improving economic data out of China. Portfolio flows to emerging markets, which had been negative in the second half of 2015 and early 2016, reversed into significant inflows in February and March. According to Institute of International Finance (IIF) data, portfolio flows into emerging markets totalled USD36,8 billion in March compared to the outflow of USD53,7 billion for the second half of 2015. In South Africa, portfolio inflow totalled USD1,6 billion in March compared to outflows of USD2,2 billion for the second half of 2015. However, local factors also played a role. The Budget delivered in February showed strong commitment to fiscal prudence, and the 75 basis points of interest rate increases by the Monetary Policy Committee in 2016 seemed to assure the market of the Bank’s commitment to maintain price stability. The recent strengthening of the rand is welcomed, following the sharp sell-off late last year. However, as the rand remains vulnerable to negative external and domestic factors, we will need to continue to monitor economic and financial developments in China as a key driver for commodity prices and emerging market currencies. Ongoing concerns about a shallow and hesitant global economic recovery (as again highlighted last week with the release of the IMF’s World Economic Outlook) will also be a key factor. Also, the expected trajectory of the policy rate in the United States will be important, with there still being a significant discrepancy between expectations of policy makers when compared to those of market participants, and uncertainties arising from how the Fed will factor in what seems to be an increased sensitivity of policy makers to international developments. In addition, at this juncture the jury is still out on the likely effectiveness and impact of negative interest rates as a policy tool. Lastly, decisions by the credit rating agencies may have an important effect on asset prices in South Africa. By this time, I am sure there is a need to replenish your refreshments, but before I conclude, allow me to take this opportunity, on a slightly different note, to announce that the Bank published its Official Gold and Foreign Exchange Reserves Management Investment Policy on its website today. The Investment Policy outlines the governance structures, roles and responsibilities pertaining to the reserves management operations. Our objective is to improve transparency around the reserves management and to align the Bank with global best practices. Also, you will recall that we launched the department’s newsletter, the FMD Update, last year, which provided a high-level review of the FMD operations and projects. Copies of the 2016 FMD Update are available here tonight, and you will also be able to find the newsletter on the Bank’s website. In conclusion, and to emphasise my comment at the start, the Bank extends its appreciation to market participants for their co-operation and support over the years and we look forward to continuing our positive interactions in the future. Last but not least, I would like to sincerely thank our financial markets team, under the leadership of Leon Myburgh, for the sterling work over the past year, for their dedication and commitment to the task. Thank you also to our staff at the Conference Centre for organising this event. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Agricultural Business Chamber Congress 2016, Cape Town, 1 June 2016.
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Lesetja Kganyago: South Africa – “Fit for the Future” Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Agricultural Business Chamber Congress 2016, Cape Town, 1 June 2016. * * * Introduction Good morning, Ladies and Gentlemen. I am honoured to be here with you today, on this 70th anniversary of the Agriculture Business Chamber. Congratulations on this milestone, Agbiz! The theme of this Congress is “Fit for the Future”, and to my mind, this is an excellent encapsulation of South Africa’s monetary policy framework. Inflation targeting, the cornerstone of this framework, is fundamentally medium- to long-term orientated. As you all know, economic activity in South Africa is currently weak. Drought has contributed much to this weakness, but it has considerably deeper roots. Structural reforms are urgently needed to improve capital and labour use, which will boost productivity in the medium term. We have also seen rising inflationary pressures for some time, which prompted the current monetary tightening cycle. Headline inflation is above the upper end of the target range of 3 to 6 per cent, and this breach is expected to persist until late next year, driven especially by food price increases. 1 The South African Reserve Bank is certain that an environment of consistently low and stable inflation is the best contribution it can make to balanced and sustainable growth in South Africa. However, inflation shocks such as the current food price spike can compromise the credibility of the Bank and thereby permanently accelerate inflation. I will focus my remarks today on explaining how the Bank views these shocks and when it deems a monetary policy response necessary. Economic conditions and the drought South Africa’s short-term prospects do not look encouraging. While growth has declined since 2011, underlying inflation1 has increased. At the same time, the economy continues to suffer spillovers from low global growth as well as idiosyncratic shocks, of which drought is the most recent. Rainfall in 2015 was 20 per cent below its long-run average. 2 Parliament recently adopted a motion that drought should be declared a national disaster. 3 After a particularly large maize harvest in the 2014/15 season, of 14,3 million tonnes, commercial maize production dropped last season and is estimated even lower for 2016/17, at just 7,2 million tonnes. We are thus likely to need up to 4 million tonnes of imported maize this year. As measured by headline inflation excluding food, non-alcoholic beverages, petrol and energy prices. Annual rainfall measured 380mm in 2015, in contrast to the 1990–2015 average of 477mm. As of end 2015, five provinces had been declared disaster areas (those are latest available figures). However on 26 May 2016, Parliament adopted a motion to declare the drought a national disaster. BIS central bankers’ speeches The agriculture, forestry and fisheries sector contracted in every quarter of last year, losing 8,4 per cent of its total value over the course of 2015. 4 Associated sectors such as manufacturing (via agro-processing) as well as banks and insurance companies that are heavily invested in the agricultural sector have felt the impact of this contraction – as everyone here will know. In addition to the issue of access to food, we continue to see enormous human suffering from water shortages affecting people’s quality of life. These shortages also endanger businesses; this, in turn, threatens the livelihood of the communities dependent on those businesses for employment. More specifically, we in the Bank have been revising our estimates of potential growth downwards. In other words, the estimated rate at which the economy can sustainably grow before inflation rises has declined. As a result, South Africa today faces a high-inflation, lowgrowth situation similar to many other commodity-exporting emerging markets. The response to this problem is to push potential growth back up while ensuring that inflation does not rise. Currency depreciation, while uncomfortable, is an important part of the adjustment to broader economic weaknesses, in particular coming from falling commodity prices. But it also tends to lift inflation as firms increase producer prices in response to higher imported input costs and as consumers demand higher wages to re-establish living standards relative to the cost of imported goods. With a drought and a weaker currency, food prices are playing an unusually strong role in complicating the inflation outlook. I will turn to this relationship in more detail shortly. For now, from a policy vantage point, preventing an inflation response is critical to keeping our overall cost of borrowing low for investment and to maintaining the competitive advantage we have gained with depreciation. In the past two years, National Treasury has embarked on a fiscal consolidation programme and the South African Reserve Bank has entered a monetary policy tightening cycle. These actions help to reduce inflation and will foster economic stability, consistent with our respective policy frameworks. In the long run, this is good for everyone. In the short run, however, we are providing less economic stimulus while the economy remains far from the hoped-for recovery. Structural reforms to improve opportunities for small businesses and job seekers would increase investment and productivity, and should therefore complement the current macroeconomic policy stance of the Bank. Food price inflation and the exchange rate In 2015, due to favourable oil price shocks, inflation averaged 4,6 per cent. In contrast, inflation outcomes have exceeded 6 per cent this year because of food and petrol prices. The Bank expects headline inflation to average 6,7 per cent in 2016 and 6,2 per cent next year. Food prices are increasing due to the drought, whereas petrol prices are increasing because oil prices have risen off the extremely low levels prevailing at the start of 2015 and a weaker exchange rate. The drought, like oil price movements, is a supply-side shock to inflation. Domestic price increases in maize, South Africa’s staple food, have been extreme. Since 1 January 2015, yellow maize prices have increased by almost 70 per cent while white maize prices have increased by more than 130 per cent over the same period. 5 In total, food prices make up 14 per cent of the consumer price index, and this measure increased by 11,3 per cent Calculated as change in real gross value added at basic prices. As traded up to 20 May 2016 on the South African Futures Exchange (SAFEX). BIS central bankers’ speeches in April 2016, up from 4,3 per cent ten months earlier. Food inflation is forecast to peak at 12 per cent in the final quarter of this year. Dry conditions since 2015 have caused a long period of herd culling, which increased the shortterm supply of meat and temporarily suppressed meat price inflation – thus, although grains inflation has accelerated since June 2015, meat price inflation accelerated this year. Meat price dynamics were an important reason why food inflation rose at a slower-thanexpected pace last year. However, this trend has reversed in 2016, as food inflation rose faster than we had anticipated in the first four months of the year. Furthermore, the rising cost of meat inputs and the lower supply of animals to the market are likely to push meat prices significantly higher over the course of 2016. Food prices are not solely determined by domestic supply and demand; they are increasingly influenced by international food prices and therefore by the exchange rate. 6 This is not necessarily negative. Although South Africa is a net food exporter, we do not have a comparative advantage in all food production. Thus we rely on international prices, which are predominantly US dollar-denominated, in markets where we are price takers. During a drought, international food prices and the currency play a greater role, as food imports are larger than in “normal” years and more food commodities trade at import parity prices. Exchange rate depreciation is thus often discussed as a disadvantage as it drives up food costs. Yet there are advantages to depreciation that are easy to overlook. For South African commodity producers, rand depreciation has mitigated the impact of international price changes: food price indices from the UN’s Food and Agriculture Organization, measured in US dollars, show international food prices deflating for the past three years. When calculated in rand terms, these prices have continued to rise. Thus, domestic producers (or at least those who have harvested during the drought) have been protected from global agricultural price deflation. In general, currency movements assist the domestic economy in adjusting to changing international conditions by signalling an appropriate allocation of resources for production. I have been talking about food prices in particular, but broader commodity prices have been declining since 2011. This has resulted in rand depreciation, making our manufacturing and services exports more competitive at a time when mining exports have become less profitable. For the agri-sectors, this implies scope for agro-processing expansion, as we have a relative advantage while the currency is depreciating. Of course, this can only happen once harvests recover from the drought. The extent to which we can lock in these benefits will depend on ensuring that future price increases are contained so as not to erode competitiveness. The rationale for inflation targeting in South Africa Before discussing the way in which the South African Reserve Bank thinks about food prices and its framework, let me briefly reiterate the inflation-targeting rationale. Inflation targeting is global best practice in monetary policy because it is transparent while also recognising that there is no long-run, or even medium-run, trade-off between inflation and growth. Instead, in the long run, price stability is a precondition for significant sustainable growth. This is also true of financial stability, which has been added to the mandate of the Bank in the aftermath of the global financial crisis. Inflation targeting is a framework that helps to create the conditions for a stable and investment-friendly business environment. Volatile or higher inflation outcomes increase business costs in several ways. They can push employees into demanding above-inflation The exchange rate also influences food production costs, as inputs such as fertiliser are usually imported. BIS central bankers’ speeches wage increases, which pressure business margins. More variable inflation also increases uncertainty about the costs of business operation, which can delay investment decisions. Finally, investors require higher returns for increased uncertainty, which means elevated longterm real interest rates. In addition, higher inflation can negatively impact on competitiveness. If inflation in South Africa is above that of our trading partners or export rivals, then the production costs of our exports will be relatively greater, and as a result we will be less competitive in global markets. This can be corrected by rand depreciation but the rand is especially volatile and, furthermore, domestic inflation can easily erode these gains. Inflation targeting helps to address these problems by guiding policymakers to respond to temporary supply shocks when they may permanently accelerate inflation, as well as by ensuring that demand-side inflation is controlled. These advantages are generic; they apply to everyone. Yet inflation targeting is also particularly suited to the structure of the South African economy. The recent increase in the unemployment rate is a reminder of the large number of people locked out of the real economy. Fundamentally, inflation targeting is a policy framework that protects the vulnerable groups in society, such as the unemployed, the poor and the elderly – basically those with a fixed or no income. Higher headline inflation affects these groups most severely as they are not able to negotiate income increases commensurate with inflation, nor are they able to access financial markets to acquire assets to protect themselves against inflation. The South African economy is characterised by strong pricing rigidities and resilient barriers to entry in many industries. Because of the high concentration of the economy as well as the shortage of skilled employees, “insiders” – meaning price and wage setters – are in a position to mark prices and wages in line with their expectations. When these price and wage setters expect higher inflation in the future, their actions make the expectations self-fulfilling: inflation duly rises and the risk of a wage-price spiral increases. Inflation targeting, once credible, has the capacity to break this cycle as it provides an external anchor for the “insiders.” They focus instead on the Bank’s inflation forecast and its communication and on how and when it will achieve the inflation target. This then protects those groups that do not have the same market power as price and wage setters, such as the unemployed, non-unionised employees and small firms. Greater certainty and lower inflation rates remove a significant constraint that these groups face in accessing the real economy. Of course, this is only the case as long as the Bank can convince price and wage setters of its commitment to the inflation target range –as long as the Bank keeps their inflation expectations anchored. Food prices and second-round effects Food prices hold a particular interest for the Bank. In part, this is because we are aware of the regressive nature of food price increases. More crucially, from an inflation-targeting perspective, if those who do have negotiating power use it in response to food price shocks, this can lead to second-round effects. By second-round effects I mean a reaction in inflation expectations or wages to higher headline inflation, which would cause a further increase in headline inflation after the initial effect of the shock would have dissipated. This occurred after the previous peak in food prices; in 2008, food price inflation averaged 15,8 per cent. In four of the five subsequent years, wage inflation exceeded both food and headline inflation. The current tightening cycle began in January 2014. Since then the Bank has hiked the repo rate by a cumulative 200 basis points to 7 per cent currently. This year, the Bank has hiked the repo rate by 75 basis points. From a historical perspective, the 7 real interest rate remains low, following a prolonged period of monetary accommodation. Furthermore, this is one of the most gradual hiking cycles on record. Let me emphasise that interest rate increases are not aimed at decreasing food inflation; the Bank understands that the food inflation we are seeing is a market-based response to a BIS central bankers’ speeches temporary shock. Typically, a flexible inflation-targeting regime will look through supply shocks that shift headline inflation away from the target range, provided that the shift is clearly temporary and will not create second-round effects. The Bank applied this approach for a number of shocks occurring between 2009 and 2013. Headline inflation spent 18 months above the upper end of the target range over that period. Yet the Bank could afford to look through those shocks; underlying inflationary pressure, as measured by core inflation, was contained, and this, alongside anchored inflation expectations, meant that there was space for temporary breaches. However, the Bank is of the view that, since January 2014, it has not been appropriate for it to look through supply shocks that drive inflation above 6 per cent. At that time, the Bank forecasted an extended breach of the target if it did not act. The risks around its forecast implied that second-round effects would manifest if it did not act to prevent them. In the run-up to the hiking cycle, the Bank noted with concern persistently above-inflation wage settlements despite weak growth and the clustering of inflation expectations around the upper end of the target range. These were signals that inflation could permanently accelerate if further shocks occurred. The problem is not that inflation may exceed 6 per cent; the problem is that people may come to believe that the South African Reserve Bank does not target 3 to 6 per cent but instead targets 6 per cent plus a “supply shock premium”. Such a perception would compromise the credibility that the Bank has earned since inflation targeting was introduced in 2000. As I’ve mentioned, price and wage setters have enormous discretion if they believe that the true target is above the set range. The Bank wants to avoid such a situation. “Fit for the Future” and the agribusiness and agro-processing sectors The environment that I have described today may feel discouraging to you. I would not want that to be my overarching message. I think that the actions South Africa takes now, to reinforce our framework, will protect economic competitiveness in the global arena and encourage future growth. The National Development Plan has highlighted the potential of the agriculture and agroprocessing sectors, particularly for increasing employment but also growth. Although South Africa is a leading exporter of certain food commodities – including maize, sugar and fruit – there is great scope for expansion of the agro-processing sector. Even a cursory glance at the manufacturing production statistics makes them look encouraging, as the weight of the food and beverages category has increased from 11 per cent in 2000 to 24 per cent currently. However, the contribution from manufacturing production to GDP has been shrinking over this period, so agro-processing volumes have merely grown in line with real GDP. I am sure that this observation will be a key focus of your conference over the next two days, so I will not say more on the subject. There are multiple advantages to expansion. Agriculture is relatively labour-intensive, and it is a crucial source of employment for rural communities. Increasing agricultural output would also strengthen food security, not just in South Africa but in sub-Saharan Africa. Furthermore, expanding manufacturing production is key to creating stable jobs suitable for our underemployed workforce. The International Monetary Fund has recommended expansion of agro-processing in sub-Saharan Africa as the region has a comparative advantage in agriculture and countries such as Ethiopia have enhanced their integration into global value chains through agro-processing. 7 Research has shown that this value chain integration is key to productivity growth for small open economies in particular, as they learn from countries See the International Monetary Fund, “Regional economic outlook – sub-Saharan Africa: navigating headwinds”, April 2015, p. 59. Available at http://www.imf.org/external/pubs/ft/reo/2015/afr/eng/pdf/sreo0415.pdf. BIS central bankers’ speeches further along in the value chain. Overall, then, expansion would assist in South Africa’s great need for export growth and give it a productivity boost and additional employment. Conclusion This Chamber is well suited to tackling challenges related to expansion. As a forum of stakeholders from different stages of the agricultural process, Agbiz is in a unique position to facilitate communication and action. It is encouraging that your strategy and objectives highlight competitive performance, transformation, inclusivity and technology – all necessary for a thriving and sustainable agriculture sector, and for managing the challenges of globalisation and climate change. Although periods of underperformance are often the most difficult times to make changes, they also provide valuable time to evaluate and strengthen frameworks with a view to sustainable growth. The many recent shocks to growth and inflation have created a great deal of uncertainty. In this context, you can at least be certain that the South African Reserve Bank is committed to containing inflation. This preserves your competitive advantage for exporting and contains long-run investment costs, creating the foundation for your expansion. You can count on the Bank to do its part. In turn, I look forward to watching you build a productive and integrated sector that is able to contribute ever more meaningfully to domestic growth and employment. 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 ICBC Standard Bank Africa Investor Conference, London, 30 June 2016.
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François Groepe: The South African situation – opportunities and challenges Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the ICBC Standard Bank Africa Investor Conference, London, 30 June 2016. * 1. * * Introduction Ladies and gentlemen, good morning. It is an honour and a pleasure to address this year’s Africa Investor Conference, and I would like to thank my hosts, ICBC and Standard Bank, for the invitation. The timing of this conference is highly appropriate, as were the discussions that have already taken place regarding the challenges facing African economies amid pedestrian global growth, low commodity prices, increased geopolitical risks, and a high degree of market uncertainty, particularly following the decision of the United Kingdom to leave the European Union (“Brexit”). The African continent, however, continues to offer attractive opportunities for growth and development, provided appropriate policies are pursued to address these challenges. South Africa is no exception. This morning, I shall examine the current economic conjuncture in South Africa and highlight those developments which make us hopeful that improvement lies ahead. I will also consider how this may affect the outlook for monetary policy, before concluding with some remarks on our country’s sovereign rating outlook. 2. International and local challenges to the South African economy The African continent in general, and South Africa in particular, have not been immune to the challenges faced by the global economy. These include a gradual but sustained slowdown, since the start of the decade, in real global demand for South African exports, in particular from China, as well as a major downward adjustment in the prices of our major commodity exports. These developments have eroded real export growth, incomes, and to some extent also corporate profitability in some sectors of the economy. Internal challenges have in recent years unfortunately compounded South Africa’s economic problems. These include electricity supply constraints, a slow expansion of rail and port capacity, skilled labour shortages, and the high incidence of labour conflicts. This situation has been exacerbated by the recent drought as well as various socio-economic and political factors that have eroded consumer and business confidence. In 2015, agricultural production contracted by an average of 5,9 per cent, and it was still falling in the first quarter of this year. This conjunction of unfavourable international and internal factors has, unsurprisingly, weighed on domestic economic activity. Real GDP contracted by 1,2 per cent (quarter-onquarter, annualised) in the first quarter of 2016, and by 0,2 per cent on a year-on-year basis. This was the first negative reading since the 2009 recession. It continued a decelerating trend which has seen real GDP growth slow from 3,2 per cent in 2011 to 1,3 per cent last year. In May, the South African Reserve Bank revised its 2016 growth forecast to 0,6 per cent from 2,2 per cent a year earlier. This growth slowdown is partially structural, reflecting, among other things, the subdued pace of private-sector fixed-capital accumulation since the most recent global financial crisis. The Bank estimates that potential GDP growth will be 1,5 per cent this year, down from 2,1 per cent in 2013. The first-quarter GDP data has also highlighted the weakness of both internal and external demand for South African goods. In addition to a marked decline in fixed investment by BIS central bankers’ speeches private corporations, household consumption expenditure contracted by 1,3 per cent in the first quarter of 2016 (quarter-on-quarter, annualised), the biggest drop since the 2009 recession, as the mix of rising inflation, higher debt service costs, and a lack of net job creation weighed on both purchasing power and sentiment. On the external side, real exports of goods and services fell by 7,1 per cent in the same quarter, after a relatively subdued 4,0 per cent average gain in 2015. This weakness in real exports is of particular concern as it exceeds, on balance, the pace of moderation in international demand for goods and services. Thus, despite the marked depreciation of the real effective exchange rate of the rand since 2011, South African exporters have struggled to stabilise their market share. 3. Some reasons for cautious optimism So, where do we go from here? There is no denying that the economic environment facing South Africa will remain difficult, at least in the short term. Most international forecasters agree that global growth will remain tepid this year. In its latest Global Economic Perspectives, for example, the World Bank projects world GDP to expand by only 2,4 per cent this year, the same as in 2015, and by only 2,8 per cent next year. At the same time, many commodity markets – including some of South Africa’s key export commodities – continue to suffer from excess supply, limiting the potential for a price recovery even as global demand shows signs of a moderate pickup. Geopolitical and financial uncertainties remain a major risk. Just last week, we saw how, in response to Brexit, many emerging-market currencies, including the rand, suffered a burst of volatility, which could add a risk premium in South African and other emerging-market asset markets. Furthermore, the oft-debated concern about the slowing trend in productivity growth in advanced economies will probably not fade in the near term. This concern has found an echo in South Africa, where annual average labour productivity growth has slowed from 2,7 per cent in the 2000s to 1,4 per cent in the last five years – mostly a consequence of a poorer performance in total factor productivity. It may seem paradoxical to observe such a parallel in South Africa, considering that, as an emerging economy, the country still has plenty of room to “catch up” with more advanced economies. Nonetheless, a slower pace of global innovation and efficiency gains may affect those South African industries operating close to the “technological frontier”, via more subdued transfers of technology. Finally, we should acknowledge that South Africa has to contend with more limited macroeconomic policy space. I shall return to monetary policy later. Nonetheless, it should suffice to say that, with policy rates 200 basis points higher now than they were at the start of 2014, funding conditions are not as accommodative for private borrowers as they were before we embarked on our gradual tightening cycle. We have observed, for instance, that interest costs on household debt amounted to 9,7 per cent of disposable income in the first quarter of 2016, up from a low of 8,5 per cent in the third quarter of 2012. As for fiscal policy – which will be discussed in more detail later this morning – the need to stabilise public debt amid weak growth has led to net tax increases both in last year’s budget and in the current one, while the pace of public spending growth has also been tightened. Nonetheless, while we guard against undue optimism, the proverbial “green shoots” of a recovery may be starting to appear. Although still well below par, the average prices of South Africa’s major commodity price exports are off their early-2016 lows. At the same time, the recent fading of El Niño conditions in the South Pacific raises hopes of a more normal agricultural season in 2016/17. If that does turn out to be the case, we could be looking at both a rebound in farm production and lower agricultural prices. Such a reduced drag from drought conditions and falling resource prices should significantly ease the downward pressure on corporate profits, which may have troughed already. In the first quarter of 2016, the gross operating surplus in the economy as a whole picked up to 3,8 per cent year on year from 1,5 per cent in the previous period, the second successive BIS central bankers’ speeches increase after six consecutive quarters of deceleration. At the same time, high-frequency indicators such as the Barclays PMI and the manufacturing production data for April suggest that the second quarter has started on a more solid footing. Admittedly, many of these developments relate to the so-called “base effects” and are no guarantee that, once these effects have worn through, we will witness a sustained, stronger momentum in the South African economy. However, several – and more fundamental – patterns do suggest that the country should be relatively well placed to take advantage of a gradually improving global economic environment, notwithstanding the possible negative implications of the Brexit. For example, continued growth in the bank deposits of the corporate sector – 8,6 per cent year on year as of April – suggests that, despite its eroded profitability, the South African corporate sector is not facing the kind of liquidity pressure that typically preceded past recessions. In fact, bank lending to corporations is also rising at a fairly dynamic pace, pointing to some expansion in niche sectors such as renewable energy and commercial property. Households, for their part, have managed to achieve some deleveraging over the prolonged period of low interest rates. Thus, while the rate of home and vehicle repossessions has risen in recent quarters, it is still relatively low by historical standards. Banks themselves continue to display solid capital adequacy, liquidity coverage and profitability ratios, suggesting that the risk of a sudden “pull-back” in lending to the private sector is quite limited at this stage. The lack of obvious imbalances in property markets, as residential house prices appear to be largely in line with underlying fundamentals, equally reduces the risk of “homegrown” financial or banking stress. The South African Reserve Bank last month released the results of its common scenario stress test which was designed to assess the soundness and resilience of the South African domestic banking sector. The test included all the domestic systemically important banks. A formal approach to risk identification and scenario design was followed, and the banks were exposed to four adverse scenarios, including a protracted recession and a period of excessive financial market volatility. The results of the exercise confirmed that South African banks were adequately capitalised to withstand significant credit losses throughout the stress scenarios, even before taking into account any mitigating action by their management teams. After the Brexit referendum, financial markets in emerging-market economies were exposed to significant levels of volatility. The South African Reserve Bank and National Treasury have been monitoring these developments and their possible implications for South Africa. In a subsequent statement, the Minister of Finance, Mr Pravin Gordhan, reassured the public that the banking and financial institutions in South Africa were well placed to withstand any Brexitrelated financial shocks. The South African financial system, including the banks and the regulatory framework which governs them, is resilient and robust and this had been clearly demonstrated during the global financial crisis. Furthermore, we are starting to see tentative signs that export-orientated and importcompeting sectors may be starting to benefit from exchange rate depreciation. The most encouraging sign has been observed in the vehicle industry, where shipments abroad increased by 20,5 per cent (in volume terms) in 2015 while the first few months of 2016 have shown a continuation of this upward momentum. The merchandise trade balance has improved, with a cumulative deficit of R18,7 billion in January to April compared with R32,0 billion in the same period a year earlier. 4. How monetary policy adjusted to the situation Some may ask: “Isn’t there a risk that the consecutive interest rate increases implemented by the South African Reserve Bank over the past year may nip this recovery in the bud?” As I’ve mentioned earlier, we must appreciate that “policy space” in South Africa has narrowed. I would, however, like to expand on the Bank’s monetary policy stance and how it interacts with the business cycle. BIS central bankers’ speeches Clearly, the situation that we have faced in the past couple of years – a combination of slowing real economic growth and accelerating price pressures – is not one that central banks particularly enjoy dealing with. Demand fell short of potential and our estimates show that the output gap remained negative in 2015 and is likely to widen somewhat this year. Yet inflation accelerated, driven by exchange rate depreciation and a number of supply side factors, including drought and electricity supply constraints. Despite a slightly improved forecast in May, inflation is still expected to remain above the upper end of the target range until the third quarter of 2017 – and the risks to this forecast were assessed to be on the upside. In light of our flexible inflation-targeting mandate, we needed to ask ourselves a number of questions, including: • How strong and durable would the drivers of inflation prove to be? • To what extent should we take the weak state of the economy into consideration? • To what extent would the persistence of the output gap limit the pass-through from exchange rate depreciation to domestic prices? • How big was the risk that this unusually large depreciation (51 per cent in nominal effective terms since the end of 2010) would unanchor inflation expectations? Indications of a lower exchange rate pass-through to inflation have been encouraging. If we look at the core rate of inflation (i.e. headline inflation excluding food, petrol and energy), it has accelerated by 2,6 percentage points since it bottomed in early 2011. By contrast, in response to the previous cycle of significant exchange rate depreciation (58 per cent between 2006 and 2008), core inflation increased by 7,9 percentage points. This suggests that the lack of dynamism in consumer demand as well as the absence of a credit boom or of significant wealth effects seem to have limited the ability of producers and retailers to pass through cost increases to the end consumer. Yet, because this reduced pass-through, which incidentally is not unique to South Africa, is not yet fully understood, we cannot become complacent and assume that it has become a permanent feature of our economic landscape. The pass-through has not been constant over time; just as it fell, it could rise again. The role of inflation expectations therefore becomes paramount. Historically – in part because of the major structural changes the economy went through in the last 50 years and in part because of a long period of high and volatile inflation (from the 1970s to the 1990s) – price expectations in South Africa appeared to be adaptive, as reflected in the behaviour of price and wage setters, be they businesses or organised labour. The introduction of inflation targeting in 2000 helped, over time, to reduce the volatility and adaptive nature of inflation expectations. Expectations have, in recent years, been relatively stable, although around the upper end of the 3–6 per cent target range. This “upward bias” in expectations limits the margin of manoeuvre of the South African Reserve Bank, insofar as any sizable shock to prices can easily create a situation where inflation settles above the target range for an extended period of time. This was indeed the risk that emerged over the past few years – and which forced the Monetary Policy Committee (or MPC) of the Bank to act. As our projections have shown, in particular from January 2016 onwards, in the absence of further action, inflation would exceed its targeted range for lengthy periods of time over the forecast horizon. Accordingly, the MPC felt the need to move to a less accommodative stance. Thus, the repurchase rate was increased from a low of 5 per cent in January 2014 to 7 per cent as of May, including a cumulative increase of 75 basis points in the first quarter of this year. I would like to emphasise, however, that this pace of increase was more gradual than in previous tightening cycles. Furthermore, when expressed relative to both actual and expected inflation, the real policy rate is still relatively low by long-term historical standards. Thus, monetary accommodation has been partly removed, but without moving to an outright restrictive stance. BIS central bankers’ speeches 5. Inflation and policy outlook As I’ve mentioned before, the combined effects of the drought and exchange rate depreciation have pushed up the rates of both headline and core inflation over the past six months – and this despite the dampening effect from lower international oil prices. Headline inflation rose from a low of 3,9 per cent in February 2015 to as high as 7,0 per cent a year later before retreating to 6,1 per cent in May. Core inflation, which had trended modestly downwards for most of 2015, rose from 5,1 per cent last November to 5,5 per cent as of May. Some of this acceleration reflects a pass-through of foreign-exchange depreciation to the prices of goods. However, the evidence varies according to specific categories, suggesting that this pass-through is far from homogeneous. In light of these relatively encouraging developments, and taking into account the moderate rebound in the rand from its early-2016 levels, the South African Reserve Bank has been able to lower its projection for core inflation, albeit only somewhat: whereas it expected a peak of 6,5 per cent in the third and fourth quarters of 2016 at the MPC meeting in March, the Bank expects core inflation to peak at 6,2 per cent around the same period before retreating to 5,1 per cent by the end of 2017. Any sign that underlying price pressures remain contained would facilitate the task of the Bank in dealing with the current conflicting risks facing real economic growth and inflation. Of course, vigilance will be needed in the coming quarters, as the secondary effects of earlier shocks (in particular on the exchange rate) are still being felt – and there is no guarantee that inflation expectations will remain stable. So far, evidence on these fronts is mixed. Expectations for CPI inflation one year ahead – as measured by the Bureau for Economic Research among analysts, businesses and unions – drifted marginally higher over the past year but, at 6,2 per cent, they are still very close to the 6,0 per cent average of the past five years. Break-even inflation expectations, derived from inflation-linked government bonds, are significantly higher (around 7,0 per cent as of 21 June for the five-year rate), but this measure is highly volatile and sensitive to exchange rate fluctuations. As for wage developments, it is encouraging to note that the Andrew Levy measure of average annual wage settlements, at 7,8 per cent in the first quarter of 2016, is little changed from the 7,7 per cent gain observed on average in 2015. However, several key wage negotiations lie ahead, with a possibility that wage demands may take cognisance of the recent acceleration in inflation. With respect to both inflation expectations and labour costs, the next few months could be crucial. 6. Investment-grade ratings, the rand, and inflation One important element in securing the stability of inflation expectations, in part because of the influence it is likely to have on the level and volatility of the rand, will be the ability of South Africa to maintain its investment-grade rating – and this leads me to my concluding points. I do not need to stress how thoroughly the South African Reserve Bank has been monitoring the evolution of South Africa’s sovereign debt ratings. A sovereign rating can have an impact on monetary policy because of how it influences the availability and cost of external financing, the yields on domestic debt and, in turn, the performance of the rand – both in absolute terms and relative to its emerging-market peers. South Africa, being a structural net capital importer, needs to secure the best possible “terms and conditions” under which it accesses global sources of funding. Any adverse developments on this front would probably further complicate the challenges of weak growth and rising inflation that the Bank has to deal with currently. This said, while investor and media attention will probably be on South Africa again come the time of the next rating reviews, there are several reasons which make us confident that, provided the right policies continue to be put in place, our country can retain its investment- BIS central bankers’ speeches grade rating. As I’ve highlighted earlier, economic growth, which has been a key concern of the rating agencies, is showing signs of bottoming. At the same time, while public debt as a share of GDP is only expected to stabilise in 2017/18, the 2016 budget has put in place genuine elements of fiscal consolidation and the discipline shown by central government in recent years to stick to its expenditure targets should facilitate the achievement of these fiscal goals. Furthermore, as far as the country’s external liabilities are concerned, it is encouraging to see that they have declined, in absolute dollar terms, over the past four quarters, breaking a lengthy upward trend. This improvement is partly due to the exchange rate-induced decline in the dollar value of rand liabilities held by non-residents. External debt has also declined relative to GDP and to the exports of goods and services. For example, as a share of exports, external debt stood at 118,9 per cent at the end of December 2015, down from a peak of 124,6 per cent three quarters earlier. A further positive side-effect of rand depreciation has been the improvement in South Africa’s net international investment position: as most investments by non-residents in South Africa are rand-denominated, in contrast to investments by South African residents abroad, the currency effect more than offset the net incurrence of new liabilities required to finance the current-account deficit. Thus, as at the end of 2015, the net investment position stood at a positive 17,8 per cent of GDP, compared to the 2,8 per cent in the previous quarter. 7. Conclusion To conclude, I would just like to emphasise once again that notwithstanding the challenges that the South African economy currently faces, we should equally not fall into excessive pessimism. The underlying corporate and financial structures of our economy remain solid; there are no major impediments to a proper allocation of resources. And provided that the right policies continue to be put in place, there is no reason to doubt the country’s ability to gradually return to a stronger economic growth path. The National Development Plan provides the right framework for addressing the structural challenges that have so far precluded a stronger and more inclusive pace of development; it is important that it gets implemented. By ensuring that inflation remains under control and that the financial sector remains healthy, the South African Reserve Bank intends to fully contribute towards these development goals. 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 International Mbali Conference, hosted by the University of Zululand, Richards Bay, KwaZulu-Natal, 6 July 2016.
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Daniel Mminele: International financial market developments – some implications for South Africa Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the International Mbali Conference, hosted by the University of Zululand, Richards Bay, KwaZulu-Natal, 6 July 2016. * * * Introduction Good morning, ladies and gentlemen. I would like to start by thanking our host, the University of Zululand, for affording me the opportunity to address you today. It is an honour to speak at this inaugural international conference of the University of Zululand. It has been a rather tumultuous year in international financial markets thus far, so I thought it appropriate to focus my remarks today on a few key global financial market developments and their impact on the domestic markets and monetary policy. International financial market developments According to the American novelist Phillip Roth, ‘fear tends to manifest itself much more quickly than greed, so volatile markets tend to be on the downside’.1 Now while this comment falls into the broader theme of the influence of human nature on market behaviour, it nevertheless is an interesting thought. Few will disagree that excessive volatility in financial markets is undesirable since it is synonymous with unpredictability and uncertainty, which normally leads to increased speculative activity and/or a flight towards safety. This, in turn, through a higher risk premium, can increase the costs of access to capital, stifling growth and development, particularly in emerging-market economies. Furthermore, history reminds us that bear markets are generally more disorderly than bull markets. Unfortunately, increased financial market volatility appears to have become entrenched in the post-global financial crisis era, with little sign of it dissipating in the immediate future. Even in the present context of elevated financial market volatility, there are a few episodes that stand out: the 2010–11 European sovereign debt crisis; the mid-2015 ‘Grexit’ negotiations and Greek referendum; the rapid fall in the Chinese stock market in 2015–16; and now, more recently, the British in/out referendum, commonly referred to as the ‘Brexit’. Given how momentous the outcome of this referendum was, I would like to spend a few minutes on this particular topic. The vote in favour of a Brexit, essentially the British people electing that the UK no longer be a member of the European Union, led to a great deal of financial market volatility, both in the run-up to the referendum and indeed right up to this point in time. The UK voted to leave the EU by 52 per cent, with a voter turnout of approximately 72 per cent, in what was an unexpected result for many. On the day of the announcement, the Chicago Board’s measure of market volatility (known as the VIX) jumped by 49 per cent from the previous day, the fear of the unknown aptly accounting for the spike in volatility. The UK’s present and future are now riddled with uncertainty, naturally accompanied by a flight to safety. As risk aversion soared, safe-haven assets were in high demand, and as such the price of gold breached the US$1300 mark for the first time since January 2015 while the US 10-year Treasury yield fell 19 basis points and the German 10-year bond yield www.thefinancialphilosopher.com. BIS central bankers’ speeches fell to a record low of –0,05 per cent. The relative safety of the Japanese yen saw the currency gain 11 per cent against the sterling, which in turn fell to a 30-year low the following day against the dollar. The market reaction was significant, described by some market participants as ‘panic buying and selling’, given the widespread expectations that the British would vote in favour of remaining within the EU. As markets slowly digested the news, however, some of these market movements were pared back, with no sustained market disruptions being reported. The decline in bond yields and demand for safe-haven assets also points to fears of the potential impact that the Brexit may have on an already weak and fragile global economy. Some of the main concerns relate to the potential ripple effects on the rest of Europe and global trade flows. The consequences of this vote will only become clear over time, and it is anticipated that it will take about two years for the UK to finalise arrangements to leave the EU, during which period various decisions and negotiations on the way forward will take place, raising the possibility of yet another prolonged period of global volatility. In the meantime, market fears are being fuelled by concerns of contagion in the EU, the probability of Scotland and perhaps also Northern Ireland leaving the UK as well, and the uncertainty surrounding trade agreements that would follow from the negotiations. For South Africa, the implications through direct trade links are expected to be relatively minimal. In 2015, the UK accounted for only 4 per cent of our total merchandise exports. Indirectly, South Africa is likely to be negatively affected by heightened market volatility and the impact of the Brexit on the EU and the global economy. The financial linkages between South Africa and the UK are somewhat large, if one considers that, at the end of 2014, South Africa’s liabilities to the UK amounted to 46,5 per cent of domestic GDP while assets amounted to 33,2 per cent of GDP. In addition, both foreign direct investment (FDI) and portfolio flows are also significant.2 This means that South Africa could very well be affected by the realization of tail risks emanating from asset liquidation by UK corporates and investment funds. However, as time progresses and the respective parties provide clarity on the process, the storm is likely to calm. Let me now turn to the importance of other international financial market developments. Given globalisation and increased financial integration, global financial markets have a significant impact on South Africa. This integration means that when one major market sneezes, the rest of the globe’s markets catch a cold. Thirty years ago, the threat of an incident like the Greek government default was unlikely to have a substantial impact on global markets, but today this conjecture is vastly different. Thus far, it has been a mixed year for equity markets, with region-specific idiosyncrasies having a dominant effect on outcomes. That being said, the Brexit result has introduced such short-term volatility that the facts I am about to mention may already be outdated. Nevertheless, US equity indices are up around 3 per cent for the year to date as the economy shook off growth concerns in the beginning of the year and continues its gradual recovery. In Europe and Asia, however, outcomes have been less positive. The large correction that took place in Chinese markets has dragged down other indices in the region, including those of Japan. Meanwhile in Europe, broad-based weakness has seen equities fall by as much as 10 per cent in Germany and 12 per cent across the region on average, even with the European Central Bank (or ECB) continuing to provide record liquidity to markets. At home, the Johannesburg Stock Exchange (or JSE) has shaken off a very poor start to the year and is currently almost 3 per cent in the black for the year thus far. After a poor showing by the mining and resource stocks in 2015, these have turned around in 2016 as commodity prices have started to come off their lows. Government bond markets have continued to rally, Would ‘Brexit’ matter for South Africa?, South African Reserve Bank Economic Note, 20 June 2016, Jean Francois Mercier and Guy Russell. BIS central bankers’ speeches as monetary policy in advanced economies remains largely accommodative, with likely further easing in a number of key economies. Moving to the policy sphere, it has been an eventful 12 months for monetary policy. Late last year, the Federal Reserve raised its policy rate for the first time in almost 10 years. On the other hand, the ECB, in an attempt to avert deflation, has expanded its quantitative easing programme and, more recently, has even included corporate debt while delving deeper into negative interest rate territory. On account of this, the amount of government debt having rates of return below zero has increased to over US$10 trillion – and is still rising. The Bank of Japan also introduced negative policy rates for the first time in its history. However, it is the Federal Reserve – which has not moved its rate since December – that continues to have the greatest impact on global financial markets. Many analysts have suggested that the broad recovery in international markets over recent months had been driven by a shift in the market assessment of risk. This is premised on the view that the likelihood of much higher US policy rates has been pared back following concerns that the US recovery is perhaps not as robust as initially envisaged and on account of international developments. More recently, in light of the financial market developments emanating from the UK referendum, market indicators suggest that the Federal Reserve is likely to keep rates constant for at least the next 12 months. Commodity market developments during 2016 have been mixed. After reaching a record low of around US$28 per barrel in January, Brent crude has undergone a remarkable rally, gaining over 80 per cent to just over US$51 since the beginning of the year – this despite OPEC (the Organization of the Petroleum Exporting Countries) not agreeing to an output cap. This rally comes notwithstanding major producers, such as Nigeria and Canada suffering production outages. It is notable that when oil prices were falling and were in the range of US$50–60 per barrel, oil rigs in the US were rapidly taken offline. It will be interesting to see if the oil price will then face resistance as shale production becomes more profitable again when oil prices reach these levels. The domestic price of petrol has increased by R1,49 in the past four months as a direct consequence of the rally in the oil price alone. Meanwhile, after a rapid decrease during 2015, the prices of our major commodity exports have recovered somewhat since then. After declining by over 26 per cent last year, platinum prices have since recovered by around 15 per cent. The prices of other major exports, such as iron ore and coal, have also recovered to a certain extent this year but are by no means anywhere near the record levels we witnessed at the height of the commodity supercycle. Demand for commodities from China is still expected to gradually decrease over the medium term, so the current rally should be considered with that in mind. The rapid decline of capital flows into emerging markets, which began in the second half of 2015, was an unwelcome development. It is a natural consequence of, inter alia, an environment where emerging markets are no longer growing as rapidly as before while their external and fiscal metrics are less favourable than a few years ago – coupled with the uncertainties related to monetary policy outcomes in advanced economies. However, the scope and speed of this capital flight surprised many, with the Institute for International Finance (IIF) estimating that approximately US$21 billion left emerging markets in the past 12 months.3 This represents a rapid reversal from the US$175 billion of inflows during the preceding 12-month period. Furthermore, while the extent of the relationship is not easy to determine, inflows such as these certainly contribute to the depreciation of emerging-market currencies. Fortunately, the most recent data illustrate a scenario where inflows to emerging markets have started to pick up again over the past few months. However, it remains to be seen how the situation evolves in light of Brexit-induced market uncertainty. Institute for International Finance Emerging Market Portfolio Flows Tracker BIS central bankers’ speeches Capital flows are particularly vital for South Africa, which has experienced a structurally stubborn current-account deficit that stood at 5,0 per cent of GDP at the end of the first quarter of 2016. While South Africa has been in the fortunate position of attracting sufficient capital to finance this deficit, this has mainly entailed portfolio inflows. According to data from the JSE, non-resident inflows to South Africa for the year to 30 June 2016 amounted to R35,7 billion, consisting of R20,4 billion in bond inflows and R15,3 billion in equity inflows. Part of the reason for the volatility in capital flows has been linked to monetary policy developments in advanced economies which in the main impacts on risk perception. In times of heightened risk aversion, money generally flows to reserve currencies such as the dollar or euro, causing emerging-market currencies to depreciate. The rand of course has been no exception. Over the past 12 months, the rand has lost roughly 21 per cent against the greenback, 20 per cent against the euro, and a staggering 44 per cent against the Japanese yen. However, we cannot restrict ourselves to comparisons with movements against advanced-economy currencies. Take, for example, the JP Morgan Emerging Market Currency Index (or EMCI), which comprises most major emerging-market currencies, including those of all the BRICS member countries. Between January and October last year, the rand moved very much in line with this basket of currencies. During that period, the EMCI, when removing the impact of the rand – which has a weight of 8,3 per cent in the basket – lost approximately 13 per cent against the US dollar, a loss that was almost exactly mirrored by the rand. However, since October, the EMCI has lost only 0,5 per cent against the US dollar, whereas the rand has shed a further 5 per cent. While all such calculations have their limitations, the fact of the matter is that the rand has been one of the worst-performing emerging-market currencies over the past nine months, despite emerging markets in general facing the same external conditions. This illustrates that factors unique to South Africa have had a bearing on the performance of the local currency. One such factor, which has recently drawn much attention in media and policy circles, has been South Africa’s credit ratings. South Africa’s sovereign credit rating South Africa’s sovereign credit rating has been a source of market uncertainty for some time. National Treasury, government in general, and the South African Reserve Bank (or SARB) have indicated that economic policy will be targeted at addressing the relevant concerns in an effort to prevent a ratings downgrade and put South Africa’s rating on an upward trajectory. Without delving into too much detail, in simple terms a country whose debt is considered non-investment grade has to pay higher interest rates on newly issued debt. The reason is simple: markets demand higher compensation for a perceived higher level of risk. Furthermore, while there are higher yields on non-investment grade debt, some institutional investors are constrained by client mandates and are only allowed to have investment-grade assets in their portfolios. Hence, a downgrade to sub-investment status would in effect mean that certain institutional investors holding these investments would have to divest their holdings of the affected debt instruments, which is likely to lower their value, further increase the country’s risk profile, and by implication raise external financing costs. This can eventually adversely impact on the country’s economic fundamentals and growth prospects. While the issue of South Africa’s sovereign credit rating has been covered extensively in the media, one aspect that has scarcely been discussed is the distinction between foreign and local currency ratings. This distinction is important. Put simply, the foreign currency rating is an indication of a country’s credit worthiness when issuing foreign currency-denominated debt. So, in addition to measuring the vulnerability of the balance sheet in rand terms, South Africa’s foreign currency rating also accounts for our exposure to exchange-rate risk. Bonds issued in US dollars, for example, must be repaid using the same currency, which following historical trends would imply a higher rand cost at maturity. BIS central bankers’ speeches While foreign currency ratings commonly make the headlines, in many ways the local currency rating is of greater significance for South Africa. South Africa does not have a significant foreign currency-denominated debt burden. At the time of the last budget review, National Treasury estimated that foreign currency public debt as a percentage of gross debt was only 11,3 per cent for the previous fiscal year.4 Furthermore, this figure is expected to stabilise at around 10 per cent over the next few years. So while a downgrade in our foreign currency rating would increase the cost of our access to foreign currency debt markets and would be seen as a serious setback, the impact of losing the local currency investment grade would be far worse. This, in effect, would make our domestic currency-denominated debt less attractive and hence more expensive. Fortunately, South Africa’s local currency rating is at least two notches above investment grade by each of the major ratings agencies. During May and June, South Africa received confirmations of unchanged credit ratings from all three major credit rating agencies. These confirmations, however, came with a very clear message: further improvements in the macroeconomic fundamentals are required, suggesting that, in the absence of demonstrable progress being made as part of a concerted effort involving all social partners, the risk of downgrades during the next reviews towards the end of this year should not be underestimated. Recent economic growth developments As I move towards the end of my remarks, let me make a few comments on domestic growth developments and touch on monetary policy issues before I conclude. After achieving pedestrian growth of only 1,3 per cent during 2015, the economy contracted by an annualised 1,2 per cent in the first quarter of 2016. This contraction more than erased the gains of the previous two quarters. In fact, the size of the economy is now smaller than it was in the final quarter of 2014. Much of this decline has originated in the primary sector, which has contracted by almost 10 per cent over the past year, with mining in particular pulling the sector down. Given the linkage effects, it is not surprising that developments in the primary sector have had spillover effects into other sectors of the economy, most notably into the manufacturing sector, which has contracted by 1 per cent over the past year. Unfortunately, the growth outlook for the rest of the year will remain challenging, as shortterm indicators suggest a difficult picture for the second quarter and most forecasters predict that the economy will grow by well below 1 per cent this year. Fortunately, two of the factors that had severely constrained the primary sector lately – the drought and electricity supply issues – are expected to fade over the coming year. This may imply that growth will reach a lower turning point during this year. The most recent forecast by the SARB suggests a modest recovery over the next two years, but the assumptions underlying this forecast had not factored in any possible spillover effects stemming from Brexit.5 Employment numbers also make for rather disappointing reading. More than 1 in 4 economically active South Africans are still without employment. Even though the economy has added approximately 200 000 jobs over the past year, the labour force has increased by almost twice that figure.6 Employment creation remains the single most important policy challenge for South Africa. In this regard, policymakers have recognised the need to increase potential output growth, which the SARB estimates at 1,5 per cent during 2016 – insufficient in light of South Africa’s developmental needs. This requires the effective and efficient implementation of growth-enhancing structural reforms. Budget Review, February 2016 (www.treasury.gov.za) Monetary Policy Committee statement, 19 May 2016 (www.resbank.co.za) Quarterly Labour Force Survey, Statistics South Africa, Pretoria, May 2016 BIS central bankers’ speeches Monetary policy Allow me to now turn to monetary policy. 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 most recent forecasts indicate that it will not return to within the target band until the second half of 2017. Inflationary pressures are currently underpinned by supply-side shocks, mainly related to exchange rate and food price movements. Exchange rate depreciation, or rand weakness, is an issue that most of us are innately aware of. It affects every South African through a number of direct and indirect channels. Consumers immediately feel the effects of depreciation at the petrol pumps and, later, through ‘first-round’ impacts on imported goods. However, as the SARB’s Monetary Policy Committee (MPC) has stated on numerous occasions, flexible inflation targeting allows monetary policy to see through these so-called ‘first-round’ inflationary effects. The greater danger is a self-enforcing inflationary process that is jump-started by these initial effects: the so-called ‘second-round’ inflationary impacts. 11 The SARB is concerned about the rising inflation expectations, and for good reason: these can become a self-fulfilling prophecy. Essentially, this implies that rational agents will demand compensation in line with their inflation expectations to protect their purchasing power, resulting in rises in input costs and eventually in the general price level. This inflationary process is in some respects similar to Newton’s First Law of Motion: an object in motion tends to remain in motion unless an external force is applied to it. Monetary policy is this external force that is required to bring down inflationary expectations from elevated levels. In order to prevent such a cycle from beginning, it is important for monetary authorities to display a commitment to keeping inflation within the target band and for agents to believe that this commitment is credible. In so doing, inflation expectations can be well anchored at levels consistent with the inflation target range, even as actual inflation temporarily exceeds it. Under these circumstances, monetary policy should strive to ensure that these shocks do not result in second-round impacts and a generalised increase in prices. This was the primary motivation for the increase in the repurchase rate by a cumulative 100 basis points since July 2015. As has been stated before, the MPC is sensitive to the possible negative effects of policy tightening on cyclical growth, but will remain focused on the mandate of maintaining price stability in the interest of ensuring sustainable growth over the medium term. Conclusion The global economy remains entrenched in a period of sub-par growth and elevated uncertainty, which makes the path ahead a very unclear one. Just as it seems that the global economy is starting to progress and is gaining traction, we are buffeted by harsh new winds which we cannot hope to escape as a small open economy. Unfortunately, in addition to being bombarded with a confluence of negative external events, the deterioration in the domestic situation has further compounded matters. It is now almost a foregone conclusion that the path ahead will be extremely challenging; it is therefore important that we take the tough decisions that are vital to securing our long-term prosperity. 12 The SARB remains ready and fully committed to making a constructive contribution in line with its mandate, which is the maintenance of price and financial stability in the interest of balanced and sustainable 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 Bundesbank Regional Office in North Rhine-Westphalia, Düsseldorf, Germany,7 July 2016.
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Daniel Mminele: The role of BRICS in the global economy Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bundesbank Regional Office in North Rhine-Westphalia, Düsseldorf, Germany,7 July 2016. * * * There may be minor differences between this version of the speech and the delivered German version. 1. Introduction Good evening and thank you to Dr Andreas Dombret, member of the Executive Board of the Deutsche Bundesbank, and Ms Magarethe Müller, President of the regional office of the Deutsche Bundesbank for the opportunity to address you today on the topic of “The role of BRICS in the global economy”. Admittedly, this may have been a much easier topic a few years ago when the successes of the BRICS economies far overshadowed their weaknesses. As the challenges facing the BRICS economies have mounted, there are now many question marks over the economic power of the BRICS grouping and the ability to realistically challenge and change the global economic order to one which is more representative and fair. Indeed, BRICS is not alone in the many challenges that it faces. Both advanced and emerging economies have slowed with each facing their own set of dynamics adversely impacting growth and which inter alia require bold actions in the implementation of much needed structural reforms. It seems appropriate to be delivering this speech in the heart of Europe, a region which has vast trade linkages with the BRICS economies and where the economic influences are strong. I would imagine that developments in Europe and the many challenges that this region has been confronted with lately, have occupied more of your attention than BRICS matters have. European developments have certainly occupied the attention of policymakers in BRICS countries since, as we all know, we live in a highly interconnected and interdependent world with significant spill-overs across countries. South Africa takes a keen interest in Europe, given large trade linkages and therefore significant implications for our economic prospects. The relationship between South Africa and Germany in particular, has been a long and fruitful one and certainly the contribution to South Africa’s development has not been insignificant. There are a large number of major German companies represented in South Africa, in particular in the automobile sector, as well as a number of small and medium sized enterprises. Approximately 600 German companies have operations in South Africa, employing over 90,000 workers 1. Such a presence contributes significantly to employment and skills-building, and no doubt, towards technological advancement in South Africa. But let me turn to the topic of the speech. I will discuss BRICS in the South African and global context, more recent developments in terms of the slowdown in BRICS economic growth and focus on the successes of the BRICS countries. I will conclude with a brief update on economic developments in South Africa, which could be of interest to some of you. www.southafrica.diplo.de. BIS central bankers’ speeches 2. BRICS and South Africa The BRIC countries, as the grouping was initially known, admitted South Africa as a member to the club in December 2010. There were many criticisms levelled towards the inclusion of South Africa in this grouping, with the perception that South Africa’s economic size was just too small for it to have any benefits for the BRIC. However, if one considers the country’s large mineral resources; very well developed, deep and sophisticated financial markets; strong institutions and robust and expanding infrastructure programme, then surely South Africa’s presence in this grouping is not misplaced. In addition to South Africa being the only African member of the G20, its inclusion into the BRIC group provides it with a more representative structure and further emphasises the BRIC countries commitment to strengthening their presence and engagement in Africa. 2 Indeed, within the Sub-Saharan Africa (SSA) region, South Africa is the second largest economy, accounting for 21 per cent of SSA GDP. SSA is an important export market, and there are significant financial linkages in terms of foreign direct investment and a strong presence of South African firms in the South African Development Community 3. South Africa’s trade with BRIC countries has expanded in recent years, as exports to BRIC countries grew from R20 billion in 2005 (EUR1 billion), to R154 billion (EUR9 billion) in 2013 (although this has since slowed to R147 billion (EUR8.5 billion) in 2015). Imports have similarly increased from R48 billion (EUR2.8 billion) in 2005 to R277 billion (EUR16 billion) in 2015. 4 Much of the exports are destined for China, which accounts for 64 per cent of South Africa’s exports to BRIC, followed by India accounting for close to 30 per cent. The bulk of exports to BRIC countries consist of mineral products, although the percentage of mineral products in total exports in China, for example, has declined from levels of close to 80 per cent to 60 per cent in 2015. This most likely reflects to some extent the slowdown in China. In terms of imports from BRIC countries, China accounts for 72 per cent of South Africa’s imports from BRIC, followed by India with approximately 20 per cent. Most of the imports from China relate to machinery products and in India’s case, mineral products. Thus, while trade with BRIC countries has expanded, there has been a slowdown in export growth more recently, with a consequent increase in the trade deficit with BRIC countries. 3. BRICS in the global context Increased globalisation has meant that BRICS has become an important source of global growth and political influence. BRICS economies have grown rapidly with their share of global GDP rising from 11 per cent in 1990 to almost 30 per cent in 2014. BRICS account for over 40 per cent of the world population, hold over US$4 trillion in reserves and account for over 17 per cent of global trade. Financial markets in the BRICS countries have similarly expanded in a rapid manner. For example, in the 20 years until 2010, Brazil’s market capitalisation increased from a very low 4 per cent of GDP to 74 per cent, India from 12 per cent to 93 per cent, Russia and China from almost zero to 70 per cent and 81 per cent, respectively. In South Africa, market capitalisation has more than doubled from 123 per cent to 278 per cent. According to S&P Global Market Intelligence global bank rankings, banks from these five countries figured among the top 100 banks in the world, with the top 4 banks headquartered in China. It therefore comes as no surprise then that these economies became the new engines of global demand. Having been victims of the global financial crisis, and suffering the impact of large and volatile capital flows and what Mohamed El Erian has referred to as “tourist www.brics5.co.za, South Africa in BRICS. World Bank 2016 Global Economic Prospects: Sub-Saharan Africa. All figures in EUR quoted at exchange rates prevailing at the time. BIS central bankers’ speeches dollars” 5, the BRICS countries were propelled into a common objective of reforming the international financial and monetary system, with a strong desire to build a more just, and balanced international order that reflects the dynamics of today’s global economy and serves the interests of all in a fair manner. To this end, the five countries in the BRICS community play an important role in the G20, in shaping global economic policy and promoting financial stability. 4. The future role of BRICS Following an impressive performance in the aftermath of the global financial crisis, BRICS countries have recently started to slow. In this respect, there seems to be an awful lot of doom and gloom bandied about the BRICS in some quarters. Some have referred to the BRICS bubble bursting, others have noted that BRICS “instead of propelling the global economy into calmer waters, now risk capsizing it” and others question “why the mighty BRICS nations have broken?” This slowdown has been reflected in a number of areas. Exports from BRICS to developed markets and investments into their respective economies have declined, while the collective contribution to global growth has fallen from a peak of nearly 50 per cent in 2013 to around 36 per cent in 2015 6. Real GDP growth of BRICS, which was over 8 per cent in 2010 declined to just over 4 per cent in 2015. In addition, the local currencies of BRICS, with the exception of China, has experienced varied levels of volatility following the onset of the global economic crisis. As Christine Lagarde noted in a recent speech 7 there have been three particular challenges confronting the global economy and also the BRICS countries. First is China’s growth transition and the rebalancing of its economy from industry to services, from exports to domestic markets, and from investment to consumption. In the short run, this will lead to slower growth with spill over effects through trade and lower demand for commodities. Global trade, which fell to 20 per cent below its pre-crisis trend, was driven by sluggish growth in advanced economies, and the maturation of global value chains which has further reduced the elasticity of trade flows to economic activity and exchange rate changes. Furthermore, higher capital requirements and tightened financial regulations have reduced banks’ willingness to extend trade finance, and the pace of trade liberalization slowed. Secondly, declining commodity prices has placed many commodity-exporting emerging economies under severe stress with very large currency depreciations in some cases and has set back growth in commodity-exporting BRICS. Third, asynchronous monetary policies has contributed to an appreciation of the U.S. dollar, putting considerable strain on emerging market currencies. Meanwhile, net capital flows to BRICS have undergone significant bouts of volatility, which have weighed on investment growth. Until 2013, the slowdown was predominantly driven by external factors, however, the role of domestic factors has increased in the past two years and have come to the forefront as the predominant forces behind slowing growth in BRICS. This reflects declining potential growth, compounded by a deterioration in fiscal positions of BRICS and political dynamics which have dented confidence and increased pressure. The question then is, does BRICS still matter and should it occupy so much of our attention? BRICS account for about two-thirds of emerging market GDP. The World Bank has estimated that in the event that growth in BRICS economies fell one percentage point below Whitman Lecture, What Lies Ahead for the Global Economy, A BRICS Perspective, October 2014. BRICS New World Order is now on Hold, Wall Street Journal, Davos 2016. The Role of Emerging Markets in a New Global Partnership for Growth, By Christine Lagarde, Managing Director, International Monetary Fund, University of Maryland, February 4, 2016. BIS central bankers’ speeches expectations, this would knock 0.8 percentage points off growth in other emerging markets over a period of two years and reduce global growth by 0.4 percentage points. The effects of a BRICS slowdown on other emerging markets and the global economy are significantly worse if one assumes that financial sector turbulence will also accompany the slowdown. 8 These effects are a result of unintended knock-on effects, in the form of financial, trade and economic spill-overs. In this context, the BRICS are at an important juncture and the question is how does BRICS emerge from the current dismal conjuncture? It should be noted that the slowdown of BRICS hampers the scope for a speedy recovery of the world economy given the much greater weight of BRICS in the global economy. As we have heard time and again, a combination of proactive countercyclical policies and structural reforms are needed to reinvigorate domestic economies and economic growth. While the recipe for success are of course not the same for all, the ingredients for success are mostly the same and include inter alia encouraging greater private sector investment, labour market reforms, stronger protection for intellectual property rights, and addressing infrastructure bottlenecks, amongst others. Given the sheer size, vast resources and youthful populations of the BRICS countries, the potential of this grouping for both domestic and global outcomes is beyond question. Indeed, recessions in Brazil and Russia and slower growth in South Africa are expected to bottom out this year, while China may experience only a modest slowdown and India continues to expand at a robust pace. This brings me to the next point of my speech, which is the progress that BRICS has made in terms of collaborating and setting up institutions to help address common challenges and risks that lie ahead. 5. The achievements of BRICS The BRICS grouping have achieved much since the first political dialogue in September 2006 and the first BRIC Summit which took place in June 2009. In the seven years since the first Summit, the BRICS countries have established the New Development Bank (NDB), and the Contingent Reserve Arrangement (CRA), amongst other initiatives. In my view, these are quite significant achievements in a relatively short period of time. For the purposes of this talk, I would like to focus on these two initiatives. The establishment of the BRICS NDB marked a milestone in BRICS co-operation and as mentioned by some analysts is a testament of the “coming of age” of these countries in the world of development finance. Others have mentioned that the NDB was established to challenge the post-Second World War international economic order, that is, the Bretton Woods System. However, as has been indicated previously by many other BRICS colleagues, one of the objectives of the NDB is to promote South–South co-operation and to better serve the needs of developing countries through the promotion of infrastructure and sustainable development. Against this background, the NDB should rather be seen as a complement to, rather than a challenge or as competition to existing Bretton Woods institutions. In the future, the World Bank and the NDB may look to co-operate and by so doing, enhance the international development financing system. The NDB is well under way in mobilising resources for infrastructure development projects. The NDB has appointed its first President and has a fully functioning Board of Governors and Board of Directors. The NDB has already disbursed its first funds for renewable energy projects in all five BRICS nations, while the NDB Board has also approved the first five year Yuan bonds. The NDB is in the process of seeking an international rating where after issuance on international markets will be pursued. World Bank Global Economic Prospects 2016. BIS central bankers’ speeches What makes the NDB a “new” development bank. Firstly, it has new financing sources in that the financing will come from the world’s major developing economies, within the framework of new South–South co-operation. Secondly, the financing is largely devoted to meeting the needs of developing countries for infrastructure development. This is different because MDBs are largely devoted to reducing global and regional poverty along with many other priorities, which limits the finance available for infrastructure development. Thirdly, it has new financing mechanisms which focuses on a more equal and balanced development partnership in the relations between major developing countries and with their smaller developing counterparts. The NDB plans to use market-oriented operations to reduce loan costs and provide innovative loan facilities so that developing countries will have a more robust, flexible and customer-oriented development finance service. 9 The CRA Treaty of the BRICS countries was signed in July 2014 and came into effect a year later with the finalisation of all the operational requirements pertaining to the Treaty. The CRA is basically a self-managed contingent reserve arrangement to forestall short-term balance of payments pressures, provide mutual support and further strengthen financial stability. Once again, as with the establishment of the NDB, the CRA is not meant to replace any financing arrangements under the IMF, but is rather a complement to existing international monetary and financial arrangements and in the main helps to strengthen the global financial safety net. The arrangement is important because it provides the possibility to quickly obtain additional liquidity in the event of a crisis. As yet, none of the BRICS countries have had a need to call upon the CRA. There are a number of new initiatives being discussed under the BRICS agenda, with a view to furthering the work already undertaken and cementing the progress that has been made to date. Allow me now to briefly touch on recent economic developments in South Africa, before I conclude my address today. Recent economic developments in South Africa The South African economy has slowed in recent years, from growing by almost 6 per cent prior to the global financial crisis, to a mere 1,3 per cent in 2015. In the first quarter of 2016, growth contracted by 1,2 per cent. South Africa has been buffeted by a number of negative developments, namely, the slowdown in China and reduction in commodity prices; weak demand in advanced and emerging market economies, as well the deterioration in growth prospects for the Sub-Saharan Africa region; policy uncertainty; and suffering one of the worst droughts on record during 2015/2016. According to the SARB’s most recent forecast the economy will only grow by a meagre 0.6 per cent in 2016. However, the Bank expects that the first quarter GDP number represents the low point, and a slow upward trend is expected going forward. This view is consistent with the favourable developments in a number of indicators, such as the Barclays Purchasing Managers Index for the manufacturing sector and an increase in the real value of non-residential building plans passed. A modest recovery is expected in the next two years, with growth forecast at 1,3 per cent and 1,7 per cent respectively. Amidst a worsening growth outlook, the inflation outlook has also deteriorated with an extended breach of the 3 – 6 per cent inflation target expected, while inflation expectations remain at uncomfortably high levels. The exchange rate remains one of the biggest risks to the inflation outlook and highly sensitive to domestic political developments and the everchanging risks associated with US monetary policy. Brexit is a further factor whose full impact on South African financial markets and the economy is still unknown. South Africa’s BRICS Insight Paper 2, New South-South Co-operation and the BRICS New Development Bank, by Zhu Jiejin. BIS central bankers’ speeches policy rate has been adjusted upwards by 200 basis points since January 2014, in line with rising inflation risks. However, it is quite obvious that the Monetary Policy Committee (MPC) faces a policy dilemma as reflected by the inflation and growth dynamics. The South African Reserve Bank operates within a flexible inflation targeting framework, and this requires carefully calibrated policy decisions. These decisions need to appropriately take account of the evolving international and domestic economic and financial markets environment. They also need to protect the credibility of the framework in managing inflation expectations. And while policy decisions need to be sensitive to growth dynamics, they also need to take into account that monetary policy cannot address structural deficiencies holding back the economy. Conclusion Let me then conclude by saying that the challenging times we face as the BRICS are by no means unique to us. Indeed, the entire global economy is at a difficult juncture at present. While we may have emerged from the global financial crisis, the recovery has by no means been as robust as one would have liked. The challenges we face need to be tackled decisively and provide us with the opportunities to implement meaningful reforms, which ultimately can lead to strong, sustainable and balanced growth. Such efforts are well underway. What has been broken can certainly be fixed, and I have no doubt that the BRICS, along with the rest of the global economy, through better co-ordination and collaboration will emerge stronger. Thank you. References: www.nkibrics.ru/system/brics/.../BRICS_AND_THE_GLOBAL_ECONOMY.pdf BRICS and the Global Economy, Dr Bandi Ram Prasad, Financial Technologies Knowledge Management. BRICS Insight Paper 2, New South-South Co-operation and the BRICS New Development Bank, by Zhu Jiejin. The Role of Emerging Markets in a New Global Partnership for Growth, By Christine Lagarde, Managing Director, International Monetary Fund, University of Maryland, February 4, 2016. BRICS Joint Statistical Publication 2015. South Africa in BRICS, www.brics5.co.za/. www.ndbbrics.org. Statement of the Monetary Policy Committee, 19 May 2016. World Bank Global Economic Prospects 2016. BIS central bankers’ speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at a Breakfast Meeting hosted by Ethical Foundation for Leadership Excellence, Polokwane, Limpopo, 27 July 2016.
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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 a Breakfast Meeting hosted by Ethical Foundation for Leadership Excellence, Polokwane, Limpopo, 27 July 2016. * 1. * * Introduction Good morning, ladies and gentlemen. Thank you to the Ethical Foundation for Leadership Excellence for creating an opportunity for us to interact over this business breakfast today. Allow me to start by commending the Foundation on the important initiatives it has been undertaking since its official launch last year, to contribute to improved governance standards through ethical leadership excellence. I have been asked to give you an update on recent economic and monetary policy developments. Many studies have highlighted the economic and social costs of bad leadership in various spheres of society, and thus one should not under-estimate the important role that ethical leadership can play in addressing the economic challenges that the world, including South Africa, currently faces. We strongly believe that the credibility and reputation of the South African Reserve Bank (SARB), which is very critical to our work, depends on excellent leadership. Thus the Bank pays particular attention to its own leadership. Having engaged for two years in a bank-wide authentic leadership training programme, to access and use reflective and coaching skills, the Bank is now embarking on leadership development customised for each management level. We concluded the most recent of our Monetary Policy Committee (MPC) meetings less than a week ago, and my remarks today will be largely informed by our assessment from that meeting. After some points on the global backdrop, I will talk about recent economic and financial market developments in South Africa, and provide an update on monetary policy in this challenging economic environment. Before I conclude I will briefly touch on economic developments in the Limpopo province, relative to national trends. 2. Global economic developments A week ago the International Monetary Fund (IMF) released the World Economic Outlook (WEO) update, which confirmed that the global economy continues to struggle to find momentum. The IMF noted lackluster growth in most advanced economies, low potential growth and a gradual closing of output gaps, while prospects remained diverse across emerging market and developing economies. Similarly, the G20 Finance Ministers and Central Bank Governors indicated over the weekend that the global economic recovery continues, but is facing challenges and downside risks, amid fluctuating commodity prices, high financial market volatility, geo-political conflicts, terrorism and refugee flows. While some of these factors have been with us for a number of years now, more recently, the downside risks facing the global economy have been compounded by the outcome of the British referendum vote, or Brexit, as it is more commonly referred to. As a result of Brexit, the global outlook for 2016–17 has worsened, as the vote added significant uncertainty to an already fragile global economic environment, and is likely to affect confidence and weigh negatively on consumption and investment. I should add that Brexit has also highlighted the importance of inclusive growth, an issue which was highlighted in the latest G20 communique. BIS central bankers’ speeches The IMF noted that prior to Brexit, economic data and financial market developments pointed to an improvement in the outlook for a few large emerging markets and a modest upward revision to global growth for 2017 (0.1 percentage point). In the aftermath of Brexit, however, the IMF downgraded global growth projections by 0,1 percentage points for both 2016 and 2017 to 3,1 and 3,4 per cent respectively. Advanced economies were primarily responsible for the more pessimistic outlook, with the IMF revising the United Kingdom’s 2017 outlook downwards by almost a full percentage point, while the euro area’s outlook was downgraded by a lesser 0,2 percentage points. With the exception of sub-Saharan Africa, where the IMF downgraded its outlook by over 1 percentage point for 2016, mainly on account of adverse developments in Nigeria and South Africa (the two largest economies), the outlook for emerging markets has generally remained steady, with stronger than expected recoveries in Russia and Brazil in the forecasts. Although the contribution of emerging markets to global growth has dwindled in recent years, they continue to account for around 58 per cent of global gross domestic product (GDP) and therefore remain significant. Given that the Brexit outcome was generally unanticipated, the outcome was initially followed by heightened financial market volatility and renewed risk aversion. Emerging market economies were subjected to a strong negative impact from Brexit, however, the emerging markets most strongly affected have been those that are highly dependent on the EU as an export market, like South Africa. Notwithstanding the short term financial market volatility, financial markets have since recovered and asset prices have rallied. This development was supported by a good level of preparedness by major central banks and quick responses after the referendum, demonstrating readiness to act decisively in dealing with any fallout in the financial markets. While there has been some reprieve in financial markets, it is to be expected that until Brexit negotiations have been completed or the likely outcome becomes clearer, there could be significant bouts of volatility and heightened uncertainty. This means that forecasts will be subject to further revisions as the impact of Brexit unfolds, and the respective positions of the negotiating partners are revealed. Heightened uncertainty is likely to spill over into financial markets, which usually means capital outflows from emerging market economies which are perceived to be more risky, as investors look for so-called safe haven assets. At the same time, however, Brexit appears to have swung the monetary policy pendulum more towards an even easier stance in advanced economies, and as such, in the short term we could still witness inflows into emerging markets as investors search for higher yields. The US Fed, which had embarked on a normalisation path for its monetary policy, may now slow down its pace, again adding to uncertainty and volatility. The results of their most recent deliberations will be announced tonight, and the markets are waiting to glean from their statements what the likely future trajectory of interest rates might be. It has been argued that in sub-Saharan Africa, Brexit could potentially have severe repercussions given that the European Union is one of the region’s biggest trade and foreign investment partners. South Africa’s trade links are relatively small, but could suffer the most, given its strong investment and financial links with the UK and the relatively high integration of domestic markets with global financial markets. According to Moody’s South Africa has been the largest recipient of UK foreign direct investment (FDI) in Africa, accounting for about 30 per cent of total UK investment in Africa in 2014. 1 Moody’s further assert that given South Africa’s lowest FDI levels in 10 years in 2015, Brexit-related uncertainty might delay investment decisions and introduce a downside risk to FDI inflows into South Africa. 2 http://www.fin24.com/Economy/why-sa-is-most-exposed-to-brexit-impact-moodys-20160708. http://www.focus-economics.com/countries/south-africa. BIS central bankers’ speeches Market expectations of even easier monetary policy in advanced economies are reflected by the decline in long term government bond yields, across all maturities. Since the date of the referendum the yield on 10-year US Treasury bonds has declined by 19 bps, while the 10-year German bond yields and the UK bond yields are down by 12 and 57 bps respectively. The universe of negative yielding fixed income instruments is now around US$13 trillion, an unusual state of affairs that may harbour many risks for financial stability. Therefore there is a need for increased vigilance to guard against distortive allocations of capital and asset price bubbles. Other risks facing the global economy include unresolved legacy issues in the European banking system; continued reliance on credit as a growth driver in China which heightens the risk of an eventual disruptive adjustment; and non-economic risks already mentioned earlier such as geopolitical threats and terrorism, amongst others. 3. Recent domestic economic and financial market developments As noted in the recent MPC statement, the domestic economic growth outlook remains extremely challenging. Real economic activity in South Africa has contracted in the first quarter of 2016, declining at an annualised rate of 1,2 per cent, whilst also contracting on a year-on-year basis for the first time since 2009 when economic conditions were dominated by the effects of the global financial crisis. The poor performance in the first quarter reflected a further decline in the real output of the primary sector coupled with slower growth in the value added by the tertiary sector. Two key factors need to be mentioned in this regard, namely the unfavourable climatic conditions which had a considerable impact on the agricultural sector, and the challenging trading environment encountered by the mining sector. Together these two factors caused the primary sector to contract at a rate of 15,5 per cent in the first quarter of 2016. Similarly concerning are trends in real gross domestic expenditure which declined at an annualised rate of 1,3 per cent in the first quarter. Contractions were recorded in real final consumption expenditure by households and real gross fixed capital formation, while growth in real final consumption expenditure by general government also slowed in the first quarter of 2016. Gross fixed capital formation contracted sharply in the first quarter of this year, the second consecutive contraction, and accounted for by both the private sector and general government. Confidence levels have deteriorated, as measured by the FNB/BER consumer confidence index, while the BER retail confidence index declined sharply in the second quarter. The deterioration in consumer confidence means that household consumption expenditure is likely to remain subdued, further exacerbated by high debt levels, rising costs of debt servicing, and slow employment growth. Consumption expenditure has been further constrained by the absence of significant wealth effects owing to the weak performance of asset markets, particularly the housing market. These factors have contributed to persistence of high rates of unemployment. In the first quarter of 2016 the official unemployment rate increased to 26,7 per cent. Annual losses in employment have been recorded in the manufacturing, private households, electricity, agriculture and transport sectors. Youth unemployment remains a serious challenge, having increased markedly to 54,5 per cent in the first quarter of 2016. 3 The unemployment challenge was emphasized by Mr David Lipton, First Deputy Managing Director of the IMF, in Johannesburg last week. In his speech he pointed to the limited progress on reforms to remedy the unemployment situation and recommended a fresh and energetic review of South Africa’s policies, followed by action. 4 SARB Quarterly Bulletin, June 2016. David Lipton. 2016. “Bridging South Africa’s Economic Divide” Lecture given at the University of Witwatersrand. July 19. BIS central bankers’ speeches Although the negative growth in the first quarter of this year is anticipated to have been the low point of the cycle, the recovery is expected to be weak. At the July meeting of the MPC, the SARB revised downward the growth projection for this year to zero per cent, from the previous projection of 0,6 per cent. In order to achieve a growth rate of zero per cent, the economy will need to grow by between 0.8 and 1.0 per cent in each of the three remaining quarters. For growth to be at 0.5 per cent for 2016, we would require growth of above 2 per cent for the remainder of the year. Furthermore, the SARB does not believe that a contraction in the second quarter is likely – a result that would tip the economy into a technical recession. The reasons for this are reasonably positive economic data thus far for the second quarter, in particular, the mining and manufacturing sectors are expected to add positively to growth, consistent with the Barclays PMI which has been above the neutral 50 level since March. In addition, the BER manufacturing confidence index also improved, while the real value of building plans passed is indicative of some improvement in the sector, particularly with respect to residential construction. Looking further out, growth rates of 1,1 per cent and 1,5 per cent are forecast for the next two years, down from 1,3 per cent and 1,7 per cent previously. The Bank’s estimate of potential output has been revised down marginally to 1,4 per cent in 2016, rising to 1,7 per cent in 2018. Turning to the external sector, although the prices of some of South Africa’s major exports such as iron ore and coal have recovered, the slowdown in the Chinese economy is generally expected to keep commodity prices depressed in the immediate future. Fortunately, whilst growth in merchandise exports remain subdued, the value of imports has edged only slightly higher, with increases in the value of imported capital and intermediate goods largely offset by lower imports of consumer goods. As a result, the country’s trade deficit narrowed to R38 billion in the first quarter of 2016 from R41 billion in the fourth quarter of 2015. South Africa’s current account balance nonetheless deteriorated in the first quarter from 4,6 per cent of GDP in the fourth quarter of 2015 to 5,0 per cent of GDP. This outcome was largely as a result of the widening deficit on the services, income and current transfer accounts. South Africa’s current account deficit leaves it vulnerable to short-term capital outflows if investors’ risk perceptions and appetite were to be adversely influenced. South Africa relies on short-term private-sector capital inflows to finance its current account deficit and a decline in capital inflows will put pressure on the country’s balance of payments. 4. Monetary policy The SARB’s primary mandate is to achieve and maintain price stability in the interest of balanced and sustainable economic growth. In this respect, the SARB follows a flexible inflation targeting (IT) policy framework, where temporary breaches of the target can be tolerated in the interest of smoothing out fluctuations in the growth trajectory. However, the disappointing growth outcomes and outlook highlighted earlier have been accompanied by rising inflationary pressures. This has presented a challenging policy environment for the MPC. The inflation rate, as measured by the increases in the consumer price index (CPI), was recorded at 6,3 per cent year-on-year in June 2016 compared to a 6,1 per cent in May 2016. The inflation rate has exceeded the upper band of the target since the beginning of the year averaging 6,3 per cent for the first 6 months of 2016. The main drivers were increases in the prices of food and non-alcoholic beverages which increased by 11,0 per cent in June, only slightly below the recent peak of 11,3 per cent in April. Goods price inflation measured 6,7 per cent, up from 6,6 per cent in May, while services inflation increased to 5,8 per cent from 5,7 per cent in May. The Reserve Bank’s measure of core inflation, which excludes food, fuel and electricity increased marginally to 5,6 per cent compared with the 5,5 per cent annual increase in the previous month. BIS central bankers’ speeches On the other hand, producer price inflation for final manufactured goods has been on a downward trend, declining from 7,0 per cent in April to 6,5 per cent in May mainly due to a moderation in price inflation of food, beverages and tobacco products. This was below the consensus forecast of 6,9 per cent but the impact of the drought is still evident in the increase in prices of agricultural products, particularly cereals and other crops as well as live animals and animal products. Inflation expectations, as reflected in the survey conducted by the Bureau for Economic Research, have remained anchored near or just above the upper end of the inflation target range. In the second quarter, average expectations for 2016 were 6,3 per cent, marginally up from 6,2 per cent. Average expectations for 2017 were unchanged at 6,2 per cent and were marginally down to 5,9 per cent for 2018. Average 5-year inflation expectations declined from 6,1 per cent to 5,9 per cent in the second quarter, with downward revisions by all groups. The yield differential between inflation linked bonds and conventional government bonds (break-even inflation expectations) declined across all maturities but remain elevated. The latest inflation forecast of the Bank shows a marginal improvement compared with the previous forecast, although an acceleration in inflation is still projected for the second half of this year. Inflation is only expected to return to within the 3 – 6 per cent target range during the third quarter of 2017, averaging 5.5 per cent in 2018. According to SARB forecasts, inflation is expected to average 6,6 per cent in 2016 and 6,0 per cent in 2017, compared with forecasts of 6,7 per cent and 6,2 per cent at the MPC meeting in May. The expected peak, at 7,1 per cent in the fourth quarter of 2016, has been revised slightly down from 7,3 per cent due in part to lower administered price inflation (mainly petrol prices). An encouraging development is the moderation in the forecast for core inflation, from an average of 5,8 per cent in 2016 to 5,3 per cent by 2018. Whereas previously core inflation was expected to breach the upper end of the target range in the third quarter of 2016 for four consecutive quarters, a one-quarter breach, at 6,1 per cent, is now expected in the fourth quarter of this year. A discussion on the inflation outlook would be incomplete without referring to developments in the exchange rate of the rand, one of the biggest risks to the inflation outlook. The recent volatility experienced by the rand exchange rate has been driven mainly by external factors and changes in global risk perceptions. Although the rand depreciated sharply in the immediate aftermath of the British referendum, it has reversed these losses. At the time of the most recent MPC meeting, the rand had appreciated against the major currencies, and on a trade-weighted basis, the rand had appreciated by 12,2 per cent. The rand has been supported by the global search for yield, the improvement in commodity prices, and also reacted to the unexpectedly large trade surplus recorded in May. Despite this recent strength, the rand remains vulnerable to possible changes in investor sentiment; changes in US monetary policy expectations; and domestic concerns including the possibility of ratings downgrades later in the year. Other risk factors for inflation include increases in average wage growth in excess of inflation and productivity gains; elevated food price inflation; and potentially higher oil prices should global demand recover. On the other hand, a weaker global growth scenario could also imply that there may be a degree of downside risk to the international oil price assumption; a sharp decline in agricultural prices next year should favourable weather patterns transpire as forecast and the absence of demand pressures and weak consumption expenditure growth may also contribute to downside pressures. As you will know, the MPC felt that local and international developments since our last meeting in May in relation to inflation and growth overall justified a pause in the hiking cycle at the July meeting. The situation will continue to be monitored closely as the risks to the inflation forecast are assessed to continue to be tilted to the upside, even if they have moderated somewhat recently. It remains to be seen if some of the favourable factors that contributed to the decision to keep interest rates unchanged will be sustained. This will BIS central bankers’ speeches require ongoing vigilance and careful analysis of incoming data and information, and the MPC will not hesitate to act when deemed appropriate. As I move towards the end of my speech, please allow me to briefly touch on some economic developments in the Limpopo Province. 5. Limpopo Province The growth performance of the province – like that of the South African economy – has been disappointing. The average growth rate for the period 2009–14 averaged 1,3 per cent as compared to the national average of 1.8 per cent. 5 Unfortunately, statistics are not available to assess the most recent economic growth performance of Limpopo in relation to the national growth rate. However, an assumption can be made that, given the dominant role of mining and agriculture in the province, developments will likely have mirrored national trends. As for inflation developments, while the inflation rate in Limpopo has declined from 8,2 per cent in May 2016 to 7,4 per cent in June 2016, it is nevertheless still over 1 percentage point higher than the national average and significantly above the top end of the inflation targeting rate. This has both adverse welfare and competitiveness effects and is something that warrants attention at the provincial level particularly in terms of addressing the bottlenecks that are adversely affecting the price formation process in the province. With an estimated share of national GDP of just over 7 per cent, Limpopo makes an important contribution to the economy of South Africa. The primary sector has always played a key role in the province, with its contribution growing from 17 per cent in 1996 to just over 27 per cent in 2014. This has in large part been due to the mining sector, with its contribution increasing from around 15 per cent in 1996 to around 25 per cent currently. Approximately, 41 per cent of South Africa’s platinum group metals (PGMs), 90 per cent of red-granite resources and approximately 50 per cent of the country’s coal reserves being located in the province. In addition, it has been found that antimony, a highly strategic mineral found in large quantities in China, is another of Limpopo’s major assets 6. In addition to mining, agriculture and tourism are the other pillars of the Limpopo economy, with the province having identified infrastructure development, industrialisation and manufacturing as potential new game changers that will enable it to achieve higher growth rates in the future. The potential of this province is beyond question. The province is well-endowed with minerals. While the fortunes of the mining industry are subject to international commodity price movements, the policy challenge is to ensure that the potential benefits that could be derived from the natural resource endowment are optimized. 6. Conclusion In conclusion, it is clear that the global and domestic economies face challenging times ahead, riddled with uncertainty which could exacerbate volatility and dampen confidence, and thus undermine consumption and investment required to support sustainable and balanced growth. What the impact of the added complication of Brexit will bring, will only become clear over time. While we may have little control over many of the external factors, we need to decisively tackle some of the local impediments that are well within our control through collaborative leadership from Government, business and labour. The SARB remains fully committed to making a constructive contribution in line with its mandate of achieving and maintaining price stability in the interest of sustainable and balanced economic growth. Thank you. Statistics South Africa: available http://www.statssa.gov.za/?page_id=1854&PPN=P0441. John Young, Investing in Limpopo, September 2013. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the PASA International Payments Conference, Sandton, 25 July 2016.
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François Groepe: Opportunities and challenges – the South African national payment system Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the PASA International Payments Conference, Sandton, 25 July 2016. * * * Introduction Ladies and gentlemen, good morning. It is an honour and a pleasure to address the second PASA International Payments Conference, and I would like to thank the organisers for the invitation to open the proceedings. The timing of this conference is highly appropriate as we are entering a new phase in the South African payment and financial regulatory environment, coupled with significant changes to the international regulatory architecture and framework. Not only do we have to contend with challenges in our domestic environment, but we need to be cognisant of the challenges facing the global economy, such as pedestrian growth, low commodity prices, increased geopolitical risks, and a high degree of market uncertainty and volatility. All these factors combined make the economic and financial environment very challenging and rapidly evolving. This morning, I will take a look at the current payment system landscape, highlighting some of the opportunities and challenges that we can expect to face in the near future and where we, the regulators, would like to see the national payment system in the next few years. Legislation, regulation, governance, and the South African national payment system The South African payment system has not escaped the fallout of the most recent global financial crisis. Following the crisis, global regulators increased their scrutiny of payment systems and of financial market infrastructures (or FMIs). This has resulted in numerous regulatory reforms, including legislation to strengthen the financial regulatory architecture. South Africa will have new, far-reaching and overarching, financial sector legislation by the end of 2016. From a payment system perspective, it will include the introduction of new and more comprehensive regulations as well as expanded oversight and supervision by various regulators. Furthermore, as you are aware, the Committee on Payments and Market Infrastructures (or CPMI) of the Bank for International Settlements (BIS) as well as the International Organisation of Securities Commissions (IOSCO) 1 published new principles for FMIs in April 2012. As a result of the new international and domestic regulatory requirements, as mentioned above, it has become necessary to re-evaluate the National Payment System Act 78 of 1998 (NPS Act). The factors that will have to be taken into account include access and participation criteria, licensing criteria in line with international standards for FMIs, the governance arrangements in the payment system, as well as the role of the payment system management body, including that of a self-regulatory organisation (SRO). The International Organisation of Securities Commissions (IOSCO) is an association of organisations that regulate the world’s securities and futures markets. For more information, please see https://www.iosco.org. BIS central bankers’ speeches As part of this work, the South African Reserve Bank (SARB) commissioned an assessment of the effectiveness of the payment system management body, namely the Payments Association of South Africa (PASA). The purpose of the review, known as the PASA Effectiveness Review, was to address any inadequacies in the regulation of the participants in the payment system and to evaluate the role of PASA in assisting the SARB in discharging its mandate. The SARB published the report last week. The recommendations of the PASA Effectiveness Review cover four themes, namely mandate and strategy, the governance framework, the regulatory model, and membership. I would like to highlight some of the main findings and recommendations contained in this report. The report found that the PASA mandate was too restrictive and that it disadvantaged nonbanks, hence it proposes that the PASA mandate be clarified and that it be expanded to include non-banks such as card networks, card associations, retailers, and merchants. Regarding the governance framework, the review found that the PASA Council was not adequately representative of the rapidly changing payments environment and of the various categories and levels of participation and participants in the national payment system. In order to strengthen the governance framework, it is recommended that the PASA Council be composed of a majority of independent non-executive councillors, representative of all the stakeholders in the national payment system and better reflecting our country’s demographics. As far as the regulatory framework is concerned, it was found that there were deficiencies relating to the enforcement framework and that the self-regulating model impacted on the objectivity of the payments clearing house (or PCH) environment. In order to enhance the credibility of our regulatory framework, it is important that compliance be enforced in a consistent, fair and transparent manner, hence it is proposed that an independent Compliance Enforcement Committee be established. This should result in compliance being enforced without fear, favour or prejudice, and should enhance the credibility and integrity of the compliance enforcement process within the national payment system. We further propose that a thorough review of the SRO model be undertaken in order to consider its appropriateness and, if it is decided to retain this model, consideration should be lent to the changes required in order to ensure that any potential conflicts of interest are avoided. Finally, the review found that the current membership composition was not representative of the broader national payment system industry and that the level and quality of representation was inadequate. More perturbing were the concerns raised pertaining to the poor meeting attendance. In response to these findings, it is proposed that PASA membership be expanded to include non-bank participants in the national payment system and that arrangements be put in place to enhance the effectiveness of PASA. The SARB intends to continue interacting with a wide range of stakeholders as we work alongside PASA towards further improving the functioning of the national payment system. Together, we also aim to improve the levels of innovation as well as the safety and soundness of the national payment system and, going forward, also that of all systemically important FMIs. The SARB also embarked on a consultation process to consider a payment system framework and strategy up to 2025. As with previous framework documents, the SARB consulted widely – and it intends to publish its proposal by the end of 2016. The themes in the Vision 2025 document include the following: • competition and collaboration in the national payment system; • regulation and governance in the national payment system; • standards, interoperability and innovation; • cybersecurity; and BIS central bankers’ speeches • financial inclusion. As these topics indicate, the SARB will cover a rather broad scope. This brings me to another matter that I would like to raise with the executive management of our banks as well as with non-banks participating in the payment system. From the above, it is evident that payment system and related matters need to be elevated from the back office to the boardroom. This has happened at the SARB and other central banks. Executives should no longer ignore the importance of the national payment system and its infrastructure, or the risks and threats (e.g. that of cybersecurity) in this environment. The national payment system is a critical and systemically important FMI, hence the SARB will interact with all participants in this environment to ensure that the necessary attention and priority is given due to the important role that it plays within our financial system and the implications of any potential failure for financial stability. Innovation and cybersecurity Recent reports have highlighted several high-level cybersecurity breaches, not only in banks but in service providers and critical infrastructures in the financial and payment systems. In June 2016, the CPMI and the IOSCO published a document titled Guidance on cyberresilience for financial market infrastructures.2 This document highlights the importance of the safe and efficient operation of FMIs in the maintenance and promotion of not only financial stability, but also economic growth. This publication intends to give guidance to industry to enhance its cyber-resilience, and hopes to provide regulators and authorities with a set of internationally agreed guidelines to effectively support, oversee, and supervise FMIs. Regulators are encouraged to cultivate a culture of awareness and an understanding of the risks inherent in the cyber-environment. All participants should not only be aware of but also understand their role and the importance of improving their cyber-resilience position at every level within the organisation. In this regard, the SARB will host a conference on cybersecurity in August with the objective of creating a platform for various role players in the financial sector to further strengthen their cyber-resilience. Globally, there has been a wave of innovation in the payment environment, ranging from mobile payments to real-time low-value payments. Advances in technology and access to the Internet have facilitated innovation in various payment technologies. The financial technology (or FinTech) revolution has played a key role in the development of innovative and disruptive technology, and is changing the way in which we look at financial, payment, banking and mobile services, to name but a few. What we are witnessing at the moment is this: where inefficiencies are perceived within the system, savvy service providers find a technology solution to overcome the inefficiency and provide the service in a cheaper and more efficient manner. Such innovation is especially prevalent in the payment, mobile, remittance and online environments, such as online shopping and e-commerce. Although FinTech is providing many exciting opportunities, it should be balanced by efficiency, safety and financial stability considerations. It is not the role of regulators to hamper innovation, but the SARB is jointly responsible for financial stability, which includes aspects such as cybersecurity, infrastructures, and a safe and efficient financial system. We therefore need to strive towards achieving a healthy balance when we respond to these developments. 2 Available at http://www.bis.org/cpmi/publ/d146.htm BIS central bankers’ speeches Recently, many central banks – including the Bank of England, the Reserve Bank of India, the Bank of Japan and the Singapore Monetary Authority – have launched FinTech working groups and/or collaboration. In June 2016, the Bank of England advised that it would collaborate with FinTech firms on measures that could support its ‘mission’ as a central bank. The Reserve Bank of India has appointed an inter-agency FinTech working group to ‘review and appropriately reorient the regulatory framework and respond to the dynamics of the rapidly evolving FinTech scenario’. Earlier this year, the Japanese and Singaporean authorities announced plans to develop a hub for technological development. These are but four examples of FinTech developments where central banks are adopting a proactive position in collaborating with the non-bank industry. The SARB acknowledges that FinTech companies have an important role to play within the financial system. I believe that FinTech can play an important role in the country’s development and, through efficiency gains, can not only assist in reducing frictions within the payments value chain and the broader economy, but also has the potential to stimulate growth and create employment opportunities. The SARB is currently reflecting on its regulatory approach towards certain FinTech developments and will address these endeavours in due course. Conclusion I have attempted to highlight some of the opportunities and challenges facing the South African payment system, in the near future and over the longer term. To be successful, it is important that we achieve the right balance between safety, efficiency and risk – and that we continue with the collaborative approach started in 1995. The first framework and strategy document for the payment system was published in November 1995, and the real-time gross settlement system (the SAMOS system.3 was introduced in March 1998. It is with pride that I can say that the South African national payment system has been extremely successful and resilient in the past 20 years. However, the world has changed. We have seen the worst global financial crisis in recent history, and innovation and technology are changing the world at a pace never seen before. Although we have been successful in the past, the time has come to look to the future, embrace change, and continue on the path by providing clear and unambiguous direction of where we want to see the future payment system: servicing the country as a whole, from wholesale real-time payments to real-time low-value payments – anytime, anywhere, safely, efficiently, and in a way that is affordable to all. Thank you. 3 South African Multiple Option Settlement system BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 96th annual ordinary general meeting of shareholders, Pretoria, 29 July 2016.
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Lesetja Kganyago: Overview of the South African economy Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 96th annual ordinary general meeting of shareholders, Pretoria, 29 July 2016. * 1. * * Governor’s address The past year has again been a challenging one for the Bank against the backdrop of a hesitant recovery in the global economy and a slowing domestic economy. While the recent decision by the UK to leave the European Union (Brexit) has raised the risks to the outlook, the extent of the spillover effects are still unclear. Much will depend on the speed and terms of the disengagement. At this stage we do not know which of a number of possible scenarios will unfold. The financial markets have stabilised following the initial volatile response to the decision. However, it is likely that growth in the UK, and to a lesser extent in the EU, will be negatively affected, as a protracted period of uncertainty is expected to undermine both business and consumer confidence. As a consequence, growth forecasts have already been revised down. This comes at a time when the eurozone growth prospects, although still muted, had improved steadily during the past year, partly in response to European Central Bank monetary stimulus. The US economic recovery appeared to be more sustained during the past year with consistent improvements in the labour market. This was despite a slowdown in the first quarter, which was viewed as temporary. The performance of the economy improved since then, but some negative spillovers from Brexit are expected. Despite sustained fiscal and monetary stimulus in Japan, economic growth was marginally positive. While the past year was slightly more favourable for advanced economies, the same cannot be said for emerging markets, although there were divergent experiences. The growth slowdown in China continued, accompanied by increased volatility in domestic financial markets. This was partly in response to policy changes and persistent concerns regarding the stability of the financial sector. The slower growth continued to impact negatively on commodity prices, further complicating the outlook for commodity-producing emerging markets. More recently, the economy appears to have responded to renewed stimulus measures, and risks of a hard landing have abated. This has also helped to stabilise commodity prices. Both Brazil and Russia slid into recession during this period and continue to contract. By contrast, India experienced high growth following a number of structural reforms. The slowdown in sub-Saharan Africa, in response to lower commodity prices and severe drought conditions in the southern part of the region in particular is of some concern. In its recent World Economic Outlook update, the IMF downgraded sub-Saharan growth for 2016 by 1,4 percentage points to 1,6 per cent. This follows a number of years of growth rates averaging around 5 per cent. The region has become a major export destination for South African manufactured goods, and a growth slowdown could impact negatively on these exports. Global inflation has remained benign over the past year in response to weak global demand, declining oil and other commodity prices, and falling food prices. The downward trend in oil prices that began in mid-2014 continued amid a supply glut and weak demand. Prices have recovered somewhat from multi-year lows of below US$30 per barrel in January following supply disruptions in a number of countries and curtailment of investment and output in others. Although prices are expected to rise in the medium term, the trajectory is expected to be moderate, in line subdued global demand. BIS central bankers’ speeches The second half of last year was dominated by speculation regarding the timing and speed of US monetary policy normalisation. This uncertainty continued to contribute to global financial market volatility as perceptions kept changing. Once it became clear that the first move was likely to be in December, attention became focused on the timing of the next moves. However, uncertainties regarding the state of the US labour markets, low inflation and heightened global risks led the US Fed to take a cautious approach, and no further tightening transpired. More recently, in the wake of the Brexit decision, market expectations of US interest rates have been scaled down significantly. Whereas the UK had previously been expected to be one of the first of the advanced economies to raise policy rates, disappointing growth outcomes and low inflation meant an unchanged policy stance during the past year. Following the Brexit vote, there are now expectations that policy will be loosened in the near future. Monetary policies in the eurozone and Japan remained accommodative during the past year, and are expected to persist for some time. The changing expectations of US monetary policy in particular has had implications for the pattern of global capital flows. The delay in normalisation and global search for yield has seen a resumption of capital flows to emerging markets, reversing the negative trend observed during the second half of 2015. The rand exchange rate has been sensitive to these developments, with elevated levels of volatility. Since the time of the previous AGM the rand depreciated on a trade-weighted basis by about 8,5 per cent. However, it traded in a wide range of between R12,70 and R16,90 against the US dollar. This volatility was not only externally generated: domestic developments, including the fallout from the political events in December last year; the risks of a sovereign ratings downgrade; the wide current account deficit and the declining growth were important contributors to these trends. Whereas a downgrade was avoided in June, similar concerns are likely to re-emerge later in the year when the next reviews are scheduled. The domestic economy was characterised by a persistent slowdown during the past year, driven by weak consumption and investment expenditure growth. The agricultural sector was particularly hard hit by the worsening drought. The economy grew by 1,3 per cent in 2015, and the outlook for the economy remains constrained, particularly following the contraction of 1,2 per cent experienced in the first quarter of this year. Nevertheless we expect that to have been the low point of the current growth cycle. The Bank forecasts economic growth of zero per cent in 2016, rising to 1,1 per cent, and 1,5 per cent in the coming two years. These growth rates are insufficient to make significant inroads into the deteriorating unemployment numbers. The direct effect of the Brexit decision on domestic growth is expected to be marginal in the short term, while the longer term impacts will depend on the outcome of the negotiations and the impact on global growth generally. Inflation averaged 4,6 per cent in 2015, and was within the target range in each month of the year, reaching a low point of 3,9 per cent in February. A large part of this favourable trend was driven by a temporary respite from lower international oil prices. Since January 2016, however, inflation has breached the upper end of the target range, and is expected to remain above target until the third quarter of next year. In the absence of domestic demand pressures, these adverse inflation trends have been driven primarily by supply side factors. These include the exchange rate, drought-induced food price increases, and a reversal of the favourable oil price shock. In response to these inflation pressures, the Monetary Policy Committee continued with its moderate tightening cycle that began in January 2014. Since July 2015 the repo rate increased by a cumulative 125 basis point, to 7,0 per cent in March 2016. The combination of a steady downward growth trend with upside risks to inflation compounded the dilemma facing monetary policy. At the last two MPC meetings, in May and July, moderate improvements in the inflation outlook and a moderation of the upside risks to the inflation BIS central bankers’ speeches outlook gave the MPC room to pause in the interest rate cycle. The MPC emphasised the continued data-dependence of future moves, as the factors that gave rise to the moderation of these risks could reverse very quickly. Although the MPC remains ready to respond to renewed inflation pressures, it remains mindful of the weak state of the economy and will continue to support the economy to the extent possible within its flexible inflation targeting remit. The expanded mandate of the Bank gives it responsibility for financial stability and this has been a key focus area during the past year. The Financial Sector Regulation Bill has been tabled in parliament, and it is expected to be promulgated during this year. The Bill assigns responsibility to the Bank to protect and enhance financial stability. The proposed Prudential Authority is taking shape, but pending finalisation of the legislative framework. This process has already had significant resource implications for the Bank. At the microprudential level there has been the successful resolution of the African Bank curatorship, and the creation of the “good bank” which commenced operations in April 2016. The domestic banking system remains sound and well capitalised. Whilst the Bank is an institution not driven by profit, the strength of the financial position of the Bank is important for its independence. I am pleased to report that the Group continued to be profitable in this past financial year. The Group recorded an after-tax profit of R1,58 billion compared with a profit of R0,63 billion in the previous financial year. The bulk of the profit is attributable to the Bank with an after tax profit of R1,51 billion, up from R0.34 billion in the previous year. This improvement in the financial position of the Bank was attributable mainly to the increase in accommodation to banks and unrealised profits due to declining global bond yields and the depreciation of the rand against major currencies. The depreciation increased the rand value of the interest earned from investing the country’s foreign-exchange reserves. Operating costs declined due to a reduction in the banknote order which lowered the cost of new currency. This decline was partly offset by higher staff costs. As we have emphasised in the past, the Bank does not have a profit-maximising objective and its operations are conducted in the broader interests of the country, in pursuit of its mandate and responsibilities. Nevertheless, we will continue to implement strict internal financial controls to ensure economy and efficiency of the Bank’s operations. BIS central bankers’ speeches
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the University of the Free State, Bloemfontein, 12 August 2016.
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François Groepe: The changing role of central banks Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the University of the Free State, Bloemfontein, 12 August 2016. * * * Good morning – and thank you for the opportunity to address you. The past few years have been extremely challenging, both domestically and internationally. The aftershocks of the global financial crisis of 2008–09 have persisted. The advanced economies are still struggling to recover on a sustained basis, while the emerging markets, initially the main engine for the recovery, have fallen out of favour in the past four years, as the Chinese economy has slowed and brought commodity prices down with it. Low growth is not the only issue. We are seeing increasingly widespread discontent about rising income and wealth disparities in many countries, where the fruits of growth have not been equitably shared and have been aggravated by persistently low growth. The initial responses to the financial crisis involved both monetary and fiscal policy loosening. But fiscal space was eroded very soon as debt ratios rose to unsustainable levels. This placed a near impossible burden on monetary policy, which persists to this day. Referring to the post-crisis focus on central banks, Mohamed El-Erian appropriately titled his most recent book The only game in town. 1 Today, I would like to highlight the role that central banks can play in the economy and, perhaps more importantly, point out the limits to what central banks can do. It is important to understand these limits because, I would argue, the biggest risk to central bank independence is the possible backlash from being unable to deliver on unreasonable expectations. Central bank mandates have expanded – perhaps appropriately so – but there are limits to what monetary policy was designed to achieve. Central banks cannot be, and should not be regarded as, “the only game in town”. The role of central banks has changed over time. The first central bank was established in Sweden in 1668 and had a chequered early history, from providing commercial banking services to financing a war against Denmark. Most of the early central banks were in fact initially private banks, and for this reason, a number of them (including the South African Reserve Bank) have private shareholders to this day. Over time, however, these banks evolved into official institutions, with various roles. It is not my intention to give a historical account of the evolution of the role of central banks through the ages. Rather, I will fast-forward to the modern period and highlight the current thinking about central banks and their appropriate mandates and policies. Important to note is that the role of central banks is still evolving, so what is conventional wisdom today could well be supplanted tomorrow. Although central banks are no longer in the business of financing wars, the cost of maintaining peace and stability during periods of crisis is perhaps far higher! Prior to the financial crisis, there were a number of generally accepted views about the role of central banks. Besides their exclusive responsibility for printing and issuing banknotes and coins, the almost unquestionable view was that a principal role of central banks should be to maintain price stability. While this opinion was generally accepted, the choice of framework was not. Before the 1990s, the focus was on intermediate targets for monetary policy, for instance money supply targets. More recently, the trend has shifted towards targeting inflation directly, generally through using an official interest rate as the policy tool. The El-Erian, M A (2016). The only game in town. Central banks, instability and avoiding the next collapse. New York: Random House. BIS central bankers’ speeches inflation-targeting framework evolved, with the objective of monetary policy clearly specified and quantified. It is worth pointing out that the choice of framework is constrained by the nature of the exchange rate regime: in a fixed exchange rate environment, the focus is on maintaining the peg, and monetary policy is determined by the policies of the currency to which it is pegged. It may be rightfully asked why price stability should be elevated to a policy objective. There are a number of reasons why we want to pursue stable prices. First, it makes planning investment for the future so much easier. The more unpredictable future prices are, the higher the risk premium that investors are likely to price into their decisions. Although price stability is not in itself a generator of economic growth, it is an important prerequisite for providing a sound macroeconomic basis within which growth can be achieved. Second, it is generally the case that it is the poor who are most vulnerable to the ravages of high inflation, as they are the least able to hedge against this. The only people who benefit from high inflation are those who have fixed-interest nominal debt, as the real value of the debt declines during inflationary periods. However, under these conditions, lenders are reluctant to lend at fixed rates and demand higher interest rates to be compensated for higher expected inflation. Therefore, high-inflation countries tend to have high nominal interest rates. The more contentious issue is the impact that monetary policy can have on economic growth and employment. It is generally accepted that monetary policy can play a role in stabilising the business cycle. The concept of ‘the potential rate of output growth’ is central to this view. This concept refers to the maximum growth rate which an economy can sustain without generating inflationary pressures and consistent with employment at the natural rate. Potential output is determined by structural factors in the economy, such as the availability of capital and labour, infrastructure, technology, skills levels, and trade policies. Changes to potential output are determined by changes in these factors. It follows then that if growth is above potential, there will be inflationary pressures and the role of monetary policy will be to moderate these pressures by reducing demand pressures to be consistent with price stability. We do this through raising interest rates. The converse also holds true. When the economy is growing at levels below potential, demand is weak, as are inflation pressures, and monetary policy has room to stimulate the economy by reducing interest rates. In other words, under normal conditions, monetary policy should be conducted contra-cyclically, by boosting growth in a downturn and cooling down an overheating economy during a cyclical upturn. The central point here is that monetary policy has little role in determining potential output. Its impact on output is cyclical. The challenge is that potential output is not observed but estimated. Although there are a number of techniques with varying levels of sophistication, these estimates are subject to a great deal of uncertainty and often vary quite considerably from one to another. This means that, while we can observe how current output changes, it is difficult to be certain at any point in time whether the potential itself has changed. This is critically important for policy purposes. For example: if cyclical growth falls below potential, then countercyclical monetary and/or fiscal policies are appropriate, but what if the current observed growth slowdown is also a reflection of a decline in potential output? This could mean that countercyclical policies would not necessarily be effective. This issue is at the heart of the current debates about the persistence of low growth in the global economy. Some have argued that below-potential growth is a cyclical phenomenon that can be resolved through contra-cyclical macroeconomic policies by stimulating demand. However, others have warned that we are experiencing a period of secular stagnation, associated with a prolonged period of low growth and declining potential output. If this is indeed the case, it follows that the effectiveness of monetary policy in stimulating the economy will be limited. What is required under such circumstances is structural change in the economy, in order to stimulate supply. BIS central bankers’ speeches Monetary policy may help to prevent deflation by underpinning demand to some extent, but it is unlikely to be the primary source of growth. Recently, many countries have revised down their estimates of potential output growth. However, it is unclear whether these are short-term estimates or whether a prolonged period of secular stagnation is with us. Domestically, we at the South African Reserve Bank have also successively revised down our estimates of potential output, from around 3,5 per cent in 2010 to the current levels of around 1,4 per cent. We see these as an estimate of short-term potential output; our longer-term estimate is higher, when, for example, the electricity supply constraint is expected to be relieved. But the longer-term estimates remain lower than previous ones. This constrains the ability of monetary policy to stimulate cyclical growth, as the output gap – which is the difference between actual output and potential output – is not as wide as would be the case with a higher potential output. Thus, if the growth problem is structural in nature, the scope for successful monetary stimulus is limited. When the global financial crisis struck, it was viewed as a cyclical downturn, and there was almost universal agreement on the need for stimulatory monetary and fiscal policies. While fiscal space was quickly eroded, monetary policies in the advanced economies remain highly expansionary and ‘unconventional’. It used to be assumed that once interest rates reached the zero lower bound, 2 then monetary policy would become ineffective. 3 But the post-crisis period saw attempts at monetary stimulus through quantitative easing (or QE) which took various forms but in essence entailed central banks buying government or corporate bonds, thereby injecting liquidity into the system. While the US ceased its QE programme in 2014, the Bank of Japan and the European Central Bank have maintained theirs while the Bank of England recently resumed its QE programme in the wake of the UK’s decision to leave the European Union. Interest rates in the advanced economies remain extremely low and in some instances in fact negative. In early 2015, both the US and the UK were expected to be the first of the advanced economies to begin raising interest rates. The US tightened policy in December 2015 but it has remained on hold since then, while the UK has recently reduced rates further. Unfortunately, this highly expansionary monetary policy environment has not generated the growth that was hoped for, but it can be argued that it prevented the immediate situation from getting worse. I should note that there are potential negative effects from very low or indeed negative interest rates, not least of which is that they create problems for defined-benefit pension funds which have to provide cover for ageing populations while many of these funds face the risk of underfunding. The amount of government debt trading at negative yields has increased significantly since the beginning of the year. Pension funds are therefore forced to search for higher yields and, almost by definition, they move their funds to more risky investment categories and jurisdictions. This is a potential time bomb waiting to explode, far more serious than the concerns over the potential inflation risks of ultra-loose monetary policy. In fact, inflation is not currently a concern in the advanced economies, and in some instances the concern is that inflation is too low. The situation in emerging markets and developing economies is more complicated, particularly in those that are currently facing rising inflation and slowing or low growth. These inflation pressures have typically been driven by weakening exchange rates in response to declining commodity prices – and not by excess demand where monetary policy is most effective. This is the case in South Africa at the moment. Our economic growth outlook is weak following the contraction in the first quarter of this year. The South African Reserve This is when short-term nominal interest rates are at or near 0 per cent. A liquidity trap is caused and the effectiveness of monetary policy is limited. This is due to the existence of physical money. As interest rates fall below 0 per cent, economic agents may switch from central bank money or electronic cash to physical cash. BIS central bankers’ speeches Bank forecasts 0 per cent growth this year and below-trend growth of just 1,1 per cent and 1,5 per cent in 2017 and 2018, respectively. At the same time, inflation is outside our target range of 3 – 6 per cent and is expected to remain outside the range until the third quarter of 2017. However, demand pressures are weak while inflation is driven primarily by supply-side factors, including drought-induced food price increases, a relatively depreciated currency, and administered prices. None of this means that monetary policy should not be used under such circumstances. We know there is nothing we can do about the impact or first-round effects of these supply-side shocks. We try to look through these effects and focus on the second-round effects, where higher prices feed into higher generalised inflation and higher wage settlements. If we ignore these pressures, inflation expectations are likely to rise. And if wage negotiators and price setters believe that inflation will accelerate, they will adjust wages and prices accordingly, and in so doing bring about a self-fulfilling prophecy. This scenario of high inflation and low growth creates a dilemma for monetary policy. The tightening of monetary policy could have a negative impact on the already weak economy, but failure to act could cause inflation expectations to become unhinged and ultimately undermine inflation. It is a difficult balancing act. Since January 2014, we have been in a gradual tightening cycle, with a cumulative increase of 200 basis points since then, the most recent a 25 basis point increase in March. The moderate nature of the tightening cycle is due to our concern over the growth outlook; the tightening would have been more aggressive had the economy been more buoyant. Furthermore, real interest rates remain relatively low, implying an accommodative monetary policy stance despite the tightening. But central banking is not only about monetary policy. Since the global financial crisis, the mandates of central banks have expanded, particularly with respect to financial stability. Prior to the crisis, many central banks had an implicit mandate, or no mandate at all, in this regard. In South Africa, for example, although the South African Reserve Bank had explicit responsibility for regulating and supervising individual banks (micro-prudential policy), it did not have an explicit mandate to ensure the stability of the financial system as a whole. By way of an example, excessive price increases or bubbles in asset markets, including the housing market – particularly if financed by excessive leverage or borrowing against these assets – could pose a risk to the financial system at large should the prices of these assets collapse. Prior to the global financial crisis, conventional wisdom dictated that there was not much that central banks could do to cool down overheating asset markets. Indeed, many – including Federal Reserve Bank Chairman Alan Greenspan – argued that there was no reason why central banks were better placed to recognise asset price bubbles – and that the best they could do was to clean up after things had already fallen apart. The predominant view at the time was that things were unlikely to fall apart. There were, of course, dissenting voices, notably at the Bank for International Settlements, who argued that central banks should not have a narrow focus on inflation only and should rather lean against this excessive leverage with higher interest rates, focusing on the financial cycle, which is usually longer than the business cycle. This would have implied higher interest rates than those prevailing before the crisis, despite the low inflation environment. History shows that these dissenting voices were correct; current conventional wisdom prescribes that financial stability should be an explicit focus of central bank policy. There are disagreements, however, about where this responsibility should lie and what instruments should be used. Some argue that it should be part of monetary policy and that interest rate settings should take the financial cycle into consideration. Others argue that monetary policy should remain focused on inflation and that the task of financial stability should be given to a separate committee, although it is not self-evident whether this separate committee should BIS central bankers’ speeches be housed within the central bank or outside the central bank in a separate institution, as is the case in Sweden. In South Africa, we have adopted a position similar to that of the Bank of England, where the responsibility for financial stability is given to the central bank overseen by a financial stability committee. This committee considers the stability of the financial system more broadly, rather than regulating and supervising individual banks. The latter remains the job of the Bank Supervision Department at the South African Reserve Bank, which is transforming into a Prudential Authority in terms of the Financial Sector Regulation Bill (FSR Bill) currently before Parliament. The promulgation of the FSR Bill will make the Bank’s responsibility for financial stability explicit. The Bill sets the provisions that will give effect to the Bank’s financial stability mandate. The Bank will be responsible for protecting and enhancing financial stability, and for maintaining or restoring financial stability if a systemic event has occurred or is imminent. In monitoring the strengths and weaknesses of the financial system, as well as any risks to financial stability, the Bank will be expected to advise the financial sector regulators and other agencies of the steps required to mitigate risks to financial stability. The FSR Bill also requires the Bank to publish its assessment of the stability of the financial system at least every six months in the Financial Stability Review, which is to be submitted to the Minister of Finance and the Financial Stability Oversight Committee. Once the FSR Bill is promulgated, the Prudential Authority will regulate individual banks and insurance companies while the Financial Services Board, previously responsible for overseeing the entire insurance sector and other non-banks, will assume responsibility for market conduct within the banking and wider financial sector. So while monetary policy, macro-prudential policy and micro-prudential policy are all separate functions of the Bank, their coordination is facilitated by them being housed within the same institution, with some degree of overlapping membership. But we could ask whether the central bank has a wider role to play in the economy, particularly within emerging markets. We are often asked why the South African Reserve Bank does not get involved with direct lending or development finance, be it to industry or the agricultural sector, and whether we should not be more involved in promoting financial inclusion. Theoretically, there is no reason why central banks cannot perform wider functions. Generally, apart from the functions I have outlined above, central banks have the important role of being responsible for issuing currency. Furthermore, in South Africa, the banking sector plays a prominent role in the national payment system, which facilitates the settlement of millions of transactions every day; the total value of transactions settled in the 12 months to March through the Bank’s SAMOS 4 system amounted to R123,9 trillion. We take for granted simple things like credit card or other card transactions that are settled immediately. This requires a significant infrastructure, and the South African Reserve Bank ensures that the rules are applied. At a regional level, we have played an important role in extending this infrastructure and expertise to a number of countries in sub-Saharan Africa, which in turn helps to facilitate intra-regional trade and promotes financial inclusion by helping communities access financial services. In some countries, central banks play a prominent role in the allocation of credit to various sectors. For example, the Nigerian central bank plays an important role in directing credit to the agricultural sector, and in South Korea the central bank decides how much credit banks should extend to small and medium enterprises. Whether such functions should indeed be performed by a central bank is often dependent on the nature of the financial system, its level South African Multiple Option Settlement. BIS central bankers’ speeches of sophistication, and the existence of other institutions that are focused on extending credit to other sectors. In South Africa, we have a number of public sector institutions that are focused on extending credit to different sectors. These include the Industrial Development Corporation, the Development Bank of Southern Africa, the Land Bank, and a number of institutions that specialise in lending to small businesses. These functions could theoretically be performed by the central bank as a separate function, but there is no clear advantage to this – unless there were scarce skills in the economy and/or a lack of resources that would make a good operational argument for this. In many developing economies, there may be a lack of skills, and combining these diverse functions into one institution may be helpful from the perspective of achieving economies of scale. But even if it were the case that the South African Reserve Bank granted loans to the agricultural sector or small businesses, these loans would not be financed by ‘printing money’. Rather, such an arrangement would disburse funds raised in the money and capital markets at competitive rates, or it would be funded by grants from government and/or multilateral organisations. There is no reason why the Bank would necessarily have the advantage of assessing the needs of these sectors, as opposed to the specialised institutions that focus on these sectors, or have the necessary expertise to do so. In developing economies, central banks often have a role in promoting financial inclusion. This is, however, a particularly challenging area of policy formulation and one that means different things to different people. At a superficial level, financial inclusion is often simply seen as having access to a bank account and consequently to the national payment system. Mobile banking has brought banking services to the rural areas in a number of African countries. In South Africa, the low-cost Mzansi accounts have given easy and cheap access to rudimentary banking services to a broader segment of the population. I would, however, argue that financial inclusion entails much more than this and that, from a political economy perspective, it is a complex matter, particularly due to the broad range of opinions on how best to achieve this policy objective. There is, however, broad consensus that financial inclusion should extend to include access to loans, transactional banking, and risk products and services. 5 Financial inclusion should not mean irresponsible or reckless lending to people who cannot afford it. After all, it was the unfettered provision of cheap loans to people who could not afford them, or the so-called sub-prime lending, that largely triggered the global financial crisis. Typically, banks grant loans on the basis of some security provided by the borrower. Often, this entails fixed property. But in a country like South Africa, with a highly skewed distribution of income and wealth, the ability to provide such security is beyond the reach of a significant proportion of the population. It becomes even more complicated when we consider rural communities and communal forms of land ownership which is not conducive for providing surety for loans. As the sub-prime crisis in the US has illustrated: while lending to disadvantaged communities may be a noble cause, there are dangers to excessive lending, particularly when such lending is simply financing consumption. In South Africa, we experienced extremely strong growth in unsecured lending between 2009 and 2013, some of which was to lower-income groups previously excluded from formal sector borrowing and some of which may yet come to manifest itself in higher levels of non-performing loans – although it is the view of the In this regard, I prefer the term “financial deepening’ over ‘financial inclusion’ for the reasons stated above; the former is a much broader concept. BIS central bankers’ speeches South African Reserve Bank that our banks have sufficient capital buffers to absorb any such increases. Access to unsecured loans has meant that lower-income groups could avoid having to borrow from ruthless informal money-lenders at exorbitant rates of interest. But it has not solved the problem of over-indebtedness of the poor and its social consequences. In numerous instances, large portions of earnings were paid over to lenders (both formal and informal), often in terms of court orders, leaving wage earners with very little to live on. There were also concerns that this form of lending and its rapid expansion posed a systemic risk to the financial sector and broader financial system. However, unsecured lending was a fairly small portion of total bank lending. Nevertheless, at a micro-prudential level, the Bank Supervision Department of the South African Reserve Bank kept a close eye on these forms of loans – and although one significant player in the field, African Bank, did collapse, its failure cannot be solely attributed to its provision of unsecured lending. The role of the central bank in this instance was not to decide who the beneficiaries of bank loans should be or how much should be lent; the role of the central bank was to ensure that commercial banks in general maintained adequate capital and made appropriate provisioning for risk. The African Bank episode did illustrate the danger of talking about the need for financial inclusion in a glibly manner. Banks have often been criticised for not extending lending to the poorer segments of society, but when they did, they were criticised in some quarters for “reckless lending” and for facilitating the accumulation of excessive debt. While increasing financial inclusion is a laudable and important goal, a fine balance needs to be struck between protecting consumers from exploitation and extending credit in such a manner that the stability and soundness of the financial system as a whole is not undermined. The market conduct regulators, including the National Credit Regulator and the Financial Services Board, are responsible for preventing reckless lending, and the role of the South African Reserve Bank in the context of promoting financial inclusion is to ensure the stability of banks and the financial system. There is a view that giving too much discretion to central banks in some of the areas I have highlighted could politicise the central bank unduly. This brings us to the issue of central bank independence. The main argument for independence is that it minimises the politicisation of monetary policy decision-making and avoids what is known as the “political interest rate cycle”. This refers to the incentive of politicians to lower interest rates in advance of elections. The argument is that an operationally independent central bank does not have to bow to such pressures. That is not to say that central banks are not pressurised by political and other elements in society to act in a particular way, and monetary policy in South Africa has not been without its domestic critics and political economy challenges. The monetary policy framework has been criticised, and, not surprisingly, opposition has tended to intensify during the upward phases of the interest rate cycle. But the South African Reserve Bank has been able to resist such pressures, as its operational independence is entrenched in the Constitution. The inflation-targeting framework lends itself well to the separation of goal and instrument independence: 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 do have instrument and operational independence to pursue the mandate given to them. However, the global crisis has created challenges for central banks that could undermine this seemingly comfortable insulation from the political arena. The expanded mandate of financial stability in itself may have implications for their independence, while the other possible objectives – such as financial inclusion and direct finance – imply political decisions being made by unelected officials. Compared to financial stability decisions, decisions on monetary policy, while not easy, are more straightforward and better understood by the public. They usually involve the use of BIS central bankers’ speeches one tool, namely the interest rate, and there is a clear objective. The financial stability mandate is more complicated, as it is a shared responsibility. It generally involves government in crisis resolution, particularly when public funds are involved, and the policy tools are more directed at particular sectors; it may therefore be more politically sensitive as the distributional impacts are more apparent than in the case of monetary policy. Furthermore, as has been argued in a paper published by the International Monetary Fund, financial stability is difficult to measure but financial stability crises are evident, so policy failures are observable, unlike successes. As has been noted in the IMF paper, “central banks would find it difficult (even ex post facto) to defend potentially unpopular measures, precisely because they succeeded in maintaining financial stability”. 6 Whichever failures may be perceived on the financial stability front have the potential to undermine monetary policy independence through a general loss of credibility of the central bank. In conclusion, we are living in challenging times. Central banks are called on to do more and more, and are still called on to provide solutions to the low-growth environment we find ourselves in. But, as I have argued, although central banks play an important role in the economy and society at large, there are limits to what they can do – and these limits are not always well understood. Mohamed El-Erian argues that while we should give central banks due credit, their effectiveness is waning given the limited number of tools available to them. He argues that the world has come to a critical junction, and faces a choice of two roads. One road “involves a restoration of high-inclusive growth that creates jobs, reduces the risk of financial instability, and counters excessive inequality. It is a path that also lowers political tensions, eases corporate governance dysfunction, and holds the hope of defusing some of the world’s geopolitical threats. The other road is one of even lower growth, persistently high unemployment, and still worsening inequality. It is a road that involves renewed global financial instability, fuels political extremism, and erodes social cohesion as well as integrity”. 7 This is a sombre warning – and relevant both domestically and at the global level. It is clear what the preferred road is. Taking it requires political leadership and political will. This is not a responsibility that can be abdicated to central banks. Thank you Bayoumi, T et al. (April 2014): Monetary policy in the new normal. International Monetary Fund Staff Discussion Note. El-Erian, M A (2016). The only game in town. Central banks, instability and avoiding the next collapse. New York: Random House. BIS central bankers’ speeches
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the launch of the T+3 Equity Market Settlement Cycle, Johannesburg, 4 August 2016.
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Daniel Mminele: Reducing systemic risk in South Africa Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the launch of the T+3 Equity Market Settlement Cycle, Johannesburg, 4 August 2016. * * * Good morning ladies and gentlemen. Thank you to the Johannesburg Stock Exchange (JSE) for inviting the South African Reserve Bank (SARB) to be part of this significant occasion to mark the launch of the T+3 settlement cycle for the equity market in South Africa. Thank you for the opportunity to make some brief remarks this morning. Allow me to start by congratulating the JSE and the T+3 Project Team, under the guidance of the JSE, on a smooth and successful implementation on the go-live date on 11th July, which represented the culmination of close collaboration over an extended period between numerous stakeholders, and including with the National Treasury, the Financial Services Board, and the SARB. This is indeed a major milestone, as many of us gathered here today know how much work has gone into this project. The move to this settlement cycle is a welcome development that contributes towards our continuous efforts to improve the efficiency of, and reduce the risk in, our financial market systems and infrastructures. Not only does T+3 in the equity market align this market segment with the implementation in the bond market, which happened some time ago, it also aligns the South African market to international best practice. Beyond just creating these efficiencies and synchronising our markets with the rest of the world, an important element of this particular initiative is that its benefits are shared by many of us as stakeholders in this project, be it as companies listed on the exchange, brokers, investors and indeed as regulators. The project team at the JSE has done well in highlighting some of the benefits 1, and if I can remind everyone present here today, these include: • Aligning operational practices of the local equity market to global standards; • Improving the credibility and operational efficiency of the local market; • Protecting the financial markets through systemic risk mitigation that will follow from reduced credit and liquidity risk; and • Through increased credibility, assisting in making South Africa a more attractive investment destination to international investors. These are only a few of the direct and indirect benefits of a shorter settlement cycle, and for South Africa it comes at a time when the JSE is becoming a home to an increasing number of dual-listed companies. According to JSE statistics, the share of companies with dual listings increased from 14 per cent of all companies listed on the JSE in January 2006 to about 24 per cent in July 2016. As such, harmonising settlement cycles across regions will help with better cash flow and treasury management, and thus facilitate better and more efficient allocation of capital. Reducing systemic risk and contributing to broader financial system stability In addition to its primary mandate of price stability, the SARB is also responsible for protecting and enhancing financial stability. We consider financial stability to exist when we have a financial system that is resilient to systemic shocks, facilitates efficient financial Johannesburg Stock Exchange T+3 Project Overview and Frequently Asked Questions, August 2016. BIS central bankers’ speeches intermediation and mitigates the macroeconomic costs of disruption in such a way that confidence in the system is maintained. The focus on financial stability is in line with the global trends where the regulatory community, in reaction to the global financial crisis, has been dedicating more effort and resources to reducing risk, achieving greater transparency and accountability, and improving efficiency in order to establish a safer market environment. A shorter-settlement cycle will foster a reduction of settlement risk and counterparty exposure by reducing the time period between trade execution and settlement. The faster delivery of cash and stock to the seller and buyer, respectively, allows for a reduction in the risk of financial loss, especially during times of financial stress. The level of interconnectedness or network structure of the various agents of our financial systems, within and across borders, speaks directly to the potential risks that may arise from poor or outdated risk management practices. However, if risk is reduced and continuous risk reduction strategies are being pursued, such as will be the case with the shorter settlement period in the equity market, then systemic financial crises are less likely to occur. Increased market credibility and operational efficiency improving the attractiveness of South Africa to international investors Other benefits that this initiative promises to unlock relate to the improvement of the credibility and operational efficiency of the local market. These benefits should help boost South Africa’s status in the global competitiveness rankings of the World Economic Forum (WEF). The competitiveness rankings are informed by a number of pillars which are organised into three main stages of development, factor-driven, efficiency-driven and innovation-driven. Each stage focusses on different market structure issues, i.e. basic requirements, efficiency enhancers and innovation and sophistication factors. Financial market development, for which South Africa is ranked an impressive 12th out of 140 countries, falls under the second stage of development. 2 This initiative, together with various other initiatives that are currently under way in our markets, will help improve the process of more efficient and safer intermediation of capital, enhance our competitiveness and contribute to the attractiveness of our markets for foreign investments. As a country that runs both budget and current account deficits, that are being predominantly financed by short term foreign capital flows, this becomes rather crucial. The sophistication and depth of our capital markets also play an important role when the country’s credit ratings are being assessed. Contributing to South Africa’s delivery on its G20 commitments Before I conclude, let me briefly touch on how this initiative also helps South Africa to meet its G20 commitments. South Africa as a member of the G20 was invited to join the Bank for International Settlements (BIS) Committee on Payment and Market Infrastructures (CPMI), and it is also a member of International Organization of Securities Commissions (IOSCO). As a member of the BIS CPMI, the SARB contributed to the development of the Principles for Financial Market Infrastructures (PFMIs). The PFMIs update, harmonise and strengthen the international risk management and associated standards applicable to systemically important payment systems (PSs), central securities depositories (CSDs), securities settlement systems (SSSs), central counterparties (CCPs) and trade repositories (TRs).These principles were published in 2012 and G20 member countries were expected to adopt them and also apply them in their jurisdictions. South Africa embraced these principles and issued a position paper to drive their application by identified FMIs in the payment system. Once the Financial Sector Regulation Bill has been enacted, followed by other consequential legislative amendments, we will be able to fully adopt the PFMI. It is, however, also encouraging to note that with assessments of compliance on South Africa as a jurisdiction by The Global Competitiveness Report 2015–2016, World Economic Forum. BIS central bankers’ speeches the BIS CPMI/IOSCO, we have been scored quite favourable overall when it comes to the expected outcomes. Furthermore, we have requested our recognised payment FMIs (including STRATE) to conduct self-assessments, which were reviewed by our National Payment System Department prior to engagement with the FMIs on appropriate action going forward. In conclusion, let me reiterate that as the SARB, we are pleased with the industry’s collaboration and commitment to align the equity market to international standards, and allow me to once again convey my appreciation to all stakeholders that had to play a constructive role since the inception of the project in 2013 right up to ensuring smooth execution in connection with the recent launch. As previously stated, the shorter settlement cycle will reduce systemic risk and release funds earlier into the market, thereby increasing liquidity for local and international investors which will translate to growth in our capital markets and also enhance public confidence. With these words, I would like to thank you all very much. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Cybersecurity Conference, Johannesburg, 23 August 2016.
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Lesetja Kganyago: Collaboration for building cyber resilience Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Cybersecurity Conference, Johannesburg, 23 August 2016. * * * Governor, Deputy Governors, other distinguished guests, ladies and gentlemen It gives me great pleasure to welcome you all to this cybersecurity conference with the theme of “Collaboration for building cyber resilience”. This is the first cybersecurity conference of this kind to be organised and hosted by the South African Reserve Bank (or SARB), which underlines the importance of cybersecurity and cyber resilience to the South African central bank. As we stand at the dawn of the Fourth Industrial Revolution, developments in information and communication technology (ICT), spurred on by the digital revolution, have brought and will continue to bring about significant and wide-ranging changes to society and the broader economy. These changes are marked by both speed and ubiquity, and therefore have an impact on almost everyone and most firms and business processes, especially in the financial services sector. While most of these advances have been beneficial, the cyber-world also has its dark side. This is where individuals, groups, and organisations use and exploit the advances made in ICT for ulterior motives. In this context, very few individuals and firms are exempt from or are left untouched by the potentially negative consequences of such activities. Our Constitution, other legislation as well as the Financial Sector Regulation Bill (FSR Bill), currently before Parliament, place tremendous responsibilities on the SARB. The SARB’s primary responsibility for monetary policy will soon be augmented by an explicit financial stability mandate, and our responsibility for the regulation and supervision of banks as well as for the oversight of the national payment system will be expanded to include the safety and soundness of insurers, financial conglomerates, and other systemically important financial institutions, as outlined in the FSR Bill. Like many other central banks, the SARB plays a key role in the regulation and supervision of the domestic financial system. In our scanning of the financial system for potential systemic risks, cyber-threats have been on our radar for a while now. As new financial products and services emerge from FinTech innovation and affect the market, the SARB will have to consider their implications for the way in which it conducts its oversight functions as well as monetary and macroprudential policy. The SARB has a balanced approach to these technological innovations. It acknowledges the greater efficiencies that ICT advances have brought to the financial services sector. We have also, within our risk management framework – and like many organisations represented here – adopted and embraced technologies that have helped us to execute our mandate more effectively and efficiently. As a central bank, we are open to innovations despite the different opinions of regulators on matters such as crypto-currencies. We are willing to consider the merits and risks of block chain technology and other distributed ledgers. Not all innovations in this area are, however, benign. The abuse of algorithmic or highfrequency trading can pose problems for the smooth functioning of financial markets. We understand that many financial and other firms – in their drive for greater efficiency and productivity, and for serving their clients more effectively – may have an even bigger stake in leveraging off these innovations and technologies. Real opportunities in the digital revolution currently underway await not only further application by the private sector, but also greater utilisation by financial regulatory authorities. As innovations bring down costs, significant transformation of the financial intermediation landscape cannot be discounted or dismissed. Leading innovators know how to turn disruption into opportunity. Possibilities for the use of improved technology in ensuring regulatory BIS central bankers’ speeches compliance abound for both regulators and the industry. Regulators have only started to scratch the surface of the potential uses of, for example, Big Data in regulatory technology – also referred to as “RegTech”. Big Data techniques can assist us to understand the state of the economy and “identify trends in systemic risks” more accurately and quickly. 1 Hopefully, this will lead to further enhancements for policymaking and greater precision in supervisory interventions. The threat landscape and the role of regulatory authorities With an expanding digital footprint comes a growing threat landscape, providing greater opportunities and increasing entry points or vectors for cyberattacks. Since the unleashing of the first computer worm in 1988 by a 23-year-old Cornell University student, malware has grown exponentially in both volume and sophistication over the last three decades. 2 There are well over 100 000 known computer viruses and the frequency of cyberattacks has increased. Old defences are quickly rendered redundant. As participants in the financial sector, you are aware of the details of the cyberattacks on privately owned banks, insurers, and other financial institutions without one having to list examples of these. Even central banks are not immune to such attacks. Reported attacks on SWIFT, 3 the financial messaging network that underpins most international money transfers, have the potential to paralyse global trade and finance, albeit for only a short while. Spare a thought for ordinary citizens, your customers, who, with their limited resources and information asymmetries, are the most vulnerable and often the biggest losers in attacks where illicit financial gain is the key motive. Innovations, such as the advances in biometrics and digital identities, hold great promise for individual security. We wait for industry to translate these gains into suitable security measures applicable to corporations. Innovation, however, cuts both ways. Advances in, for example, cryptography prompt further improvement in decryption technology. We therefore cannot be complacent about our cyberdefences. Given this threat landscape, it is no surprise that cybersecurity has in the recent past moved swiftly up the list of priority issues in a number of countries as regulatory authorities seek to address cybersecurity threats and enhance cyber resilience. As a central bank and a regulator in the financial sector, the SARB would be remiss in its duty if it ignored the growing risks emerging from the financial services sector’s increasing reliance on cyberspace and the Internet. Because of its access to capital, the financial sector is a key target. Cyber-related attacks are therefore more likely to be directed at financial systems, institutions, and their customers. Hackers’ attacks are also becoming more sophisticated as their understanding of the value chains in financial services improves. At an international level, global standard-setting bodies – such as the International Organization of Securities Commissions as well as the Committee on Payments and Market Infrastructures – recently issued a document titled Guidance on cyber resilience for financial market infrastructures that should be used to address the cyber resilience of FMIs. While these guidelines are aimed directly at FMIs, it is important that FMIs actively reach out to their participants and other relevant stakeholders to promote the understanding and support of resilience objectives and their implementation. Carney, M. Enabling the FinTech transformation: revolution, restoration or reformation? Bradshaw, S. December 2015. Combatting cyber-threats: CSIRTs and fostering international cooperation on cybersecurity. Paper Series No. 23. Chatham House: the Royal Institute of International Affairs. Society for Worldwide Interbank Financial Telecommunication. BIS central bankers’ speeches The guidance document covers themes such as: • situational awareness to understand and pre-empt cyber-events; • collaboration to drive resilience in support of broader financial stability objectives; • cyber-governance to implement and review the approach to managing protection against cyber-risks to ensure effective security controls that protect confidentiality; and • the integrity and availability of assets and services as well as the testing of the elements of the cyber-resilience framework to ensure their overall effectiveness. These guidelines will have implications for the way in which we exercise oversight over both national and regional payment FMIs, the way in which we regulate and supervise the financial institutions under the SARB mandate, as well as the way in which we monitor financial stability. At a domestic level, the bankers among you would have noted that this year cybersecurity is one of the flavour-of-the-year topics that the Bank Supervision Department of the SARB will cover in its annual engagements with the boards of directors of banks. Motives for cyberattacks are, however, not limited to theft and often extend into a more sinister realm. Regulatory authorities must consider the possibility of systemic risks in the financial ecosystem, such as hackers bringing down a critical financial infrastructure for a prolonged period of time and the consequences of such an event. To this end, the SARB has established the Financial Sector Contingency Forum (FSCF), in which all the major financial sector stakeholders are represented. One of the responsibilities of the FSCF is to put contingency plans in place for such eventualities. But that is not enough. We must do more, which brings me to the purpose of this conference. The purpose of this conference Against the background of an expanded mandate, as described in the FSR Bill, the SARB has taken the initiative to organise this cybersecurity conference. Given the potentially systemic impact of new innovations, the SARB does not take cyber-threats lightly and it is serious about deepening cyber resilience in the financial services sector. The selection of the theme for this conference – “Collaboration for building cyber resilience” – has been deliberate. We want to galvanise collective thinking and action around cyber resilience and facilitate the emergence of appropriate measures to counter common threats. We also cannot address this problem in isolation. In a highly interconnected world, our cyber-defences are literally as strong as the weakest link. All role players – from critical infrastructure operators and financial firms through to technologists and law enforcement agencies to regulators and vendors – need to work together to counter the dangers that we face. We need to extend the focus beyond the mere reporting of cybersecurity incidents and recovery times. The whole industry needs to become more proactive in its approach and embed a healthier cyber-culture in each firm. This proposed culture will have to be risk-based and inclusive. More prominence will have to be given to greater deterrence, early detection, regular penetration testing, and quicker response times. How we strengthen our computer security incident response teams (or CSIRTs) and coordination centres becomes important. To be effective, we need to coordinate our efforts and work together. The SARB believes that cybersecurity is a terrain with enough non-competitive and mutual interests, where public and private stakeholders can collaborate to build the resilience that is required against a common threat. A number of countries have cybersecurity frameworks in place to deal with cyber-threats. While there is a significant amount of variation and overlap across national frameworks, an important shortcoming is often the lack of coordination and cohesion at national and regional levels. We should avoid this. Indeed, there are hurdles that we will have to overcome, including privacy concerns, trust deficits, and the lack of expertise. BIS central bankers’ speeches But these are not insurmountable obstacles. I hope you will engage fruitfully on these matters of coordination and cohesion in your deliberations and arrive at workable solutions. Cyberattacks know no national borders. We have thus called on knowledgeable experts, both local and international, to address us on a number of relevant topics, ranging from the nature of the threat landscape and regulatory approaches to cybersecurity through future cyberdefensive tools to emerging cyber-resilience trends. To make matters a little more practical, I believe that you may examine one or two case studies and consider how to build cyber resilience into FinTech innovation. I am sure that you are also looking forward to learning how cyber-threats are addressed by the other central banks represented here and the latest developments in this regard. Conclusion I encourage you to explore and share your ideas on cybersecurity candidly, and I wish you well as you work on the important details of collaborating on, and laying the foundations of, effective and efficient resilience against the cyber-threats of today and of the future. May you remain forever vigilant. Thank you. BIS central bankers’ speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Labour Law Conference, Johannesburg, 24 August 2016.
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Lesetja Kganyago: Inflation, but no jobs or growth – policy responses to South Africa’s economic challenges Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Labour Law Conference, Johannesburg, 24 August 2016. * * * Good morning, ladies and gentlemen Thank you for inviting me here today to address this forum. South Africa is suffering from a combination of stagnant economic growth and rising inflation. The economy contracted in the first quarter of the year, and although the second quarter looks considerably better, we expect no growth in 2016 overall – which compares unfavourably to the 1,3 per cent achieved in 2015 or the 3 per cent average since 1994. Furthermore, for the first time since the global financial crisis, we expect to lose jobs this year, on a net basis. Yet even as economic growth and job creation stall, prices – fuelled by food price and currency shocks – as well as wages and salaries continue to increase above the targeted inflation rate. 1 This keeps headline inflation higher than economic conditions warrant. Underlying this inflation outcome is a set of markets, rules and systems that generate strong price, wage and salary pressures and play a large role in generating this combination of high inflation, high unemployment, and low growth. Today, I will discuss policy options for addressing this problem, including the contribution from monetary policy. One of the things we need is for price and wage demands to abide by the inflation target, so that we achieve a lower inflation rate more consistently. Attaining these outcomes will require change, including institutional reforms. And reforms will create space for monetary policy. We would prefer not to tighten policy during a slowdown, but as long as our economy is geared to produce weak growth and high inflation, we have to do just that. Higher inflation begets higher interest rates. Lower inflation, alternatively, enhances the competitiveness of the economy and reduces interest rates, supporting investment, job creation, and poverty reduction. South Africa as a labour market outlier South Africa’s unemployment rates, narrowly defined, have exceeded 20 per cent since the early 1990s. From a comparative perspective, sustained unemployment rates at these levels are very rare. At the moment, according to data published by the International Monetary Fund (IMF), they are shared by just four other countries. Two of these are Greece and Spain, which have suffered intense and prolonged economic crises. 2 But both expect to see unemployment decline in the next few years. In fact, Spanish data in May showed unemployment falling to just under 20 per cent for the first time since the global financial crisis. In South Africa, no such improvement is being forecast. In fact, the IMF numbers show our unemployment deteriorating, from about 25 per cent now to around 27 per cent in three years’ time. Over the past five years, average wages and salaries have consistently outpaced inflation. From 2011 to 2015, annual headline inflation stood at 5 per cent, 5,7 per cent, 5,8 per cent, 6,1 per cent and 4,6 per cent. Average wages and salaries, by contrast, grew by 7,6 per cent, 7,5 per cent, 9,3 per cent, 7,7 per cent and 8,5 per cent over the same period. Employment growth has slowed every year from 2011 to 2015. The other two are Bosnia and Herzegovina as well as the former Yugoslav Republic of Macedonia. These are more complicated cases than Greece or Spain, but both were affected by the violent breakup of Yugoslavia and the loss of historical markets. BIS central bankers’ speeches It is quite extraordinary for unemployment to remain so high throughout an economic cycle. Compare South Africa with Brazil, a country similar in many ways. When Brazil’s economy boomed, unemployment fell to below 5 per cent. Since then, Brazil has fallen into a deep recession, with growth close to minus 4 per cent in each of the past two years, the worst performance in a century, including the Great Depression. Unemployment has more than doubled; it is now over 10 per cent. This is a terrible economic experience. But if we could get unemployment in South Africa to 10 per cent, that would be viewed as a tremendous success. There isn’t much to envy about Brazil’s economy these days, but I would happily take their unemployment rates. Many observers look at South Africa’s levels of joblessness and reflexively describe them as unsustainable. But they have persisted for around two decades, so it is a bold prediction to say that they cannot continue. A better interpretation is that we have very unusual, even unnatural, labour market dynamics. This implies that we have vast scope for improvement. Almost every other country has a larger share of its people in work – and most have a larger share participating in the workforce. The National Development Plan sets unemployment goals of 14 per cent by 2020 and 6 per cent by 2030. For labour force participation rates, the plan envisions 60 per cent by 2020 and 65 per cent by 2030, up from the estimated 56 per cent today. 3 We don’t have to achieve a world-beating performance to arrive at these sorts of numbers. Mexico has a 65 per cent labour force participation rate right now. Brazil is at 70 per cent. Meanwhile, world average unemployment rates are at about 5,5 per cent currently, and a little lower in emerging markets. 4 In other words, the goals of the National Development Plan are perfectly sensible. By world standards, they are normal, or even a little worse than normal. But if we’re going to get there, we’re going to need to create 11 million new jobs given the population growth. At the moment, however, we are going in the wrong direction. Both the Quarterly Employment Statistics and the Quarterly Labour Force Survey have recently shown declines in the number of people working – the first negative numbers since the global financial crisis. Our forecasts suggest that this trend will continue, as the public sector achieves financial sustainability and the private sector only slowly recovers from the current lows. The private sector remains the major employer in this economy, providing around threequarters of all jobs. And while we have seen higher employment in service sectors such as finance and trade, catering, and accommodation since the crisis, private-sector job growth stalled a few years ago. The mining sector is grappling with lower commodity prices and a difficult investment environment; it now employs about 80 000 fewer people than it did at its peak in mid-2012. The manufacturing sector continues to shed workers, persisting on a multi-decade trend. We need to get private-sector employment going again. The public sector employs far fewer people than the private sector does, but it has been the prime source of new jobs in the post-crisis period. Since 2009, public-sector employment has grown by about 300 000 people. The share of the budget spent on compensation has also risen markedly; South Africa’s government wage bill is now one of the highest among emerging markets – not so much because the state employs an unusual number of people, but because it pays them comparatively well. 5 Our national finances can no longer bear this National Planning Commission, Our future – make it work: National Development Plan – 2030, p. 118. The labour force participation data are drawn from the Organisation for Economic Co-operation and Development database; see https://data.oecd.org/emp/labour-force-participation-rate.htm. The unemployment numbers are from the Bank for International Settlements; see http://www.bis.org/statistics/ ar2016stats.htm, Figure I.1. The average wage in the public sector is about 1,8 times the South African gross domestic product (GDP) per capita, well above the emerging market average (which is about 1,4 times the GDP per capita). See the BIS central bankers’ speeches sort of wage growth and government has had to implement a personnel freeze, removing one source of job growth in recent years. The overall result is a bleak outlook for labour markets. The question is what to do about it. The inclusive reform agenda The answer is fundamentally about growing again, reforming product markets, and making labour markets more inclusive. We’ve built an economy that produces much more inflation than growth and spits out unemployment as a by-product. As long as we can use commodity prices or debt to grow – the path taken between 2004 and 2014 – we look like we’re making progress. The economy expands (albeit modestly) and jobs are sustained, but real income per capita doesn’t move much. 6 When the debt burdens get too heavy and commodity prices fall, however, inflation stays sticky while growth falls below the population growth rate, entrenching inequality and worsening poverty. At its core, the formal sector of the economy protects itself from the growth slowdown by raising prices, aggravating the downturn, and imposing the cost on those losing their jobs and those without the market power to set prices and wages. There is an alternative path, in which strong investment and increasing labour force absorption allow the economy to expand without accelerating inflation. 7 That’s where we need to go. There are a series of product and labour market reforms that can help us get there. Start with product markets, which offer us our most attractive reform opportunities. OECD 8 studies of product market regulation show that South Africa has unusually high barriers to entry for new businesses. 9 Targeting and reducing these barriers would encourage new business creation and investment, and would raise productivity. In particular, lowering the costs in network industries – such as telecommunications, energy, and transport – would benefit many other parts of the economy. The cost of utilities feeds into the underlying cost structure of the economy; it makes South African goods expensive for the export market and raises that cost of living for the average South African. Research suggests that we could raise our potential growth rate by 1,5 percentage points by reducing the markups in product markets to world benchmarks – which would roughly double the economy’s current “speed limit”. 10 Of course, structural reforms of this type are difficult. Their benefits, in the form of stronger growth and more employment, tend to be widely distributed across the population. The diffusion of benefits is important in the policy debate, because the costs, by contrast, generally appear quickly and affect a smaller number of people. For example, bringing down International Monetary Fund, 2016 Article IV consultation: South Africa, pp. 18–20, July 2016 (https://www.imf.org/external/pubs/ft/scr/2016/cr16217.pdf). From 1991 to 2000, the gross domestic product (GDP) per capita contracted slightly by, on average, –0,2 per cent per year. From 2001 to 2010, it grew by 2,2 per cent per year (on average). From 2011 to 2015, GDP growth per capita slowed to 0,5 per cent on average; the numbers for 2014 and 2015 are –0,04 per cent and –0,48 per cent respectively. This is discussed, for instance, by Ruchir Sharma in The rise and fall of nations: forces of change in the postcrisis world, published by W.W. Norton & Company, New York, in 2016. See especially chapter 7. Organisation for Economic Co-operation and Development. This is available from the Organisation for Economic Co-operation and Development, Indicators of product market regulation (http://www.oecd.org/eco/growth/indicatorsofproductmarketregulationhomepage.htm). See David Faulkner, Chris Loewald and Konstantin Makrelov, ‘Achieving higher growth and employment: policy options for South Africa’, Working Paper 13/03, July 2013 (http://www.resbank.co.za/Lists/ News%20and%20Publications/Attachments/5806/WP1303.pdf). BIS central bankers’ speeches the price of a product like electricity is good for all the millions of users of electricity but painful for the producer, the latter having to become more efficient. For this reason, reform opponents usually mobilise more effectively than the prospective beneficiaries. Nonetheless, there are extra, easy benefits that make reform yet more attractive right now. South Africa has acquired a reputation for devising sound development strategies and then failing to implement them. Following through on reform could reframe the whole South African narrative and boost business confidence. Global conditions would also help. Interest rates are now exceptionally low internationally, and investors are desperately searching for yield. That’s an opportunity; a lot of money would move this way if we became a better growth and investment story. Then there are reforms which affect the labour market directly. South Africa, arguably, has a three-tier labour market. One is mostly informal and pays low wages. The second is formalised and pays intermediate-range salaries, typically negotiated on an industry-wide basis. The third tier pays the highest salaries and features mostly highly skilled employees. Each of these poses different challenges. On average, participants in the third market earn the highest salaries and benefit from skills shortages in South Africa. These shortages mean that employer competition for workers is quite intense, and unemployment in this category is therefore relatively low. But this doesn’t mean that the labour market for the highly skilled is a healthy one. The elevated wages in this market feed our high levels of inequality and contribute to inflation. Furthermore, skills shortages are a problem for economic growth and employment creation. Workers of different skill levels are complementary “goods”; with more engineers you can employ more construction workers to build more bridges. What this segment of the labour market needs, in the longer run, is more and better education to open the highly skilled job market to more South Africans and better match what students study with the skills required by the private sector. We could also temporarily welcome more skilled immigrants to increase competition and help firms find the people they need to grow while we invest in growing our domestic knowledge base. The possibility of pro-growth, pro-equality reform in this area should make it a policy priority. South Africa’s other two labour markets don’t absorb nearly enough people, which leaves many South Africans unemployed or out of the labour force entirely. As the National Development Plan recognises, this problem has a lot to do with spatial legacies and access to information about work. As a result, the plan pays special attention to the distances between people and jobs. It also points out that if we are going to create 11 million new jobs by 2030, many of them cannot be highly paid. This ties in with the product market reform agenda: if the wages in new jobs can’t be that high, we need to achieve downward pressure on prices so that the possible wages command decent buying power. It also speaks to the links between wages and employment. As Bheki Ntshalintshali of COSATU 11 recently reminded us, there is the real risk of excessive wage demands producing higher unemployment. 12 We know that the agricultural sector shed hundreds of thousands of workers after the imposition of a minimum wage at an excessive level. 13 We know that this economy lost a disproportionate number of jobs during the global financial crisis relative to the decline in Congress of South African Trade Unions. ‘COSATU urges members to balance pay with job security in wage talks, Business Day, 4 July 2016 (http://www.bdlive.co.za/national/labour/2016/07/04/cosatu-urges-members-to-balance-pay-with-job-securityin-wage-talks). See Haroon Bhorat, Ravi Kanbur and Benjamin Stanwix, ‘Estimating the impact of minimum wages on employment, wages, and non-wage benefits: the case of agriculture in South Africa’, American Journal of Agricultural Economics, first published online on 27 June 2014. BIS central bankers’ speeches economic output, in large part because of high wages and rigidities during periods of normal business operations. 14 Based on historical trends, we forecast persistent wage growth despite rising unemployment and minimal growth. If we try to play a game in which fewer and fewer people get higher and higher wages while more and more people wind up unemployed, we can only lose. We have to get more people into work. To tackle this problem, one of the things we should do is reconsider the institutions we use to negotiate wage pricing. There is an important argument in academic literature, specifically by Lars Calmfors and John Driffill, connecting unemployment to the kinds of collective bargaining rules used in a country. 15 The basic idea is that a country can achieve better employment outcomes when collective bargaining is done either at a low level, such as one union per firm or plant, or at a very high level, such as the whole economy. The worst outcome is to be in the middle, between the two options. This is because company or plantspecific unions have a special interest in the health of the firm that employs their members and will not want agreements that make the firm unsustainable. By contrast, very large unions have the power to shape macroeconomic outcomes. They will therefore avoid making deals which will push up inflation, drive up interest rates, reduce investment and growth, and ultimately destroy jobs. By contrast, medium-sized institutions, such as those that cover industries, are big enough to inflict costs on the economy but not big enough to experience those costs themselves – the costs are pushed onto others. In these systems, it is easy to reach a deal that keeps out new and smaller firms, so you get a lower level of employment at higher wages and a smaller number of businesses with larger profits. This is a reasonable description of South Africa’s collective bargaining arrangements. We should not be surprised that this is contributing to bad employment outcomes, an effect probably only partially mitigated by exemptions. 16 Indeed, there are reliable estimates suggesting that these arrangements reduce employment in affected industries by 8–13 per cent, in large part because they hurt small, labour-intensive firms. 17 South Africa has surprisingly few of these firms, relative to its peers. This helps explain our unusually high levels of unemployment. The reform conversation and the problem of good faith Ladies and gentlemen, labour market discussions in South Africa are difficult. In particular, they are difficult because they are convened against a backdrop of historical oppression and deep race and class divides. As in some other countries with large economic and social problems, the discussion quickly moves beyond economics. It stops being about appropriate trade-offs and the sorts of experiments which might get us to a better place. Rather, it becomes a discussion about fear of the future and about a shortage of trust; the exchange stops too soon and often at the point where insults fly. If the conversation ends there, nothing gets solved. We are, together, responsible for the choices we make now – and we have the power to make better choices. The people who have the most to gain from reform are the people locked out of the economy. They don’t have much power. Government therefore has a special duty to See Nir Klein, ‘Real wage, labor productivity, and employment trends in South Africa: a closer look’, International Monetary Fund Working Paper 12/92, April 2012. See Lars Calmfors and John Driffill, ‘Bargaining structure, corporatism and macroeconomic performance’, Economic Policy, No. 88, 1988. Bargaining council agreements typically disallow exemptions for “economic reasons”. This presumably includes low productivity or unaffordability. See Jeremy R. Magruder, ‘High unemployment yet few small firms: the role of centralised bargaining in South Africa’, American Economic Journal: Applied Economics, Volume 4, No. 3, July 2012. BIS central bankers’ speeches prioritise their interests. For many South Africans in jobs, the struggle is to hold on to employment and keep wages growing enough to support large numbers of dependents. We need to turn this around, increasing employment and lowering dependency ratios. The best way to raise household incomes is to increase employment. A growing economy and rising productivity will push up real incomes for workers; this need not be done at the expense of jobs. For this reason, there will be long-run benefits for both the unemployed and the workers in the reform agenda. By contrast, opening up product markets will deprive some people of lucrative, overprotected niches in the economy. That’s a good thing. Capitalists often preach the benefits of free markets; we think they should try some competition themselves. We can also see that the labour market reforms needed to temper bad economic outcomes should go hand in hand with other reforms to boost economic growth. By achieving both sets of reforms, we will create permanent gains from greater inclusion and higher productivity – gains sufficient to offset any temporary economic sacrifices imposed on our economy’s “insiders”. In addition to managing labour laws, government also has a role to play in managing labour market dynamics. Firstly, by writing the rules and regulations which ensure that product markets remain competitive. Secondly, by providing basic services that are accessible and lower the cost of living. Planning for affordable housing that is closer to centres of employment and the provision of adequate public transport systems would be examples of these. One of the things that have become clear from the experience in the mining sector is that we do not have adequate rental housing stock for entry-level workers. Thirdly, government will support long-term labour market productivity by providing quality education and health care. Finally, government can ensure that policy conversations balance the interests of “insiders” and “outsiders”. The role of monetary policy I’d like to end on the subject of the contribution from monetary policy. The South African Reserve Bank has been tasked with maintaining inflation within the target range of 3–6 per cent, to be implemented flexibly. Being flexible means that inflation may, from time to time, find itself temporarily outside the target range. There are several reasons for this. Sometimes, there are inflation surprises and it is impossible to change policy in time to have any impact. Sometimes, it would be costly to return inflation to target very rapidly, so we may prefer to disinflate more gradually. And sometimes, we choose to look through departures from the target range because they are expected to be temporary. But there are limits to how flexible we can be. We acknowledge that inflation has been rising recently in response to supply shocks. South Africa has been suffering from a severe drought, which has so far pushed food prices 11 per cent higher than they were in the middle of last year. We are also seeing the effects of sustained currency depreciation, with the rand losing about half its value against the US dollar over the period May 2013 to July 2016. Our forecasts, and our experience, suggest that shocks of this scale pass through into prices and wages more generally and over time, accelerating both inflation and unemployment. This would have been an unacceptable outcome. Accordingly, we have been raising interest rates in a gradual way, taking the repo rate from 5,0 per cent in January 2014 to 7,0 per cent in March this year. By defending the target range, even in difficult conditions, we have helped to control the expectations of future inflation. Together with some currency strength, and the prospect of softening food prices, we expect underlying inflation to remain reasonably well contained. And yet, with inflation hovering at around 6,5 per cent, the real interest rate level of about 0,5 per cent remains exceptionally supportive of economic activity. We are sometimes asked how we could have raised interest rates when the economy was slowing, but when inflation is sticky and even rising despite slowing growth, more and more monetary accommodation has adverse longer-run consequences. If above-target inflation BIS central bankers’ speeches becomes the “new normal”, longer-term interest rates will quickly rise in response. Lenders expect to be compensated for inflation and inflation risk. In turn, the share of current income that we need to spend on servicing debt increases, draining resources from other priorities, like investment. So it is clear that we need to focus on doing things that reduce the general level of lending rates instead of permanently raising them. As I have discussed today, the markets for goods and services in South Africa are commonly dominated by a few big firms. And labour markets are uncompetitive because of skills shortages, restricted entry, and extended industry or sectoral determinations. The result is that prices and wages are only flexible in an upward direction, and are otherwise rigid. This rigidity problem constrains our efforts to improve outcomes and permanently lower interest rates. Our inflation outcomes appear to have settled at around the top of the target range, close to 6 per cent. This implies that nominal market interest rates will never fall much below 9 per cent. This cannot be an acceptable end point of macroeconomic policy, but it also cannot be changed easily with shifts in the monetary policy stance. If we want lower interest rates and we want them without going through a recession, then we have to lower inflation outcomes arising from administered price processes and, above all else, the way in which prices and wages are determined in our collective bargaining system. Simply reducing the inflationary impulse from price and wage setting, to something around the middle of the inflation target range, would help to create jobs economy-wide and ease constraints on policy. Conclusion In conclusion, I have spoken today about some key challenges facing the South African economy. The solution probably isn’t going to emerge from rising commodity prices or a big rebound in world growth which helps exports. It also cannot come from yet more fiscal or monetary stimulus. Macroeconomic policy is already doing what it can, but the constraints are tightening; we are running out of room to borrow and we have too much inflation to lower interest rates. This leaves us with the option of reforms. South African product markets are ripe for change; opening up network industries would in particular have widespread growth benefits. Labour markets for skilled people could be made more competitive, helping growth and reducing inequality at the same time. Our wage bargaining institutions could be more supportive of better economic outcomes. Less nominal wage pressure on prices would help us to lower inflation and the overall level of interest rates. Our institutions could also be less hostile to small firms, the kinds of companies which create lots of jobs – and which are also scarcer here than they are in other countries. Getting more people into jobs would lower dependency ratios, reducing the urgency of high real wages which themselves price many people out of work entirely. Finally, we need to think about the kind of conversation we are having. The reform discussion can be difficult, partly because of vested interests and partly because of a shortage of trust between parties. Given our difficult situation, we need to find ways of talking to each other that ultimately solve problems instead of merely emphasising our differences. We are all partners in this country and its future. We have a shared responsibility to make that future better. 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 University of KwaZulu-Natal Business Management Conference "Innovative and creative solutions for economic growth strategies and sustainable futures", Durban, 26 August 2016.
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Daniel Mminele: The role of monetary policy in encouraging and supporting economic growth Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the University of KwaZulu-Natal Business Management Conference “Innovative and creative solutions for economic growth strategies and sustainable futures”, Durban, 26 August 2016. * * * Good morning, ladies and gentlemen I thank the University of KwaZulu-Natal, for inviting me to speak at this 4th Business Management Conference. The theme of this conference is well-chosen and very relevant to our current context as, eight years after the global financial crisis, strong, sustainable and balanced growth remains elusive, and policymakers across the world, including in South Africa, are indeed grappling with finding innovative and creative solutions for generating growth. South African GDP 1 growth has been decelerating since 2011, registering a mere 1,3 per cent in 2015 following a similarly disappointing growth rate of 1,6 per cent in 2014. This is a far cry from the growth rates of almost 6 per cent that we celebrated prior to the global financial crisis. A number of domestic and external factors have been responsible, including electricity supply constraints and one of the most severe droughts to affect the agricultural sector, the slowdown in China and lower commodity prices (adversely affecting mining and manufacturing production), as well as weak demand in both advanced and emerging market countries, including those in sub-Saharan Africa. According to the most recent forecasts of the South African Reserve Bank, released at the time of the Monetary Policy Committee (MPC) meeting in July, growth prospects remain challenging, with the economy not expected to grow in 2016 and growth rising to 1,1 per cent next year and to 1,5 per cent in 2018. By contrast, our forecasts show inflation remaining above the target range in 2016, averaging 6,6 per cent this year before declining to 6 per cent and 5,5 per cent over the next two years respectively. In my remarks today, I will discuss the role of monetary policy in encouraging and supporting economic growth – a role complicated by the current context of structurally low growth. In an environment characterised by such weak expansion, there are two obvious questions for monetary policymakers. First, why is the MPC not doing more to support growth? Second, what is the long-term role of monetary policy in encouraging and supporting sustainable growth? Monetary policy and short-term growth Since January 2014, the MPC has increased the repurchase rate – or repo rate – by a cumulative 200 basis points, to the current 7 per cent. While it may seem counterintuitive to increase interest rates when growth is weakening, the Bank has been facing a policy dilemma in the face of this weaker growth being accompanied by rising inflation risks over this period, mainly in the form of rising food prices and currency depreciation. Core inflation, which measures underlying inflationary pressure, has continuously exceeded 5 per cent since February 2013, indicating limited space for unfavourable shocks. In addition, inflation expectations remain at uncomfortably elevated levels. Gross Domestic Product. BIS central bankers’ speeches While policy decisions need to appropriately take account of growth dynamics, monetary policy cannot influence growth outcomes in the long run – and there is broad consensus that South Africa needs structural reforms to increase output. The MPC has, however, shown caution in this hiking cycle – and has emphasised the importance of data dependency in making its decisions to ensure that the Bank’s response is calibrated to changing economic conditions. This approach has resulted in rates being hiked more gradually, and by a lower magnitude, than in previous hiking cycles in South Africa. Consider the difference: from January 2002 the MPC increased the repo rate by 400 basis points over 16 months, whereas in the past 31 months we have increased the rate by 200 basis points. As a small open economy, South Africa is highly exposed to exogenous shocks that can affect inflation. Often – with the recent exception of falling international oil prices – these shocks are inflationary, such as the continuous currency depreciation since 2011. The gradual hiking cycle has been a response to the concern that repeated shocks would drive inflation persistently above the target range, which could create a ‘new normal’ target of 6 per cent plus a supply shock in the public’s consciousness. If that were the case, then a shock pushing headline inflation above 6 per cent could in turn pull inflation expectations and/or wage growth with it, causing a generalised, economy-wide increase in prices via these second-round effects. The shock would then embed itself permanently into prices instead of having only a temporary impact. This year, the disinflationary impetus from lower oil prices has dissipated while domestic food price inflation has increased above 10 per cent as a result of the severe regional drought I mentioned earlier. Food prices last rose this sharply in 2011 and, as with an even sharper upsurge in 2008, they were followed by spikes in wage inflation. The MPC is thus cognisant of the increased possibility of second-round effects if the shock is to food prices. Admittedly, we have seen some encouraging developments recently, mainly as a result of renewed search-for-yield strategies based on changed perceptions about the pace of US policy normalisation and easing measures elsewhere. But the currency remains an important risk factor as recent trends can quickly reverse should global risk perceptions change. Even taking near-term improvements into account, the rand has depreciated 11,7 per cent against the US dollar and, on a trade-weighted basis, by 8,6 per cent over the past year – significantly in excess of inflation differentials with our major trading partners. 2 Between May and July, the Bank lowered its inflation forecasts. Yet inflation is still anticipated to remain above the target range until the middle of 2017, peaking in the fourth quarter of this year at 7,1 per cent. At its July meeting, the MPC stated that recent developments had allowed for a pause in the hiking cycle. This pause is evidence of the MPC’s flexible approach to inflation targeting, but is in part also due to the Bank having increased interest rates earlier in response to inflation risks. Although the MPC is removing accommodation gradually, monetary policy is not yet tight. Our real interest rate is not high when compared to other emerging markets such as Chile, India and Mexico. Household credit growth is weak but this is very much linked to still-high household debt as a percentage of disposable income. 3 Meanwhile, the credit extended to corporates has in fact accelerated since interest rates have risen, and averaged 13 per cent over the past year. 4 Such indications add to other evidence that interest rate hikes have not been the primary constraint to growth outcomes over the period. Unusually severe shocks – including the strikes in 2014, electricity shortages in 2015, and the drought in the past two years – have hit This is the change from June 2015 to July 2016. Household debt to disposable income measured 76,6 per cent in the first quarter of 2016. This is the average year-on-year growth from July 2015 to June 2016. BIS central bankers’ speeches the domestic economy. Our cyclical recovery has been hampered by disappointingly low global trade and world economic growth. More important, however, is the fact that domestic growth is also weak for structural reasons, as illustrated by the repeated downward revisions to our estimates of potential growth. This last problem requires structural reforms rather than a monetary policy response. Our most recent estimates show potential growth remaining under 2 per cent into 2018; this is well below the rate needed for meaningful per capita increases in income and faster job creation. Lately, there has been speculation about the end of the hiking cycle possibly having been reached. While the recent improvements to the inflation outlook are a positive development, the risks in the policy environment remain too numerous to be able to say definitively that the hiking cycle is over. We will continue to be guided by the evolving data and our collective understanding as the MPC of what any new data and information suggests for the inflation trajectory. Monetary policy and long-term growth This brings me to my second question, about the role of monetary policy in fostering longterm economic growth. It is now widely accepted that the appropriate role of monetary policy is in focusing on price stability in the medium to long run. It can also assist in smoothing short-term growth fluctuations provided that this does not compromise price stability. Monetary policy helps to provide a stable, growth-friendly environment but it is most effective if the broader environment is similarly geared towards encouraging investment and unlocking growth potential. In South Africa, we have made progress with alleviating infrastructure constraints over the past few years but now – as in the majority of emerging markets – we urgently require structural reforms. Without reforms, growth will not accelerate significantly – irrespective of the appropriateness of monetary policy settings. Structural reforms required refer to, for example, policies aimed at increasing competition in product and labour markets. Many South African sectors are highly concentrated and the barriers to entry for small or new firms are high in an environment dominated by a few longestablished firms. Small firms tend to be relatively more labour intensive than large firms, so if the barriers to entry were lowered and more small firms entered the sectors, employment would rise – and it would likely rise faster if this shift were accompanied by labour market reforms. Both these policies would not only improve the competitiveness of the economy but also make it more inclusive, providing opportunity for the unemployed, existing small firms and potential entrepreneurs, many of whom are currently locked out of the formal economy. The International Monetary Fund’s recent Article IV assessment of South Africa reiterates the need for these reforms, which have also been recommended by the World Bank and the OECD 5. Fortunately, South Africa has a long-term growth and job creation strategy encapsulated by the National Development Plan that includes many of these policies. And although structural reforms take time to implement, demonstrable progress with regard to implementation will likely increase business confidence from its current low level and thus also boost the economy in the short term. The South African Reserve Bank also has a growth-supportive role to play, which I would like to explain. We have two mandates, namely price stability (as our primary mandate) and financial stability. Financial stability, expressed in a more explicit manner, is a relatively new mandate, in line with international best practice following the global financial crisis. Organization for Economic Cooperation and Development. BIS central bankers’ speeches By various measures – including currency liquidity 6, stock market capitalisation 7, and localcurrency bond demand 8 – South Africa has exceptionally deep and sophisticated financial markets for a middle-income country. Indeed, the country is ranked 12th in the world in terms of financial market development, as measured by the World Economic Forum. 9 The finance sector has become an increasingly important contributor to growth, rising as a proportion of total real gross value added from 17 per cent in 2000 to 22 per cent in 2015. Stability in this sector is thus important to the South African economy as a whole – and also supports a more efficient transmission of monetary policy. Fortunately, South Africa has an established history of financial stability. In a recent comprehensive study of banking development, South Africa was identified as one of only four large countries that granted large amounts of domestic credit and had not experienced any banking sector crises since 1970. 10 This combination of financial stability and relatively adequate credit is rare, and the Bank has an important role in safeguarding it. Price and financial stability alone cannot create growth. Rather, they provide a platform enabling medium- and long-run growth. Financial stability means that institutions and markets are well regulated, which ensures adequate capitalisation and prevents excessive risk-taking. As a result, the economy has sufficient access to credit for investment and growth. Price stability means that investors are assured of a competitive and predictable inflation environment, leading to greater certainty over future business conditions and therefore lower long-term interest rates. In South Africa, we define price stability as meeting our continuous 3-6 per cent inflation target. The flexible inflation-targeting framework that we implement relies on anchored inflation expectations, especially among price and wage setters. This framework has led to an improvement in our inflation performance. From 1970 to 2000, inflation averaged 11,2 per cent. Since 2002 – the first year in which we committed to a target – inflation has averaged 5,9 per cent, despite two severe spikes in 2002 and 2008. That said, inflation targeting is still relatively young as a policy, and our inflation rate remains structurally high – higher, in fact, than in other emerging markets and in the countries of rival exporters. 11 It is thus especially important to ensure that expectations in South Africa are appropriately anchored. Inflation expectations have become much less volatile during the inflation-targeting period, indicating increased trust in the Bank’s commitment to the target. However, since 2008, when severe food and energy price increases hit South Africa, we have suffered exogenous price shocks that have repeatedly driven inflation outside the target range. Inflation expectations have shifted upwards as a result. From an average of 5 per cent from 2004 to 2007, inflation expectations 12 rose to average 6,1 per cent between 2011 and 2013. They have remained stable since then, but are unfortunately stable right at the top of the target The Bank for International Settlements conducts a triennial survey of global foreign exchange markets. It has found the rand to be the 18th most traded currency globally as of 2013. The Johannesburg Stock Exchange is the 19th largest stock exchange in the world by this measure. See https://www.jse.co.za/about/history-company-overview. For example, only 10 per cent of national government debt is foreign currency-denominated. This is South Africa’s most recent ranking on the Global Competitiveness Index (2015/16). Calomiris, C W and Haber, S H. 2014. Fragile by design. New Jersey: Princeton University Press. The comparison with other emerging markets relies on International Monetary Fund (IMF) World Economic Outlook (WEO) data for 2001-2015. The inflation rate for rival exporters was calculated using IMF WEO and United Nations Comtrade data, with a weighted inflation rate calculated for 2011-2015 using South Africa’s nine largest export categories (73 per cent of total) from 2012 to 2014. As measured (for two years ahead) by the Bureau for Economic Research. BIS central bankers’ speeches range. A situation where expectations are lower, and the target range is thus more resilient to shocks, provides more flexibility for accommodative monetary. Flexible inflation targeting allows us to look through once-off shocks to prices from exogenous sources, such as the petrol price increases that pushed inflation above 6 per cent in July and August 2013. However, this is possible only if second-round effects do not occur as a result of the shock. If they do occur, they can set off a chain of price increases in the economy with the possibility of persistently driving inflation higher. In such a context, the MPC would need to act. Much of the current hiking cycle has been about preventing secondround effects from manifesting, in turn preventing the need for steeper, more rapid interest rate increases later on. Second-round effects relate directly to central bank credibility. Simply put: if price makers in the economy trust the central bank to maintain medium-term inflation within the target range, then they expect exogenous shocks to be temporary and are less inclined to increase their prices in response. If, however, they do not trust the central bank’s intent or ability to contain inflation within the target range, then, rationally, they will react. The South African Reserve Bank has worked hard to build credibility with the public, especially with price and wage setters. Not long ago, central bankers had the reputation of being aloof and opaque; in fact, unpredictability seemed central to the design of monetary policy. We have shifted our framework, but also our public engagement, to be more transparent and accessible, not least to groups who do not always agree with our policy approach. In addition, our economic round tables include representatives from the public and private sectors as well as organised labour. We do national roadshows around our biannual policy publication, the Monetary Policy Review. We have press conferences after each MPC meeting and publish our growth and inflation forecasts, as well as key assumptions. And we publish all public engagements by policymakers, such as this speech, on our website. In our view, this kind of engagement is necessary to ensure that the public understands the goals and instruments of monetary policy. In general, though, we believe it is good public policy to encourage broad social participation in policy discourse. Everyone in our society should be committed to sustainable growth, lower unemployment, and a more inclusive, high-growth economy. A credible, well-communicated monetary policy is one of our most important contributions to those goals. Allow me to use this opportunity to clarify that our outreach programmes with stakeholders, particularly in the media, should not be misconstrued to represent formal briefings by the MPC. These engagement by the Governor, Deputy Governors and senior officials are aimed at deepening the understanding of the work of the SARB with stakeholders, explaining what the SARB does, what decisions it makes, and, where relevant, how such decisions were arrived at. In keeping with our commitment to transparency, any formal interaction or announcement by the MPC as a committee will be pre-announced. Conclusion The economic performance of South Africa has been weak recently. Monetary policy can mitigate cyclical downturns, provided that inflationary pressures are contained, but monetary policy is not effective in combating structural growth problems. Such problems can only be addressed by implementing structural reforms. The South African Reserve Bank remains focused on containing medium-term inflation. The best contribution that central banking can make to growth outcomes is to play a facilitative role aimed at implementing policies that provide a stable macroeconomic and financial markets environment. Thank you. BIS central bankers’ speeches
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A public lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Nelson Mandela Metropolitan University Business School, Port Elizabeth, 7 September 2016.
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Lesetja Kganyago: The influence of South Africa’s price-setting environment on monetary policy trajectory A public lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Nelson Mandela Metropolitan University Business School, Port Elizabeth, 7 September 2016. * * * Good afternoon, ladies and gentlemen, and thank you for the opportunity to share a few thoughts and ideas with you today. South Africa’s economy has been slowing since 2011 in an environment of sluggish global growth and falling commodity prices. In July, we expected the GDP 1 growth rate for 2016 to be about 0 per cent. With the relatively good second-quarter figures released on Tuesday, the Monetary Policy Committee (or MPC) of the South African Reserve Bank will be able to revise up its annual estimates at the September meeting, but the annual figure will remain low. At the same time, inflation has been elevated. Since 2011, it has averaged 5,5 per cent, and so far this year it has averaged 6,3 per cent, above the target range of 3–6 per cent. All other things equal, the MPC would like to respond to slow and below-trend growth with lower interest rates. But all other things have been far from equal. We have had to make decisions where we don’t like all the consequences because of the nature of the factors driving inflation out of the target range. I would like to discuss what those factors are and how we should think about them. The immediate inflation problem comes from rising food prices. Two other crucial factors are the exchange rate, which I will discuss in some detail, and rigidities in labour and product markets that prevent wages and prices from adjusting in line with economic conditions. A final issue is the way in which we have operationalised the 3–6 per cent target range over time. The main point I would like to make is that monetary policy decisions necessarily involve trade-offs, and the MPC has opted for trade-offs that serve our inflation-targeting mandate and the long-term interests of all South Africans. Had the starting point been different – had inflation been well within the target range – we could have made different choices. But policymakers have to work with the facts they have, not the facts they’d like to have. This is my second point. As a society, we must aspire to a set of better economic outcomes than we have now. South Africa is facing the unenviable and difficult-to-solve combination of little growth, high inflation, and growing unemployment. We have to do better. Thinking through the conditions we face and the alternatives to them helps us to envision a reform agenda. Food prices I’ll start with food prices, the factor over which we have the least amount of influence. As you know, South Africa has been suffering from a particularly severe drought. The result has been double-digit food price inflation in 2016. This is adding about 1,5 percentage points to inflation, which is enough to push headline inflation outside the 3–6 per cent target range. Most of the impact this year is coming from higher prices for bread and cereals as well as fruit and vegetables. A little later this year, we expect meat prices to rise more strongly and keep food inflation relatively high, even if the drought abates. The reason for this is that gross domestic product. BIS central bankers’ speeches farmers have responded to water shortages by selling animals for slaughter and are likely to withhold supply while they rebuild their stocks. Accordingly, we expect food prices to come down quite slowly, even if we do get enough rain this year. Higher food prices pose an interesting policy problem. They are a classic supply shock. More expensive food tends to put downward pressure on other prices because it reduces buying power and subdues demand. If this helps to check price increases, and if inflation expectations are already well anchored within the target range, then policymakers can be confident that any inflation increase will be temporary. Policy can mostly ignore these kinds of temporary shocks. But if those conditions are missing – if the initial shock generates increases in the prices of other products and factors – then a policy response may be required. To put it in another way, a pebble can start an avalanche. If you’ve already got all the other conditions for an avalanche, you need to worry about pebbles. The exchange rate The exchange rate of the rand is another important driver of, and risk to, the inflation outlook. It has been highly volatile in recent months, reflecting rapid changes in the world economy and in South Africa. As such, I would like to discuss it in some detail. The rand has been on a depreciating trend since early 2011. It reached the high point of R6,63 to the US 2 dollar in December 2010 and then commenced a long slide all the way to R16,87 to the dollar in mid-January of this year. In real effective terms, meaning the exchange rate adjusted for inflation differentials with trading partner countries, January’s exchange rate was just about as depreciated as it has ever been. Only the sudden rand crash of 2001 comes close. The rand’s steady depreciation has two underlying causes. The first factor is commodity prices. In 2011, our terms of trade reached an all-time high, meaning that the prices of our export goods had never before been as favourable relative to the prices of our imports. China’s economy was still growing at close to 10 per cent a year and its investment levels were at nearly 50 per cent of GDP, one of the highest levels ever recorded, which generated huge demand for commodities such as iron ore, copper, and coal. Five years later, that growth rate has come down to between 6 and 7 per cent. Investment has subsided. At the same time, many other commodity suppliers have entered the market, further suppressing prices. To take one especially clear example, iron ore has fallen from almost US$180 per tonne in mid-2011 to under US$50 in the first half of 2016. The second factor underlying rand depreciation is capital flows. In 2010 and 2011, the US Federal Reserve was implementing quantitative easing in response to weak growth and a slow recovery in labour markets. Meanwhile, emerging markets were enjoying a strong rebound from the global financial crisis. The result was investment in search of higher yields flowing out of advanced economies into emerging markets, including South Africa. Fast-forward a few years and the situation is rather different. US unemployment has fallen dramatically and is now close to its likely natural rate. The Federal Reserve has stopped quantitative easing and is trying to decide how much more to raise interest rates. Meanwhile, emerging markets have suffered a severe slowdown. Some of these countries have also become reliant on foreign savings to fulfil all their spending plans, meaning that they are running current-account deficits. Together, these forces have produced a reversal in capital flows and currency depreciation. United States. BIS central bankers’ speeches These two factors underpin the steady depreciation of the rand over the past half-decade. But to explain the shifts in recent months, we need to expand the story. The first important episode is the sudden and intense bout of rand depreciation around the end of 2015 and the start of 2016. Commodity prices and capital flows played their role: the prices of South Africa’s export commodities weakened during the second half of the year and the Federal Reserve raised its main policy rate in December 2015. Perceptions of South African risk were also important, with the rand depreciating abruptly on news that Finance Minister Nhlanhla Nene had been removed from his post. Bond prices and credit default swaps on South African government debt also spiked, signalling investor concern about the reliability of the South African government as a borrower. Research suggests that markets were pricing government bonds as if South Africa had already lost its investment grade credit rating. Conditions deteriorated further early in the New Year, when China’s economy experienced a period of stress. The Shanghai stock market index fell sharply and the renminbi was allowed to depreciate abruptly against the US dollar, triggering a bout of capital flight from China. In an atmosphere of market fear and risk aversion, the rand depreciated further, in line with many of its peer currencies. This sell-off in emerging market currencies went too far – an excellent example of the wellknown phenomenon of overshooting in exchange rate markets. As a result, emerging market currencies were primed for a rebound episode. World economic conditions began to move back in their favour in the second quarter of the year. China’s growth stabilised with help from stimulus policies, and commodity prices stopped falling and even registered gains. Meanwhile, risks emanating from the Brexit convinced the world’s largest central banks to either ease policy or delay further tightening. The net result was an appreciating trend in emerging market currencies. In line with the overshooting diagnosis, the countries which experienced the largest depreciations during the sell-off phase enjoyed the biggest rebounds. South Africa joined this rally: the rand strengthened through June and July, reaching a recent high of R13,23 in early August. The South African currency benefitted from commodity movements, including from a higher gold price following the Brexit. We also saw the effects of a renewed search for yield by investors looking for something better than negative interest rates on advanced economy government bonds. In addition, domestic factors were supportive of the rand. The major ratings agencies reaffirmed South Africa’s sovereign investment grade credit rating in June. The local elections in August demonstrated the vitality and competence of our democratic institutions. But the rand’s appreciation phase would be short-lived. By late August, the rand was up to R14,70 to the dollar. Credit default swaps and bond yields also rose again, responding to heightened perceptions of political risk. On this occasion, the global exogenous factors remained positive. The rand’s renewed weakness reflected local concerns yet again. How should monetary policy respond to a problem like currency depreciation? There is a short game and a long game – and I would like to explore both. South Africa has been playing the long game since 2000. It is about getting domestic wage and price setters to count the exchange rate less when forming their expectations of future inflation. If these economic actors watch the exchange rate, price accordingly, and thereby turn large parts of any depreciation into inflation, the overall economy and policymakers specifically are left with only bad outcomes. To minimise this effect – depreciation leading to inflation – we try to align expectations, and consequently pricing decisions by households and firms, to an inflation target that is expected to be reached over time. Economists tend to think that exchange rates go up and down and not in one direction; this has indeed been the case for the rand. But inflation weakens an economy’s response to depreciation and therefore also weakens the prospect of the currency strengthening in future. BIS central bankers’ speeches In the 1990s, the South African Reserve Bank tried to control inflation in part by managing the exchange rate. But this approach proved to be unusually difficult; it generated very large contingent fiscal liabilities as markets bet against our ability to defend the currency. 3 The history of emerging market central banking is littered with cases of countries which tried controlling their currencies and ended up depleting their foreign exchange reserves and hobbling their economies with disruptive exchange controls. These stories usually finish with the central banks bowing to inevitable depreciation. One solution to this dilemma is to get price and wage setters to use another anchor – to allow the exchange rate to depreciate in response to shocks without wages and prices taking off. This is a fundamental rationale for inflation targeting. In recent years, we have observed that the pass-through from depreciation to inflation seems to be lower than it used to be. Many of our fellow inflation-targeting central banks have reported the same observation. This suggests that we are reaping the rewards of playing the long game. Since 2011, the South African economy has absorbed a 50 per cent depreciation of the currency without a major acceleration in inflation, and core inflation 4 has not exceeded 6 per cent. Then there’s the short game. The South African Reserve Bank is often asked if we make monetary policy decisions based on the exchange rate. We certainly consider the impact of the exchange rate on the inflation forecast. However, given the well-established inflationtargeting regime and reduced pass-through, we do not need to react to depreciation too strongly. We can avoid unscheduled MPC meetings and instant rate hikes of hundreds of basis points. But this doesn’t mean that we can ignore depreciation entirely. Monetary policy requires some judgement as to whether currency weakness will cause inflation to accelerate to a persistently higher level that is inconsistent with the inflation target range. If we see this threat emerging, a monetary policy response is appropriate to reassure wage and price setters that longer-term inflation will remain on target. When the rand began appreciating in recent months, some observers started speculating about a possible end of the interest rate hiking cycle and the possibility of rate cuts. The MPC explained, as clearly as it could, that such speculation was premature. South Africa’s risk factors had not subsided. At the time, we believed that the rand’s appreciation would not last – as indeed it did not. Wage and price rigidity The South African Reserve Bank has been concerned for some time about inflation persistence because of the way in which wage and price determination works in South Africa. I spoke at some length about this issue at the Labour Law Conference in Johannesburg last month and would like to repeat a few key ideas here because of their central importance to our economic circumstances. The typical pattern is that wages and salaries, or overall remuneration, rises strongly, usually faster than prices and irrespective of where we are in the business cycle. In other words, remuneration costs rise when the economy is doing well and also when economic output is stagnant, which is where we are now. However, unlike food prices that can cause widespread inflation, rising remuneration doesn’t have to become an inflation problem. If workers and firms negotiate pay and in the end agree on lower profits with higher pay, that’s a distributional issue, not an inflationary one. In such a case, product prices don’t rise but the In 1998, the net open forward position was about US$25 billion. Core inflation is defined as headline inflation excluding energy and food prices. BIS central bankers’ speeches distribution of returns from the sale of the product does, with workers getting more and shareholders less. Similarly, if employees become more productive and get higher pay as a result, inflation should be stable. In such a case, the higher pay is matched by higher output. However, inflation pressures occur when remuneration goes up and firms just pass the higher costs on to consumers. With the relative lack of competition in our product markets, that’s typically what happens. The end result is a sustained rise in inflation, which in turn keeps nominal interest rates high and undermines competitiveness. As long as this remuneration-price dynamic persists, our ability to lower interest rates is constrained. To see if higher wages and salaries will become an inflation problem, the South African Reserve Bank pays close attention to unit labour costs (or ULCs), defined as average cost of labour per unit of output. Since 2010, ULC growth has ranged between around 6 and 8 per cent. 5 Given our weaker economic growth, however, these ULCs should have moderated, resulting in less persistent inflation. They, of course, did not – or at least not by as much as we would have liked to see. Moreover, with food prices rising and the currency depreciating, the risk of ULCs rising much more strongly has been fairly high. Higher food prices are likely to feed into ULCs with a lag, as employees over the next year demand pay increases to compensate for the above-target inflation we’re experiencing this year. History has shown us that these responses to rising food prices carry through into inflation and can push inflation outside the target range for extended periods of time. Monetary policy plays an important role in tackling this wage-price spiral. By defining and defending an inflation target range, the South African Reserve Bank can help wage and price setters to escape the spiral by giving them a focal point for their demands. But then it becomes very important for the inflation target range to hold. If wage and price setters start to believe that higher inflation is going to last, then they will adjust their demands upwards – and, in the end, they’ll be right. They will fulfil their own prophecy and create higher inflation, with the more marginal, less productive jobs destroyed in the process. Getting to the root of the remuneration and inflation problem requires more work – over and above what monetary policy can achieve. Our labour markets are quite segmented, each part operating differently from the others and each requiring different reforms to get a better mix of job creation and less inflation. The highly skilled market reflects skills shortages, with employer competition fairly intense and unemployment low. This, in turn, generates strong salary increases, unhealthily feeding inequality and inflation. More jobs need to be created in this market, not just to reduce inequality and moderate inflation, but also to create more jobs for less-skilled workers. What this segment of the labour market needs, in the longer run, is more and better education to open the highly skilled job market to more South Africans and better match what students study with the skills required by the private sector. Temporary skilled immigrants would further ease salaries in this segment of the market and encourage economic growth directly by growing our domestic knowledge base. The possibility of pro-growth, pro-equality reform in this area should make it a policy priority. South Africa’s other two labour markets don’t absorb nearly enough people, which leaves many South Africans unemployed or out of the labour force entirely. As the National Development Plan recognises, this problem has a lot to do with spatial legacies and access to job networks. Reducing the costs of transport and the costs of accessing job opportunities Between 2010 and 2015, annual unit labour cost (ULC) growth has been as follows: 8,3 per cent, 6,6 per cent, 6,5 per cent, 7,3 per cent, 6,2 per cent and 6,6 per cent. ULC growth is forecast to accelerate to almost 8 per cent in 2016. BIS central bankers’ speeches should lower both the supply cost of labour and, indirectly, the cost of creating jobs. Both would help to moderate wage inflation. Institutions also play a key role in our inflation process. An important argument in academic literature, specifically by Lars Calmfors and John Driffill, connects unemployment to the kinds of collective bargaining rules used in a country. 6 The basic idea is that a country can achieve better employment outcomes when costs take into account firm-level productivity or are guided at a very high, macroeconomic level. This is because company- or plant-specific unions have a special interest in the health of the firm that employs their members and will not want agreements that make the firm unsustainable. By contrast, very large unions have the power to shape macroeconomic outcomes. They will therefore avoid making deals which will push up inflation, drive up interest rates, reduce investment and growth, and ultimately destroy jobs. The worst outcome is to be in the middle, between the two options. Yet our current arrangements lie precisely there, with industry or sectoral bargaining, implying that the actors (meaning unions and business associations) are big enough to inflict costs on the economy but not big enough to experience those costs themselves. Newer and smaller firms tend to have productivity levels that cannot be easily accommodated in such sectoral agreements, resulting in less job creation than we would like to have. 7 This cost in jobs has been estimated at somewhere between 8 and 13 per cent of total employment, in large part because sectoral agreements hurt small, labour-intensive firms. 8 South Africa has surprisingly few of these firms, relative to its peers. This helps to explain our unusually high levels of unemployment. The implementation of the 3–6 per cent inflation target range The last factor influencing our current position of being outside the inflation target range that I would like to discuss today is how we’ve gone about implementing the 3–6 per cent target range. The original plan for the inflation target range, drafted in 1999, was to start with 3–6 per cent and then to narrow the range to 3–5 per cent. 9 From there we would have had a pretty obvious midpoint, 4 per cent, on which to anchor inflation expectations. 10 Unfortunately, the planned switch to the 3–5 per cent inflation target range was put off when the rand depreciated in 2001 and never reinstated. South Africa was left with a wide target range. In hindsight, this might have been useful. After all, it is not possible or even always desirable to steer inflation at one exact speed all the time. For instance, the standard practice with a temporary shock – such as a collapse in oil prices – is to look through the initial change in inflation and only respond if the effect is expected to be permanent. A wide target range means that these inevitable fluctuations can usually be contained within the range: See Lars Calmfors and John Driffill, ‘Bargaining structure, corporatism, and macroeconomic performance’, Economic Policy, No. 88, 1988. Bargaining council agreements typically disallow exemptions for ‘economic reasons’. These presumably include low productivity and unaffordability. See Jeremy R. Magruder, ‘High unemployment yet few small firms: the role of centralised bargaining in South Africa’, American Economic Journal: Applied Economics, Volume 4, No. 3, July 2012. The 2001 Medium Term Budget Policy Statement revised the inflation target range to 3–5 per cent for 2004 and 2005. In 2002, however, with inflation close to 10 per cent, the Finance Minister postponed the target range revision indefinitely. See Trevor Manuel, Address to the National Assembly on the introduction of the 2002 Medium Term Budget Policy Statement and the 2002/03 Adjustments Appropriation Bill, 29 October 2002 (http://www.treasury.gov.za/documents/mtbps/2002/speech.pdf). As an aside, we see that India has chosen 4 per cent as the midpoint for its recently adopted inflation target range.The new target is 4 per cent plus or minus 2 per cent. BIS central bankers’ speeches inflation might move to the top or the bottom of the range but it will rarely breach the target range entirely. Yet this isn’t the way in which the policy committee has targeted inflation. Rather, we have kept monetary policy relatively loose over long periods of time, hoping for a bit more growth. We have tended to cut rates whenever inflation looked like falling below the midpoint of the target range. We have hit the lower half of the target range only for brief periods of time. Looking back, headline inflation has averaged 6,2 per cent over the entire inflation-targeting period (since 2000). Furthermore, in the event of shocks, we have repeatedly breached the upper end of the target range, with inflation at over 6 per cent for about a third of the time in the last five years. The perception of wage and price setters is that we have primed ourselves to miss the inflation target by aiming close to the top of the range, regardless of our position in the business cycle. Trade-offs: final thoughts By now, it should be clear why we’ve had high and rising inflation despite weakening GDP growth. We’ve experienced a drought that has led to sharply higher food prices. The exchange rate has been depreciating for several years and is now very weak. Some of this depreciation was appropriate and necessary, given falling commodity prices and some measure of policy tightening in the US. But the scale of depreciation we have experienced speaks to domestic challenges as much as to international ones. Our wage and salary arrangements, along with rigid product markets, generate persistent inflation pressure, sometimes accelerating inflation but always preventing it from falling substantially. Finally, by allowing inflation to settle at the top of the inflation target range, target misses have been more common whenever any of the underlying drivers of inflation exceeded their expected trajectory. Imagine the counterfactuals. If wage and salary demands responded to economic conditions, they would have moderated as the economy weakened, weakening inflationary pressure. Exchange rate depreciation would have been less extreme without the domestic risk factors. With inflation expectations anchored at the midpoint of the target range, we would have had an easier time tolerating temporarily high inflation from food prices – and we would have had a clearer trigger for a monetary policy response. Indeed, inflation would probably have remained within the target range because the starting point would have been lower. In such circumstances, it might even have been possible to cut interest rates – the kind of response seen in commodity exporters such as Australia and Canada. But we didn’t have these advantages. The best response in our specific circumstances wasn’t to cut rates. At a minimum, we needed to defend the upper end of the target range, ensuring that inflation expectations did not stray from the target entirely. The policy response helped to prevent investors from demanding higher interest rates to compensate for inflation risk, limiting the rise in longer-term borrowing costs. In our second-best world, a gradual and cautious rise in rates was an appropriate means of countering rising inflation expectations. I would encourage you to be satisfied with this conclusion, but not happy. Happiness will only be appropriate after we have addressed the other problems, including the rigidities in our labour and product markets as well as the domestic risk factors that are exacerbating the rand weakness. Monetary policy can offset some of the worst consequences of these problems, but it cannot, single-handedly, get us out of this troubling mix of little growth, high inflation, and growing unemployment. 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 Institute of International Finance, Africa Financial Summit, Johannesburg, 30 September 2016.
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An update on ‘Africa rising’ Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Institute of International Finance Africa Financial Summit Johannesburg 30 September 2016 1. Introduction Good morning, ladies and gentlemen It is a pleasure for me to address you today, some five years since the inaugural Africa Financial Summit that was held in Cape Town in 2012. At that time, George Abed1 noted the great progress that African countries had realised in stabilising their economies – a particularly remarkable achievement during a period of unprecedented global financial turbulence. However, he also cautioned that the prospects for continued growth in sub-Saharan Africa (SSA) were contingent on greater economic diversification and on reducing dependence on commodity exports – an issue to which I will return later in my address. I see from the programme that yesterday you have covered much ground regarding the economic and financial issues currently facing Africa. There is no doubt that the economic environment has changed drastically since 2012. Indeed, the challenges are presently somewhat greater and more complex. Today, I will touch on this changing economic landscape, focusing on digital finance and financial inclusion as George Abed is the former Senior Counsellor and Director for Africa and the Middle East at the Institute of International Finance. Page 1 of 11 well as the financial regulatory environment. Each one of these is important in the African growth context. 2. A pause in the ‘Africa rising’ narrative? Beset by war, corruption, bad governance as well as poor macroeconomic policies, Africa was labelled ‘the hopeless continent’ in 2000. Some 10 years later, this narrative changed to a more inspiring one, of ‘Africa rising’, facilitated by the commodities boom, growing manufacturing and services sectors, a rapidly growing middle class, improved health prospects for many Africans, and a new-found passion for technology. With a stable economic outlook, foreign investment also increased. This was all the result of most African economies putting in place good governance frameworks as well as sound macroeconomic and market-orientated policies which spurred growth, trade, and investment. The Global Financial Crisis, which caused turmoil in both advanced and emerging economies, did not affect SSA quite as severely. In part, limited financial integration with international capital markets and an inward focus of African banks had shielded the region. So instead, SSA flourished, ranking second behind emerging and developing Asia in terms of growth. Easy monetary policy in the advanced economies, the search for yield as well as excess liquidity in global financial markets benefitted Africa, and ‘frontier markets’ became the new buzzword and investment destinations of choice. However, there has been a notable economic turnaround since 2014, coinciding with the period when crude oil prices and commodity prices lost significant ground. Furthermore, as soon as it became clear that the Federal Reserve would begin to normalise monetary policy, international investors and creditors started to withdraw capital. African countries heavily reliant on commodity revenues were negatively affected, their position exacerbated by a failure to build fiscal buffers during the good times, combined with a significant pickup in foreign currency-denominated sovereign bond issuance by African countries during the boom years. Consequently, the overall Page 2 of 11 fiscal balance for SSA moved from an average surplus of 1,7 per cent of GDP2 in 2004-08 to a deficit of 4,9 per cent in 2016. Government debt accelerated markedly over this period, for example from 28 per cent of GDP to around 70 per cent in Angola and from 30 to 50 per cent of GDP in South Africa. Foreign exchange reserves have been run down in some countries and inflows of foreign direct investment declined in the region as a whole. In addition, SSA’s current account deficit increased from an average of 2,1 per cent of GDP in 2004-08 to 5,9 per cent in 2015; it is expected to widen further, to levels above 6 per cent, this year. The most pronounced shifts could be observed in the oil-exporting countries where the average balance moved from a surplus of 13,1 per cent of GDP to a deficit of 3,9 per cent over the same period.3 Thus, 2014 marked the end of the ‘Goldilocks years’ for Africa. SSA growth dropped from 6,8 per cent in 2004-08 to 3,4 per cent in 2015, and, according to the International Monetary Fund (IMF), it is set to decelerate further this year, to around 1,6 per cent – the weakest growth rate since the early 1990s, undershooting global growth for the first time since 2000. Also according to the IMF, per capita income in SSA is anticipated to fall this year for the first time since 1994. Much of the more recent slowdown in SSA can be attributed to developments in the two largest economies, Nigeria and South Africa, which account for more than half of SSA growth. To put this into context: the IMF projects that Nigeria, which had been growing by 10 per cent in the 2000s, will contract by 1,8 per cent this year while South Africa will barely grow at 0,1 per cent in 2016. I should, however, mention that the most recent forecast of the South African Reserve Bank (SARB) has lifted the projection for economic growth in the country to 0,4 per cent in 2016. McKinsey highlights that, for the African continent, economic deterioration emanates from two distinct groups: the North African countries affected by the Arab Spring, and the oil exporters (which include Nigeria) affected by the sharp decline in oil prices. Together, these two groups account for nearly three-fifths of Africa’s combined GDP. gross domestic product Various issues of the sub-Saharan Africa Regional Economic Outlook of the International Monetary Fund Page 3 of 11 The real annual GDP of the Arab Spring countries declined by 4,8 per cent in 201015, and that of the oil exporters by 3,3 per cent.4 Many parts of SSA have witnessed a turnaround, but this is not true of the entire region. We need to recognise the increasingly important role that East Africa is playing in driving growth, as it benefits from cheap oil, slowing inflation, lower interest rates, and an improved regulatory regime with increased investment in key sectors such as transport and telecommunications. Nonetheless, some believe that the ‘Africa rising’ story was directly related to elevated commodity prices underpinned by China’s success and its many years of double-digit growth rates. It is postulated in some quarters that the rebalancing of China’s economy away from investment to focus more on domestic consumption would give rise to a slowing in the Chinese economy, spilling over to commodity prices and negatively affecting commodity-producing countries in Africa. But this is only part of the story; the global economic recovery has not been particularly robust and the slowdown is also not unique to SSA. Emerging markets in general have slowed, with a few key economies having entered recession. It is imperative to ensure that the deceleration in Africa’s growth trajectory is indeed temporary. For this reason, countries on the continent must ensure that there is strict fiscal discipline, that market-friendly policies are implemented (such as flexible exchange rates), and that the strides made in strengthening institutions are maintained and further entrenched. To reiterate what George Abed said in 2012: revenue bases must be broadened, and Africa needs to continue improving the basics, including infrastructure development. On this note, it was heartening to note German Chancellor Angela Merkel’s remarks a few weeks ago, made on the sidelines of the G-205 Summit in China, that, during Germany’s presidency of the G-20 in 2017, there will be a focus on Africa, Lions on the move II: realizing the potential of Africa’s economies, McKinsey & Company, September 2016. Group of Twenty (Finance Ministers and Central Bank Governors) Page 4 of 11 particularly pertaining to investment in infrastructure and direct investment in the continent. It has been said many times before: it would be difficult to ignore the potential that this continent has to offer in terms of its fast-growing young population which is more educated and wealthier than ever. According to the United Nations (UN), Africa’s population is expected to rise from the current 1,2 billion people to 2,5 billion in 2050. Granted, such population growth can be to the detriment of the continent if there are no new jobs, but a recent report by McKinsey shows that job creation is outpacing labour force growth at 3,8 per cent a year versus 2,8 per cent.6 Africa is also the world’s fastest-urbanising region; its household consumption is expected to grow at 3,8 per cent a year between now and 2025 to reach US$2,1 trillion that year. Africa could double its manufacturing output from the current US$500 billion to almost US$1 trillion in 2025, largely based on African companies meeting domestic demand. We should also remember that Africa’s natural resources remain in abundance and that the continent is more peaceful and democratic than it was a decade ago. Indeed, in terms of projected growth rates for 2016, of the 10 fastestgrowing economies in the world, 3 are from Africa.7 The World Bank ease of doing business report further shows that, despite the economic turnaround, 5 of the 10 fastest reformers are African.8 In addition, regional integration remains a priority for Africa over the long term. In this respect, Agenda 2063 sets out the vision for this path, recognising that with deeper regional integration come larger markets, greater industrialization and productivity, as well as greater talent mobility. Investment in infrastructure means less congestion along regional corridors and the facilitation of trade by cutting barriers such as time and costs. The African Regional Integration Index9 was launched earlier this year for the purpose of measuring and providing an assessment of developments across the continent to identify gaps in terms of integration. The average Regional Economic Lions on the move II: realizing the potential of Africa’s economies, McKinsey & Company, September 2016. These are Ivory Coast (8,5 per cent), Tanzania (6,9 per cent), and Senegal (6,6 per cent). ‘Business in Africa, making Africa work’, The Economist, 16 April 2016 Africa Regional Integration Index Report 2016 by the United Nations Economic Commission for Africa, African Union and African Development Bank. Page 5 of 11 Community (REC) scores are around 0,47 on a scale of 0 (low) to 1 (high). Overall, the index shows that integration in the region could significantly progress, with the East African Community the top performer (0,54) followed closely by SADC10 (0,531). It is interesting to note that the highest scores are on trade integration while the lowest scores are on financial and macroeconomic integration. The African Central Bank (ACB)11, one of the three financial institutions of the African Union, is due to be set up by 2028, after the achievement of certain milestones, including the establishment of an African Common Market as well as an Economic and Monetary Union that would include Continental Fiscal and Banking Unions. All these milestones (including the establishment of the ACB) are envisaged to be achieved between 2029 and 2034. Given the tight timelines, it is doubtful whether the establishment of the ACB is still within schedule. It may therefore be useful to pause at this juncture and take stock in order to assess where the continent finds itself in its economic and financial integration journey in relation to set goals. The focus should first be on pursuing integration within regions before accelerating integration across the continent. 3. Digital finance and financial inclusion Globalisation and the information technology (IT) revolution provide unprecedented opportunities for countries and regions to make significant advances in reducing poverty and improving incomes, which in turn could underpin the desired economic and social transformations. As the G20 High Level Principles for Digital Financial Inclusion pointed out, one can no longer talk about growth without reference to the Fourth Industrial Revolution and digital finance – a powerful and effective tool of expanding access beyond financial services to other sectors, holding enormous opportunities for the expansion of basic services and enhancing financial inclusion. Southern African Development Community The African Central Bank (ACB) was agreed upon in the 1991 Abuja Treaty. Once fully implemented via Pan-African Parliament legislation, the ACB will be the sole issuer of the African Single Currency, it will become the banker of the African Government, it will become the banker to Africa's private and public banking institutions, it will regulate and supervise the African banking industry, and it will set the official interest and exchange rates – all in conjunction with the African Government’s administration. Page 6 of 11 These are powerful engines for job creation in developing countries – and they have an increasingly important role to play in promoting the development of small businesses. Indeed, this was a key topic at the most recent World Economic Forum on Africa, held in Kigali during May 2016. The World Bank highlighted digital finance as an area which can contribute to achieving the goal of universal access to financial services by 2020. The G-20 also recognised the potential role that digital finance can play and released the G-20 high-level principles for digital financial inclusion during its Hangzhou Leaders’ Summit in September 2016. Countries were encouraged to consider these principles as a basis for the development of country action plans to leverage the huge potential offered by digital technologies. The promotion of digital financial services would contribute towards the growth of inclusive economies. At this stage, allow me to hone in on financial inclusion as it relates to the sphere of digital finance. As has recently been reported by the G-20 through the work done by the Global Partnership for Financial Inclusion, 2 billion adults globally – the majority of whom are women – do not have access to formal financial services and are thus excluded from opportunities to improve their lives. In SSA, the percentage of the population with an account at a financial institution is just above 30 per cent, compared with almost 50 per cent in emerging Asia and almost 70 per cent in East Asia. Only about 23 per cent of small and medium enterprises in Africa have access to formal financing.12 The SADC Financial Inclusion Strategy Workshop Report13, developed by the FinMark Trust and presented to stakeholders in February 2016, notes that financial inclusion in the SADC region is relatively low and varies widely across countries. A number of supply barriers have been identified, which include a lack of incentives and appropriate delivery channels that constrain financial institutions in providing and extending financial products and services to unserved and underserved segments of the population. On the demand side, barriers include administrative, systemic as well as attitudinal challenges, many of which are more pronounced among certain groups, such as the youth and women. These barriers World Bank (http://datatopics.worldbank.org/financialinclusion/region/sub-saharan-africa) FinMark Trust (http://www.finmark.org.za/wp-content/uploads/2016/03/Rep_SADC-FinancialInclusion-Strategy-Workshop_Feb2016.pdf) Page 7 of 11 undermine or downright prohibit the ability to access and use financial products and services. Thus, much remains to be done in furthering financial inclusion, as the financial markets in many African countries continue to lack depth and therefore offer limited financing opportunities to small- and medium-sized enterprises, and to the population at large. It is widely acknowledged that there are limited financial avenues for basic services such as savings and making payments. For example, by paying wages and transfers digitally, instead of in cash, governments and the private sector can play a pivotal role in increasing financial inclusion. While there is wide recognition on the continent of the growing importance of mobile money accounts and digital technology in the financial sector, this potential needs to be leveraged much more. However, we also need to keep in mind that there is a key trade-off between inclusion and maintaining the integrity of the financial system; a balanced regulatory and supervisory approach is therefore required in considering the Fourth Industrial Revolution.14 The breakthrough innovation brought on by crypto-currencies and block chain technology, amongst others, will continue to bring about significant and wide-ranging changes to society and the broader economy, and is very likely to have a positive spillover effect on the financial services sector and markets in the African continent. Many financial institutions have already experienced cyber attacks, including banks, insurers, and even central banks. Central banks have to be vigilant in assessing potential systemic risks and enhancing the financial system’s resilience to cyberthreats. Reported attacks, such as those on the Society for Worldwide Interbank Financial Telecommunication (SWIFT)15, the financial messaging network that underpins most international money transfers, have the potential to paralyse global trade and finance. It is no surprise that cybersecurity has in the recent past moved swiftly up the list of priority issues in a number of countries as regulatory authorities Wolrd Bank Global Findex Database 2014, Measuring Financial Inclusion around the World. There have been three successful attacks on banks using the SWIFT money transfer network. The latest of these affected an Ecuadorian bank on 12-22 January 2015. During this period, at least 12 fraudulent transfer requests instructed Wells Fargo to send US$12 million belonging to Ecuador’s Banco del Austro to accounts in Dubai, Hong Kong, and the United States. Wells Fargo complied with these requests. Page 8 of 11 seek to address cybersecurity threats and enhance cyber-resilience. It is therefore very important to strengthen international cooperation and peer exchange of information in this area. In this regard, the SARB hosted its first cybersecurity conference last month, with the theme of ‘Collaboration for building cyber-resilience’. 4. The rise in African cross-border banks and financial regulatory impacts on Africa As I come to the end of my remarks, I would like to briefly touch on the rapid growth in recent years of African cross-border banks, or pan-African banks (PABs) – a further testimony to the ‘Africa rising’ theme. PABs are improving competition, especially in host countries with small markets, driving innovation and bringing new opportunities for diversification for the home countries. But with rapid growth come a number of responsibilities, such as maintaining financial stability and ensuring adequate cooperation and resolution strategies among home and host financial supervisors16. The rising trend of crossborder banking in Africa is an opportunity to further strengthen regional financial integration. In this regard, the work of the Association of African Central Banks under the auspices of the Community of African Banking Supervisors (CABS) is an important initiative to consider the potential macro financial spillovers across countries. Implementing regulatory coordination measures on financial integration and access will have substantial benefits in promoting growth on the continent. The global regulatory reforms agreed to in the aftermath of the Global Financial Crisis have been vast, complex, and ground-breaking in many aspects, requiring effective coordination among many stakeholders. Many of the ‘fault lines’ that had contributed to the Crisis have been addressed, but the full, consistent, and timely implementation – ensuring a level playing field and addressing the major unintended consequences of the reforms – remains an ongoing challenge. The report on Pan-African Banks-Opportunities and Challenges for Cross-Border Oversight, IMF, January 12, 2015. Page 9 of 11 One of these unintended consequences is related to the effects arising from the global reforms addressing the problem of ‘too big to fail’ (TBTF). South Africa directly experienced such changes in business models recently when Barclays announced its intention to reduce its 62 per cent share in Barclays Africa Group Limited (BAGL), a material subsidiary publically listed in South Africa which includes Absa, one of the largest South African banks. Barclays’ intention to reduce its controlling stake in BAGL was mainly informed by global regulatory pressures to meet additional GSIB17 requirements. The objective of addressing the problem of TBTF was thus achieved, but in so doing other adverse and unintended effects were introduced. Significant strategic changes by G-SIBs, as well as the fact that these changes are at times made in reaction to regulatory changes rather than necessarily on business considerations, can lead to increased market uncertainty and short-term volatility. A fallout from the international reforms has been the effect of the decline in correspondent banking relationships (CBRs) on the operations of banks on the African continent. Some G-SIBs have either restricted or exited CBRs in more than 10 African markets. A recent report of the Working Group on Correspondent Banking of the Committee on Payment and Market Infrastructures 18 acknowledges that the issues surrounding the withdrawal from CBRs are very complex and that costs related to anti-money laundering and combating the financing of terrorism (AML/CFT) compliance are only one of the elements that have to be considered in order to understand recent trends. The report states that it is difficult to disentangle the effects of de-risking from other causes, including declining economic activity, external shocks, and the consolidation of the banking system. In Africa, the most pronounced declines in CBRs occurred in Northern Africa and partly in Southern Africa; other regions experienced substantial increases. Markets in all jurisdictions must have access to a well-functioning global financial system in order to develop and prosper, but de-risking can create financial exclusion and has the potential to drive certain payment flows underground, which can set the global systemically important bank Correspondent banking, Committee on Payment and Market Infrastructures, Bank for International Settlements, July 2016. Page 10 of 11 goal of creating an open and global integrated financial system at risk. In this regard, the efforts of the Financial Stability Board and its outreach programme through the six Regional Consultative Groups (RCGs)19 to better understand and address the reasons behind the decline in CBRs, as well as the global trend of de-globalising and de-risking, are to be welcomed. The RCG for SSA, which will be held in Cape Town on 25-26 October, will focus on CBRs and the effects of the reforms. 5. Conclusion In conclusion: while the growth paths in Africa may have diverged, the potential that this continent has is tremendous and outpaces that of any other region in the world. But this potential needs to be harnessed. Integration needs to be deepened, infrastructure improved, and productivity lifted. The long-term fundamentals remain strong, and while regional integration may not be proceeding at the speed hoped for, this is not necessarily a bad thing, but rather an opportunity to take stock, readjust plans where necessary and implement them with renewed vigour. In this regard, the Fourth Industrial Revolution promises significant benefits, if harnessed correctly. While some have suggested that the ‘Africa rising’ narrative may have been exaggerated and are starting to question it, to me it looks more like a pause, and we should not allow the current headwinds to detract from the vast potential and opportunities that the African continent continues to offer. Thank you. The Financial Stability Board (FSB) has six Regional Consultative Groups (RCGs), established under the FSB Charter to bring together the financial authorities from the FSB member (24) and nonmember (41) countries to exchange views on the vulnerabilities affecting financial systems and initiatives to promote financial stability. The FSB RCG for sub-Saharan Africa is co-chaired by Governor Emefiele of the Central Bank of Nigeria and Governor Kganyago of the South African Reserve Bank. Page 11 of 11
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Annual Convention of the South African Chamber of Commerce and Industry (SACCI), Johannesburg, 20 October 2016.
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Address by Lesetja Kganyago Governor of the South African Reserve Bank at the Annual Convention of the South African Chamber of Commerce and Industry (SACCI) Emperors Palace, Johannesburg 20 October 2016 Distinguished guests, ladies and gentlemen. Thank you for the opportunity to address the annual convention of SACCI. The theme of institutions and competitiveness is particularly apt in today’s economic and political environment. Strong and sound institutions are essential for the smooth functioning of society, as they prescribe the behaviour of individuals, and set out the “rules of the game”. Well-functioning institutions are what investors look for when making long-term decisions to invest in a country. Institutions and the institutional framework are generated over time through interactions in society in general, and are dynamic and endogenous. In other words, they change over time and can be expected to both affect, and be affected by, the current political and economic dispensation. Furthermore, institutional arrangements in society are often selfperpetuating with strong institutions creating incentives for further institutional improvements and vice versa. But their dynamic nature means that we cannot be complacent, and we have to resist attempts to undermine strong institutions. Often people think of competitiveness in terms of the exchange rate. However, this is only one limited aspect of competitiveness. While relative prices matter, it is the institutions that underpin the economy that count. The exchange rate, to a certain extent, simply reflects the strength or weakness of institutions, or changes or threats to their integrity. In the recent Global Competitiveness Report, the areas in which South Africa fared well are those that are underpinned by strong institutions and governance such as the strength of auditing standards, the protection of minority shareholder interests, the efficacy of corporate boards and the efficiency of the legal framework and judicial independence. The soundness of banks is also highly ranked. South Africa was one of the relatively few countries whose banking system emerged largely unscathed from the global financial crisis. In my address today I will reflect on the place of the Reserve Bank within the current institutional framework, the relationship between the exchange rate, competitiveness and institutional strength, and make a few comments on the financial stability mandate. The Bank’s role in South Africa’s institutional landscape The Bank has a long and proud history of supporting South Africa’s institutional strength. In fact, in June the Bank celebrated its 95th anniversary. The role of the Reserve Bank and its independence is clearly enshrined in the Constitution. The South African Reserve Bank, in pursuit of its primary objective, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.” But this notion of the Reserve Bank as an independent institution is often misunderstood. Independence does not mean that we sit in our glass and granite tower and make decisions independently of the needs of the economy or of the overall goals of government policy. In this respect, it is useful to distinguish between goal independence and operational independence with respect to monetary policy. Goal independence refers to the setting of the objectives of monetary policy, while operational independence relates to the implementation of the mandate that is given to the central bank. Globally it is generally, although not exclusively, the case that monetary policy objectives are set by elected representatives of the country. That is how it should be. But these policy objectives can only be set within the constraints of what monetary policy can achieve, and not what some people would like it to achieve. Monetary policy independence usually relates to operational independence, and has its roots in the need to prevent monetary policy being used for political expedience. In particular, to avoid the so-called “political interest rate cycle” phenomenon where rates are lowered in advance of elections and then raised again thereafter. This dichotomy is in fact consistent with the Constitution of South Africa, where it is stated that the primary objective of the Bank is to “protect the value of the currency in the interest of balanced and sustainable economic growth. The Constitution therefore does not give the Bank goal independence, but our operational independence is explicit. The inflation targeting framework, which is a good example of an evolving institutional structure, aligns well with this aspect of the Constitution. The goal of monetary policy, the inflation target, is set by government. The current target is for us to be within a range of 3-6 per cent. But within that context, the Bank has full operational independence to implement appropriate policies to achieve that goal. We are given the responsibility for protecting the value of the currency, but we are also accountable for this responsibility. Government cannot dictate interest rate policy to the Bank, and the requirement to consult regularly with the Minister of Finance does not undermine our independence, but is a mechanism to ensure effective macroeconomic coordination and information sharing. To us, protecting the value of the currency means maintaining the purchasing power of the rand in South Africa by containing inflation. By adjusting monetary policy or through its communications, the MPC aims to influence both demand conditions in the economy, as well as the inflation expectations of businesses and consumers. The commitment to an inflation target acts as a signal to these stakeholders that broad-based price or unit labour cost increases above the target will influence the monetary policy stance. Through this process the SARB is working to build the credibility of the inflation target to the extent that, during inflation spikes, labour unions and businesses do not meaningfully raise their expectations for future inflation. Achieving this goal ensures that the country avoids an inflation spiral wherein wage demands and price increases persistently ratchet up in response to current inflation outcomes. Embedding the inflation target within the minds of the general public, through various communication strategies and initiatives, is a task which the Bank has been working at for the past sixteen years. The inflation targeting framework is a good example of an institutional structure which reduces uncertainty for businesses and households. This increased certainty, in turn, facilitates long term investment and economic growth and this is the main contribution that the Bank can make to balance and sustainable growth. At the same time, maintaining price stability helps to protect the poor in particular, who are most vulnerable to the ravages of inflation. It also helps to prevent the erosion of our international competitiveness, a point to which I will return later. In recent years, the Bank has been confronted with a challenging economic environment in which GDP growth has been slowing, with a deteriorating inflation outlook. In order to avoid a persistent breach of the inflation target, the MPC began a gradual interest rate hiking cycle in January 2014. Since then the repo rate has been increased by 200 basis points. Part of the challenge has been that inflation has been driven primarily by supply-side factors, particularly the exchange rate and food prices. Our approach has been to try and look through these shocks and focus on second round effects. Given the persistence of inflation expectations at the upper end of the target range, and wage settlement rates in excess of inflation, it has been difficult to avoid a tightening cycle. More recently there has been some improvement to the inflation outlook. The Bank’s latest inflation forecast is for an average of 6,4 per cent in 2016, 5,8 per cent in 2017 and 5,5 per cent in 2018. The moderating inflation trajectory reflects recent policy tightening by the Bank, an expected deceleration in food price growth and an improvement in the exchange rate outlook relative to previous forecasts. The MPC is of the view that should the forecasts materialise, the hiking cycle may be nearing its end. However, this does not mean the interest rate reductions are imminent, as we would like to see inflation more firmly within the target range on a sustainable basis over the forecast horizon. We are also clear that the bar for any future rate cuts has been set very high. Although our mandate is inflation, it does not mean that we ignore growth considerations. The Constitution states that what we do should be in the interest of balanced and sustainable growth in the Republic. We have to be clear, however, about what monetary policy can achieve in this respect. Our view is that long-term trend growth or potential output is determined by real factors in the economy. These include infrastructure, education, labour and product market efficiency, productivity growth, and institutional strength, to name a few. Monetary policy can only impact on cyclical variations of growth around the growth trend. Monetary policy cannot be an engine for sustained growth. This requires structural reform, in order to arrest the declining trend of potential output that we have observed over the past few years. However, implementing structural reform is difficult and it requires strong institutions and political management. Some of it requires changes in processes that are expenditure neutral, for example product market reforms, and changing competition laws or labour laws, while others could require huge investment layouts, as in the case of infrastructure. These are political decisions, which are often difficult, and inevitably involve entrenched interests. It is often difficult to get societal buy-in or to change expenditure priorities when the country’s requirements are diverse and the means limited. In South Africa, we do have a structural reform framework in the form of the National Development Plan, which has been adopted by all parties. It is not the plan that is lacking, rather its implementation. It is far easier to look for a quick fix such as monetary policy. This is not a peculiar South African phenomenon, however. Monetary policies, in conjunction with fiscal policies, were instrumental in avoiding worse outcomes to the global financial crisis. But monetary policy is not the appropriate policy to raise potential output. Yet, in the absence of meaningful structural reforms, the focus globally remains on monetary policy to provide the solution. This creates a challenge for central banks. As Mohamed El-Erian has noted in his recent book, central banks are now seen as the “only game in town” due to slow progress in the implementation of structural reforms. This inability to do so creates unreasonable expectations for monetary policy to achieve objectives that it is not competent to deliver. Ultimately it could lead to an undermining of central bank credibility and institutional strength, even in those areas where it is best suited to operate. The exchange rate and competitiveness As I mentioned earlier, when people think about global competitiveness, the exchange rate immediately comes to mind. Central Banks talk about the exchange rate and global competitiveness, we are referring to the real exchange rate, or the nominal exchange rate adjusted for inflation differentials between South Africa and its trading partners. A depreciation only improves competitiveness if it is not eroded by higher inflation. In other words, if it is a real depreciation. So the Bank’s contribution to keeping inflation low is relevant in this respect. Our constitutional mandate to protect the value of the currency is often interpreted as a mandate to keep the nominal exchange rate stable. In the absence of other shocks, the exchange rate should remain stable if our inflation rate is the same as that of our trading partners. But assuming our inflation rate is higher and we attempt to maintain a stable exchange rate (and assuming that we have the means to do that), our real exchange rate will in fact be appreciating. In other words, we will be losing competitiveness, as the cost of producing goods domestically will have increased relative to our competitors. This persistent overvaluation of the currency will not be sustainable. Since the beginning of 2011, the real effective exchange rate has depreciated by 26,8 per cent, in contrast to the nominal effective depreciation of 41,9 per cent. So on this measure we are more competitive, but we have not seen a strong adjustment to this, as evident in the persistent current account deficit. There are a number of possible explanations but I will highlight a few points. It is important to understand what the key drivers of the depreciation have been. While there are a whole range of factors that impact the rand on a day to day basis, terms of trade changes and capital flows have been among the key underlying drivers or determinants. Falling commodity prices since 2011 have been an important factor in the weakening of the rand. This does not necessarily provide an impetus for increased production of commodities, but rather it shields the rand value of mining output. It does make non-mining exports more attractive, and that is how the adjustment is supposed to work. In other words, a real depreciation is supposed to be positive for growth. Capital flows are multidimensional. Some are driven by interest rate differentials, and the current global low interest rate environment makes emerging markets a desirable portfolio investment destination. These inflows have given support to the rand over the past few years. But periodic reversals of these flows, for example during global risk-off scenarios and risks of interest rate increases in the US have impacted negatively on the rand. Portfolio inflows into equity markets are growth sensitive, and this explains why non-residents have been net sellers of South African shares in recent months. To some extent, the rand has followed the pattern of commodity-producing emerging market economies over the past few years in response to changes in terms of trade and the pattern of global capital flows. However, there have been important divergences relating to domestic idiosyncratic events which have resulted in heightened perceived political risk, and reflected in the weaker exchange rate. The increased risk premium is often associated with falling business confidence. The resulting exchange rate depreciation is consequently unlikely to be a big boost to investment and exports. Rather, it will reflect weakening institutions. The adjustment is then unlikely to come about through increased exports, but through import compression, in the form lower investment and consumption expenditure. A weakening currency in the face of heightened political risk is therefore not a sign of increased global competitiveness, and is unlikely to be accompanied by higher growth. Currently, South Africa remains under threat of a possible downgrade from the rating agencies to sub-investment grade. One of the explicit factors contributing to some of the agencies maintaining our investment grade rate in the past few months has been the strength of some of our critical institutions. There is no doubt that should a downgrade transpire, it will be reflected in the exchange rate (to the extent that it is not already reflected). This will not be a sign of increased competitiveness, rather an adjustment to a deterioration in our competitive standing globally as an investment destination. The impact of strong institutions on our global competitiveness cannot be underestimated. The financial stability mandate Aside from price stability, the Bank has now also been given an explicit mandate to oversee financial stability as envisaged in the Financial Sector Regulation Bill (FSRB), which is currently before Parliament. The bill defines financial stability in two important ways. Firstly, it is the ability of financial institutions to provide products and services within the confines of the law, without interruption, regardless of changing economic circumstances. Secondly, it means that the public has confidence in the financial sector and its ability to function appropriately. The FSRB also provides for a Twin Peaks approach to financial sector regulation, which, when enacted, will expand the SARB’s scope of prudential regulation beyond banks, to include insurers and financial market infrastructures, resulting in the establishment of the “Financial Sector Conduct Authority” focusing on the conduct of financial institutions towards their clients. Whilst South Africa’s financial sector is widely seen as globally competitive and soundly managed, the reforms contained in the FSRB are likely to add additional institutional strength in this sector. This is because an explicit separation between the conduct and prudential regulator will allow for improved oversight. The responsibility of ensuring financial stability and the soundness of financial institutions and the financial sector is complementary to the Bank’s current mandate of price stability. Both objectives are seen as necessary conditions for sustainable and balanced long-term economic growth. Furthermore, financial stability provides a platform for the implementation of monetary policy. Without a well- functioning financial sector, it is impossible to effectively transmit monetary policy through the economy. The Bank constantly strives to strengthen the public’s confidence in our financial sector because it is only through the assurance of financial stability that South Africans will save and invest for the long term. This institutional strength also contributes to giving confidence to foreign investors to invest in the country. While the role of the Bank in regulating and supervising the individual banks has been well established, (i.e microprudential oversight), we also have an important evolving role to play in macroprudential oversight. Here the focus is on the financial system as a whole and our role is to monitor and act against financial excesses that threaten to undermine the broader economy. The pre-Crisis approach by central banks was that they did not have the ability to recognise bubbles and the best they could do was to clean up after the bubble had popped. Central banks also believed that price stability and micro-prudential supervision were sufficient to ensure broader financial stability. However, the Global Financial Crisis taught us that financial excesses can emerge during times of low inflation and strong individual bank metrics. The current view is that these excesses should be nipped in the bud by appropriate policies that constrain lending, either through macroprudential policies directed at the particular market segment, or through some form of targeted brakes on bank lending or higher interest rates. Our approach currently is for interest rate policy to be focused on inflation, and for the Bank’s Financial Stability Committee (FSC) to use other macroprudential policies to moderate financial stability risks. While our tool-kit is still being refined, we have implemented the framework of a countercyclical buffer for banks which will be over and above the capital requirements of individual banks. This provides the FSC with a tool to change capital requirements in order to protect the banking system from the boom and bust phases of the financial cycle, and is an integral part of the internationally agreed standards for risk-based capital requirements. Currently, given the weak state of bank lending, this buffer is set at zero. Concluding remarks In many ways, strong institutions are constraints on the abuse of political and economic power that society puts in place. As such, there is always the danger that there are incentives for some to undermine some of these institutions. We must therefore ensure that strong institutions are supported by society. It is important to regularly question whether our institutional arrangements are providing the right incentives to the stakeholders in our society. Furthermore, we must ensure that our institutions encourage broad-based participation in the economy and do not give rise to alternative forms of collusion between interest groups. But it is also important to bear in mind that institutions are not static. We live in a changing world, and institutional change is inevitable. But we must ensure that change is positive and in the interest of the broader society. The Bank will continue to pursue its constitutional mandate within a flexible inflation targeting framework without fear or favour. We have built a strong reputation as a respected institution within our young democracy. Together with the National Treasury we will continue to strive to bring about a stable macroeconomic environment, conducive to long term growth and development. Thank you.
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the South African Summer Macro Conference 2016, Johannesburg, 25 November 2016.
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The outlook for monetary policy Address by Lesetja Kganyago, Governor of the South African Reserve Bank at the South African Summer Macro Conference 2016 Johannesburg 25 November 2016 Over the past five years or so, emerging markets got used to bad news. Growth has been slowing, and growth forecasts have been marked down repeatedly. For a number of countries – particularly commodity exporters and countries with substantial external financing needs – inflation has also been accelerating. From the vantage point of late 2016, however, it seems possible we are at a turning point. In South Africa, for instance, we see inflation returning to target in early 2017 and then staying within the target range throughout the forecast period. Growth is expected to recover slowly from 2016 lows, and our growth forecasts have lately been revised up slightly, breaking a multi-year trend of downward revisions. Furthermore, the rand may just about end the year stronger than it started, for the first time since 2010. In the late 2000s, and in the immediate aftermath of the Global Financial Crisis, many emerging markets probably got more credit than they deserved for strong economic outcomes. Now, on the other side of the cycle, the pessimism may be overdone. Indeed, at the moment it is the advanced economies which have enjoyed the strongest recoveries – specifically the United States and the United Kingdom – that now seem less robust, given political surprises and abrupt reversals in growth forecasts. By contrast, a number of major emerging markets are doing, if not better, at least less badly. Let me set out some tentative reflections on our most recent global shock, the potential for a shift in US macroeconomic policy. Let me stress that we are aware of the risk, and considerable time was spent at our MPC meeting this week discussing the issue. The basic idea is for a shift from fiscal consolidation with accommodative monetary policy to fiscal expansion with tighter monetary policy. This new combination will result in investment shifting out of bonds and into equities, with repercussions for both asset prices and currencies, and considerable volatility in the near term. The cost of financing debt has risen, and this will place pressure on overstretched economies, at least until we see whether the shift results in better real economic growth outcomes. But that outcome will remain unclear for some time. Stronger US and global growth rates could entail improvements down the line in emerging market exports and commodity prices, and an improvement in South Africa’s current account deficit. But much depends on whether higher tariff barriers are realised and on how capital markets assess US fiscal policy. If a larger US fiscal deficit does not generate strong growth, then higher financing costs could weigh quite heavily on the global economy. This combination, weak global growth, higher rates and risk premia is where we are already coming from. It is the set of conditions that we hoped we were exiting from this year, and should, therefore, in mitigation spur us on to work harder to reduce our macroeconomic risk profile and take steps to encourage more rapid economic growth here at home. Today, I’d like to discuss the outlook for recovery and the role of monetary policy. This is necessarily uncertain. It is easy to imagine shocks which could throw us off course, both from the global economy and domestically. Some important political shocks have recently occurred, and it will take time for their full economic meaning and impact to be felt – a point I will return to in the conclusion. Yet our policy thinking can’t simply be about waiting for new information and complaining about uncertainty. Being data dependent is sensible in as much as you should revise your strategy in line with new facts, but it is not a substitute for strategy. As former US Treasury Secretary Tim Geithner reminded us during the Crisis, ‘plan beats no plan’. Inflation I will start with inflation, because it is our primary mandate, and because it is important for the economy’s overall trajectory. As you will all know, inflation has been outside the 3-6% target range for much of this year. It is currently expected to return to within the target sometime in the second quarter of next year. The main drivers of the breach have been higher food prices and pass-through from currency depreciation. Apart from these shocks, however, inflation would still have been quite elevated for an economy with almost no growth. This is because wage and salary settlements continue to come in above inflation and productivity gains, and because some administered prices like electricity are still being adjusted higher in real terms. The policy response to this set of challenges has been nuanced. We are flexible inflation targeters, which means we are mindful of the origins of shocks as well as the broader economic consequences of our decisions. Administered prices and food prices are classic supply shocks, and we think of short term volatility in the exchange rate the same way. This means we prefer to focus on the so-called second round inflation effects. If inflation is higher due to these shocks, but inflation expectations don’t move and broader prices and wages don’t accelerate, then shocks will have only temporary consequences and we can afford to look through them. If the consequences are that inflation will deviate from the target in a more permanent way, however, then policy should respond. Of course, it is difficult to determine if shocks will be permanent. We have forecasts and surveys to help guide our judgement, but these are imperfect tools. Furthermore, by the time you have firm proof of second round effects, the policy response is sure to catch out economic agents that have already increased prices, causing economic dislocation. This implies that we need to take into consideration the expected second round price effects of shocks. In late 2015 and early 2016, policy was tightened. We were experiencing large and simultaneous price shocks – a major drought and sustained depreciation. Inflation expectations were already close to or above 6%, and core inflation was over 5% and climbing. So there was minimal room for error. The inflation forecast showed a protracted breach of the target range. It was therefore likely that without a policy response, inflation would have shifted outside the target range in a more sustained way. The gradual policy adjustments helped prevent this outcome, while recognizing the relatively weak economic environment. We have not had to tighten policy sharply to achieve high real interest rates, as has been necessary in countries such as Brazil, Russia, Ghana and Zambia. All this is in the past. The rate hikes from late 2015 and early 2016 are only beginning to affect the economy now. Those hikes help explain why inflation is returning to target. Any new decisions will shape economic outcomes in about one to two years’ time. We are therefore focussed on the outlook for late 2017 and 2018. We see the shocks of 2016 dissipating. Food price inflation is expected to slow from the first quarter of next year as weather conditions normalise. The exchange rate has recovered some ground, and although its volatility reminds us how rapidly these gains could unwind, the rand has appreciated roughly 15% against the US dollar from January’s lows. Accordingly, our forecasts show inflation reaching 5.5% by the end of 2018. The MPC noted in the last two policy statements that if these forecasts prove durable, the end of the hiking cycle may be close. One of the biggest questions is over inflation expectations, which remain clustered around 6%, where they have been for about six years. We are relieved they have not shifted markedly higher despite above-target inflation in 2016. On the other hand, we are concerned that expectations are not anchored more comfortably within the 3-6% target range. Indeed, the main reason inflation is not moving much lower even as the food and currency shocks dissipate is because expectations are elevated: price and wage setters continue to believe they must demand increases close to 6% just to maintain the real value of earnings. The forecast decline in inflation is a consequence of supply shocks falling away, not a moderation in underlying inflation. This implies that we need to continue to look through the first round effects and focus on second round effects. This means inflation expectations remain central to policy. Our understanding of inflation expectations is that they are a mix of forward-looking and backward-looking views. Expectations are sometimes dismissed as completely backward looking, and therefore of no real value to policymakers. This is incompatible with the evidence. After all, the oil shock lowered inflation to 4.6% in 2015, yet even as short term expectations adjusted, longer term expectations didn’t move lower. Similarly, higher inflation in 2016 has affected current year expectations but not longer-term views. This shows that respondents have a reasonable sense of current or actual inflation, but do not let it fully define their views for the future. Still, there is little evidence that expectations are exclusively forward-looking. There are few if any examples of this in the real world. Guiding expectations lower therefore involves a mix of optimising communication and delivering lower inflation. Cutting rates as soon as inflation edges under 6% would be a clear signal that we are targeting the very top of the target range, so rational expectations would stay there. Meanwhile, backward looking expectations are unlikely to adjust without an experience of lower inflation. Either way, it would be premature to ease policy without a corresponding improvement in expectations, so that they are anchored more comfortably within the 3-6% target range. Growth and interest rates What about growth? In our communications over the course of the hiking cycle, we have repeatedly emphasised a policy dilemma – slowing growth alongside rising inflation. The outlook shows this dilemma easing from both sides: more growth, moving closer to the economy’s potential and though inflation is slowing, it is still outside, or too close to the upper end of the target range. This weakens the case for lowering interest rates. In particular, three considerations stand out. First, as I have mentioned, the policy stance has been accommodative and has moved closer to neutral. But we have to treat neutral rate estimates with some scepticism. The available methods produce divergent results. It is clear, however, that we are not like Brazil, where rates were recently cut for the first time in several years, but from the very high starting point of 14.25% (and a real rate of nearly 9%). Had we raised rates by 700 basis points, for example, the inflation outlook today might justify easier monetary policy. In our case, a cumulative increase of 200 basis points to 7 per cent translated to a real repo rate of just over 1 per cent. This compares to a potential real GDP growth rate of about 1.5%. Second, the way we exited from the global financial crisis and its accompanying drop in growth currently limits the impact of our accommodative policy on growth. The standard macroeconomic justification for lower interest rates is to address a demand shortfall caused by excessive saving. South African saving habits can rarely be described as excessive. Household debt levels remain high in comparative perspective. Government debt is closer to international norms at about 50% of GDP, but the pace of debt accumulation has been unusually rapid. Our current account deficit is expected to remain over 4% of GDP for the foreseeable future, and we have to keep on importing foreign savings to make up for domestic shortfalls. The financing cost of debt remains quite low, but our debt stock, counting both the public and private sectors, is uncomfortably high. Private sector credit extension has been muted through much of the post-crisis period, reflecting both an ongoing reluctance to borrow and supply constraints related to regulations to limit the growth in household debt burdens. Rapid credit growth has been seen in some sub-sectors, such as unsecured lending, but the larger credit aggregates for households have not moved significantly. This has been true both before and after we started raising rates. For these reasons, proponents of lower interest rates irrespective of the inflation rate remind me of the proverbial dogs chasing cars. The dog is unlikely to catch the car, and will be in trouble if it does – credit extension may continue to be weak while inflation rises. This characterises the 2011 to 2014 period well. There are, of course, some forms of credit growth we would like to see, particularly those which support investment, but a strong rise in household debt seems like an unsustainable growth model. Third, we need to keep an eye on international competitiveness. A depreciated rand makes our goods and services relatively attractive, but inflation counteracts this – naturally, the more we raise prices, the more expensive we get. South African inflation tends to be higher than that of our trading partners, so as the exchange rate recovers, our real, inflation-adjusted exchange rate appreciates quite rapidly. Unfortunately, the line between cheap and expensive is not always that clear. The real effective exchange rate still looks highly depreciated, relative to its historical average, and on a purchasing power parity basis. However, more sophisticated exchange rate models, such as those which incorporate variables such as productivity differences and current account balances, put the fair value of the rand much closer to current levels. These latter estimates tell us something about one of the puzzles of the post-crisis period, which is that rand depreciation has not brought about all the trade benefits we would normally expect. In 2010, with the rand close to seven to the dollar, we were repeatedly urged to intervene with the message that a rand closer to nine or ten to the dollar would do wonderful things for exports. Yet as the rand passed ten, then twelve, then fourteen, then sixteen, net exports stayed weak. In part, this reflects global factors. For instance, falling commodity prices lower export values. With the spread of global value chains, moreover, national exchange rate movements have smaller effects on trade: higher import prices offset lower selling prices. In addition, domestic factors may have played important roles. New research demonstrates convincingly that constraints such as electricity shortages, as well as product and labour market rigidities, have reduced the stimulatory effect of a cheap exchange rate. There is also compelling evidence that policy uncertainty has further weakened net exports. Anand, Rahul, Roberto Perrelli, and Boyang Zhang (2016), “South Africa’s Exports Performance: Any Role for Structural Factors?” IMF Working Paper WP/16/24. Hlatshwayo, Sandile and Magnus Saxegaard (2016), “The Consequence of Policy Uncertainty: Disconnects and Dilutions in the South African Real Effective Exchange Rate-Export Relationship”, IMF Working Paper WP/16/113. This lack of a trade response to rand depreciation is one of the biggest missing parts of the recovery. It would have made two vital contributions, supporting growth and moderating the current account deficit. As it is, we can feel confident that rand depreciation has at least supported existing exporters, such as our miners. We should also anticipate a stronger net export response if some of the constraints on the economy loosen, as we expect them to do over the next few years. As such, it is important for growth and rebalancing that inflation moderates and we maintain the beneficial effects of a depreciated rand. Raising potential growth I should be clear, the growth recovery envisioned in our forecasts is hardly robust. Monetary policy can provide support to short-term growth by closing gaps between actual growth and the economy’s potential. And while our forecasts are starting to improve, from a broader perspective, growth rates under 2% are very disappointing, below both the longer run South African average of 3% and the National Development Plan aspiration of over 5%. Higher growth rates should be achievable. We have on our side what Larry Summers and Lant Pritchett have called “perhaps the single most robust and empirical relevant fact about cross-national growth rates”, which is that different countries revert to the same growth average over time. They say that “… current growth has very little predictive power for future growth” . That is ominous when you’re China and growing above average rates and it is reassuring when your current performance is below average. Nor is it that difficult to imagine how growth would improve. Business and consumer confidence is exceptionally subdued amid acute policy uncertainty. Investment growth is weak, with private sector investment growth negative. If confidence returns to more normal levels and investment recovers, both actual growth and the economy’s potential growth rate should be expected to rise, clearing a path to higher growth without rising inflation. Lant Pritchett and Larry Summers (2014) “Asiaphoria meets regression to the mean” NBER Working Paper 20573, available at http://www.nber.org/papers/w20573.pdf Conclusion Today, I have set out a view for policy based on the existing forecasts. We expect better growth and lower inflation. We would like to see inflation expectations moderate so that they are more comfortably within the inflation target range, to help us permanently and structurally lower inflation and therefore interest rates. We expect lower inflation to yield benefits, including for growth. By contrast, given pricing behaviour in the economy, achieving lower rates as soon as possible may not have benign consequences for inflation expectations and competitiveness. Given our current forecast trajectory, we may be closer to the end of the hiking cycle, but the bar for cutting rates is very high. It is possible that some shock could make the ideas I have discussed today seem fanciful and obsolete. That is part of the job: there are usually surprises, and we are always ready to adjust policy in line with new developments. As the boxer Mike Tyson remarked, ‘everyone has a plan till they get punched in the mouth’. If the punches do not land, however, we should know what we want to do with policy. The answer is to get inflation down into the target range and prepare for another period of sustainable growth. For all the talk of policy dilemmas, of short term growth and inflation trade-offs, we should remember that in the long-run low inflation and growth reinforce each other. The world’s most successful economies have both, and the worst failures have neither. We should look forward to inflation trending lower and growth moving higher, a positive prospect which implies no great dilemma for the central bank. Thank you
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Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Conference on "Financial Intermediation in Emerging Markets", Cape Town, 9 December 2016.
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Keynote address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the Conference on Financial Intermediation in Emerging Markets hosted by the University of Cape Town / Imperial Business School / Economic Research Southern Africa / Review of Finance Cape Town 7-10 December 2016 Good morning, ladies and gentlemen. Let me begin by thanking the organisers for inviting me to address you today. Today, I would like to talk about the evolving banking landscape, specifically the regulatory and governance challenges that face banks in emerging markets. I would also like to discuss the challenges relating to correspondent banking as well as the opportunities and risks that come with fintech and digitisation developments. Last but not least, I will touch on the concept of ‘financial inclusion’ and the framework for the resolution of troubled financial institutions. The increased volume, complexity and impact of regulatory reforms on the financial sector in recent years are a challenge for both supervisors and banks. The concern for supervisors is that the volume and complexity of new international standards are placing increased demands on limited supervisory resources (particularly in emerging markets). This may affect supervisory effectiveness. Supervisors and the supervised institutions alike demonstrate a high demand for staff most suitable for ensuring regulatory compliance. It remains a challenge for the regulator, similarly to the rest of the financial sector, to attract and retain adequately skilled human resources in the current environment of increased regulatory and compliance scrutiny, as the South African Reserve Bank – or SARB – competes with commercial banks for the same set of skills and experience to address the regulatory requirements imposed on banks. The combination of the new credit, market and interest rate risk in the banking book and liquidity standards, the changes to provisioning, capital buffers as well as the implementation of the total loss-absorbing capital (or TLAC) and resolution frameworks are specific challenges. Banks are also facing growing compliance challenges from the increase in new requirements, which further affect their resources in order to keep up with regulatory developments. A concern we hear frequently relates to the potential risks and impact on banks of the interaction of the various new regulatory and supervisory standards. The understanding of these risks and their likely impact is necessary to avoid the unintended consequences of the cumulative modification of regulatory standards. As a member of the Basel Committee on Bank Supervision, South Africa continuously strives to strengthen its regulatory and supervisory framework as well as to promote and enhance the stability of its financial system. The G-201, the Financial Stability Board and the Basel Committee on Banking Supervision have made significant strides in future-proofing the resilience of the global financial system and finalising the core elements of the regulatory reforms. The first phase of this new global regulatory initiative focused on ending the ‘too big to fail’ problem in order to reduce the risk to the fiscus and taxpayers. In particular, this has meant increasing the resilience of individual institutions. The G-20 has tasked the Financial Stability Board with developing a framework and ensuring that the relevant international standard-setting bodies prepare new standards for large and important financial institutions, particularly the systemically Founded in 1999, the Group of Twenty (G-20) is an international forum for the governments and central bank governors from 20 major economies. important financial institutions (SIFIs). Regulatory bodies have since developed common standards, monitored by mutual peer reviews, to ensure that economies can still enjoy the benefits of global trade while reducing the risks caused by a financial crisis. South Africa is also imposing new regulatory requirements, especially on banking groups, which are material subsidiaries of global systemically important banks (or GSIBs). The requirements being imposed on these G-SIBs and their material subsidiaries in the emerging markets have the potential to create an uneven playing field with other locally incorporated banking groups and carry the consequence of bringing unwanted risk into the South African financial system. The second phase of the global reforms involves authorities reducing the costs from the failure of a financial institution. In a document titled Key attributes of effective resolution regimes for financial institutions, the Financial Stability Board has set out key principles to ensure that the consequences of the failure of individual financial firms are minimised. South Africa has implemented Basel III through the 2013 Bank Regulations and the Banks Amendment Act 22 of 2013. A new prudential framework for insurers will be introduced through the Insurance Bill now being considered by Parliament. This prudential framework may be expanded to other financial sectors in the near future to ensure a consistent regulatory approach. These reforms will support the shift towards the coming Twin Peaks approach to regulating the financial sector in South Africa. Making financial institutions safer is important, but the possibility of failure remains. Considering the fact that South Africa is an emerging market and that South African banking groups operate mainly in other emerging markets, some of the regulatory requirements developed or being developed could have a negative impact on the South African banking system and/or financial market, such as the Net Stable Funding Ratio or the proposals being developed around TLAC. Some of these requirements may in fact be more suitable for, or may have been calibrated to be more applicable in, developed markets; they may not always be fit-for-purpose in emerging markets such as South Africa. The large banking groups regulated by the SARB mainly have operations on the African continent and/or in other emerging markets. Some supervisors on the continent and in other emerging markets where South African banks have operations have yet to implement the regulatory reforms. This imposes an obligation on the SARB, which is the only African member of the Basel Committee on Banking Supervision, to effectively supervise the subsidiaries of South African banks in the rest of the African continent and other emerging markets. Failure to do this creates inconsistencies in how regulatory capital and other risks are measured, and in how supervisory standards are applied. Another example of an inconsistent application of international standards is different supervisory expectations in Africa of the same international standards relating to the use of risk models under the advanced measurement approaches. Although there is a need for more standardisation and comparability of risk-weighted assets across banks and jurisdictions, the SARB believes that there remains a need for banks to be able to apply quantitative risk models to adequately measure risk across portfolios and/or risk types. If the expectation is to reduce the use of risk models in measuring regulatory capital, then banks will become less inclined to invest in the use of test requirements imposed under Basel II. The SARB believes that the use of test requirements has made a significant positive contribution to the way in which banks measure and manage risk, and that this has led to improved risk management and pricing of risk across the regulated entities. The SARB supports the risk models under the advanced measurement approaches to be used. The regulatory framework is beginning to succeed in meeting its objective of addressing the ‘too big to fail’ problem as G-SIBs are in general adjusting their balance sheets and evaluating their complex business models to meet strengthened regulatory demands in many areas, especially in respect of higher-quality capital ratios and the difficult economic environment we are currently facing. As you know, these developments have spilled over into South Africa when a G-SIB headquartered in the UK2 announced its partial withdrawal from a domestic systemically important bank, or D-SIB, mainly due to global regulatory pressures. As a result, we might face various policy considerations going forward as we need to carefully assess the effect and potential impact of home regulatory requirements on local markets and if we are not perhaps importing structural instability (uncertainty) into our markets. An unintended consequence of the reforms to end ‘too big to fail’ is deglobalisation, resulting in G-SIBs reducing their activity in some emerging market economies, which in turn has a potential impact on the stability of those financial systems and policy implications. Another consequence of the regulatory reforms is that the regulated banking system is being scrutinised and regulated more strictly but no similar requirements or oversight are currently imposed on the shadow-banking environment. This is being discussed in the international meetings we attend. Let me turn to digital innovations. Innovative technologies are emerging as a potentially transformative force in financial markets. ‘Fintech’ is used as a broad term for technically enabled financial innovation that results in new business models, applications and/or products with an associated material effect on financial markets, institutions and the provision of financial services. Coping with opportunities and threats from innovation and technology remains a key area for banks and continues to pose challenges for supervisors. New technologies may be outpacing the ability of banks to put in place adequate controls and information technology (IT) systems. Furthermore, supervisors do not necessarily have sufficient expertise to assess a bank’s capability in this area. Building capacity United Kingdom to address IT needs and cyber-risks is therefore becoming more urgent in the context of the growth of fintech. With greater reliance on technology comes a greater risk of cyberattacks. The risk of cyberattacks on the financial sector has dramatically increased in recent years. The financial sector stands out as a particularly attractive target for cyberattackers. Cyberattackers’ ambition and capacity to manipulate and gain direct access to financial data and services may lead not only to severe losses of trust in the global financial sector but also to high costs for market participants and customers. With today’s financial systems being globally interconnected and dependent on technical core infrastructures and services, cybersecurity incidents compromising such a core function could, by contagion across sectors and jurisdictions, even develop a capacity to undermine global financial stability. The SARB joined the Alliance for Financial Inclusion (AFI) during 2016. Representatives from the SARB have attended AFI Global Policy Forums in the past two years. We are also a member of the AFI African Mobile Phone Initiative (AMPI). By participating in international forums, it is clear that the solutions are probably in fintech, specifically mobile phones and regulatory sandboxes. Financial inclusion covers aspects of affordability and the ability to use financial services, which involves a certain level of financial literacy. The SARB has not been actively driving financial inclusion, but it has done some work on financial literacy. Going forward, financial inclusion will be an ancillary objective for the Prudential Authority in terms of the Financial Sector Regulation Bill. Derisking and deglobalisation contribute to global financial market fragmentation and could end the open and integrated structure we are all striving for. Derisking can create financial exclusion. Digital innovation can also be used to enhance global financial inclusion. A peer exchange between countries and regions on emerging policy practices for achieving digital financial inclusion could help those who lack access to financial services to better steer their implementation efforts. We believe that the global phenomenon of derisking through a decline in correspondent banking services requires priority and expedited action. This is one area where proportionality in the implementation of regulatory reforms is very appropriate. Evidence reveals that the picture is especially bleak in the sub-Sahara Africa region where some countries are constrained since they are potentially unable to process payments across international borders. To date, a limited number of correspondent banking relationships with South African banks have been terminated but derisking has not had a significant impact on crossborder flows from a South African point of view. However, South African banks are being subjected to heightened scrutiny by foreign counterparts. Markets in all jurisdictions must have access to a well-functioning global financial system in order to develop and prosper. This development goes straight against our goal of financial inclusion, which is a critical element for long-term global economic growth and for the elimination of poverty. In conclusion, the fact that the South African banking sector remains profitable and adequately capitalised is not a cause for complacency. The future performance of the domestic banking sector could be adversely affected by a number of factors, including constrained household-sector balance sheets, a weak domestic economic growth outlook, the subdued global growth outlook, the effects of the threat of a sovereign downgrade, and increasing regulatory compliance pressures. As a regulator, the SARB will remain vigilant in monitoring and, where possible and appropriate, mitigating the impact of the challenging environment in which domestic banks are operating. Thank you.
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Deutsche Bundesbank regional office for Hamburg, Mecklenburg Western Pomerania and Schleswig-Holstein, Hamburg, 26 January 2017.
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Address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bundesbank regional office in Hamburg, Germany 26 January 2017 German G-20 presidency in 2017: opportunities and challenges for South Africa 1. Introduction Good evening, ladies and gentlemen. Thank you to Dr Andreas Dombret, member of the Executive Board of the Deutsche Bundesbank, and to Dr Arno Bäcker, President of the Deutsche Bundesbank regional office for Hamburg, Mecklenburg Western Pomerania and Schleswig-Holstein for the kind invitation to speak to you today in this great Hanseatic city. This is certainly an intriguing city, often referred to as ‘the gateway to the world’ and ‘the Venice of the North’, names derived from the fact that Hamburg is home to one of the largest harbours in Europe, and therefore the centre of German trade. Interestingly, it has more bridges than Venice. We also know that Hamburg has a vibrant cultural life when it comes to art and music, including its unique association with the Beatles. South Africa takes a keen interest in Germany and Europe at large, given the substantial trade linkages and therefore significant implications for our economic prospects. Not only is Germany the second-largest trading partner for South Africa, but also one of the biggest investors in the domestic economy, with close to 600 German companies located in South Africa and Disclaimer: There may be minor differences between this version of the speech and the delivered German version providing over 90 000 jobs.1 Such a presence contributes significantly to employment and skills development, but also to technological advancement in South Africa. I thought that since I am in the G-202 host country, it may be useful to share some thoughts with you on the G-20 in general and more specifically insofar as South Africa and the South African Reserve Bank have experienced it thus far, and highlight some of the opportunities and challenges as we perceive them. Indeed, Germany has assumed the G-20 presidency at an important juncture, a time when countries are increasingly turning inward, with anti-globalisation sentiment and populist rhetoric growing stronger. As Chancellor Angela Merkel noted a few months back, the current environment is marked by a strong emphasis on the nation state. She cautioned that withdrawing and concentrating on one’s own country has never been of benefit to anyone in the end, instead, this has always caused harm. As such, Germany’s motto of ‘shaping an interconnected world’ is certainly appropriate as it talks to the benefits of globalisation and, along with it, the need to ensure that the fruits thereof are shared in a manner that is more inclusive. 2. G-20 track record Germany played a leading role in the formation of the G-20. It was in the wake of the 1997 Asian financial crisis and during the 1999 German presidency of the G-73 that the G-20 was launched as a new forum on ‘key economic and financial policy issues among systemically significant economies’4. Ten years later, and coincidentally after yet another financial crisis, the status of the G-20 www.southafrica.diplo.de Group of Twenty Group of Seven (industrialized democracies) http://www.g20.org Disclaimer: There may be minor differences between this version of the speech and the delivered German version was elevated to that of a Leaders’ Summit; it has become the premier forum for international economic and financial cooperation. Prior to this, the G-20 initiative had been at the level of finance ministers and central bank governors. Almost a decade on from the 2007 global financial crisis, perhaps it is prudent to ask: does the G-20 remain the premier forum for international engagement and cooperation on global economic and financial affairs, as it purports to be? How much has it achieved? Is it still relevant and effective? I think it can be argued that the G-20 has achieved a number of successes, certainly remains relevant, and many would agree that it is indeed the most appropriate forum given its representation, and as such is well placed to address issues of global economic and financial importance. However, we can never become complacent since there is little doubt that there is much more that can and should be done, especially given some criticism voiced that the G20 was a good crisis manager, but may be less successful as a forum for coordinating crisis prevention. The purpose of the G-20 forum is to enhance cooperation. Cooperation is about collaboration, partnerships, unity and compromise, which ultimately means working and acting together for a common purpose. The German Federal Finance Minister, Wolfgang Schäuble, could not have put it in a simpler and more concise way when he said the following at the first G-20 meeting under the German presidency in Berlin in December 2016: “We will only be able to solve the problems of the world if we work together.” He went on to mention that “global solutions are needed for global challenges”. During the first Leaders’ Summit in 2008, the G-20 focused primarily on strengthening economic growth, dealing with the economic and financial crisis, and laying the foundation for much-needed reform of the financial sector. There was a drive to reform the International Monetary Fund (IMF), the World Bank and other multilateral development banks, coupled with initiatives to resist trade protectionism and work towards the conclusion of the Doha Disclaimer: There may be minor differences between this version of the speech and the delivered German version Development Round, the objective of which was to lower trade barriers and facilitate increased global trade. The London Summit of April 2009 focused on coordinated fiscal and monetary stimulus measures to avert the threat of a global depression. Leaders agreed on additional resources of up to US$1 trillion for the IMF to assist countries in weathering the financial crisis. The Financial Stability Forum at the Bank for International Settlements, which at the time was only represented by advanced economies, was transformed into the Financial Stability Board (FSB), with key emerging market economies represented on the FSB. In September 2009, the G-20 leaders also agreed on the implementation of a framework for strong, sustainable and balanced growth. By the time of the Toronto Summit in June 2010, fears were escalating over the deteriorating fiscal health of various advanced economies as they tried to support growth. Advanced economies with large deficits agreed to at least halve their fiscal deficits by 2013 and to stabilise or reduce sovereign debt ratios by 2016. These commitments included ongoing structural reforms 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. By 2012, the European banking and sovereign debt crisis received much attention, with the spillover effects to other member countries in a globally interconnected world and the need for policymakers in Europe to take decisive and credible action featuring strongly. With this in mind, and with the potential for increased instability, the G-20 leaders pledged over US$450 billion in financial resources to boost the IMF firewall at the June 2012 Los Cabos Summit. In 2014, the G-20 adopted the 2-in-5 objective, committing to collectively raise G-20 output by an additional 2 per cent over a five-year period, by 2018. Disclaimer: There may be minor differences between this version of the speech and the delivered German version The contribution of central banks, within their mandates, has largely been through supportive monetary policies, reforms to the international financial architecture, strengthening the resilience of the financial sector, leading the dialogue on global regulatory reform, playing a key role on the FSB, and assisting in developing strategies for sustainable economic growth. Without too much chest-beating for my own guild, I do think that the contribution of monetary policy in addressing the economic challenges is beyond question. In fact, it has been widely recognised that there has, at times, been an overreliance on monetary policy to address the binding growth constraints in many economies. It is thus clear that the G-20 has taken much action over the years, but the global economic recovery has nevertheless been less than inspiring. Hence, we are now witnessing a rise in anti-globalisation rhetoric, a rise in populism, and countries developing greater nationalist tendencies. The G-20 has an important leadership role to play in unpacking and addressing the reasons for this change in sentiment and highlighting the negative ramifications of an inward bias. We need to emphasise the positive spillovers of globalisation, but also accept that we may have underestimated the number of people were left behind and who did not share in the spoils of globalisation. It is with this in mind then, that Germany’s focus on ‘shaping an interconnected world’ and enhancing resilience is very pertinent. Germany’s three main pillars for the G-20 presidency – of ensuring stability, improving viability for the future, and accepting responsibility – reflect continuity of the G-20 agenda over the years and also aim to tackle the issues I have just spoken of. The issue of accepting responsibility is borne out by the new agenda item, ‘Compact with Africa’, which speaks directly to achieving sustainable economic progress in Africa as part of addressing some of the root causes for the various migration crises we have been observing. I will return to this later. Disclaimer: There may be minor differences between this version of the speech and the delivered German version I must add that we certainly welcome the more streamlined agenda that the German presidency has put together, particularly in light of the fact that the agenda of the G-20 had become more bloated over the years, with the increasing risk of detracting from the effectiveness, efficiency and credibility of this forum. We are looking forward to Germany’s G-20 leadership during 2017, and I am convinced that the forum will greatly benefit from some of the virtues that Germany is famous for, such as thoroughness, efficiency and punctuality. Some of our colleagues have already had a taste of this at our meetings in Berlin during December. 3. South Africa’s participation in the G-20: opportunities and challenges How does a small, open economy such as South Africa fit into the G-20? South Africa has a high level of interconnectedness to Africa and within the global economy, not only through trade links but also because of our deep and sophisticated financial markets. Our membership of the G-20 forum provides South Africa with the space to participate in shaping key international policies that could have an impact on our own economy, the region and the continent as a whole. Our network of contacts from our interactions in various G-20 forums provides great opportunities to enhance South Africa’s international profile and reputation. It also allows us to keep pace with global best practice and learn from others, helping us to make more informed and therefore better policy decisions. South Africa’s participation in the G-20 helps to leverage its voice and effectiveness in other international standard-setting bodies, including the FSB, the Basel Committee on Bank Supervision, and the Financial Action Task Force, to name a few. South Africa has already adopted international best practice in areas such as financial regulatory reform, including being an early adopter of Basle III. Disclaimer: There may be minor differences between this version of the speech and the delivered German version It is important to focus on the underdevelopment of various regions in the global economy, including sub-Saharan Africa, and to ensure that the issues of relevance to these regions are on the table of the global policy agenda. At the Toronto Summit in June 2010, the G-20 leaders confirmed the inclusion of ‘development’ as a key agenda topic, and at the Seoul Summit later that year they agreed to establish a Working Group on this issue. Building on the development theme, we welcome the initiative that Germany has placed on the table, namely ‘Compact with Africa’, through which it hopes to encourage private-sector investment, including in infrastructure, to increase employment and foster sustainable growth on the continent. Under this initiative, African countries are being encouraged to discuss and agree on individual compacts, committing to concrete actions to enhance investment opportunities. As we know, the investment financing gap in Africa is huge, and closing its infrastructure gap is a top priority in order to put the continent on a path of higher and more sustainable growth and development. The ‘Compact’, which should tune into other African initiatives already underway on the continent, should help to make private investment in Africa more attractive by making it more secure, thereby reducing the barriers to investment. South Africa has the potential to contribute significantly to the growth and development agenda of the G-20 and to the ‘Compact’, and we look forward to this initiative gaining momentum in the coming months and beyond. South Africa’s participation in the G-20 and other international forums is not without its challenges. These include constraints related to human and other resources to fully and effectively participate. The breadth of the G-20 agenda requires careful prioritization, which invariably involves compromises and tradeoffs, sometimes affecting important agenda items. Another challenge relates to the ‘small country problem’, which in effect means that much energy needs to be devoted to ensure that issues of relevance to both emerging market and developing countries receive appropriate attention. Then there is the issue of countries being at different stages of development, which requires country-specific circumstances to be taken into account, and which needs to find expression in Disclaimer: There may be minor differences between this version of the speech and the delivered German version such a manner so as not to compromise international standards. As the only African country at the G-20 table, South Africa also endeavours to highlight regional and continental issues whenever the opportunity arises, albeit without any formal mandate. In this regard we are supported by the African Union Commission and the NEPAD Secretariat as invitees to G20 meetings. 4. Opportunities and challenges for the G-20 as a forum It seems that while the G-20 has moved beyond its teething problems and idealism as a forum for cooperation and coordination and has actually produced tangible outcomes, we have now reached the stage where we run the risk of being viewed as a forum where process issues have become more prominent and actions more difficult to agree on or implement. Indeed, at the start of the global financial crisis, the level of cooperation and coordination within the G-20 was impressive, as an array of appropriate measures was implemented to deal with the crisis and to improve resilience. Besides the achievements already referred to earlier, other very important actions were taken in the midst of the crisis, such as swap-line facilities among major advanced economies and a few select emerging markets, revisions to the IMF lending toolkit to make it more flexible and relevant, and adapting views on capital flow management measures in reaction to the changed operating environment. However, this desire to cooperate seems to have faded somewhat and some G-20 countries have since become or are becoming inwardly focused. Last year we witnessed various unexpected political developments which could have a bearing on the work of the G-20. In 2017, there could be more surprises in store as far as voter choices are concerned, and thus major political shifts with potentially significant economic consequences. Much uncertainty currently exists with regard to the future policy direction in some of the major economies, which brings with it the possibility of increased financial market volatility. Disclaimer: There may be minor differences between this version of the speech and the delivered German version The pushback against globalisation has become a popular theme, as an increasing number of voters believe that there is not much to gain from the current system. Instead, many believe that globalisation has benefited a small privileged elite. There are indications that policies most likely to be enacted in reaction to this phenomenon include increased restrictions to immigration and trade. Simultaneously, greater political tensions globally are, making it harder for governments to pursue the structural reforms needed to encourage investment and so boost productivity and growth. The G-20 needs to intensify its communication and highlight that with globalisation comes more trade, more wealth, more investment, and ultimately more jobs. It means lower-cost goods from abroad, which increases spending power and results in a higher standard of living. Competition from abroad forces local firms to become more efficient and to use resources more efficiently. Clearly, globalisation is good, but we need to acknowledge the challenge that everyone should share in its fruits. We need to ensure that globalisation is accompanied by greater inclusiveness and reduced inequality. Regarding the G-20 structural reform agenda and the 2-in-5 objective, we have made progress and implemented reforms, but, once again, we could do more. The structural reforms implemented thus far have contributed to supporting economic growth and have therefore contributed to the collective growth ambition set by the Brisbane Summit. However, we know that potential growth remains low, so we need to step up our implementation efforts, reassess on a continuous basis whether we are still on the right path with our structural reform initiatives, and review and change course where necessary A final issue that I would like to point out relates to outreach. It is important to bear in mind that, while as a group the G-20 makes up about 80 per cent of global trade and approximately 90 per cent global GDP5, it consists of only 19 countries, which effectively excludes more than 160 countries. Only one African country is Gross Domestic Product Disclaimer: There may be minor differences between this version of the speech and the delivered German version represented in the forum. Hence, the G-20 needs to do significantly more outreach to ensure that the views and interests of these countries are not unduly compromised by a member-focused G-20 Agenda. It is important to recognise that amidst the challenges, there are always opportunities. Digitalization is one such opportunity, and we know that Germany intends to focus more on digital transformation in a bid to make economies ‘fit for the future’. Digitalization has immense benefits, ranging from improved access to financial services to cost savings from efficiency gains. A more financially inclusive global economy could help to support real economic activity and the growing importance of financial technology is a key contributor towards the common goal of financial inclusion. In a 2014 report, the World Bank mentioned that mobilemoney accounts can drive financial inclusion in sub-Saharan Africa and that there are big opportunities to expand financial inclusion – particularly among women and the poor – through financial innovation. Once more, the G-20 is the ideal platform to jointly discuss digitalization and devise means of using it responsibly to our advantage. However, it is important that in doing so we do not lose sight of the financial stability considerations associated with the evolving digital world. Thus, South Africa welcomes the proposal that the G-20 take action to improve cybersecurity in the financial sector to address financial stability risks. Continued investment in the ability to detect and respond to cybersecurity threats is needed to ensure that we remain in a proactive rather than a reactive mode to counter the potential threats posed by cybercrime. Another opportunity advocated by Germany is the development of a holistic policy framework to measure the effects of financial reforms. We must remain sensitive to the potential unintended consequences of the implementation of these reforms, especially given the differing levels of financial sophistication in different jurisdictions. A lack of international consistency among and within regulators and central banks regarding roles, policies, directives and guidance could pose risks of instability, especially where cross-border flows are affected. Disclaimer: There may be minor differences between this version of the speech and the delivered German version How do we make the best of the opportunities presented? How do we react to and deal with these challenges? Only through cooperation and collaboration for a common purpose, since by so doing, we contribute to the creation of a more equitable world, both in terms of geographical distribution as well as within national boundaries. 5. Conclusion Let me then conclude by saying that we are very excited about the year ahead and the promises it holds. We believe that much can be gained if we work together, if we tackle the difficult issues of exclusion and inequality, if we make the most of the opportunities presented to us. We appreciate Germany’s desire to use its presidency to intensify international cooperation and ensure that globalisation benefits everyone. This is not an easy task, but it is necessary to ensure strong, sustainable, balanced and inclusive growth. South Africa is fully supportive of this objective and will contribute wherever appropriate. Thank you. Disclaimer: There may be minor differences between this version of the speech and the delivered German version
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the T-20 Africa Conference, Johannesburg, 1 February 2017.
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Keynote address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the T-20 Africa Conference Crowne Plaza Hotel, Johannesburg 1 February 2017 Africa and the G-20: some implications for the work of the T-20 1. Introduction Good evening, distinguished guests, ladies and gentlemen. I would like to thank the South African Institute of International Affairs (SAIIA) and the Germany co-chairs of the T-201, namely the German Development Institute and the Kiel Institute for the World Economy (IFW Kiel), for the kind invitation to address you this evening. The Think Tank 20 was initiated during the Mexican presidency of the G-202 in 2012 as a collaborative network of premier think tanks from the G-20 economies and other high-level experts. The aim of the T-20 is to provide analytical depth to G-20 discussions so as to assist in developing concrete and sustainable research based policy measures. Think tanks and academics from the G-20 countries have indeed made important contributions in the past to the G-20 dialogue via the T-20 forum. Events such as this conference serve to reinforce this view and showcase the work being undertaken by the T-20. Dennis Snower, President of the IFW Kiel, summarised the work of the T-20 for this year aptly when he said: “In 2017, the T-20 aims to The ‘T-20’ is the Think Tank 20, the ‘ideas bank’ of the Group of Twenty (G-20). Group of Twenty Page 1 of 10 support the German G-20 presidency in rising to the diverse but interconnected global challenges that the G-20 faces.” Judging by the impressive conference programme, you must have had a fruitful day. It is especially encouraging to see the involvement of experts from the African continent as well as from other emerging economies in this conference. In my remarks this evening, I would like to first make a few general observations about Africa and the G-20 before making some specific comments on two of the issues that feature on the conference programme and which are topical in central banking circles at the moment. 2. Africa and the G-20 As a group, the G-20 consists of only 19 countries, which means that it is made up of only 10 per cent of world’s nations. However, these 19 countries account for about 80 per cent of global trade and approximately 90 per cent of global GDP 3. The G-20 is therefore representative, more so since it includes both major advanced economies and systemically important emerging market economies. The G-20 has an impact on policies relevant to Africa’s economic development, with the agenda focusing on issues ranging from financial inclusion through infrastructure investment to illicit financial flows. Africa too is important to the G-20, as the continent, while accounting for only 5 per cent of the world’s GDP, makes up 17 per cent of the world’s population. As the only African member country of the G-20, South Africa seeks to advance both regional and continental interests when participating in G-20 deliberations, albeit without a formal mandate to do so. South Africa consults with a number of stakeholders and, regionally, the Committee of Ten African Countries4 (C-10) was formed in 2009 in order to help solicit views from countries across the continent on gross domestic product The C-10 comprises Algeria, Botswana, Cameroon, Egypt, Kenya, Nigeria, South Africa, Tanzania, the Central Bank of Central African States and the Central Bank of West African States. Page 2 of 10 how the G-20 could address their concerns. The C-10 seeks to provide support and input to enable South Africa, or any other African country involved in deliberations related to international finance, to act more effectively in the interest of the continent as a whole. It has to be admitted, however, that the consultation process could be more effective, and that more needs to be done to strengthen these initiatives and to ensure that they work as intended. These efforts are also complemented by the chair of the African Union (AU) and a representative of the New Partnership for Africa’s Development (NEPAD) being invited to attend G-20 meetings as observers. Unfortunately, due to the fact that the AU and NEPAD representatives are often rotated, there is insufficient continuity which, at times, adversely affects effectiveness and impact. Furthermore, the AU has only an observer status, in contrast to the European Commission, which is a fully fledged G-20 member. The role of both the AU and NEPAD could be strengthened to allow them to play a more meaningful part in coordinating the preparation of African positions. As SAIIA has noted in one of its policy briefs, what is required is a concrete, sustainable mechanism through which Africa’s participation can be coordinated.5 It has been suggested that this could include a designated secretariat or a coordinating unit within the AU Commission that would conduct outreach, consult with a range of stakeholders, and put forward African positions at the G-20.6 SAIIA has provided some recommendations on how the capacity constraints on the continent could be addressed, which would entail, among others, the following: collecting information about relevant issues on the G-20 agenda and preparing clear African positions in line with the continent’s overall development objectives, possibly also coordinating African delegations participating in G-20 events, as was done at the time of the Cannes Summit in 2011; E Nnadozie and C G Makokera, Development: ensuring greater African participation, Policy Briefing 117, Economic Diplomacy Programme, November 2014. P Fabricius, Institute for Security Studies, Africa should take advantage of the opportunities presented by its seat at the G-20 table, 9 April 2015. Page 3 of 10 supporting African representatives during the negotiating processes of the G20 in order to promote their greater involvement in agenda-setting and therefore greater influence on the final outcomes in areas of priority interest; and continuously monitoring the implementation of key G-20 commitments directly relevant to Africa in order to ensure that their impact is assessed and to maintain pressure to achieve tangible results. However, while these recommendations are laudable, they require dedicated resources, which may be difficult to mobilise. I would now like to turn to the opportunities for Africa under Germany’s presidency of the G-20. Let me first note that we welcome Germany’s focus on Africa, which builds on efforts by the Chinese presidency last year. We believe that this is a step in the right direction in both highlighting and confronting the challenges that the continent faces. As you know, the German Federal Ministry for Economic Cooperation and Development released a document titled The Marshall plan for Africa two weeks ago, which proposes a partnership between Europe and Africa to find solutions to the challenges the continent confronts. The Marshall plan for Africa acknowledges that ‘in the long term and as neighbours, we can either prosper together or suffer together’. I will not say too much about The Marshall plan for Africa at this stage given that it still requires consultation. Indeed, it has been met with great optimism in some quarters but also with scepticism in others. Let me rather take this opportunity to focus on one of the components of The Marshall plan for Africa, namely the G-20 Compact with Africa, an initiative in which South Africa, through the G-20, is more closely involved. The idea of a Compact with Africa should be welcomed based on what it could achieve given its focus on encouraging private-sector investment, including in infrastructure. By so doing, it is hoped that employment will increase and that sustainable, inclusive growth and development on the continent can be fostered. As we know, the investment financing gap in Africa is huge, and closing this gap is a top priority in order to put the continent Page 4 of 10 on a path of higher and more sustainable growth and development. Under this initiative, African countries are being encouraged to discuss and agree on individual compacts, and to match commitments from G-20 countries with commitments of their own in respect of concrete actions to enhance investment opportunities, such as further enhancing governance standards and creating investor-friendly environments. The G-20 is taking the initiative very seriously and we should expect it to gain momentum in the coming months and beyond. However, we also have to stress that the Compact should take cognisance of existing initiatives by Pan-African organisations such as the AU and NEPAD, as much of the groundwork has already been laid and there is a need to ensure economies of scale by bringing all these initiatives together, fill the existing gaps, and drive implementation in such a way that there is concrete action and tangible results. It is therefore encouraging that both The Marshall plan for Africa and the Compact acknowledge that the starting point will be the AU’s Agenda 2063 and its key pillars around industrialisation, infrastructure development, intra-African trade and combatting illicit flows. Given that the Compact is still in its infancy, that it will take some time for it to become entrenched and for there to be visible outcomes, it will be important that the Compact does not end with the German presidency. We hope that the Compact will be carried forward into Argentina’s presidency in 2018 and beyond, into future G-20 presidencies. We will therefore need to develop mechanisms for hold each other accountable for the commitments we make. 3. Some observations on the T-20 topics under discussion Allow me to now make some comments on two issues that are in the domain of central banking but relate quite closely to some of the topics that you are discussing at this conference. I would like to focus on the issue of de-risking as it relates to correspondent banking and, secondly, on some developments in the digital economy. Much of the work in the G-20 has focussed on improving the resilience of the financial system. The global financial system is stronger and safer now than before the Global Financial Crisis, and regulatory reforms to future-proof the financial Page 5 of 10 system are well under way. However, we have to admit that some of the reforms have had unintended consequences and have led to a number of global systemically important financial institutions reassessing the sustainability of their business models following the Global Financial Crisis; de-risking has consequently taken the form of reducing or withdrawing entirely from certain activities in some emerging market and developing economies. A case in point is the decline in correspondent banking services on the African continent. Research conducted by the BIS7 Committee on Payments and Market Infrastructures (CPMI) Working Group on Correspondent Banking in 2016 highlighted the pronounced declines in correspondent banking relationships in Northern Africa and partly in Southern Africa.8 The International Monetary Fund has similarly pointed out a decline in correspondent banking relationships in banks’ operations in countries such as Angola, Guinea and Liberia where some international banks have either restricted or exited correspondent banking relations.9 Continued efforts by regulators, national authorities and institutions such as the T-20 are crucial in identifying solutions and encouraging concrete and swift actions to mitigate financial exclusion in affected countries while still prioritising efforts to ensure compliance with anti-money laundering and combating the financing of terrorism regulations. Markets in all jurisdictions must have access to a well-functioning global financial system in order to develop and prosper. De-risking and deglobalisation contribute to global financial market fragmentation and uncertainty, and could fatally compromise the open and integrated structure we are all striving for. On the other hand, this trend poses an opportunity for Pan-African banks to fill the gap in services left by European and US10 banks subject to having appropriate access to reserve currencies. Bank for International Settlements BIS CPMI, Correspondent Banking, July 2016. Available at http://www.bis.org/cpmi/publ/d147.htm Erbenová, M., Y. Liu, N. Kyriakos-Saad, A. López-Mejίa, G. Gasha, E. Mathias, M. Norat, F. Fernando and Y. Almeida, “The Wishdrawal of Correspondent Banking Relationships: A Case for Policy Action”, June 2016, IMF Staff Discussion Note series, SDN/16/06. Available at http://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf United States (of America) Page 6 of 10 The second issue I would like to touch on has to do with innovations in the digital economy. Africa in particular shows enormous potential in this area as the broader population gains increasingly more access to the Internet. Developments such as mobile money and e-wallets, P2P lending, alternative credit scoring, cross-border remittances as well as payment technologies leveraging digital platforms support real economic activity and contribute towards the common goal of financial inclusion. Quite rightly, the T-20 Summit in Beijing last year highlighted the importance of innovation as a key driver of sustained economic growth. The G-20 has emphasised the potential role of digital finance in promoting financial inclusion in the G-20 highlevel principles for digital financial inclusion, released in September 2016. There is widespread recognition that the Fourth Industrial Revolution is evolving at an exponential pace, touching almost every fabric of society, with potentially significant implications for almost every sector and industry. This Fourth Industrial Revolution and developments in digital finance hold huge potential for job creation and the promotion of small business development in emerging market and developing economies. According to the Global Information Technology Report 2016, the future of countries, businesses and indeed individuals will depend more than ever on digital technologies. This would apply equally to African countries and businesses, with the added challenge that many of those who stand to gain the most are not yet connected to the web. If we consider that Africa is expected to have a population of 2 billion by 2050, with a significant proportion being young people who will need employment, it is important that we reap the economic and social benefits that the digital economy can provide.11 The latest Networked Readiness Index, which assesses countries’ preparedness to reap the benefits of emerging technologies and to capitalise thereon, reports that seven countries stand out in terms of economic and digital innovation impact: Finland, Israel, the Netherlands, Singapore, Sweden, Switzerland and the United States. Compared to 2015, South Africa’s digital economy has jumped ten places to 65th out of 139 countries surveyed. This makes South Africa one of the ten most11 Baller, S., S. Dutta and B. Lavin (Eds.) (2016),Global Information Technology Report 2016: Innovating in the Digital Economy. Geneva: World Economic Forum Page 7 of 10 improved countries, alongside Italy and Slovakia. But South Africa is not the only African country to improve in the last year; Ethiopia and the Ivory Coast also made significant jumps in the rankings. Africa offers enormous potential for e-commerce growth given that online shopping is in its infancy on the continent. It was mentioned at the e-commerce Africa Confex that, in 2016, e-commerce sales globally would reach almost US$2 trillion, of which Africa’s stake in the pie would be just 2 per cent. However, despite infrastructure challenges across the continent, e-commerce in Africa is expected to see 40 per cent annual growth for the next ten years. Internet penetration jumped from very low levels in 2009 to 16 per cent of individuals in 2013 and over 20 per cent in 2015. But the proportion of people online is still far behind the global average of 50,1 per cent12 – only 17,4 per cent of Africans have access to mobile broadband, while fixed broadband connections remain very low.13 Nonetheless, the prospects for Africa look promising, with 50 per cent of the continent expected to have access to the Internet by 2025 compared to the current 28,7 per cent14 while online shopping could account for as much as 10 per cent of retail sales, or US$75 billion, according to a 2013 McKinsey report.15 With the magnified impact of mobile phones in emerging economies and broader Internet penetration, McKinsey project that the Internet could contribute as much as 10 per cent of GDP to the African economy by 2025, from levels of around 1 per cent currently. For these projections to be realised, there needs to be increased investment in infrastructure, such as expanded access to mobile broadband, fibreoptic cable connections to households, and power-supply expansion. Infrastructure challenges are wider than just ‘bricks and mortar’ – for example, the lack of a formal delivery address complicates the logistics and is costly for online retailers. http://www.internetworldstats.com/stats.htm https://www.itu.int/en/ITU-D/Statistics/Documents/facts/ICTFactsFigures2015.pdf http://www.internetworldstats.com/stats.htm Manyika, J., A. Cabral, L. Moodley, S. Moraje, S. Yeboah-Amankwah, M. Chui and J. Anthonyrajah, Lions go digital: The Internet’s transformative potential in Africa, November 2013. McKinsey Global Institute. Available at http://www.mckinsey.com/industries/high-tech/our-insights/lions-go-digital-theinternets-transformative-potential-in-africa Page 8 of 10 Although digital opportunities are encouraging, especially in the financial sector, numerous regulatory challenges need to be addressed, relating specifically to the development of an innovative and enabling policy environment for financial technology while at the same time managing the risks to consumers and the financial systems. These regulatory challenges would include keeping pace with innovations while crafting smart and appropriate regulations that meet the overarching objectives of financial stability, prudential soundness, consumer protection and competition. Furthermore, we need harmonised rules and consistency among regulators and central banks, both domestically and internationally, and a level playing field between existing regulated entities and new financial technology firms competing for the same business. The emphasis placed by the G-20 and other international standard-setting bodies on sharing cross-border experiences on the regulation of innovative financial technologies is very much supported by South Africa. 4. Conclusion Globalisation, innovation and for that matter increasing vulnerabilities force us to appreciate our interconnectedness and the need for strengthening cooperative relations. In this regard, the T-20 can make a meaningful contribution towards addressing the key challenges on the G-20 agenda, of both the Sherpa and the Finance tracks. I am convinced that, in the coming years, we will collectively make further strides towards the accomplishment of the global objective of strong, sustainable and balanced growth. In doing so, the T-20 can reach out on a continuous basis to non-G-20 think tanks to ensure a more inclusive approach to the initiatives we pursue. Let me conclude by wishing you all the very best in your deliberations on developing recommendations on how African voices could be better integrated into the G-20 agenda and, in so doing, how they could positively contribute towards the ‘Africa rising’ narrative. Page 9 of 10 Allow me to close with a quote from our other T-20 co-chair, Dirk Messner from the German Development Institute: “The world urgently needs a G-20 solving global problems and investing in a global culture of cooperation. ‘Our country first’ movements are threatening stability, wealth and peace in our interdependent world.” Thank you. Page 10 of 10
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the networking lunch co-hosted by the South African German Chamber of Commerce and Industry, the Eastern Cape Economic Development Corporation and the East London Industrial Development Zone, East London, South Africa, 24 February 2017.
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Address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the networking lunch co-hosted by the South African German Chamber of Commerce and Industry, the Eastern Cape Economic Development Corporation and the East London Industrial Development Zone East London, South Africa 24 February 2017 Economic prospects for 2017 1. Introduction Good afternoon, ladies and gentlemen. And to the co-hosts of this networking lunch, allow me to express my gratitude for creating the opportunity for us to interact today. It is not often that I find myself in the Eastern Cape, addressing a business gathering such as this one. I was intrigued to learn a few things about this city, such as the fact that it is home to the only dodo egg in existence and that a remarkable number of our national sports heroes hail from here. The German influence is also quite evident, as reflected by some of the names given to the suburbs and surrounding towns, such as Berlin and Hamburg. Today I would like to engage you on economic developments and some of the main themes which I believe will shape the year ahead for the global and domestic economy. But before I do that, I would like to briefly touch on conditions in this region. 2. Economic situation and developments in the Eastern Cape The Eastern Cape, also known as the Adventure Province and the Province of Possibilities, is an important contributor to South Africa’s economic fortunes. The province is home to around 12 per cent of South Africa’s population and makes up around 8 per cent of South Africa’s GDP1, making it the fourth-largest contributor to GDP.2 The Eastern Cape economy is characterised by the dominance of the secondary and tertiary sectors, with the manufacturing industry accounting for almost 14 per cent of the province’s GDP, while trade and finance contribute approximately 20 per cent each. The automotive sector is an important contributor to manufacturing, accounting for 30 per cent of manufacturing employment and 32 per cent of manufacturing gross value added, generating 51 per cent of the country’s motor exports and producing half of South Africa’s passenger vehicles.3 Unfortunately, the latest growth statistics for the province are disappointing. On a quarter-on-quarter basis, the national economy expanded by an annualised rate of 0,2 per cent in the third quarter while the Eastern Cape economy contracted by 0,3 per cent. On a year-on-year basis, the South African economy grew by 0,7 per cent while the Eastern Cape economy grew by 0,6 per cent.4 Comparing the Eastern Cape to other regions, the province has experienced one of the lowest growth rates in recent years. The decline in its economic activity can mainly be attributed to the manufacturing and trade sectors. This slowdown has mimicked the trend in the national economy, which witnessed a contraction in the manufacturing sector of 3,2 per cent quarter on quarter in the third quarter of 2016 compared to the 8,1 per cent quarter-on-quarter expansion in the previous quarter. gross domestic product Eastern Cape Department of Economic Development, Environmental Affairs and Tourism Province of the Eastern Cape website, www.dedea.gov.za Eastern Cape Socio Economic Consultative Council, Provincial economic growth, December 2016 The latest unemployment statistics from the Quarterly Labour Force Survey show that the number of people employed in the Eastern Cape grew by 5 000 over the fourth quarter of 2016. At the same time, the number of job seekers grew by 9 000, thus resulting in a slight increase in the unemployment rate: it rose by 0,2 of a percentage point to 28,4 per cent in the fourth quarter of 2016 from the third quarter of 2016. Unemployment in the Eastern Cape is thus above the national unemployment rate of 26,5 per cent, which in itself is unacceptably high. Youth unemployment is even higher, with the national figure at 35,6 per cent. And considering that the Eastern Cape is said to have the lowest absorption rate of just over 30 per cent, this means that the challenges in finding a job for the youth in the province are even more daunting. I was, however, very interested to read about the success of the East London industrial zone, which has grown rapidly in the past two years to now account for almost 3 500 direct manufacturing and services jobs, at a time when the manufacturing sector has been struggling considerably. We need more initiatives of this nature to address the unemployment problem in this province. Of promise are the processes put in place by national government to revive rural economies. Here, for example, I refer to the investment programmes in Special Economic Zones and Agri-Parks as well as the training initiatives underway for the youth in the Eastern Cape. The province has also been a strong beneficiary of investment in renewable projects. The Coega Development Corporation has an optimistic outlook for the province in terms of investment, with investment growth expected to reach an estimated R44,6 billion in 2020. Furthermore, the establishment of the Beijing Automobile International Corporation automobile manufacturing plant and other major investment projects within the Coega Industrial Development Zone bodes well for the province. However, much more needs to be done to sustainably raise growth in the Province of Possibilities. The Coega Development Corporation predicts that the province’s economy should perform better going forward, but it is expected to reach a rate of only 2,3 per cent by 20205. The Eastern Cape socio-economic analysis and forecast 2016, A Coega Development Corporation Publication 3. Themes that shaped the global economy in 2016 At the beginning of 2016, the International Monetary Fund (IMF) forecast that global economic activity would increase by 3,4 per cent for the year, with advanced economies projected to grow by 2,1 per cent and emerging market and developing economies (EMDEs) by 4,3 per cent.6 Fast-forward to a year later and the actual outcomes have been weaker, with the projection for 2016 global growth now lowered to 3,1 per cent, advanced economies downgraded to 1,6 per cent and EMDEs to 4,1 per cent. A number of themes and events shaped the economic and financial market landscape during 2016, and I would like to briefly touch on a few of these. At the start of the year, one of the key risks was that of a possible hard landing in China. There were concerns around whether China would achieve an orderly rebalancing of its economy towards domestic consumption and away from exportdriven growth while at the same time dealing with rising financial imbalances and concerns about a potential property bubble bursting. While these risks have not disappeared, they did not materialise as feared and, thus far, Chinese authorities seem to have managed to continue supporting economic activity while navigating the complex transition. China’s economy has undergone a structural shift, where consumption’s share of GDP has increased to over 50 per cent from just over 35 per cent in 2012. Although China’s rebalancing has been negative for commodity exporters, one cannot deny that, in the long term, it could open a path towards more sustainable and balanced growth, and if successful in dealing with domestic challenges, China could contribute to reviving global optimism. It is interesting to note that, in January 2016, the IMF forecast for China’s growth for 2016 was 6,3 per cent; this number has since been revised to 6,7 per cent. International Monetary Fund, World Economic Outlook Update: Subdued Growth, Diminished Prospects, Action Needed, January 2016 The UK7 referendum was the next major event, where the outcome was somewhat of a surprise. The decision to leave the European Union (also known as Brexit) prompted a strong negative reaction from UK financial markets, at least initially. In other parts of the world, financial markets took the news in their stride, bar a few knee-jerk reactions. I would agree with the sentiments that this muted global reaction to Brexit is testament to the much-strengthened financial systems in the aftermath of the latest global financial crisis, although one cannot discount the actions of the advanced economy central banks who stepped in and offered liquidity support to financial markets at the time. Although the initial fallout from Brexit was relatively well-contained, going forward, as the rules of engagement are defined and the terms of the divorce are hammered out, not only will the implications for the UK become clearer, but Brexit will also be a key factor moulding Europe’s economic, financial as well as political landscape. The final major event of 2016 was the outcome of the US8 presidential elections, once again largely unexpected. Many consider this outcome to be a reflection of the backlash against globalisation, and there is a concern that, over the course of 2017, elections in some of the key advanced countries could move in the same direction. Popular opinion has shifted towards a negative narrative, where globalisation is said to be creating unfair competition from foreign firms and labour, with the result that countries are increasingly turning inward. Nonetheless, financial markets have shown resilience against a weak global backdrop. In 2016, we witnessed a historic rally in bonds, in the process raising some concerns over frothy valuations. Corporate bonds also benefitted from the decline in sovereign bond yields. And while it was a mixed bag with regard to currencies, the uncertainty and downside risks from the Brexit decision were certainly reflected in the exchange rate of the British pound. In general, however, the US dollar gained ground on expectations of a higher policy rate. EMDEs regained their allure as emerging market currencies were among the best performers across foreign exchange markets. Commodity prices also recovered from their lows. Finally, United Kingdom United States of America concerns around the risk of US policy normalisation possibly causing some dislocation in financial markets also turned out to be misplaced. All in all, 2016 was a tough year, but one that was better than most of us had feared it would be. 4. A global economy that is expected to turn the corner in 20179 The latest IMF World Economic Outlook (WEO)10 projects a pickup in economic activity over the next two years, driven by EMDEs which are growing at well above the world average. Global growth for 2016 has been estimated at 3,1 per cent and is projected to increase to 3,4 per cent and 3,6 per cent in 2017 and 2018 respectively. It is expected that advanced economies will experience a lift in activity from an estimated 1,6 per cent in 2016 to 2,0 per cent in 2018. The US in particular is projected to grow by 2,3 per cent in 2017 and 2,5 per cent in 2018, from an estimated 1,6 per cent in 2016. Much of this pickup in growth is premised on expectations of fiscal stimulus, tax reforms as well as cuts in both personal and corporate marginal tax rates. Incentives to repatriate corporate profits held abroad are also likely. However, the timing as well as the actual size and mechanics of the fiscal stimulus are highly uncertain at this stage and implementation may take time. It is largely expected that the net stimulus will only take effect by 2018. On the other hand, trade policies and immigration reforms could offset these effects while there could also be a potential drag from a stronger dollar and higher longer-term interest rates. Euro area growth is set to remain steady at 1,6 per cent in both 2017 and 2018. The European Central Bank will be slowing its purchases of bonds from April, and while monetary policy is set to remain accommodative, the decision to slow quantitative easing has already seen the trend towards increasing negative yielding debt reverse, such that more recent numbers point to a deceleration from around US$13 trillion in Unless indicated otherwise, all the forecasts in this section are taken from the International Monetary Fund World Economic Outlook Update of January 2017. International Monetary Fund, A shifting global economic landscape, January 2017 2016 to US$9 trillion more recently. Fiscal authorities appear to be increasingly open to providing fiscal support and implementing structural reforms. However, the potential banking problems in Italy and the rising political risks associated with a number of upcoming elections, including in Germany and France, will likely weigh in. In the UK, the economy has so far proved relatively resilient against Brexit risks, but this is unlikely to be the case going forward; indeed growth is projected to slow from 2,0 per cent in 2016 to 1,4 per cent in 2018. The UK growth forecast for 2017 was revised up by 0,4 per cent in the latest WEO Update, to 1,5 per cent. By all accounts, the deflation fears which once gripped the advanced world, apart from Japan, seem to be abating. This is partly due to the increase in oil prices following the agreement among OPEC11 members and several other major producers to limit supply. Emerging markets are set to accelerate from an estimated growth of 4,1 per cent in 2016 to 4,8 per cent in 2018. As the IMF points out, this projection largely reflects a gradual normalization of conditions in a number of large economies that are currently experiencing macroeconomic strains. China is expected to grow by 6,5 per cent in 2017, as a policy bias of easy fiscal policy and accommodative monetary policy is expected to remain in place. However, the rapid expansion of credit, combined with insufficient progress in addressing corporate debt, raises the risk of a sharper slowdown or a disruptive adjustment. India is forecast to grow by 7,2 per cent in 2017, although this forecast was trimmed somewhat due to the government’s decision to demonetise almost 90 per cent of the currency in circulation. This move induced a temporary negative consumption shock owing to cash shortages and payment disruptions. Both Brazil and Russia are expected to return to positive growth in 2017. So while the global economy is expected to turn the corner this year, there are a number of risks that warrant attention. These include the possible shift towards inward-looking policies, the continued threat of a potentially severe slowdown in China, greater protectionism, a sharper-than-expected tightening in global financial Organization of the Petroleum Exporting Countries conditions (as monetary policy in advanced economies is expected to be less accommodative going forward), and increased geopolitical tensions related to the rise of populism; and Brexit, amongst others. As much as a fiscal stimulus from advanced economies should be positive, the change to a less accommodative monetary policy stance in advanced economies, in particular the US, combined with a stronger US dollar, can have adverse consequences for emerging markets, including accelerating capital outflows and putting the rebound in emerging market economies in jeopardy. However, having said this, it is also true that emerging markets are more resilient than before as macroeconomic fundamentals have improved considerably and vulnerabilities have declined. 5. A domestic economy that is expected to recover in 2017 The domestic economy recovered from negative growth in 2009 to grow at 3,0 per cent in 2010 but slowed to 1,3 per cent in 2015. The challenges mounted such that, at the beginning of 2016, the South African Reserve Bank projected growth of 1,5 per cent for 2016. Some months later, the forecast was lowered to no growth at all. This more pessimistic outlook came on the back of continued disappointing growth outcomes as a result of a severe drought affecting the agricultural and manufacturing sectors, negative growth in the mining sector and a weaker-than-expected global backdrop, combined with political developments affecting business and consumer confidence. Subsequently, however, growth forecasts were revised higher to 0,4 per cent as the second quarter of 2016 delivered a positive growth surprise. This acceleration in growth was short-lived, however, as the third quarter witnessed a slowdown to 0,2 per cent. The primary sector, which had experienced sustained contractions since the second quarter of 2015, saw a real production increase in the second and third quarters of 2016, although this recovery lost momentum in the third quarter. Agricultural production logged seven consecutive quarters of contraction as it continues to recover from a historically severe drought. The manufacturing sector has been very volatile, contracting by 3,2 per cent in the third quarter after growing by 8,1 per cent in the second quarter. The contraction was broad-based as this sector has been hampered by weak global and domestic demand, rising input costs and low business confidence. The construction sector is also under stress, while both retail trade sales and domestic new vehicle sales have continued their negative trend. The employment outlook remains bleak – not surprising given the poor economic situation. The official unemployment rate stood at 26,5 per cent in the fourth quarter of 2016 – down from 27,3 per cent in the third quarter but still about 2 percentage points higher than a year ago. Recent data suggest some downside risks to the 2016 economic growth forecast, such as a continued decline in business and consumer confidence as well as the contraction in mining output during both October and November. And while the Barclays Purchasing Managers’ Index increased to just above 50 in January 2017, it had been in negative territory for five consecutive months. Looking ahead, the most recent growth forecasts of the South African Reserve Bank suggest growth of 1,1 per cent in 2017 and 1,6 per cent in 2018. However, it should be noted that the recent monthly data for the fourth quarter suggest that there may be a downside risk to these forecasts. It is clear that the deceleration in the South African economy has underlying structural causes. The economy’s estimated potential growth rate has been revised downwards to approximately 1,4 per cent. Restoring growth rates to historical averages will require structural reforms, without which the economy is expected to expand at rates of between 1,0 and 2,0 per cent for the foreseeable future, generating little or no improvement in either employment or individual living standards – particularly when considered in the context of the 1,5 per cent annual population growth over the past decade. What is required is an increased focus on reforms in product and labour markets, an environment more conducive to increasing investment levels (particularly in the private sector), and better-quality education outcomes which are more consistent with the future needs of the economy. Ensuring better delivery by state-owned enterprises is also critical given the important role that these entities play in providing the infrastructure to support growth in the economy. It is well known that South Africa has endured an environment of high inflation and low growth, a situation presenting a challenge to monetary policy authorities. The main priority for the South African Reserve Bank is price stability in the interest of balanced and sustainable growth. Faced with this situation, the Monetary Policy Committee (MPC) has increased the repurchase rate gradually since January 2014, by a total of 200 basis points, to the current level of 7,0 per cent. This hiking cycle was more gradual when compared to previous hiking cycles, responding to a more uncertain and volatile policy environment which, given the weakening growth outcomes, at times required the MPC to pause and carefully evaluate incoming data to inform future monetary policy moves. During 2016, there was some upward pressure on consumer prices as these generally remained above the upper end of the 3-6 per cent inflation target range throughout the year. These upward pressures emanated from food price inflation, which increased by close to 12,0 per cent in the final quarter of 2016, the highest increase since 2009 when prices increased in excess of 15 per cent. The upward pressure on food inflation was mainly as a result of the severe drought experienced. The exchange rate of the rand also recorded substantial depreciations at times, such as that which occurred in December 2015 and January 2016, exacerbating the inflation outlook. Underlying inflation, as measured by core inflation (which excludes food, fuel and electricity), is at seven-year highs, which reflects some pass-through from a prolonged period of currency depreciation and pricing behaviour in product and labour markets. The near-term outlook for inflation shows that prices are likely to remain elevated. The latest inflation forecast of the South African Reserve Bank shows that headline inflation may only return to within the target range during the final quarter of 2017, average 6,2 per cent for this year, and decelerate to 5,5 per cent in 2018. This forecast represents a deterioration from the previous MPC forecast of November 2016 and is mainly based on the assumption for higher international oil prices which impact on the domestic fuel prices and more than offset the more favourable exchange rate assumption. By contrast, the forecast for core inflation remains unchanged, averaging 5,5 per cent and 5,2 per cent in 2017 and 2018 respectively. In the most recent MPC statement, published last month, we noted that the inflation forecast is a cause for concern but that the main drivers of this deterioration are supply-side shocks, in particular oil and food prices. As the MPC has noted time and again, its approach is to look through the first-round effects of exogenous shocks but at the same time to exercise vigilance on the possible emergence of second-round effects which could require a policy response. In this regard, while oil prices have now risen from their low levels, various supplyside factors are expected to constrain these prices. Assuming normal weather patterns, food inflation is likely to have peaked at 12,0 per cent towards the end of 2016 and should decline following good rainfall and subsequent declines in spot wheat and maize prices. However, some upward pressure will remain, originating from the lagged response of meat prices to drought conditions. The more favourable rand exchange rate bodes well and, barring any significant depreciation pressures, it should help to offset some of the inflationary pressures in the forecast horizon. Indeed, the rand has been resilient and has strengthened considerably, at times to levels below R13,00 to the US dollar more recently. It is against this background that the most recent MPC deliberations retained the view that we may be near the end of the hiking cycle. However, should risks emerge of second-round effects that undermine the longer-term inflation outlook, there may be a reassessment of this view. Before I conclude, allow me to make a few remarks about a topic that has generated much interest during the last week, namely the outcome of the Competition Commission’s investigation into unlawful collusive practices among certain financial institutions in foreign exchange trading involving the South African rand, predominantly in major international financial centres. The South African Reserve Bank views the allegations that have been referred to the Competition Tribunal for prosecution in a very serious light and is of the view that those found to have violated the law should accept full responsibility for their actions and be held accountable, and corrective measures should be implemented. It is also important, however, that we do not jump to conclusions and allow the steps now initiated to be completed following due process. A resolution of this matter, without undue delay or prolonged uncertainty, is in the interest of our financial markets and banking system, as the allegations also involve a number of large and systemically important South African banks. 6. Conclusion In conclusion, we are hopeful that the global economy has reached a turning point, that growth will now accelerate on a more sustainable basis, and that the threat of deflation in advanced economies will subside. It is important that the levers of fiscal policy, structural reforms and monetary policy are engaged in the appropriate mix so as to underpin the recovery and make it sustainable. The current geopolitical risks will need to be managed carefully so as to not undermine the recovery. No doubt, 2017 will have its own set of challenges. Top of mind here is the impact of the rising anti-globalisation and trade-protectionist rhetoric, the changing monetaryfiscal mix which may present some challenges as the markets adjust to tighter monetary policy in the US, uncertainty regarding the Brexit negotiations, and the actual reforms and stimulus to be implemented by the new US administration. The IMF also highlights that underlying vulnerabilities remain among some large emerging market economies, including high levels of foreign currency denominated corporate debt, declining profitability, weak balance sheets, and thin policy buffers. Domestically, a more favourable global backdrop will certainly help. Having reached the lower turning point in terms of growth and medium-term inflation prospects having improved overall in recent times, it will be important for us to capitalise on these encouraging developments and complement them with confidence-enhancing measures while being mindful of the risks and addressing them in a systematic and structured manner. South Africa is a small and open economy, exposed to many risks beyond its control. This makes it imperative that, through a collaborative national effort, we do not get wrong that which is well within our control. Thank you for your attention.
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Remarks by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the press conference to announce the sale of SARB shares to the general public, South African Reserve Bank, Pretoria, 2 March 2017.
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Remarks by Lesetja Kganyago, Governor of the South African Reserve Bank, at the press conference to announce the sale of SARB shares to the general public South African Reserve Bank, Pretoria 2 March 2017 Members of the media, ladies and gentlemen. We have called today’s media briefing to make South Africans aware of the opportunity to buy shares of the South African Reserve Bank (SARB). How did these shares become available? Some of you will recall that the SARB Act1 was amended in September 2010 to, among other things, limit the shareholding in the SARB to 10 000 shares each for a SARB shareholder and their associates. This means that no shareholder and their immediate family, and/or associates, can collectively own more than 10 000 SARB shares. After some shareholders had failed to comply with the legislative measures pertaining to this limitation of shareholding, the SARB applied for, and was granted, an order by the High Court of South Africa authorising the sale of the shares held by these shareholders and their associates in excess of the statutory limit of 10 000. South African Reserve Bank Act 90 of 1989 Page 1 of 4 The High court order was issued on 4 November 2016: a) Directing affected shareholders, with their associates, to dispose of those SARB shares which they held in excess of 10 000; b) Appointing Investec Securities Proprietary Limited to act as an independent broker to facilitate the disposal of those shares over a period of two years from the date of the order, at a sale price of not less than a pre-determined market price; and c) Directed the General Counsel of the SARB to do all things necessary to enable the sale of the shares, including signing all necessary documentation and providing whatever assistance is necessary to Investec Securities Proprietary Limited. As a result of this process, some 149 200 shares in the SARB have become available for sale. We would like to use this opportunity to diversify our shareholder base, and we would like to encourage all eligible South Africans to take up this opportunity to own shares in the SARB. Any person is eligible to buy shares in the SARB, except if they already hold, together with their associates, 10 000 of these shares. I must emphasise that the SARB does not have a profit-maximising objective; our operations are conducted in the broader interests of the country, in pursuit of the SARB’s mandate and responsibilities. The mandate and independence of the SARB are entrenched in sections 224 and 225 of the Constitution of the Republic of South Africa. In carrying out its mandate, the SARB does not bow to any pressure, be it political or from the private sector. The SARB accounts to the people of South Africa through Parliament. Page 2 of 4 Shareholding in the SARB is based exclusively on the principles of shared community representation and participation in the governance of the SARB in order to enhance the independence, transparency and accountability of the SARB in the interest of all South Africans. The SARB has a total of 2 million ordinary shares and its shareholders are paid a fixed annual dividend of 10 cents per share, as stipulated by the law. SARB shareholders have no say on any policy decisions that the executive management of the SARB takes in implementing the SARB’s constitutional mandate. However, SARB shareholders can elect a maximum of seven non-executive directors of the Board of the SARB from a list of candidates approved by a panel chaired by the Governor of the SARB. These votes are normally exercised at the annual ordinary general meeting (AGM) of the SARB and each shareholder is limited to 1 vote for every 200 shares held. It just so happens that, earlier this week, the SARB put out a call for the nomination of candidates for election as non-executive directors to the Board. I would once again like to encourage all members of the public to nominate candidates who have skills and experience in the mining sector, labour sector and commerce or finance sectors. Nominations close on Friday, 17 March 2017 and forms are available on the SARB website. SARB shareholders can vote from an approved list of candidates following a rigorous pre-qualification process, including an evaluation of the nominees by a panel. Page 3 of 4 SARB shareholders are also required to discuss the Annual Report and the audit reports of the SARB, appoint its external auditors and approve their remuneration, and consider any special business that may have been placed on the agenda of the AGM. In conclusion, let me take this opportunity to once again encourage all South Africans to get a share of the SARB today – and in so doing join the SARB in serving the economic well-being of all South Africans. Thank you. Page 4 of 4
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the annual Financial Markets Department cocktail function, Pretoria, 4 April 2017.
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Remarks by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the annual Financial Markets Department cocktail function Pretoria 4 April 2017 Good evening, ladies and gentlemen. It is once again that time of the year when we welcome you all to the annual cocktail function of the Financial Markets Department of the South African Reserve Bank (SARB). Thank you for accepting our invitation and joining us tonight. Introduction As you are aware, the main idea behind this function is to create a networking opportunity between SARB staff members and other market participants in order to facilitate an exchange of views on financial market developments in a more relaxed environment. This annual event also provides an opportunity for us as the central bank to convey our appreciation for the cooperation we have been receiving from market participants over the past year, both in the execution of open market operations and when we conduct financial markets research to enhance our understanding of market dynamics. These interactions are crucial for our role in the financial markets as we seek to give effect to the monetary policy stance which underpins the execution of our price stability mandate. Page 1 of 9 My colleagues in the Financial Markets Department remind me every year that this is not the occasion to deliver my ‘speech of the year’ but that I am merely a curtainraiser to the main event, namely conducting ‘special’ liquidity management operations. In welcoming you to the SARB, allow me to make a few remarks to take stock of the recent developments in international and domestic financial markets and their implications, last year’s cocktail function being the reference point. Before I conclude I would also like to touch briefly on market conduct issues. I will try and heed the advice that Franklin D. Roosevelt once gave: “Be sincere, be brief, be seated.” Developments in global financial markets Since the previous cocktail function, policy uncertainty has come to dominate price action in global financial markets. Among other things, this is due to what Marvin Barth has called the ‘politics of rage’1, referring to the rise in anti-globalisation sentiment, populist rhetoric, and countries increasingly turning inward. While an element of this uncertainty may have diminished, at least as far as the election outcomes in certain parts of the world are concerned, the outcomes themselves have ushered in a period of unusually high levels of uncertainty as regards policy direction, the timing with regard to the adoption of policies as well as the likelihood of successful implementation. The risks stemming from the possible election outcomes across Europe this year appear to be receding, but one thing last year taught us is that impossible things are possible. As a result of this, global financial markets may well be in for further bumpy rides, not least because market risk indicators such as high-yield corporate bond spreads, the spread on foreign currency emerging market debt, and general equity market volatility – which often reflect investor nervousness – remain low, pointing to a possible dislocation that could understate the downside risk profile to economic growth. Nevertheless, as is the norm, markets have moved ahead of ‘the fact’, for Marvin Barth, The Politics of Rage, 2016, Barclays, United Kingdom. Page 2 of 9 instance pricing in a higher trajectory for US2 economic growth. Analysts expect real GDP3 in the US to average 2.2% in 2017,4 more or less in line with the median projection of the Federal Open Market Committee (FOMC). The positive momentum in terms of growth prospects is not confined to the US and is relatively broad-based, particularly when it comes to advanced economies. Against a backdrop of an improving growth trajectory, economic policy uncertainty presents a new challenge for the already complex environment in which central banks operate – more so because the actual and expected inflation figures are seemingly on an uptrend. For central banks, who have said for so long that rising inflation is a necessary precursor to ‘normalising’ their policies, the macro-financial implications of this increasingly uncertain political environment could complicate monetary policy normalisation. As the forward guidance thresholds are being reached, the question remains whether central banks (specifically those in Europe) will once again re-emphasise the broader notion of economic slack that may result from the current political landscape as an additional qualitative feature of their policies. The UK5 facing headline inflation that is now above the central bank’s official target and, on the other hand, threats to its economic growth is a classic example. The US is in a slightly different position. Having gradually lowered the projected path of its policy rate since the time of our previous cocktail function, the FOMC changed its course in September 2016 and revised upwards the future path of interest rates that it deems most likely to foster outcomes for economic activity and inflation that best satisfy its dual mandate. The FOMC’s projections now point to two additional 25 basis point increases in the federal funds rate following the March hike. These expectations are in line with those implied from Fed funds futures and are also evident in the pricing of US currency and fixed-income markets. The US dollar index has appreciated by 6.2% since April 2016, reflecting the change in the outlook for US monetary policy. At the same time, the US Treasury curve has bear flattened, with yields at the shorter end rising by as much as 60 basis points. United States gross domestic product This was the Bloomberg median forecast as at 23 March 2017. United Kingdom Page 3 of 9 In the emerging market economies, things look slightly better than over the previous year. Soon after last year’s cocktail function, we noted an increase in the universe of negative-yielding bonds that, in an environment dominated by the search for yield, benefited certain emerging markets. During this period, yields on emerging market local- and hard-currency debt declined and equities rallied, but currencies presented a mixed picture, although in most cases still with an appreciation bias. The rally in emerging market assets was largely driven by signs of stabilisation in China’s economy and financial markets, a rebound in energy and other commodity prices, and more supportive central bank policies in developed markets. Furthermore, on the back of the last-mentioned, net capital flows to emerging economies (excluding China) peaked at US$26.1 billion in June 2016, according to estimates by the Institute of International Finance. However, after this June peak and for the remainder of 2016, the build-up to and outcome of the US presidential election sparked a wave of outflows from emerging markets, with portfolio flows estimated to have plummeted to a 41-month low as the so-called ‘Trump Trade’ favoured a stronger US dollar and higher US yields. Emerging market capital flows have since rebounded across the major developing regions but potential headwinds persist, especially given that it cannot be argued that such were in any way related to a change in economic fundamentals. Developments in domestic financial markets Price action in the South African markets was more or less in line with that of other developing economies. The most notable development has been the strengthening of the rand which, by last week, had appreciated to a low of R12.31 against the US dollar since our previous cocktail function. This was the strongest that the rand had traded since mid-2015. On a trade-weighted basis, the South African currency had appreciated by about 19%. Page 4 of 9 This rally can be attributed to a number of factors, including the pickup in commodity prices, investor positioning, and a reprieve from international credit rating agencies regarding a possible downgrade of South Africa to sub-investment grade. The rand was also supported by more favourable terms of trade and an improvement in the current account balance that has reduced the perceived vulnerability of the currency to possible capital flow reversals. This made the rand more resilient even during externally induced risk-off episodes, appreciating alongside a stronger US dollar and/or depreciating by less compared to its emerging market peers. Other financial assets followed a similar path of appreciation over the year. Bond yields rallied and breakeven inflation declined. The yield on the benchmark R186 bond had declined from just over 9% a year ago to a low last week of 8.32% while breakeven inflation on the R197 (5-year) inflation-linked bond declined from 7.2% in April last year to around 5.8% last week. With the lower inflation expectations, the (FRA) market had, by last week, priced in more than one rate cut by the first quarter of 2018, with the 12x15 FRA trading below 7.0%. The Monetary Policy Committee (MPC) noted the improvement in the inflation outlook, which over the past year had allowed multiple downward revisions to the forecast, and expressed last week, at the conclusion of its most recent meeting, the view that we may have reached the end of the moderate tightening cycle. According to our most recent forecast, we expect headline inflation to fall below 6% in the second quarter of 2017 and to remain within the target range for the remainder of the forecast horizon. Notwithstanding the fact that there was one member of the MPC who preferred a 25 basis point reduction in the repo rate at the March meeting, the general feeling was that evidence of a more sustained improvement in the inflation outlook is required before interest rates can be reduced. The MPC remains concerned about the elevated levels of inflation expectations that are still around the upper end of the inflation target band. Page 5 of 9 As you are aware, some of the positive trends we had been observing were interrupted by political events during the last week, which triggered a significant movement in the financial markets. Since last Monday, the rand traded in a range of 163 cents, between its strongest level of R12.31 to the dollar on Monday and its weakest level of R13.94 around midday today. The currency did, however, appreciate somewhat and was at levels of around R13.55 to the dollar earlier this afternoon. The R186 yield also lost most of the gains it had made last year and is now trading at just above 9.0%. The 12x15 FRA is back to 7.49%, implying an unchanged repo rate for next year. Financial markets will likely need more time to fully process the recent political events and their economic consequences. It remains to be seen whether the recent market developments represent a reassessment or a repricing of the South African credit. It is similarly too early to draw any firm conclusions on how these developments will affect SARB’s own inflation forecasts. The MPC has previously cautioned that, should some of the factors which had contributed to a more favourable outlook reverse and undermine the inflation outlook, it may reassess its views; the MPC stands ready to respond appropriately in line with its mandate should the need arise. Yesterday’s decision by S&P Global Ratings to lower South Africa long-term foreign currency sovereign credit rating to sub-investment grade, with a continuing negative outlook, is a serious setback for the country. We will now need to redouble our efforts in providing assurance and communicating continued commitment to sound macro-economic policies and their consistent and predictable implementation, so as to reverse the current ratings trajectory. This will require a continued collaborative effort between Government, business and labour to boost domestic and international investor confidence. Page 6 of 9 Market conduct developments Before I conclude, let me touch on an issue that has been receiving some attention recently. While it is true that traders and investors need to continually evaluate the fundamental drivers of asset prices, the behaviour of market participants should always meet the highest conduct standards. Ensuring and continuously promoting adherence to high standards of ethical conduct is an integral part of contributing to the efficiency, integrity and reputation of our financial markets. The Competition Commission of South Africa has referred for prosecution to the Competition Tribunal allegations of collusive and therefore unlawful practices among certain financial institutions in their foreign exchange trading operations involving the rand. As stated previously, the SARB views these allegations in a very serious light and is of the view that those found to have violated the law should accept full responsibility and bear the consequences. However, it is also important that we do not jump to conclusions and allow the steps now initiated to be completed, following due process. Building on the review of foreign exchange operations of local authorised dealers conducted in 2015, National Treasury, the Financial Services Board and the SARB will soon embark on a more comprehensive review of conduct in the wholesale money, debt capital, foreign exchange, commodities and derivatives markets in South Africa in order to strengthen market conduct. The exercise is expected to be similar to the Fair and Effective Markets Review conducted in the UK. The review, which is scheduled to commence next month (with further details to be announced in due course), will look at the standards and practices in South Africa’s wholesale financial markets, both regulated and unregulated, in terms of governance, accountability and incentives; it will ultimately develop recommendations for overall conduct standards to enhance the integrity of our financial markets. Page 7 of 9 The Bank for International Settlements is in the process of developing a Global Code of Conduct for Foreign Exchange Markets which will set out the principles of good practice in the foreign exchange market. The code will be released on 25 May 2017. The SARB participated in its development and is now in the process of consulting with a wide range of market participants via the Foreign Exchange Subcommittee of the Financial Markets Liaison Group with the view that South Africa should be an early adopter of the code within any proposed time frames. Conclusion Let me conclude by once again expressing, on behalf of the Financial Markets Department and the entire SARB, our appreciation to all the market participants for their cooperation and support over the years. We look forward to continuing our interactions in the future. I would like to thank our financial markets team for the sterling work over the past year, for their dedication and commitment to the task. Allow me to also draw to your attention some changes that have taken place in the senior management of the Financial Markets Department. In preparation for the upcoming retirement of Mr Callie Hugo in 2018, with effect from 01 April 2017 Callie assumed the role of Special Projects Manager in the office of the Head of Department. Mr Zafar Parker, who previously headed up our Reserves Management team, has taken over from him as Head: Market Intelligence and Operations this week. While Callie still has his work cut out for 15 months or so, it is only proper that we already thank him today for his tremendous contribution in guiding our money market operations over many, many years. Thank you also to our staff at the Conference Centre for organising this event. Page 8 of 9 As in previous years, a newsletter called FMD Update has been prepared for the occasion, which provides information on some of the key strategic initiatives that the Financial Markets Department is involved in. It is available for you to take home, but you can also find it on our website. Thank you for your attention. Enjoy the rest of the evening. Page 9 of 9
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of KwaZulu-Natal, Durban, 25 April 2017.
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Monetary Policy: Why we target inflation – an address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of KwaZuluNatal Durban 25 April 2017 Good evening, and thank you for the opportunity to deliver this lecture on why we target inflation. Introduction South Africa is at an intensely contested, creative moment in its history. The country is energetically debating the problems we face and the policies we should implement to fix these problems. Many of these problems have no straightforward answers. But if we are to fix them, it is appropriate that we take risks, conduct experiments, and accept some chance of failure. However, not all our policies need to be experimental.1 It is crucial that we get this distinction right. Let me illustrate this point with a medical analogy. If you go to the doctor with an incurable disease, you may well accept some experimental, high-risk treatment. But for flu you should just accept regular medicine. Some medical practitioners may tell you that their medicine is better and that it will also bring back your lost lover, but this promise is always too good to be true. A similar point has been made by India’s previous Reserve Bank Governor, Raghuram Rajan. See The fight against inflation: a measure of our institutional development (http://www.bis.org/review/r160628f.htm). Page 1 of 12 Similarly, there may be socio-economic problems that require experimentation. But for most problems we already have tried and tested solutions, many of them based on other countries’ experiences and a vast literature. We know which policies work and which cause economic damage. We also know that many economic problems take time to resolve, improving the education of our people to increase productivity and incomes perhaps the best example. With this in mind, it would be inexcusable to implement policies that have been proven to cause lasting economic damage; the ability to learn from our own history and that of others is within our grasp. Today, I would like to address some frequently asked questions to explain the design of our monetary policy framework. I will discuss why we target inflation and not some other variable, like unemployment. I will talk about who bears a disproportionate brunt of inflation and why inflation is essentially a badly designed tax that increases poverty and inequality. I will also explain how inflation targeting keeps interest rates low and why it is therefore an important element of developmental policy. How inflation targeting keeps interest rates low From time to time, I hear the argument that if we did not target inflation, we could have lower interest rates. Another version of this argument is that if we had a higher inflation target, then interest rates could come down. These claims make superficial sense but are fundamentally wrong. In fact, higher inflation raises interest rates. The best way to get permanently lower interest rates is to bring down inflation – and then keep it low and predictable. To understand why this is so, let us start with a few basic concepts. The Fisher equation says that the interest rate charged for a loan will include expected inflation plus a real rate of interest.2 The inflation part of the interest rate ensures that a lender gets their initial capital back when the loan is repaid; if that does not happen, then the loan is actually partly a gift because, thanks to inflation, a portion of the loan is not being paid back. On top of that is a small payment to the lender because the capital cannot be used for other purposes while it is with the borrower. Furthermore, This equation, also called the Fisher effect, was originally set out by Irving Fisher in his 1930 classic, The theory of interest. Page 2 of 12 the lender gets paid some insurance against the borrower defaulting. Therefore, if you think inflation will be 10%, you will start with a 10% interest rate and then add these terms and risk premiums. These premiums are normally quite small, unless uncertainty and/or risk are very high. The largest part of the interest cost is inflation. This implies that lowering inflation is the easiest way to lower interest rates. Consider another example. The South African government borrows in both local and foreign currency. When it borrows for 10 years in rand, it pays an interest rate of close to 9%. But when it borrows in US3 dollars, the interest rate is a little below 5%.4 In both cases the borrower is the same. The most important difference between the two cases is that the rand loses value faster than the dollar: US inflation is normally close to 2% while South African inflation has been nearer to 6%. Accordingly, lenders demand a higher interest rate on the rand debt to compensate for inflation and inflation risk. Another example comes from Europe. Before 2000, different European countries had different currencies. Germany borrowed in Deutsche marks, France in francs, and Italy in lira. Some of Europe’s countries had higher average inflation rates than others, and inflation was also more variable, meaning that it sometimes got out of control. In other countries – Germany being the prime example – inflation was much lower and more stable. So during the 1980s, for instance, West German inflation averaged 2.9%, French inflation was 7.6%, and Italian inflation was 11.4%. No doubt you can see what this did to borrowing costs: the spread of government borrowing costs over West Germany was, on average, 4.1% for France and 7.1% for Italy; where the West Germans could borrow at about 8%, the French had to pay nearly 12% and the Italians almost 15%. United States For the year to date, the rand-denominated South African government bond maturing in 2026 has earned 8.73%. The equivalent US dollar-denominated bond yield has been 4.69% over the same period. Page 3 of 12 To lower borrowing costs, European governments realised they needed to bring down inflation and make a credible promise to keep it low. To achieve this, they created the euro, a currency controlled by an independent central bank situated in Germany and modelled on the Deutsche Bundesbank, the German central bank. It worked: by the time the euro became a binding commitment, French and Italian borrowing costs were very close to Germany’s, and the other countries which had committed to the euro had a similar experience. Of course, the experience after the 2007/08 global financial crisis illustrates the cost of giving up monetary policy to an external agency, and in particular the cost of giving up a country’s own flexible exchange rate. This seems especially true for peripheral economies that needed greater economic adjustment. For others, like Germany, one might also conclude that interest rates can sometimes be too low, hampering efficient credit allocation and causing asset price bubbles. The clearest lesson remains, however, that a low and stable inflation policy generates low interest rates over time, not high interest rates. For a final example, consider the policy rates in other emerging markets which are similar to South Africa. This is a little different to the examples mentioned above, because these are very short-term rates and they are set by central banks, not in markets. The example is interesting also because these are the rates which critics of monetary policy think could be lowered if inflation targets were higher. Since 2005, the average repo rate in South Africa has been 7.1%. Over the same period, it has been 5.7% in Colombia, 5.4% in Mexico, 4.1% in Chile, and 4.0% in Peru. Over this period, all of these countries have had lower inflation and lower inflation targets than South Africa. Their headline inflation has averaged between 3.0% and 4.5%, whereas South Africa’s inflation has averaged about 6.0%. Of course, policy rates have moved up and down in all these Latin American countries over time. But they have fluctuated around a lower average precisely because their inflation is lower. People who believe that a higher inflation target will lower rates need to explain why countries with lower targets and lower inflation have lower interest rates, including emerging markets very similar to South Africa. Page 4 of 12 When we were planning South Africa’s monetary policy framework back in the 1990s, we came from a difficult starting point. Inflation was relatively variable and also quite high, averaging 9% between 1994 and 1999. We set out to stabilise inflation and anchor expectations through an inflation-targeting framework, and we chose to accumulate reserves to enhance South Africa’s robustness to external shocks. These reforms paid off: within a few years, we closed the forward position and inflation expectations stabilised within the inflation target range. We have been benefiting from these policies ever since. There is one instance, of course, in which inflation can bring down interest rates, and that is by reducing the real value of debt so that it is worth less when repayment is due. But this only works once. If you can persuade a lender that inflation will be 6% but then inflation is actually 10%, you can reduce your real interest rate by 4%. Of course, this is bad for the lender. Yet it is also bad for the borrower. Lenders will not be fooled twice, so the next time you want to borrow, your interest rate will now be at least 4% higher, with a larger risk premium in case inflation surprises again. You may also be unable to borrow in your own currency, especially over the longer term, because people will rather lend in euros or dollars to protect themselves from inflation risk. This will make it more difficult to finance major investments that pay off over longer periods of time, and it will increase vulnerability to currency depreciation. For this reason, using inflation to get low interest rates may work once, but after that it always means higher interest rates. Who benefits from low inflation? Low inflation is desirable for reasons beyond low interest rates. One of the most important is that inflation has adverse redistributional consequences. Some people can protect themselves from inflation and even profit from it. Other people are less fortunate. Inflation is therefore essentially a regressive tax – a tax which impoverishes those whom society should really be helping. Page 5 of 12 To protect yourself from inflation, you need knowledge, power and assets that hold their real value. Inflation was 6.3% in South Africa last year. If your salary of R6 000 went up to R6 300, you did not get a raise because you only got 5% more. You got a pay cut in real terms. If you had R20 000 in a savings account and you earned R1 000 in interest, you are now poorer than you were last year. Not understanding these concepts makes people vulnerable to inflation. Furthermore, even where people do understand inflation, they may lack the negotiating power to respond. If you have a strong union to negotiate on your behalf or if you have scarce skills your employer needs, then you should be able to negotiate a raise big enough to keep up with inflation. Unfortunately, many South Africans are not in such an advantageous position. Although data limitations preclude an exact measurement of this point, we get some sense of its scale from the Labour Force Dynamics report published by Statistics South Africa. It shows that, between 2010 and 2015, the median wage in South Africa increased by just 6.9%. The median for skilled people increased by 37.8%. The price level rose by 30.0%. This strongly implies that some earnings are better protected from inflation than others.5 Finally, inflation affects wealth. For a rich South African with shares in big companies and some real estate, more inflation is not much of a problem. Those big companies can just charge higher prices and their foreign operations will continue to earn foreign currency, so their equity valuations will at least stay constant in real terms. Similarly, house prices can adjust and a house will still have the same real value, irrespective of the level of the price index. Yet if you depend on a fixed income, perhaps from money in a savings account or from an annuity, inflation is expensive. For these reasons, it is better to keep inflation low rather than let high inflation hurt the poor and exacerbate inequality between the people privileged with knowledge, power and assets, and those without. See by Statistics South Africa (http://www.statssa.gov.za/publications/Report-02-11-02/Report-0211-022015.pdf). Page 6 of 12 A low interest rate policy that raises inflation is effectively a tax that takes money away from people lacking knowledge, power and protected forms of wealth, and gives it to borrowers and the people who sell to them. We have a tax system that works the way it does precisely because there are more efficient and progressive ways to transfer financial resources. Should the South African Reserve Bank also target employment or unemployment rate? Many people agree that low inflation is beneficial, and they appreciate the efforts of the South African Reserve Bank (or SARB) to keep it low. Their question, though, is whether the SARB could do more, such as targeting unemployment rate, in the same way the US Federal Reserve has twin mandates for low inflation and low unemployment. South Africa has a terrible unemployment problem which has lasted for at least two decades. It therefore makes sense that we should be looking for creative solutions to the problem. However, the central bank is not well placed to solve this with monetary policy. The first reason for this is that almost all of South Africa’s unemployment is explained by structural factors, not the kind of cyclical factors that can be addressed by changes in interest rates. The second reason is that monetary policy is already sensitive to cyclical factors; the difference in approach between a dual-mandate central bank (like the Fed) and a more straightforward, single-mandate inflation targeter (like the SARB) is quite small. One of the more important concepts in macroeconomics has the acronym NAIRU; it stands for the ‘non-accelerating inflation rate of unemployment’. When the unemployment rate is near the NAIRU rate, then wages start accelerating and this generates price inflation. By contrast, when unemployment is above the NAIRU rate, wage pressure is weak and this keeps firms’ costs down, so inflation is softer. The best a central bank can do is to stabilise unemployment at its natural rate. If a central bank attempts to get unemployment below the NAIRU rate, the result will be more inflation but only a small and temporary increase in the number of jobs. Page 7 of 12 What, then, is the NAIRU rate in South Africa? It is difficult to estimate, in part because the relevant data are incomplete. As policymakers, we usually find that other measures, such as the output gap and capacity utilisation, are more useful. Nonetheless, our best estimate of the NAIRU rate is in the region of 25%.6 This is a very high level. In the US, where the concept is heavily used, the corresponding number is currently estimated at around 4.6%.7 The difference between the two is explained by the structural factors I alluded to earlier. One of these factors is spatial patterns. Many South Africans do not live close enough to where the job opportunities are. Another factor is skills constraints. Employers would like to hire people but cannot find people with the skills they need.8 High unemployment is also affected by the design of our labour market institutions, which tend to penalise small businesses and favour larger firms.9 Looser monetary policies will not get our people Bachelor of Science degrees or move their residences closer to where the job opportunities are. Nor will lower interest rates reform our labour markets. The scope for reducing unemployment through monetary policy is therefore much smaller than its proponents perhaps imagine. For all those reasons, the difference that a dual mandate would make for the central bank would probably also be small. Consider how the Fed implements its dual mandate. It sets out a goal for inflation, which it specifies as 2%. This goal is fixed over time: there is no policy of aiming for higher inflation when unemployment is high, or vice versa. See ‘Estimating a time-varying Phillip’s curve for South Africa’, South African Reserve Bank Working Paper 16(05), by A Kabundi, E Schaling and M Some, published in May 2016 (http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7277/WP1605.pdf). This is according to Congressional Budget Office estimates of the short-term natural rate of unemployment, available from the FRED database (https://fred.stlouisfed.org/series/NROUST). See REDI3x3 conference: policies for inclusive growth by M Leibbrandt and P Green, published in February 2017 (http://www.econ3x3.org/sites/default/files/articles/Leibbrandt%20%26%20Green%202017%20REDI %20conference%20on%20inclusive%20growth%20FINAL_0.pdf). See ‘High unemployment yet few small firms: the role of centralised bargaining in South Africa’, American Economic Journal: Applied Economics 4(3), by J R Magruder, published in July 2012. Page 8 of 12 That said, as long as the Fed has credibility around its price stability mandate, meaning that as long as its commitment to 2% is believed, there is scope for flexibility.10 For this reason, interest rate decisions tend to respond to both inflation and employment dynamics. As the economist John Taylor has shown, one can predict the path of interest rates quite accurately by using simple rules that include the deviation of inflation from the target and the deviation of unemployment from the NAIRU rate. At the SARB, we also look at these sorts of rules. We do not use them to dictate policy, but we certainly consider both inflation and the real economy when we set interest rates. This is why the Taylor rules for South Africa have a weighting on both the output gap and inflation relative to the target.11 This should also be clear from any statement of the SARB’s Monetary Policy Committee (MPC) or from the biannual Monetary Policy Review, all of which are available on our website. There are two ‘takeaways’ from this discussion. Even a central bank with an employment mandate will still behave like an inflation targeter. And inflation-targeting central banks also consider real variables such as growth and unemployment when they make monetary policy. Conclusion Central banks have the power to deliver low inflation. Where monetary policymakers have adopted other priorities, such as financing governments or prioritising high employment, they have caused widespread economic damage. In such cases, countries have struggled with higher inflation, higher borrowing costs and eventually As former Chairman Ben Bernanke once explained: “The key to explaining why price stability promotes stability in both output and employment is the realization that, when inflation itself is wellcontrolled, then the public’s expectations of inflation will also be low and stable. In a virtuous circle, stable inflation expectations help the central bank to keep inflation low even as it retains substantial freedom to respond to disturbances to the broader economy.” From The benefits of price stability published on 24 February 2006 (https://www.federalreserve.gov/newsevents/speech/bernanke20060224a.htm). See, for instance, ‘A revised Quarterly Projection Model for South Africa’, South African Reserve Bank Working Paper 15(3), by S de Jager, M Johnston and R Steinbach, published in August 2015 (https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/6839/WP1503.pdf). Page 9 of 12 high economic costs to reverse earlier policy mistakes. Such policies tend to exacerbate inequality and deepen poverty. By contrast, when monetary policy starts with a strong commitment to price stability (which is the case with inflation targeting), it can also offer other benefits. A credible monetary policy can be more flexible, meaning it can do more about any short-term deviations of employment and output from natural rates. A credible monetary policy can also keep borrowing costs lower than they would otherwise be. This is a central benefit to long-term economic growth and job creation. When inflation rises and stays high, investment decisions are distorted towards short-term investments that carry with them short-term jobs. For this reason, low inflation is a sound developmental policy. It encourages firms across the private and public sectors to make long-term investment decisions that imply productivity growth over time. This is critical, indeed a prerequisite, for sustainable jobs and income growth. Critics often miss the fact that monetary policy is about creating a healthy long-run environment for investment and consumption, where inflation is predictable and purchasing power is protected. They just want us to cut interest rates, in part because they equate long-run economic growth with household consumption. They think a good decision is a cut of 25 basis points and a better decision is a bigger cut. Unfortunately, this does not always work out well. Household debt rises if productivity and incomes do not also increase, and this boom eventually turns into a bust, with marginal workers getting hurt the most. Consumption based on rising debt levels cannot be a sustainable growth and development strategy. Growth and development can be built on a low inflation and low interest rate strategy but, as I have emphasised, they need to go together. Individual interest rate decisions can be difficult, and we often have vigorous debates in MPC meetings about the exact policy stance. At times, different people will favour a somewhat higher or lower repo rate. We all agree, however, that the larger policy framework is the right one. It does more for South Africa than the alternatives would because it allows for flexibility while being grounded in how to best support long-term sustainable economic growth and job creation. Interest rates do go up and down, but on average they are lower than they would be otherwise. Inflation is under control, Page 10 of 12 which reduces poverty and inequality. We are more flexible precisely because we have more credibility. We have built this framework up over many years, and it is one of this country’s strengths. Thank you. Page 11 of 12 Supplementary charts Government borrowing costs Germany Italy France Per cent -5 1980 - 1983 - 1986 - 1989 - 1992 - 1995 - 1998 - 2001 - 2004 - 2007 - 2010 - 2013 - 2016 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Central Bank rates for EMs similar to SA Per cent 2005/01/31 Colombia 2008/01/31 Mexico 2011/01/31 2014/01/31 South Africa Page 12 of 12 Chile 2017/01/31 Peru
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the "Managing Capital Flows: Challenges for Developing Economies Conference", Livingstone, Zambia, 5 May 2017.
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Remarks by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Managing Capital Flows: Challenges for Developing Economies Conference Livingstone, Zambia 5 May 2017 Good afternoon, ladies and gentlemen. Let me start by thanking the International Monetary Fund (IMF) for inviting the South African Reserve Bank to be a part of this conference – and in these rather spectacular and splendid surroundings. As many of you will know, the Victoria Falls next to us were declared one of the seven natural wonders of the world. Luckily, the issues we have been asked to address today do not leave us at the mercy of nature, but are rather about the choices we need to make to ensure that we harness the good that comes with international capital flows while managing the risk of damage that they admittedly may cause under certain circumstances. 1. Introduction In this session, we have been asked to provide some concrete advice to policymakers in light of what has been discussed during the course of the day. When I read this, I was reminded of an old Zambian saying: “One who enters the forest does not listen to the breaking of twigs in the bush.” This speaks to remaining focused on one’s particular task despite what one may see or hear in the process of the quest. Unfortunately, when it comes to providing advice on managing capital flows, one tends to hear many twigs breaking. This is a complicated task. Any piece of advice cannot be based on generalisations or extrapolations as country-specific factors and features of the financial system, as well as the time at which measures are considered, are of critical importance. In my remarks today, rather than dispensing concrete advice on liberalisation and volatility management, I will restrict myself to making some general observations on capital flow management, followed by sharing experiences from South Africa. I will leave it to you to judge which of our experiences could be useful in certain environments and which should rather be avoided. What will be successful or effective will be highly dependent on countryspecific circumstances, although we should always be cognisant of the potential spillover effects of our individual and collective actions. 2. Views on the liberalisation of capital flows It is an undisputed fact that most countries have made impressive progress in the liberalisation of their capital flows in order to reap the benefits of capital inflows while remaining mindful of the unintended consequences of these inflows. According to the IMF publication titled Capital flows: review of experience with the institutional view, published in December 2016, the average number of easing measures introduced between 2013 and 2016 amounted to 851, with almost 60% representing easing by emerging market economies. China, Colombia, India, Indonesia, Malaysia, South Africa and Thailand introduced about 127 easing measures. During the same period, only 233 tightening measures were introduced, with more than half representing emerging market economies. In order to rationalise this behaviour, it is perhaps at this point worth recapping some benefits of capital flows. Countries with a liberalised capital account tend to be able to tap into foreign savings to invest in infrastructural projects that contribute to sustainable domestic employment creation and generate income to service the underlying debt. The other benefit relates to the typically ensuing technology transfer and financial market development and innovation that assist countries in increasing the absorption capacity of flows without distorting the macroeconomic fundamentals. Needless to say, opening a country’s capital account also increases its vulnerability to the changing conditions in global financial markets. The most fundamental and intricate rule about the liberalisation of the capital account is that the process has to be well thought through in terms of timing and sequencing in order to minimise costs and unintended consequences. The manner in which these controls are eased should be tailored to a country’s specific circumstances and economic objectives. Careful planning ensures that macroeconomic stability is maintained over time and that the benefits outweigh the costs. The IMF has recommended a phased approach to capital flow liberalisation, prioritising the liberalisation of stable flows such as foreign direct investment, which are closely correlated with growth, before more volatile and short-term portfolio flows. It further recommends that the relaxation of controls on capital inflows be prioritised before capital outflows. As Napoleon Bonaparte once said: “Forethought we may have, undoubtedly, but not foresight.” Some countries which may have planned the process of capital account liberalisation and subsequently met some macroeconomic preconditions to liberalisation (like strong and stable growth, low inflation, and high levels of foreign reserves) might in retrospect discover that they have liberalised prematurely or too rapidly. While the liberalisation of the capital account is generally associated with the abolishing of capital flows measures that confine capital mobility, the reimposition of temporary controls in instances where the openness was prematurely or too rapidly undertaken or posed a risk to macroeconomic and/or financial stability may be justified. If a country has liberalised at too fast a pace than its economy was able to handle, temporary and limited measures may be effective in providing some stability until macroeconomic adjustments and policies have created, once again, a more suitable environment that can support the free movement of capital. As stated earlier and according to the institutional view of the IMF, it is permissible to reimpose capital flow measures on a temporary basis when the excessive flows pose a risk to the macroeconomic and/or financial stability of the country. More so, the Code of Liberalisation of Capital Movements of the Organisation for Economic Co-operation and Development (OECD), established in 1961 and currently under review, provides an established process of international dialogue and cooperation with regard to the management of capital flows. In addition, the Code serves as the platform for countries adhering to it to explain their policies on capital controls and raise questions about the policies of others. Ideally, one would prefer to avoid a situation where capital flow measures are reimposed. However, it would be important to accept the burden of explaining rather than putting financial systems and economies at risk for fear of being accused of having committed policy mistakes. Ongoing engagement and collaboration to stay abreast of the developments in the capital liberalisation of other countries, including exchanging views and sharing experiences at conferences such as this one, is necessary to both avoid the need to possibly reimpose capital flow measures and be better prepared should the need to reimpose arise. To further the international debate on understanding and managing capital flows better, including the macroprudential tools that have a capital flow intent, the G201 re-established in 2016 the International Financial Architecture Working Group which is in the process of compiling a report on its work for the G20 Hamburg Summit scheduled for July this year. 3. The case of South Africa The administration of exchange controls is a function delegated to the South African Reserve Bank by the Minister of Finance. South Africa has progressively liberalised its exchange control framework since 1994, removing all restrictions on the capital flows of nonresidents. These initiatives were undertaken with the explicit objective of attracting investment into South Africa. As a result of this predetermined approach, South Africa has thus far never found itself having to reimpose capital controls but has instead endeavoured to minimise the barriers on residents, enabling domestic firms to expand internationally, particularly into Africa. In South Africa, the sequencing of liberalising controls by type of flow was generally broadbased for both inward and outward flows. The country does not have restrictions on inward capital flows and these inflows have thus far been effective in adequately financing the deficit on the current account of the balance of payments. The country’s reliance on portfolio inflows makes it difficult to impose measures that may dry up this source of funding. Regarding outward capital flows, a phased as opposed to a ‘big bang’ approach was adopted to ensure that financial stability was maintained. The sequencing started with current account transactions, followed by removing controls on non-residents capital flow, direct foreign investments by South African corporates, and finally allowing for the diversification of the portfolios of institutional investors. This approach was followed also because of the large amount of domestic savings after years of tightening. Although prudential limits to regulate the foreign exposure of domestic institutional investors still exist, 1 Group of Twenty they have a built-in stabilising effect, such that as the rand depreciates, the institutions closer to their limit will breach the threshold and will over time be required to repatriate the funds. As the only source of knowledge is experience, allow me at this point to share our use of the policy toolkit for managing capital flows. The policy response to capital flows is embedded in maintaining macroeconomic policy discipline and strengthening the depth and regulation of financial markets. The flexible exchange rate continues to act as a shock absorber, where the currency is allowed to strengthen if it is not deemed overvalued relative to the fundamentals or to weaken if it is not deemed undervalued. In a nutshell, South Africa has a relatively hands-off approach to managing capital inflows while monetary policy is not focused on the exchange rate but rather on the possible inflationary implications of exchange rate changes. However, during periods of sustained inflows, the authorities accumulated foreign exchange reserves, without in any way seeking to influence the exchange rate towards a particular level or range. During periods of large capital outflows, such as in the final quarter of 2008, the South African Reserve authorities deemed it inappropriate to impose capital control measures on outflows, for the following reasons: According to the 2016 results of the triennial survey conducted by the Bank for International Settlements, about two thirds of rand trading occurs in offshore markets. Any domestic capital flow restrictions will therefore have little to no impact on this trading but could rather lead to an increase in offshore trading. The risk of the prevailing domestic financial stability being disturbed if the exchange rate were to depreciate is limited by the fact that both the private sector and government borrow mainly in the local currency. There is no major mismatch between South African banks’ foreign assets and liabilities, which are both moderate relative to the size of their total balance sheets. The low level of foreign currency-denominated indebtedness protects balance sheets as it limits the impact of sudden stops on the accessibility of foreign liabilities. Large corporates also adopt strategies, such as hedging, to manage exchange rate volatility. South Africa recorded a positive net international investment position in September 2015, the first time on record (since 1956). The national balance sheet acts as a stabilising mechanism as a weaker exchange rate increases the value of South Africa’s foreign assets. South Africa’s view on capital account liberalisation and capital flow management is aligned with the institutional view of the IMF. As an enhanced engagement member of the OECD Advisory Task Force Committee (ATFC) with no voting rights, the country has been fully engaged in the ongoing review of the OECD Code. Continued cooperation between the IMF and the OECD remains crucial for addressing any perception that countries might receive seemingly conflicting signals regarding the appropriateness of capital flow measures, and is helpful in enhancing the consistency between the IMF’s institutional view and OECD approaches with the G20 Coherent Conclusions for the Management of Capital Flows. This cooperation is also crucial for ensuring that the approaches by various international organisations do not give rise to any conflicting policy advice. Participation in the ATFC affords South Africa an opportunity to learn about the effective use of capital flow measures from a full description of the experiences of other countries. The work on capital flow management by the IMF and the OECD is also crucial for the macroprudential framework and the policy tools that are being developed by the South African Reserve Bank. The constant updating on the developmental work on capital flow management, which forms part of the G20 agenda on the reform of the international monetary system, under the International Financial Architecture Working Group, is crucial in the construction of a macroprudential framework and policy tools currently under consideration by the South African Reserve Bank. In addition to reviewing its capital flow measures framework, South Africa is continuously pursuing efforts to further modernise its regulatory framework through reforms in its financial regulatory and supervisory architecture. In 2016, the South African Reserve Bank published, as part of its financial stability mandate, a proposed macroprudential policy framework for the South African financial system and its regulated entities. Although this macroprudential framework is currently silent on capital flow measures that have a macroprudential intent, the inclusion of capital flow measures in South Africa’s macroprudential framework is an integral part of the South African Reserve Bank’s current research agenda. While acknowledging the role of foreign savings in financing domestic demand, it is of utmost importance to develop a toolkit of macroprudential measures required to deal with credit and asset price cycles driven by global capital flows. I must, however, stress that the prudent way of dealing with volatile capital flows is to maintain disciplined macroeconomic and countercyclical policies during periods of inflows to ensure that the economy is resilient should outflows occur. In a broader context, it is important for source countries of capital flows to be cognisant of the role and effect of their measures on the policies of recipient countries. Improved global policy coordination will help to mitigate the unintended spillovers from country-specific policies and will add stability to and improve efficiency in the global financial system. In summary, South Africa has made remarkable strides in liberalising capital controls since 1994, especially on non-resident investors. Exchange control restrictions on foreign investment by private individual residents in South Africa have been progressively relaxed since 1997, such that the current limits are no longer a constraint. It is estimated that by now less than 3% of individuals are ‘somewhat constrained’ by the remaining exchange controls. Limits on outward foreign direct investments for corporates have also been abolished. And as a step towards prudential regulations, institutional investors are permitted to invest abroad, subject to a foreign exposure asset limit (currently 25% or 35% depending on the type of institutional investor). With every experience there is a lesson to be learnt; the progressive liberalisation of the exchange controls came at the cost of losing key information on cross-border flows that is crucial for macroeconomic policy decisions. It was at this point that the authorities strengthened the cross-border system for monitoring and reporting. As the process of applying for approval of foreign exchange was largely eliminated, authorities were also required to strengthen regulatory, supervisory, inspection and monitoring roles to prevent the illegal export of capital. The illicit flow of capital is currently a big challenge for most countries that have liberalised capital control measures, but that is a topic for another day. 4. Conclusion In conclusion, I would like to reiterate the IMF’s views on the importance of maintaining sound policies and strong frameworks, including monetary policy and exchange rate flexibility, as the first line of defence against excessive capital flows. Robust macroprudential measures as well as capital flow management measures can serve as a supplementary defence mechanism, where warranted. The macroeconomic environment should encourage domestic savings and the deepening of financial markets so that capital flows can be effectively absorbed and channelled towards productive investment. The work on capital flow management by the IMF and the OECD, which forms part of the G20 agenda on the reform of the international monetary system, under the International Financial Architecture Working Group, is crucial in the construction of a macroprudential framework and policy tools currently under consideration by various countries. Therefore, a more consistent global approach to capital flow management issues among various international frameworks and agreements should be facilitated, including addressing data gaps. We therefore welcome and support the current collaboration between the IMF, the OECD, the G20 and the Bank for International Settlements in this area. Thank you.
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the ACI South Africa - The Financial Markets Association, Johannesburg, 1 June 2017.
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Remarks by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the ACI South Africa – The Financial Markets Association Market conduct and market best practice Johannesburg 1 June 2017 Introduction Good evening, ladies and gentlemen. Thank you to ACI South Africa for inviting me this evening, and for creating the opportunity for us to interact on the very pertinent subject of market conduct issues and best market practice. In the over 60 years of its existence, ACI has made good progress in influencing industry behaviour and supporting market best practice, with member education and the promotion of the highest standards of ethical conduct being among the core principles guiding the work of the ACI worldwide. It is indeed always a pleasure to engage with you as our partners in the financial markets as we continue to strive towards promoting more effective and more efficient foreign exchange markets, our collective efforts aimed at increasing transparency, minimising risks, and enhancing confidence between ourselves as market participants and the people we serve. About 15 months ago, the South African Reserve Bank (SARB) co-hosted, with the Group of Thirty (G30) and Barclays Africa, a forum on banking conduct and culture. At the time, we spoke extensively about the enormous trust deficit that had built up since the global financial Page 1 of 8 crisis as well as about efforts to restore confidence and trust not only in banks, but also in the effective and efficient functioning of financial markets. The G30 had just released a report, titled Banking conduct and culture: a call for sustained and comprehensive reform, which is still very relevant today, not least because the implementation of required conduct reforms has been somewhat slow. The focus of that G30 Forum was mainly on banks because, as Sir David Walker of the G30 had put it, ‘the social externalities of banking are as great as, if not greater than, those of any other “business”’. Moreover, the majority of the conduct issues that we are grappling with has originated from the banking sector, be it issues around reference rates, as we saw with the Libor scandal in 2012, or the manipulation of foreign exchange rates and benchmark fixings, including, as you know, allegations of distorting competition being levelled at certain institutions trading in our own currency. Focusing on banks, however, should not be construed to suggest that we should be less worried about the role played by other financial services providers and in the process inadvertently create scope for arbitrage opportunities. Today, we have broadened the scope of our activities to recognise this and to avoid an unintended consequence of creating an uneven playing field that could fuel financial disintermediation. I will talk more about broadening the scope of our initiatives later when I give a review of what we have already implemented and are still in the process of implementing here in South Africa. Often, when misconduct has occurred, there tends to be the temptation to look to increased regulation as the best way to go about fixing the problem. As I said at the G30 Forum, it is preferable for market participants to self-correct on the basis of guidelines (not rules) that are developed to address integrity within banks as well as between banks and other stakeholders in the financial services industry – all in the interest of financial stability and the longevity of the role of banking in financial systems. Longer-lasting solutions are required to embed the correct culture rather than to impose conduct rules and police market participants. The financial services industry needs a fundamental shift in its mind-set on culture – that which is a value system that shapes the way in which we do business and contributes to building and maintaining trust. This is not to say that these value systems do not exist; I just think that the need to ‘meet targets’ in a profit-driven environment often Page 2 of 8 supersedes other goals and creates conflicts of interest. A regulatory response should be the last resort, only when there is clear evidence that self-regulation has failed. All market participants should ensure that the performance assessment and compensation of employees takes adequate account of governance, compliance and market conduct – and not solely of profits generated. Individuals who do not meet a specified threshold of acceptable behaviour that is aligned to their employer’s value system and conduct expectations should feel the direct effect on their discretionary compensation. To guide this, the Financial Stability Board (FSB) has developed a set of principles for sound compensation practices; the aim of these principles is to reduce incentives for excessive risk taking that may arise from the structure of compensation schemes in significant financial institutions. As a member of the FSB, South Africa subscribes fully to these principles. Moreover, advancement in the financial services industry should increasingly recognise the behaviour and conduct of employees. This should be done in the spirit of encouraging the type of behaviour that is aligned to the desired culture and addressing lapses by holding those responsible accountable. The leadership should be seen to be leading by example. The desired culture and conduct should cascade from top to bottom. Boards of directors and chief executive officers should also change their behaviour from recognising just the results to also embracing the ‘how’ aspect that should talk more to the manner in which the results were achieved. The financial markets review Let me return to my earlier remark about the initiatives of regulatory authorities in overseeing market conduct. It is very important to emphasise that the initiatives which we have thus far embarked on are not about creating rules of conduct, but are meant to be guiding principles intended to create consensus on the standards of market practice. The Fixed Income, Currencies and Commodities Markets Standards Board (FMSB) in the United Kingdom (UK) is a good example of what this means. The FMSB is a private-sector body , which cooperates closely with the official sector, with a mission to create and enhance standards of behaviour by Page 3 of 8 developing principles of good conduct. Since its inception in 2015 the FMSB has already issued standards relating to ‘Reference Price Transactions for the Fixed Income Markets’, Binary Option for the Commodities Market, and New Issue Process Standard for the Fixed Income Markets’. South Africa is working on establishing a standards group similar to the FMSB as part of a broader financial markets review. The former Minister of Finance announced in his Budget Speech in February 2017 that a financial markets review, modelled on the Fair and Effective Markets Review in the UK – which gave rise to the formation of the FMSB just mentioned – would be undertaken in 2017. This work has already started and market participants will be consulted as part of the process. The review will focus on conduct practices aimed at improving effectiveness to the benefit of market participants and customers. This review exercise will be a lot more comprehensive than the initial foreign exchange review that the SARB and the Financial Services conducted in 2014; it will consider conduct in the wholesale money, debt capital, foreign exchange, commodities and derivatives markets. The Financial Markets Review Committee (FMRC) – which operates under the guidance of a joint steering committee comprising National Treasury, the Financial Services Board and the SARB – will look mainly into the following aspects in relation to market conduct: Review the standards and practices in South Africa’s wholesale financial markets, both regulated and unregulated. Review governance, accountability and incentives in wholesale financial markets. Develop overarching principles for conduct and integrity to provide a consistent framework for specific reforms in wholesale financial markets. Identify any gaps in the legislation, regulation and/or supervision of conduct in wholesale financial markets, to be addressed through the market conduct policy framework under the Twin Peaks model of regulation. Identify and incorporate the role of global standards and good practice in South Africa’s regulatory approach to wholesale financial markets. Develop recommendations for regulators on a pre-emptive, outcomes-focused and risk-based approach to conduct and integrity in wholesale financial markets. Facilitate the establishment of a market-led Financial Markets Standards Group. Page 4 of 8 The FMRC will develop an overarching definition and high-level principles of sound conduct and integrity for wholesale financial markets. The recommendations will focus on specific tools to strengthen the implementation and governance of conduct standards by market participants as well as on areas where changes to financial markets legislation and associated subordinate legislation are required to support a new conduct framework for wholesale financial markets. This area of work will evaluate the concept of market integrity in South Africa and will set out the expected outcomes that characterise market integrity. It will examine how, where appropriate, the market integrity objective can be given effect through legislation and market-led initiatives. The review will examine existing initiatives relating to wholesale market conduct and incorporate these work streams under the recommendations. The review will not duplicate work that has already been undertaken or is in progress but will rather draw on conclusions and recommendations, where available. To ensure that this is not a one-off exercise to tick a box that we, like other jurisdictions, have conducted a market review, a Financial Markets Standards Group will be established with the objective of sustaining the good practice standards for wholesale financial markets. The mandate of the FMRC indicates that its focus is much broader than just the banking sector. This is one of the ways in which we are trying to prevent the unintended consequence of creating an uneven playing field. This approach is meant to recognise the evolution of asset managers and hedge funds, for example, from being niche businesses to playing a more important role in the financial system. The financial markets review, which we hope will be completed by the end of 2018, is just one of many initiatives that South Africa has embarked on. Allow me to now touch briefly on the other initiatives that are also aimed at strengthening market conduct. The Twin Peaks model of financial regulation Very relevant to our discussions here today is the introduction of the Twin Peaks model of financial regulation in South Africa that proposes a new approach to the regulation of market conduct, namely through the establishment of a standalone conduct authority for the financial services industry. This proposal was first put forward by National Treasury in 2011 Page 5 of 8 and I am sure everyone here is aware of what the plan is going forward. Nonetheless, let me remind you that, among other things, the proposed conduct authority will have a mandate to enhance and support the integrity and efficiency of the domestic financial system. This mandate will be provided for in the Financial Sector Regulation Bill which is expected to confer powers on the SARB (as the Prudential Authority) and the Financial Services Board (as the Financial Sector Conduct Regulator) to preserve and enhance financial stability and to improve market conduct in order to protect financial customers. Codes of conduct In the wake of the recent scandals of market manipulation, South Africa has been very active in the development of codes of conduct, starting with the Jibar1 Code of Conduct in 2012, the Code of Conduct for authorised Over-the-counter (OTC) Derivative Providers is in the process of being finalised and, most recently, the Code of Conduct for wholesale OTC financial markets (OTC Code) which is still in a developmental phase, having had the benefit of input from relevant financial market stakeholders. It is envisaged that a number of other specialist codes of conduct will be developed for different segments of the wholesale financial markets, with the OTC Code serving as a general code for those market participants who are not covered by a specific code of conduct pertaining to their market segment. As regards the foreign exchange market, many of you will be aware that the BIS Foreign Exchange Working Group released the Global Foreign Exchange Code (the Global Code) last week, which addresses, in a comprehensive manner, best practice covering areas such as market ethics and information sharing, but also tackles complex issues such as electronic trading and algorithmic trading. This is the first time that a single, unified, global code was established, providing guidance and principles that can apply across many jurisdictions and market segments. The SARB was afforded the opportunity to participate in the development of the Global Code. South Africa has become a member of an expanded and formalised Global Foreign Exchange Committee, whose objectives are to promote collaboration among local foreign exchange committees, to exchange views on trends and developments in 1 Johannesburg Interbank Agreed Rate Page 6 of 8 global foreign exchange markets, and to promote, maintain and update the Global Code on a regular basis to ensure its continued relevance. Each member foreign exchange committee designates a central bank and private sector representative for the Global Foreign Exchange Committee. Following consultations with the Financial Markets Liaison Group and its foreign exchange subcommittee, we have endorsed and adopted the Global Code. This endorsement of the Global Foreign Exchange Code implies that we are now committed to evolving our own institutions’ foreign exchange practices to be consistent with the principles outlined in the Code. This will include a review of the structure of our local foreign exchange committee over the next few months. We believe that this code is a big step in the right direction and will contribute to strengthening standards in foreign exchange markets around the globe. The Global Code contains principles of good practice that provide a common set of guidelines to the market, with the intention of promoting the integrity and effective functioning of the relevant financial markets without imposing legal or regulatory obligations on market participants; the Code is not a substitute for regulation. Having endorsed the Global Code, the SARB will strive to adhere to it in its own market operations and, over time, we would also expect counterparties that we transact with in the foreign exchange market to confirm their commitment and adherence to the Global Code for them to continue to be eligible counterparties. Conclusion I would like to conclude by saying that we are still some distance away from the finish line when it comes to inculcating the highest standards of conduct and market best practice. And it is not the job of the regulators alone to cross that line; it is the job of the financial sector as a whole. We recognise the contributions that each of you makes towards strengthening the standards of market practice. In continuing to do so, I would like to appeal to you to take very seriously the challenge of aligning your current culture to the desired culture. There is definitely the need for a fundamental shift in the mind-set of the financial services industry on the issue of culture; more regulation is not necessarily the best way to go about fixing problematic conduct. Page 7 of 8 I am pleased to note that, following the launch of the Global Code last week, ACI Worldwide has announced that it has developed a new ACI Global Foreign Exchange Code Certificate aligned to the principles and practices of the new code. This initiative is certainly a step in the right direction to promote the integrity and effectiveness of the foreign exchange market. Let me use this opportunity to ask for your cooperation with our current review of the standards and practices in the domestic wholesale financial markets. The committee that has been appointed to carry out this review will soon be on your doorsteps, seeking to engage with you on various aspects relating to the structure of the financial markets. Together we can make it work. Thank you very much. Page 8 of 8
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the SANEF Nat Nakasa Awards Ceremony, Durban, 10 June 2017.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the SANEF Nat Nakasa Awards Ceremony Durban 10 June 2017 Good evening, ladies and gentlemen. Thank you to SANEF, the South African National Editors Forum, for the invitation to address you this evening. As we all know, South Africa is going through a turbulent period at the moment – and this puts an enormous responsibility on the press to report on and interpret events in an open and balanced way. South Africa has a long tradition of journalists, such as Nat Nakasa, fighting for and trying to preserve media freedom, particularly during the era when the freedom of the press was an anathema. It is a testament to the resilience of our institutions that the country’s post-1994 new-found press freedom endures till today, despite noises from some quarters trying to undermine it. I salute all those of you who have carried on this tradition and have been nominated for the award tonight. You do not need the Governor of the South African Reserve Bank to tell you about your role in society. In my address this evening, I would prefer to talk about the governance of monetary policy decision-making processes and our accountability as the country's central bank. Page 1 of 10 Accountability means that we have to explain ourselves to the public. One of the most important channels through which we account to the public is the media. So our relationship with the media is of critical importance. Some of you would have read the monetary policy statements that we publish at the conclusion of our Monetary Policy Committee (MPC) meetings; some of you would have seen me reading out the MPC statement at the press conference which is broadcast live on television. In this statement, the South African Reserve Bank (SARB) sets out how we view the state of the global and domestic economy – and how the situation impacts on our outlook for inflation. At the end of the statement, we announce the policy rate decision. This decision regarding interest rates is of enormous importance to the economy in general, and it affects most people, either directly or indirectly. This raises the question as to how these decisions are made, the governance around the MPC decision-making process, and our accountability. Central banks are generally viewed as conservative institutions, and 'conservative' implies a reluctance to change. However, there have been significant changes in how central banks operate in the last few decades. I would like to highlight the three main aspects to this central bank evolution or, perhaps more appropriately, revolution. The first is the move towards monetary policy independence. Many people assume that independence has been common practice since the establishment of central banks. But this is not the case. It is something that has evolved over time. In fact, the Bank of England, which in literature is often held up as the epitome of 'best practice' in central banking, was only granted monetary policy independence in 1997. Before then, all monetary policy decisions were taken by the Chancellor of the Exchequer, with the Bank of England merely implementing those decisions. One of the theoretical rationales for an independent central bank is to avoid the socalled 'political electoral cycles' in monetary policy, which is the tendency of governments to lower interest rates or loosen monetary policy before an election and then tightening them afterwards. Having a central bank with a time horizon that is longer than the electoral cycle should ensure that monetary policy decisions are not Page 2 of 10 subject to political pressures. In other words, it should avoid the possibility of taking advantage of short-term and temporary positive trade-offs which ultimately lead to longer-term pain. These cycles are well documented in a number of countries. In South Africa, the SARB reportedly lowered interest rates in advance of the Primrose byelection in 1984, only to raise them again a few weeks after the election. The granting of operational independence to central banks has meant that monetary policy was in essence handed over to non-elected officials. Holding them accountable would require well-defined goals for monetary policy and effective channels of communication. This resulted in the second step of the revolution: a sea change in monetary policy communication. From being highly secretive institutions, central banks have become masters of communication, with communication strategy in fact now regarded as one of their policy tools. This change coincided with the evolving view of how monetary policy should be conducted. The idea that monetary policy should surprise the markets made way for the current conventional wisdom that central banks should guide the markets – and this requires open communication as well. The third aspect of this central bank revolution is the move from a single decision maker to committee-based decision making. Historically, monetary policy decisions were generally made by the Governor, perhaps with a committee in a purely advisory role. But along with this change came the need for governance structures around the decision-making process. I should point out that inflation-targeting frameworks emerged hand in hand with these developments, which are entirely consistent with this framework. In fact, they had a symbiotic relationship. Inflation targeting requires a clear objective for monetary policy, and independence of decision making is therefore of the essence. Inflation targeting works partly through anchoring inflation expectations, and for this, clear and credible communication is required. For credibility, there needs to be transparency of policy objectives and of decision making. Independence also requires accountability. Therefore, good governance structures relating to committee workings and decision making are also important. Page 3 of 10 While decision making by committee is not a prerequisite for inflation targeting, there are good arguments for it. It is an irony, however, that in New Zealand, the first country to adopt inflation targeting, the Governor is the sole decision maker. He does take advice from a committee, but the decision is ultimately his. This is mainly because the Policy Targets Agreement that the Governor signs with the government makes him personally responsible for achieving the target. His job is on the line if the target is missed. There is a sizeable literature on the relative efficiency of committee-based decision making. The general conclusion appears to be that, subject to certain features being present, a committee structure outperforms individual decision making. A committee tends to pool information and ideas from a group comprising different skills and views, and it also provides insurance against extreme preferences and outcomes. One of the arguments against committees is that they tend to be inertial and over time may be subject to 'group think'. The structure and governance frameworks of monetary policy committees differ across countries. Sometimes this is because of the legislative environment that governs the committees. In other instances, the institutional design and processes of the committee are determined by past practice and institutional culture and traditions, as well as by the mix of people and personalities. To give some examples. In the United Kingdom, the MPC consists of internal and external members, with the latter appointed by the Chancellor. Each member is individually responsible for his or her vote and has to explain, if asked, for example by a parliamentary committee, why they voted in a particular way. In the European Central Bank (ECB), by contrast, each member state appoints one member to the Governing Council, the main decision-making body of the ECB. Each member has a vote and these votes are not revealed; the Governing Council takes collective responsibility. The United States practice is a bit more complex. The Federal Open Market Committee (FOMC) consists of the 7 members of the Board of Governors of the Page 4 of 10 Federal Reserve System, the President of the Federal Reserve Bank of New York, and 4 of the remaining 11 Reserve Bank Presidents who serve one-year terms on a rotating basis. The Presidents of all the other Reserve Banks attend the meetings but they do not have a vote. The voting record of the FOMC is made public. Revealing the individual members' votes does not necessarily mean that there is a democratic outcome. Alan Blinder, the former Vice Chair of the Board of Governors of the Federal Reserve System, refers the possibility of 'autocratic collegial' processes where the Chair’s preference is likely to be the consensus outcome. It is well documented that under Alan Greenspan’s chairmanship of the Fed, for example, there was a tradition that no more than two members would vote against the Chair’s wishes. In such instances, while there is an appearance of democratic processes, the reality may be quite different. What is the practice in South Africa? The primary goal of the SARB is the maintenance of price stability. This is confirmed in the Constitution of the country, and we have applied policy within an inflation-targeting framework since February 2000. The target in effect quantifies our constitutional mandate. The Constitution is, however, silent on how monetary policy should be conducted, and this allows for monetary policy practices to evolve over time. The 'how' is discretionary, and the Constitution gives the SARB autonomy or independence in making these policy decisions. An MPC was first constituted in October 1999. Prior to this, decisions were made by the Governor at times that were not pre-set. Generally, announcements were a surprise, made on late Friday afternoons after the local financial markets had closed. With the introduction of inflation targeting, practices have evolved. It is not my intention to outline all these changes here tonight, but I would rather like to focus on the current practice. Monetary policy decisions are made by the MPC, which currently comprises six members: the Governor, the three Deputy Governors, and two other senior officials of the SARB. The composition and workings of the MPC are governed by internal terms Page 5 of 10 of reference, which make provision for up to four senior officials apart from the four governors. The choice of these officials is the prerogative of the Governor, after consultation with the Deputy Governors. These appointments are not ex-officio and are therefore not automatically related to a specific position within the SARB. Rather, they are focused on the contribution that particular individuals can make to the monetary policy decision-making process. But within these constraints, we also have to be mindful of the gender composition of the MPC, which is currently all male. This explains the absence of a full complement as provided for in the terms of reference, and it is something that we are working hard at to rectify. Every monetary policy decision is an outcome of in-depth discussion and debate. Even a 'no change' decision is a policy decision. I should also note that the monetary policy decision is not a one-off event; it is a continuous process which culminates in the MPC meeting where decisions are finally taken. We are constantly talking to each other, discussing what we see and how we interpret what we see. These discussions are not only amongst MPC members, but also with other staff members in the SARB who keep us updated about developments. We also interact with analysts outside the SARB, and we hear what they are thinking as well. A few days before each meeting we receive further documentation prepared by various units in the SARB, so by the time we have the MPC meeting, we are well prepared! MPC meetings last three days. The first day of the MPC meeting is devoted to discussions about global and domestic economic and financial market developments. This part of the meeting is attended by the MPC as well as about 55 other staff members. Each presentation is followed by a discussion, where we interrogate the presenters and their colleagues. All attendees are invited to contribute to this discussion. At this point, however, there is no discussion of the policy stance. The following morning is devoted to a discussion of the forecast. These deliberations are attended by some members of the modelling team as well as about eight other senior officials, apart from the MPC members. The outputs of two of the main models are presented and discussed. Page 6 of 10 Given the centrality of the forecast, it is important to say something about the role of the forecast in the monetary policy decision-making process. Monetary policy acts with a lag. According to our models, the full impact of a change in interest rates could take between 12 and 18 months to fully work its way through the economy to impact on GDP1 and inflation. For this reason, monetary policy decisions need to be based on the expected path of inflation and not on current inflation, which is a function of past monetary policy. The forecast is therefore of central importance and is given much attention, both in our deliberations and in our communication of the monetary policy stance. Given this, it is important that there are appropriate governance structures around the forecast. We are aware that there is a possibility that the forecasters themselves could bias the forecast in such a way as to influence the direction of the policy stance. One way in which we ensure that this does not happen is by making the MPC members part of the process that decides on the assumptions regarding the exogenous variables of the model. This in effect makes the MPC ultimately responsible for the forecast. The assumptions can make a material difference to the outcome of the longer-term inflation forecast. These assumptions, which have to be made to cover each quarter over the three-year forecast period, include international oil prices, international commodity prices, global inflation, and the starting point for the real effective exchange rate. The assumptions are finalised at a meeting about two weeks before an MPC meeting. In the interest of transparency, these assumptions of the exogenous variables are published as an annexure to monetary policy statement. The SARB's core model has also been published, and this allows analysts to compare forecasts and understand the source of the differences in forecasts that may arise. I should also emphasise that we do not follow the forecast in a mechanical way. If we did, we could simply hand over the decision to a computer which would tell us the appropriate policy path to follow in order to ensure that inflation is brought back into 1 gross domestic product Page 7 of 10 target within an appropriate and achievable time horizon. We know that models are merely an approximation of reality and are therefore prone to error. Furthermore, we know that the assumptions that we make could also turn out to be incorrect. Each MPC member would have their own view about the risks to the assumptions and therefore to the forecast. Ultimately, we have to rely on our own judgement. Following the presentation of the forecast, the MPC has a session with a few key staff to get their views. Thereafter, the MPC members meet on their own, where they review the highlights of the previous two days. The MPC then meets on the following morning, where each member sets out his view of the economy and policy preference. This is not a repeat of the facts, but rather an assessment of how the information received confirms our priors and how it affects the assessment of the risks to the outlook. After a presentation by each MPC member, the other members can raise questions or debate issues raised in the presentation. The debates that follow the presentations are inevitably robust. But while there are disagreements, the atmosphere is collegial and marked by mutual respect. There have been instances where members changed their policy stance after these debates, but this was because they had been convinced by other arguments, not because of pressure from peers or from the chair. It has been a long-standing tradition of the MPC that the views of the majority carry the day. A vote different to that of the Governor is not regarded as 'dissent’, but rather as an expression of a different viewpoint, which is encouraged. In the event that the preferences are evenly split, the Governor has the casting say. Disagreements at South Africa's MPC are quite common and reflect an absence of group think. Of the past 16 meetings, only half were unanimous. In the other seven, there were 4-2 splits on three occasions, 5-1 splits on three occasions, and a 3-3 split on one occasion. On one occasion, three members preferred a 50 basis point increase, two preferred a 25 basis point increase, and one preferred no change in the policy rate. Page 8 of 10 The preferences are revealed in the monetary policy statement, although we do not reveal individual member preferences. As I noted earlier, there are different practices in this respect. Our view is that identifying the individual votes would place excessive focus on the individual rather than on the decision. While we do allow for different opinions and views, we take collective responsibility once a decision is made. An important part of accountability is the communication of the decision. We do this in various ways. First, we do not publish the transcripts of the MPC meetings. There is much debate globally about this. Experience in other countries shows that publishing the transcripts of committee deliberations could stifle debate and result in an excessive reliance on prepared statements that are read out. We do, however, release a statement at the end of each meeting. The statement outlines how the MPC sees the economy, the reasons for its policy stance, the assessment of the risks, the voting preferences, as well as some qualitative forward guidance. The statement is read out at a press conference that is televised live on a number of channels; it is also streamed live on the SARB website. All MPC members constitute the press conference panel, and questions are taken from the press and other analysts who can dial in. Accountability and transparency are further enhanced through the biannual publication of the Monetary Policy Review (MPR), in which an in-depth analysis of the monetary policy stance is presented. The MPR is launched at a national Monetary Policy Forum (MPF), with all MPC members on the panel; the launch is open to all interested stakeholders. The MPF is usually attended by more than 300 people. Thereafter, a series of regional MPFs is conducted, with at least one MPC member as chair, at about nine different venues around the country. As part of our communication strategy, we also arrange stakeholder engagements. We regularly meet with foreign and domestic asset managers and investors. Our outreach programme includes different groups from the broader society. These include trade unions, business associations and political parties. We also have an economic round-table discussion with economic analysts every alternate month, and we engage regularly with the academic community. Ultimately, we are accountable to Parliament. The SARB's Annual Report is presented to the parliamentary Standing Page 9 of 10 Committee on Finance, and we report to the committee whenever requested by Parliament to do so. Last but not least, the press and general news media are an integral part of our communication strategy. Not only do the media report what we say, but they also interpret (and in some cases misinterpret) what we say. In order to improve the understanding of our thinking, and to encourage accurate coverage, the MPC meets with editors from the main publications at least twice a year, and once a year with senior journalists. And in order to enhance the quality of financial journalism, the SARB sponsors a Chair in Financial Journalism at Rhodes University. The steps towards communication and transparency undertaken by central banks and the SARB in particular have been significant. While we have our own communication strategies, we cannot do this without close interaction with the press and broader media. We depend on each other. The press in South Africa has a proud tradition of being open, vibrant and questioning. I am sure that you, present here this evening, will carry on this tradition. My heartiest congratulations go to the winner of the award. Thank you. Page 10 of 10
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Remarks by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the annual dinner in honour of the Ambassadors and High Commissioners to the Republic of South Africa, Pretoria, 7 June 2017.
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Remarks by Lesetja Kganyago, Governor of the South African Reserve Bank, at the annual dinner in honour of the Ambassadors and High Commissioners to the Republic of South Africa South African Reserve Bank, Pretoria 7 June 2017 Introduction Dean of the Diplomatic Corps, Ambassadors, High Commissioners, Counsellors and Diplomats – a very good evening to you all. Thank you for accepting our invitation to this event, which has become a permanent feature on our calendar. South Africa has its fair share of challenges. Our country finds itself at an intensely contested but creative moment in its history. South Africans are energetically debating the problems we face today and the policies we should be implementing to fix these problems. Notwithstanding these challenges, South Africa has a number of positive things going for it, not least of which are its institutions, which remain resilient. However, it is not my intention to bore you with the developments in South Africa tonight. I would prefer to use the limited time I have on this podium to touch on global economic developments and say a bit more about some of the initiatives that the South African Reserve Bank (SARB) has been involved in on the continent and in other global forums. I will be brief, so that we can enjoy the excellent food and wine on offer tonight. A global economy experiencing a cyclical recovery Page 1 of 7 Over the past few years, the world has had to become accustomed to disappointing global growth outcomes. Therefore, when the International Monetary Fund (IMF) identified 2016 as the turning point in the global growth cycle and upgraded the outlook for the global economy for 2017, it came as a welcome surprise. Broad-based gains were pencilled in across both the developed world and emerging markets. It seemed that the many years of accommodative and often unorthodox monetary policy, coupled with the more recent easier fiscal policy in the advanced economies, had helped to propel the global economy into a cyclical upswing. But despite the promising short-term outlook, a number of challenges and risks persist, and I would like to highlight a few of these. The shift towards more inward-looking policies threatens to derail global trade, with negative consequences for growth. And the lack of progress in the implementation of some of the financial regulatory reforms agreed on since the most recent global financial crisis, such as finalising the capital framework under Basel III, is also something we need to address as it threatens to create an uneven global playing field, putting some countries at a disadvantage by creating space for regulatory arbitrage. Policy uncertainty in many countries, specifically the uncertainty arising from the tax proposals in the United States, also warrants careful attention. Furthermore, more aggressive monetary policy actions than currently anticipated could tighten global financial conditions, causing disruptions to capital flows to emerging market and developing economies (EMDEs) like South Africa. So while the short-term outlook is an optimistic one, there is general recognition that we cannot afford to be complacent. Securing a sustained recovery over the medium term requires stronger international cooperation. Allow me to highlight some of the initiatives in this regard. International cooperation Page 2 of 7 International forums such as the G201 and BRICS2 continue to give attention to initiatives aimed at supporting stronger, more sustainable, balanced, and inclusive growth. As part of that, the G20 and BRICS also give much attention to improving the resilience of the global financial system. Structural reforms have been a key objective of the G20 and have consequently been receiving greater emphasis since the Australian Presidency of the G20 in 2014. These reforms are aimed at raising the collective G20 GDP3 by an additional 2% by 2018. Each G20 country has devised a growth strategy, highlighting the key structural reforms to be undertaken to raise potential output. Every year, member countries update their growth strategies (which are peer-reviewed), new measures are committed to (where possible), and progress towards the stated objectives is assessed. Under China’s G20 Presidency in 2016, the structural reform agenda was further enhanced by the development of a set of priorities and guiding principles as a reference for G20 reform efforts. An indicator system was devised to assist with the monitoring and assessment of the implementation of structural reforms and their adequacy to address the structural challenges. This year, under Germany’s Presidency, the G20 has devised a set of principles as a means of enhancing member countries’ resilience to shocks. There is little doubt that progress is being made in building a more resilient global financial architecture. The IMF is currently reviewing its lending toolkit to make it more relevant and more balanced, and to also work towards closing the existing gaps within the global financial safety net. Numerous discussions are also continuing on developing macroprudential policies and devising ways of improving the availability and quality of relevant data to enhance economic policy formulation and implementation. 1 Group of Twenty 2 Brazil, Russia, India, China, South Africa 3 gross domestic product Page 3 of 7 South Africa continues to reaffirm its support for the agreed reforms to strengthen the global financial system. It is our hope that various jurisdictions will expedite their respective processes to find a compromise on the remaining Basel III elements to ensure level playing fields. We support the efforts of the German G20 Presidency to try and establish a more holistic monitoring framework of the effects of the reforms, especially for EMDEs. This is essential to determine the adjustments and/or refinements to the reforms that may be needed to reduce their unintended effects. Digital innovations in the financial sphere are another key topic in international forums. South Africa is fully supportive of the ongoing work on the regulatory approaches to financial digital innovations as well as of the stocktake of cybercrime regulations in the financial sector. The reduction of correspondent banking services in some EMDEs has presented some challenges for countries on the African continent. Reasons for this reduction in correspondent banking services relate mainly to more stringent regulatory requirements which have brought about reviews of business models. The resultant impact of these developments, inter alia on financial inclusion, warrants closer attention. Beyond the G20, the BRICS grouping has achieved much since its first political dialogue in September 2006. The New Development Bank (NDB) was established to mobilise resources for infrastructure development, particularly within the BRICS countries but also in other EMDEs. The NDB is doing well in mobilising resources for infrastructure development projects and, in 2016 alone, approved seven projects in the BRICS countries with a total value of over US$1.5 billion. These projects are all in the areas of renewable and green energy and transportation. The first ‘green bond’ was issued in 2016 and the NDB has signed memorandums of understanding with other development banks such as the World Bank and the Asian Development Bank. I should also mention that the African Regional Centre of the NDB will likely be opened in South Africa later this year. Another initiative which the BRICS grouping has undertaken in its quest to strengthen the global financial safety net is the Contingent Reserve Arrangement (CRA). The CRA Treaty was signed in July 2014 and came into effect a year later; it is now fully operational. Page 4 of 7 The CRA is a self-managed contingent reserves arrangement to forestall short-term balance-of-payments pressures, provide mutual support, and further strengthen financial stability. The arrangement, which is a pool of US$100 billion, provides the BRICS countries with access to additional liquidity in the event of a crisis. Fortunately, none of the BRICS countries have had a need to call upon the CRA to date. A number of new initiatives are being discussed under the BRICS agenda, with a view to furthering the work already undertaken and cementing the progress that has been made to date. More details will emerge at the BRICS summit later this year. Next year, South Africa will take over the Presidency of the BRICS grouping. We will continue the work aimed at further strengthening the cooperation and collaboration among the BRICS members. Regional economic integration The SARB is an active participant in various forums on the continent, which include the Southern African Development Community (SADC), the Association of African Central Banks (AACB), and the Common Monetary Area (CMA). The main aim of SADC is to promote economic and financial integration in the interest of sustainable economic development in the region. In this regard, the SADC Heads of State adopted the revised Regional Integrated Strategic Development Plan in 2016. The SARB’s regional initiatives are mainly conducted through the Committee of Central Bank Governors (CCBG), which is chaired by the SARB. The main objective of the CCBG is to undertake initiatives in support of the SADC Finance and Investment Protocol. A notable achievement of the CCBG in recent years relates to the implementation of the SADC Integrated Regional Electronic Settlement System, known as SIRESS. Through SIRESS, 14 regional central banks and 76 commercial banks are electronically linked to effect cross-border payments and settlements in real time. Since its inception in 2015, more than 700 000 transactions to the value of almost R3.1 trillion have been cleared on the SIRESS platform. Page 5 of 7 The SARB is also a member of the AACB. The main objectives of the AACB include the promotion of cooperation in the monetary, banking and financial spheres in the interest of maintaining price and financial stability. The work of the AACB is in line with the broad framework of Agenda 2063 adopted by the African Union in 2013. The SARB is currently the Vice Chair of the AACB and will host the Ordinary Annual Meeting as well as the Governors Symposium on 12-16 August 2017 here in Pretoria. At this annual meeting, the SARB will assume the chairmanship of the AACB. During our tenure as chair, we will continue to enhance cooperation among African central banks on cross-border banking supervision and payment systems, continental training on issues relating to banking supervision and regulation, and the collection of data needed to support bank supervisory activities. Closer to home, the SARB also engages with the central banks of Lesotho, Namibia and Swaziland, who together with South Africa are members of the CMA. The central bank governors of the CMA meet three times a year to discuss economic developments in their respective countries as well as other issues related to crossborder spillover effects among CMA members. The exchange of information as well as the collaboration on research and other matters of mutual interest have proven extremely useful in assisting the CMA countries to fulfil their respective obligations stipulated in the Multilateral Monetary Agreement which governs the CMA arrangement. Conclusion The SARB remains committed to playing its role in the development of the region, the continent, and the global economy. In many instances, we do this in collaboration with our counterparts in your respective countries. Tonight, we celebrate this cooperation, and we trust that our partnerships will only strengthen in the times ahead. In the spirit of this cooperation, I would like to invite you to approach the SARB through our International Economic Relations and Policy Department should you need an update on economic and/or monetary policy developments. Page 6 of 7 Thank you for honouring our invitation. Please enjoy the rest of the evening. Page 7 of 7
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Centre for Education in Economics and Finance (CEEF) Africa Annual Banquet in celebration of 21 years of leadership investment, Johannesburg, 19 June 2017.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the CEEF Africa Annual Banquet in celebration of 21 years of leadership investment Johannesburg, 19 June 2017 South Africa’s crisis of confidence and the policy response Good evening, ladies and gentlemen. Thank you for inviting me to address you today. The global economy has been as favourable recently as it has been for some time. We are experiencing a synchronised cyclical upturn across major economies. South Africa’s terms of trade are near all-time highs. Meanwhile, global financial markets have resumed a search for yield, causing stronger capital inflows to emerging markets, including South Africa. By contrast, the domestic economy has fallen into recession, with output contracting in both the last quarter of 2016 and the first quarter of 2017. Although this is the first technical recession since 2009, it continues a trend of exceptionally poor economic performance. We have warned about poor economic performance for several years, and although we did not expect the first-quarter GDP1 figure to be quite so weak in quarter-on-quarter terms, our assessment in the May MPC2 meeting was that the risks to the growth forecast were on the downside. 1 gross domestic product 2 Monetary Policy Committee Page 1 of 10 Meanwhile, inflation has returned to within the target range, as expected. Some recent numbers have come in a bit lower than anticipated, but our forecast still indicates inflation in the upper half of the target range across the forecast horizon, which stretches to the end of 2019. The combination of lower inflation and lower growth suggests, at least to some, that the time has come for rate cuts. The MPC will meet in late July to consider how the outlook has changed, and we will make the appropriate decision at that time. We are not here for me to give interesting hints about the next repo rate decision. The best source on MPC decisions is the MPC statement, not speeches a month prior. Instead, this speech is about our broader policy constraints and the medium-term outlook for the South African economy. We confront major challenges – challenges which cannot be resolved in any meaningful sense by fine-tuning the repo rate – and we need to grapple with those problems. Monetary policy does have a role to play, but it is crucial to acknowledge the limits to monetary policy and to focus on its optimal contribution over a medium-term horizon. Today, I will start by discussing South Africa’s macroeconomic strategy since 2009 before turning to the outlook. The world economy and South Africa’s macroeconomic strategy The most recent Global Financial Crisis was a huge economic earthquake, one which threw South Africa and most other countries into recession. Like many big earthquakes, it was followed by a series of aftershocks. One was the euro area crisis of 2011-12, which produced two years of negative growth in one of our most important trading partners. More recently, the global economy has suffered a second aftershock in the form of an emerging market slowdown, linked to weaker commodity prices, overstretched policy frameworks, and risk-off sentiment in global financial markets. Because of these shocks, world economic growth has repeatedly fallen short of forecasts. Page 2 of 10 The South African policy response to these conditions can be summarised as ‘support and wait’. Macroeconomic policy provided support in the form of low interest rates and large budget deficits. At the same time, we waited for the global economy to recover. But this strategy has yielded disappointing results. In part, this is because we ended up waiting much longer than expected. Furthermore, as the waiting went on and domestic growth kept slowing, loose policy settings became not simply a response to slow growth but also one of its causes. As the post-Crisis period dragged on without a robust global recovery, persistently large fiscal deficits caused our debt-to-GDP ratio to almost double.3 By importing large quantities of savings from the rest of the world and then exporting revenue to pay the interest, our current account widened to become very large, exceeding 6% of GDP in some quarters. Investor doubt about the strength of our macroeconomic framework contributed to higher borrowing costs as well as exchange rate weakness, with the rand becoming one of the world’s worst-performing currencies. The depreciated currency was, of course, a major reason why inflation forecasts began indicating prolonged breaches of the top end of our inflation target range. By 2014, it was clear that this broad macroeconomic trajectory was unsustainable; something had to change. Accordingly, monetary policy embarked on a gradual tightening cycle, with the repo rate rising from 5% to 7% over the course of two years. Similarly, fiscal policymakers set out a consolidation agenda to stabilise debt and contain spending growth. It would be wrong to say that policymakers slammed on the brakes. Rather, we eased off the accelerator. The monetary policy adjustment was the most limited and gradual in recent history, with the repo rate rising by just 2 percentage points over 27 months. At 7%, which is where we are now, the policy rate remains quite low from a historical perspective. Meanwhile, although fiscal policy has become less expansionary, deficits have remained larger than 3.5% of GDP over the past three years. These deficits have been 3 In gross debt terms, as a share of GDP, government’s debt stock was 26.5% of GDP in 2008. In 2016, it was 50.5% of GDP, and IMF forecasts indicate that it will reach 52.5% of GDP in 2017. Page 3 of 10 more than simply the unfortunate consequence of low tax revenues caused by slowing growth. In structural terms – that is, correcting for the economic cycle – South Africa’s fiscal deficit has still averaged about 3% over the past three years, according to IMF4 estimates.5 As an illustration, 3% is greater than the output of the entire agriculture, forestry and fishing sector; it is a large amount to borrow every year and it injects substantial spending into the economy. South Africa’s macroeconomic settings also look accommodative in comparison with those of other countries. In fiscal terms, most of our peer countries have borrowed less heavily. Amongst the major non-oil commodity exporters, South Africa’s average postCrisis deficit is larger than any country’s except Brazil’s.6 Indeed, not only have many of our peers achieved smaller deficits than we have; sometimes they have even managed budget surpluses. For example, Chile, Colombia and Peru all exploited the post-Crisis rebound in commodity prices to balance their budgets.7 If anything, South Africa stands out for running consistently large budget deficits despite historically high commodity prices. The result has been higher debt service costs and reduced fiscal space. In monetary policy terms, South Africa more closely resembles its emerging market peers. Most of these countries began tightening policy around 2013 or 2014. Some of these countries faced inflation well above their targets and therefore raised rates sharply. The most prominent cases were Brazil and Russia, where policy rates went up by 700 and 1 150 basis points respectively. Where the inflation challenge was less extreme, smaller adjustments were possible. Colombia, for instance, tightened by 450 basis points, Indonesia by 200 basis points, and Chile by just 50 basis points. 4 International Monetary Fund 5 The April 2017 Fiscal Monitor estimates South Africa’s structural budget balance at -3.4% for 2014, -2.8% for 2015 and -2.8% for 2016. Since 2009, the structural budget balance has averaged -3.5% of GDP. Internal SARB estimates are very similar. 6 This comparison refers to the following countries (with the average 2010-2016 fiscal balances in brackets): Brazil (-5.1%), South Africa (-3.9%), Argentina (-3.6%), Australia (-3.4%), Canada (-2.2%), Colombia (-2.1%), New Zealand (-1.9%), Indonesia (-1.8%), Chile (-0.7%) and Peru (0%). Specifically, Chile recorded budget surpluses in 2011 and 2012, Colombia in 2012, and Peru in each year from 2010-2013. Page 4 of 10 More recently, some emerging markets have had space to cut rates. The prevailing pattern has been that the countries that are closer to their inflation targets, and which previously increased rates more, now have greater scope to cut. For instance, inflation in Chile has fallen from 5.7% at its peak to just 2.6%, below the 3% inflation target, permitting the central bank to reduce rates by 100 basis points. In Brazil, inflation has declined from a high of 10.6% at the start of 2016 to 4.1% in May, and the policy rate has come down from 14.25% to 10.25%. Brazil’s inflation target, for your information, is a point of 4.5% within a range of 3-6%. In sum, we have run accommodative macroeconomic policies throughout the postCrisis period. Since 2014, the degree of stimulus provided by policy has been reduced to contain inflation and slow the pace of debt accumulation. Policy nonetheless remains broadly supportive of economic activity. Despite this fact, growth has slowed steadily throughout the post-Crisis period. To some extent, we have been able to blame this on an unfavourable global economic environment. Yet, now the global economy looks as healthy as it has in years – but the South African economy is still struggling. So why are we doing so badly? And what can be done about it? South Africa’s crisis of confidence At the present juncture, our fundamental problem is confidence. In economic discussions, ‘confidence’ is sometimes an opaque and disreputable concept. Paul Krugman in 2010 coined the term ‘confidence fairy’ for when pundits rely on magical thinking to explain how their favourite policies can have only good effects.8 But I’m afraid that, in South Africa at the moment, we can’t comfort ourselves that confidence is a mythical creature. It would be more accurate to say that it is very real – but badly endangered. We have reliable measures of business and consumer confidence. The BER’s9 surveys show that the confidence levels of both these sectors are at their lowest since 8 See the article by Paul Krugman, ‘Myths of austerity, published on 1 July 2010, available at http://www.nytimes.com/2010/07/02/opinion/02krugman.html. 9 Bureau for Economic Research (Stellenbosch University) Page 5 of 10 the Global Financial Crisis. These two indicators slipped below their long-term averages in late 2015 and have stayed there ever since. Just last week, for example, new data for business confidence in the second quarter came out at a fresh post-Crisis low, with 70% of the respondents pessimistic about local business conditions. Weak confidence has profound economic consequences. When people are this worried about the economy, theory tells us, they don’t make large purchases. Businesses defer investments. All of this weakens economic growth. These theoretical predictions are completely consistent with what we see in the data. Why is confidence so subdued? The answer is simple. Everyone in South Africa is worried about their country. Twice a year, South African Reserve Bank (SARB) hosts monetary policy forums in 10 major and secondary cities. During these forums we find that people want to talk about governance, about the exchange rate, about credit rating downgrades. They’re worried about policy; they’re worried about living in a junk status country. It is a depressing discussion, but in a way it is impressive: economic issues often seem obscure, yet people quickly become informed and passionate when the situation is serious. The message we get from regular South African citizens is fundamentally very similar to the one we hear from the ratings agencies. We have deep-rooted problems of unemployment, poverty and inequality. Our economy is not growing as fast as it needs to, and this problem has been getting worse. Nonetheless, South Africa still has strengths. In particular, we have functioning institutions that deliver on their mandates. We also have sophisticated firms and markets, even if there is always room for improvement. Nonetheless, these general positives help to maintain South Africa’s status as an upper-middle-income country, a member of the G2010, and a member of the BRICS11 grouping. Many other countries do worse. But if South Africa doesn’t start doing better, it won’t be able to meet its 10 Group of Twenty 11 Brazil, Russia, India, China, South Africa Page 6 of 10 challenges – and it will be overtaken by other countries. So what do we do about our growth trap, our downgrade challenges, and our crisis of confidence? There are roughly two narratives forming around the subject. One of them holds that if the ratings agencies don’t like us, that’s their problem – and their judgement is unreliable and biased anyhow. Policy settings are much too tight; fiscal and monetary discipline really means asphyxiation. If private confidence is so elusive, it might as well be ignored. This view is wrong-headed and dangerous. In my view, it amounts to shooting yourself in the foot, finding it hurts, then shooting yourself in the other foot to get even. The alternative view is that South Africa needs to re-establish its strengths and recover from there. Back before the Global Financial Crisis, some observers used to look at growth rates of 3% or even 4% and complain that they weren’t high enough, that we had implemented such excellent macroeconomic policies and worked so hard to make the country attractive to investors, yet the rewards were meagre. We are now seeing what it looks like when we are not so virtuous. We don’t grow at 3% anymore; we don’t even grow fast enough to keep up with the growth rate of the population. There was a lot to be said for an economy with rock-solid finances, confident investors and 3% growth. I think we can do even better than 3% growth, but we certainly need not do worse. The contribution of the South African Reserve Bank So what is the contribution from the SARB? Our fundamental, constitutional mandate is to protect the value of the currency in the interests of balanced and sustainable growth. Balanced growth is about seeing to it that the value of the currency allows both exporters and importers to engage productively in the economy. It also means that the economy’s growth is sustainable, that imbalances are neither generated that cause crises through over-heating nor throw the economy into severe downturns. All of this is clearly in the interest of all South Africans. We implement this mandate through a flexible inflation targeting framework. We sometimes hear the objection that targeting inflation is bad for growth – that is, one Page 7 of 10 part of our constitutional mandate conflicts with the other, and protecting the buying power of the rand is anti-development. However, low inflation is actually the ally of development. There are several reasons for this. Low inflation helps maintain the value of the money in your pocket. This is good for all South Africans, but especially the marginalised and poor – those without the information or power to protect themselves from inflation. Low inflation also helps maintain the competitiveness of South African goods and services in foreign and domestic markets, by moderating real exchange rate appreciation. Furthermore, low inflation produces lower interest rates. In summary, there is no long-term trade-off between growth or inflation. Keeping inflation low, protecting the value of the currency, is supportive of growth. Through history, some countries have tried to deny these truths, pretending that high inflation somehow begets sustainable growth. This kind of macroeconomic populism is usually a precursor to misery, not least because it impoverishes nearly everyone in society. The few who benefit are those that somehow are able to capture a dwindling supply of the necessities of life or gain privileged access to foreign currency (for a short time). Neither the middle classes nor the poor of high inflation countries are likely today to be partisans of such an approach to policy. The impact of inflation on interest rates is often misunderstood. This is probably because the interest rate is our main tool for controlling inflation, so when interest rates rise the reason for this is typically higher inflation. Sometimes people suggest that if we would just ignore the inflation, then interest rates wouldn’t have to move and we could have more growth. But as I explained in my speech at the University of KwazuluNatal earlier in the year, interest rates incorporate compensation for expected inflation. For this reason, as the Fisher equation states, the rate of interest is equal to expected inflation plus a real premium. If you have two identical countries, and one has a three percent inflation target and the other has a six percent target, then interest rates will be exactly three per cent higher in the country with the higher target. If that country raises its target to nine per cent, then interest rates will end up rising another three percent. And if that country simply stops trying to control inflation at all, then it will become harder to borrow in its currency, with lenders switching to some other currency with more predictable inflation. In the short run, you can get lower interest rates by Page 8 of 10 surprising people with higher inflation. But once they wake up – and investors aren’t slow to see higher inflation – interest rates have to rise. For this reason, one of the most effective ways for lowering interest rates is to keep inflation low and predictable. Looking around the world, the evidence is very clear that low inflation countries have low interest rates and high inflation countries have high interest rates. In the extreme cases, such as Sweden, inflation is so low they even have negative interest rates. Sweden’s repo rate, for example, is currently at -0.5 per cent. By contrast, in countries with much higher inflation, like Argentina or Nigeria, policy rates are much higher. Nigeria’s is currently 14 per cent. Argentina’s is 26.25 per cent.12 So although it is the case that interest rates typically rise in response to higher inflation, on average interest rates are lower because of lower inflation. This is why inflation targeting is a way to get lower rates over time. This sets the context for our current policy settings. Inflation in South Africa has moderated in recent months. We now have a good chance of getting inflation down well within the middle part of the target. Inflation is likely to move in this direction because of declining food inflation, our policy communications, the stronger exchange rate, and the sensitivity of price and wage setters to weak economic conditions. If we can keep inflation lower, anchoring inflation expectations, that should in turn generate a lower rate of interest to support the economy. Unfortunately, we also have to worry about higher inflation if things go wrong – that is, if the exchange rate begins depreciating again, if wage settlements are excessive, or if our monetary policy communication isn’t heard, loud and clear. These factors limit our policy space.13 The ratings agencies have been clear that the effectiveness of the central bank is one of the strongest pillars supporting this economy – a claim that speaks to both our price and financial stability mandates. We will continue to honour our constitutional mandate and the trust placed in us by the South African society. Argentina’s May 2017 inflation rate was 24%. Nigeria’s was 16.25%. (Data from Haver.) Page 9 of 10 Thank you. Page 10 of 10
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the launch of the MPC Schools Challenge, Pretoria, 21 July 2017.
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Executive Management Department An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the launch of the MPC Schools Challenge, Pretoria 21 July 2017 Good morning ladies and gentlemen Decisions whether to cut, increase, or keep interest rates unchanged are of enormous importance to the economy general, and they affect most people, either directly or indirectly. This often raises the question: how do central banks make these decisions, and specifically, what factors do they take into account in making these decisions. One of the channels that many central banks use to explain how they make these decisions and what factors they take into account is to run a competition for high school learners. Typically, these competitions involve a group of learners forming themselves into a Monetary Policy Committee and making a case either to cut, increase, or keep interest rates unchanged. The South African Reserve Bank began a pilot in 2012 in partnership with the Gauteng Department of Education to: Offer learners the opportunity to enhance their understanding of monetary policy and how it relates to the economy as a whole; Help learners understand better how the economy works; Assist learners to better understand how the SARB’s Monetary Policy Committee makes decisions; Improve broad economic literacy in the country; Create an opportunity for learners to put the classroom economic theory into practice and thereby enhancing their understanding of economics; Stimulate interest among learners in a career as an economist; and Raise awareness and understanding of the role and responsibilities of the SARB. The MPC Schools Challenge has since been expanded to cover 7 provinces. We have also since partnered with the Department of Basic Education and the provincial departments. We have had 450 schools participate in the challenge since 2012, involving 1 340 learners. By participation we mean schools whose team submitted an essay. A requirement of the programme is that participants take a combination of economics and mathematics subjects, excluding maths literacy. Certain schools therefore do not qualify as they do not provide this learning combination. Next year, the challenge will become national with the addition of KwaZulu-Natal and the Western Cape provinces. Hence, today’s launch of the MPC Schools Challenge. The way the competition works is that each school must constitute a team of four learners who model themselves on the Monetary Policy Committee (MPC). The team presents its case to a panel of SA Reserve Bank economists. Representatives of the Department of Basic Education moderate the outcome. To ensure that all entrants have access to the same basic data, the SARB provides learners with relevant economic data. Accessing data is perhaps the easy part. The first hurdle is deciding how the outlook for domestic and global economy impacts on future inflation. To clear this hurdle requires the team to interpret current economic conditions and events, and to apply judgement about the likely future path of the economy. There are many factors that the team must consider, and they are often moving in different directions, making judgment on how they will affect future inflation that much more difficult. At the end of it all, committees rely on judgement in making the call whether to cut, increase, or keep interest rates unchanged. Monetary policy decisions in the SARB are made by the Monetary Policy Committee (MPC). The MPC currently comprises six members, being the Governor, the three Deputy Governors, and two other senior officials of the SARB. Every decision of the MPC is an outcome of in-depth discussion and debate. Even a 'no change' decision is a policy decision. I should also note that the monetary policy decision is not a one-off event; it is a continuous process which culminates in the MPC meeting where decisions are finally taken. We are constantly talking to each other, discussing what we see and how we interpret what we see. There is a sizeable literature on the relative efficiency of committee-based decision making. A committee tends to pool information and ideas from a group comprising different skills and views, and it also provides insurance against extreme preferences and outcomes. So, there is an additional benefit that participation in the MPC Schools Challenge potentially offers learners. And that is that those learners get an opportunity to develop or put their social skills into practice. By social skills I mean the ability to interact with fellow human beings. Literature shows that the ability to interact with fellow workers, successfully working as a team remains among the most important skills in the modern economy. This is because technology has yet to successfully simulate human interaction. The ability to listen to the views of your colleagues, question or debate the issues they raise and attempt to persuade them otherwise has a broad societal benefit, way beyond application in policymaking. In that sense, the ability to engage with the ideas of fellow workers and collaborate with them will, for a long time to come, remain one of the prized skills by employers. The MPC Schools Challenge is therefore a contribution by the SA Reserve Bank towards improving the understanding by young South Africans of how the economy works, why high inflation is bad for an economy and how the Monetary Policy Committee makes decisions. Thank you
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 9th Annual Conference, organised by the Central Reserve Bank of Peru and the Reinventing Bretton Woods Committee, Cusco, 24 July 2017.
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Remarks by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 9th Annual Conference organised by the Central Reserve Bank of Peru and the Reinventing Bretton Woods Committee Cusco, Peru, 24 July 2017 Emerging market economies in a new global cycle 1. Introduction Ladies and gentlemen, good afternoon. Let me start by thanking the Central Reserve Bank of Peru and the Reinventing Bretton Woods Committee for the opportunity to participate in this conference on the highly relevant topic of how a changing global economic cycle might impact emerging market economies. The near-decade since the global financial crisis has brought with it an unprecedented financial environment for emerging countries. The financial characteristics of this evolving cycle of globalisation as well as the challenges and benefits it poses to emerging market economies indeed deserve our attention, especially against the background of an environment in which the benefits of multilateralism are being questioned by some, when in fact the role of international institutions and regional financial cooperation should be intensified. Page 1 of 8 2. The financial characteristics of a new global cycle Policy rates in the United States (US) remained at around zero from late 2008 to late 2015, and even today they are 1.7 percentage points below their average of the past 25 years. In Japan, the eurozone and several other European economies, the policy rates remain near or below zero. Following several phases of quantitative easing, the balance sheets of the US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England currently account for almost 38% of their respective country’s gross domestic product (GDP), versus 10% in June 2007. Such accommodative policies have compressed long-term interest rates and financial risk premiums, with spillover effects of strong portfolio inflows and downward pressure on domestic real yields enjoyed by emerging market economies. South Africa was no exception; in the period between 2009 and 2016, non-resident portfolio inflows averaged 3.9% of GDP, versus 2.4% in the previous 20 years, fully funding a wider current account deficit and contributing to a compression of average real yields on government debt. 1 Yet this environment may be about to change. The gradual fading of economic slack in the advanced economies raises legitimate questions about whether the current degree of global monetary stimulus remains appropriate, and indeed a number of central banks in advanced economies have signalled intentions to move from their current highly accommodative monetary policy stances. Policy rates in most of the advanced economies could eventually follow the US path towards gradual normalisation, and central bank balance sheets could probably decline to levels more consistent with ‘normal’ central banking operations. Such steps may well raise the real long-term interest rates to levels more in line with economic fundamentals, especially as budget austerity has faded in most of these economies. Should this happen, emerging countries may start finding easy and cheap external financing less forthcoming. Currently, cross-border bank flows from advanced economies into the emerging world are already experiencing headwinds from a Deflated by CPI inflation, South African 10-year government bond yields in the past five years averaged 2.55%, about 35 basis points less than the average of the previous 10 years – this is despite the gradual deterioration in South Africa’s sovereign credit rating in recent years. Page 2 of 8 tighter regulatory environment, which has generally led banks to reduce risk exposure and place greater focus on the domestic business. 2 A situation where emerging countries have to compete harder for international capital could be another element in the broader picture of ‘reduced globalisation’. 3. Another step towards lesser globalisation? According to the World Bank, trade in goods and services as a share of GDP has generally been declining post-crisis. For sub-Saharan Africa, in particular, it had fallen as low as 55% of GDP in 2015 from 74% in 2008. While cyclical weakness in import-intensive fixed investment growth accounts, to some extent, for this partial reversal of earlier trends, other – more structural – factors are also at play. These include the sharp slowdown in the expansion of global value chains (GVCs) as the number of trade protection measures put in place across the world now tends to exceed that of liberalising measures. 3 At the same time, current political trends in some advanced economies make the imposition of restrictions on migratory flows more likely. To some extent, the challenges of attracting capital from advanced economies could be compared to the slowing growth in GVCs. In the late 1990s and early 2000s, the growing development of securities markets in emerging countries, the further deregulation of the insurance and pension fund industries in advanced economies as well as a reduced ‘home bias’ by international investors all contributed to a structural rise in the global portfolio allocation to emerging market assets. The monetary policies implemented after the global financial crisis exacerbated that trend, but this structural shift appears to have now run its course. 4. Potential challenges and benefits A slower pace of globalisation, let alone the reversal of some of its aspects, will no doubt bring challenges to many emerging countries. In an environment where According to Bank for International Settlements data, cross-border claims of all reporting banks to emerging and developing economies rose from US$1.65 trillion (4.9% of world GDP) in 2000 to a peak of US$4.0 trillion (6.3% of GDP) at the start of 2008, but then fell back to US$3.7 trillion (4.9% of GDP) at the end of 2016. See ‘The future of globalisation’, Barclays Economic Research 2 March 2017. Page 3 of 8 international trade may no longer grow as a share of GDP, countries which had followed an export-orientated development model are probably most exposed. Also exposed are countries which had benefitted from strong integration in GVCs. At the same time, countries that run structural current account deficits, and hence rely on capital inflows to finance their investment growth, are exposed to reduced financial globalisation. Sub-Saharan African countries, including South Africa, partly ‘missed out’ on the inclusion in GVCs, with their exports still largely dominated by raw or lesstransformed commodities. This may leave them relatively sheltered from protectionist measures, especially as they do not run large external imbalances with advanced economies, the US in particular. Yet this is no cause for complacency: growth models are also changing in some large emerging economies, potentially reducing their relative demand for commodities. For example, South Africa’s exports to Asia grew by an average of 13% per annum in the past 15 years, a move mostly driven by these countries’ surging appetite for commodities, which is likely to ease as they reach higher levels of development. Against such a challenging global backdrop, many of South Africa’s structural issues – notably its poor competitiveness in non-commodity exports, its inability to absorb a large part of the workforce, and its dependency on high value-added imports – stress the need for an increased focus on implementing structural reforms. However, it need not all be gloom and doom for emerging economies. A new global growth model could also bring opportunities to emerging countries – provided that they are properly exploited. Monetary policy normalisation in advanced economies could end up reducing the elevated sensitivity of financial conditions in specific emerging economies to their global counterparts. 4 In market parlance this is often referred to as ‘risk on, risk off’ behaviour – and while this facilitates external financing in periods of elevated risk appetite, it can also reduce domestic policy autonomy. In fact, in a world where more conventional monetary policies are in place, financial risk may be priced more accurately, resulting in proper market rewards for good policies See ‘Are countries losing control of domestic financial conditions?’ in the Global Financial Stability Report, published by the International Monetary Fund in April 2017. Page 4 of 8 – an incentive for policymakers to implement prudent policies. A reduced role for cross-border capital flows, or a lower level of dependency, could also provide more protection for emerging markets in periods of a global crisis, as it would reduce the risk that advanced economies’ fund managers and banks would withdraw their investments or loans in a rush. In fact, this might greatly reduce the risk of financial crises, as international financial exposure is managed in a more risk-conscious manner. At the same time, a lesser degree of financial globalisation could help to reduce global imbalances. Sizeable cross-border reallocation of capital allowed the persistence of large current account deficits or surpluses in some countries which posed threats to global financial stability. In some countries, capital inflows have exceeded financing needs, and are either being recycled into excessive domestic credit growth or forcing authorities to accumulate sizeable and costly foreign exchange reserves. In other countries, large deficits fuelled strong increases in external liabilities, endangering macroeconomic stability and putting sovereign ratings at risk. 5. Role of international organisations and regional financial cooperation It is important, however, to recognise that the optimal economic development of emerging countries is still likely to require access to international financial markets. However, these countries may increasingly have to seek such opportunities within the emerging region itself. With regard to financial coordination, there are two issues that have a strong bearing on vulnerabilities in the international financial architecture that require global action from international organisations such as the International Monetary Fund (IMF) and forums such as the G20. The first issue relates to the management of capital flows. The gradual liberalisation of capital flows in countries with large external surpluses provides additional scope for the foreign financing of emerging economies. However, excessively volatile capital flows and the related spillover effects remain key concerns for many emerging market economies. In instances where these are accompanied by increased credit extension and posing a threat of increased financial stability risk, a Page 5 of 8 sharp focus on the management of systemic risks is of importance. In assisting countries to deal with the unintended consequences of these excessive capital flows in a manner that promotes sound policies and strong frameworks – including monetary policy and exchange rate flexibility – as the first line of defence against excessive capital flows, the IMF published a guidance paper titled “The liberalization and management of capital flows: An institutional view 5”. South Africa’s approach to capital flow management has been broadly in line with the IMF’s institutional view. We have adopted a relatively hands-off approach to managing capital inflows, allowing the exchange rate to act at as a shock-absorber, while monetary policy is not focused on the exchange rate but rather on the possible inflationary implications of exchange rate movements. As you know, the Organisation for Economic Co-operation and Development (OECD) is currently reviewing its Code of Liberalisation of Capital Movements (Code). The IMF is also participating in the review of the OECD Code. Continued cooperation between the IMF and the OECD remains crucial for addressing any perception that countries might receive seemingly conflicting signals, or policy advice, regarding the appropriateness of capital flow measures. Additionally, the support from the IMF through the establishment of the Data Gaps Initiative framework, aimed at supporting enhanced policy analysis of risk in the financial sector as well as an analysis of vulnerabilities, interconnections and spillovers, including cross-border risks, promises to be of great use. Let me now address the second issue, which has to do with the adequacy of the global financial safety net (GFSN) at national, bilateral, regional and global level. Members of the G20 have agreed to collaborate closely to advance cooperation and form consistent policy stances with the aim of advancing structural reforms, fostering economic resilience, promoting infrastructure investment, and promoting the stability of the international financial architecture – all to enforce stronger, more sustainable, more balanced, and more inclusive growth. IMF Policy Paper, 14 November 2012. “The liberalization and management of capital flows: An institutional view” Page 6 of 8 In this regard, the IMF could assist by applying a consistent approach to the monitoring and surveillance of countries to help identify potential risks and shocks that could emanate from the global financial system. The G20 Hamburg Action plan called on “the IMF to further enhance the effectiveness of its lending toolkit in line with its mandate, including considerations on a new short-term liquidity instrument and a new non-financial policy cooperation instrument”, and I understand that this work is receiving attention at the highest level in the IMF. An improvement in the IMF policy toolkit and financing instruments would assist in closing the gaps in the financial system and, in so doing, assist with improving the resilience of economies to exogenous shocks. The IMF and regional institutions in Africa should further explore ways to improve access for African countries to the GFSN beyond what is available at multilateral financial institutions. The importance of regional financing arrangements (RFAs) remains key to strengthening the GFSN, and they provide multilateral insurance properties of a different nature to the safety net. However, there is a need for African countries to work together with the IMF in developing RFA facilities in the region. 6. Conclusion In conclusion, the new global cycle, partly characterised by normalisation in the global financial markets after a prolonged period of a low interest rate environment and reforms in the banking sector, harbours both challenges and opportunities for emerging market economies. The interconnectedness and interdependencies of our economies makes international cooperation indispensable, and the rhetoric around trade protectionism and pushback against multilateralism is occurring at a time when we can least afford it. However, any success in international cooperation will only be achieved if it is built on maintaining macroeconomic policy discipline and strengthening the depth and regulation of financial markets at individual county level. Thank you for your attention. Page 7 of 8 Page 8 of 8
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, to the ninety-seventh annual ordinary general meeting of the SARB shareholders, Pretoria, 28 July 2017.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank (SARB), to the Ninety-Seventh Annual Ordinary General Meeting of the SARB Shareholders South African Reserve Bank, Pretoria 28 July 2017 at 10:00 This past year has been extremely eventful, from both an economic and a political perspective. This has been the case both globally and domestically. A number of themes dominated the global backdrop. First, there were major shifts in the political settings. Surprise outcomes in the UK1 referendum regarding its continued membership of the European Union and in the US2 presidential election coincided with increased concerns about the rise of political populism in a number of regions, a backlash against rising inequality blamed on globalisation, and a rise in nationalistic tendencies. The French political landscape changed dramatically, given the decimation of traditional parties, but a strong move to the extreme right did not transpire as feared. Second, these developments threatened the sustainability of the global economic recovery which had shown signs of resilience after a few years of disappointing outcomes and false starts. But despite these uncertainties, there appear to be definite signs that most regions are on a path of sustained recovery from the most recent global economic crisis. It has taken almost 10 years to reach this point, which is indicative of how long it takes to recover from economic slowdowns following a financial crisis. Nevertheless, expectations are for a lower growth trend than in the pre-crisis period. 1 United Kingdom 2 United States Page - 1 - of 11 Third, most of the advanced economies saw a decline in unemployment rates, although they remain relatively high in the euro area on average. Despite tightening labour market conditions, wage growth in these economies has remained minimal. While some ascribe this trend in part to low productivity growth or the impact of technological change, the full explanation remains a subject of much debate. But this trend could contribute to the persistence in rising inequality and political instability. The fourth global theme relates to inflation. Earlier concerns about deflation have abated. Inflation generally remains benign and below target in most of the advanced economies despite the improved growth outlook and lower unemployment. The volatility that was observed was driven primarily by oil price fluctuations. A notable exception is the UK where the inflation target has been exceeded following the Brexitinduced depreciation of the sterling. The subdued global inflation environment is ascribed in part to low wage growth. Fifth, despite the absence of inflation pressures, monetary policies in the advanced economies have begun a slow retreat from their highly accommodative stances. The US Fed3 has led the way with three Fed Funds rate increases of 25 basis points each in the past year. The Fed has also communicated its intention to begin slowly shrinking its balance sheet – which was expanded significantly during the global financial crisis – this year. The ECB4 and the Bank of England have also recently signalled a possible end to their extremely accommodative monetary policy stances later this year, but rates are expected to remain low in Japan. Sixth, capital flows to emerging markets have remained relatively robust but sensitive to changes in advanced economy policy signals. While changing expectations regarding ECB and US monetary policy in particular have impacted on a number of emerging market currencies and bond yields, the reaction has been relatively muted. Those economies that were most sensitive to the 2013 ‘taper tantrum’ episode have 3 US Federal Reserve 4 European Central Bank Page - 2 - of 11 much-improved macroeconomic balances, and their currencies are less vulnerable to possible spillover effects from US monetary tightening. Finally, international oil prices have also been fairly volatile. Attempts by OPEC 5 and other producers to underpin falling prices through output restrictions were effective in the short run, with oil prices rising to around US$58 per barrel in December 2016 from earlier levels of around US$45-50, after they had fallen to below US$30 per barrel in early 2016. Since April we have seen this strategy being undermined by increased output from shale gas producers in the US in particular, and by non-compliance by parties to the agreement. Turning closer to home: while global growth prospects have generally improved, South Africa is unfortunately an outlier. This past year has seen the worst domestic growth performance since the recession during the global financial crisis. The economy grew at a paltry 0.3% in 2016, and recently recorded two consecutive quarters of negative growth. The SARB6 had expected the fourth quarter of 2016 to be the low point in the cycle, but growth in the first quarter of this year surprised significantly on the downside at -0.7%. This contraction was broad-based, with only the primary sector recording positive growth. Despite this, we believe that the worst is behind us – and that growth in the second quarter of this year will be positive. However, the SARB’s growth forecast was revised down significantly, as communicated at the recent meeting of the MPC7. Growth of just 0.5% is now forecast for this year, rising to 1.3% and 1.5% respectively in the next two years. This is clearly too low to make any meaningful inroads on unemployment. For most of the past year, headline inflation was above the upper end of the target range of 3-6%, at an average of 6.3% and a peak of 6.8% in December. In the early months of 2017, inflation moderated considerably and returned to within the inflation target range in April. 5 Organization of the Petroleum Exporting Countries 6 South African Reserve Bank 7 Monetary Policy Committee Page - 3 - of 11 The inflation forecast presented to the MPC at its most recent meeting showed a marked improvement. While previous forecasts had suggested that the longer-term inflation trajectory would be uncomfortably close to the upper end of the target range over the forecast period, the new forecast showed a more benign path. Inflation is now expected to average 5.3% in 2017 and 4.9% and 5.2% respectively in the coming two years, with a low point of 4.6% in early 2018. The core inflation forecast is just below 5.0% for all three forecast years. The drivers of these improved inflation outcomes over the past few months include: lower food price inflation, as the effects of the drought recede; lower international oil prices; lower electricity tariff increases; a more resilient exchange rate than had previously been expected, coupled with muted exchange rate pass-through; and weak domestic demand. More recently, there have also been indications of some wage moderation. Despite the improved outlook, the MPC is still concerned that inflation expectations remain sticky at the upper end of the target range. As indicated in our post-MPC statement, we would prefer expectations to be anchored closer to the midpoint of the range. Furthermore, we are aware that the inflation outlook can change quickly in the event of supply-side shocks. At this point, however, we view the risks to the inflation outlook to be broadly balanced. The main risk to the inflation outlook has, for some time, been the exchange rate. During the past year, while volatile, the rand has been relatively resilient, considering the adverse shocks it has had to face. At current levels, it is still stronger than it was at this time last year. The local currency has been supported by the significant improvement of the current account of the balance of payments, favourable terms of trade, and the generally positive capital flow environment for emerging markets. The rand has been adversely affected by low growth, political and policy uncertainty, and Page - 4 - of 11 the credit ratings downgrades. These factors, along with the possibility of advanced economy monetary tightening, continue to weigh on the rand. For much of the past year, monetary policy has had to deal with the increasingly difficult scenario of accelerating inflation in the context of slowing domestic economic growth. With inflation expectations anchored at levels of around 6.0%, the monetary policy challenges were significant. Furthermore, most of the pressures on inflation emanated from the supply side, in particular food prices, and were not driven by excess demand. Faced with this policy dilemma, the MPC accommodated the temporary breach of the upper end of the inflation target band and maintained an unchanged monetary policy stance since the 25 basis point increase of the repo rate8 to 7.0% in March 2016. In both March and May of this year, as the inflation outlook improved, the MPC indicated that the tightening cycle was likely to have ended but that a further improvement in the inflation outlook would be required before the policy rate could be reduced. At its most recent meeting, following the improved inflation forecast and deteriorating growth outlook, the MPC reduced the repo rate by 25 basis points, to 6.75% per annum. The MPC also noted that future policy decisions would be dependent on data outcomes and the assessment of the balance of risks. The MPC will remain vigilant and will not hesitate to reverse this decision should the inflation outlook and risks deteriorate. The most recent global financial crisis saw increased financial stability responsibilities being given to central banks around the world. Although the SARB has had a role in ensuring financial stability for some time, our responsibilities in this area have expanded. The SARB’s role in maintaining, promoting, and enhancing financial stability is formally mandated in the Financial Sector Regulation Bill (FSR Bill). Unfortunately, the parliamentary processes to promulgate the FSR Bill took longer than expected. This has delayed the establishment of the proposed Prudential Authority, which will expand the SARB’s regulatory responsibilities in the financial sector. I am, however, pleased to be able to report that the FSR Bill has now been 8 repurchase rate Page - 5 - of 11 passed, and is awaiting the signature of the President. Implementation planning is nonetheless well advanced. The delay in the promulgation of the FSR Bill has not detracted from our focus on those areas of responsibility that we currently have, both at macroprudential and at microprudential levels. As I alluded to earlier, the recovery in the advanced economies from the global financial crisis has taken 10 years and is still not completely assured. This underlines the importance of financial crisis prevention. We therefore need to ensure the stability of the banking sector through appropriate regulation and supervision, and to monitor the broader economy for excesses that could undermine financial stability. As you are all no doubt aware, the SARB has been in the spotlight for the past few weeks, mainly for the wrong reasons. It is appropriate for me to make a few brief comments about some of these issues. The first relates to the remedial instruction by the Public Protector to Parliament to set in motion a process to change the constitutional mandate of the SARB. We have challenged this remedial action in the High Court on a number of grounds, and the matter will be heard in court next week, even though the Public Protector has chosen not to oppose our submissions. Apart from the issue of whether the Public Protector has overstepped her legal powers in this regard, or the issue that the remedial actions proposed were unrelated to the original complaint under investigation, these developments have opened the door to a debate about the appropriateness of our mandate and of the inflation-targeting mandate specifically. Price stability, or the protection of the value of the currency, is a core function of central banks. I know of no central bank that does not have this mandate. These institutions are best equipped to carry out this function, and stripping them of this mandate would raise the question as to where the responsibility for price stability should lie. Our Constitution is very clear: this is, correctly, a SARB function, and we should protect the value of the currency in the interest of balanced and sustainable growth in the South African economy. Page - 6 - of 11 There is no virtue to high inflation, which ravages the incomes and savings of the poor in particular, but which has also wiped out the savings of the middle classes in a number of countries. We need not look further than our northern border to see the impact. The wealthy are more able to protect themselves through various hedging mechanisms, and in this respect inflation has a negative distributive effect. Low inflation, by contrast, protects the purchasing power of incomes and social pensions and savings, and provides a more conducive environment for investment and job creation by reducing uncertainty about future prices. Any mandate given to a central bank should focus on what it can do and not on what we would like it to do. A socio-economic objective such as protecting the buying power of the money in the pockets of South African citizens is an important and attainable objective, and in the area of our core competency. Apart from this objective, we also: ensure the availability of good-quality banknotes and coin; ensure the effective functioning of the national payment system; prudently manage the official gold and foreign exchange reserves of the country; strive for a stable financial system; and regulate and supervise the banking system. As we have seen from the global financial crisis, such crises have a devastating effect on the economy – and it takes many years to recover. It would be counterproductive to divert the SARB’s policies away from these important socio-economic objectives in order to try and achieve outcomes over which the SARB has little or no influence. The fact that we do not have an explicit employment or growth mandate does not imply that we have a narrow focus on inflation to the exclusion of these considerations. However, we must be clear about what a growth mandate means for central banks. Monetary policy cannot determine the longer-run growth potential of the economy. This is the domain of other policies, as potential growth is determined by structural policies (e.g. on education, infrastructure, and technology). South Africa’s high Page - 7 - of 11 unemployment rate is largely structural. The contribution that monetary policy can make to long-run growth is through ensuring price stability, which is more conducive to longer-term investment and expenditure decisions. The higher and more volatile inflation is, the higher the riskiness of investment. Monetary policy can, however, impact on the real economy over the economic cycle, i.e. on the extent to which growth fluctuates around potential output. The extremely moderate nature of the tightening cycle since 2014 is an illustration of our concerns for cyclical growth. While it is true that excessively tight monetary policy conditions can undermine growth and employment, the low and at times negative policy rate prevailing in South Africa in recent years is indicative of an accommodative monetary policy stance. The bottom line is this: we cannot solve a structural growth problem with monetary policy, irrespective of our monetary policy framework. Keeping interest rates artificially low may have short-term benefits, but it will result in higher inflation in the long run. We cannot ‘buy’ higher growth and employment through high inflation. In fact, high inflation inhibits growth. Low inflation, by contrast, allows for lower interest rates and higher growth. Whether we operate in an inflation-targeting framework or not, our objective will still be the protection of the value of the currency. Inflation targeting is a framework within which to achieve this target. It makes our objective transparent and helps to anchor inflation expectations. We would not behave differently in the absence of an explicit target. Inflation targeting has been successfully adopted by many other emerging markets as well, and more recently by a number of developing economies, including Ghana and Uganda. The issue of private shareholding in the SARB also needs addressing, particularly in this forum. Private shareholding in central banks is an historical legacy, as originally central banks were in fact privately owned. This changed over time, particularly since the 1930s. Apart from the SARB, there are nine other central banks that have some Page - 8 - of 11 form of private shareholding. These include the US Federal Reserve System as well as the central banks of Belgium, Greece, Italy, Japan, and Switzerland. The critical issue is the role that private shareholders play and the potential for conflicts of interest. In the SARB, private shareholding does not impart the same rights and benefits that shareholders in private companies have. The notion of a central bank as a public policy institution, with the main goal of promoting monetary and financial stability in the interests of the general public, is remote from the traditional concept of a commercial company with a profit motive. The SARB is an independent legal person, a public institution that has no profit motive and is not owned by its shareholders or anyone else. Accordingly, shareholders in the SARB: have very limited rights; have no role whatsoever in the setting of, or influencing, the key mandates of the SARB, i.e. monetary policy and financial stability policy; have no sway over the day-to-day management of the SARB; are restricted to a maximum of 10 000 shares per shareholder out of 2 million issued shares (including those of their associates); receive a fixed return on their shares of 10 cents per share from profits made (This amounts to an overall divided payment by the SARB of R200 000 per year. In fact, 90% of the SARB’s profits are transferred to government, and the remaining 10% are allocated to the SARB’s reserves.); do not have any claim on the foreign exchange reserves of the SARB; and are unable, by means of a resolution or otherwise, to amend or change the SARB’s affairs by deviating from the prescriptions of the SARB Act9. In terms of the SARB Act, the most effective powers of the shareholders are: the approval of the appointment of auditors for the SARB and their remuneration; and 9 South African Reserve Bank Act 90 of 1989 Page - 9 - of 11 the election, from a vetted list, of seven non-executive directors to the Board. (The other eight members are appointed by the President. These include the Governor and the three Deputy Governors.) Furthermore, the Board itself is a corporate governance board, and has no input or say in policies related to the SARB’s mandates and primary functions. The Board’s functions are limited to corporate governance issues, internal controls (including auditing), staff policies, and staff remuneration. The management of the business of the SARB, including the setting of monetary policy, vests in the Governor and Deputy Governors, who are appointed by the President after consultations with the Minister of Finance and the SARB Board. The Governor and Deputy Governors are clothed with decentralised original powers of management. Private shareholding represents an additional layer in the governance framework, to strengthen accountability and transparency, and complements the mechanism of how we are accountable to South Africans through their representatives in Parliament. While international experience does not suggest that the shareholding structure of a central bank meaningfully affects its performance, there is equally no obvious case for changing this structure at present. Any move towards ‘nationalisation’ would be largely symbolic and would have no impact whatsoever on the SARB’s mandate. The view that the SARB is owned and run in the interest of the private sector is incorrect. Our independence and mandate are enshrined in the Constitution. Whether the SARB has private shareholders or whether all its shares are owned by government, its primary mandate remains. A considerable number of legal considerations would have to be taken into account if private shareholding were to be removed. The potential purchase of all the SARB shares by government would require the introduction of suitable legislative measures, since the SARB Act does not currently provide for this. This legislation would also have Page - 10 - of 11 to provide for measures such as the determination of the value of the shares, as determined by the Legislature. On private shareholding, it should also be noted that the SARB embarked on a process of regularising its shareholder structure, which culminated in a judgement obtained from the Gauteng division of the High Court in November 2016. In terms of said court order, a total of 149 200 SARB shares held by 15 shareholders were disposed of, which resulted in 57 new shareholders spread across the general public. The interest in SARB shares is currently exceptionally high, with standing buy offers from 28 buyers wishing to purchase 90 109 shares. Conclusion The economy has been in recession but is expected to recover in the latter part of this year. Understandably, in times like these questions arise about the role of central banks and their contribution to economic growth. Our Constitution is very clear: the core mandate of the SARB is to protect the value of the currency in the interest of balanced and sustainable growth in the South African economy. However, monetary policy cannot determine the longer-run growth potential of the economy. Our Constitution is clear on this, too: in carrying out its mandate, the SARB must not bow to any pressure, be it political or from the private sector. Despite the challenging environment in which we operate, the SARB as an institution remains strong; it is staffed by people who are committed to the promotion of the economic well-being of all South Africans. Thank you. Page - 11 - of 11
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Actuarial Society Banking Seminar, Sandton, 2 August 2017.
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An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Actuarial Society Banking Seminar The Maslow Hotel, Sandton 2 August 2017 Bank-wide stress testing as a risk management tool Members of the Actuarial Society, ladies and gentlemen. Thank you for the invitation to address you at this third Actuarial Society Banking Seminar. The South African Reserve Bank (SARB) would like to congratulate the Actuarial Society of South Africa on its efforts to build expertise in banking – and on becoming a world leader in this regard. Your initiative to introduce a Banking Fellowship coupled with allowing actuaries to qualify as banking actuaries is commendable and could make important contributions to improving the resilience and stability of the domestic banking sector. My address today will focus on stress testing and how it is being applied as a risk management tool. I would also like to share the progress the SARB has made and the methodologies it has applied in its approach to stress testing the South African banking sector. Stress testing forms part of the macroprudential monitoring framework applied by the SARB in fulfilling its now-expanded mandate of protecting and enhancing financial stability, in addition to its price stability mandate. As you are all aware, the mandate of the SARB, specifically its primary objective and independence, as entrenched in the Constitution, has come into sharp focus recently. The primary objective of the SARB is stated in the Constitution: “Protect the value of the currency in the interest of balanced and sustainable economic growth.” This objective and the independence Page 1 of 9 provided to the SARB in the Constitution can only be changed by a two-thirds majority of the members of Parliament; thereafter any such change would need to be ratified by the Constitutional Court. In this way, the courts protect the SARB against any unlawful encroachment of its independence. Furthermore, the notion of a central bank as a public institution, with the goal of promoting monetary and financial stability in the interest of the general public, is remote from the traditional concept of a commercial company with a profit motive. Central banks have been structured by their respective governments to suit publicinterest ends. The shareholding structures have been retained in some cases, including by the SARB and in various others, such as the central banks of Belgium and Switzerland. But the inconsistencies with the shareholding of private companies necessitated a realignment of the rights and powers of shareholders in central banks. Limitations were consequently built into the rights and powers of the shareholders in the SARB, such as no policymaking or management roles, a fixed return of R200 000 per annum on shares held, no claim on the reserves held by the SARB, and the election of a minority of the Board of Directors (Board). The management of the business of the SARB, including the setting of monetary and financial stability policies, vests in the Governor and Deputy Governors, appointed by the President after consultations with the Minister of Finance and the Board of the SARB. The Financial Sector Regulation Bill, approved by Parliament in June 2017 and currently awaiting sign-off by the President, makes provision for an expanded mandate for the SARB, which includes financial stability. Financial stability aims to enhance resilience to systemic shocks and to mitigate the macroeconomic costs of a disruption in financial sectors. Financial stability is not an end in itself but is generally regarded as an important precondition for sustainable economic growth, serving the constitutional mandate of the SARB. Financial stability is not about preventing shocks or crises, but more about identifying and mitigating the build-up of risks and vulnerabilities in the financial sector. Neither is financial stability about preventing bank failures at all cost, as the failure of non-systemic banks ameliorates the risk of moral hazard and reinforces market discipline. Page 2 of 9 A stable banking sector is, however, crucial for financial stability as these risks and vulnerabilities often originate from systemically important banks and their clients in the corporate and household sectors. To identify the vulnerabilities that might be building up in the banking sector early enough and to ensure proactive mitigating action, stress testing has become an important tool in the toolkit of systemic regulators. It adds an important macroprudential dimension to the supervision of banks by assisting supervisors and macroprudential authorities in evaluating the aggregate capital position of the largest banking firms as well as their individual capital levels. Internationally active banks have been applying stress testing at the level of individual institutions since the early 1990s; today bank regulators require the use of stress tests for monitoring both market and credit risks. Macro stress testing, as a tool to assess the vulnerability of entire financial systems, is instead much more recent. It has been an important component of the Financial Sector Assessment Programs (FSAPs) launched by the International Monetary Fund (IMF) and the World Bank in the late 1990s, and has become an integral part of the financial stability toolbox of policymakers. It was during one of these FSAPs that stress testing experienced severe criticism and major challenges as a technique to assess the soundness of banking systems. In its Financial System Stability Assessment after the FSAP on Iceland in August 2008, the IMF stated that the financial indicators of the Icelandic banking system were above the minimum regulatory requirements and indicated that stress tests had suggested that the system was resilient. As you all know, the Icelandic banking system collapsed soon afterwards. To the uninitiated, what the IMF said then may sound astonishing. But it simply echoed the message of the stress tests carried out by authorities and banks around the globe ahead of what turned out to be one of the worst financial crises in world history, namely that the financial system was resilient, sound, and strong. This was the unyielding message confronting those who were deeply involved in assessing vulnerabilities during the years of the so-called Great Moderation, even as the cracks started to appear. It is, of course, all too easy to criticise stress tests after the fact, but the most recent global financial crisis raised a key question: what can and cannot be expected of stress Page 3 of 9 tests, both now and in the future? It was only in 2009 – when bank regulatory agencies in the United States (US) applied their Supervisory Capital Assessment Program, or SCAP, popularly known as the ‘bank stress tests’ – that the technique regained some of its credibility. The SCAP marked the first time that the US bank regulatory agencies had conducted a supervisory stress test simultaneously across the largest banking firms. In retrospect, the SCAP stands out for me as one of the critical turning points in the global financial crisis. It provided anxious investors with credible information about prospective losses at banks. Supervisors’ public disclosure of the stress-test results helped to restore confidence in the banking system and enabled its successful recapitalization. The resilience of the US banking system has greatly improved since then, and the more intensive use and greater sophistication of supervisory stress testing, as well as supervisors’ increased emphasis on the effectiveness of banks’ own capital planning processes, deserve some credit for that improvement. Today, the US has two distinct but related supervisory programs that rely on stress testing. The first is the stress testing required by the Dodd-Frank Act, which has the purpose to quantitatively assess how bank capital levels would fare in stressful economic and financial scenarios. The second program, called the Comprehensive Capital Analysis and Review, combines the quantitative results from the stress tests with the more qualitative assessments of the capital planning processes used by banks in the US. These supervisory programs, developed as part of regulatory reforms following the global financial crisis, have been strongly challenged by the new political regime in the US. The US Federal Reserve (Fed) conducted its first exercise in 2009 to increase confidence in the system. Today, bankers believe the tests have morphed into a mysterious, laborious, and time-consuming process from what was once a straightforward examination of financial strength. The outcome determines how much capital banks must hold, but experience shows that getting a passing grade can be tough. The tests also prove to be resource-intensive as some of the bigger banks have to call on hundreds of their employees to work on stress-test submissions each year. Page 4 of 9 Politicians and bankers argue that reducing the stress tests’ complexity and frequency could not only save man-hours, but also help the US economy by stimulating more lending. They argue for a fresh look at how stress testing is conducted, making their case in meetings with legislators who are stewarding a financial overhaul by the current US administration. Regulators, however, remain sceptic, pushing back on the industry’s pleas, arguing that it is crucial that a strong capital regime be maintained, especially as it applies to systemically important banks. Former Fed Governor Daniel Tarullo said in April: “Neither regulators nor legislators should agree to changes that would effectively weaken the regulatory regime.” Irrespective of what the outcome of the debate in the US might be, macro stress testing has become a tool of the macroprudential frameworks that authorities are implementing globally. It is, however, important to keep in mind that stress testing cannot address all the risk management weaknesses by itself. As part of a comprehensive approach, it has a leading role to play in strengthening bank corporate governance as well as the resilience of individual banks and the financial system. Whether macro stress tests will ever be able to act as effective early warning devices is an open question, given the analytical challenges. By contrast, macro stress testing can be quite effective as a tool for crisis management and resolution, since in that context its messages may be more reliable. More generally speaking, macro stress tests can discipline thinking about financial stability risks. In the process, they can yield additional benefits, such as: helping to reconcile the widely different perspectives of the various stakeholders (banks, supervisory authorities, central banks, and the public at large); fostering better communication; cross-checking the performance of individual firms’ risk models; and identifying important data gaps. That said, in order to yield the hoped-for benefits, it is critical to design stress tests properly, tailoring them to the specific purpose. Furthermore, the tool can only be the beginning, never the end, of a conversation about financial stability risks. It can only be a complement, never a substitute, for other tools and processes. Stress testing plays a particularly important role in: Page 5 of 9 providing forward-looking assessments of risk; overcoming the limitations of models and historical data; supporting internal and external communication; feeding into capital and liquidity planning procedures; informing the setting of banks’ risk tolerance levels; and facilitating the development of risk mitigation and/or contingency plans across a range of stressed conditions. Ideally, one would like to subject the whole financial system to a macro stress test. In practice, however, tests have considered parts of the overall system. The banking sector is the most common object of analysis, given its importance for financial stability. But stress tests have sometimes also covered other institutions, such as insurance companies and pension funds. These tests have tended to assess the strength of institutions in individual jurisdictions, although typically including their consolidated balance sheets worldwide. The only coordinated multi-country tests have been the recent exercises in the European Union. More recently, the European Banking Authority started the process of its 2018 stress testing of Europe’s largest banks when it published its draft stress-test methodology. This test will again look at the effect of macroeconomic stress on a bank’s viability, taking into account market risk and litigation risk. It will, however, be much tougher than previous tests, as it will include the International Financial Reporting Standard (IFRS) 9, which requires that banks model credit risk losses for loans even before they have defaulted. This is likely to result in higher levels of provisioning and may potentially impact somewhat on capital adequacy ratios. Incremental risk provisioning under IFRS 9 will focus on loans that show deterioration in borrowers’ credit quality since the inception of the loan. It is therefore expected that banks that are challenged by low growth and persistent asset quality pressures will be more severely affected. In the United Kingdom (UK), the Bank of England (BoE) announced the key elements of its 2017 stress test in March. The 2017 stress test includes two stress scenarios. Alongside the annual cyclical scenario, the BoE is for the first time running an additional exploratory scenario. The aim of this additional scenario is to consider how the UK banking system might evolve if recent headwinds to bank profitability persist Page 6 of 9 or intensify. It includes weak global growth, persistently low interest rates, and stagnant world trade; it has a seven-year horizon to capture these long-term trends. As I have mentioned before, stress testing forms an important component of the financial stability framework in South Africa. As part of the 2014 FSAP for South Africa, the IMF conducted a full stress-testing exercise for the banking and insurance sectors. The focus of the exercise was on both solvency and liquidity stress testing. In its recommendations, the IMF proposed that the SARB develop a macroprudential stresstesting framework (following a top-down approach) to complement the existing bottomup exercises conducted by banks. In January 2015, the SARB established a Stress Testing Division within its Financial Stability Department. The division conducted a full stress-testing exercise on the domestic operations of the major banks in South Africa during the period from December 2015 to April 2016. Six major banks participated in the exercise, covering in excess of 80% of the banking sector’s assets. The SARB requested the participating banks to conduct a bottom-up stress test focusing mainly on credit risk while the SARB conducted a top-down exercise using a common scenario. The Stress Testing Division followed a formal risk identification and scenario design by developing a Risk Assessment Matrix, involving the identification of the most relevant risks from the global and domestic environments, an assessment of their likelihood, as well as a qualitative evaluation of their impact on the real economy, the banking sector, and the financial system. Major global risks were identified on which to base the scenarios; these included a surge in global financial market volatility combined with a prolonged period of slower growth in both advanced and emerging markets. The results of the bottom-up stress tests were aggregated and validated against SARB’s top-down stress-testing exercise. The participating banks were found to be adequately capitalised to withstand significant credit losses throughout the stress scenarios before taking into account any mitigating action by banks’ management. This resilience stems from the high capital buffers already prevailing in the banking Page 7 of 9 system. The results of the exercise were published in the Financial Stability Review in May 2016. This stress-testing exercise was subjected to two peer reviews, firstly by the Deutsche Bundesbank and secondly by the IMF, to ensure the robustness of the procedures and future stress-testing exercises. The contributions that emanated from the peer reviews have been actioned and incorporated into the refinement and expansion of the stress-testing model and framework. In line with the SARB’s governance framework, full stress-testing exercises will be conducted once every two years or if and when they may be required. Work on the next cycle of the exercise is underway. I would like to conclude by stating that banking systems are much stronger since the implementation of stress-testing frameworks – and this has contributed in part to the improvement of economies in many countries. Stress tests are forward-looking and focus on improbable but plausible risks, as opposed to common risks. As a result, they complement conventional capital and leverage ratios. The disclosure of the results of stress-testing exercises, coupled with firms’ disclosure of their own stress-test results, provides market participants with deeper insight and confidence, not only into the financial strength of banks, but also into the quality of their risk management and capital planning. Stress testing is also proving highly complementary to supervisors’ monitoring and analysis of potential systemic risks. A very important benefit of regular stress testing is that it forces banks and supervisors to develop the capacity to assess the enterprise-wide exposures of their institutions to risks, and to use this information to ensure that they maintain adequate levels of capital and liquidity. The development and ongoing refinement of risk management capacity is in itself critical for protecting individual banks and the banking system, upon which the health of our economy rests. I wish you everything of the best with your further deliberations today. Thank you. Page 8 of 9 Reference Borio, C., Drehmann, M. and Tsatsoronis, K. 2012. Stress-testing macro stress testing: does it live up to expectations? Basel: Bank for International Settlements. Page 9 of 9
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the 60th anniversary celebration of the Bank of Ghana, Accra, 18 August 2017.
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South African Reserve Bank An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the 60th anniversary celebration of the Bank of Ghana Accra, Ghana 18 August 2017 The changing role of the central bank in economic policy Governor Addison, distinguished guests, ladies and gentlemen. It is a great honour for me to address you on this auspicious occasion. Thank you for the invitation. The Bank of Ghana has been operating for 60 years. Much has changed over this period in terms of its role and operations. This is not surprising, as the historical backdrop in which central banks have had to operate has kept changing over the decades. Central banks in the developing world often play a vital role in economic policymaking, but that role tends to change as the economy and financial markets develop and new institutional capacity evolves. This is true of many African central banks. Similarly, in the advanced economies, the role and even mandates of central banks have come under intense scrutiny and challenge, and many have found themselves with broader mandates and a wider scope of responsibilities in the wake of the most recent global financial crisis. Numerous roles have been assigned to central banks over the years, many of which do not have to be performed exclusively by these institutions and could also be Page 1 of 12 carried out by others. Apart from supporting state financing during times of crisis, two main functional roles have traditionally been at the heart of central banking: maintaining price stability (subject to the monetary regime) and maintaining financial stability. This includes crisis prevention and management and resolution as well as the promotion of financial development in the economy. How these roles have been interpreted and implemented and their relative emphasis, however, has continued to evolve over time in response to changing circumstances. Today, central banks have many other functions, some of which have also evolved over time. In South Africa, apart from the price stability and financial stability objectives, the responsibilities of the central bank include the printing of physical notes and coin, the regulation and supervision of the banking system, ensuring the effective functioning of the national payment system, and managing the foreign exchange reserves of the country. However, in the African context, central banks have had to take on other roles as well. This is partly due to a relative scarcity of skills and other resources in the context of pressing developmental needs. In some African countries, central banks have an explicit developmental role. In Nigeria, for example, the central bank plays a significant role in providing finance to the agricultural sector. How multiple developmental needs are dealt with differs from country to country. As is often the case when it comes to policy prescription, there is no ‘one size fits all’ solution. In my remarks to you today, I give you a perspective of how South Africa has dealt with changing demands and circumstances, particularly since the global financial crisis. The South African Reserve Bank (SARB) has been confined to a relatively narrow and traditional mandate. We do not play a central role in development issues, as there are specialised institutions for these purposes. The Land and Agricultural Development Bank of South Africa, as its name suggests, provides financing and technical assistance to the farming community. The Industrial Development Corporation provides loans to facilitate industrial development. The Development Bank of Southern Africa specialises in funding for infrastructure expenditure in Page 2 of 12 Southern Africa. There are also a number of institutions that specialise in the financing and promotion of small businesses. Why does the SARB not engage in developmental activities beyond those traditionally in the ambit of central banking? The short answer is: because South Africa has institutions that are better equipped to do so than us. There is no reason for these activities to be conducted by central banks. By the same token, there is no reason why central banks should not undertake such activities if resources and capacity are limited in the rest of the economy. It should, however, be remembered that central banks are not elected and hence it is preferred that their mandates are specific and narrowly defined. There should also be a clear delineation between the balance sheets of these different activities of central banks – to avoid any conflicts of policy objectives, but also to ensure that these activities are not financed through direct loans from the central bank, i.e. through money creation. Under these circumstances, the role of the central bank would generally be to disburse funds that are raised in the capital markets at competitive rates, or that are funded by grants from government and/or multilateral organisations. There is no inherent reason why the central bank would have the advantage of assessing the needs of these sectors relative to the specialised institutions that would have the necessary expertise to do so. Having separate institutions helps to avoid conflicts over resources within the central bank and reduces the possibility of the politicisation of monetary policy, which could ultimately undermine central bank independence. The conduct of monetary policy changed markedly during the 1980s, in line with global developments. Price stability became an important focus, particularly following the emergence of inflation that followed the collapse of the Bretton Woods era and the 1973 oil crisis. During this period, there was a general move away from direct controls and quantitative restrictions and ceilings to the targeting of monetary aggregates in the context of more liberalised financial markets. Interest rates became the main instrument of monetary policy, and during the 1990s the trend moved away from a focus on intermediate targets to targeting inflation directly. Page 3 of 12 In 2000, South Africa adopted an inflation-targeting framework, with government and the SARB agreeing on a target range of 3-6%. Similar developments were evident in many other African countries, including in Ghana, which adopted inflation targeting in 2011. While the operational framework had changed, the underlying objective of price stability did not. During the 1990s, the SARB’s primary mandate was written into the country’s new Constitution. This mandate was and remains the protection of the value of the currency in the interest of balanced and sustainable economic growth in the country. We are given constitutionally entrenched independence in carrying out this objective. This approach is not very different from that of the Bank of Ghana, whose ‘monetary policy objective is to ensure price stability – low inflation – and, subject to that, to support the government’s economic objectives, including those for growth and employment’.1 Having a price stability objective does not, however, necessarily resolve the debates about the broader role of monetary policy in the economy or reduce the pressure on central banks to play a more prominent role in stimulating growth. As a flexible inflation-targeting central bank, we do not ignore growth or employment. In carrying out our price stability mandate, we have always been highly sensitive to the growth needs of the economy and to the implications of our policies for growth. Ideally, we would try to conduct a contracyclical monetary policy: tightening policy when the economy is overheating with inflationary pressures evident, and providing some stimulus or accommodation when the economy is in a downturn – and when inflationary pressures are benign. This approach is, of course, standard textbook prescription. Admittedly, we have faced a number of challenges, not least of which is the fact that the breaches of our target range have generally been the result of supply-side pressures, including international oil prices, food prices, and the exchange rate of the rand. These exogenous forces have at times pushed us in the direction of procyclical monetary policy. Although we do try to look through the first-round effects of these pressures and only react to the emergence of second-round effects, our objectives are at times Bank of Ghana website (https://www.bog.gov.gh/) Page 4 of 12 criticised for not being sufficiently pro-growth. Furthermore, in times of very slow growth, as is currently the case in South Africa, there are those who see monetary policy as a solution to the growth problem, despite the fact that monetary policy has a very limited ability to change the long term growth potential of an economy. While we see some role for monetary policy in a cyclical context, we view our main contribution to growth as being in the provision of a stable and enabling environment for investment and employment creation – through maintaining price stability. Price stability also has other important social outcomes, not least of which is the protection of the poorest in society from the ravages of inflation. The poor are the least able to hedge against price increases. However, we are very clear that monetary policy has a limited role to play in addressing structural growth problems in an economy. In other words, monetary policy has a limited impact on potential output. This is the role of other policies. The decade from the mid-1990s was a period of widespread adoption of inflation targeting in the advanced economies and in a number of emerging market economies. It was also the period of the ‘great moderation’, which some analysts interpreted as the end of the business cycle. Asset markets were booming and global inflation was low, as were interest rates. In fact, in the early part of the 2000s, only a handful of countries were experiencing double-digit inflation. The role of central banks was increasingly seen as simply maintaining this benign inflation environment. At the same time, there were, however, increasing concerns that the excessive leverage created by the low interest rate environment could pose financial stability risks. The prevailing view at the time was that low inflation would be a sufficient condition for financial stability. It was also generally believed that it was not the duty of central banks to deal with financial stability risks. This view was epitomised in Alan Greenspan’s address at the 2003 Jackson Hole Symposium where he argued that not only were central banks not well equipped to recognise asset price bubbles, but that they also did not have the tools to deal with such excesses – and that the best they could therefore hope to do was to clean up once the bubble had popped. Page 5 of 12 Dissenting voices, notably from Bill White and Claudio Borio2 of the Bank for International Settlements (BIS), maintained that asset prices were in bubble territory, driven by excessive bank lending. This view argued that central banks should not have a narrow focus on inflation and that they should rather lean against this excessive leverage with higher interest rates and focus on the financial cycle, which is typically longer than the business cycle. This would have implied significantly higher interest rates than those prevailing before the global financial crisis, despite the low inflation environment. At that stage, when it came to financial stability, the focus of central banks was on the microprudential regulation and supervision of individual banks and on the banking system as a whole. Not much attention from a policy perspective was given to asset markets. The trend was also increasingly more towards a ‘light touch’ regulation of banks, with moves in a number of countries to more self-regulation. The macroprudential view was not very widespread. At that time, many central banks had only implicit financial stability mandates or no mandate at all in this respect. In South Africa, for example, although the SARB had explicit microprudential responsibilities for regulating and supervising individual banks, we did not have an explicit mandate to ensure the stability of the broader financial system. I should point out that while many central banks were responsible for bank regulation and supervision, this is not necessarily an exclusive central bank function. In South Africa, for example, this responsibility was transferred from the then Department of Finance to the SARB only in 1986. In a number of countries, for example in the United Kingdom (UK) and Australia, this function was transferred out of the respective central banks in the 1990s to independent regulators. The UK move was reversed in the post-crisis period with the establishment of the Prudential Regulation Authority within the Bank of England. The global financial crisis brought the need for a broader financial stability focus starkly to the fore. The dangers that some were warning about were real, and the See, for example, the article titled ‘Should monetary policy lean or clean: a reassessment’ by W White, published in Central Banking 19(4) in 2010. Page 6 of 12 consequences of ignoring them were disastrous. It also became clear that inflation targeting on its own was not sufficient to guarantee financial stability. Central banks then found themselves with an increased number of responsibilities. Not only were they expected to play a leading role in responding to the global recession; they were now also given explicit financial stability mandates. The role that central banks play in combatting inflation is clear-cut, but their role in financial stability is less so. This is because financial stability is multifaceted, and because not all aspects of financial stability are within the control of the central bank. In general, therefore, financial stability is a shared responsibility. While it has now been generally accepted that financial stability should be an explicit focus of policy, there is no complete unanimity about where this responsibility should lie and which instruments should be used. The debate has partly centred around the relationship between monetary policy and macroprudential policy. If interest rates are used for macoprudential policy purposes, it could result in potential conflicts between monetary and financial stability policies. An example is Sweden, where the Riksbank attempted to deal with a perceived financial stability risk of sharply rising house prices and burgeoning household debt by raising interest rates in 2010 – even though inflation was below target and the unemployment forecast was above the estimated long-run sustainable rate. This led to inflation falling well below the target and rising unemployment, forcing a reversal of the monetary policy tightening. One view, put forward by the BIS and others, has argued in favour of using interest rates as a financial stability tool, but with policy focusing on the financial cycle. This would result in tighter monetary conditions in the event of excessive leverage, even if inflation risks were relatively low. The advantage of using interest rates is that it affects all parts of the financial sector, although this could be a disadvantage at the same time, as interest rates are seen to be a ‘blunt tool’, impacting on the cost of credit in areas where this is not desired. Using the interest rate tool could also result in higher inflation variability. Although there is evidence that raising interest rates Page 7 of 12 can reduce leverage and reliance on short-term funding, some analysts have argued that the required levels could be prohibitively high and impact negatively on growth. Others, however, have argued that these two policy objectives should be separated, with different tools applied to different objectives. Lars Svensson, for example, argues that monetary policy and financial policy are different and distinct policies that should be conducted independently and with different instruments, although each policy should take account of the other.3 The well-known Tinbergen rule suggests that there should be the same number of instruments as there are targets. If the same instrument is used for multiple objectives, conflicts could occur and trade-offs could be required. According to this view, interest rate policy should remain a monetary policy tool and be the main instrument to control inflation. Other policies, which could be well targeted, would need to be introduced in order to deal with financial stability risks. This suggests a need for a different committee, separate from the monetary policy committee. Although it does not necessarily follow that such a committee should be located within the central bank, it is generally the model that is followed. Sweden is a notable exception, where the responsibility for financial stability lies outside the central bank. There are strong arguments for locating the financial stability function within the central bank. Charles Goodhart argues that the essence of central banking lies in its power to create liquidity by manipulating its own balance sheet, i.e. to lend either to an individual bank or to the market as a whole. To quote him: “It would cause massive complications if liquidity management remained the sole province of the central bank while a separate financial stability authority was to be established without any command over liquidity management. I infer from that that the financial stability authority has to be given command over liquidity management; but that also implies that the financial Svensson, L E O. (2014). ‘Monetary policy and financial stability are different and normally best conducted independently’. Paper presented to European Central Bank Forum on Central Banking. Page 8 of 12 stability authority would have command over the central bank balance sheet. Indeed the financial stability authority would then, de facto, become the true central bank.”4 There are practical advantages to allocating monetary, microprudential and macroprudential policy responsibilities to a single institution. Such an arrangement makes the coordination of different policies much easier, be it through crisis prevention or crisis management. This is particularly relevant during times of a financial crisis when the situation tends to deteriorate very rapidly and quick responses are required. In South Africa, we have adopted the latter approach. The responsibility for financial stability has been given explicitly to the SARB, and is overseen by an internal Financial Stability Committee (FSC). The FSC monitors the broader financial system but does not regulate or supervise individual banks. This remains the responsibility of the Bank Supervision Department at the SARB. This department will be transformed into a Prudential Authority (PA) in terms of the Financial Sector Regulation Bill (FSR Bill) that has recently been through the parliamentary process and currently awaits the signature of the President. Once established, the PA will regulate individual banks, insurance companies, and financial market infrastructures, while the Financial Sector Conduct Authority, previously the Financial Services Board, which oversaw the insurance sector, will take responsibility for market conduct. The FSR Bill also provides for the establishment of a Financial Stability Oversight Committee, chaired by the SARB Governor and including representatives from the Bank, National Treasury, and other financial regulators. The objective of this advisory committee is to support the SARB in protecting and enhancing financial stability and to facilitate cooperation and coordination of action among the financial sector regulators and the SARB in financial stability matters. Within the SARB, the formulation of macroprudential policy is the responsibility of the FSC. While monetary, macroprudential and microprudential policy are all separate functions within the SARB, their coordination is facilitated by being within the same institution and through some degree of overlapping membership of committee structures. Goodhart, C. (2010). ‘The changing role of central banks’. Bank for International Settlements Working Papers No. 326. Page 9 of 12 This raises the question as to the nature of macroprudential tools. Many countries are still grappling with this concept. Part of the challenge is that financial instability could emanate from multiple and sometimes unexpected sources. A number of different tools are required to deal with different eventualities. We are also unsure as to how effective such tools would be and because institutional structures and banking systems vary widely, we cannot assume that policies which work in one country would necessarily work in others. The SARB’s approach is set out in a paper5 released for comment in November 2016. The macroprudential instruments that are being considered are classified into three categories, namely capital-based instruments (including countercyclical capital buffers, sectoral capital requirements, and dynamic provisions), asset-side instruments (including loan-to-value and debt-to-income ratio caps), and liquidity-based instruments (including countercyclical liquidity requirements). These tools are intended to target the sources of systemic risk, such as liquidity and maturity mismatches, leverage, and interconnectedness. The advantage of using a more targeted, or function, approach is that it can cover the shadow-banking sector, asset markets, and the non-financial sector as well. Financial vulnerabilities do not only emerge from the banking sector. At this stage, the main policy decision that is made in the FSC relates to the Basel III countercyclical capital buffer. This is a potential capital add-on to bank capital should the committee decide to increase the capital requirement of the banking sector as a whole during an upswing, and should the ratio of credit growth to GDP6 be above its long-term trend. This would then be reversed during a downswing. Up to now, this requirement has been set at zero, as the credit gaps are very low. At present, the focus of the FSC is on identifying any vulnerabilities that could cause systemic risk. This is done by monitoring potential risks to the system through assessing various macroprudential systemic risk indicators. These indicators include macroeconomic, financial sector, market-based as well as other qualitative indicators. Should any mitigating actions be required, the FSR Bill provides the South African Reserve Bank. (2016). ‘A new macroprudential policy framework for South Africa’. gross domestic product Page 10 of 12 SARB with the powers to advise and/or direct financial regulators to take certain actions; this is done through the FSC. Having these additional responsibilities comes with its own set of challenges. The expanded mandate of financial stability in itself may have implications for central bank independence. Compared to financial stability, monetary policy decisions, while not easy, are nevertheless more straightforward and better understood by the public. These decisions generally involve the use of one tool (the interest rate), and there is a clear objective. It is important to appreciate that financial stability is not an end in itself but rather a means to an end, generally regarded as an important precondition for sustainable economic growth, serving the constitutional mandate of the SARB. A financial stability mandate is however more complicated, as it is a shared responsibility. The political economy aspect of this comes out strongly when we distinguish between crisis prevention and crisis management or resolution. The policy tools are more directed at particular sectors, and may therefore be more politically sensitive as the distributional impacts are more apparent than in the case of monetary policy. There could be perceptions of particular institutions or sectors being favoured over others. In particular, crisis management generally involves lender-of-last-resort facilities and/or providing some sort of assistance to banks that need it. These are inevitably quasi-fiscal decisions or actions, as they either directly involve government money or could lead to losses on the central bank balance sheet, which are potentially losses for government. As we saw during the global financial crisis, there were often political tensions between the need to save individual institutions in order to prevent the whole system from collapsing and the moral hazard concerns of bailing out large institutions. However, even crisis-prevention tools may be politically unpopular, especially in good times. Furthermore, as has been argued in an International Monetary Fund staff discussion note7, financial stability is difficult to measure but crises are evident, so policy Bayoumi, T et al. (2014). ‘Monetary policy in the new normal’. International Monetary Fund staff discussion note. Page 11 of 12 failures are observable, unlike successes. As noted in the paper, ‘central banks would find it difficult (even ex post) to defend potentially unpopular measures, precisely because they succeeded in maintaining financial stability’. 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. In conclusion, the role of central banks has changed since the global financial crisis. There is a sharper focus on financial stability issues, and there is also a different way of looking at these issues. This, however, does not mean that other areas of policy have been downplayed. In the wake of the crisis, central banks were relied upon, possibly excessively so, to help the recovery from the global recession and to avoid deflation. The recovery has taken some time. Fortunately, there appears to be a sustained recovery in the global economy, and there are now tentative moves by central banks in the advanced economies to normalise monetary policy settings. It would also appear that the concerns that extraordinary monetary accommodation would generate widespread inflation have not transpired. Although central banks have been given expanded mandates, the role of ensuring price stability has not been undermined or minimised. It is as important and as relevant as ever, and remains a crucial pillar of central banking. Thank you again, Bank of Ghana, for the honour of addressing you at this celebration of 60 years of central banking in your country. Page 12 of 12
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Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Strate GIBS FinTech Innovation Conference 2017, Gordon Institute of Business Science, Johannesburg, 22 August 2017.
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South African Reserve Bank Keynote address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Strate GIBS FinTech Innovation Conference 2017 Gordon Institute of Business Science, Johannesburg 22 August 2017 Regulatory responses to FinTech developments Introduction Programme Director, distinguished guests, ladies and gentlemen. I would like to start by thanking the organisers for the invitation to address you at this year’s Strate GIBS FinTech Innovation Conference. The conference is timely as we potentially face one of the most severe innovation- and technology-driven disruptions to products and services, particularly in the financial sector space. Arvind Sankaran, an advisor on FinTech, argues: “We are witnessing the creative destruction of financial services, rearranging itself around the consumer. Who does this in the most relevant, exciting way, using data and digital, wins!” To paraphrase the famous Austrian-born economist Joseph Schumpter: it is the process of industrial mutation that revolutionises the economic structure within, incessantly destroying the old one, incessantly creating a new one, a prominent feature of capitalism – which he further describes as the ‘perennial gale of creative destruction’. My address today will focus on regulatory responses to FinTech developments. Page 1 of 11 FinTech developments viewed from a regulatory perspective Over the last decade or so, FinTech has attracted attention from many quarters; publicity around FinTech developments continues to increase. Interestingly, some parties suggest that FinTech may offer revolutionary changes, such as completely new ways of banking where peer-to-peer lending arrangements, for example, may displace more traditional intermediaries. By contrast, others suggest that this type of innovation is not different to that experienced in the past. Moreover, like the Internet, these innovations are likely to integrate existing value chains and business processes that will give expression to a symbiosis between new FinTech firms and incumbents. Along these lines, others still argue that developments in the FinTech space are merely part of an evolutionary process driven by innovation – that this is therefore nothing new and that regulatory regimes are adequate to deal with these developments. Given these varying perspectives, regulators continue to reflect on how to respond to developments in the FinTech space. I believe that the following three proposals could serve to strengthen regulatory approaches to FinTech developments. These are: i. focusing analysis on activities involving financial services rather than on firms or technologies; ii. continuing collaboration between local and global regulatory authorities; and iii. investigating and deciding on the most appropriate structures, such as sandboxes, to keep abreast of FinTech developments and to allow for demonstration of the technology and experimentation with user cases. These three approaches are not mutually exclusive and are of importance in developing sound policy stances for FinTech. I will address each of these in turn. Page 2 of 11 Focusing analysis on financial services activities FinTech is developing rapidly. It has a vast scope that touches, among other things, on chatbots, artificial intelligence, block chains, cloud computing, and smart contracts. Given the pace of change, regulators, like most mortals, may find it hard to remain up to date with these developments; we are faced with the daunting prospect of having to reflect on the most appropriate regulatory responses to technologies that we may not fully comprehend yet. In this regard, I favour a ‘back to basics’ approach. Regulators should focus on regulatory principles that are risk-based rather than creating excessive rules-based regulations aimed at these technologies or products. For example, financial regulators do not regulate the Internet, biometric technology, or mobile devices. Regulatory intervention should be appropriate and applied to the underlying economic function. In the case of most central banks, the regulated activities should fall within the ambit of their regulatory mandate and would typically include deposit taking, payments, lending, insurance, and investments. The Financial Stability Board describes FinTech as ‘technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services’1 by focusing on the identified activities. In this regard, the focus centres on business process innovations and de-emphasises both the entities and the emerging technologies. Through this lens, we identify four areas of economic activities and potential areas of financial services provision. New forms of money or value storage The concept of virtual currencies is increasingly recognised. As people become more familiar with the concept, it has the potential to become more widely adopted. The ‘traditional’ currency issued by the central bank, also known as ‘fiat Financial stability implications from FinTech supervisory and regulatory issues that merit authorities’ attention, 2016, Financial Stability Board Page 3 of 11 money’, has the advantage that its issuer is a trusted third party. However, it is conceivable that other trusted third parties may emerge issuing virtual currency in the future. Virtual currencies that utilise advanced cryptography have enabled the issuance of private crypto-currency. In particular, Bitcoin and its underlying enabling technology, the blockchain protocol, has created the capability to exchange value on a peer-to-peer basis. In the words of Thomas Carper, a US Senator, ‘virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us’. According to the website coinmarketcap.com2, the total market capitalisation of more than 800 different virtual currencies is about US$146 billion, of which Bitcoin makes up approximately 47%, followed by Etherium, Ripple, and Litecoin3. This is still significantly lower than the current value of all money (approximately US$84 trillion) or physical money (approximately US$31 trillion). Although much lower in value, virtual currencies are emerging as a new form of money and/or a new ‘store of value’ that is ‘held’ within a network of computers. The underlying technology, such as the distributed ledger technology (DLT), although immature and still needing to be fully proven, could serve as a means to possibly reshaping financial services. Potential applications include general banking activities, trade finance, insurance, and payments. However, virtual currency is not without controversy. According to a paper issued by the Financial Action Task Force on Money Laundering (FATF) in 20144, one of the challenges facing regulators, the private sector, government as well as law enforcement agencies is the lack of a common understanding of virtual currencies, including how virtual currencies operate, the potential risks associated with them, and the vocabulary used to talk about them. https://coinmarketcap.com/charts/ www.coinbase.com http://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions-and-potential-aml-cftrisks.pdf Page 4 of 11 Payments The second set of innovations that affects financial services is the transfer of value undertaken through the effecting of payments. Due to its nature, the payment environment lends itself to being a ‘natural testing environment’ to allow for developmental innovations such as FinTech. Attention has been drawn to innovations such as SamsungPay or ApplePay, which have created the ability of paying with your mobile device, using your smartphone as a point-of-sale device5. A preliminary analysis conducted by the South African Reserve Bank (SARB) reveals that these innovations leverage existing payments infrastructure and that these new firms integrate themselves into existing value chains. Whether these innovations will fundamentally reshape or disintermediate existing business models remains an open question. In addition, new payment business models are emerging where current DLT solutions are applied to extended value chains. An example includes cross-border remittances where FinTech firms use DLT solutions to streamline the remittance value chain. The new business processes remove intermediaries, thus lowering costs and reducing the time taken to effect these payments and remittances. Against this backdrop, the SARB continues to monitor payment use cases involving DLT closely. Other activities include the use of social media and other emerging platforms such as WeChat and AliPay. Innovations that remove friction in the system, but also reduce transaction costs and information asymmetries are encouraging but, as regulators, we should be mindful of the risks and social costs. A FATF report6 highlights some of the risks when virtual currency is exchanged for real currency. These include money-laundering and terrorism financing. As virtual currencies permit anonymity, they are ideally placed to be traded on the Internet (which then becomes the ‘darknet’) and allow for anonymous funding activity. The traditional ‘know your customer’ philosophy and the tracing of funds become Examples include Square and Zettle. http://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions-and-potential-aml-cftrisks.pdf Page 5 of 11 nearly impossible. An unintended consequence of these developments may be increased regulatory costs. Lending The third major domain of financial services that may potentially be impacted by FinTech developments is the provision of credit. Online peer-to-peer and equity crowd-based funding platforms have provided alternative financial services options. These platforms connect investors to borrowers and disintermediate the traditional lending by banks and other service providers. Some of these platforms have grown rapidly, providing consumers and small businesses with opportunities to access credit. Regulatory authorities, however, have to balance this with concerns regarding issues such as the protection of consumers, investors and lenders alike, liquidity, procyclicality, general business risk7 as well as the unintended consequences that these activities may potentially have for the traditional banking models. Investments The so-called ‘robo-advice’ and high-frequency trading (HFT) are FinTech innovations in the investment domain. ‘Robo-advisors’ are a class of financial advisors that provides financial advice and portfolio management services online, with minimal human intervention. The software that is used for these services utilises its algorithms to automatically allocate, manage, and optimise clients’ assets. Similarly to ‘robo-advisors’, HFT firms have established themselves as notable participants in the financial markets. The Financial Stability Review published by the Banque de France in 20168 highlights that HFT firms have two characteristics which enable them to carry out very large numbers of small trades with short-term investment horizons (often intraday), namely: This would include, as an example, the structure of the platforms’ balance sheet. Banque de France, ‘Constructing the possible trinity of innovation, stability and regulation for digital finance’, Financial Stability Review, April 2016 Page 6 of 11 i. ultra-fast access – just a few milliseconds – to trading platforms and market information; and ii. trading algorithms that operate autonomously without human involvement when markets are open. The rapid development of HFT firms takes advantage of low entry barriers. These financial services providers tend to be non-banks with small or even negligible amounts of capital compared with the traditional market makers, i.e. the banks, whose regulatory capital requirements for trading books have increased. The rapid growth of these activities has attracted the attention of regulators due to the impact and potential systemic risks that HFT companies may unleash on financial markets and market stability. An example of this is short-lived but severe market crashes, such as the ‘Flash Crash’ in the US markets in May 20109. In summary, FinTech innovation can be observed across multiple financial services, including deposit taking, payments, lending, and investments. An in-depth analysis of the activities rather than of the technologies and/or firms providing these services helps one to understand these developments. New technologies will continue to present opportunities to reshape financial services. I would like to suggest that policymakers should focus unrelentingly on financial services and their underlying activities, as opposed to the ever-evolving technologies per se. Such a focus will most likely ensure appropriate regulatory treatment of similar activities, irrespective of the entity providing such activities, and will thus aim to better achieve level playing fields. Continuing collaboration between local and global authorities I would now like to turn to the importance of continued collaboration by regulatory authorities. Given the fast pace of change and the global nature of these innovations, collaboration between regulators is important. On 6 May 2010, a ‘Flash Crash’ occurred in the US markets. HFT allows firms to submit orders and execute trades (using algorithms) and to interact with markets in unpredictable ways, causing price pressure and dislocation of financial markets (albeit momentarily). Page 7 of 11 At the domestic level, the SARB’s involvement in monitoring FinTech innovation started in 2013 when it joined an informal intergovernmental working group (IWG) in our jurisdiction. This work group was established to better understand virtual currencies such as Bitcoin and their regulatory implications. The IWG consisted of National Treasury, the Financial Intelligence Centre, the South African Revenue Services, and the SARB. In 2014, the working group issued a user alert on virtual currencies through National Treasury. The SARB in turn, through its National Payment System Department, furthermore issued a position paper on virtual currencies later that same year. In 2016, the SARB established an internal Virtual Currencies and DLT Working Group. In recognising the growing evolution of cryptocurrencies, the SARB tasked this cross-disciplinary working group to research and analyse the evolution of user cases of emerging technologies, including blockchain and DLT. The main objective was to gain a better understanding of underlying DLT and smart contracts that leverage these emerging technologies. Further, by focusing on financial services activities, the SARB has accepted that FinTech extends beyond virtual currencies and DLT. For this reason, the SARB has recently decided to establish a broader FinTech programme, with three dedicated full-time staff members that report directly to me. Although it is at an early stage, this programme will be required to strategically review the emergence of FinTech and assess the related user cases. The primary responsibilities are expected to include the facilitation of the development of refreshed policy stances for the SARB across the FinTech domain. This will be done by robustly analysing both the pros and the cons of emerging FinTech innovations as well as the appropriate regulatory responses to these developments. A critical success factor of the programme will be the ongoing collaboration with our fellow regulators. We thus continue to work closely with National Treasury, the Financial Services Board, and the Financial Intelligence Centre in an intergovernmental FinTech working group. We will collectively determine the appropriateness of applicable regulatory frameworks and further review how our Page 8 of 11 frameworks can strengthen policy goals such as financial inclusion and the deepening of competition. Besides collaborating locally, the SARB actively participates in international regulatory and standard-setting bodies. Work undertaken by the various working groups at the Financial Stability Board and the Bank for International Settlements has been proactive in trying to understand the FinTech phenomenon and robustly explore its benefits, risks and appropriate regulatory frameworks. The SARB has contributed a paper recently published on assessing DLT and its impact on payments and securities markets. Additional work has also been published on the impact of FinTech on financial stability. In addition, work continues on matters such as machine learning, artificial intelligence, and digital currencies issued by central banks. The ongoing global collaboration is vital in order to keep pace with these developments. The SARB is committed to staying abreast of and contributing to global thought leadership on FinTech. Deciding on the appropriateness of structures, such as innovation hubs and sandboxes to keep abreast of FinTech developments Lastly, I would like to turn to innovation hubs and sandboxes. The SARB has been following the approaches, adopted by other jurisdictions, to assist policymakers and regulators in staying abreast of FinTech developments given how some lending and payment platforms have grown to become systemically important systems within a short space of time. For this reason, jurisdictions such as Australia, Hong Kong, Singapore and the United Kingdom have implemented innovation hubs and regulatory sandboxes. Innovation hubs provide support, advice and guidance to firms in navigating the regulatory framework and/or identifying supervisory, policy or legal issues and concerns. Regulatory sandboxes provide the platform for live or virtual testing of new products or services, in a controlled environment, with or without any ‘regulatory relief’. With added attention to FinTech, through the newly established FinTech programme within the SARB, we will urgently review the need for and Page 9 of 11 appropriateness of innovation hubs and regulatory sandboxes and how to be in a potion to take a firm decision within the coming year in this regard. Conclusion In conclusion, I would like to note that we live in an era of ongoing and rapid change which may hold significant implications for the regulation of financial services in response to these changes. I have suggested approaches that could aid the development of new regulatory frameworks in response to FinTech developments. The first fundamental principle is to focus sharply on regulating financial services provision or related activities. Regulation must, however, be appropriate, purposeful and smart – and it must aim to ensure a level playing field. Regulations should not be an impediment to progress, competition, or efficiency. The second fundamental principle that needs to be adopted relates to continued collaborating at both local and international levels. In the current age of universal provision of financial services, ensuring harmonised frameworks that limit regulatory arbitrage is crucial. Lastly, structures such as innovation hubs and sandboxes need to be considered carefully. The success of these structures is dependent on a clear regulatory purpose, open and transparent participation criteria, and measurable success criteria. Charles Darwin famously said: “It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.” Significant incumbent financial sector firms and other service providers would need to learn to appreciate that the biggest threat to the sustainability of their business is not necessarily their traditional competitors. It may very well be firms still to be established, that utilise technology still to be developed, and that leverage innovations still to be incubated. Page 10 of 11 I wish you well in your deliberations and hope that these thoughts have created insights on how we as regulators may respond to developments in the FinTech space. Thank you. Page 11 of 11
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Opening remarks by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the public workshop on proposals to establish a deposit insurance scheme for South Africa, South African Reserve Bank, Pretoria, 23 August 2017.
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Opening remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the public workshop on proposals to establish a deposit insurance scheme for South Africa South African Reserve Bank, Pretoria 23 August 2017 Introduction Good afternoon, distinguished guests, ladies and gentlemen. It gives me great pleasure to welcome you to this workshop on a possible deposit insurance scheme for South Africa. We are privileged to have present here today fellow central bankers, commercial bankers, financial market participants, regulators, public sector representatives, academics, members of the media fraternity, and other staff members of the South African Reserve Bank (SARB). In particular, I would like to extend a very warm welcome to the representatives from the World Bank, which has been very supportive over the past two to three years in the formulation of the proposals that will be discussed today, as well as to the representatives from other central banks in the Common Monetary Area that are present. We hope that this workshop will be the first step in expanding our fruitful cooperation in the area of managing bank failures. The SARB and National Treasury are currently developing new legislation to put in place a framework that will facilitate the resolution of failing financial institutions in an orderly and transparent way, one which seeks to minimise the use of government funding to bail out such institutions. This new resolution framework is an important pillar of the SARB’s expanded and explicit financial stability mandate, as contained in the Financial Sector Regulation Bill. A key component of such a resolution framework is the establishment of Page 1 of 6 an explicit deposit insurance scheme to ensure that the depositors who are most exposed to an asymmetry of information and thus least able to hedge themselves against financial loss in the event of a bank failure are protected against any losses and hardship that may stem from a bank failure. This framework is expected to enhance the public’s trust in the banking sector, which is an important aspect of financial stability. The implementation of a prefunded deposit insurance scheme will bring about closer adherence to the Key Attributes of Effective Resolution Regimes and to the Core Principles of Effective Deposit Insurance Systems issued by the Financial Stability Board and the International Association of Deposit Insurers respectively. South Africa has a well regulated and stable banking sector, but one that is also quite concentrated. Where one tends to find relatively regular failures of small banks in some other countries, bank failures in South Africa are rare – although when they do occur, they are typically more disrupting. Because bank failures in South Africa do not occur often and because, in the past, these failures involved relatively small banks or banks with limited retail funding (like African Bank), it was possible for government to compensate at least the retail depositors. Over time, this practice has led many South Africans to believe that their bank deposits are fully insured. However, this type of deposit protection is implicit rather than explicit, with compensation being largely dependent on the size of the failing bank and the fiscal strength of government at the time of such failure. There is unfortunately no clear, upfront guarantee of deposits in place, which creates uncertainty in the event of a payout about the deposits that will be compensated and to what amounts. Such decisions are often arbitrary, depending on the circumstances at the time. Furthermore, even if deposits are paid out, it can be a lengthy process to actually execute the payments in the absence of readily available depositor information and payout mechanisms. This can cause prolonged periods of hardship for depositors who do not have access to their bank accounts. Page 2 of 6 Another important disadvantage of an implicit deposit guarantee system is that it relies on government funding and tends to be procyclical; as such, support is usually required at a time when the economy and the financial system may already be vulnerable as a result of wider-spread bank failures. In principle, it is not desirable that public funds are used to pay for private failures. The main advantage of the implicit deposit insurance arrangements that South Africa has had in place to date, and probably the reason why we have lived with them for such a long time, is that the current framework does not put a direct cost on the banking sector – and it hardly costs the government anything unless there is actually a bank failure. However, we regard such arrangements as risky and acknowledge that they create a significant contingent liability for government. It is for all these reasons that South Africa is moving away from government-funded, implicit deposit insurance scheme to a privately-funded, explicit deposit insurance scheme. An explicit deposit insurance scheme sets out payment arrangements in law and ensures there is always adequate funding available. This funding is built up by the private banking sector in good times rather than at the point of failure. And although the proposed deposit insurance scheme will be prefunded, we will endeavour to ensure that we avoid placing an excessive cost on the banking system, distorting the competitiveness in the banking sector, or causing moral hazard to the extent that it may become a threat to financial stability. South Africa is currently the only G201 country that does not have an explicit deposit insurance scheme. In fact, about 125 countries have an explicit deposit insurance scheme, of which the Federal Deposit Insurance Corporation in the US2 is probably the best known, having been established in the 1930s just after the Great Depression. The organisation, funding, and operations of deposit insurance schemes varies greatly between countries; while there are a number of generic characteristics, each jurisdiction 1 Group of Twenty 2 United States Page 3 of 6 ultimately decides on the type and structure of the deposit insurance scheme that best suits its own financial system. However, a common denominator of all deposit insurance schemes is that they play an important role in the resolution of failed banks and the prevention of financial crises emanating from institutional failures. They also facilitate the process through which poorly managed and weak banks can leave the system in an orderly way, without causing extreme hardship, thereby making way for efficiently managed firms that can better serve the needs of the economy and of the population. The purpose of today’s workshop is to discuss the proposals outlined in the discussion paper that was published on 30 May 2017, which contains the joint views of the SARB and National Treasury on the design features of a possible deposit insurance scheme for South Africa. The paper deals in detail with all the aspects of the envisaged deposit insurance scheme; these will also be covered in subsequent presentations today, which I do not want to front-run or repeat. Let me just highlight, briefly, the key features of the envisaged scheme. Firstly, the deposit insurance scheme would be housed in a separate legal entity established as a subsidiary of the SARB. This organisational structure would ensure adequate independence for the deposit insurance scheme to pursue its objectives, but with the backing of the SARB for good governance and operational support. Secondly, all deposits (except those by other financial institutions and government, listed in the paper) would be covered, irrespective of the type or term of the deposits. Deposits at all banks, small and medium and large, would be covered to the same limit of R100 000. Based on a survey of the deposits at all banks, we estimate that R100 000 would be sufficient to fully cover the deposits of about 98% of the retail depositors in South Africa. Among the other benefits that have been mentioned, we expect that this level of coverage would help the small banks to expand their funding base and, over time, contribute to the diversification of the banking sector. Page 4 of 6 Thirdly, the envisaged deposit insurance scheme would be funded by the banks themselves, and all registered banks would be obliged to contribute to the fund. The paper proposes two possible funding options that were considered at the time. However, the most cost-efficient funding mechanism is still being discussed with the banking sector, and the ultimate decision may well differ from the proposals in the paper. It is important that the deposit insurance scheme is funded in such a way that the cost to the banking sector does not exceed the financial stability benefits, and that there is sufficient funding available to make the deposit insurance scheme effective. It is also important to have emergency funding available in the event that the deposit insurance scheme experiences a funding shortfall. Emergency funding arrangements should include prearranged and guaranteed sources of liquidity funding and be legislated. This is, however, subject to the proviso that such emergency funding is subsequently recovered from the remaining banks after the failure event. Fourthly, the build-up of a fund is but one aspect of the deposit insurance scheme. Equally important is the availability of accurate depositor information as well as IT3 systems and mechanisms to enable the prompt payout of deposits, supported by a sound legal framework, effective operational controls, and a strong governance framework. There will be much work for both the deposit insurance scheme and the banks once the legislation is in place. In this regard, the International Association of Deposit Insurers, of which South Africa is currently an associate member, has developed a set of tried and tested Core Principles to guide us in the development of a world-class scheme. There are also some more detailed areas that will require further research and deliberation, for example how exactly pooled accounts should be treated and how the small cooperative financial institutions should fit into the deposit insurance scheme framework. These aspects are important and will receive special attention in the coming months, without delaying the legislative processes. We appreciate your interest in this important initiative as a major part of the success of the deposit insurance scheme will depend on the public’s awareness of the scheme and knowledge about how it works. Enhancing such awareness will be an ongoing task of the 3 information technology Page 5 of 6 deposit insurance scheme, in which the media will be our close allies. The workshop today is a good start. Finally, we would like to remind you that there is also an opportunity to submit written comments on the deposit insurance scheme paper until 31 August 2017. We encourage you to make use of this opportunity as it will assist us in making the best policy choices. Thank you. Page 6 of 6
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Lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of South Africa (Unisa) Graduate School of Business, Pretoria, 30 August 2017.
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A lecture by Lesetja Kganyago, Governor of the South African Reserve Bank, at the Unisa Graduate School of Business 30 August 2017 Balanced and sustainable growth: the role and mandate of the SARB Good evening, ladies and gentlemen. The mandate and role of central banks is a hotly debated topic in many countries around the world. In South Africa, we tend to engage in this debate through rhetoric rather than facts. In our article published on 2 July, we set the basis for a more informed discussion.1 I would like to open the next chapter in that dialogue tonight. Let me start by asking: why does our money have value? Why can you exchange it for goods and services? The money is not backed by silver or gold or platinum. It is not backed by land. It is not pegged to another currency, such as the dollar or the pound. It works because of trust – trust in a promise made in the Constitution, which gives the South African Reserve Bank (SARB) a very specific job: “to protect the value of the currency in the interests of balanced and sustainable economic growth in the Republic.” Today, I will explain how we go about doing that job. While there are questions of constitutional principle in recent debates about the SARB‟s mandate, I would prefer to give you the economic argument for what we do. Independence needs to be earned; it is not enough for it to be Kganyago, Lesetja. „Why low inflation is the best way to stimulate economic growth‟. The Sunday Times, 2 July 2017. Page 1 of 17 enshrined in the Constitution. The economic argument is crucial for assessing our effectiveness – and for understanding why the SARB should be independent. There is no distinction, and hence no choice to be made, between protecting the value of the currency and attending to the socio-economic well-being of South Africans. Destroying the value of the rand through inflation, reducing what it purchases in terms of daily sustenance, would be of no benefit to anyone. The recent report by Statistics South Africa shows that our tragic rise in poverty coincides with a time of rising inflation and weakening growth, between 2011 and 2015.2 While we are happy to discuss alternatives to policy targets and to the way in which we now make monetary policy, the case for the existing framework is very strong; our own experiences and those of other countries overwhelmingly support it. Our monetary policy framework has helped us to achieve a historically low rate of inflation and, as a direct consequence of that, historically low interest rates. This suggests that, in our current economic predicament, rethinking monetary policy may not be the best use of our time. South Africa has far more urgent economic challenges, in particular reducing our structural unemployment rate. Statistics South Africa, Poverty trends in South Africa: an examination of absolute poverty between 2006 and 2011, 2015. 22 August 2017. The South African Multidimensional Poverty Index (SAMPI) shows a sharp decline in poverty, from 17.9% in 2001 to 8% in 2011, falling somewhat further to 7% by 2016. Page 2 of 17 How we protect the value of the currency Let me start with a classic problem of central banking. In general, everyone wants money to keep its value. However, everyone also wants lower interest rates – and there are always some people who ignore inflation and demand lower rates straight away. Unfortunately, if you give in to these short-term demands, you end up with more inflation and higher interest rates. When people see that the short-term demand for low interest rates is stronger than the long-term preference for low inflation, they change their behaviour. For instance, banks may charge more to lend, as protection against higher inflation. Or businesses may put up prices in advance, speeding up inflation. As a result, the shortterm desire for lower rates ultimately gives you higher inflation and higher rates. This is a well-understood problem. It is what economists call a „time inconsistency‟ problem. A solution is to make a binding commitment, a promise people can believe over time. In monetary policy, this has meant giving central banks their independence, leaving them to target inflation and set the marginal cost of borrowing in the money markets. The inflation target allows for some inflation but not too much. This is precisely why the Constitution tells us to protect the value of the currency – and to do so without fear or favour. We disregard short-term, private demands for higher inflation so that we can look after the longerrun interests of the general public. How, then, do we go about delivering on this mandate? Since 2000 we have used an inflation target. This means we protect the value of the currency as measured by changes in consumer prices. We like this Page 3 of 17 measure of value because it is relevant to the lives of all South Africans. Furthermore, we have had more success hitting our inflation targets than we have had with other, older approaches, such as pursuing money supply targets or trying to control the exchange rate. Importantly, like many other countries, we have found that inflation targeting has helped to deliver good economic outcomes. Why inflation targeting produces good economic outcomes For a start, as intended, inflation targeting has helped us to get lower inflation. In the 1980s inflation averaged about 15%. It was almost 10% in the 1990s. Since the adoption of inflation targeting in 2000 it has been close to 6%. Lower inflation protects South Africans‟ living standards, especially of people without the power or financial knowledge to shield themselves from price increases – most of all the poor. I will give you a very simple example. Bread costs about R11 at the moment.3 If inflation stays at around 6%, bread is going to cost R35 in 20 years‟ time. If inflation goes back to pre-democracy levels, that same loaf of bread is going to cost R180 in 20 years. These kinds of huge price increases will leave many more people behind. This is why higher inflation is a recipe for more poverty and more inequality. Lower inflation has also permitted lower interest rates. The average prime rate in the 1990s was almost 19%. It was about 13% in the 2000s and has averaged just under 10% since 2010. Among other benefits – like supporting long-term, job-creating investment – this decline in rates Sasko Premium Brown Bread, 700g, Pick ‟n Pay, R10.99, priced on 13 July 2017 Page 4 of 17 has contributed to the inclusion of millions more South Africans in the market for financial services.4 Furthermore, targeting inflation has allowed us to be more flexible. When you are aiming at a relatively slow-moving variable like inflation, you do not need to react as rapidly as you might have had to with something like the exchange rate. As a result, interest rate changes have been smoother. Back in 1998, for example, before we started inflation targeting, we raised interest rates by almost 7 percentage points in just five months. The policy rate went to nearly 22% and the prime rate reached 25.5%. In more recent years, by contrast, we adjusted the policy rate by just 2 percentage points over three-and-a-half years, to 7%, before lowering it to 6.75% in July. This sort of smooth adjustment is much easier on firms, households and government than large, rapid adjustments. In textbooks, there is a short-term trade-off between growth and inflation. Many people think of this as permanent and wonder why we do not accept more inflation so we can have more growth and more jobs. This is not how it works. In fact, the data show clearly that inflation and growth have moved in opposite directions, with more inflation coinciding with lower growth and higher growth accompanied by lower inflation. This makes sense: inflation eats into peoples‟ real incomes, making them poorer – as they can buy fewer goods with the same money. It also generates higher and more volatile interest rates. All of this affects For instance, the proportion of South Africans with a financial product from a regulated provider has risen from 55% in 2005 to 85% in 2016. See National Treasury, 2017, A financial sector that serves all South Africans, available at http://www.treasury.gov.za/documents/national%20budget/2017/review/Annexure%20F.pdf. Page 5 of 17 growth. So keeping inflation under control should be growth-friendly, which is just what the numbers show. This pattern also holds in a comparison across countries. Besides South Africa, 11 other emerging markets adopted inflation targeting in the late 1990s and early 2000s. These included Brazil, Thailand, and Colombia. Those with lower inflation than South Africa have had better growth and less unemployment. This suggests that there is nothing growth-friendly about higher inflation targets. Of course, there are many things that affect a country‟s growth rate. But if inflation targeting is such a big „problem‟, and if there is a significant trade-off between growth and inflation, then countries with lower, tighter targets should have suffered more. They did not. They did better.5 Since the Public Protector‟s report, some old complaints about the inflation-targeting framework have reappeared in the press. One objection is that inflation targeting is appropriate only for advanced economies, not for emerging markets. A second is that we should be targeting growth or employment instead. A third objection is that inflation targeting hurts exports because high interest rates keep the rand too strong. I would like to explain why these are not convincing arguments for replacing inflation targeting. First, let me tackle the criticism that inflation targeting is allegedly more of a „rich country policy‟. In fact, inflation targeting is popular in both advanced economies and emerging markets. Research by the Since 2000, South Africa has had the second-highest inflation rate, on average, of these 12 countries. (Brazil is first.) South Africa ranks eighth for growth and last for unemployment. Since the most recent global financial crisis, South Africa has once again had the second-highest inflation rate, after Brazil, but its growth rank has slipped to ninth place. It remains last for unemployment. Page 6 of 17 International Monetary Fund identifies 28 „pure‟ inflation-targeting countries.6 Of these, 20 (or 71%) are emerging markets. If we use a broader definition, more countries qualify. There are 64 countries with a published inflation target for 2017; 49 of these (or 77%) are emerging markets.7 Furthermore, if anyone is having trouble hitting inflation targets, it is the advanced economies. Most of the central banks in the major advanced economies are below their inflation targets and have been so for some time. By contrast, emerging markets are mostly on target or getting there. South African inflation, to take the most immediate example, fell back within the target range in April this year and is expected to stay there for the foreseeable future. The reason why emerging market central banks are doing better than their rich country peers is probably because we know more about lowering inflation than raising it – especially when interest rates are already at zero. My conclusion is therefore that inflation targeting is more of an emerging market practice than an advanced economy one – one that has been working better in emerging markets, too. Should we be targeting something besides inflation? I know of no central banks that are employment targeters or growth targeters. There are good reasons for this. Contemporary economic thinking and lots of experience indicates that monetary policies cannot do much about structural growth and employment problems. If you do not have enough skilled workers, the central bank cannot mint doctors and engineers. The thinking and experience also stresses that any trade-off between growth See Sarwat J, March 2012, Inflation targeting: holding the line, available at http://www.imf.org/external/pubs/ft/fandd/basics/target.htm. The data for 2017 inflation targets are drawn from http://www.centralbanknews.info/p/inflationtargets.html. Page 7 of 17 and inflation, or unemployment and inflation, is short-term only. What you can do is stabilise inflation at the target and employment or growth at its sustainable rate. For this reason, even the central banks with multiple mandates tend to behave a lot like inflation targeters. The US Federal Reserve (Fed), for instance, has a triple mandate, for low inflation, low unemployment, and low interest rates.8 In practice, the Fed aims to anchor inflation expectations in line with its 2% target. In turn, low inflation helps to keep interest rates low, and the two together help to maximise employment. One can explain US interest rate decisions pretty well using a simple rule, as the economist John Taylor famously showed. Simply put, the Fed reacts when inflation is not on target and when unemployment is away from its normal levels. We consult very similar models in the SARB, and they also describe our policy decisions pretty well. This is because we, as monetary policymakers, already care about cyclical variations in employment and growth. This is the nature of flexible inflation targeting; I have never sat in an MPC9 meeting where we just looked at the inflation rate and ignored everything else. Of course, any inflation-targeting central bank can give you low rates if inflation is well behaved; you do not need an extra mandate to do that. We try very hard to keep interest rates as low as they can be given the inflation forecast. Finally, does inflation targeting get in the way of export-led growth, by keeping the exchange rate too strong? Back in the late 2000s, the visiting International Growth Advisory Panel suggested that a more Although the Fed is widely thought to have a dual mandate, the Federal Reserve Act actually specifies three objectives. Ben Bernanke discusses this in The Courage to Act, published in 2015. Monetary Policy Committee Page 8 of 17 competitive exchange rate could be helpful for boosting exports. The Panel also suggested running a fiscal surplus to create space for lower interest rates, and they encouraged us to keep inflation targeting.10 More recently, some people have claimed that the Harvard Panel report shows that even experts have a problem with inflation targeting – ignoring what the Panel really said.11 They also forget that by the time the Panel‟s report was released, this suggestion had been overtaken by events, with the rand having weakened again.12 In fact, under inflation targeting, excessive exchange rate appreciation has been rare and short-lived. These discrete periods occurred when capital flowed in as a result of high commodity prices, sustained public borrowing, and low yields in advanced economies – not because of inflation targeting. The inflation-targeting framework, all else being equal, has lowered inflation and interest rates, reducing the pull on hot money in recent times. In fact, a fundamental, and achieved, objective of inflation targeting was to obtain a more competitive exchange rate. Exchange rate targeting, the implicit policy of the 1990s, kept the rand uncompetitive. It is likely that the act of introducing the inflation-targeting framework helped to attract capital in 2000 because it signalled a move to a much better policy framework, but South Africa was starved of capital at the For the Panel‟s recommendations, see Ricardo Hausmann‟s Final recommendations of the International Panel on Growth, available at http://www.treasury.gov.za/comm_media/press/2008/Final%20Recommendations%20of%20the%20I nternational%20Panel.pdf, especially pages 6 and 12-13. See, for instance, Luke Jordan‟s It’s time to debate the central bank’s mandate, available at https://www.dailymaverick.co.za/opinionista/2017-06-23-its-time-to-debate-the-central-banksmandate/#.WVuR5RWGOUm (June 2017). This point was made at the time by Kenneth Creamer, in “SA needs an inclusive growth path”, Mail & Guardian, published on 4 July 2008. Page 9 of 17 time. Any other policy framework that improved on the previous one would have had the same effect. Let me make a broader point about this debate. South Africa needs capital to develop. It also needs a reasonably competitive real exchange rate. Achieving both is not easy, but the simple solutions occasionally proffered are seriously inadequate. First, they invariably focus on nominal depreciation and not on real depreciation; the inflationary sideeffects of nominal depreciation are ignored. Second, the proposals never say anything about the implications for the fiscus, for interest rates, and for the broader economy of targeting a specific exchange rate level.13 Third, I would like to hear why this effort would be successful in South Africa when it has not worked well in other democracies that have tried it. Even a cursory review of the Asian success stories shows they had a very high savings rate and used financial and wage repression and price controls to achieve real undervaluation. How exactly would these authoritarian approaches to policy be implemented here? At the end of the day, we have had a major depreciation in both nominal and real terms of the exchange rate since 2011, yet the net export response has been very weak. If nominal depreciation is so critical, we should have experienced an export boom. I do not doubt that a competitive exchange rate is useful, but it is the real depreciation that matters here and, on balance, keeping inflation low contributes to that aim. Maintaining a specific exchange rate level requires the daily management of the supply and demand for foreign currency, often involving large and abrupt moves in interest rates, access to unlimited foreign currency, and large swings in economic activity. Page 10 of 17 Have we been too focused on inflation? I think that inflation targeting makes sense for South Africa as it is an effective way to uphold our constitutional duty to protect the value of the rand. That said, we need to have some important conversations about the South African version of inflation targeting. Reading (and believing) some of our critics, you would think the SARB is obsessed with inflation – and little else. From a worldwide comparative perspective, South African inflation has become quite high. Back in 2005, we had lower inflation than 60% of all countries. More recently, in 2011, we were about in the middle – lower than half, higher than half. In 2016, however, we had higher inflation than most other countries – 80% of them. This is not just because we had a drought and food prices were high. Based on forecasts, it will be much the same story for 2017.14 One big reason why we have higher inflation than most other countries is because our target is unusually high and wide, plus we typically have inflation right at the top of the target range, close to 6%. Furthermore, of the peer emerging markets I mentioned earlier, we are the only one where the inflation target has not been revised down at least once. Nowadays most emerging markets have targets of around 3% or 4%. For instance, India adopted a 4% inflation target last year, and Brazil has just revised its target down to 4%. A frank reassessment of the 3-6% inflation target – which is now almost 18 years old – would probably conclude that the target should be lower. My economists have worked on the numbers, and they report that if we want an inflation rate in line This comparison uses IMF data from the April 2017 World Economic Outlook. Page 11 of 17 with our trading partners, we should be aiming for 3-4%15 - that is not where we are today. As you can see, we are certainly willing to reflect critically on monetary policy. But let me add that we also need to prioritise. We have been suffering from a recession provoked chiefly by a collapse in confidence, driven by serious policy uncertainty. We have been downgraded by all the major ratings agencies, and we are barely clinging to investment grade status for our rand-denominated debt. The ratings agencies tell us that the major policy pillar that supports the South African investment case is our monetary policy framework. Why then, in this environment, would you want to make the discussion about changing the monetary policy framework? As a matter of science, there are no settled questions and more research is always appropriate. As a matter of policy, this focus seems misguided. Central bank accountability What about accountability? Our fundamental purpose, as with the other parts of South Africa‟s system of government, comes from the Constitution. Our job is to figure out a monetary policy framework that delivers on this mandate. In line with many other countries, we use an inflation target. We identify the precise inflation target after consultation with National Treasury. This is as transparent to the public as it can be. No one can give the SARB secret instructions. Our mission is in plain view, and the evidence for judging us is independently produced and For details, see „Box 4, South African inflation: an international perspective‟ in the Monetary Policy Review, published by the SARB in October 2016, available at http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7504/MPROctober2016.p df. Page 12 of 17 publicly available, in the form of the consumer price index published by Statistics South Africa. Of course, this is not the only way in which the SARB is held accountable. Our other roles and powers, such as bank supervision and financial stability, are assigned to us by laws passed by Parliament and signed by the President. We submit our Annual Report to Parliament. Furthermore, the Governor and the Deputy Governors are appointed by the President following consultation with the Minister of Finance and the SARB‟s Board of Directors.16 This system is designed to create the space for the SARB to make good decisions while maintaining democratic accountability. If you believe that the SARB is so independent that it can ignore the public interest, you need to reflect on how our work is specified in law and how we consult on our target. At this point in the conversation, you can usually rely on someone to ask about the SARB‟s private shareholders. What is a central bank with private shareholders doing in South Africa‟s Constitution? Does this not mean the SARB is run in the interests of private individuals, not in the interests of South Africans? This has become something of a zombie argument: no matter how many times you kill it, it keeps coming back. The fact is: private shareholders have no influence whatsoever on monetary policy, financial stability, or banking regulation. Their rights are highly circumscribed. A shareholder, and his or her associates, cannot hold more than 10 000 shares out of the total of 2 million shares in issue. According to the SARB Act, shareholders receive a fixed annual Governors and Deputy Governors are appointed for fixed five-year terms. My current term, for instance, began in November 2014 and expires in late 2019. Of the Deputy Governors, Daniel Mminele concludes his current term in June 2019, Kuben Naidoo in March 2020, and Francois Groepe in December 2022?. Page 13 of 17 dividend of 10c per share. This dividend policy has not been updated in 90 years, so I am afraid it has not been a great investment. Our total dividend payout each year is R200 000. Some of the shareholders are annoyed by this and would like to be paid much more. However, this is not the way the shares work. Instead, the SARB‟s aftertax profits – which were R1.4 billion for the last financial year – mostly go to National Treasury, with a small portion being kept for the SARB‟s own reserves. The shareholders got 0.014%, or roughly one ten-thousandth, of total profits made. For the record, R200 000 is somewhat less than the salary we pay a single junior economist. In other words, come work for us in a junior role and you will make more than all the SARB‟s shareholders combined. The fact that we have private shareholders is admittedly slightly unusual. It used to be a common practice, and today there are still a few other central banks with a degree of private ownership, including those of the US, Japan, Turkey, and Switzerland. I think our shareholders are helpful with some governance issues. It is useful, for instance, to hear from the members of our Board with experience in the agriculture, mining, and public sectors. However, if we had a fully nationalised central bank, I would not be giving speeches suggesting that we privatise it. So why not just nationalise the SARB? Simple. It would not change anything useful that we cannot change anyway, and it would be expensive. It would not change anything useful because shareholders already have no control over the SARB‟s policy responsibilities, as I have explained. Why would it be expensive? I will tell you another story. SARB shares normally trade Page 14 of 17 for about R3. The funny thing is: if you ask about buying SARB shares, you will find there are standing offers to sell from people whose price is R7 900 per share. Who would charge almost R8 000 for something that normally sells for R3? I suspect there are sellers out there who think we will have to nationalise the SARB in the end because it will be the only way to kill this zombie argument about private shareholders once and for all. As a result, they will get to make a nice profit at the expense of the South African people. My economic advice is: let us not pay large sums of money for purely cosmetic changes. Conclusion In this lecture, I have discussed how the SARB protects the long-run interests of South Africans, and I have demonstrated that South Africa has experienced better economic outcomes under inflation targeting than it did previously. We are always interested in monetary policy research, but a major overhaul of the monetary policy framework does not strike me as our most pressing issue. Maintaining a relatively low inflation rate helps to keep long-term interest rates low, and, all else being equal, supports long-term investment. This also works against the real appreciation of our currency. This is as much as monetary policy can do to support economic growth. Low inflation and low interest rates – just like our commodity endowment, our population growth rate and demographic dividend, our excellent higher education system, and our creativity and spirit – are critical to long-run growth and job creation. Thank you. Page 15 of 17 Charts: Bread prices at different inflation rates Average inflation @ 4.5% p.a. Avg inflation 2003 to 2016 @ 6% p.a. R180 Avg inflation 1993 to 2002 @ 8% p.a. Avg inflation 1983 to 1992 @ 15% p.a. R51 R35 R10 R27 Share of countries with public inflation targets for 2017 Advanced Economies 23% Emerging Markets 77% Source: Central Bank News Page 16 of 17 SA's inflation rank in the world (IMF data) 100% 90% 80% 70% [VALUE] 60% 50% 40% 30% 20% 10% [VALUE] 0% 2003 2005 2007 2009 2011 2013 2015 2017 Share of countries with higher inflation Share of countries with lower inflation SA percentage rank Page 17 of 17
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Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at SAICA's Courageous Conversation Session, Johannesburg, 26 September 2017.
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Keynote address by Lesetja Kganyago, Governor of the South African Reserve Bank, at SAICA’s Courageous Conversation Session Nelson Mandela Centre of Memory, Johannesburg 26 September 2017 Sovereign rating downgrades and their impact on the poor Good evening, ladies and gentlemen. The sovereign ratings of South Africa, which are the key theme of my speech this evening, have been a prominent concern for policymakers and investors alike in recent years, and will again feature heavily in policy discussions as the year-end approaches. Following the gradual and regular improvement in our country’s sovereign ratings from the advent of democracy to the mid-2000s, which saw South Africa regain investmentgrade status, South Africa’s credit standing has again deteriorated in recent years. Both Standard & Poor’s and Moody’s rating agencies started downgrading South Africa in 2012; this process culminated in the loss of investmentgrade status (for foreign-currency debt) in 2016 with two of the three major rating agencies. Further reviews of South Africa’s ratings are due before year-end. Our growth and fiscal performance, in particular, are therefore under a high degree of international scrutiny at present. Page 1 of 10 The financial market and policy implications of rating downgrades are well documented, ranging from difficulties in getting non-resident investors to finance the current account deficit, through a greater volatility of financial markets, to higher costs of borrowing for the sovereign. What many people are less familiar with are the implications for the public at large, for incomes and inequality, and in particular for the lower-income segment of the population. These are the points that I would like to discuss this evening. The general public, in particular the poorer households, may wonder how a rating downgrade can directly affect their daily lives. After all, poor people do not borrow overseas; they do not run businesses that are dependent on financing by foreign investors; they rarely travel overseas; they do not directly hold shares in listed companies. Some voices, indeed, may go further and say that South Africa’s government should not pay excessive attention to the decisions of foreignbased rating agencies. These voices may argue that the decisions of rating agencies mostly affect wealthy individuals and have limited bearings on the economic well-being of the poorer majority. Let me explain why such thoughts are misguided. Irrespective of its direct implications, a sovereign rating downgrade does have indirect impacts on all the citizens of the country. These can be felt harder by the poorer households who, unlike the wealthier ones, do not have the possibility of ‘hedging themselves’ from the consequences of a downgrade by diversifying their assets. There are five major channels through which the recent rating downgrades can undermine the well-being of poorer households, which I will discuss more in detail. Page 2 of 10 The ratings of a listed entity (be it a government or a corporation) are meant to reflect its ‘credit quality’. Hence, they are used by international investors to gauge the risk of buying the bonds issued by that entity. In theory, therefore, these investors will – subsequent to a downgrade – require a premium in the form of a higher interest rate, or they will shun these bonds altogether. South Africa requires foreign investors to finance its external deficit (as its imports regularly exceed its exports). A rating downgrade therefore means that financial markets will move to a new equilibrium where the interest rates on bonds are higher and the exchange rate of the rand is weaker than before the downgrade. Obviously, the recent empirical evidence is clouded by the fact that many other factors, bar sovereign ratings, influence the price of South African financial assets. Nonetheless, a standard measure of sovereign credit risk for South Africa, namely the credit default swap (CDS) spread, has underperformed compared to its emerging-market peers in recent years, and is now trading at similar levels to non-investment-grade countries. This is clear evidence that investors are requiring a higher risk premium, if only in relative terms, on South African government debt. The increase in the yield on inflation-linked bonds issued by National Treasury, over the past two to three years, is another such indication. Even after being fully protected against inflation, bond investors require a higher return – even as global economic factors have continued to depress risk-free, real interest rates all over the world. These higher yields on South African bonds will, over time, negatively affect the poor. As the South African government faces a higher cost of borrowing, it will have to devote a larger share of its (finite) resources to Page 3 of 10 servicing debt. Already, estimates by National Treasury indicate that government debt-servicing costs are expected to represent 10.4% of total budget spending (and 3.5% of GDP1) in 2017/18, up from a low of 7.0% in 2009/10. This stands in contrast to the years prior to the global financial crisis, when the improvement to South Africa’s credit rating coincided with a gradual decline in the share of public spending devoted to servicing debt. In turn, when debt-servicing costs rise faster than the overall budget, the amount of money available for other missions – especially those of utmost importance to the poor, like public health, education, infrastructure, and social services – is reduced. Across the world, countries with the lowest creditworthiness and with the most difficult access to international market financing are generally those with the poorest Human Development Indices. To a large extent, poor households ‘pay’ for the low credit quality of their sovereign. Some may argue that, faced with higher debt-servicing costs, there are policy alternatives to curbing redistributive government expenditure, such as increasing public borrowing or raising taxes on higher-income households. However, these alternatives are probably not sustainable in the long run. Simply adding to borrowing would most likely, over time, prompt further downgrades, raise interest rates, and threaten a financial crisis. From 26% of GDP just before the global financial crisis, South Africa’s debt-to-GDP ratio is expected to rise to 52% in the current financial year, even without including contingent liabilities. (This is, effectively, a doubling of the ratio in less than 10 years.) From what was 1 gross domestic product Page 4 of 10 a relatively low level by emerging-market standards in the 2000s, South Africa’s debt-to-GDP ratio has moved to a relatively high position, which could – if continued – reduce our country’s relative attractiveness to global investors. Equally, raising taxes on higher-income households and corporations, in a country where the tax system is already fairly progressive (and the tax burden, at least by emerging-market standards, relatively high), could undermine the already anaemic pace of economic growth or trigger capital outflows. For the state to effectively help the poor, it needs maximum fiscal space, and that means (among other things) well-managed public finances and sustainable debt burdens. This also has key repercussions for monetary policy’s ability to best contribute to sustainable long-term economic growth. In the event that public finances keep deteriorating, a country can experience ‘fiscal dominance’ – when the central bank’s interest rate policy is primarily dictated by the need to ensure adequate financing of the budget deficit at the expense of other, real, economic considerations. It is easy to see how this can be a suboptimal outcome from the point of view of economic development. Fortunately, these difficult trade-offs have to be made by duly elected representatives of the people of South Africa. As the South African Reserve Bank, we only look at what the implications of these are for monetary policy. Furthermore, a rating downgrade will not only affect the price of government debt; it will also affect what is paid by all the other bond issuers in the country – raising, for instance, the cost of issuing and servicing debt for banks and state-owned utilities. To maintain profitability, Page 5 of 10 it is likely that banks will pass on these higher costs to their customers, in the form of higher rates on loans or higher bank fees or lower interest rates paid on deposits. In fact, higher funding costs for banks may be one of the reasons why the spreads between bank lending rates and the repurchase rate as well as deposit rates have widened since the global financial crisis. With many low-income households relying on cash loans for meeting their subsistence needs (often at already-high rates) or using bank deposits as a major form of savings, one can easily see how higher borrowing costs of banks can penalise them. Equally, if a state-owned utility like Eskom is forced to pay higher interest rates on its debt, such costs are likely to ultimately be passed through to their customers – in the form of higher electricity tariffs, including for poorer households. Separately, South Africa’s domestic savings are insufficient to meet its investment needs. Offshore borrowing is therefore required to fund growth and development. So, any downgrade in sovereign ratings is bound, sooner or later, to have negative consequences for the exchange rate of the rand. This, too, can potentially harm the poorer households. Historically, because of the openness of the South African economy, a depreciation of the exchange rate has tended to raise inflation. In turn, a higher rate of inflation hits the most vulnerable harder, especially people who depend on basic grants which only get adjusted once a year at most. In particular, food prices and transportation costs rise on the back of rand depreciation. This reflects one of two things: either the need to import some of these goods (for instance petrol, which will over time affect the prices of public and collective transport) or linkages between the prices of foodstuffs and those of agricultural commodities on the global market. These items account for a larger part of total expenses for the poorer Page 6 of 10 households. For example, according to calculations by Statistics South Africa, food and non-alcoholic beverages account for 48% of consumption expenses for the 10% poorest households, compared with a weight of only 17% for the whole population. The impact of a rating downgrade on financial markets may also have more direct implications for the poor than generally assumed. As mentioned earlier, poor households do not directly hold share portfolios, but some – in particular, older people who worked for a while in the public or private sector – rely on payments from pension or provident funds as their main, if not sole, source of income. If the value of financial assets declines, the money available in these pension and provident pools will shrink accordingly. Separately, research shows that some of the savings vehicles typically used by poor people, such as stokvels, are gradually being invested in financial assets to create wealth rather than being used solely for short-term purposes (such as, for instance, to cover funeral costs). 2 Again, any drop in the value of these financial assets would undermine the efforts aimed at creating wealth through such savings vehicles. Finally, rating downgrades cast general doubts on the long-term economic and financial health of a country. This is because downgrades typically weigh on business confidence, undermining companies’ willingness to invest in new productive capacities and boost the size of their workforce. At worst, businesses fearing a worsening economic future may shed jobs, resulting in an overall decline in the number of employment opportunities throughout the country. In South Africa, unemployment exceeds 27% of 2 See ‘Investments in stokvels gaining ground’ published on the Fin24 website on 9 July 2014. Page 7 of 10 the workforce, while the ability to find a job often provides the main chance to escape poverty for an individual and his or her family. Declining job opportunities would therefore risk aggravating the incidence of such poverty. Arguably, many of the channels described above operate through investor sentiment and financial asset prices, including the exchange rate of the rand. One can therefore argue that so far, in particular since the latest rating downgrades, the reaction of financial markets has been rather benign. For instance, the yield on the 10-year South African government bond is still close to the average of the past five years, and the 5-year CDS spread on South African sovereign debt is around its lowest since late 2014. As for the rand, it has recovered by about 20% on a tradeweighted basis from the lows it had reached in early 2016. Yet this relative stability is fragile, dependent on developments that may reverse in the not-too-distant future. The lack of a strong sell-off in either the rand or local bonds has more to do with a conjunction of favourable international factors than with investors downplaying the possible negative consequences of a downgrade. In particular, the factors referred to are the improvements in global economic developments, the absence of inflationary pressures in the advanced economies, and a stillaccommodative stance by the world’s major central banks. These factors have ensured that capital continues to flow to the emerging world, even to countries which have experienced a deterioration in their creditworthiness. But these flows could easily reverse. And amid tighter global financial conditions, investors would be more likely to differentiate between stronger and weaker sovereign credits. Should South Africa face another global shock, like it did during the 2008-09 global recession, its Page 8 of 10 recent rating downgrades could well make it more vulnerable to that shock. Admittedly, some commentators claim that further downgrades to South Africa’s sovereign ratings would not starve the country of foreign capital, as other investors – specifically, funds of a more speculative nature – would still buy domestic financial assets. However, apart from the fact that these investors would require a higher return on South African assets than recent historical norms, their investments would be more short-term in nature, most likely resulting in a higher volatility of market prices. This, in turn, would increase the climate of uncertainty facing domestic businesses, with negative consequences for fixed investment, job creation, and therefore poverty and inequality. In conclusion, let me say that a sovereign rating is not a policy goal per se. Rather, it is a reflection of a broad range of economic, social, and political factors that constitute the creditworthiness of a country. Key among these factors is the strength of our institutions, including the Chapter 9 institutions, the judiciary, and the South African Reserve Bank. These institutions underpin our democracy and our creditworthiness. It is this creditworthiness that policymakers should strive to improve, for goals that include development and poverty reduction. As international experience shows, it is failure to generate sufficient economic growth and to maintain healthy fiscal and external balances that keeps large portions of a country’s population in poverty. For South Africa’s economy to become stronger and more resilient, and to make inroads into poverty, we need not only to avoid further downgrades; we should also ensure that the recent downgrades are eventually reversed. Page 9 of 10 Thank you. Page 10 of 10
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Opening remarks by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the workshop on "The impact of IFRS 9 on banks and regulators in Africa", jointly hosted by the Working Group on Cross-border Banking Supervision and the South African Reserve Bank, Pretoria, 26 September 2017.
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Opening remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the workshop on the impact of IFRS 9 on banks and regulators in Africa, jointly hosted by the Working Group on Cross-border Banking Supervision and the South African Reserve Bank South African Reserve Bank, Pretoria 26 September 2017 Introduction Good morning, distinguished guests, ladies and gentlemen. It gives me great pleasure to warmly welcome you to this workshop on the impact of International Financial Reporting Standard (IFRS) 9 on banks and regulators in Africa, which the South African Reserve Bank (SARB) is hosting jointly with the Working Group on Cross-Border Banking Supervision. I would like to thank the Association of African Central Banks and, in particular, the Working Group on Cross-Border Supervision of the Committee of African Banking Supervisors for being present here today. We are indeed privileged to host fellow central bankers and regulators from across the African continent to discuss matters relating to the implementation of IFRS 9. The SARB truly values the cooperation with its peers from the continent and opportunities like this allow us to nurture networks and build relationships, share experiences and learnings, and contribute towards improving the overall quality of our continent’s prudential supervision of the financial sector. Page 1 of 9 Financial reporting It is believed that Luca Pacioli, a Franciscan monk known as the father of accounting, was the first to codify the double-entry system of bookkeeping in his mathematical textbook titled Summa de arithmetica, geometria proportioni et proportionalita which was published in Venice in 1494. The celebrated German writer Johann Wolfgang von Goethe sang the praises of this system and described it as the finest invention of the human mind as it allowed the merchant to survey the whole of his business activities at any time; he even suggested that ‘every prudent master of a house should introduce it into his economy’. As any system, however, this system also has its challenges and shortcomings, and the renowned investor Warren Buffet warns that financial accounting is an imperfect language and that to understand accounting one needs to understand its nuances. Buffet further warns that, ‘in the long run, management’s stressing of accounting appearance over economic substance usually achieves little of either’. It is therefore critical that, to extract the most from the system of financial accounting, one is mindful of the inherent shortcomings of the system. In order to address some of the challenges in this area, much progress has been made towards the ideal of developing a set of high-quality international accounting standards that are widely used. In this regard, international standard-setting bodies, such as the International Financial Reporting Standards Foundation, play a vital role in working towards this goal. This Foundation has as its mission the development of standards that bring transparency, accountability, and efficiency to financial markets around the world and serving the public interest by fostering trust, growth, and long-term financial stability in the global economy. The International Accounting Standards Board (IASB), an independent private sector body which was established in 2001 and operates under the oversight of the International Reporting Standards Foundation, has been tasked with the development and approval of IFRSs, as well as the issuing of interpretations of these IFRSs. Page 2 of 9 IFRSs are now required in 125 jurisdictions and South Africa too subscribes to the accounting standards issued by the IASB, as do many of the jurisdictions represented here today. Irrespective of whether your respective jurisdiction has adopted IFRS or not, I am sure that all of you will find benefit from the discussions and presentations that will take place during this workshop. IFRS 9 and the G20 On 24 July 2014, the IASB issued a new accounting standard on financial instruments called IFRS 9, which replaced the existing standard, namely International Accounting Standard (IAS) 39, and which has a mandatory effective date of 1 January 2018. IFRS 9 inter alia specifies how an entity should classify and measure financial assets and liabilities. One of the fundamental changes that IFRS 9 introduces is the concept of Expected Credit Loss (ECL) provisioning. This new principle replaces the current incurred losses model and will materially change the way in which companies, and in particular banks, are required to approach and account for impairments for credit losses. According to the Bank for International Settlements (BIS), the great financial crisis of 2007-09 highlighted the systemic costs of a delayed recognition of credit losses on the part of banks and other lenders, and the application of the prevailing standards at the time was seen as having prevented banks from provisioning appropriately for credit losses likely to arise from emerging risks. These delays resulted in the recognition of credit losses that were widely regarded as ‘too little, too late’, and gave rise to questions of procyclicality by spurring excessive lending during the boom and forcing a sharp reduction in the subsequent bust. The development of the ECL accounting framework is consistent with the call by the leaders of the Group of Twenty (G20) in April 2009 to strengthen accounting recognition of loan loss provisions by incorporating a broader range of credit information. One of the consequences of this new framework is the fact that while, in the past, a loss event had to have occurred before an impairment was raised by a bank. The standard now requires that loss provisions be raised earlier and take into account not only past and present Page 3 of 9 information but also forward-looking information, which emphasises the future probability of credit losses in determining them. This standard is aimed at resolving the weaknesses identified during the global financial crisis of ‘too little, too late’ referred to above, and this will hopefully result in a more robust financial system that is more resilient and hence better able to withstand shocks. The adoption of IFRS 9 will give rise to higher levels of credit impairments. A study undertaken by the European Banking Authority estimated that the implementation of IFRS 9 would give rise to an average increase of 13% in loss provisions compared to the current levels under IAS 39; it is further expected that the Core Equity Tier (CET) 1 ratios will decrease by an average of 45 basis points. Smaller banks, which mainly use the standardised approach to measuring credit risk, estimate a larger impact on their own fund ratios than the larger banks. Estimates of the exact impact differ, however, and only time will tell which of these estimates was accurate. There are those that argue that the adoption of IFRS 9 may in fact increase procyclicality, because during recessionary conditions there may be a sharp fall in CET 1 capital levels and this, in turn, may lead to a sharp easing in credit extension due to the so-called ‘cliff effect’ of the staged approach prescribed by IFRS 9. Others, notably the BIS, reject this argument on the basis that banks, after the global financial crisis, are now better capitalised with higher buffers and thus are better able to absorb losses. They further argue that the early loss recognition of credit losses enables a quicker ‘clean-up’ of banks’ balance sheets, thus enabling them to support economic recovery. This debate is clearly not yet settled and we will need to wait and see how this plays out during the next recession. The economic impact is, however, not only limited to the level of losses and the timing of the recognition; the implementation of IFRS 9 is also likely to impact on the pricing of products which may thus impact on overall credit extension within the economy and ultimately consumption and hence economic growth. It is furthermore likely that banks’ earnings will be more volatile in the future due to the effect of the forward-looking approach that is required under IFRS 9. Therefore, Page 4 of 9 disclosure and the education of stakeholders on how to interpret financial information under IFRS 9 will be imperative and an important consideration. Over the past two years, many seminars, workshops, and training sessions have been provided by a range of organisations. However, very few of these have focused on jurisdictions from the African continent. There are factors that are unique to Africa that need to be taken into account. With this workshop, we want to fill this gap and provide a platform for African regulators to discuss the specific issues and concerns that may affect them in the implementation of IFRS 9. In this context, we are very much looking forward to the presentation from the Bank of Zambia on its in-country regulator perspective. Auditors The BIS correctly points out that the effectiveness of the new standards will not only depend on how banks implement them but will also depend on the contributions of central banks, supervisors, and other stakeholders, such as auditors. The BIS highlights that supervisors can play a very important role in promoting sound bank implementation practices through their banking supervision activities in a manner that complements the efforts of accosting standard setters. The auditing profession, as mentioned, is an important stakeholder when it comes to the implementation of IFRS 9, so a discussion of IFRS 9 would not be complete without reference to their role. There is little doubt that the audit profession is likely to be challenged with the introduction of IFRS 9. The reason is that the audit of accounting estimates, such as impairments, has always been a very complex area and the introduction of IFRS 9 will further add to that complexity. We are extremely pleased to have multiple representatives from the audit profession in our midst today and tomorrow. We will listen to presentations from both PwC and KPMG dealing with audit expectations, while EY will provide us with their perspective during the panel discussion tomorrow. We especially want to welcome the representatives from PwC Kenya who will be sharing with us their experience to date. Page 5 of 9 Before I conclude, I would like to touch on two audit-related topics, namely mandatory audit firm rotation and the recent developments that engulfed the global audit firm KPMG. The Independent Regulatory Board for Auditors (IRBA) recently issued a new rule on mandatory audit firm rotation, which limits audit firm appointments to a maximum period of 10 years. The efforts by IRBA to improve independence are to be welcomed. The SARB has been proactive with regard to auditor independence, for example section 61 of the Banks Act provides that the Registrar of Banks must approve the appointment of an auditor before such an auditor can take up office. Such an appointment further requires that the Audit Committee do a proper assessment of the suitability of the auditor to hold office, after which the Office of the Registrar of Banks would also do a fit and proper assessment prior to the approval of the auditor’s appointment. The SARB, from a supervisory perspective has furthermore, for many years now, required large banks to appoint joint auditors as this further reduces the independence-related risk. The SARB therefore, while broadly supportive of the principle of mandatory audit firm rotation, believes that banks should be exempted from these requirements as our supervisory standards and practices as it relate to auditor independence far exceed those that have recently been put in place. We further believe that the maximum period of appointment should be increased from the proposed 10 years to a longer period of between 15 and 20 years, as individual audit partner rotation is already in effect. The challenges around skills shortages are furthermore a reality that may act as an obstacle to achieving this objective of rotating audit firms after 10 years. If mandatory audit firm rotation is retained in the current form, the SARB may be compelled to revisit the requirement of joint auditor appointments for large financial institutions due to some of these practical considerations. Although the removal of the requirement of joint auditors for large financial institutions will lead to reduced audit fees and other efficiencies, we believe that this is likely to weaken auditor independence and may detract from the current high levels of audit quality and thus possibly erode the effective oversight and supervision of banks. This would not be in the public interest. We Page 6 of 9 further remain unconvinced that mandatory audit firm rotation represents an effective policy intervention to address the stated secondary objectives of redressing the high levels of market concentration and to promote transformation within the auditing profession. As a regulator, the SARB as a rule does not comment on individual firms. We, however, took the extraordinary step to comment publicly on the developments surrounding KPMG last week as they are the auditors to three of the big four banks, as well as to other banks and insurance companies. Our interest stems solely from a public policy perspective that arises from our financial stability mandate. We had noted with concern the regrettable auditing practices and serious errors of judgment that had occurred at KPMG and which had led to significant damage being inflicted on certain individuals, organisations, and the country as a whole. During our engagement with the local and global leadership of KPMG, we have noted the increasing and firm commitment of the new management team to fully own up to past mistakes and to work towards restoring the public trust. The recent announcements in this regard are recognised as important first steps towards this end and we are eagerly awaiting the results of the independent investigations undertaken by IRBA and the more recently announced one by KPMG. As a regulator, we do not pick winners or losers, but we are concerned stemming from our extensive experience of regulating banks this unfolding situation may take the form of a bank run with contagion risk that extends beyond an individual firm. This situation calls for thoughtful leadership and restraint as we believe that our economy will be better served if we can avoid further market concentration within the auditing and auxiliary professional services sector. These recent developments have, however, provided us cause to pause. In the coming months and years, the following policy considerations may need to be pondered in the interest of further strengthening governance and transparency within the auditing and accounting professions. These include: Page 7 of 9 (i) The requirement that audit firms may be ‘too big to fail’ and whether this may require regulatory intervention, including limiting the extent to which audit firms provide non-audit services, especially to audit clients. The imposition of caps regarding the value of non-audit services rendered to audit clients and prohibiting the rendering of certain category of non-audit services to audit clients in line with the reforms announced by the European Commission in 2016 should enjoy serious consideration. (ii) A far greater degree of disclosure and transparency by the auditing and accounting profession are required, given the public functions that audit firms perform when they inter alia attest the financial statements of public companies. Hence, consideration should be given to making the full public disclosure of a comprehensive set of audited financial statements mandatory, irrespective of the form or legal structure of ownership of such firms. (iii) The appointment of independent boards of directors and the strengthening of the risk management function within audit firms will further strengthen oversight and governance within auditing and accounting firms. (iv) The publication of an integrated report by the large and medium size audit firms as this may contribute to improve transparency around transformation initiatives and could assist to accelerate transformation within this sector. Full disclosure regarding compliance with governance frameworks such as King IV could also assist in improving governance arrangements within these firms. While this list is not exhaustive, it would be useful if there were a public discourse around these policy questions. We firmly believe that the implementation of some of these proposals may go some way to strengthening the governance within the audit and accounting professions and could assist to further support and possibly strengthen the trust that society places in them. Page 8 of 9 Conclusion The saying goes that change is the only constant in life. IFRS 9 certainly represents a major change for the banking industry. It is certainly a change that needs to be embraced. The regulated sector will be looking towards their regulators for guidance, hence we need to be up to date and well versed in order to be able to provide effective guidance. To this end banks, auditors and regulators will have to work together to ensure that the implementation of IFRS 9 will be a success. I hope that this workshop will contribute towards this goal. I am sure that during the next one and a half days, there will be very interesting and fruitful discussions that will benefit all the jurisdictions present here today and even after the workshops, I am sure conversations will continue. I wish you well on your IFRS 9 implementation journey and hope you will enjoy the workshop. Thank you. Page 9 of 9
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Payments Innovation Conference, Johannesburg, 5 October 2017.
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An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Payments Innovation Conference Sandton Convention Centre, Johannesburg 5 October 2017 The South African Reserve Bank’s perspective on a changing and innovative payments environment Introduction Fellow Deputy Governors, other distinguished guests, ladies and gentlemen. It gives me great pleasure to welcome you to the first Payments Innovation Conference organised by the South African Reserve Bank (SARB), which we are hosting in collaboration with domestic and international payments stakeholders. This conference takes place at an appropriate time as innovation and technology have the potential to spur growth and development. According to EY’s FinTech Adoption Index1, South Africa boasts financial technology (FinTech) adoption levels of 33%, which is in line with the global average. The survey respondents expect this type of adoption to increase to an average of 52% globally, with South Africa counting among the countries with the highest intended use among consumers at 71%. The purpose of this conference is therefore to develop deeper insights into emerging innovations in the payments ecosystem, which we hope will provide a better understanding of regulatory frameworks, stimulate debate, and spur development within the payments space in support of our country’s developmental objectives. EY. 2017. ‘EY FinTech Adoption Index 2017 – The rapid emergence of FinTech’. Available http://www.ey.com/Publication/vwLUAssets/ey-fintech-adoption-index-2017/$FILE/ey-fintech-adoption-index-2017.pdf. Page 1 of 9 at My address today will focus on the SARB’s perspective on the changing and innovative payments environment. We are in an era of unprecedented exponential change, where rapid advances in technology have the potential to fundamentally change financial services. The International Organization of Securities Commissions (IOSCO), for example, reports that, in 2014, there were 1 800 FinTech companies with a total funding of US$5.5 billion. This has risen to over 8 800 FinTech companies with investment of US$100.2 billion by 2016. 2 Technology’s impact extends beyond mere services. It also allows for the democratisation of communication and information, and thus for the transfer of power to the end user. Countries and institutions were previously the main controllers of communication and information due to high barriers to entry, such as information asymmetries and the large capital investment that was required to facilitate access. This has fundamentally changed. Powerful and super-fast processors, cheaper computing power, wide availability of access devices, and the roll-out of high-speed broadband have created an environment primed for a burst of innovation and ideas. Due to these rapid advances in technology, there has been an increasing effort to take advantage of these developments in service offerings, including within the financial services sector. The emergence of FinTech, that covers digital innovations and technology-enabled business model innovations in the financial sector, also presents exciting opportunities. Examples of innovations that are fundamental to FinTech today centre around value provision in the lending environment, value storage in the form of wallets and tokens, value protection in the form of insurance and investments, as well as value transfer in the payments and remittances areas. Cryptocurrencies that utilise block chain technologies, new digital advisory and trading systems, artificial intelligence and machine learning, peer-to-peer lending, equity crowdfunding and the Internet of things are some of the better-known developments that are normally cited. The drivers of International Organization of Securities Commissions (IOSCO). 2017. ‘Research report on financial technologies’. Available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD554.pdf. Page 2 of 9 these developments, from the demand side, emanate from shifting consumer preferences and an expectation for more, faster and cheaper services. From the supply side, they emanate from opportunities presented by evolving technology, as well as the changing regulatory environment. Currently, there is intense global interest in these developments, as is evident from numerous research initiatives, consourtium efforts, collaborative bank experimentations, venture capital deployment, as well as a number of central bank projects. According to the Bank for International Settlements (BIS) working paper on The FinTech opportunity 3, these innovations may: a) disrupt existing industry structures and blur industry boundaries; b) facilitate strategic disintermediation; c) revolutionise how existing firms create and deliver products and services; d) provide new gateways for entrepreneurship; and e) democratise access to financial services Although FinTech enterprises have changed the way in which financial services are structured, provisioned, and consumed, they have not acquired dominance yet. They do, however, have the potential to significantly change the competitive landscape. The World Economic Forum 4 (WEF) highlights eight factors that have the potential to alter the competitive landscape of the financial ecosystem, namely: 5 a. the commoditisation of cost bases; b. the redistribution of profit pools; c. ownership of the customer experience; d. the delivery of financial services through platforms; e. the monetisation of data; f. automation in the workplace; g. systemically important technology firms; and h. financial regionalisation due to differing regulatory priorities and customer needs. BIS Working Papers [Paper?] No. 655, The FinTech opportunity, Thomas Philippon, Monetary and Economic Department, August 2017. Available at http://www.bis.org/publ/work655.htm. World Economic Forum (WEF). 2017. ‘Beyond fintech: A pragmatic assessment of disruptive potential in financial services’. http://www3.weforum.org/docs/Beyond_Fintech_-_A_Pragmatic_Assessment_of_Disruptive_Potential_in_Financial_Services.pdf World Economic Forum (WEF). 2017. Beyond FinTech: a pragmatic assessment of disruptive potential in financial services. Available at http://www3.weforum.org/docs/Beyond_Fintech_-_A_Pragmatic_Assessment_of_Disruptive_Potential_in_Financial_Services.pdf. Page 3 of 9 These developments also have the potential to rapidly alter the payments space. Innovation in the payments ecosystem is resulting in an expansion of payment services, broadening the reach of payments platforms and networks. Payment services innovations have recently included the leveraging of mobile devices and connectivity to make payments simpler and more convenient and to reduce the use of cash and make payments less visible to payers. 6 A preliminary analysis conducted by the SARB reveals that the current crop of innovations leverages the existing foundations of the payments infrastructure and that these new firms integrate themselves into existing value chains. For example, mobile technology has catalysed the introduction of new mobile point-of-sale (POS) players in South Africa. These players have deepened the reach of electronic payment networks by targeting flea markets, self-employed artisans such as plumbers and spaza shops in rural areas – all previously underserved markets in terms of access to card payment networks. The potential of this type of technology means that, in the near future, we could possibly triple the level of the current 600 POS devices per 100 000 citizens to close to 2 000. This vividly demonstrates the potential of FinTech to broaden the network and deepen inclusion. Other benefits that innovation may bring about include, operational simplification, counterparty risk reduction, clearing and settlement time reduction, liquidity and capital management improvement and fraud minimisation. It should, however, be recognised that while these developments present tangible benefits, they may also give rise to certain challenges, including, but not limited to issues related to privacy as well as regulation, criminality and law enforcement. Given this reality, a balance necessarily need to be struck when developing regulatory frameworks. ‘The future of financial services: how fs:h disruptive innovations are reshaping the way financial services are structured, provisioned and consumed’. An industry project of the financial services community. fsc. Prepared in collaboration with Deloitte Final Report, June 2015. Available at http://www3.weforum.org/docs/WEF_The_future__of_financial_services.pdf. Page 4 of 9 The innovation trade-off The possible benefits of innovation are numerous and broad, and those that are often touted relate to costs, convenience, and speed. Big Data and information analytics that allow financial intermediaries to understand and cater to their customers’ needs at an individual level presently exist and already in wide use. These developments have the potential to lead to advances in risk management, credit extension processes and an economy that potentially makes less use of cash. The inclusion of previously under- and unserved consumers into formal financial services through the introduction of novel and bespoke products is a promising and welcome development. As stated above, the pursuit of these developments, in the absence of appropriate and sound regulatory frameworks, could lead to the emergence of new risks. As an example, with these advances in technology, some of the platforms and systems have moved to the cloud. This is compounded by the rapid improvements and usage of mobile devices. A WEF white paper highlighted that in order to improve risk management, it is important to highlight that the right tools should be used, including: 7 a. data on the emerging new innovation and its potential impact; b. assessment tools for the systemic risks introduced by innovation; c. a more standardised regulatory treatment framework for new competitors across jurisdictions; and d. an improved mechanism for public-private cooperation to combat cyberattacks. A further key regulatory consideration is to support initiatives that could assist in easing frictional costs, within the system and the economy, and to respond to the need for all interbank payments to be processed and finalised in near real-time. Cybersecurity There is no doubt that cyber-threats have increased substantially over the past few years. As technology evolves and is more widely embraced and become more World Economic Forum (WEF). 2017. ‘Balancing financial stability, innovation, and economic growth’. Available at http://www3.weforum.org/docs/IP/2017/FS/WEF_Whitepaper_FSIEG.pdf. Page 5 of 9 accessible, criminal activity is rapidly expanding to the cyber-world. The source of this threat vector is both privately and state-sponsored - the latter is far more difficult to counter. Cybersecurity and strengthening resilience across the entire value chain is therefore non-negotiable. In response to this reality, the SARB hosted a Cybersecurity Conference with the theme of ‘Collaboration for building cyber-resilience’ last year. The conference was an important event for creating a platform to share experiences from both global and local stakeholders, creating awareness and a common understanding of the fundamental issues, and assisting in determining the deficiencies that needs to be addressed. Through this Payments Innovation Conference, we will also explore payment threats and security interventions in the digital age, with a focus on the analysis of emerging threats in the payments domain and counteracting threats (the tactics, tools, and techniques) in order to remain safe and secure in the digital age. It is important to recognise that, in an interconnected world, one is only as safe as the weakest link. It is, therefore, crucial for us to think about how to strengthen the resilience of the wider financial system. Developments in regulations and policy objectives The South African Reserve Bank Act 90 of 1989 (SARB Act) bestows the mandate of ensuring the efficiency, safety and soundness of the entire payments value chain and related matters on the SARB. Aligned to this mandate in the SARB Act is the enabling legislation, namely the National Payment System Act 78 of 1998, which ‘‘provides for the management, administration, operation, regulation and supervision of the payment, clearing and settlement systems in the Republic of South Africa 8. In the quest to execute this mandate, the SARB endevours to increasingly establish an enabling regulatory environment for innovation to take place. One of the benefits of payments innovation is the potential expansion of access to financial services and achieving financial inclusion to reach the under- and unserved See the National Payment System Act, available at www.resbank.co.za > Regulation and supervision > National Payment System (NPS) > NPS Legislation. Page 6 of 9 consumers and to reduce transaction costs while providing greater transparency with simpler products and greater convenience and efficiency. By leveraging technology and proactively shaping a conducive environment for innovation through regulation, the payments system can serve as a gateway to achieving financial inclusion and address the need to deepen and strengthen access for both consumers and providers. As the payments industry becomes increasingly innovative and continues to improve the traditional payments landscape, regulatory and legislative frameworks need to be flexible and adaptable to these changes and provide an enabling environment for innovation to thrive. Furthermore, the regulatory framework should remain robust and resilient to risks that may be posed to the safety and efficiency of the payments system. A number of developments have necessitated a rethink of the adequacy and relevance of the existing payments regulatory framework. These include global policy developments, relating to financial inclusion, access, financial stability, financial integrity and competition, international best practice and standards, and recommendations from global policy-setting structures, including the assessments undertaken by institutions such as the World Bank and the International Monetary Fund. How the South African Reserve Bank collaborates with the industry In 2015, the SARB initiated a project to develop a vision for the national payment system. This process culminated in the drafting of the National payment system framework and strategy: Vision 2025 document (Vision 2025). The SARB is currently in the last phase of consultations with the industry regarding the strategies that will be implemented to advance the development of the national payment system. The Vision 2025 process has and will continue to be consultative and collaborative. In March 2016, the SARB Executive approved the establishment of an internal Virtual Currencies (VCs) and Distributed Ledger Technologies (DLTs) Steering Committee (SteerCo) and working group. Subsequently, we established a FinTech SteerCo and working group. These structures are tasked to strategically review the emergence of FinTech initiatives and assess the related use cases. Their primary responsibilities Page 7 of 9 include the facilitation of the development and review of policy positions for the SARB across its regulatory domains. This will be undertaken through an analysis of both the pros and the cons of emerging FinTech innovations, as well as through the testing of appropriate regulatory responses to these developments. The SARB is also looking forward to exploring the potential for sandboxes and innovation hubs to test the relevance of existing regulatory frameworks and make the necessary changes, where appropriate. An intergovernmental FinTech working group consisting of various government agencies – including the SARB, National Treasury, the Financial Intelligence Centre, the Financial Services Board and the South African Revenue Service – was also established in December 2016. Its main purpose is to assess different FinTech innovations and their impact on the South African regulatory landscape. This is aimed at fostering safe FinTech innovation in South Africa. Conclusion I hope that the focus of the next two days will be on the potential innovative developments within the payments systems environment and the possible benefits that these may give rise to. This calls for critical reflections, including on how we may collaborate in order to advance the development of and growth in our economy. This conference thus presents an opportunity to jointly contemplate the payments system’s development potential and the roles that each one of us could play in realising this aspiration. Frank and open discussions are required on our strengths and shortcomings, with a specific focus on where we can do better and how we should position the South African payments system going forward. As a regulatory authority, the SARB will also continue to focus on areas where policy and regulation may be improved to provide the financial industry with a more enabling regulatory environment. I would like to reassure you that the SARB is committed in its support of innovation and the responsible improvement of the services offered to all our people in a manner that does not give rise to increased threats to the soundness or stability of the wider financial system. Page 8 of 9 Finally, I would like to encourage the industry to continue collaborating and innovating, while also supporting policy objectives and taking cybersecurity risks into account. Thank you. Page 9 of 9
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the launch of commemorative coins to mark the 100th anniversary of Oliver Tambo's birth, Pretoria, 4 October 2017.
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Lesetja Kganyago: Protecting the buying power of South Africa's currency Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the launch of commemorative coins to mark the 100th anniversary of Oliver Tambo's birth, Pretoria, 4 October 2017. * * * Oliver Reginald Tambo’s life was integrity, trust and accountability personified. The power and emotion behind his speeches lay in the clarity of his thoughts, not in the delivery and the fiery of his rhetoric. That is partly why he was able to mobilise the world against apartheid. That is partly why he succeeded in keeping together people of diverse backgrounds united under the ANC umbrella. His integrity shone through, defining all his interactions with everyone, young and old, senior and rank and file members. The dictionary describes integrity as the quality of being honest and having strong moral principles. It lists honourableness, decency, fairness, sincerity, truthfulness and trustworthiness as some of the synonyms of integrity. Tambo’s conduct was one of integrity and accountability. Integrity, trust and accountability also matter a great deal for the South African Reserve Bank (SARB) and, indeed, other central banks elsewhere in the world. The SARB exists to serve the economic wellbeing of South Africans by protecting the buying power of the domestic currency – the banknotes and coin. This primary mandate of the SARB, as well as its independence in carrying out this mandate, are entrenched in sections 224 and 225 of the Constitution of the Republic of South Africa. Our Constitution which has been tested many times in recent years bears testimony to the calibre and the foresight of the leadership of the founders of this nation. To borrow the words of Justice Albie Sachs, a paternity test on our Constitution will find Tambo’s DNA.1 The SARB does not bow to any pressure, whether it be political or from the private sector. But the SARB does account to the people of South Africa through Parliament. The other main function of the SARB is to ensure there is a sufficient supply of high quality banknotes and coin. This is one function of the SARB that puts it in the pockets, wallets and the hearts of all South Africans. The SARB banknotes may not be in the pockets or wallets of all South Africans all of the time, but they can be if all of us work harder to make our economy grow at a rate fast enough to ensure that there is work, bread, water and salt for all. It is the responsibility of the SARB to ensure the integrity of banknotes and coin in circulation. The SARB has to ensure that banknotes and coin remain a secure method of payment and a store of wealth. A banknote is but a piece of paper, a coin but a piece of metal. Both derive their worth from the trust that the citizens of a country have in the country’s currency. The confidence that South Africans have in banknotes and coin is based on trust that the banknotes and coin are authentic, and trust in the institution that issues them. Whatever the SARB does, it must, without fear or favour, ensure that the buying power of the currency is protected. It must also ensure that public trust in banknotes and coin as well as the institution that issues them is maintained. 1/2 BIS central bankers' speeches So, when some among us demand that we must open the sluicegates of inflation what they are demanding is that we must erode public trust and confidence in the currency. As the history of money globally show, when inflation walks through the door, public trust in the currency jumps out of the window. Then banknotes and coin become nothing but worthless pieces of paper and metal. 1 Oliver Tambo’s Dream, Justice Albie Sachs, Oliver Tambo Centenary lecture, University of Pretoria. 2/2 BIS central bankers' speeches
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Central Banking Seminar of the Federal Reserve Bank of New York, New York City, 16 October 2017.
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An address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Central Banking Seminar of the Federal Reserve Bank of New York New York 16 October 2017 Economic and monetary policy developments in South Africa Introduction Ladies and gentlemen, good afternoon. It is my great pleasure to address this distinguished audience of fellow central bankers as we gather here in New York City to compare the current economic and financial developments across the major regions and to discuss the conduct of monetary policy in a world that finds itself in a transition. For many of the previous years, as we gathered for the annual meetings of the International Monetary Fund and the World Bank, we had to discuss the reasons for the continued disappointing performance of global growth, and the most appropriate role that monetary policy could play in contributing to remedying the shortfalls. This year, I am pleased to say, the outlook is finally looking somewhat promising: global economic growth, especially in the advanced economies, is gathering some momentum, is generally stronger than most observers expected a year ago, and looks sustainable, even if medium-term risks, which need tackling to safeguard these encouraging developments, cannot be ignored. Page 1 of 8 As much as these developments are welcomed by the emerging economies, some of which have struggled with sub-par growth in recent years, there are some accompanying challenges. For example, stronger economic growth will continue to reduce the degree of economic slack in the advanced economies, calling for ongoing monetary policy normalization and, eventually, higher real interest rates across the world. For the emerging economies that have become used to elevated capital inflows of late, this may force unpopular policy adjustments. My remarks today will focus on the South African experience and how our monetary policy is negotiating the present challenges of low growth, inflation risks, and a benign yet uncertain global environment. The dilemma of slowing growth and stubborn inflation In its conduct of monetary policy, the South African Reserve Bank (SARB) has faced a growing dilemma in recent years: that of slowing economic growth coupled with inflation that is stubbornly rigid above the midpoint of its 3-6% target range. Following the short-lived rebound in the aftermath of the global financial crisis, which saw real GDP1 expand by about 3% in both 2010 and 2011, the economy‟s growth rate has gradually slowed, reaching a low of 0.3% in 2016. The average growth of 1.6% in the past five years is a far cry from the 4.7% seen in the five years leading up to the 2008/09 recession. Our forecasts currently see real GDP registering growth of only 0.6% in 2017 before recovering moderately to a similarly weak 1.2% in 2018 and 1.5% in 2019. Yet inflation has not shown a typical response. From a low of 3% in late 2010, the year-on-year rate of increase in the consumer price index (CPI) has mostly hovered around the upper end of the SARB‟s 3-6% target band, breaching it on the upside on five occasions – the last time between September 2016 and March this year. Even if we look at the core rate of inflation – which excludes the volatile food, non-alcoholic gross domestic product Page 2 of 8 beverages, fuel, and electricity components – the picture is quite similar. From a low of 3.6% year on year in the early months of 2011, core inflation rose for most of the following five years, only declining since the beginning of this year. Why has this happened? To a large extent, the answer lies in the structural nature of the economic slowdown. A self-reinforcing cycle of poor private-sector confidence, coupled with subdued business investment and infrastructure bottlenecks (in particular in the electricity sector), has led to a gradual but sustained deterioration in the potential rate of economic growth. From the 3-4% range seen for most of the 2000s, the SARB‟s estimate of potential growth has slowed to no more than 1.1% for this year, with only a mild pickup expected in the next two years. Consequently, while we estimate that actual GDP is currently about 1.7% below potential, this output gap explains only a minor part of the poor growth performance of recent years. Yet, even the presence of an output gap for most of the past eight years has not had a major impact on inflation. Indeed, our internal models suggest that the degree of slack in the economy has a lesser impact on the formation of price trends than other factors do, for instance exchange rate developments – which, incidentally, have been unfavourable over the past few years. Several other factors are frequently cited to explain this relative lack of responsiveness, including rigidities in the wage formation process, insufficient competition in many sectors of the economy, and the adaptive and backward-looking nature of inflation expectations. Recent improvements in the inflation outcome and inflation outlook Admittedly, the last three quarters have seen an encouraging improvement on the inflation front, despite the stickiness above the midpoint of the target band. The headline rate of inflation, which peaked at 6.7% in December 2016, fell to 4.6% in July 2017. Part of this slowdown reflects the more benign developments on the food and energy fronts. Helped by a strong rebound in grain production following the 2015/16 drought, which sharply reduced the prices of cereals, food inflation has fallen to 5.7% from a high of 11.8% last December. Fuel inflation is still off its early- Page 3 of 8 year highs, while the modest gain in electricity prices in July 2017 has improved the overall year-on-year CPI comparison. However, not all of the inflation slowdown is attributable to these transitory factors. Encouragingly, after a long upward drift, core inflation fell from a peak of 5.9% last December to 4.6% in July. Furthermore, this moderation was stronger than both the market consensus and the SARB expectations at the start of the year, as evidenced by the regular downward adjustments to our inflation projections. True: a large part of the deceleration in core inflation occurred in the goods sector, especially in those subsectors where import penetration is elevated, and these subsectors clearly benefitted from a recovery in the rand from early 2016 to March 2017 (an improvement of 37% in nominal, trade-weighted terms). Yet the magnitude of that slowdown in inflation, just like the absence of upside price pressures in the services sector (in particular in housing and insurance), surprised most observers. The marked improvement in the inflation forecast, as well as the significant deterioration in the growth outlook coupled with an assessment by the Monetary Policy Committee (MPC) of the risks to the inflation outlook being more or less balanced, gave the MPC room for a moderate reduction in the repurchase rate of 25 basis points to 6.75% at its July meeting. The current rates of inflation are not expected to fully persist, in large part because they still reflect the lagged impact of last year‟s rand recovery, which has already partly reversed. Indeed, the SARB‟s latest projections see inflation rising back to 5.3% by the third quarter of 2018 and stabilising around these levels over the remainder of the forecast period. By the time of the MPC‟s September meeting, while the inflation outlook was more or less unchanged and the growth outlook had improved moderately, the risks to the inflation outlook were assessed to be somewhat on the upside, resulting in the MPC opting to keep rates unchanged at that meeting. Page 4 of 8 Risks to the more benign environment While the overall situation looks more benign when compared to previous periods, this should not allow a sense of complacency to creep in. The exchange rate of the rand, whose recovery over the past year has been key to the decline in inflation, remains volatile but does not display any major deviation, at present, from what our internal models suggest as fair valuation. Yet the risks to the rand are probably skewed towards renewed depreciation, for both internal and external reasons. On the internal front, factors such as the combination of political and policy uncertainty, growing fiscal challenges of addressing growth-induced revenue shortfalls, the continuing upward drift in the debt-to-GDP ratio as well as growing funding needs for state-owned enterprises could all add to currency vulnerability. Global market developments could also easily compound the rand‟s vulnerability. So far this year, the combination of low global market volatility, relatively flat government bond yield curves, and compressed risk premiums across a broad range of financial assets has largely sheltered South African assets from domestic causes of volatility. Net portfolio inflows into the local bond market have remained positive, and even in instances where domestic developments did put local assets under pressure, such tension proved short-lived. Yet the recent upward correction in interest rate expectations in several advanced economies, including the US2 and the UK3, serves as a warning that even a gradual pace of monetary policy normalization – after years of very loose global monetary conditions – may not be without adverse consequences for emerging market currencies such as the rand. Other factors present upside risks to inflation over the coming two years. On the exchange rate front, we must also remember that the 2016 and early 2017 appreciation was greatly helped by a recovery in South Africa‟s terms of trade.4 But the recent developments in commodity prices, including the stronger prices of crude United States United Kingdom The SARB‟s broad measure of South Africa‟s terms of trade, including gold, increased by 7.1% year on year as of the first quarter of 2017; it was relatively stable in the second quarter. Page 5 of 8 oil and the downward correction in the prices of iron ore, indicate that this improvement could partly reverse. The possibility remains for a larger electricity tariff increase in 2018 than the 8% assumed in the SARB‟s forecast. In addition, in the longer run, the implementation of minimum wage legislation could put upward pressure on labour costs, even though the size and timing of that impact is not yet fully understood. Monetary policy’s unclear margin of manoeuvre Amid such elevated uncertainties, and despite the subdued nature of domestic demand, it is not clear how much space exists, if at all, for additional policy rate cuts by the MPC in the coming quarters. However, this does not mean that the SARB does not take the weakness of real economic growth into consideration. It certainly does. Indeed, estimates by the SARB‟s Quarterly Projection Model (QPM) of a Taylor rule based on the historical policy rate path show that the output gap has played a role in determining that policy rate.5 Furthermore, the policy stance is, at present, probably not far from what can be perceived as „neutral‟. According to estimates from the above-mentioned QPM model, the current real interest rate is not far from its equilibrium, or „neutral‟, level. Admittedly, estimates of this „neutral‟ level are fraught with high uncertainty, in South Africa and elsewhere. Nonetheless, such calculations suggest that the SARB does not have the kind of „room to ease‟ it had when policy was unambiguously tight, for instance at the start of the 2008/09 recession. Arguably, because of the existence of an output gap, monetary policy could – under normal circumstances – be allowed to loosen somewhat, with a real interest rate that is moderately below its „neutral‟ level. This bias must, however, be weighed against both the upside risks to inflation (which I have already highlighted) and the stubbornly high level of inflation expectations. While expectations are currently less volatile, and probably less adaptive than in the early years of the inflation-targeting See the Monetary Policy Review published by the SARB in October 2017. Page 6 of 8 regime, they remain above the midpoint of the target range and uncomfortably close to its upper end. The consequence is a relatively large risk of persistent above-target inflation in the event of an inflationary shock to the economy – and it is the mandate of the MPC to mitigate such a risk. As indicated earlier, in light of the balance of risks to the outlook and to the current policy stance, the MPC decided to keep the policy rate unchanged at its September meeting. This does not prejudge any future moves. Rather, because of the elevated level of uncertainty we are currently facing, the MPC feels a particularly strong need to reassess the balance of risks at every meeting. Consequently, monetary policy decisions, now more than ever, have to be data-dependent. The most recent decision of the MPC appeared to surprise domestic money markets somewhat, as they had come to discount a 25 basis points rate cut in the wake of the July move. We prefer not to surprise markets. In fact, we see policy transparency and consistency as crucial in ensuring an effective transmission of rate decisions to the economy. Yet in a fluid environment, where even small changes in the balance of risks can tip the policy scales one way or another, it is not possible to systematically come up with fully predictable policy decisions – just as it is not possible, in such an environment, for the MPC to give the kind of forward guidance that some call for. If anything, domestic financial market indicators seem to broadly echo the SARB‟s view that the uncertain environment is forcing a cautious approach to policy. Thus, forward rate agreements only discount a short and shallow easing cycle while the yield curve is positively sloped – a sign that investors are cognisant of the upside risks to inflation, and therefore to policy rates, in the medium to long term. Conclusion – the continued relevance of the inflation target range The challenges that South Africa has had to face over the past few years – in particular the combination of slow growth and relatively high inflation – may have led some observers to question whether the current inflation target range remains Page 7 of 8 relevant for the country at this stage. In my view, raising or even contemplating abandoning the inflation target band would be a misguided approach. Both economic theory and historical experience show that whenever the price and wage formation process is rigid and price expectations are adaptive rather than well anchored, the cost of negative shocks tends to be higher and longer-lasting in real economic terms. South Africa‟s own experience of the most recent global financial crisis, which saw the country suffer a relatively high number of job losses, illustrates the merit of such a strong and credible price anchor. In fact, many emerging economies, including those at a similar level of development as South Africa, have enjoyed both stronger economic growth as well as lower and more stable inflation since introducing inflation targets. This observation has continued to apply since the global financial crisis. Equally, the adoption of a different anchor – for example the exchange rate – would be very difficult for South Africa as we are a commodity exporter and therefore regularly exposed to large terms-of-trade fluctuations. The truth of the matter is this: low and stable inflation is the best contribution that monetary policy can make towards stronger and more sustainable economic growth and poverty reduction. As the saying goes: “Facts do not cease to exist because they are ignored.” There is no better way to contribute to the socio-economic well-being of a nation than to protect the cost of living of its citizens. In his speech titled „Whip inflation now‟, US President Gerald Ford warned that inflation would „destroy our country, our homes, our liberties, our property, and finally our national pride‟. As the SARB, we remain committed to formulating and implementing monetary policy aimed at controlling inflation at low levels, in line with the independence that the Constitution guarantees us, while remaining relevant to the context in which we operate. Thank you. Page 8 of 8
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Economist Corporate Network event, Johannesburg, 30 October 2017.
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Address by Daniel Mminele, Deputy Governor of the South African Reserve Bank at The Economist Corporate Network event Johannesburg 30 October 2017 The performance of and outlook for the South African economy Introduction Ladies and gentlemen, good morning. Thank you to The Economist for inviting me to come and address you on the topic ‘The performance of and outlook for the South African economy’. This is a very pertinent topic, which could not be more relevant at this stage. Last week, when presenting the Medium Term Budget Policy Statement, Finance Minister Gigaba announced that National Treasury had revised its forecasts for domestic GDP1 growth to 0.7% in 2017 and 1.1% in 2018, an adjustment of 0.6 and 0.9 percentage points respectively, from the projections made in February. These forecasts are in line with those released two weeks earlier by the IMF2 in its October 2017 World Economic Outlook, with the IMF similarly having scaled down its forecasts for South African GDP growth, by 0.3 and 0.1 percentage points for 2017 and 2018 respectively. 1 gross domestic product 2 International Monetary Fund Page 1 of 11 Describing government’s view of the economy, the former US3 President Ronald Reagan once put it this way: “If the economy moves, tax it. If it keeps on moving, regulate it. And if it stops moving, subsidise it.” In my view, almost every economy has been through all these phases – and South Africa is currently moving, albeit at a relatively much slower pace than we would all like, and would be required to address the challenges of unemployment and inclusive economic development. The slack in growth is perhaps the most crucial economic issue in South Africa at present. Indeed, when it downgraded South Africa’s sovereign credit rating in June, ratings agency Moody’s listed ‘reduced growth prospects’ as one of the three key drivers of the downgrade. Yet at the same time, most observers of the global economy concur that the world’s economic and financial situation is more favourable than it has been for years. So why is South Africa missing out on the global recovery? What has driven the poor performance of the past few years? Will this trend continue? If so, what role can the South African Reserve Bank (or SARB) can play in making a contribution to address the issue? These are the questions that I will attempt to answer in my address today. When activity is volatile but broadly underperforming The ability to analyse trends in the South African economy has been complicated of late by the high volatility in quarterly GDP data. The standard deviation of the quarteron-quarter seasonally adjusted change in GDP has been close to 2.0 percentage points, on average, over the past five years. To some extent, this volatility makes it difficult to use the latest data point as an indication of a trend or to determine ‘in real time’ inflections in the pace of activity. For example, data for the fourth quarter of 2016 and the first quarter of 2017 showed that the South African economy was in ‘a technical recession’, with two consecutive contractions, however marginal they may have been. This was followed by a rebound of 2.5% in the second quarter. 3 United States Page 2 of 11 Surprisingly enough, this short-term volatility was not limited to those demand components which, like public-sector investment or inventory changes, regularly experience large deviations from the trend. Rather, it extended to generally more stable aggregates, for example the household consumption of services. At this stage, it is difficult to say to what extent this volatility reflects changes in household-sector behaviour or data measurement challenges. What we can assume, however, is that the underlying trend of the economy is somewhere ‘in-between’ the latest observations. We may not be in a recession, but it is quite doubtful that the 2.5% momentum of the second quarter can be sustained. It seems pretty certain that South Africa is presently mired in very low growth. Following an increase of only 0.3% in GDP last year, our models project a meagre expansion of just 0.6% in 2017. These numbers continue to fall short of the domestic population growth of around 1.5%. This means that, in per-capita terms, GDP is declining and is likely to drop back this year to levels last seen in 2011. Effectively, real GDP per capita will only have grown by 4% overall over the past 10 years, compared with a growth of 20% over the previous 10 years. Furthermore, as mentioned earlier, South Africa seems to be ‘missing out’ on the global recovery. Because we are an open and relatively small economy, with commodity-dependent exports and hence terms of trade that are highly sensitive to global industrial demand, our domestic cycle generally moves ‘in sync’ with its global counterparts. South Africa entered and exited the 2008-09 global recession with a slight delay, but more or less at the same time as most of the world’s largest economies. Such cyclical patterns are largely unavoidable, and the best that macroeconomic policy can do is to limit their magnitude and hence their potential distortionary effects. What is worrying, however, is that while the gap between South African and world growth hovered at around zero just before and during the global recession, this growth gap has gradually widened ever since. It has averaged 1.8 percentage points in the last five years, stood at 2.9 in 2016, and – based on the IMF’s and the SARB’s forecasts – could increase to 3.0 in the current year. A similar observation arises when Page 3 of 11 comparing South Africa to its upper-middle-income peers4: in 2002-07, domestic growth was, on average, 0.4 percentage points below this group’s median; last year, the gap had widened to 2.5 percentage points. Not ‘a traditional recession’ but ‘a slow grind to a halt’ How can we explain this lacklustre performance of the South African economy? And how can we explain its underperformance versus its peers? In many ways, the downturn of the past few years does not display the traditional characteristics of a recession. For example, there was no build-up of inflationary pressures that necessitated the shift to a restrictive, demand-constraining monetary policy. Inflation has displayed a rising trend since 2011, resulting in the Monetary Policy Committee of the SARB raising the repurchase rate by 200 basis points between January 2014 and March 2016. But by our own, admittedly imprecise, calculations, the real interest rate remained below its neutral level for most of that period. This would suggest that while monetary policy provided less stimulus, it did not turn outright restrictive. Equally, we did not see the kind of asset-price bubbles or the build-up of other financial vulnerabilities which typically precede a recession, as the unwinding of such imbalances generally results in lower private-sector appetite for borrowing, tighter lending standards by banks, and a rise in precautionary savings by households. In recent years, in part thanks to the generally accommodative stance of monetary policy, banks’ non-performing loans have declined, the number of home repossessions has equally fallen to low levels, and while equity prices have performed strongly, home prices have broadly stagnated in real terms. Admittedly, growth in loans and advances to the private sector slowed in 2016, from almost 9% year on year in late 2015 to a low of 4.5% in November last year. Yet this deceleration proved milder than in previous downward phases of the business cycle. Confidence in the retail banking sector, as measured by the EY Financial Services 4 This refers to the World Bank’s definition of ‘upper-middle income’, which comprises 56 countries. Page 4 of 11 Index, remains above par, in contrast to the other major sectors of the domestic economy. Civil cases for debt and insolvencies are below the average of the past decade, even though surveys show that consumers are feeling increasingly vulnerable.5 As for the savings ratio of households, while it rose from -2% of disposable income in 2013 to around 0% thus far in 2017, it is only back to the levels last seen after the global recession in 2008 and remains very low by historical standards. Rather than ‘a traditional recession’, then, what South Africa experienced was ‘a slow grind to a halt’ that was driven more by long-term supply factors than by long-term demand factors. Admittedly, several external factors, besides short-term domestic disruptions, contributed to the weakness in GDP growth. The recovery in world demand since the global financial crisis has been sluggish and has displayed low trade intensity by historical standards. For example, the average annual real import growth in South Africa’s export markets – as measured by the OECD6 – amounted to only 3.0% in the last five years and 2.1% in 2016, compared to the 8.6% in the five years leading up to the global recession.7 And this was not just a volume story: the prices of domestic commodity exports also fell, resulting in a decline in South Africa’s terms of trade by 7% between 2011 and 2014. On the domestic front, the drought that affected South Africa over the 2015/16 summer season resulted in an 8% contraction in agricultural output last year, which shaved off 0.2% from the 2016 GDP growth. Safety-related stoppages also affected mining production in 2016. Yet both these external and domestic factors do not explain the full extent of the economic slowdown. Nor do they explain why our domestic economy, in contrast to many of its peers, has failed to get much traction in the first half of 2017. After all, the end of the drought, together with the improving global environment and the recovery 5 For example, the Consumer Financial Vulnerability Index (computed by the Bureau of Market Research, the University of South Africa, and Momentum) showed a significant deterioration in the second quarter of 2017. 6 Organisation for Economic Co-operation and Development 7 The OECD calculates export market growth for a specific country as the weighted average of import growth in its trading partners, with the shares of these partners in the country’s total exports as weights. Page 5 of 11 in South Africa’s terms of trade from the second quarter of 2016 onwards, was expected to engineer at least some economic rebound – but so far it is missing. Most likely, the key to this lack of growth resides in a self-reinforcing ‘negative feedback loop’ of policy uncertainties, low private-sector confidence, subdued investment in productive capacities, and poor competitive performance. Causality implications between growth and confidence go both ways. Attempts by our in-house research to identify the possible causes of the ever-widening gap between South African and world growth have found that the negative impact of low confidence has increased in recent years, explaining as much as 1.15 percentage points of that gap in 2016. In turn, weak business confidence amid disappointing demand performance has depressed private-sector fixed investment. Last year, it contracted by 6.8%. As of the second quarter of 2017, it was down by 2.7% year on year and stood at 11.8% of GDP compared to a high of more than 15% at the start of the global recession – its lowest level since 2004. In an environment of low consumer confidence and a lack of property price growth in real terms, the housing sector does not remain immune to such subdued performance. Because of such softness in capital formation, as well as subdued productivity growth, the potential pace of GDP growth has slowed to an estimated 1.1% in both 2016 and 2017 from more than 3% at the start of the decade. Weak private-sector investment, currently focusing mostly on replacing obsolete capital rather than creating new capacities, coupled with a shortage of skilled labour and, possibly, product market rigidities, appears to be weighing on external competitiveness and export performance. South African firms may be slow to adjust to changes in global demand patterns; they may lack the innovative edge to keep pace with foreign competitors. While the causes may be uncertain, the fact remains that, over the past decade or two, South African export volumes have consistently fallen short of the demand in its trading partners, implying a loss of market share.8 A trend towards real exchange-rate depreciation has not helped. In fact, market share often 8 The OECD’s measure of export market growth for South African goods and services shows average annual growth of 5.0% since 2010. Over that same period, though, the average annual growth in South African exports has only been 2.2%. Page 6 of 11 stagnated in the aftermath of rand-depreciation phases but it declined when the local currency recovered. Most likely scenario: a modest recovery The question remains: will economic stagnation persist in South Africa? There are presently some grounds for very prudent optimism for the next year or two. The external economic environment has improved. Last month, the IMF again revised upwards its forecast for world growth in both 2017 and 2018, by 0.1 percentage points in each case, to 3.6% and 3.7% respectively, up from 3.2% last year. Such upward revisions mark a welcome break from the pattern of earlier years, when forecasters regularly pushed back the timing and the scale of the global recovery. Furthermore, this recovery is relatively broad-based, both geographically and across sectors, and it is not generating the kind of price pressures that would prompt the major central banks to aggressively tighten monetary policy and, as such, curtail that recovery. Closer to home, the decline in inflation over the past year has provided some breathing space to the consumer, allowing some gains in real disposable income despite net job losses. Equally, the decline in the current account deficit, to 2.2% of GDP on average in the first half of the year from as high as 5.9% of GDP in 2013, is helping (together with an elevated global-investor appetite for higher-yielding government debt) to shelter domestic financial markets from external or local shocks. This explains, in part, why the rand and domestic bonds have not shown a strong or durable reaction, this year, to adverse political or policy news. In recent months, some domestic high-frequency data have shown signs of improvement. Following a downward trend lasting more than three years, new vehicle sales, expressed in seasonally adjusted terms, rose by 10% in September from an April low. Manufacturing production, which had stagnated for the past five years, increased in both July and August to its highest levels in more than a year. The rebound in the mining sector has been even more pronounced. It would therefore appear that both sectors will contribute positively to GDP growth in the third quarter of Page 7 of 11 this year. The RMB/BER9 business confidence index, while still well below the neutral 50 mark, rose off eight-year lows in the previous quarter. However, all this is no cause for premature celebration. Many factors still limit the room for a meaningful improvement in South African economic growth. Confidence remains highly vulnerable to upcoming political events given their potential implications for important government policies; it also remains vulnerable to the risk of further sovereign credit rating downgrades. A further rise in the oil price could boost inflation and undermine the terms of trade. And the extent of the impact that the normalization of monetary policies in the advanced economies could have on emerging-market assets, including the rand and domestic securities, is still unclear. Even in a relatively favourable scenario – where confidence gradually improves, inflation remains moderate, and the output gap gradually closes – structural factors are likely to limit the scope for a meaningful growth pickup. Productivity performance remains weak, with an average annual gain of only 1.2% in the past five years. The shortages of skilled labour are likely to remain acute for an extended period of time even if educational outcomes improve. Job-searching costs are high, making it that much more difficult for low-skilled people to find employment. And the relatively high concentration in many sectors, together with elevated regulation, results in barriers to entry for new firms.10 Consequently, even with the gradual removal of infrastructure bottlenecks – for example, as more power supply comes on stream – it is difficult to envisage much of a pickup in potential growth in the next two years or so. For these reasons, the SARB projects only a moderate acceleration in actual real GDP growth, from 0.6% this year to 1.2% in 2018 and 1.5% in 2019. How can monetary policy help? How should monetary policy respond to such a situation? Conventional wisdom may argue that, in the wake of a slowdown, interest rates should be reduced so as to 9 Rand Merchant Bank / Bureau for Economic Research 10 See OECD Economic Survey: South Africa, 2017. Page 8 of 11 rekindle domestic demand. The SARB is cognisant of the fragile economic situation, and to the extent that its decisions remain consistent with its mandate of ensuring price stability, it takes appropriate actions to support economic activity. The 25 basis points cut in the repurchase rate in July, which had been made possible by an improvement in the inflation outlook, illustrates this approach. However, an aggressive easing of monetary policy – for the sole purpose of kick-starting the economy – could yield disappointing returns for an unacceptable degree of risk, for the following reasons. First, as I have mentioned earlier, monetary policy was not tight at the start of the downturn, nor was that downturn the consequence of restrictive financial conditions. In recent years, South Africa’s monetary stance merely moved from loose to roughly neutral. Surveys and economic data support this assessment: fewer businesses than usual report the level of interest rates as an obstacle to expansion – in contrast to political uncertainty, which has grown as a constraint in recent years. Equally, at 9.4%, the ratio of household debt-servicing costs to income is in line with long-run historical norms. Second, because the downturn reflects non-monetary factors, it is doubtful how much rate reductions, at present, would stimulate demand. The experience of the advanced economies since the most recent global recession shows that if conditions are not met for a rise in private-sector willingness to borrow, rate cuts are likely to have limited influence on credit and demand growth. For example, if the main concern of many businesses is a lack of policy and regulatory clarity, it is doubtful whether lowering the cost of capital will entice them to invest. Equally, risk-averse households may use lower interest rates to ensure a faster repayment of their debt rather than increasing their expenditure or investing in new residential property. Third, even if demand were to respond to meaningful interest-rate cuts, the economy’s supply constraints might soon limit its ability to meet the increase in demand, resulting in higher prices either directly or indirectly via a rise in imports that would widen the trade balance and depreciate the exchange rate. Domestic demand in South Africa – and this includes household consumption as well as fixed investment – has always been import-intensive, even in periods of prevailing economic slack. And while our Page 9 of 11 estimates of the output gap point to some degree of slack in the economy, others (such as capacity utilization in manufacturing) paint a more ambiguous picture. Fourth, the risks to the inflation outlook appear presently too skewed to the upside to allow the SARB to embark on a sizable monetary stimulus without fears of a sustained overshoot in the inflation target range. Ongoing careful assessment of evolving data and vigilance continue to be imperative. Our own models suggest that, because of the rigidities in the domestic wage and price formation process, the output gap does not have a large impact on inflation trends. By contrast, the sensitivity to changes in the rand, which could easily depreciate in the event of sizable rate cuts, is generally higher, even if it appeared to decline in recent years. Conclusion: the merits of a stability-oriented framework Nevertheless, monetary policy does have a role to play in attaining stronger, more sustainable economic growth in South Africa. However, it remains the SARB’s view that the best way it can assist in reaching this goal is by fostering medium-term price stability so as to minimise the distortionary effects of a volatile inflation. In particular, historical evidence – both in South Africa and abroad – suggests that when price expectations are better anchored, any shock to inflation is more transient and hence allows the central bank greater latitude to quickly respond to a slowdown in real economic activity. South Africa’s inflation-targeting regime is bearing fruit in that respect. Inflation expectations (as measured by the BER11 survey of analysts, businesses, and trade unions) are currently better anchored than in the early years of the inflation target range. This, in turn, has resulted in more moderate fluctuations, both in the short-term and in the long-term interest rates, over the economic cycle. The SARB remains concerned, however, that these expectations have become too closely anchored around the upper end of the 3-6% target band. Not only does this raise the risk that any shock to prices will result in a durable overshoot of the target range; it also leaves South African inflation structurally higher than in most of its trading partners. This 11 Bureau for Economic Research Page 10 of 11 means that external competitiveness can only be maintained through a regular weakening of the rand, which perpetuates a cycle of inflation and exchange-rate depreciation that probably adds to the risk premiums in financial assets and, in turn, unnecessarily raises the cost of capital. In fact, international experience suggests that, since they have adopted a similar regime, most of the other emerging countries that have managed to keep a lower rate of inflation than South Africa have also enjoyed a stronger rate of economic growth. Looking at a dozen or so large and open emerging economies with an inflationtargeting regime, we find that the sample’s median GDP growth (since the adoption of the regime) has been about 0.5 percentage points higher than South Africa’s whereas its inflation rate has been about 2.0 percentage points lower. If anything, the growth gap is even bigger in the years since the global financial crisis. In conclusion, it would appear that the economic difficulties that South Africa is currently facing are not an indictment on the monetary-policy framework that has been followed for the past 15 years or so. Rather, they illustrate that even a well-calibrated monetary policy cannot, on its own, address the economy’s structural challenges. Of course, monetary policy is always perfectible; its framework can evolve as underlying economic structures change. And the SARB remains committed to constantly looking for ways of carrying out its mandate better. But at the end of the day, a central bank has too few tools at its disposal to solve the large number of problems that we are currently facing – both here and abroad. This brings to mind the words of James Penney, businessman and entrepreneur: “Growth is never by a mere chance, but it is a result of forces working together.” Thank you. Page 11 of 11
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 5th SA Tomorrow Investor Conference, New York City, 9 November 2017.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the 5th SA Tomorrow Investor Conference New York 9 November 2017 Good morning, ladies and gentlemen. Thank you for the opportunity to address this important conference today. As many of you will know, the South African economy faces some major challenges. Economic growth is weak and unemployment remains high despite favourable terms of trade and a robust global recovery. We have good ideas for addressing these problems, but regulatory and policy uncertainty as well as corruption and a lack of direction in some areas have all sapped consumer and investor confidence and weakened private-sector investment. It should not be a difficult task to turn things around. Setting out some investment-friendly ambitions for the economy and reducing political uncertainty would go a long way towards boosting confidence. As is often said, raising confidence is the cheapest form of stimulus. Given the economy’s poor performance, there is an understandable focus on the negatives – but we should not forget that there are also positives. I will touch on these during my address today, particularly on those that impact directly on the work of the South African Reserve Bank (or SARB). These include a much smaller current account deficit, which has made the rand more resilient to risks. There has also been some moderation in inflation, which has eased the near-term pressure on monetary policy. Given our enhanced focus on keeping inflation expectations low, this could extend well into the future. Page 1 of 9 Current account rebalancing Four years ago, South Africa was counted as one of the Fragile Five, along with Brazil, India, Indonesia, and Turkey. These were all countries with weak external positions, which seemed vulnerable to shifting capital flows. In particular, all five experienced sharp currency depreciations after the Fed 1 signalled that it could tighten policy faster than the market then expected – provoking the so-called ‘taper tantrum’. The impact of this shock was that South Africa focused on the need for rebalancing. At the time, the fiscal deficit (for 2012/13) was 4.3% of GDP 2 while the current account deficit was unsustainable at nearly 6% of GDP (-5.88% in 2013). The combined twin deficits were just over 10%. Monetary policy was fairly loose: with a repo rate 3 of 5% and an inflation rate close to 6%, our real interest rate was negative and also lower than real interest rates in the major advanced economies. This couldn’t go on, and thankfully it didn’t. By 2014, most of the high-deficit countries had begun to adjust their imbalances, even though the capital-flow reversal was more modest than expected. The start of normalization in the advanced economies kept on being delayed, and when it did begin in the US 4, the pace was much slower than initially expected. Today, these ‘fragile’ countries have adjusted significantly, in response to increased macroeconomic policy discipline. They are now in a better position to deal with the possible consequences of higher interest rates in the advanced economies. Although the speed of South Africa’s current account adjustment was slow, the extent of the adjustment was significant. Over a three-year period, the deficit went from a quarterly trough of 6.8% of GDP to just 1.7% of GDP in the fourth quarter of 2016, and then to 2.0% and 2.4% in the first two quarters of 2017. This correction was facilitated by a more depreciated exchange rate, the tighter monetary policy stance from January 2014, as well as a degree of fiscal consolidation. 1 Federal Reserve System (United States) 2 gross domestic product 3 repurchase rate 4 United States Page 2 of 9 The adjustment has come mainly through the trade account, which turned positive in the second quarter of 2016 and has since been roughly balanced. This reflects better net exports, partly through more favourable terms of trade but also because weak investment expenditure has led to lower imports. The overall current account remains in deficit, however, due to services, transfers, and income payments to foreign investors – which are the inevitable consequence of attracting large quantities of foreign savings on a sustained basis. Before the global financial crisis, the current account was financed predominantly through equity purchases by non-residents while bond flows were comparatively small on a net basis. Since the crisis, with interest rates in the advanced economies close to 0%, the search for yield has resulted in large-scale net purchases of randdenominated government bonds by non-residents. This trend intensified following the inclusion of South Africa in the Citibank World Government Bond Index. Whereas before the crisis non-residents held about 7% of domestic currency government debt, this ratio increased to current levels of around 40%. This is a positive development; it reflects South Africa’s deep and liquid domestic bond market and an absence of ‘original sin’. There are, however, concerns that the increased holdings may make us more vulnerable to changes in non-resident sentiment. In the context of concerns about the impact of possible sovereign ratings downgrades, the narrower current account deficit implies a lower financing requirement. It puts us in a better position to cope with a possible portfolio capital outflow or reduced inflows. Furthermore, the fact that South Africa has a positive international investment position also means that we do not have a ‘fear of floating’ as is the case in a number of other emerging markets, where foreign-currency liabilities are relatively high. Under those circumstances, currency depreciations have significant negative balance-sheet effects. The floating rand remains a key shock absorber for the economy, assisting in the correct direction of economic adjustment and making a market in rand assets. That is not to say that we will emerge unscathed should our local-currency debt be downgraded to sub-investment grade. There is little doubt that such a move would impact negatively on the rand, government bond yields, and confidence. Short-term Page 3 of 9 overshooting of the currency is likely, with some longer-term level change and passthrough into inflation expectations. But the exact long-term impact is uncertain. Estimates of the possible extent of selling by index-tracker funds range between R100 billion and R180 billion. The short-term impact will also depend on how much is already priced into the markets, the extent to which exposures have already been reduced, and whether the buyers of these bonds are residents or non-residents. While South Africa’s risk premiums have increased in line with those of countries that are subinvestment grade, the possibility of an additional deterioration is high as the broader downgrade shock is felt in medium-term decisions of households and firms. From a monetary policy perspective, a central objective is to reduce the impact that currency volatility and level shifts have on the inflation trajectory. And while passthrough, as in other economies, has been weaker in the post-crisis period, we saw greater price responsiveness to rand strength early this year. We should be cautious in inferring too much from this for our pass-through estimates, but with renewed currency weakness in recent months it does warn us against complacency. Various factors beyond a credit rating review present themselves as risks to the currency, and there are even some, like slower normalization in the advanced economies, that push risk towards a stronger currency. Indeed, conditions in the global economy have generally played a strong role in reducing downside risk to the rand in recent years. The inflation outlook and monetary policy The outlook for the exchange rate is an important, although not the only, consideration when making monetary policy decisions. The current environment has created challenges for monetary policy, but the positive news is that inflation has moderated and has been sitting fairly comfortably within the target range for the past few months. However, the expected inflation trajectory is still higher than we would prefer, with the risks tilted to the upside. At the same time, we have to take cognisance of the growth outlook and provide whatever support we can. This is exactly what we did at the Monetary Policy Committee (MPC) meeting in July. However, we must be clear about the limits of monetary policy, and what it can and cannot do. We cannot expect monetary policy to solve what are essentially structural problems in the economy. Page 4 of 9 Year-on-year headline CPI 5 inflation returned to within the inflation target range in April this year, having declined steadily from 6.6% in January. It reached a low of 4.6% in July before rising to 4.8% in August and to 5.1% in September, in line with our forecasts. At the September MPC meeting, the headline CPI inflation forecast was 5.3% for 2017 and 5.0% and 5.3% for 2018 and 2019 respectively. A lower turning point of 4.6% was still expected in the first quarter of 2018. The forecast for core inflation – which strips out the volatile components of food, petrol, and electricity – and which is a reflection of underlying price pressures, was 4.8% for 2017, rising marginally to 4.9% and 5.0% in the next two years. These forecasts are markedly lower than those from earlier in the year. We remain concerned, however, that inflation expectations, as reflected in the survey conducted by the Bureau for Economic Research, remain anchored at the upper end of the target range. This is particularly the case for the price-setters in the economy, i.e. business and labour respondents. We would prefer to see these expectations anchored at the midpoint of the target band. Inflation at this level would bring our inflation rate closer to, though still remaining somewhat above, those of our peer emerging-market economies. It would also give us more headroom within the target range to absorb adverse supply-side shocks without breaching the upper end of the range. Getting inflation expectations to converge on the midpoint of the target band would help to ensure that inflation actually gravitates towards that level. Yet inflation expectations are unlikely to moderate much, unless price-setters believe that lower inflation can be sustained. This requires improving monetary policy credibility by bringing inflation closer to the 4.5% midpoint of the inflation target range. Bringing inflation to the midpoint and ultimately anchoring expectations there, instead of at 6%, is one of the SARB’s most important medium-term strategic goals. Yet we are well aware that the economy is undergoing one of its worst growth phases in several decades, and although most of the growth problem is structural, there is some scope to provide countercyclical stimulus. We therefore aim for a policy stance that 5 consumer price index Page 5 of 9 balances short-term growth support with long-term disinflation, and all its accompanying benefits. It is difficult to calibrate the exact repo rate this requires. In July, the combination of better-than-expected inflation outcomes and worse-than-expected-growth prompted us to reduce the repo rate by 25 basis points to 6.75%. This adjustment also flattened out a spike in the real interest rate, keeping the policy stance fairly expansionary. At that stage, we assessed the risks to the inflation forecast to be broadly balanced. There was a widely held view in the markets that a further cut would transpire in September. In the event, the MPC decided to keep the monetary policy stance unchanged as the inflation forecast shifted marginally while our assessment of the risks to the inflation outlook deteriorated significantly. Events have since vindicated that September decision; in particular, the rand has depreciated quite sharply recently, demonstrating that some of the risks we had in mind were not already priced in by asset markets. It is, perhaps, unfortunate that some market players were surprised by our decisions. Nonetheless, at times of heightened uncertainty, monetary policy becomes highly data-dependent and also more sensitive to our assessment of the risks to the forecast. We have tried to communicate this data dependence and its implications. We also include, in our MPC statements, the preferences of the different MPC members, which should help analysts to understand which decisions are finely poised and which are more straightforward. With a four-two spilt in July and a three-three divide in September, it should have been reasonably clear to observers that monetary policy was not on a predetermined course. Although it may be comfortable for markets to have certainty around the short-term repo rate path, the real priority for the larger economy is fostering confidence that inflation will be well behaved over the medium and long terms. To this end, we implement monetary policy through flexible inflation targeting. This provides a framework both for interpreting economic news and for communicating our policy stance to our stakeholders so that it is more predictable over time. How, then, does the outlook appear through this lens? Page 6 of 9 As outlined earlier, the exchange rate and its long-term impact on price and wage determination remains the single biggest risk to inflation. In analysing these risks, we would want to look through short-term volatility and focus on the longer-term trend. This is often easier said than done, given the tendency of the rand to overshoot (in both directions) and the conflicting factors weighing on it. Apart from the exchange rate, the main risks to the inflation outlook emanate from the supply side. The application by Eskom for a 20% tariff increase from mid-2018 poses a significant risk. An increase of this magnitude could increase the inflation trajectory by 0.2-0.3 percentage points, relative to the current assumption of an 8% tariff increase. The National Energy Regulator of South Africa is currently conducting public hearings into Eskom’s request, but at this stage we have not adjusted our assumption and will await the outcome of that determination. However, to the extent that there is an upside surprise, our reaction will be guided by the extent to which we assess the second-round effects. In general, we would not automatically react to the first-round effects of a supply-side shock. International oil prices have increased significantly since their lows of below US$45 per barrel in June. They are currently trading at over US$60 per barrel, above our current assumptions of US$55 and US$56 in the next two years. Increased global demand, coupled with output restrictions by some producers, has contributed to the higher trend. The prices may, however, be ultimately capped by increased output by US shale producers, who have now become the main swing supplier in the international oil market. While we still expect a moderate increase over the forecast period, there may be some upside risk to this. At this stage, we see the main risk to the domestic petrol price coming from the exchange rate and higher fuel levies. Demand pressures are expected to remain relatively muted. They may have contributed to the more moderate trend of core inflation in 2017. This is also reflected in the persistence of a negative output gap despite potential output growth of only 1.1% for this year rising to only 1.3% by 2019. We do not see inflation pressures coming from the demand side for some time, although global growth is expected to close the global output gap in 2018 – and this will also further narrow our own gap. Household consumption expenditure growth is expected to remain relatively muted, at Page 7 of 9 around 1% per annum, over the forecast period. This is against a backdrop of weak growth in credit extension to households, low levels of consumer confidence, higher tax burdens, and the absence of significant wealth effects. By contrast, some support to consumption expenditure is expected to come from lower inflation and real, albeit modest, wage growth. Wage pressures remain a concern, as nominal wage settlements continue to contribute to the persistence of inflation at higher levels. Overall, we remain concerned about the weak economic growth outlook. The SARB’s forecast for GDP growth for 2017 has been revised upwards, albeit marginally, from 0.5% to 0.6% in September, while the forecasts for 2018 and 2019 have remained unchanged at 1.2% and 1.5% respectively. The risks were assessed to be slightly on the downside. Of major concern is the negative growth in gross fixed capital formation, particularly by the private sector. Growth in private-sector fixed capital formation has been negative for six consecutive quarters. As I mentioned earlier, restoring confidence will go a long way in getting us on a recovery path. Without growth, we will not be able to make any inroads into our most pressing problem of high unemployment, currently at over 27%. So, what can monetary policy do to help in this situation? It is clear that the problems the economy faces are mostly of a structural nature – not something that can be solved by monetary policy alone. In addition, recent surveys conducted by the Bureau for Economic Research also indicate that the uncertain political environment is the single biggest factor weighing on business confidence, and therefore on investment. Research conducted at the SARB indicates that the confidence factor shaved off at least one percentage point from growth in 2016. Nonetheless, we do not believe that low growth is a non-issue for monetary policy. The moderate nature of the tightening cycle in 2014-16, when we raised interest rates by a cumulative 200 basis points, attests to our sensitivity to growth and the output gap. Furthermore, as we noted in the July MPC statement, we saw the reduction of the repo rate as having a positive impact on growth at the margin, providing a measure of support to the economy. Page 8 of 9 Conclusion The SARB will continue to focus on its constitutional mandate to pursue price stability. This is the best contribution we can make to the economy because it creates the conditions for long-term investment decisions that generate jobs. However, this will be done within a flexible inflation-targeting framework, always mindful of the trade-offs and the impact we may have on growth in the short run. This balancing is important. It implies that, while our bi-monthly monetary policy deliberations have become intensely data-dependent and are likely to remain so with uncertainty and risk high, we will continue to see through the noise and focus on long-run outcomes. This stability in our approach to monetary policy can contribute to better long-term inflation outcomes and therefore a more favourable environment for investment. In conjunction with appropriate structural and confidence-boosting policies, there is no reason why we cannot get investment and growth going again and make South Africa an investment destination of choice once more. Thank you. Page 9 of 9
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Sixth Bank of America Merrill Lynch Annual Summer Macro Investor Conference, Johannesburg, 24 November 2017.
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An address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Sixth Bank of America Merrill Lynch Annual Summer Macro Investor Conference Johannesburg 24 November 2017 Macroeconomic policy and financial risks – From 2017 into 2018 Introduction Ladies and gentlemen, good morning. Thank you for the invitation to deliver the keynote address at this sixth Bank of America Merrill Lynch Annual Summer Macro Investor Conference. The end of the year is upon us. No later than yesterday did the South African Reserve Bank (SARB) conclude its last Monetary Policy Committee (MPC) meeting for the year. It is around this time when many analysts and forecasters publish their respective outlooks for the year ahead, complete with „baseline scenarios‟ and a list of the major risks thereto. But to what extent will these risks differ from those that most of us flagged as the biggest threats 12 months ago? Does the way in which economic agents and policymakers responded to those threats hold lessons for the future? Or do we face as many uncertainties now as we did last year? As American author David Levithan once said: “The mistake is thinking that there can be an antidote to the uncertainty.” We have to strive to achieve the best we can under the circumstances. Page 1 of 12 In trying to tackle the questions I have just posed, I will look back at some of the global risks which both official and private forecasters highlighted at the turn of 2017, to try and gauge the extent to which these risks materialised, if at all. I will also consider whether any new risks are emerging as we approach start of 2018, which may deserve our attention in the year ahead. I will then zoom in on South Africa‟s situation, analysing how much the global environment has influenced domestic developments over the past year and, equally, how new global uncertainties may combine with local issues to influence monetary policy over the coming year. At the end, I will also briefly touch on yesterday‟s monetary policy decision, assuming however, that most of you would have seen our statement. What investors feared most in early 2017 There was a general feeling of economic optimism, albeit a prudent one, at the start of 2017. For example, in its World Economic Outlook Update published in January, the International Monetary Fund (IMF) wrote that „in [the] advanced economies, a modest and uneven recovery [was] expected to continue, with a gradual further narrowing of output gaps‟. Yet, in the same document, the IMF also warned that risks to the global outlook remained „tilted to the downside‟ and related to „ongoing adjustments in the global economy‟. Fears of disorderly adjustment were indeed numerous, including in the US1 – the major country which had recovered relatively fast from the global financial crisis even though it had been at its epicentre. Indeed, because the imbalances created by the global crisis had healed earlier than in other jurisdictions, the US was also the first advanced economy to raise its interest rates from the zero-lower bound. This process was initially very gradual. However, the US Federal Reserve System (Fed) then signalled a likely acceleration in the pace of interest-rate increases (and and that it would embark on the process of reducing in its balance sheet) as it had become increasingly confident of meeting its mediumterm growth and inflation goals. In light of the earlier key influence that low US interest rates had exerted on boosting risk appetite and compressing term premiums in global financial markets, investors became concerned about a reversal of these earlier favourable market developments. United States Page 2 of 12 The election of a new US administration in November 2016, which pledged largescale tax cuts and an „America first‟ approach to external trade, compounded market fears of a disruptive rise in US interest rates and an appreciation of the dollar. In fact, many observers viewed the 2016 presidential election result in the US as one of many examples – albeit a key one – depicting a general shift of voters in advanced economies towards populist politics and policies, including a rejection of several key tenets of the wave of globalisation over the past few decades. The growing hostility towards these tenets – including free trade, free capital flows, and easier crossborder movement of labour – was seen at its strongest in continental Europe. With key elections scheduled throughout 2017, not least in France and Germany, observers feared a move towards populism that had the potential to torpedo the already delayed eurozone economic recovery. At the same time, at the other end of the Eurasian continent, economic observers noted some stabilization in the Chinese economy and capital markets, yet doubted whether this pattern would be durable in light of the continued growth in imbalances that it seemed to involve, not least of which was the ongoing build-up of corporate debt, especially in state-owned enterprises. In turn, investors feared that China would continue to suffer capital outflows, which might force the authorities to again allow the kind of depreciation in the yuan exchange rate that had prompted a tightening in global financial conditions in late 2015 and early 2016. Concerns about the sustainability of economic stabilization in China also raised worries that the prices of many commodities (in particular of metals and minerals) could experience a renewed sell-off in view of China‟s key role in shaping demand for these commodities. Furthermore, the last few months of 2016 saw a jump in crude oil prices as key producers, both inside and outside of OPEC2, somewhat surprisingly agreed on freezing production levels. As the market adjusted to a new supplydemand equilibrium, the possibility of a further rise in oil prices at a time when other commodity prices could be on the back foot posed a risk to the economic recovery of both the advanced economies and the oil-importing emerging economies. Organization of the Petroleum Exporting Countries Page 3 of 12 The global backdrop that proved benign in 2017 However, as we look back at the developments over this year, we can be thankful that most of the risks I have listed above did not materialise. In the US, policy normalization continued largely like the Fed had anticipated at the start of the year. The FOMC3 raised its Federal funds target rate by 25 basis points each at its March and June meetings, and markets largely anticipate a third hike in December, which would bring the funds target rate to 1.25-1.50%, in line with the median forecast of the FOMC participants at the start of 2017. Separately, the Fed began the gradual unwinding of its balance sheet in October. Yet these steps have not triggered the yield-curve steepening or the sell-off in riskier assets that many feared. In fact, on 17 November, the 10-year US Treasury yield stood at 2.36, which was 8 basis points lower than at the beginning of the year. The yield curve has thus flattened. At the same time, US corporate credit spreads, both investment-grade and high-yield, are lower than at the start of 2017, and the S&P 500 equity index has rallied by 15% over the period. Several factors contributed to this solid market performance. On the macroeconomic front, while real economic activity in the US continued to expand at a solid pace, price and wage inflation kept undershooting most official and private forecasts. Indications that prices may have become structurally less responsive to an erosion of economic slack, as well as perceptions that potential US GDP4 may have slowed over time, led the FOMC to lower its medium-term projection for the equilibrium Federal funds rate, even as monetary accommodation was being withdrawn.5 At the same time, expectations for a quick and sizable fiscal stimulus in the US, which could have been a justification for a faster pace of monetary tightening, gradually faded throughout 2017. The economic recovery in the eurozone continued to display stronger momentum than had been expected at the start of the year. Consensus forecasts for GDP growth Federal Open Market Committee gross domestic product As of the December 2016 FOMC meeting, its median projection for the medium-term Federal funds rate was 3.0%; it declined to 2.75% by the September 2017 meeting. Page 4 of 12 in 2017 and 2018, which stood at 1.3% and 1.6% respectively at the beginning of the year, have since been revised upwards by 0.9 and 0.2 percentage points respectively. But the so-called „populist risk‟ has not disappeared. While the antimainstream candidates did not cause major upsets in elections in France or the Netherlands, the results still generally confirmed that a significant portion of the electorate chose candidates who were openly critical of globalisation and of the policy consensus that has prevailed over the past few decades. Nonetheless, this political background did not prevent a further rise in business and consumer confidence in the region. If anything, the current confidence readings in the eurozone stand well above the average of the past decade and their increase has been broadbased across countries. The Chinese economy also performed somewhat better this year than most analysts had anticipated. While a degree of policy tightening, mostly through stricter regulation, did weigh on certain components of domestic demand, Chinese exports benefitted from an improved global and regional trade environment. At the same time, the authorities‟ tighter regulatory stance appears to have succeeded in curbing specific components of private-sector financing (specifically the funding of and by shadow-banking institutions) while keeping bank loan growth relatively stable and thus avoiding a broad-based credit slowdown. Finally, pressure on China‟s capital account has continued to moderate, allowing official foreign-exchange reserves to edge up again after the losses of the previous years. With respect to the oil market, OPEC members appear to have largely complied with their late-2016 deal to limit output, although that agreement has not been the „game changer‟ that some observers had feared, in part because of the US shale industry‟s ability to quickly ramp up production once oil prices exceed the break-even point. Admittedly, oil prices posted significant gains in the latter part of the year, rising from a low of US$44 per barrel in mid-June to US$63 per barrel as of 23 November. Yet this move seemed to be more a reflection of stronger demand (as global economic growth exceeded expectations) than of a supply constraint that could endanger the economic recovery. Overall, considering that many of the risks feared in early 2017 did not materialise and the fact that the „push and pull‟ factors have remained favourable, the year saw Page 5 of 12 renewed and solid net non-resident capital inflows into emerging markets, including South Africa. In an October report, the Institute of International Finance (IIF) projected that such flows would rise to US$1.1 trillion this year, or to about 4% of emerging-market GDP – meaningfully higher than the lows of 1.5% in 2015 although still far off the pre-crisis peak of over 9% in 2007. The bulk of the improvement would reflect debt portfolio and banking-related flows. Indeed, the IIF estimates that in the first 10 months of 2017, the former totalled US$162 billion versus only US$37 billion for the whole of 2016. What should we worry about for 2018? Of course, the fact that major risks did not materialise in 2017 should not breed complacency about the coming year, even though most official and private forecasters broadly agree about a continuation of the broad-based, relatively inflation-free economic expansion in most regions of the world in 2018. History teaches us that it is often when most observers concur about the low probability of negative scenarios that these unfold. The trigger of the next downturn may well be an event that no forecaster sees as a risk right now. Nevertheless, economic downturns – beyond their immediate trigger – always have deeper underlying causes. Let me list a few of these underlying trends which could be sources of fragility for the world‟s economy. First, considerable uncertainty remains about the long-term impacts of the large-scale monetary stimulus put in place by the major central banks since the global financial crisis as well as about the (more short-term) implications of its gradual unwinding. While the degree of global monetary stimulus has so far had surprisingly little impact on inflation, the debate remains open as to whether this pattern will continue once output gaps have fully closed and once legacy issues from the crisis (for instance in the banking sector) have finally been resolved. Equally, analysts debate whether even a gradual unwinding of central banks‟ balance sheets can trigger a quick decompression of term and risk premiums across major financial assets. Because the size of these balance sheets (relative to world GDP) is unprecedented, guidance from economic history is limited. Page 6 of 12 Second, the recent cyclical improvement in global GDP growth may mask persistent issues around low trend gains in productivity which, if unresolved, could result in economic agents and financial market participants being over-optimistic about future economic activity. In most of the large economies, both average labour productivity and total factor productivity have slowed in the past decade or so – a trend which, at least in the advanced economies, has predated the global financial crisis. The exact causes of this „secular stagnation‟ are not yet fully understood, and economists disagree on how long it may last. As of yet, there are limited signs that this trend is reversing. Third, despite efforts at deleveraging in some sectors and in some countries, global debt, as a share of GDP, remains higher than before the global financial crisis. Data from the Bank for International Settlements show that, as of the first quarter of 2017, total credit to the non-financial sector (in all reporting countries) stood at 219% of GDP compared to 185% at the end of 2008.6 While the credit to households has stabilised relative to GDP, the financing extended to general government and nonfinancial corporations has steadily increased. If unchecked, this rising trend has the potential to trigger phases of financial instability in the future, weighing on growth and undermining financial assets. In fact, in many cases the market valuations of these assets already appear elevated relative to long-run norms, which increases their vulnerability to any potential repricing of risk. And while these valuations may not be inconsistent across different categories – the equity risk premiums over bond yields, for example, are relatively large – this does not preclude a situation where all asset categories sell off together. The catalyst for such a sell-off need not be an economic one. Geopolitical tensions in regions as diverse as the Middle East, the Korean Peninsula, and the South China Sea indicate that the world is not necessarily a safer place than in previous decades. The global backdrop and the South African economy Let me now turn to the influence that this global backdrop has had, and is likely to have, on the South African economy. These statistics use credit data at market value, converted at PPP-adjusted exchange rates. Page 7 of 12 As I have mentioned above: the relatively benign global environment, coupled with the failure of key risks to materialise, has supported a continued inflow of capital towards emerging markets in 2017 – and South Africa was no exception. IIF statistics show that, in the first 10 months of the year, net non-resident purchases of South African debt instruments totalled US$4.9 billion, up from US$1.9 billion in the whole of last year. Such inflows, up to the last couple of months, have helped the country‟s financial assets to weather unfavourable domestic growth developments as well as political and policy uncertainty without any major, or lasting, consequences. For example, from early January to the end of August 2017, the rand‟s trade-weighted exchange rate depreciated by only 2.5% and the yield on the benchmark R186 government bond declined by 35 basis points. In addition to global factors, downside surprises in domestic inflation figures for most of the first half of the year as well as a reduced deficit on the current account have contributed to the resilience of domestic fixedincome assets. Yet, South Africa‟s domestic problems have prevented the country from fully benefiting from the benign global backdrop that historical experience and international comparisons would suggest. In fact, while the global risks seen at the start of 2017 did not materialise, several domestic risks became a reality, especially later in the year. This was illustrated by the depreciation of 6.3% in the nominal effective exchange rate of the rand and a rise of 53 basis points in the benchmark R186 government bond yield from the end of August to the end of October 2017. Real economic growth failed to display any meaningful acceleration after a poor performance in 2016, despite the rebound in agricultural production following the previous year‟s drought. At present, the SARB forecasts average growth of only 0.7% in 2017, after a mere 0.3% last year. Hence, the gap between South African GDP growth and world GDP growth, which was minimal up to 2013, continues to widen. Disappointing economic growth, together with the surprisingly low buoyancy of major tax revenues relative to their bases, has compounded the fragility of South Africa‟s fiscal situation. Page 8 of 12 For several years already, projected fiscal consolidation and debt stabilization have had to be postponed because of GDP growth shortfalls relative to budget projections. However, the Medium Term Budget Policy Statement of October 2017 not only saw a meaningful upward revision to deficit estimates for the current year, but also did not project a reduction in that deficit in the outer years. Consequently, the debt-to-GDP ratio is now projected to keep rising throughout the period, approaching 60% by 2020/21. This mixture of weak growth and rising debt – the two concerns repeatedly flagged by ratings agencies – suggests that South Africa must increasingly be wary of possible further downgrades to its sovereign ratings. Following the announcement by Fitch Ratings yesterday that it has affirmed South Africa‟s BB+ rating (which in their case applies to both local and foreign currency debt), announcements will be made later today by both S&P and Moody‟s on the outcome of ratings reviews recently undertaken by them. While exhibiting uncertainty and generating volatility, the recent behaviour of financial markets clearly highlights this risk. Admittedly, as I have indicated earlier, the global economic and financial backdrop has sheltered South African assets for most of the year. Yet they underperformed relative to their emerging-market peers. For example, in the first nine months of 2017, the J P Morgan emerging-market foreign-exchange index appreciated by 5.6% while the rand gained only 1.3% against the US dollar. Such an underperformance was already a warning sign of the relative unattractiveness of South African assets, as generally, in periods of improved global risk appetite, both the rand and domestic bonds tend to outperform their peers. In recent weeks, and in particular since the upward revision to the deficit and debt projections in the Medium Term Budget Policy Statement, the sell-off in both the local currency and domestic bonds is a much clearer indication of investors‟ nervousness about South Africa‟s rising economic and fiscal risks as we draw the curtain on 2017 and move towards 2018. Recent monetary policy developments The SARB cannot ignore this recent shift in the balance of risks affecting South Africa‟s economy or the way it is perceived by financial markets. Obviously, the Page 9 of 12 central bank does not target the exchange rate or the level of bond yields, as its mandate is to keep inflation within the 3-6% target range. Nonetheless, market developments are important inputs in policy formulation – fairly directly for the exchange rate (which impacts on inflation with a lag) and more indirectly for the level of bond yields (which reflects investors‟ perceived risks to the inflation outlook and how they expect monetary policy to respond as a consequence). In its July meeting, the MPC of the SARB lowered the repurchase rate by 25 basis points, both in reaction to a sequence of better-than-expected inflation data and a stronger likelihood that inflation would remain comfortably within the target range over the forecast period. In fact, the SARB‟s projections for both headline and core inflation in 2018/19 had been revised downwards on several instances in the first half of the year. Nonetheless, the MPC guarded against expectations that this rate reduction would mark the start of an easing cycle and warned that any future moves would remain data-dependent. This reflected a high degree of uncertainty about the future inflation profile; the decision was also informed by the MPC‟s continued discomfort with the broad measures of inflation expectations remaining uncomfortably close to the upper end of the target range. By its September meeting, the MPC was of the view that the balance of risks to inflation had tilted to the upside and warranted a more cautious approach, and thus decided to leave the policy rate unchanged. At the conclusion of our MPC meeting yesterday, we decided to leave the repurchase rate unchanged at 6.75 per annum. Our decision to err on the side of caution at the September meeting appears to have been correct, as upside risks to the inflation outlook have increased in the last two months. The Bank‟s inflation forecast shows some deterioration, with inflation expected to be 0.2 percentage points higher in both 2018 and 2019, at levels of 5.2 and 5.5 per cent, respectively. These revisions were mainly influenced by a weaker exchange rate path, higher international oil prices, and higher average wage growth. Inflation is expected to remain within the target range over the forecast period. Yet this „baseline scenario‟ only tells part of the story. Although inflation is not expected to breach the upper end of the target range over the forecast horizon, as Page 10 of 12 indicated, the risks to the outlook are currently assessed to be skewed to the upside, at a time when imminent key event risks contribute to an environment of heightened uncertainty. In light of the growing fiscal risks and increased domestic financial market volatility, the MPC has to be cognisant of the possibility that the inflation outlook could deteriorate further. The MPC also has to weigh the risks I have outlined earlier, including the possibility that the global environment could turn less favourable, which, in the current circumstances, could exacerbate the downward pressure on domestic financial assets. At the end of the day, the MPC is well aware of the current weakness in economic growth, with continued downside risks, and will, wherever possible within its mandate, strive to support an improvement in economic activity through an appropriate monetary stance. However, in an environment characterised by elevated uncertainty, where inflation expectations could become unanchored, the best approach for the SARB is to minimise the number of threats to price and financial stability. Consequently, the MPC will continue to closely monitor both global and domestic developments as well as their implications for the inflation outlook, and will act accordingly. Conclusion While acknowledging that five weeks can be a long time in economies and markets, I think we can reasonably safely already draw the conclusion that the global backdrop in 2017 proved to be more benign than many had anticipated. For the first time in many years, the outlook is finally looking promising, with global growth gathering momentum, without yet generating too much inflation. Financial markets have generally performed well. South Africa faced a particularly challenging domestic environment, which affected growth performance, mainly because of low business and consumer confidence. We failed to fully take advantage of the global cyclical upswing. The inflation outlook improved during the year, and inflation is expected to be inside the target range over the forecast horizon. But more recently upside risks to the inflation outlook have been intensifying, which will require careful monitoring. Page 11 of 12 As Niels Bohr said: “Prediction is very difficult, especially if it‟s about the future”. We do not know what 2018 has in store for us, and how the global risk profile will unfold. The relatively benign global backdrop in 2017, should not make us complacent, but rather encourage us to take advantage of the current cyclical economic upswing to strengthen our structural reforms and implement growth-friendly policies that are needed to boost economic growth and create employment. In South Africa, 2018 provides an opportunity to press the “reset button” and, through a collaborative approach, to try and break the self-reinforcing negative feedback loop of policy uncertainties, low private-sector confidence, subdued investment in productive capacities, and poor competitive performance. Thank you. Page 12 of 12
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the 13th BCBS-FSI High-level Meeting for Africa on "Strengthening financial sector supervision and current regulatory priorities", Cape Town, 25 January 2018.
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An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the 13th BCBS-FSI high-level meeting for Africa on ‘Strengthening financial sector supervision and current regulatory priorities’ Cape Town, South Africa 25-26 January 2018 Page 1 of 13 Introduction Good morning, distinguished guests, ladies and gentlemen. It gives me great pleasure to warmly welcome you to Cape Town, South Africa, for the 13th BCBS-FSI1 high-level meeting for Africa on „Strengthening financial sector supervision and current regulatory priorities‟. I would like to thank you for your attendance and wish to emphasise that the South African Reserve Bank (SARB) truly values such interactions which, among other things, facilitate the sharing of each of our views and experiences as well as the establishment and fostering of professional relationships. This can only contribute towards the strengthening of cross-border regulation and supervision through enhanced relationships with our peers and thus contribute towards a safer and more sound global financial system. Regulatory blind-spot quotes about the 2008 global financial crisis The lessons learned from and the stories told about the global financial crisis of 2008 can never be referred to as a platitude. The crisis continues to be a constant reminder of our ostensible blind spots as well as the incessant need for us, as regulators and supervisors, to be ever aware of avoiding regulatory and supervisory complacency – notwithstanding the charges of over-regulation and the more recent attempts to roll back some of the reforms. It is important to acknowledge that the financial sector and the risks associated with it are constantly evolving. It therefore follows that regulatory frameworks need to evolve with the sector. Increased regulation should not be construed as a burden of over-regulation, but should rather be viewed as evidence of the evolution of the financial sector as well as the associated risks and the regulatory response to them. Basel Committee on Banking Supervision – Financial Stability Institute Page 2 of 13 I would like to share a quote with you, which relates to the global financial crisis of 2008. Barack Obama, the former US2 President, once said: The question we ask today is not whether our government is too big or too small, but whether it works … Nor is the question before us whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but this crisis has reminded us that without a watchful eye, the market can spin out of control. This quote gives impetus to the need for avoiding regulatory complacency. Efforts to constantly strengthen and enhance our regulatory platforms should therefore be viewed in a positive light. Before the global financial crisis of 2008, while the banking world focused on the implementation of Basel 2, the extent of regulatory deficiencies was not fully known and, in hindsight, regulatory and oversight weaknesses were clearly more than significant. The crisis of 2008 has highlighted the extent to which financial groups are embedded within economic and financial systems as well as the high degree of interconnectedness and which significantly increase spill over risks. Governments and central banks in a number of jurisdictions had to implement crisis resolution measures to stabilise and mitigate the potentially damaging effects of the failure of large financial groups on their respective economies. The way for Basel 3 had thus been paved. These were, in essence, reactive regulatory reforms in response to the lessons learned from the global financial crisis. Failures in supervision have highlighted the shortcomings in traditional supervisory frameworks, where oversight was restricted. This is particularly important for financial groups that operate in multiple jurisdictions and conduct cross-sector activities. United States Page 3 of 13 South Africa has recognised the integral importance of Financial Conglomerate Supervision, and significant regulatory reforms have been introduced in favour of this supervisory model. The intended outcome of these regulatory reforms is to strengthen domestic financial sector regulation, which in turn should play a part in strengthening financial sector regulation on the continent. Evidence of regulatory complacency and the existence of regulatory blind spots may reveal itself in the form of inertia with regard to the introduction of new and enhanced regulations. I am pleased to note, however, that since the global financial crisis that inertia has lifted, as is evident in the tightening of regulation and supervision of banks on a global scale. It is further chronicled by the regular publications of the BCBS. Proportionality and bank regulation The Basel Standards, as developed by the BCBS, are designed to apply to internationally active banks. In South Africa, proportionality is limited to the regulatory options embedded in the Basel framework for each of the Pillar 1 risk categories. For example, for credit risk purposes, banks may choose between the standardised approach, the simplified standardised approach, the foundation internal-ratings-based approach, and the advanced internal-ratings-based approach. In 2012, the South African Minister of Finance approved the amended Banks Regulations that incorporated the applicable requirements set out in the Basel 3 framework. The amended Regulations, including specific reporting requirements, took effect on 1 January 2013. These Regulations continue to apply to all banks, with the exception of mutual banks and cooperative banks. Additional capital requirements have been imposed on domestic systemically important banks. Page 4 of 13 The Regulations continue to make provision for separate and additional capital requirements to be imposed on banks based on idiosyncratic risk factors in the form of Pillar 2b capital add-ons. The SARB prefers a risk-based approach to supervision and applies the principle of proportionality as an integral part of its regulatory and supervisory frameworks. Additional reporting requirements are imposed on banks as and when necessary. The requirements specified in the Basel Standards remain the minimum regulatory requirements for all South African banks, with the exceptions previously mentioned. Expected loss provisioning International Financial Reporting Standard (IFRS) 9, „Financial instruments‟, became effective for the financial periods beginning on or after 1 January 2018. This international accounting standard will significantly change the manner in which banks determine impairments for non-performing loans – and will therefore affect banks‟ profits and capital levels. While the aim of IFRS 9 is to ensure that impairments recognised earlier than under International Accounting Standard 39, i.e. as soon as a significant increase in credit risk has been identified and after considering forwardlooking macroeconomic information, the changes required to data, processes, and systems are onerous and will require a much greater coordination of efforts between the various functions in banks, e.g. between the risk and finance functions. Over the past three years, the SARB has engaged through various means with banks and the auditing profession to monitor the IFRS 9 implementation process by the banking industry. A significant amount of time was spent on debating technical accounting, financial modelling, and disclosure issues. There were and there remain, to some extent, some challenges to overcome. For example, an industry-wide shortage of the necessary skills and resources, particularly suitable quantitative modelling resources, resulted in some banks finding it difficult to meet internal project milestones and targets. Consequently, some banks Page 5 of 13 had to reduce the duration of their planned parallel runs prior to the implementation date. Banks with operations across the African continent were also experiencing challenges with regard to data availability and quality suitability for impairment modelling purposes. Furthermore, IFRS 9 does not define what a „significant increase in credit risk‟ is, and it was left to each bank to develop an appropriate methodology that would meet the objective of the standard. The industry, not just locally but internationally, grappled with this and other interpretative issues. The various methodologies adopted will have to pass the rigorous analysis and scrutiny that are expected from the auditing profession when they audit these accounting entries. It should come as no surprise that IFRS 9 will also impact on bank regulators. For this reason, the BCBS issued a guidance document titled „Credit risk and accounting for expected losses‟ in December 2015. This document contains, among other things, the principles that regulators will expect banks to follow with regard to expected credit loss provisioning. In March 2016, the SARB issued Guidance Note 3 of 2016, requesting banks to assess their current policies, processes, and practices against the principles contained in the BCBS document, taking into account the nature, size, complexity, and risk profile of their activities. Compliance with the BCBS requirements will be a focus area for the SARB going forward. Another important area relating to IFRS 9 that has received particular attention is the issue of disclosure and communication with stakeholders such as market analysts. The SARB has engaged with the Johannesburg Stock Exchange on what its expectations are in terms of reporting to the market. Given the substantial effort and dedication that has been and is still being directed at this change in the accounting framework, I am confident that we can expect a smooth transition to IFRS 9 which will serve the overall banking sector well into the future. Page 6 of 13 Declining correspondent banking relationships Over the past few years, it has been reported that a number of the large international financial institutions have reduced their foreign correspondent banking relationships. This is a process commonly referred to as „de-risking‟. Notwithstanding the underlying reasons for de-risking, its culmination may be that financial transactions are forced into less-regulated or even non-regulated channels, thereby reducing the transparency of financial flows and countering efforts aimed at reducing financial exclusion. This will inevitably result in increased risks of moneylaundering and terrorism financing. Furthermore, the decline in correspondent banking relationships renders it difficult to effect cross-border payments and may potentially threaten the stability of financial systems in the adversely affected countries. The World Bank and the International Monetary Fund conducted studies in 2015 and 2016 which found that one of the common key drivers responsible for the decline in correspondent banking relationships was the fact that correspondent banks did not find some of their correspondent banking relationships to be cost-effective and also perceived the money-laundering and terrorism financing risks as unmanageable. A further contributing factor was the fear of administrative sanctions and enforcement by regulators in the event of the correspondent bank being found to have inadequate systems and/or controls in place to curb money-laundering and the financing of terrorism. The Eastern and Southern Africa Anti-Money Laundering Group (ESAAMLG) conducted a survey on de-risking for its 2016-2018 work programme. A fair number of respondent banks in the ESAAMLG region indicated that correspondent banking relationships had been terminated or restricted between 2011 and 2016. The reasons cited for the terminations and restrictions varied and included, but were not limited to, concerns over money-laundering and the financing of terrorism. Countries that were particularly affected countries included Angola, Tanzania, and Zimbabwe. Page 7 of 13 The ESAAMLG survey also indicated that not all respondent banks reported having found replacement correspondent banking relationships or having made alternative arrangements. Once individuals and entities become unbankable as a result of derisking, the risk increases that underground financial systems may develop. The magnitude of illicit capital flows in Africa Illicit capital flows continue to present a serious problem to authorities, particularly on the African continent. In order to resolve the problem of illicit capital flows, there is a need for coordinated efforts in sourcing data from all countries in order to understand the magnitude of the problem. One of the reasons is that the availability of data in respect of illicit capital flows is inadequate. Organisations such as Global Financial Integrity and the Organisation for Economic Co-operation and Development play an important role in attempting to estimate of the magnitude of global illicit financial flows. There are however significant challenges when it comes to conducting research in this regard. African governments have a strong interest in stemming illicit financial flows, including through obtaining the cooperation, compliance, and commitment of other actors. In the context of absent political will in some jurisdictions, there is a need to take urgent steps towards international coordination with the intention of collecting reliable data and addressing the problem of illicit capital flow. The need for effective crisis resolution regimes The most recent global financial crisis has demonstrated unequivocally that there is a strong case to be made for robust resolution regimes being established for financial institutions given their vital role in any country‟s economy. The global financial crisis severely compromised the stability of the financial sectors of many countries. Even in countries where the direct impact was limited, significant indirect consequences were experienced due to the subsequent global economic downturn. Page 8 of 13 This proved that more stringent supervision is not necessarily sufficient to appropriately safeguard the resilience of the global financial system and that inadequate powers to deal with financial failures pose a financial stability and a fiscal risk. The failure or distress of financial institutions as well as the possible spillover effect that these failures can have on the wider economy is something that all countries are exposed to. History has also shown that disorderly bankruptcies lead to uncertainty, which in turn leads to a disruption in financial markets and a sharp fall in bank equity prices. To best deal with the risk that failed or distressed financial institutions might pose, regulators have to ensure that they have appropriate powers and arrangements in place to effectively contain or mitigate the risk(s) that the failed or distressed institution poses to the wider economy. The Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes) set out the powers and tools that national resolution authorities should have at their disposal for firms in all financial sectors that could have a systemic impact if they failed. The Key Attributes also set out recovery and resolution planning requirements for such firms, and require that crisis management groups of home and key host authorities are set up to coordinate group-wide resolution strategies and plans for global systemically important banks. The overarching objective of the Key Attributes is to assist in an orderly resolution without making use of taxpayer funds as it has been proven that the injection of capital from national authorities into a stressed institution might lead to recurring calls for further capital injections. The Key Attributes therefore aim to provide resolution authorities with the necessary powers, allowing them to recapitalise the stressed financial institution and to avoid making use of public funds as far as practically possible. It is important for resolution authorities to have these powers to assist with orderly resolutions, but it is just as vital to put these powers to the test in a simulated Page 9 of 13 scenario. To this end, simulation exercises are powerful tools to diagnose what is not working in existing crisis management regimes and to provide training in the form of „learning by doing‟. Simulation exercises are therefore useful in refining conceptually adequate crisis management arrangements. Simulations, especially regional crises resolution simulations, are important for a number of reasons. The resolution of a distressed financial institution in one jurisdiction can have an economic impact on other jurisdictions, especially the neighbouring countries. Quick and adequate information sharing between home and host regulators is therefore critical considering that a chosen resolution option might be highly beneficial for the financial institution in distress but that it can also have a negative impact in the host jurisdiction if there is a lack of coordination between the home and host regulators. As an example: a banking group in the home country might find it beneficial to sell off one of its banking subsidiaries in a host country as it will relieve the liquidity stress of the banking group within the home country, but the banking subsidiary might be significant in the host country‟s financial sector and can therefore have far-reaching effects on the host country‟s financial stability. Even though cross-jurisdictional information-sharing arrangements are in place, in times of crises it is likely that jurisdictions will first act in their own best interest before considering wider regional repercussions. A regional crisis resolution simulation would therefore assist in testing the available resolution tools, the communication plans in place, and the possible knock-on crossborder effects, thus allowing regulators to be better prepared in a real-life situation by ensuring that the most appropriate solution with the most desirable intended consequences is exercised. Page 10 of 13 FinTech Given the rapid developments in financial technology (FinTech), it is evident that we are potentially facing one of the most severe innovation- and technology-driven disruptions to products and services, particularly in the financial sector space. Regulators across the globe are grappling with understanding these technological developments and assessing the regulatory implications. We as the SARB favour a „back to basics‟ approach. Regulators should focus on regulatory principles that are risk-based rather than creating excessive rules-based regulations aimed at these technologies or products. For example, financial regulators do not regulate the Internet, biometric technology, or mobile devices. Regulatory intervention should be appropriate and should be applied to the underlying economic function. In the case of most central banks, the regulated activities should fall within the ambit of their regulatory mandate and would typically include deposit taking, payments, lending, insurance, and investments. The SARB has recently decided to establish a FinTech Unit, with three dedicated full-time staff members that report directly to me. This unit is required to strategically review the emergence of FinTech and assess the related user cases. Its primary responsibilities are expected to include the facilitation of the development of appropriate policy frameworks for the SARB across the FinTech domain. This will be done by robustly analysing both the pros and the cons of emerging FinTech innovations as well as the appropriate regulatory responses to these developments. Besides collaborating locally, the SARB actively participates in international regulatory and standard-setting bodies. Work undertaken by the various working groups at the Financial Stability Board and the Bank for International Settlements has been proactive in trying to understand FinTech developments and robustly exploring its benefits, risks, and appropriate regulatory frameworks. The SARB is committed to staying abreast of and contributing to global thought leadership on FinTech. Page 11 of 13 Cyber-risk In addition to these FinTech innovations, we are witnessing a rise in cybersecurity risk, which could undermine financial stability. The rapid adoption of new and emerging technologies increases the possibility of technology and systems failure. Customers are demanding real-time and remote access to financial services while institutions are sharing data more freely and more frequently; this consequently creates additional opportunities for cybercriminals. Increased access along with the rise in blockchain technologies increases the number of entry points for cyber attackers. As interconnectivity increases the attack surface for cyber-hackers into financial systems, institutions need to develop a more detailed understanding of mobile, cloud, Big Data, and security technologies. Authorities should persist in increasing collaboration with industry players to ensure that integrity, security, and privacy are all part of the design, operation, and development process of innovations. Conclusion As has been said on numerous occasions: in these times that we live and operate, change is the only constant we are guaranteed. When presented with opportunities to learn from each other and to lean on the areas of expertise of our counterparts – global, regional, and local – none of us should offer any resistance, whatever the reasons may be. Engaging and interacting with each other is a powerful tool that we should never take for granted. Page 12 of 13 As the 19th-century French author Alexandre Dumas wrote in his famous book, The Three Musketeers: “One for all and all for one.” This is very relevant to us as regulators and supervisors who each play a part in maintaining global financial stability in our respective jurisdiction and in the process are contributing towards a more stable global financial system. Please do enjoy the rest of this meeting day. Thank you. Page 13 of 13
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the National Asset and Liability Management Conference, London, 2 March 2018.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the National Asset and Liability Management Conference London 2 March 2018 Challenges for emerging-market central banks Good morning, ladies and gentlemen, and thank you for the opportunity to address you on some of the challenges facing emerging-market central banks. Since the most recent global financial crisis, central banks have faced mounting challenges. Not only were they at the forefront of saving the global economy from collapse; they were also seen as ‘the only game in town’ in restoring economic growth. Central banks also began to play a more pivotal role in ensuring financial stability in general. With these additional responsibilities and expectations, the independence of central banks became increasingly questioned, as financial regulation is considered by some to be primarily political in nature rather than technical. The economic dimension to independence is also of importance, particularly in emerging-market economies. My remarks today will focus on these two dimensions of independence and will consider the extent to which emerging markets have increased their resilience in recent years. Page 1 of 11 Political independence The case for central-bank independence is based on the time inconsistency argument that politicians promise low inflation but are tempted to go for higher growth through expansionary monetary policies. An independent central bank, with a clear mandate to maintain price stability and without the concerns of the electoral cycle, is betterplaced to focus on and achieve price stability. The problem of ceding enormous power to unelected officials in democratic societies is solved by distinguishing between goal independence and operational independence. In many countries, central banks have been granted the latter form of independence. This distinction accords neatly with an inflation-targeting framework, where the goal of monetary policy – the inflation target – is set by law or by the elected government, and the central bank has to implement monetary policy and achieve the inflation target without political interference. Pressures on central banks to use monetary policy to stimulate growth are not new. It is generally accepted among central bankers that while monetary policy can affect cyclical growth, its ability to determine longer-term potential output is limited. Since the global financial crisis, we have seen the potential output estimates in many countries being revised downwards. And while the need for structural reforms has been very clear in many countries too, the focus has been on monetary policy to sustain a growth recovery. Concerted central-bank actions were probably successful in preventing a full-blown global depression, but their ability to bring about a growth recovery was less certain. There were, at times, excessively high expectations as to what monetary policy could achieve with respect to growth, and failure in this respect had the potential to undermine the credibility and legitimacy of monetary policy in general. In the event, recovery has taken some time, and it is only now that we are seeing a return to ‘normal’ growth rates on a sustainable basis. We have yet to see if the massive expansion of balance sheets and the high levels of liquidity generated by low interest rates and Page 2 of 11 quantitative easing will ultimately lead to the high inflation that some have feared. While this is unlikely, it remains a risk. The global crisis originated in the financial sector and subsequently required a rethinking of the role of central banks with respect to financial stability. Prior to the crisis, this responsibility was often not explicitly part of central-bank mandates. Since then, much has changed. And while there are differing approaches among countries, the tendency has increasingly been to locate this responsibility within central banks. A financial-stability mandate becomes more complex when dealing with the issue of independence, as it does not fit neatly into the ‘goal versus operational independence’ dichotomy. What constitutes financial-stability goals is less clear-cut than in the case of monetary policy. In addition, the policies that are available to achieve or maintain financial stability often require cooperation and coordination between various regulatory authorities, including, at times, the fiscal authorities. A challenge for central banks is ensuring that monetary-policy independence is not undermined in the process. This is particularly the case in the event of conflicts between competing objectives. Furthermore, macroprudential policies – for example caps on loan-to-value and loanto-income ratios and criteria for loan eligibility – often have a more visible distributional dimension, and financial-sector lobbies and interest groups are usually strong. As a consequence, central banks have unwittingly been thrust more squarely into the political realm. As their responsibility for financial stability increases, central banks could become increasingly politicized, more so than in the case of monetary policy. Macroprudential policies are often likened to taking the punchbowl away just as the party is starting. Such actions are never popular. If independence is to be maintained, central banks need to foster the political consensus that underpins independence. This requires even greater transparency and accountability than in the case of monetary policy. Central banks also need to have the courage and political backing to make tough calls. There is always the danger that unhappiness with central-bank actions in the financial-stability field could undermine the credibility and legitimacy with respect to their core mandate of price stability. Page 3 of 11 The issue of independence can also be related to central-bank balance sheets, which were brought under greater scrutiny in the wake of the global financial crisis. The balance sheets in the advanced economies expanded dramatically following the extraordinary monetary-policy measures undertaken in those economies. As I will elaborate on a little later, these actions also had implications for the balance sheets of central banks in the emerging markets. It is generally agreed that central banks should not be too concerned about incurring losses or making profits on their balance sheets. These should be regarded as part of the broader government budget constraint. Furthermore, central banks do not have a profit motive but act in the broader interest of the economy. However, central banks that incur continuous losses may ultimately require recapitalization by government and may consequently bring themselves under greater political scrutiny. These issues could divert attention from their core mandate. The South African experience is perhaps instructive – although not unlike the problems faced by other emerging markets. The South African Reserve Bank recorded losses for five consecutive years from 2010, mainly attributable to reserve-accumulation activities. As capital flows to the emerging markets expanded as the search for yield intensified, many central banks attempted to ameliorate the impact on their currencies by buying reserves. In South Africa’s case, we stepped up reserve accumulation – not to influence the currency, but rather to add to what we considered to be a suboptimal level of reserves. Whatever the motive, the impact on profitability is the same. With interest rates at the lower bound in the advanced economies and typically significantly higher in the emerging markets, sterilization activities were conducted at a loss. Countries differ as to how they treat these losses, and the preferred approach often depends on legal frameworks and institutional structures. It can, however, in some instances raise questions about central-bank activities, as they are often seen as ‘losing taxpayers’ money’ and putting independence at risk. Page 4 of 11 Monetary-policy independence While the political dimension of independence remains an ongoing challenge, the issue of monetary-policy independence in the emerging markets has come to the fore again recently. This is against a backdrop of what appears to be a turning point for global financial markets, following an extended period of low volatility and low interest rates in the advanced economies and an absence of inflation pressures. For some time now, the world has been anticipating interest-rate normalization in the United States (US) in particular. To date, this has been happening at a very slow and measured pace, and has been well communicated. Over the past few weeks, global financial markets have reacted to the prospect of tighter-than-expected monetary-policy settings in the US. There was a widespread market reaction to the sharp drop in US equity prices and a large spike in the VIX. After the initial bout of volatility, the markets appear to have stabilised somewhat, but they remain vulnerable to further changes in sentiment and perceptions of risk. It does seem, however, that the prolonged period of easy money and highly liquid markets may be coming to an end, raising concerns about spillovers to the emerging markets who, as usual, are the innocent bystanders. The current turbulence in global financial markets coupled with the return of volatility is in some ways reminiscent of the so-called ‘taper tantrum’ of 2013. After a number of years of interest rates at the zero bound and quantitative easing, the world suddenly faced the prospect of a withdrawal of stimulus. The mere suggestion that the Federal Reserve System (Fed) was considering a reduction in quantitative easing hit the financial markets hard. Long bond yields ratcheted up in the US, raising fears that the nascent growth recovery would be reversed. In the event, the Fed had to allay fears of an excessively tight policy cycle and, in reality, what tightening has occurred since then has been very moderate and well communicated. But while there are similarities to the taper tantrum, there are important differences as well. At that stage, it was only the US that was looking to tighten policy. Today, the cycle is more synchronised. There are expectations for a more aggressive tightening cycle in the US than had previously been priced in, and further interest-rate increases Page 5 of 11 are expected in the United Kingdom. In addition, the European Central Bank is beginning a gradual withdrawal of stimulus. Monetary policy in Japan is, however, expected to remain highly accommodative. A further important difference between then and now is that, after a number of false starts, the growth recovery in the advanced economies appears to be more entrenched and broad-based. This will be positive for the emerging markets. There are also tentative signs that inflation may be on the rise as well, and the likely fiscal expansion in the US is also expected to provide some impetus. Wage growth in the US, which has been surprisingly subdued despite the tighter labour-market conditions, recently showed signs of increasing and contributed to much of the recent bout of volatility in the markets. This time does seem to be different, and monetary-policy tightening appears to be more clearly countercyclical. The market overreaction at the time of the taper tantrum in 2013 had a marked effect on a number of emerging markets, who had been the main beneficiaries of the capital flows generated by the highly liquid conditions. Long bond yields in the emerging markets increased and currencies depreciated as capital flows began to reverse. Monetary policies were generally tightened, although there were differences in timing and degree. According to Eichengreen and Gupta1, the countries hit the hardest were those with wide fiscal and current-account deficits and open capital markets. South Africa fell into this category, along with Brazil, India, Indonesia, and Turkey – together given the dubious title of ‘the fragile five’. Since then, however, most emerging markets have adjusted significantly and are more resilient. But this resilience is currently being put to the test. Eichengreen, B and Gupta, P. 2013. ‘Tapering talk: the impact of expectations of reduced Federal Reserve security purchases on emerging markets’. World Bank Working Paper No 6754 Page 6 of 11 One of the clear lessons of the 2013 episode was that the emerging markets are not immune to monetary-policy developments in the advanced economies. This raises the question as to whether small open economies (and that is what most emerging markets are) can conduct monetary policy independently of developments in advanced-economy financial markets. The traditional Mundell–Fleming model has taught us that monetary policy cannot be conducted independently where exchange rates are fixed. However, flexible exchange rates were expected to provide insulation against cross-border spillovers. Furthermore, perfect exchange-rate flexibility would obviate the need for reserves. This view of the world has changed since then, and for good reasons. Very few countries allow their exchange rates to float freely nowadays. In the past few years, the issue of monetary-policy independence and the insulation properties of flexible exchange rates have been reconsidered. There is little doubt that very few countries are immune to spillovers from developments in the major advanced economies. The question is: to what extent, if at all, can emerging markets insulate themselves from external shocks? The well-known ‘trilemma’ tells us that, with free capital mobility, independent monetary policies are possible only if exchange rates are floating. However, the sheer scale of financial globalisation in recent years has led to a rethinking of the trilemma. Hélène Rey2, for example, has posited the existence of a global financial cycle that is strongly related to monetary conditions in the US and to changes in uncertainty and risk aversion. It is argued that, because credit cycles and capital flows respond to global factors, they may be inappropriate for the prevailing cyclical conditions of many economies. This implies that, for some countries, the global cycle can lead to excessive credit growth when the economy is booming and excessive contraction during a downturn. In other words, it is conditions in the advanced economies that determine domestic financial conditions in the smaller economies, and not domestic policy rates. Rey, H. 2015. ‘Dilemma, not trilemma: the global financial cycle and monetary policy independence’. National Bureau of Economic Research Working Paper No. 21162. Page 7 of 11 As Obstfeld, Ostry, and Qureshi3 have pointed out, there are a number of reasons why we would expect monetary policy to be constrained where financial integration pertains. For example, the substitutability between domestic and external financing could limit the effectiveness of domestic policy interest-rate changes on credit extension and asset prices. They also note that, even if we observe divergences between short-term rates as an indicator of insulation, there is likely to be greater comovement of longer-term rates. Much will then depend on the extent to which longterm rates influence real variables. For Rey, therefore, the trilemma does not exist. Rather, it is a dilemma – or what she calls ‘an irreconcilable duo’. That is: independent monetary policies are possible if, and only if, the capital account is managed, directly or indirectly, via macroprudential policies. These could include capital controls if macroprudential policies are insufficient. In other words: flexible exchange rates do not ensure independent monetary policies when capital is highly mobile. This is a rather significant conclusion for emerging markets as it means that, under conditions of free capital mobility, monetary-policy independence is not possible, irrespective of the prevailing exchangerate regime. But this view is not without its critics. For example, Obstfeld et al. and Gita Gopinath4 agree that the dilemma view may be overstated. However, their evidence suggests that although the trilemma lives on, it does not appear to exist in its strong form. They show that countries with exchange-rate flexibility are less sensitive to changes in global risk and less prone to economic boom-bust cycles. And although independence is not absolute, there is less loss of independence than in the case of countries with fixed exchange rates. In other words: the choice of exchange-rate regime does matter, but we should not expect complete independence with flexibility. The trilemma may be weakened, but it still applies. Furthermore, the extent to which countries can conduct independent monetary policies also depends on their underlying resilience to global spillovers. It is generally accepted Obstfeld, M, Ostry, J D and Qureshi, M S. 2017. ‘A tie that binds: revisiting the trilemma in emerging market economies’. International Monetary Fund Working Paper WP/17/130. Gopinath, G. 2017. ‘Rethinking macroeconomic policy: international economy issues’. A paper presented to the conference on ‘Rethinking macroeconomic policy IV’ at the Peterson Institute for International Economics. Page 8 of 11 that most emerging markets have also become more resilient since the taper tantrum: the macroeconomic fundamentals have generally improved and the domestic financial markets have developed further. In particular, real policy rates are generally higher, inflation is within the target range in most of the inflation-targeting emerging markets, and both fiscal and current-account deficits have generally narrowed. For example: for a selected sample of non-oil-exporting emerging markets5, current-account deficits as a percentage of gross domestic product (GDP) have narrowed significantly since 2012, averaging 0.7% in 2016 compared with 2.2% in 2013. In South Africa’s case, our deficit has narrowed from its widest level of almost 6% of GDP in 2013 to its current level of 2.3% of GDP. The deficits of the other so-called ‘fragile’ countries have also shown sizeable contractions. As a group, therefore, they have greater ability to withstand the impact of exogenous shocks, including sudden stops and higher interest rates in the advanced economies. An indicator of increased resilience is the fact that, since the crisis, a number of emerging markets have made considerable progress in developing deeper and more accessible domestic-currency-denominated bond markets. They no longer suffer from what is often referred to as ‘original sin’. South Africa is again a good example of this. Prior to the crisis, although South Africa had a well-developed domestic bond market by emerging-market standards, non-residents held about 9% of total randdenominated government debt. Today, this stands at around 40%. This development is seen as reducing emerging-market dependence on foreigncurrency debt. It is also seen as a means to reduce exposure to external shocks and increase resilience. However, this does not insulate emerging markets completely. A sudden stop or a reversal of flows would impact on bond yields and the exchange rate. The ability to absorb exchange-rate changes would differ from country to country. Countries with lower levels of foreign-currency indebtedness would be less sensitive Argentina, Brazil, Egypt, India, Indonesia, Malaysia, Mexico, Pakistan, the Philippines, Poland, South Africa, Thailand, Turkey Page 9 of 11 to the balance-sheet effects of large exchange-rate changes. Furthermore, it also implies that bond yields become more sensitive to global factors. Nevertheless, there is evidence that local-currency credit spreads are much less correlated across countries than foreign-currency credit spreads, and global factors explain significantly less variation in local-currency spreads than in foreign-currency spreads.6 In a similar vein, work by Shakill Hassan7 at the South African Reserve Bank shows a low correlation between South African short-term rates and global rates, but the correlation increases for longer maturities. Yields at the short end of the South African terms structure are highly responsive to domestic factors which affect the domestic monetary-policy stance. By contrast, long-term yields are highly responsive to changes in global bond-market developments. A further indicator of increased resilience is the level of foreign-exchange reserves – something that would be close to the heart of the attendees of this conference. As I’ve mentioned earlier: despite increased exchange-rate flexibility, the need for reserves has not disappeared. We have seen that, over time, foreign-exchange reserve holdings have increased quite markedly in the emerging markets. This is true even if we exclude China, which has the largest holdings of reserves. Since 2005, the reserve holdings in a sample of emerging markets referred to earlier (excluding China) increased by 178% by the year 2017. It is generally agreed that the primary motive for reserve accumulation is precautionary, as insurance against speculative attacks in times of crisis. According to research conducted by the International Monetary Fund 8, there is strong empirical evidence that reserves reduce the likelihood of balance-of-payments pressures in the emerging markets. Reserves could provide the means to respond to exogenous shocks, and could calm or even prevent disorderly markets. Central banks have, however, tended to accumulate rather than to use reserves – a phenomenon sometimes referred to as ‘the fear of losing reserves’. Du, W and Schregger, J. 2016. ‘Local currency sovereign risk’. Journal of Finance 71(3). Hassan, S. 2015. ‘Speculative flows, exchange rate volatility and monetary policy: the South African experience’. South African Reserve Bank Working Paper Series WP/15/02. International Monetary Fund. 2014. Assessing reserve adequacy – specific proposals. Page 10 of 11 While higher levels of reserves may create the perception of resilience, simply having reserves on their own is not an effective buffer against speculative attacks or crises. Reserves do not eliminate vulnerabilities. They are not a substitute for sound policies and strong, well-regulated financial sectors. Conclusion In conclusion, it would appear that, at long last, the recovery from the global financial crisis is on track. It has been a difficult path, with a number of false starts and disappointments. No doubt, the road going forward will not be without its difficulties. The recovery itself is expected to bring about new challenges, for the emerging markets in particular. It is inevitable that monetary-policy normalization in the advanced economies will happen, and that the era of high global liquidity will come to an end. The impact on capital flows and global financial markets will create particular challenges for central banks at a time when political independence is being questioned. While vulnerabilities differ from country to country, the emerging markets in general appear to be more resilient in the face of the recent market volatility. Their macroeconomic fundamentals and policies have improved, making them better-placed to weather the storm than was the case five years ago. Thank you. Page 11 of 11
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Opening remarks by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Inaugural Intergovernmental Fintech Outreach Workshop, Council for Scientific and Industrial Research, Pretoria, 19 April 2018.
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Opening remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Inaugural Intergovernmental Fintech Outreach Workshop Council for Scientific and Industrial Research, Pretoria 19 April 2018 The fintech phenomenon: five emerging habits that may influence effective fintech regulation Introduction Good morning, ladies and gentlemen. Welcome to the inaugural Intergovernmental Fintech Outreach Workshop. Let us begin with the words of Joseph Schumpeter: “Situations emerge in the process of creative destruction in which many firms may have to perish that nevertheless would be able to live on vigorously and usefully if they could weather a particular storm.”1 There is no doubt that we are witnessing a wave of disruptive innovation and technology that one can liken to Schumpeter’s ‘creative destruction’, one that will leave no aspect of human endeavour untouched. Financial services in particular are within the eye of the storm of the change as a result of financial technology, or ‘fintech’. An elementary Google search on fintech results in no fewer than 35.2 million hits. Investment in fintech over the last three years is estimated to have been well over US$300 billion dollars.2 Joseph A. Schumpeter (2013). Capitalism, socialism and democracy. Routledge. KPMG (August 2017). Global analysis of investment in fintech. Page 1 of 11 Attention to the emergence of fintech has come from every quarter. There have been contributions from the World Economic Forum reflecting the potential of distributed ledger technology across wide-ranging financial services and activities. The International Monetary Fund has been vocal about the potential impact of cryptocurrencies. More recently, under the Argentinian presidency, the G203 has committed to deepening the analysis on how financial inclusion could be achieved through digital innovations. All of these examples suggest a heightened expectation of shifts to financial services as a result of fintech. At the outset, it may be appropriate to attempt to define what fintech is. ‘Fintech’ usually refers to innovative start-ups or underlying technologies such as blockchain, cloud computing, and machine learning. Founded on an activity-based analysis conducted by the Financial Stability Board (FSB), the evolving definition of ‘fintech’ is that it is neither the fintech firms, nor the start-ups, nor the emerging technologies. Rather, ‘fintech’ is the technology-enabled innovation in financial services as a result of the process of ‘creative destruction’. It may lead to new business models and new configurations within financial services. The potential of financial technology The potential of fintech is well described in one of the earliest reports on fintech commissioned by the UK4 Treasury. This report is useful in that it outlines how countries can positively position themselves in relation to fintech. A key finding of this report is that a country could establish a well-functioning fintech ecosystem and competitively position itself provided that a holistic view is taken that focuses on the following four core ecosystem attributes: policy, talent, capital and demand. Policy refers to the following: (i) regulatory regimes, which includes regulatory support for new entrants and innovative business models; Group of Twenty United Kingdom Page 2 of 11 (ii) government programmes, including sector-growth initiatives which, in turn, include efforts to open up the sector, increase competition, attract foreign fintechs, and improve cyber-resilience; and (iii) taxation policy, which refers to the introduction of appropriate incentives to drive greater investment in fintech, but, dare I add, should also include revisions to the tax code to ensure that profits generated are included in the taxation net of this nascent sector. While clear and appropriate fintech policies are important catalysts to innovation, without talent and capital, fintech is likely to grow at a slower pace. Talent refers to both the availability of technical, financial sector and entrepreneurial talent as well as the strengthening of the talent pipeline through immigration policies and the promotion of fintech in schools and universities with specialist modules, apprenticeships and sponsored work placements. Capital refers to access that start-ups and scale-ups should have to seed and growth capital as well as to public capital markets. The report, for example, lists investor-focused programmes such as the sponsorship of events for venture capital funds to meet early-stage fintechs and the creation of a growth capital fund to finance fintechs. Last, but not least: although each of the previous factors is necessary for the emergence of fintech, actual demand relates to the end-client demand across consumers, corporates and financial institutions. Governments can play a significant role in promoting the adoption rate of fintech through the modernisation of payment and supply chain solutions. Although demand is not a prerequisite, without it innovation in financial services is likely to take off at a slower pace. This framework lays the foundation for developing fintech, especially at a time when the demand for cheaper, faster, simpler and more convenient financial services is high. As policymakers and regulators, we have been acutely aware of the power of developing ecosystems. I further believe that fintech can play a significant role in Page 3 of 11 addressing broader public-policy objectives such as financial deepening, increased competition, and greater efficiency in the provision of financial services. For regulators, though, the challenge is to balance the benefits that fintech may bring with its potential risks. The global and domestic approaches to financial technology Over the past year, the FSB and the Bank for International Settlements (BIS) have also analysed fintech and its implications for policy objectives such as greater financial inclusion and financial stability. Although the BIS concluded that, at present, there are no compelling risks from emerging fintech innovations, it does highlight that the assessment of financial stability implications for fintech are challenging due to the limited availability of data and the fact that many innovations have not yet been tested through a full financial cycle. South African policymakers and regulators have been following the developments and discourse on fintech very closely. Given the global developments, the local innovations as well as the fast-paced and cross-cutting nature of fintech, we have established an Intergovernmental Fintech Working Group (IFWG). The IFWG comprises National Treasury, the Financial Services Board, the Financial Intelligence Centre, and the South African Reserve Bank. It is anticipated that the National Credit Regulator and the Competition Commission will join the working group in due course. Effective coordination between policymakers, central banks, financial supervisors, regulatory authorities, financial ombudsmen and others, all with responsibilities related to fintech, is key to ensuring that that policy is coordinated and synchronised in the financial sector. Regulation has to be harmonised. Given the cross-border nature of digital services, coordination on a global scale is vital, and the role of bodies such as the FSB and G20 will be important in this regard. In South Africa, the Twin Peaks model of financial sector regulation, which is currently being implemented, aims to put in place a regulatory framework that better responds to the dynamic nature of the financial sector, including fintech. The model places Page 4 of 11 emphasis on ensuring consistent, harmonised regulatory approaches to activities in the financial sector, so that comparable activities face similar regulatory requirements - regardless of whether the institution performing the activity is a ‘traditional’ financial institution or a new fintech entrant. This approach is intended to better keep pace with changes in the sector, including those brought about by technological innovations. An example is the establishment of the IFWG mentioned earlier, which is a positive development in driving a coordinated and consistent approach under the Twin Peaks model. Given this broad background and context on fintech, and with this coordinated approach in mind, I would like to turn our attention to this inaugural fintech outreach established by the IFWG. Why is this outreach important? And what is the IFWG attempting to achieve through these engagements? The importance of IFWG outreach To position this outreach initiative, and to draw out its importance, allow me to synthesise the findings from three seminal reports. These reports collectively point to possible best practices related to regulators’ efforts on fintech. The reports are: the FSB’s Fintech Issues Group (FIG) report on Fintech supervisory and regulatory issues that merit authorities’ attention (published in June 2017); the Basel Committee on Banking Supervision (BCBS) report on the Implications of fintech developments for banks and bank supervisors (published in December 2017); and the Fintech Action Plan released by the European Commission in March 2018. These reports highlight five emerging practices that may influence effective fintech regulation over time. These practices may be important in fostering responsible innovation, promoting financial stability, and aligning regulators’ efforts to achieve a more inclusive and a more competitive financial system. Page 5 of 11 Practice 1: focused attention on innovation as a result of technological advancements and the active review of regulatory regimes The first best practice is for policymakers and regulators to dedicate attention to fintech innovations and be supportive of them - or at least to ensure that any barriers to fintech innovations are limited. This could be achieved through ensuring clear and appropriate regulatory regimes. The pro-innovation stance is drawn out in each of the reports. The FIG report suggests that regulators should be agile whenever there is a need to respond to the fast changes in the fintech space, and they should be quick to implement or contribute towards a process of reviewing the regulatory perimeter regularly. The suggestion is to adopt an approach that is technology-agnostic or neutral, and to focus on financial service activities. In the BCBS report, it is suggested that while bank supervisors must remain focused on ensuring the safety and soundness of the banking system, they may wish to consider ways of executing their mission without unduly hampering beneficial innovations in the financial industry. In the European Union’s (EU) Fintech Action Plan, one of the explicit goals is enabling innovative business models to scale up across the EU region through clear and consistent licensing requirements. Actions include reviewing regulation on investment-based and lending-based crowdfunding service providers for business. The proposal specifically aims to ensure an appropriate and proportionate regulatory framework, which allows crowdfunding platforms that want to operate cross-border to do so with a comprehensive ‘passporting’ regime under unified supervision. Another action that supports innovation includes a review of the current authorising and licensing approaches for innovative fintech business models. The European Commission will set up an expert group to assess whether there are any unjustified regulatory obstacles to financial innovation in the EU’s financial services regulatory framework. Page 6 of 11 Authorities should therefore not merely acknowledge or observe innovation but should actively review fintech innovations (including those with new business models) with a view to ensuring proportionate and consistent authorising and licensing regimes. This practice is driven by an underpinning open philosophy and a flexible approach to fintech. Speakers and participants who have had experience of this approach in other jurisdictions will tell us more about the impact of this practice. We will hear how initiatives in cryptocurrencies, digital identity and digital mobile wallets may benefit from a pro-innovation philosophy. We will also hear from jurisdictions with Smart Nation policies about the importance of such national philosophies and policies. Of course, as authorities, we will need to ensure level playing fields and manage the risk of regulatory arbitrage. This is why a coordinated multiple regulator approach is so important. Practice 2: the creation of innovation facilitators such as hubs and sandboxes to keep close to emerging developments and foster shared learning The second practice is the review and creation of structural mechanisms to enable ongoing market engagements. These include efforts aimed at collecting fintech data, organising market outreach initiatives, and implementing structures such as innovation hubs, innovation accelerators and regulatory sandboxes. Each of the reports strongly encourages shared learning with a diverse set of private-sector parties. In order to support the benefits of innovation through shared learning and through greater access to information on developments, authorities should continue to improve communication channels with the private sector and should continue sharing their experiences with innovation hubs, innovation accelerators and regulatory sandboxes, besides other forms of interaction. The reports suggest that the successes and challenges derived from such approaches may provide fruitful insights into new emerging regulatory engagement models. Given the rapid pace of change as well as the emergence of new business models, I believe that, over time, the second practice that may influence effective regulation is the establishment of innovation facilitators. We will hear and learn from our colleagues Page 7 of 11 from the World Bank about the successes and learnings from those that have already implemented such mechanisms. We are pleased to also have the Monetary Authority of Singapore with us today; they can share first-hand their experience with their Innovation Hub, the Looking Glass and related initiatives, such as Project Ubin. Practice 3: coordination, collaboration and communication between domestic regulators We suggest that the third practice relates to coordination and collaboration between regulators. With the emergence of innovations such as crypto-assets or crypto-tokens, initial coin offerings and other alternate financial services platforms, there is often a ‘grey area’ around the relevance and applicability of current regulatory frameworks. Furthermore, the development of new regulatory regimes, if applicable, requires coordination between regulators. As noted before, such coordination is important in ensuring consistent understanding and approaches between regulators. The importance of this coordination is emphasised in the FIG report. Due to the growing importance of fintech activities and the interconnections across the financial system, authorities may wish to develop further their lines of communication. The BCBS report highlights that fintech developments are expected to raise issues that go beyond the scope of, for example, prudential supervision, as other public-policy objectives may also be at stake. This may include objectives such as the safeguarding of data privacy, cybersecurity, consumer protection, the fostering of competition, and compliance with anti-money laundering and combating the financing of terrorism regulations. I would like to emphasise the importance of harmonised approaches and regulatory regimes between domestic regulators. The principle that has to be emphasised is that, as innovations are reviewed and as regulatory frameworks are developed (where required and appropriate), regulators that are best placed to supervise certain activities should be given the task to do so. Regulations should be appropriate and purposeful. Over the next two days, we will hear from you on how important you think Page 8 of 11 this coordination and collaboration between domestic regulators is and what steps we can take to further improve such coordination and collaboration. Practice 4: global cooperation with standard-setting bodies Turning our attention to the fourth practice, we suggest that continued cooperation with our international peers and standard setting bodies remains important. In an environment of financial services that are unconstrained by geographical borders and globally situated third-party financial services providers such as cloud providers, continued sharing and coordination is necessary. Three areas that require international cooperation by authorities are suggested in the FIG report: the monitoring of macrofinancial risks (such as procyclicality), the mitigating of cyber-risks, and the managing of operational risks from third-party providers. In support of this cooperation, the European Commission’s report highlights the importance of the development of standards. Standards for open banking and application programming interfaces (APIs) as well as standards to limit cyber-threats, to improve regulatory reporting, and for distributed ledger technologies (where appropriate) may be areas of priority. Through these engagements, the IFWG would appreciate your feedback on how important you think this global cooperation is and the areas where you think we may need to strengthen coordination with regards to standards development. Practice 5: building staff capacity through deep knowledge of exponential technologies The last practice is about developing deep knowledge structures due to the fast-evolving innovation landscape. For the first time in the history of humankind, we have a new form of money: digital money. This type of ‘creative destruction’ does not have a single issuer, and it is not the liability of any single entity. Rather, it can appear in multiple databases at the same time. It cannot be changed except through defined updating protocols. To understand this, and to apply appropriate regulatory tools to Page 9 of 11 these innovations, is not a simple matter. Equally, assessing the impact of these innovations on monetary policy and financial stability is not straightforward. Technologies such as the Internet, cryptography, blockchain, Big Data and machine learning are shifting the types of skills and knowledge required to remain relevant in the Fourth Industrial Revolution. Work that is routine will likely be replaced by robotics and/or artificial intelligence. Regulators also need to evolve, and new skills will be required in order to keep pace with market innovations. Making appropriate regulatory assessments will depend on such refined skills sets. We suggest that the last practice relates to building deeper knowledge and related skills sets of regulatory staff. Each of the mentioned reports raises the importance of intentionally building these skills sets. Conclusion In conclusion: in reviewing the emerging regulatory practices deemed best, we have hopefully motivated, through reflections on three influential reports, why this outreach event and future market engagements are pivotal. You will notice during this workshop that the IFWG is pursuing the five practices discussed earlier. In this round, we look forward to hearing your views on private cryptocurrencies and initial coin offerings. We welcome a balanced and honest approach to reviewing both risks and benefits. Learning humbly and openly from other jurisdictions on what works and what does not work will help us improve our own regulatory approach and regime. These should be appropriate for our context and conditions. Our society remains divided and sometimes deprived of important financial services. Financial inclusion is an important consideration in this Digital Age. Shifts such as open banking and APIs may play a role in financial deepening. We look forward to hearing how innovation facilitators could be customised for our unique conditions. Fintech is no doubt the consequence of disruptive innovation and as such will lead to the demise of many previously thriving businesses. It offers an immense opportunity to unlock efficiencies and reduce frictions, and could offer an important boost to our economy. Fintech can therefore play an important role in making inroads in addressing Page 10 of 11 the triple challenges of unemployment, poverty and inequality. In order to achieve this, all of us - whether we are regulators, government or private business - have a vital role to play to deepen our understanding of this nascent sector and the opportunities and risks that it presents, and above all to collaborate and coordinate much better, both domestically and internationally. If we succeed, we would have contributed towards improving the lives of millions. If we fail, we would have missed a golden opportunity to make a meaningful difference. Hence, we do not have the luxury of allowing this workshop to turn out to be yet another ‘talk shop’. Too much is at stake. Please participate actively. We welcome your views, and I would like to assure you that this outreach workshop is designed in such a manner that your inputs will be carefully considered by the IFWG leadership. With this thought, let me wish you well in your deliberations over the next two days. I would like to conclude with more words from Schumpeter: “Profit is the payment you get when you take advantage of change.” We could adopt this saying and claim that economic progress is the payment you get when you take advantage of change. Thank you. Page 11 of 11
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Introductory remarks by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Financial Stability Forum and release of the first edition of the Financial Stability Review for 2018, South African Reserve Bank, Pretoria, 25 April 2018.
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Introductory remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Financial Stability Forum and release of the first edition of the Financial Stability Review for 2018 South African Reserve Bank, Pretoria 25 April 2018 Members of the press, guests and colleagues, ladies and gentlemen. Welcome to the release of the first edition of the Financial Stability Review (FSR) for 2018. The FSR has been published twice a year since 2004. Through this publication, the South African Reserve Bank (SARB) communicates its assessment of systemic risk in the domestic financial system. Your presence at this Financial Stability Forum is appreciated, as the forum intends to encourage informed debate on, and therefore to enhance the understanding of, the complex and challenging matters related to financial stability. Consensus is growing globally that regulatory frameworks should focus more on mitigating the risks to the financial system as a whole, as significant risks can build up and threaten the stability of the financial system while individual financial institutions seem stable and sound. In pursuing this goal, the Financial Sector Regulation Act 9 of 2017 (FSR Act) confers on the SARB an explicit statutory mandate to protect and enhance financial stability. The SARB and National Treasury have consequently developed new legislation that will facilitate the orderly resolution of systemically important financial institutions that are failing, which is an important pillar of the SARB’s expanded mandate. This legislation will be effected through amendments to the FSR Act. A key component of the resolution framework is the establishment of an explicit deposit insurance scheme for banks in order to protect depositors from losses in the event of a bank failure. Page 1 of 5 Overall, the message of this FSR is that the stability of the financial system in South Africa has improved notably since the previous FSR. This is based on a more synchonised and more sustained economic recovery in the advanced economies, a more positive (albeit still a challenging) domestic economic growth outlook, as well as improved levels of confidence domestically following positive political developments and ratings outcomes. Against this background, the SARB has assessed the risks to financial stability with a view to identifying and mitigating any vulnerabilities in the domestic financial system; it has also analysed the probabilities and potential impacts of these risks in the FSR. In the presentation to follow, Dr Greg Farrell will share a more detailed assessment of these risks. During the reporting period, a number of event risks occurred that proved not to be systemic in nature but which had potential financial stability implications. These risks included the announcement of an investigation into accounting irregularities at Steinhoff International Holdings in December 2017, followed by the resignation of their Chief Executive Officer and Chairman. The Group’s share price subsequently declined by more than 80%, which resulted in a short-term liquidity crisis within the Group. To date, the Group has taken various actions in an effort to stabilise its finances and operations in the medium term. Any potential financial implications arising from this event would most likely be the result of some form of default risk in respect to the Group and related parties’ debt obligations that the financial sector may be exposed to. While such a default could cause losses for banks, lenders and investors, it is unlikely to result in financial instability as most of the exposure to the Group and related parties’ lies with foreign banks. Developments relating to this situation are, nevertheless, closely monitored. Furthermore, since December 2017 we have observed an increase in the volatility of selected equities listed on the JSE Limited. The sharp, though brief, decline in the share price of Capitec Bank (Capitec) was likely been triggered by a ‘short-selling’ strategy applied by certain investors. The common traits of such a ‘short-selling’ strategy include influencing market participants’ perceptions by means of extensive use of social media platforms and potentially, running an ongoing campaign against the targeted entity. Page 2 of 5 This type of ‘short-selling’ strategy has the potential to create financial instability, especially if the targeted company is a deposit-taking institution. Although a decline in a bank’s share price does not necessarily create systemic risk, there may be a risk to financial stability. This could transpire if the information being spread by the ‘short-selling’ campaign, whether it be true or not, results in a negative feedback loop between lower investor confidence, as reflected in a decline in the equity price of the targeted institution and a loss of depositors’ and lenders’ confidence in the targeted deposit-taking institution. This may ultimately result in a decline in deposits or a ‘run’ on the bank. The negative feedback loop can exacerbate the circumstances even if the trigger event was based on inaccurate information. In the Capitec case, statements by the SARB and appropriate responses by Capitec calmed fears and led to a recovery in Capitec’s share price. VBS Mutual Bank (VBS) was placed under curatorship on 11 March 2018 in order to maintain the functioning of the bank and to promote the safety of depositors’ funds. This intervention was deemed necessary to, among other objectives, preserve depositors’ confidence and trust in the South African banking system. After a thorough assessment of VBS, the curator recommended that an independent review of VBS’s business conduct be undertaken, after which the SARB commissioned a forensic investigation into the affairs of the bank. Other potentially systemic events that occurred during the reporting period included two settlement failures at domestic financial market infrastructures causing certain trades to either fail or remain in an unsettled state in the securities market. These events were reported via the Financial Sector Contingency Forum and then managed by the SARB through its interaction with market participants. A review of these settlement disruptions has been commissioned, and they will be addressed and monitored in future. Globally, economic conditions continued to improve during the second half of 2017, and it appears that a broad-based cyclical recovery is underway. In January 2018, the International Monetary Fund (IMF) revised upwards most countries’ economic growth outlooks for 2018 and 2019, but also warned against possible risks to economic growth recovery, including subdued productivity, increased protectionism, higher geopolitical Page 3 of 5 pressures, and the possibility of sharp financial market corrections in cases where asset valuations were overextended. Institutional soundness remains a feature of the financial system in South Africa. The analysis presented in this FSR confirms that banks are well-capitalised and profitable, and that they hold sufficient levels of liquidity. Although impaired advances and credit impairments increased in January 2018, this was largely a result of the implementation of International Financial Reporting Standard 9 (IFRS 9). It inter alia specifies how an entity should classify and measure financial assets and liabilities and one of the fundamental changes that IFRS 9 introduces is the concept of Expected Credit Loss (ECL) provisioning. This new principle replaces the current incurred losses model and has materially changed the way in which companies, and in particular banks, are required to account for impairments for credit losses. Similarly, the insurance sector seems to be sound. A selection of indicators commonly used to identify macroprudential risks in the industry did not reveal any significant concerns from a systemic risk perspective despite the subdued level of economic growth and which impacts negatively on the insurance industry’s premium income, lapses and surrenders. Pension funds are subject to risks stemming from a sovereign credit rating downgrade because of the size of their bond holdings. Their large exposure to this asset class does not, however, present a financial stability risk as pension funds normally hold these bonds to maturity. A healthy, well-functioning financial system is integral to an environment in which structural, fiscal and monetary policies can be most effective. Recent assessments of the South African financial system by the IMF claim that regulatory reform has made the system relatively safer. Designated procedures for systemically important financial institutions have been put in place; stress testing has become a regular part of the supervisory toolkit; capital buffers have been increased; new rules to address liquidity vulnerabilities have been introduced; resolution frameworks have been strengthened; and over-the-counter derivative regulation has been enhanced. Page 4 of 5 There are important areas where more progress is still required, including the full implementation of strengthened resolution frameworks, measures to increase the resilience of central counterparties, and measures to address the systemic risk emanating from asset management activities. New challenges are emerging from technological changes and innovation, such as the digitisation of finance. Ongoing financial innovation, changes in business models, and strengthened bank regulation have all supported an increasing shift from bank lending to market-based finance, and the importance of non-banks has continued to grow. In conclusion, it is clear that the global and domestic financial systems’ have become more resilience since the publication of the previous FSR in November 2017. Some global uncertainties caused by a number of economic and financial developments remain, including faster-than-expected monetary policy normalisation in the advanced economies, as well as protectionist measures and possible retaliatory actions by others. Despite these challenges, the South African financial system continues to efficiently facilitate financial intermediation and mitigate negative spillovers and disruptions. Overall, despite some headwinds from a moderate economic growth scenario and some remaining fiscal challenges, the South African financial sector is assessed as strong and stable. The sector is characterised by well-regulated, highly capitalised, liquid and profitable financial institutions, supported by a robust regulatory and financial infrastructure. I have briefly highlighted the key issues raised in this FSR. More detailed analyses are available in the publication itself, and some of these will be highlighted in the presentation by my colleague, Dr Farrell. I trust that you will find these interesting, stimulating, and relevant to the current environment, and I invite you to share your views as part of the all-important process of ongoing debate on financial stability. Thank you. Page 5 of 5
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the SwissCham Southern Africa General Assembly, Zurich, 8 May 2018.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the SwissCham Southern Africa General Assembly Zurich 8 May 2018 Recent developments in South Africa: has the country turned for the better? Introduction Good evening, ladies and gentlemen, and thank you for the opportunity to address you tonight. Switzerland and South Africa have close economic ties, and there are numerous opportunities to improve and expand on these. The outlook for the South African economy has improved significantly over the past few months. Recent political developments have generated renewed business and consumer confidence, and investment prospects have been enhanced considerably. However, a number of domestic challenges remain, and the global environment, while favourable, is becoming more volatile and increasingly unpredictable. From the perspective of the South African Reserve Bank (SARB), inflation appears to be under control, but there are incipient risks. In my remarks this evening, I will highlight some of these domestic and global developments, and how we see them impacting on the South African growth and inflation outlook. Page 1 of 10 The South African political and economic landscape The political and economic landscape in South Africa has changed remarkably since December 2017. At that time, both business and consumer confidence were at alarmingly low levels, and the economic growth outlook was very weak. Standard & Poor’s had recently downgraded the country’s local-currency debt rating to subinvestment grade, while Moody’s1 had placed the country on review for a downgrade to sub-investment grade. The rand exchange rate was trading at around R14.20 against the US dollar in the face of increased portfolio capital outflows. Long-term bond yields were at around 9.5% and risk premiums were elevated. The Medium Term Budget Policy Statement of October 2017 had signalled a departure from the fiscal consolidation path, contributing to these unfavourable conditions. Overshadowing this environment was the high degree of uncertainty regarding the outcome of the African National Congress (ANC) leadership electoral conference in mid-December. Let us fast-forward four months or so to 2018. The ANC leadership outcome was well received, followed by a Cabinet reshuffle that contributed to restoring economic confidence and growth. The national Budget tabled in February reaffirmed government’s commitment to the fiscal consolidation path, a move which has gone some way in restoring confidence in the country’s commitment to sustainable public finances. There has also been a positive response to the new President’s commitment and actions to start rooting out corruption in various spheres of society, particularly in government and state-owned enterprises. Business confidence indicators improved, with the ‘Expected business conditions’ category in the Absa Purchasing Managers’ Index surging in February to its highest level since 2001. Similarly, the FNB/BER2 Consumer Confidence Index reached an all-time high in the first quarter of this year. Moody’s affirmed the country’s investment grade rating and changed the negative outlook to stable, preventing South Africa from falling out of the Citibank World Government Bond Index, an event that could have precipitated large-scale selling of South African government bonds by non-residents. 1 Moody’s Investors Service 2 First National Bank / Bureau for Economic Research Page 2 of 10 The rand is currently trading at around R12.50 against the US dollar, after having appreciated to a low of around R11.60 in late February. There has been a resurgence of capital inflows against the emerging market trend, while credit default swap spreads have narrowed by over 50 basis points. Economic growth outcomes surprised on the upside in the fourth quarter of 2017, and the growth outlook has improved. The key question is: is South Africa finally on the road to a sustained recovery? Furthermore, are these developments ‘real’ rather than just a reflection of ephemeral euphoria? It has been a very positive start, and no doubt an important turning point for the country. But it is too early to declare that we are on a new growth trajectory. Most of the economic growth forecasts have been revised upwards, with the latest Reuters consensus forecasts expecting growth of 1.6% and 1.9% for 2018 and 2019 respectively, up by almost 0.5 percentage points since November last year, and a forecast of 2.3% for 2020. The SARB’s growth forecast for 2018 has been revised upwards from 1.2% in November to 1.7% in March. Our model predicts a slight moderation to 1.5% in 2019 due to tax effects, but reaching 2.0% in 2020. The Monetary Policy Committee’s (MPC) assessment is that the risks to these forecasts are on the upside. The improved outlook is based, together with upward revisions to past economic data, on the strong improvement in confidence. Recent research conducted at the SARB3 suggests that the collapse in levels of confidence in the past few years had shaved off around one percentage point from growth in both 2015 and 2016. In a similar vein, the National Treasury estimates that the rebound in confidence could add 0.4 percentage points to potential output. But a cyclical recovery based on a rebound in confidence, however welcome, is not enough. Raising potential output significantly and in a sustained way requires not just a commitment to structural reforms, but actual implementation. This should go hand in hand with increased fixed capital formation. 3 Theo Janse van Rensburg and Erik Visser (2017). ‘Decoupling from global growth – is confidence becoming a scarce commodity?’ South African Reserve Bank Occasional Bulletin of Economic Notes, October. Page 3 of 10 Underlying the subdued growth performance of the South African economy has been the weak trend in gross fixed capital formation, particularly by the private sector. Following two years of annual contractions, private-sector fixed capital formation grew by 1.2% in 2017 and by 9.9% in the final quarter of the year, mainly due to expenditure on transport equipment and machinery. It is still too early to tell whether this unexpected increase is the beginning of a positive trend. However, we do need to reverse the downward trend in the ratio of gross fixed capital formation to gross domestic product (GDP), which had declined to 18.7% in 2017, down from a peak of 23.5% in 2008. This is some way off the 25% target set in the National Development Plan. The South African government has committed itself to a range of structural reforms, many of which are contained in the National Development Plan, which remains a ‘living’ document. Some of the necessary interventions require longer time frames, for example fixing the education system and ensuring broader skills development. However, a number of selected reforms have been identified as the so-called ‘lowhanging fruit’ – these could be implemented relatively quickly and yield high returns. According to the National Treasury, these reforms could increase potential output by two to three percentage points from the current estimate of 1.5%. Telecommunications reforms, which would entail the much-needed release of additional broadband spectrum, could add an additional 0.6 percentage points to potential output. Other reforms include lowering barriers to entry by addressing anti-competitive practices, transport sector reforms, and prioritising labour-intensive sectors such as agriculture and tourism. In addition, there are reports of significant pent-up private-sector investment which has been waiting for increased policy certainty. A notable sector is mining, which has not seen any investment of significance for a number of years. Regulatory and policy uncertainty, coupled with disagreement around the new Mining Charter, has undermined one of the key sectors in the South African economy. According to the Chamber of Mines, the resolution of these issues could unlock a significant amount of investment capital. Page 4 of 10 Government has also expressed commitment to addressing the problems of poor governance at some of the major state-owned enterprises. In turn, these issues have resulted in costs borne by the broader economy and ultimately consumers. Governance issues are also of great concern to foreign investors, particularly those who already hold, or are considering buying, bonds of these corporations. The fragile state of Eskom’s finances has potential fiscal consequences. All these issues need to be sorted out and have been identified as priorities. A start was made when the boards of some of these companies were changed and when audits of previous procurement decisions were conducted. Much work still needs to be done at the operational level to improve efficiencies and reduce costs. These corporations cannot simply rely on unsustainable tariff increases, as in the case of Eskom, or on further government bailouts, as in the case of South African Airways. The role of the South African Reserve Bank Achieving higher potential output growth is not within the power of the central bank. The SARB can, however, contribute to an improved environment in a number of ways. For some time, ratings agencies and investors identified South Africa’s institutional strength as one of the stand-out features of its economy. The past few years have seen a steady erosion of some of our key institutions. Fortunately, there is now renewed focus on reversing this negative trend. In fact, this renewed focus is part of the reason forwarded by Moody’s for retaining the country’s investment grade rating. The SARB, specifically its independence coupled with its mandate on price and financial stability, is seen as an important part of the institutional strength of the country. We have vigorously and successfully defended attempts to undermine our independence and integrity, and we will continue to do so. The SARB’s longer-term role, as set out in the South African Constitution, is to achieve price stability in the interest of balanced and sustainable economic growth. As we have emphasised on numerous occasions, interest rate policy is not the appropriate policy lever to achieve higher potential output. However, lower inflation brings about lower nominal interest rates, and because of lower risk premiums, real rates can decline as well. Page 5 of 10 Low inflation also creates an environment that is more conducive for making investment decisions, which is essential for growth. Furthermore, a low-inflation environment protects the poor in particular; they are least able to protect themselves against the ravages of high inflation. Although the SARB’s key objective is price stability, we have explicitly adopted a flexible inflation-targeting framework, which implies that we are sensitive to the impact of any policy actions on cyclical growth. Our approach also recognises the importance of distinguishing between demand and supply shocks. In the event of significant exogenous supply-side shocks, we generally try to look through the first-round effects of these shocks and focus instead on how these shocks feed through to higher inflation expectations as well as higher wage and price setting. At the same time, however, we recognise the importance of inflation expectations declining to lower levels. Unless the wage and price setters in the economy adjust their expectations lower, wage and price setting will be at higher levels, creating a selffulfilling outcome of higher inflation. We would prefer to see inflation expectations anchored closer to the midpoint of the inflation target range of 3-6%. Recent inflation developments have been generally favourable. Headline consumer price index (CPI) inflation moderated to 3.8% in March, its lowest level since early 2011. However, this benign environment is not expected to continue as the expectation is that the most recent reading was the low point in the current inflation cycle due to a combination of base effects and tax increases (including the VAT4 and fuel levy increases) is expected to confirm that the most recent reading was the low point of the current inflation cycle. The SARB’s most recent forecast was for inflation to average 4.9% this year, and 5.2% and 5.1% in the next two years respectively. So while headline inflation is currently well below the midpoint of the target range, the longer-term outlook is slightly above 5%. 4 value-added tax Page 6 of 10 There are admittedly a number of other positive developments. First, core inflation (i.e. headline inflation excluding food, fuel and electricity) is more benign, indicative of subdued underlying demand pressures in the economy. Core inflation measured 4.1% in March and is forecast to average 4.6% this year and 4.9% in both 2019 and 2020. Second, there has been a welcome decline in inflation expectations, as reflected in the survey conducted by the BER. For some time, these expectations had been stuck at around the upper end of the target range. In the most recent BER survey, however, the average declined by half a percentage point to 5.2% and 5.3% for 2018 and 2019 respectively. Similarly, the five-year-ahead inflation expectations declined to 5.3%, their lowest since they were first surveyed in 2011. The SARB recognises, however, that one reading does not constitute a trend, and we would need to see further declines, or at least a stabilisation at these recent levels, to feel confident that inflation expectations have fallen on a sustained basis. Furthermore, to the extent that inflation expectations are backward-looking, it could take some time for these expectations to move to lower levels, particularly if actual inflation is expected to trend upwards from here on. In other words, it is too early to declare victory in our quest to anchor inflation expectations closer to the midpoint of the target range. This improved inflation environment has contributed to a sounder macroeconomic environment, one where earnings are not eroded at an excessively fast rate. It has also afforded some room for monetary policy to remain accommodative for now and help foster improved economic growth. At the most recent MPC meeting, the repurchase rate (repo rate) was reduced by 25 basis points to 6.5%. With mediumterm inflation expectations at just over 5%, this implies a real repo rate of around 1.5% compared with the SARB model’s estimate of the current neutral rate of around 2%. The MPC’s assessment at that time was that the risks to the inflation outlook were more or less balanced. In its deliberations, most of the upside risks emanated from external sources. These risks are transmitted to the economy via the exchange rate and, by extension, to the risks to inflation. Page 7 of 10 As an inflation-targeting central bank, the SARB does not target the exchange rate but rather focuses on the second-round effects of exchange rate changes (in both directions) on the inflation outlook. This implies that our assessment of the risks to the rand is an important, although certainly not the only, determinant of how we see the inflation trajectory going forward. At the March 2018 MPC meeting, when the rand was trading at around R11.80 against the US dollar, the exchange rate was assessed to be somewhat overvalued, and we viewed further appreciation potential to be somewhat limited. Since then, this view has been reinforced by a number of global developments that have clouded the outlook. The global outlook and risks For some time now, the global context has been relatively supportive and benign. Global growth has been picking up in a steady but synchronised manner, and global inflation has remained low, allowing monetary policies in the advanced economies to remain broadly accommodative. This environment, together with unusually low financial market volatility, has contributed to the continued strong capital flows to emerging markets. There are, however, a number of indications that this Goldilocks period is probably over. Financial market volatility has re-emerged. Some investors appear concerned about potential upside inflation surprises in the US, which could usher in a considerably faster pace of normalisation than the one currently being signalled by the US Federal Reserve (Fed). Furthermore, fiscal expansion in the US could place additional upward pressure on both US short- and long-term interest rates, with negative spill-over effects on most emerging market currencies and bonds. Additional risks to many emerging-market assets stem from the recent rise in oil prices and international trade tensions. The recent increases were underpinned by OPEC’s5 resolve to continue restraining supply in order to support prices. It is too early to tell whether the US shale oil producers, as the new swing producers in the market, will 5 Organization of Petroleum Exporting Countries Page 8 of 10 respond in a meaningful way and either cap or moderate these increases. And while the trade conflict seemingly developing between the US and China is perhaps best described (for now) as a skirmish, it could easily develop into a larger-scale trade war. Any broader retreat from a multilateral, rules based global trade system would not leave emerging markets unscathed. Global value chains would be affected, while reduced risk appetite could undermine cross-border capital flows. I should note that while these recent developments are likely to create challenges for South Africa and emerging markets in general, not all emerging market economies are equally vulnerable to higher advanced economy interest rates. In fact, it is generally accepted that most have become more resilient since the so-called ‘taper tantrum’ of 2013. Their macroeconomic fundamentals have generally improved, their real policy rates are generally higher, and their current account and fiscal deficits have narrowed. Inflation is within target in most of the inflation-targeting emerging markets. In South Africa’s case, our current account deficit has narrowed from its widest level of almost 6% of GDP in 2013 to 2.5% of GDP in 2017, while growth prospects have improved and positive policy signals should reduce the risk premium investors require in domestic assets. In that respect, we are encouraged that the recent weakening of the rand (from relatively strong levels) seemed more a reflection of dollar strength rather than idiosyncratic factors. Conclusion In the context of a supportive global environment, a strong financial sector and recent developments that reinforce the strength of South African institutions, our assessment is that South Africa’s investment case remains compelling. The South African outlook is currently far better than has been the case for some time now. Enormous potential can be unlocked by further reforms and improved policy coordination, which will open up numerous investment opportunities for foreign investors in the country. In addition, Government remains committed to improving the investment climate, as highlighted in the Presidency announcement of our intention to host an investment conference around September 2018. As the South African Reserve Bank we support this through Page 9 of 10 ensuring a prudent and transparent policy approach which is consistent with our constitutional mandate. I have no doubt that the trade and investment ties between Switzerland and South Africa can improve even further. SwissCham Southern Africa has been playing an important role in fostering these ties, and I wish you all the best in promoting trade and investment in our country. Thank you. Page 10 of 10
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the annual Financial Markets Department cocktail function, Johannesburg, 10 May 2018.
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Remarks by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the annual Financial Markets Department cocktail function Johannesburg 10 May 2018 Ladies and gentlemen, good evening. It is with pleasure that I welcome you to the annual cocktail function of the Financial Markets Department (FMD) of the South African Reserve Bank (SARB), which is now in its 12th year. We are greatly honoured by your presence tonight. The deal I struck with our Financial Markets Department for moving this function from Pretoria to Johannesburg was that I would be allowed to speak for 90 minutes. Introduction Allow me in welcoming you to this event, to make some brief observations about financial market developments since we last met and to touch on what could be in store for us in the period ahead. I would also like to draw your attention to two of our initiatives that are gathering momentum, and which will require your cooperation over the next few months. I know that our views on domestic monetary policy are always of interest to financial market participants, but as we are on the eve of entering into the closed period for our next Monetary Policy Committee meeting, which starts on 22nd May, I shall refrain from any comments today, and ask for your patience until you get our most recent take in about two weeks’ time. The global financial markets backdrop Since the last FMD cocktail function, global financial markets have had to ponder over a plethora of developments, including the strengthening synchronised global growth environment, changing perceptions around monetary policy normalisation, rising Page 1 of 8 financial market volatility, threats of escalating trade conflicts, and rising geopolitical tensions. In many ways, the period since our last cocktail function to now has been one of transition; from markets being very complacent about risks, to the current environment in which risk-sensitivity levels appear to be rising again, even against still relatively overall supportive financial conditions. The initial period was characterised by volatility being subdued across a broad range of asset classes, in certain instances with indicators touching record lows. While US interest rate futures increased to reflect expectations that the Fed would hike interest rates, and also appeared to factor-in that the US Treasury would issue more short-term debt, the anticipated pace of such interest rates increases was expected to follow a relatively slow and gradual profile. The other major economies were seen to be still somewhat behind the US with regard to changes to their monetary policy settings. One puzzling issue for the markets had been the fact that even with expectations for better growth in the US, further stimulus coming from the implementation of tax reforms, both of which pointed to possible further hike by the Fed, the USD was weakening. During this period of a relatively benign global environment, capital flows to emerging markets also held up rather well. We have now moved into a period where the market is adjusting to the strength of the cyclical growth momentum that has started to put upward pressure on short-term interest rates and push volatility higher. Adjustments to monetary policy by way of policy rate increases and reducing the pace of asset purchases are now featuring more prominently when assessing future developments. This has already been witnessed with the 10-year US Treasury yield rising to the psychologically significant level of 3% – a level last seen, albeit briefly, in 2013. Now all market-generated paths for policy rates suggest an upward trajectory. Concomitantly, the US dollar has been regaining the ground lost previously, which had seen the USD reaching a three-year low in February 2018. Developments in the domestic financial markets You are all very familiar with developments in the domestic markets, which will allow me to be very brief. Prior to the recent dollar strength, but subsequent to the FMD cocktail function last year, price formulation in the domestic financial markets reflected a confluence of idiosyncratic and global factors. Page 2 of 8 The rand was range-bound during the second and third quarters of last year, trading between R12.62 and R13.95 against a steadily weakening US dollar. The benign global environment had to an extent helped shield domestic financial assets from unfavourable domestic growth developments as well as political and policy uncertainty. However, in the latter part of the year, domestic factors were more dominant and resulted in the rand depreciating to a year’s high of R14.47 in November 2017, before subsequently rebounding on positive sentiment towards domestic fiscal and political developments as well as concomitant views from credit rating agencies which were positively received by the market, which included Moody’s Investor Service retaining South Africa’s sovereign credit rating at investment grade level and improving the outlook to stable from negative. A key factor in Moody’s assessment was their reduced nervousness about South Africa’s rising economic and fiscal risks, and higher levels of comfort with regard to efforts to restore the strength of key institutions. The strengthening rand led to a sharp decline in local bond yields, with the yield on the benchmark R186 declining by 141 basis points to 7.98% while the 30-year R2048 bond’s yield compressed by 146 basis points as investors repriced the political risk premium. The five-year sovereign credit default swap spread improved by 60 basis points from its peak of just over 200 basis points in November 2017. In recent weeks, the rand has been relatively volatile with a weakening profile currently trading around R12.40 to the USD. In line with developments in other emerging markets, this development has been more reflective of USD strength rather than exhibiting rand-intrinsic weakness. What do we need to look out for? While the degree of monetary stimulus of recent years has so far had surprisingly little impact on inflation, the debate remains as to whether this pattern is likely to continue, or rather at what speed any changes will occur, now that some economies are operating with positive output gaps. There are some concerns that the shift to higher volatility may not necessarily be orderly against the background of fears of protectionism, increased geo-political risks, Page 3 of 8 and uncertainty over the pace of monetary policy normalisation. This may lead to an abrupt tightening of financial conditions, which in turn may curtail global growth. Even with some recent corrections, asset valuations remain generally stretched, and currency mismatches arising from large amounts of USD denominated debt incurred to take advantage of low rates (by both corporates and sovereigns), could make financial markets vulnerable to financial conditions tightening at a faster pace than currently anticipated. At the most recent IMF/World Bank Spring Meetings another issue that received particular attention was the rising level of global debt, which if unchecked has the potential to trigger financial instability in the future, weighing on growth and undermining financial assets. These developments may harbour some serious implications for emerging markets. Firstly, risk-aversion may reduce the attractiveness of the emerging market assets, including carry-trade related transactions, which may negatively affect portfolio flows to these markets, as witnessed in the sharp pull-back in flows since mid-April 2018. Secondly, export-dependent emerging economies will be impacted as commodity prices tend to fall when the dollar strengthens. Lastly, a stronger dollar would put pressure on emerging markets with large dollar liabilities, further increasing their financial vulnerabilities. We have already seen some early signs of these risks materialising for emerging economies, with a number of emerging market currencies, including the rand, weakening not only to the dollar, but also to other advanced economy currencies, such as the euro and the yen. But admittedly others have been tested a lot more when compared to South Africa. A key risk to the outlook on the rand remains the possibility of accelerated monetary policy tightening by central banks in the advanced economies, particularly in the US. Escalating trade conflicts and geo-political developments, present another risk factor that needs to be monitored carefully. Page 4 of 8 The impact of trade conflicts could result in decreased demand for South African exports and potentially higher volatility in currency markets. Key initiatives to strengthen the domestic markets Let me turn to the two major initiatives undertaken by the SARB to strengthen domestic financial markets. The first one relates to a consultation paper on selected interest rate benchmarks in South Africa that we will be releasing in the next few weeks. This initiative partly emanates from a coordinated response by international regulators and central banks, to the instances of attempted and actual manipulation of key global interest rate benchmarks and reference interest rates, in particular the London Interbank Offered Rate in 2012. Consequently, the Official Sector Steering Group1, established under the auspices of the Financial Stability Board, recommended that interest rate benchmarks should be underpinned by transaction data and that risk-free interest rates benchmarks should be developed to support certain financial instruments, including derivative contracts. This initiative was also informed by research conducted into the robustness, representativeness and sustainability of the Johannesburg Interbank Average Rate (JIBAR), given its wide usage as a reference rate in South Africa, especially the 3month JIBAR. The research indicated some shortcomings in JIBAR, which do not allow it to fully perform its role as a key indicator of underlying market conditions. The majority of floating interest rate securities and derivatives contracts are linked to the three-month JIBAR, which underscores JIBAR’s importance in the transmission of the SARB’s monetary policy stance through the financial market channel. This work is not limited to the JIBAR, but covers selected other interest rate benchmarks in South Africa. Following the release of the consultation paper containing certain reform proposals, there will be a two-month period for comments, to be followed by a final implementation document in due course. In July 2013, the Financial Stability Board (FSB) established the Official Sector Steering Group, which comprises senior officials from central banks and regulatory agencies, to focus on the FSB’s work on interest rate benchmarks given the significant role they play in the global financial system. Page 5 of 8 I would like to call upon you to please engage with the document and provide us with your comments. This is a very important initiative for financial markets development in South Africa. The second initiative that I would like to update you on relates to the work of the Financial Markets Review Committee (FMRC). In the 2017 national Budget speech, the Minister of Finance announced that the SARB, the Financial Services Board and National Treasury had begun working on a comprehensive financial markets review under the leadership of former SARB Senior Deputy Governor James Cross. The objective is to review the standards, practices and issues of governance, accountability and incentives in wholesale financial markets. The FMRC will consider the mechanisms that are necessary to augmenting the implementation and governance of conduct standards by market participants. Furthermore, it will identify areas where changes to legislation are needed to support a new conduct framework for wholesale financial markets. One of the painful lessons of the great financial crisis has been the importance of conduct in financial markets, and how poor conduct can end up being globally systemic. It is therefore important that we strengthen domestic and global collaborative efforts between the private and public sector, aimed at building trust as an important contribution to creating effective, fair, and resilient markets. The review is well underway and much progress has been made already. You may have participated in the FMRC questionnaire or in meetings held by the project team. It is envisaged, that a draft report will be published later in the year for public comment. Again, this will be an important document for you to interact with and provide comments. There are other important initiatives that the SARB has undertaken in the past year, in relation to financial markets, many of which were in collaboration with you as market participants, such as the launch of South African Foreign Exchange Committee (SAFXC). Page 6 of 8 The SAFXC will be member of the Global Foreign Exchange Committee, the body that has been tasked with the ongoing maintenance of the FX Global Code and ensuring continuing collaboration between central banks and the private sector on developing principles for good governance in the foreign exchange market 2 . The SARB has previously announced that as from 01 September 2018 it will only transact with counterparties in the foreign exchange market that have committed to adhering to the FX Global Code. Some of the other initiatives are contained in FMD’s newsletter, the FMD Update, copies of which are both available here tonight as well as on the SARB website3. Conclusion Allow me now to conclude by saying that we have come through another busy and challenging year, characterised by high levels of volatility and uncertainly in our markets. The collaboration between the SARB and financial market participants continued in a constructive atmosphere and ensured the orderly functioning of our markets in the wake of these challenges. Our collaboration extends to many of you being our partners in our monetary policy implementation activities, government debt operations, sharing of market information and analyses, as well as participation in various market forums. We look forward to our continued cooperation so as to enhance the effectiveness, integrity and resilience of our financial markets. Let me take this opportunity to thank our financial markets team, under the leadership of Mr Leon Myburgh, for their hard work and dedication to the work of the Bank during the past year. Many projects had to be managed simultaneously while keeping the day-to-day operations running smoothly. I should also mention that Mr Callie Hugo will be going on retirement later this year, and that this will be his last attendance of the annual cocktail function in his current capacity. 2 http://w w w.resbank.co.za/Markets/South_African_Foreign_Exchange_Committee/Pages/Announcements.aspx http://w w w.resbank.co.za/Pages/default.aspx Page 7 of 8 I believe that I can speak for all of us in conveying our gratitude to Callie for the great work he has done over many years in contributing to the development of our financial markets, and being one of the key links between the SARB and financial market participants. Even if somewhat pre-mature, because you are still around and have some work to do, we wish you all the best for the future, Callie. Last but not least, a very special thank you must also go to Ms Sharlay Madalane, from the SARB protocol section for her assistance in organising this event. Ladies and gentlemen, please enjoy the rest of the evening. Thank you. Page 8 of 8
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Opening remarks by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the launch of the Project Khokha report, Johannesburg, 5 June 2018.
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Opening remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the launch of the Project Khokha report Sandton Convention Centre, Johannesburg 5 June 2018 Good afternoon, ladies and gentlemen. On behalf of the South African Reserve Bank (SARB), I would like to extend a sincere and warm welcome to everyone here today on the occasion of the launch of the report on Project Khokha, which had as its scope the trial of interbank wholesale settlement using distributed ledger technology (DLT). This was our first DLT initiative; its aim was to contribute to the global initiatives that assess the application and use case for DLT. I am pleased to confirm that Project Khokha was successful in that it proved that the typical daily volume of the South African payments system could be processed in less than two hours with full confidentiality of transactions and settlement finality. This was done using ISO1 20022 standard messages within two seconds across a network of distributed nodes and with the requisite resilient distributed consensus. The SARB is pleased that so many of you have taken the time out of your busy schedules to join us today. We appreciate that there is great interest in this work, both locally and from abroad. 1 International Organization for Standardization Page 1 of 4 I will make brief introductory remarks and then hand over to the Governor of the SARB, Mr Lesetja Kganyago, to deliver the keynote address. My remarks centre around three observations. Barely six months ago, I could not have imagined that we would successfully trial the use of DLT to process high-value transactions. This was in part because I am acutely aware of the challenges involved in building wholesale payments capabilities and appreciate that, and proofs of concept can be both complex and take time to develop. As an example, the requirements for such an endeavour need to be carefully defined, prioritised, and mapped into functional and technical specifications. Furthermore, the coding, development and testing required is an intense and laborious exercise. Add to that the challenge of integration between multiple participants one comes to an appreciation why such initiatives are often multi-year projects. The design, building and delivery of Project Khokha happened in less than three months. This is a noteworthy achievement. It is evident that the pace of innovation and technological development requires a shift to this new ‘agile design approach’ which demands fast turnaround. After all, the mantra of financial technology, or ‘fintech’, is ‘design flexibly, fail fast and succeed sooner’. This rapid prototyping and agile process to trial new ways of innovating in financial services is rapidly becoming the norm. As regulators, we are keenly aware that the days of playing catch-up with often long lags are no longer appropriate as such an approach may allow for systemic risk to build and for market conduct failures to go unchecked. Project Khokha is therefore significant as it has demonstrated that regulatory institutions are indeed capable of responding to the rapidly changing environment with agility, flexibility and speed. The insights gained will also be beneficial in other areas of the SARB’s activity which extend beyond fintech initiatives. Page 2 of 4 My second observation is that the success of complex projects is built on strong collaboration – even in the trial or prototyping phase. This goes beyond the collaboration between participants; this also involves connecting with experts on ongoing unresolved challenges. For example, reaching settlement finality on DLT was a major issue not long ago. With the speed of change and a dedicated global effort, issues such as these are addressed over shorter timeframes as compared to the past. I am proud to announce that Project Khokha has contributed to the global DLT body of knowledge as it is thought that this was the first time that the Istanbul Byzantine Fault Tolerance consensus mechanism and the Pedersen commitments for confidentiality had been used with Quorum. This helped to ensure that the tokenised rand remained a legitimate transaction during transfer, and it assisted with the honouring of participants’ privacy and confidentiality requirements. It is evident that, in this new digital economy with potentially decentralised architecture, progress is made by gradually crossing new frontiers and by extending concepts and solutions. There is little doubt that DLT has huge potential, but that it equally has a substantial road ahead before large-scale adoption across multiple interconnected systems can be considered. Much more work is required, and collaboration is of vital importance as it deepens the collective knowledge base in an area where there is great variability in understanding due to the speed at which the technology is changing. There is huge expectation among the broader financial services community around emerging exponential technologies such as blockchains and distributed ledgers. Multiple trials across many different industries across the globe are taking place. As South Africans, we should be active participants in leveraging innovation and technology to drive efficiencies within our financial system in order to reduce frictions. We furthermore should leverage the immense social and welfare benefits that these developments may deliver while ensuring that financial stability is not compromised. Page 3 of 4 Finally, while contributing to these efforts, we should be careful not to treat emerging technologies as a panacea for every problem. Whereas rapid prototyping brings the benefit of gaining practical insights and a deeper understanding, critically reflecting on what works and what doesn’t is an important aspect of the journey. Complex networked ecosystems encompass multiple dimensions: policy, legislation, economics, process, governance, business and, of course, legacy. The economists will remind us of the ‘stickiness’ and integrated nature of path-dependent systems. I would thus encourage all of us to continue to trial new approaches with vigour, but equally to be frank about the applicability and appropriateness of new emerging architectures. Finally, let me take this opportunity to thank the Project Khokha team that has led this effort. Many thanks to the banking participants, the ConsenSys and PwC2 teams, and of course the numerous SARB colleagues and departments that have been actively involved. Special thanks to Mr Edward Leach, the business owner, and to Dr Arif Ismail, Mr Gerhard van Deventer and Mr Anrich Daseman of the FinTech Unit. With that, I would like to hand over to Governor Kganyago to reflect on the advent of the Fourth Industrial Revolution, the emergence of fintech, as well as the SARB’s role amidst all these changes. The team will then take us through specific detail on Project Khokha, its main findings and potential future work. Thank you. 2 PricewaterhouseCoopers Inc Page 4 of 4
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Nelson Mandela commemorative banknotes and R5 circulation coin launch, Pretoria, 13 July 2018.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the Nelson Mandela commemorative banknotes and R5 circulation coin launch Freedom Park, Pretoria 13 July 2018 Honourable Ministers Esteemed guests My fellow South Africans It is both a pleasure and a privilege to welcome all of you to Freedom Park on this very special day. For the first time in its history of nearly 100 years, the South African Reserve Bank (SARB) is launching commemorative banknotes, besides a third commemorative R5 circulation coin, in honour of our first democratically elected President, the late Nelson Rolihlahla Mandela, fondly known to many South Africans as ‘Madiba or simply Tata’. While many of us are familiar with commemorative items such as stamps and other memorabilia, it has become tradition among central banks to issue commemorative banknotes and/or coins on a significant date to honour a place, an event, a person or an object. As the first President of our democratic era, Nelson Mandela promoted reconciliation, led our reintegration into the global economy, strengthened the framework for macroeconomic management, and ushered in our new constitution. One of the Page 1 of 4 founding principles of the constitution is the establishment of an independent central bank, whose objective it is to protect the value of the local currency in the interest of balanced and sustainable economic growth. Why capture the memory of Madiba on money? One of the main functions of the SARB is to ensure there is a sufficient supply of highquality banknotes and coin. This is the function of the SARB that puts it in the pockets, wallets and hearts of all South Africans. For many of us in this room, cash is only a secondary form of payment and exchange, but physical money remains the foundation of the local economy. Every South African, young and old, uses money. For all the talk about a ‘cashless society’, digital transactions, mobile money and so-called cryptocurrencies, millions of South Africans still depend on cash for daily transactions. The value of banknotes and coin in circulation amounts to more than R140 billion, and the public’s demand for banknotes continues to grow. But not everyone has a phone with Internet access or a digital wallet. In a ‘cashless society’, people who do not have access to banking services could end up being excluded from the economy. It is the responsibility of the SARB to ensure the integrity of banknotes and coin in circulation. The central bank has to ensure that banknotes and coin remain a secure method of payment, unit of account, and store of wealth. A banknote is but a piece of paper, a coin but a piece of metal. Both derive their worth from the trust that the citizens of a country have in the country’s currency. South African banknotes and coin are among the most secure internationally. Over the past five years, the number of counterfeited South African banknotes has continued to decline. The security features embedded in our banknotes and coin represent the most innovative advances in global design and technology. It is important that South Africans know these security features of our banknotes, and the SARB is making a special effort to educate the public in this regard. Please take note of our ‘look, feel, tilt’ approach to checking for the security features and verifying the authenticity of your money. Page 2 of 4 Today, the SARB is also launching a mobile application as a platform to create greater public awareness of the security, technical and design features of our banknotes. The app features interesting details on the life and times of Tata Madiba – aligned to the commemorative banknotes. The confidence that South Africans have in their banknotes and coin is based on trust that the banknotes and coin are authentic – and trust in the institution that issues them. Therefore, the SARB must, without fear or favour, ensure that the buying power of the currency is protected. We therefore strive to ensure that the public trust in our banknotes and coin, as well as in the SARB, as the institution that issues them, is maintained. Preserving the value of our money contributes to stronger economic growth and employment creation over time. Furthermore, a low and stable inflation rate protects the purchasing power of all South Africans and contributes to a lower cost of living . South Africans should be proud that, despite all the challenges that we face as a country, we do not live in an economy with very high inflation. Imagine having to cart your cash in a wheelbarrow to buy a loaf of bread, or the effort it would take to withdraw that much cash from an ATM. As I have mentioned in the past: the history of money globally shows that when inflation walks through the door, public trust in the currency jumps out of the window. Banknotes and coin become nothing but worthless pieces of paper and metal. Our banknotes, however, are representative of an economy with sound fundamentals and prudent monetary policy. So, how does one celebrate the life of a globally respected and celebrated statesman? There is such a rich history to the story of Nelson Mandela, as told in his own words in his bestselling book Long Walk to Freedom, that the SARB has had to use our full range of banknotes as well as a commemorative R5 circulation coin. The banknotes highlight President Mandela’s historical journey from the rolling hills of the Eastern Cape, to Soweto, to Howick, to Robben Island, to the Union Buildings. The Page 3 of 4 commemorative R5 circulation coin features a portrait of Tata Madiba, smiling at the nation he helped to build. Nelson Mandela’s life has touched all of us: South Africans from all walks of life, rural and urban. What could be more fitting than to commemorate his life through an instrument that we all use every day? Money touches all of us, young and old. Tata represents the best version of ourselves as South Africans, and there is no more appropriate an occasion than his birthday centenary to honour all that he represents with these commemorative banknotes and R5 circulation coin. When a young girl in Mvezo or a pensioner in Soweto carry a R10 or R20 note to buy a loaf of bread, they should know that those two banknotes will change hands more often than all the other banknotes in South Africa and in some of our neighbouring countries. One banknote touches many lives. By drawing strength from our fellow South Africans and identifying those traits which best reflect The Madiba In Me, we will remind ourselves in the words of Nelson Mandela that, : “We are together in this. Our human compassion binds us, the one to the other – not in pity or patronisingly, but as human beings who have learnt how to turn our common suffering into hope for the future.” Finally, if you have not already done so, I would really like to encourage you to walk around the exhibit outside, which reflects on the images on the banknotes and coin. I also hope that you will take the time to download the currency mobile app from any of the mainstream app stores and that you will use this app to empower yourself by learning about the interesting facts and details of our banknotes. Thank you very much. Page 4 of 4
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Asset and Risk Management Forum, organized by the South African Reserve Bank, Pretoria, 15 June 2018.
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A keynote address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Asset and Risk Management Forum South African Reserve Bank, Pretoria 15 June 2018 Good morning, ladies and gentlemen. It gives me great pleasure to welcome you to this second day of the Asset and Risk Management Forum. Yesterday’s sessions touched on some pertinent and topical issues, as well as on the risks facing us as central-bank reserve managers. I hope that you have found yesterday’s sessions informative, and I am sure today’s session will be equally so. In some sense, as the era of low policy rates and quantitative easing seems to be drawing to a close, we are entering new and unchartered territory. While the landscape in front of us appears ever-changing, complexities continue to abound. As such, opportunities to engage with peers – opportunities such as this forum – are proving to be invaluable. In keeping with information exchange and peer learning being one of the objectives of this forum, I thought that I should use my key note address this morning to focus on a topic that was the subject of one of the panels yesterday, namely strategic asset allocation, and share with you the evolution of the South African Reserve Bank’s (SARB) approach to the SAA over the last few years, and what we are currently up to. The importance of an appropriate SAA framework cannot be overemphasised. Page 1 of 13 The asset allocation decision is widely regarded as one of the most important investment decisions to be made, and in support of this view, numerous studies have also shown that the asset allocation decision is one of the key determinants of performance.1 For reserve managers, the asset allocation decision does not start with optimising for performance. Its first objective is to ensure capital preservation and liquidity. As such, the SAA process becomes ever more important but also ever more complex. Only once capital preservation and liquidity have been adequately provided for, will considerations of return be incorporated. The process governing the SAA becomes vital to ensure that this non-trivial and important tool is implemented efficiently. The South African Reserve Bank’s strategic asset allocation framework The management of the SARB’s official gold and foreign exchange reserves is governed by our Investment Policy, which provides a framework for our risk appetite and defines the criteria for the management of reserves. The policy specifies, among other things, the governance structures, the aggregate risk tolerance levels, and the eligible asset classes. However, on its own the Investment Policy can be seen as nothing more than a wish list. The SAA is a process which aims to ensure that the Investment Policy’s objectives and targets are implemented successfully. In this sense, it serves as the key vehicle through which the investment policy is pursued. At a high level, the SAA is presented as a set of long-term target currency and asset allocations with the highest likelihood of achieving long-term investment goals within certain risk constraints, as defined by the Investment Policy. In a way, this presents SAA as a pure optimisation problem. However, a purely quantitative solution does not always lend itself to practical implementations. 1 See, for example, Strategic asset allocation and other determinants of portfolio returns by Hoernemann et al. (2005) and The asset allocation debate: a review and reconciliation by Tokat et al. (2006). Page 2 of 13 Consequently, the SAA process also contains an important qualitative assessment, which can result in a portfolio construction that sits below the efficient frontier but which can efficiently be invested in – and which reflects practical considerations. From an overarching perspective, this seems simple enough: run an optimisation across a set of benchmarks and select that portfolio which is as close to the efficient frontier as possible but is also practically implementable. However, this description masks the myriad of complexities and moving parts within a truly successful SAA process. As is often the case, theory and practice are not perfectly aligned! For us at the SARB, SAA is an ever-evolving process, refined through experience and learning. As a result, our SAA process has developed over time, both in response to various crises but also as we have become more aware of the specific challenges and requirements that face us as managers of the country’s reserves. Background to the South African Reserve Bank’s strategic asset allocation framework As an introduction to our most recent SAA review, and to give some context, allow me to provide a brief history of reserves management in the SARB. It was not until 2004 that the SARB actively managed parts of its own reserves through its internal portfolio management team. Prior to that, we had exclusively made use of external fund managers. This started in 1999, with a programme of US$500 million managed between five private sector fund managers. Three years later, in 2002, the programme size would increase to US$1 billion. It is important to note that, at this stage, we had not implemented an SAA yet and that a large portion of the reserves was borrowed funds. The goal was to preserve capital, including the cost of holding reserves. At the time, the benchmark was the London Interbank Offered Rate, or LIBOR, plus 30 basis points to cover our borrowing costs, and another 20 basis points to cover fund management fees. We soon realised that achieving this target of LIBOR plus 50 basis points was not possible given the conservative nature of the mandates we had provided to the external fund managers. Page 3 of 13 Around 2002, we started a rather informal relationship with the World Bank Treasury. It was during this interaction that initial steps were taken to consider developing an SAA, which was eventually implemented four years later, in 2006. Needless to say, this required a revamp of our systems’ capabilities and also led to our first Investment Policy being designed. We began separating the reserves into two tranches: the investment tranche and the liquidity tranche. With more insight and exposure gained through the interaction with external fund managers and the World Bank, the SARB launched its first internally managed global government bond portfolio in 2004. At this stage, we had not yet formally joined the World Bank’s Reserves Advisory and Management Programme (RAMP), but we had come to the realisation that, with net reserves in positive territory and having gained knowledge from the external fund managers, we needed a much more objective and quantitative approach to our investment decisions. In view of this, the SARB, with the assistance of the World Bank Treasury, dedicated the most part of 2005 to capacitybuilding initiatives around reserves management. That same year, we joined RAMP. The aim of our partnership was to ensure that foreign reserves were managed as efficiently as possible. RAMP assisted with all aspects of reserves management, including governance structures, reporting lines, risk management and analytical capabilities, as well as the design of an SAA framework. In fact, in the following year, the SARB would complete a comprehensive review of its Reserves Management Investment Policy, and implemented its first SAA. At that stage, reserves showed good growth and net reserves sat at approximately US$25 billion. In our first SAA, we had begun structuring the foreign reserves into three tranches: the liquidity, buffer and investment tranches. However, given the good growth in reserves and the fact that the liquidity and buffer tranches were sufficient to cover both known and unexpected outflows, we started to increase our risk appetite by setting the investment tranche to target higher returns. Of course, shortly thereafter, in 2008, the global financial markets would be roiled by a global financial crisis. Notwithstanding this, our SAA actually enjoyed good performance given the global investor flight to quality that ensued. Page 4 of 13 Securities lending Although the robust SAA framework shielded the performance of the actively managed portfolios, both during and even after the global financial crisis, challenges were experienced in the area we had viewed as the most conservative part of the reserves: the securities lending programme. On the cash collateral reinvestment part of the programme, we had limits on the duration of the instruments into which the securities lending agent could deploy the cash collateral but there was less of a restriction on credit quality. Through this reinvestment, and at the height of the global financial crisis, we found ourselves with some debt that would eventually trade at a few cents on the dollar. The losses, most of which were valuation losses at the time, raised many questions and provoked intense introspection on our part. However, we later recouped the bulk of the valuation losses and eventually settled for a small realised loss on the paper in question. This experience led to an overhaul of the controls around our securities lending programme, with one of the key lessons being that every element of the reserves management value chain should be actively monitored and stress-tested. In 2015, we completed a formal review of our securities lending programme. We concluded that the securities lending activity should be viewed as a value proposition in its own right and, as a result, in 2016 we transitioned to a third-party securities lending agent model. The South African Reserve Bank’s second and third strategic asset allocation Returning to my discussion on the evolution of the SARB’s SAA, the gradual growth in reserves over the years created a need to review the SAA implemented in 2006. Taking into consideration the valuable lessons learnt from our first SAA, and the significant amount of infrastructure and skills development picked up through our partnership with RAMP, we drafted our second SAA in 2009, which preceded the second review of our External Fund Management Programme. Page 5 of 13 The 2009 SAA performed relatively well but was not without its own challenges, this time in the form of the eurozone crisis. At the time, we had modelled Europe as one single entity in our SAA process and not as individual countries. As a result, and given our allocation to the eurozone as a whole, we had exposures to Greece, Ireland, Italy, Portugal and Spain. With spreads widening dramatically, a decision was made to exclude these countries. This resulted in a number of challenges. Firstly, a decision had to be made on whether to sell the existing positions or hold them to maturity. Secondly, all the benchmarks used for the European portfolios had to be customised, a process which took a considerable time while spreads continued to widen daily. This event also started an important discussion on when and how a breach of the investment guidelines would be handled. Eventually, a defined breach management process was deemed necessary to be included in the investment management agreements. The SARB’s third SAA, implemented in 2013, marked an important turning point in a number of areas. At that time, gross reserves were close to US$50 billion and we now needed to seek a balance between accumulating reserves and the cost of holding foreign reserves. During this time, we had migrated to a much more defined approach to tranching, using the Jeanne-Ranciere model as a guide to the optimal amount of reserves to hold. As a result, the three tranches were reduced to two tranches. The liquidity and buffer tranches were consolidated into one tranche, whose purpose was to provide insurance against a sudden stop in capital flows. Any excess reserves were allocated to the investment tranche, the purpose of which was to recoup the cost of holding the now singular buffer tranche. The investment tranche, however, remained subject to the constraints of capital preservation and liquidity. A number of other important changes were made in our third SAA framework. We expanded the investment universe for internal portfolio managers to include Australia, China, Japan, South Korea and Sweden. Page 6 of 13 The aim of these changes was to include higher-yielding assets and high-quality commodity currencies. Furthermore, we introduced new asset classes: United States (US) mortgage-backed securities, dollar-denominated supranational bonds, eurocovered bonds, and the use of bond futures to enhance the efficiency of internal portfolios as global yields normalised. At that stage, however, the existing systems could not effectively support the expansion of the reserves into additional asset classes and markets. The new asset classes also came with a requirement for more sophisticated risk analytics. As a result, the SARB commenced a process of systems renewal, which also included a total endto-end solution supporting reserves management, treasury operations and third-party payments. The first phase was rolled out a few years later. We had come a long way at that point, both in terms of the size of our reserves and in terms of the approach and processes around how we managed those reserves. As a sign of this improvement, in 2015 the SARB was given the CentralBanking.com ‘Reserve Manager of the Year’ award in recognition of the measures it had taken to ensure resilience during a challenging year for the emerging markets and in addressing the fundamental change in perceptions of risk and return under which reserve managers operate in a post-crisis world. As alluded to during my earlier remarks on our securities lending programme, we also undertook a complete review of our custody model after the roll-out of the 2013 SAA. At that stage, we were making use of two custodians, but this led to some efficiency challenges when it came to risk and performance reporting. This review was completed in 2015 and resulted in the appointment of a single custodian, with a second custodian acting as a shadow custodian should the active custodian become inoperative. This review provided us with great new insights into custodian services and led to a much-improved overall service offering. We concluded that custodial services should also be subjected to a regular review exercise. However, given the complexities of transitioning between custodians, the cycle would be longer than for external fund managers or securities lenders. Page 7 of 13 The selection of fund managers I would now like to take a moment to touch on the process we follow when selecting our fund managers. At a strategic level, we believe that we should maintain a combination of internal and external fund managers. This provides benefits such as greater diversification of portfolio returns, the transfer of key skills and expertise, and a means to benchmark internal portfolio managers. Internally, portfolios are allocated according to their complexity, size and intended level of active management. More passively managed portfolios are allocated to junior portfolio managers under the supervision of a senior portfolio manager. More complicated and more actively managed portfolios are allocated to senior portfolio managers. Our external mandates, however, typically aim to generate alpha. As a consequence, almost no external mandates are passively managed. Given the focus on active management, external fund managers are usually given slightly more freedom, in terms of credit and currency allocations for example, than internal portfolio managers. Our External Fund Management Programme is also aimed at diversifying reserves into asset classes which we do not have the required resources to manage internally, in terms of both systems and human capital. This includes specialist asset classes such as corporate bonds, asset-backed securities and mortgage-backed securities. In line with our most recent SAA review, which started in 2016, we also decided on a different approach to enhance the way in which we selected our external fund managers. This time around, we decided to focus more intensely on the value proposition and value-add the fund manager presented on a specific investment mandate. While the final selection was based on the value proposition in managing a specific mandate, capacity building remained a key consideration in our fund manager selection. Page 8 of 13 We have maintained our three-stage selection process. In the first step, a ‘Request for Information’ is used to survey the landscape of fund managers and to identify those fund managers that have sufficient experience in the required asset classes as well as in the management of central-bank portfolios. The second stage, which takes the form of a ‘Request for Proposal’, is considerably more detailed. Here, we conduct an indepth investigation of fund manager suitability with regards to organisational capabilities in areas such as risk management and organisational stability. We also request participants to select the mandate or mandates which suit their strongest skill set. Importantly, we ask them to submit detailed performance track records in those areas. These track records are then analysed in detail by our risk managers. The subsequently shortlisted candidates are asked to present only on the mandates that they had proposed as their strongest and where we felt, given their track record, they could add the most value. In the panel interviews, the candidates are asked to present their value proposition in their respective mandate in very specific terms, and also to comment on and commit to an outperformance target within a proposed risk limit. This approach has been followed to enhance the efficiency of our selection process and to expose ourselves to those managers who have real and verifiable specialities. This is important not only in terms of optimising performance, but also in terms of skills transfer between the external fund managers and ourselves. The South African Reserve Bank’s current strategic asset allocation framework As I’ve mentioned, the most recent appointment of external fund managers was concluded with the implementation of the current SAA in 2017. If you recall, in our previous SAA, developed in 2013, we had started following the Jeanne-Ranciere model as a guide to the optimal amount of reserves to hold. As a result, we had implemented a tranching methodology which consisted of two tranches: the buffer tranche and the investment tranche. The buffer tranche is invested in a highly conservative manner, while the investment tranche is aimed at generating excess returns, albeit subject to the same constraints of capital preservation and liquidity. Page 9 of 13 In developing our latest SAA framework, we were, however, faced with a completely different set of circumstances to those that had prevailed in 2013. The end of the quantitative easing programme in the US, their move to tighter monetary policy and the consequential rising rates presented us with a new set of risks. However, the divergent macroeconomic policy stances of the developed markets, the volatility in the emerging markets, other risky assets which seemed overvalued at the time, the uncertainty around China’s soft landing, and the possibility of the Brexit all posed a myriad of other, also significant, risks. As such, this most recent SAA was constructed to prioritise capital preservation and to reduce tail risks rather than to focus on return enhancement. To encapsulate this, we placed greater emphasis on the conditional value at risk, or CVaR. Unlike the oftenused value at risk (VaR) metric, CVaR is the expected return given that the portfolio has failed to achieve even the lowest return as per the VaR metric. In other words, the CVaR aims to estimate the average loss in extreme events which fall below the VaR threshold. Our optimisation goal was focused on those portfolios that satisfied the capital preservation criteria or, more specifically, those that defined as the probability of zero negative returns with a 99% confidence level. This resulted in a number of changes, the most important of which was a significant reduction in overall portfolio duration and the introduction of a new asset class at an SAA level, namely the US Treasury Inflation Protection Securities. Strategic asset allocation simulation Our most recent SAA involved a tremendous amount of rigor and numerous engagements, both internally and externally, to ensure that it encapsulated the latest developments in investment management. However, every process has room for reflection and improvement. With this in mind, we have this year embarked on an SAA simulation exercise. The purpose of this exercise is to re-engineer the full value chain of the SAA through a simulated but abbreviated SAA process to ensure that the process itself is appropriately structured and meets the right governance standards. This value chain Page 10 of 13 starts with the formulation of the Investment Policy and runs through a review of market identification, asset optimisation, the expression of risk appetite in Investment Guidelines, and the ultimate roll-out of the portfolios. Among other things, the simulation aims to ensure that each subcomponent of the greater SAA exercise is owned, that timelines are accurate and effective, and that each procedure is well documented by owners in a complete and up-to-date procedure manual. In doing this, we hope to create a separate environment and process where we can focus solely on the SAA process itself, removed from the overarching deadlines which are present in real-life SAAs. In this way, we aim to create a more robust operational framework for future SAAs. Governance As I approach the end of my speech, I would like to take a moment to discuss the role of governance. Not only do reserve managers have to contend with the challenges and complexities of managing foreign exchange reserves efficiently; it is also imperative that we do so with an appropriate level of transparency and with accountability. Sound governance structures go a long way to ensuring that we meet these high standards. The Governor briefly touched on this in his opening remarks yesterday. The governance structure surrounding foreign exchange reserves management at the SARB is separated at different levels. At the highest level, the Governors’ Executive Committee (GEC), which is responsible for overall risk tolerance at the SARB, approves the Investment Policy, the Financial Risk Management Policy and SAA. The Risk Management Committee plays another vital role in the SARB’s governance structure. The committee, which reports to the GEC, oversees the risk management process in the SARB and reviews the Financial Risk Management Policy to ensure its relevance to current business activities. Furthermore, the Risk and Ethics Committee of the SARB’s Board of Directors also reviews the status of risk management in the SARB as well as the effectiveness of risk management activities, key risks, and the mitigating measures to address them. Page 11 of 13 Certain elements of the risk oversight role, however, are delegated to the Reserves Management Committee (RESMANCO), which is chaired at Deputy Governor level. RESMANCO approves investment guidelines and allocates the active risk budget to portfolios in order to limit deviations from the benchmarks. In addition, the committee also has the delegated authority to appoint and/or remove external fund managers, custodians and securities lending agents. While RESMANCO’s role is one of oversight, portfolio management activities, however, are conducted within the Financial Markets Department and, in line with principles of sound internal governance, the Bank has separated the activities of portfolio management, financial risk management, and operational risk management. While these activities all reside within the Financial Markets Department, the Head of Financial Risk has a dotted reporting line to the Deputy Governor: Markets and International and the Head of the Risk Management and Compliance Department. These measures ensure adequate segregation of duties to prevent any conflicts of interest while at the same time allow for operational efficiency. Furthermore, in an effort to promote and improve transparency around reserves management, in 2016 the South African Reserve Bank began publishing the Official Gold and Foreign Exchange Reserves Management Investment Policy on the Bank’s website. These governance structures are vital to ensure that the Investment Policy, through the SAA in this instance, is implemented effectively and lends credibility to the SAA process itself. Conclusion To conclude, I would like to paraphrase a quote attributed to Saint Francis of Assisi: “Start by doing what’s necessary. Then do what’s possible. And suddenly you are doing the impossible.” Page 12 of 13 Looking back at where we started in 1999 to where we are now, we have progressed considerably in terms of our approach to investing our reserves. We have achieved what might have seemed impossible back then. Our current SAA simulation initiative is a combination of the latest thinking in investments, lessons learnt, and all the challenges we have faced along the way. Of course, as with any process, there are areas for improvement, and I am sure that, through future iterations, our SAAs will be even more robust and more effective. I hope that this journey through the history of the SARB’s foreign exchange reserves management, and the SAA’s vital role therein, has been informative, and that it has given you an idea of the challenges and opportunities we have faced along the way. I look forward to engaging with you all in the session that follows, and hope that you enjoy the remaining sessions today. Thank you. Page 13 of 13
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, to the ninety-eighth annual ordinary general meeting of the SARB shareholders, Pretoria, 27 July 2018.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank (SARB), at the Ninety-eighth annual Ordinary General Meeting of the SARB shareholders South African Reserve Bank, Pretoria 27 July 2018 This past year was, to some extent, one of contrasting halves. The second half of 2017 saw a generally constructive global backdrop for South Africa and other emerging markets. The recovery in the advanced economies continued at a steady pace, with most showing signs of sustained growth. In the United States (US), growth was above the estimated potential, and unemployment continued to decline. Economic activity in the euro area surprised on the upside after a protracted period of sluggish growth. A notable exception to this trend was the United Kingdom, where growth prospects were adversely affected by the uncertainty arising from the decision to leave the European Union. There were also indications that, while the withdrawal of monetary policy stimulus was likely to continue in the advanced economies, the policy tightening cycle was expected to be moderate. These settings remained supportive of strong capital flows to emerging markets. Stronger demand underpinned higher commodity prices, reinforced by strong growth in China. This favourable setting did not last long into the first half of 2018. Expectations of a faster pace of monetary tightening than previously expected began to emerge as the strong US growth was sustained. The US unemployment rate reached levels below the estimated natural rate, while fiscal policy became more expansionary. This put upward pressure on long-term US Treasury yields, which exceeded 3% for the first Page - 1 - of 9 time since July 2011. Surprisingly, US inflation remained stubbornly below the target of 2% in the absence of significant wage growth. The recent communications of the Federal Open Market Committee appear to have reinforced the likelihood of a tighter stance, which in turn has sustained US dollar strength. By contrast, growth in the euro area and Japan slowed, leading to a reassessment of expectations of early withdrawal of monetary policy accommodation in these regions. In addition, the strong dollar effect dominated global markets, which saw a reversal of capital flows from emerging markets, reminiscent of the so-called taper tantrum in 2013. While most emerging markets are assessed to be more resilient to these developments than was the case at that time, their exchange rates and bond yields have come under pressure, although experiences have differed widely. Two other developments overshadowed the global environment in the first half of 2018. First, while most commodity prices declined during the first half of this year, the international oil price continued what seemed to be an inexorable ascent. This was driven to a large degree by the successful implementation of the agreement to restrict output by the Organization of Petroleum Exporting Countries (OPEC) and some nonOPEC countries. The result was a steady increase in the price of Brent crude oil, from US$50 per barrel in July last year to around US$80 by June this year. Although some moderation has been evident recently, the outlook remains uncertain, with mixed views by analysts in this regard. To date, the impact on domestic petrol prices and on inflation has been significant. The second development was a marked escalation in the changes to US trade policy. Initially, tariff increases were focused primarily on China, but have subsequently been broadened to encompass some traditional allies of the US as well. It is still unclear whether these actions and countervailing reactions will evolve into a full-blown trade war. However, the rise in protectionism has already had a moderating impact on the optimism for global growth, and has also already contributed to risk-off scenarios in global financial markets. Of concern is that the sharp contraction in world trade that was recorded in April would be protracted. This was the worst performance in world trade since May 2015. Page - 2 - of 9 The net result of all of these recent global developments has been a generally deteriorating environment for emerging markets. During the second half of last year, the domestic economic outlook was overshadowed by heightened political uncertainty in the lead-up to the African National Congress (ANC) elective conference. Business and consumer confidence were at extremely low levels. Although the 1.3% growth rate for the year exceeded the post-crisis low of 0.6% recorded in 2016, it was in stark contrast to the average emerging market growth rate of 4.7%. The low growth and deteriorating fiscal position exacerbated the risk of rating agencies’ downgrades that could have seen South African bonds falling out of some of the major global bond indices. In response to these developments and risks, the rand remained under pressure for much of that period and reached its weakest level of R14.47 against the US dollar during November. Renewed optimism following the outcome of the ANC’s elective conference set in during the early part of 2018. Consumer confidence reached a record high in the first quarter of the year and remained high, although slightly lower in the second quarter. Business confidence also improved significantly in the first quarter, but fell back again in the second quarter. The rand exchange rate appreciated to R11.55 in late February, a level last seen in mid-2015. At the same time, there was a positive response to the 2018 government budget, which reconfirmed the commitment to fiscal consolidation and maintaining the expenditure ceiling. This also helped to avoid a downgrade of South African domestic government debt to sub-investment grade. Unfortunately, the boost to confidence did not translate into a short-term boost to actual growth. Following an upside surprise growth rate of 3.1% in the final quarter of 2017, the economy contracted by 2.2% in the first quarter of this year. At this stage, the high-frequency data for the second quarter indicate that a modest improvement is likely in the quarter, and the South African Reserve Bank (SARB) does not expect a second consecutive quarter of contraction. Nevertheless, a reassessment of the growth outlook has resulted in a downward revision to the SARB’s gross domestic product (GDP) growth forecast for 2018, from 1.7% to 1.2%. Growth of 1.9% is expected in 2019, while the forecast for 2020 remains unchanged at 2.0%. At these Page - 3 - of 9 growth levels, we cannot expect to make appreciable inroads into the unemployment problem of the country. During the past year, monetary policy has been able to achieve its objective of keeping inflation within the target range of 3-6%. Consumer price index (CPI) inflation has been continuously within the target range since April 2017, and is expected to remain within the target range for the rest of the forecast period, ending in 2020. Inflation averaged 4.7% during the past financial year, and reached a recent low of 3.8% in March of this year, the lowest level recorded since 2010. The favourable outcome was due, in part, to lower food price increases following the end of the drought in most parts of the country, as well as subdued domestic demand. However, the low point of the inflation cycle appears to be behind us, as the impact of the value-added tax (VAT) increase and higher petrol prices, and more recently the depreciated exchange rate, is being felt. The improved inflation outlook and below-potential growth afforded some space for monetary policy to be more accommodative. This was particularly in the context of a moderation in inflation expectations during the first half of this year. For some time, these expectations had been stubbornly anchored at the upper end of the target range. In July 2017 and March 2018, the SARB’s Monetary Policy Committee (MPC) reduced the repurchase rate by 25 basis points on each occasion, to its current level of 6.5%. The MPC still assesses the monetary policy stance to be accommodative, and appropriate in the context of the current state of the economy. But there is a limit to what monetary policy can do to stimulate growth. At best, monetary policy can provide some support over the cycle, and can provide a stable environment for growth. As the MPC has emphasised on numerous occasions, a firm commitment by government to credible structural policy initiatives and implementation is required to make an appreciable impact on employment and potential output. At the March MPC meeting, we warned that the global risks in particular could upset the improved inflation outlook. Unfortunately, these risks, which I have highlighted earlier, have taken centre stage. Since April, the rand has depreciated, alongside other emerging market currencies. Together with the higher international oil prices, the Page - 4 - of 9 depreciation of local currency has resulted in domestic petrol prices reaching record highs in nominal terms. Furthermore, risks from higher electricity prices have also emerged. At the recent meeting of the MPC, the repurchase rate was kept unchanged, although concern was expressed regarding the possibility of upside risks to the inflation outlook materialising. At this stage, inflation is still expected to remain within the target range for the forecast period, but at higher average levels than previously thought. The most recent forecast suggests that inflation will average 4.8% this year, but is then expected to rise to 5.6% and 5.4% respectively in the coming two years. This upward drift will not help in our quest to get inflation and inflation expectations anchored closer to the midpoint of the target range. However, because the deteriorating outlook is driven mainly by supply-side factors, the MPC will look through the first-round effects. The MPC will maintain its vigilance and will react should there be second-round effects that take inflation significantly away from the midpoint of the target range. Protecting and enhancing financial stability is now an explicit statutory mandate of the SARB. After a protracted process, the Financial Sector Regulation Act was enacted in August last year, and the Prudential Authority was officially established within the SARB on 1 April 2018. This involved the transfer of a number of employees from the former Financial Services Board, particularly those tasked with the regulation of the insurance industry. This responsibility now resides in the SARB and adds to the longstanding role that the SARB has played in regulating and supervising the banking sector. The amalgamation facilitates the SARB’s role in maintaining, promoting and enhancing financial stability in the country, at both the macro- and the microprudential levels. In general, the banking system remains sound and well capitalised and there were no significant financial stability risks during the past year. Nevertheless, there were a number of highly publicised events that were not assessed to be systemic in nature, but which do hold important lessons for all of us. In particular, they have underlined the importance of having a strong and ethical auditing profession as an integral component of maintaining financial stability. Page - 5 - of 9 In March 2018, having observed signs of a severe liquidity crisis, the SARB placed VBS Mutual Bank under curatorship with the aim of protecting the interests of depositors. Subsequent to this step, the SARB instituted a forensic investigation into possible fraud and/or material misstatements. Financial statements are currently being restated, and until they are, we will not know the full extent of the problem. Any evidence of wrongdoing will be handed over to the relevant law enforcement agencies. Given the size of VBS Mutual Bank and its limited interconnectedness with the rest of the financial sector, it is not assessed to pose a systemic risk. Nevertheless, it did create hardship and anxiety for the thousands of retail depositors who stood to lose their life savings. Fortunately, most of these deposits are now guaranteed by the National Treasury, although the corporate and municipal deposits are not. On 9 July, the SARB announced a mechanism to repay retail depositors up to R100 000 of their deposits in the troubled bank. Some criticism has been levelled at the SARB for not picking up evidence of fraud and/or wrongdoing at VBS Mutual Bank earlier. It is not the role of the regulator to run the bank. The regulator’s role is to protect the depositors of the bank, not the shareholders, and to ensure that the bank adheres to its prescribed prudential requirements. The governance of the bank is the responsibility of its board, and its operations are in the hands of management. It goes without saying that proper control systems and governance structures are of paramount importance. As regulators, we have to rely on the accounts given to us by the bank as the basis for our risk assessment, and these will have been signed off by both the internal and the external auditors. The auditors, in turn, rely on the information provided to them and cannot be held responsible if they are misled by fraudulent activities. However, if they are complicit in the misstatements or irregularities in the running of the bank, they will be held accountable. Page - 6 - of 9 Regulators cannot prevent banks from failing if bad or illegal business decisions are made. Our role is to ensure that bank failures do not put the entire banking and financial system at risk. The issue of the integrity of company audits was also in the spotlight with another potential financial stability risk. The collapse of the share price of Steinhoff International Holding NV, following the announcement of an investigation into alleged accounting irregularities, raised concerns about the exposure of South African banks to the company. Fortunately, the company’s debt is mainly concentrated in foreign banks, and the impact of a potential default on loans on the domestic banking system appears to be limited. During the past year we also had to deal with the potential risks posed by a questionable report on Capitec Bank and the subsequent short-selling of the bank’s shares, which caused some volatility in its share price. The SARB’s view is that Capitec Bank is well capitalised and has sufficient liquidity. The share price has since clawed back most of its losses, and there was no run on the bank. At the previous AGM, I reported on our challenge to the Public Protector’s ruling on the legality of the SARB’s assistance to Bankorp over 30 years ago as well as her finding that Absa, as the purchasing bank, was liable to repay the facility. We were particularly concerned about the binding remedial instruction to Parliament to set in motion a process to change the constitutional mandate of the SARB away from price stability. We challenged this remedial action, as well as the Public Protector’s other findings. The judgement, as you may know, went in our favour. The entire report was set aside, and we have finality on these issues. Our mandate, to protect the value of the currency in the interest of balanced and sustainable economic growth in the country, remains unchanged and enshrined in the Constitution. We will continue to vigorously defend challenges to our independence and mandate. The issue of the mandate of the SARB is often confused with the proposed nationalisation of the SARB. Some proponents of nationalisation believe, erroneously, that such a move would facilitate a change in our mandate. This view is partly based on the premise that the SARB operates in the interest of private shareholders. This is Page - 7 - of 9 definitely not the case. We act in the interest of the economy as a whole, guided by our mandates, and we do not favour any particular interest group or groups. Given that this issue remains very much part of current debates, it may be instructive to explain again the role that SARB shareholders play and the SARB’s view on this matter. The rights of our shareholders are extremely constrained, limited to voting for some Board members at the SARB’s AGM. In fact, government appoints 8 of the 15 Board members, but it plays no role in the broader policy or regulatory decisions of the SARB. These decisions are the responsibility of the Governor and the Deputy Governors, who are themselves appointed by government. Private shareholders and Board members they elect have no influence whatsoever on monetary policy, financial stability or banking regulation. There is also no mechanism through which the shareholders, or indeed even the Board, can influence these policies. Furthermore, the South African Reserve Bank Act 90 of 1989 caps shareholder dividends at 10 cents per share per annum. With two million shares on issue, and a limit of 10 000 shares per shareholder and associates, the total dividend payment by the SARB to its shareholders is R200 000 per year, and a maximum of R1 000 per shareholder per year. In addition, any surplus remaining at the end of the SARB’s financial year, after provisioning for bad debts; depreciation of assets, pension benefits for employees and the payment of the dividend to shareholders, one tenth (10%) is allocated to the reserves of the Bank and 90% to government. Private shareholders do, however, represent an additional layer in the governance framework of the SARB. This helps to strengthen accountability and transparency. Shareholder-elected Board members add valuable expertise and inputs to the internal operations of the SARB. Getting rid of private shareholders would not necessarily improve governance. The South African experience has taught us that boards appointed by government are no guarantee of good governance, nor are they a guarantee that decisions will be taken in the interest of the broader economy. Private shareholding in central banks is an historical legacy, and is no longer common. Admittedly, there is no strong argument, in principle, in favour of retaining private shareholders. However, we are concerned that the process could be expensive, as Page - 8 - of 9 the shares trade for far less than what some existing shareholders are prepared to sell their shares for. Indeed, it is the case that a group of shareholders is agitating for the SARB’s nationalisation as they believe that they are entitled to a share of the assets of the SARB and see this as an opportunity to make enormous profits at the expense of taxpayers. This could turn out to be a protracted legal process and a very expensive exercise for what would, at best, be a cosmetic gain. To reiterate: whatever the shareholding structure, the primary mandate of the SARB will remain unchanged. This past year leading up to this AGM has been challenging, but we have ended it on a positive note. As you are all no doubt aware, this year marks the centenary celebrations of former President Mandela’s birth. The SARB played its role in these celebrations by issuing a commemorative banknote series and a commemorative R5 circulation coin in Tata Madiba’s honour earlier this month. This was the first time in the SARB’s nearly 100-year history that commemorative banknotes were issued. The full range of banknotes, as well as the commemorative circulation coin, depict the history of Madiba’s long walk to freedom. At the same time as the commemorative notes, we launched a mobile app as a platform to create greater public awareness of the security, technical and design features of our bank notes. The app also features interesting details on the life and times of Madiba – aligned with the commemorative banknotes. I encourage you all to download the mobile app from any of the mainstream app stores to learn interesting facts and details about our currency. It is our responsibility to ensure that the integrity of Madiba is reflected in the integrity and value of our currency. This we will do not only by constantly upgrading the security features of our notes, but also through protecting the value of the currency by striving for price stability. This is, after all, the primary mandate of the SARB, and we will continue to pursue prudent monetary policy in the interest of balanced and sustainable economic growth in our country. Thank you. Page - 9 - of 9
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Speech by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the University of Zululand, MBALI International conference, Richard's Bay, 1 August 2018.
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Speech by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the University of Zululand, MBALI International conference Richard’s Bay 1 August 2018 The Fourth Industrial Revolution and the future of work: some implications for central banking Introduction Good morning, ladies and gentlemen. I would like to start by thanking the University of Zululand for the opportunity to share some thoughts with you on an issue which will invariably have an impact on all of our lives, namely ‘The Fourth Industrial Revolution and the future of work’. Policymakers (including fiscal and monetary authorities), business entities and academic institutions all around the world are grappling with the implications of the Fourth Industrial Revolution and what this means for the future of work. This issue also formed part of the theme of the 10th BRICS1 Summit that was concluded in Johannesburg last week. Indeed, this topic is also relevant for an institution such as yours, as education is the key to unlocking benefits and avoiding the potential negative repercussions. Machines are developing at a rapid speed and their application is becoming increasingly sophisticated, which undoubtedly has massive implications for education and the skills set required for moving successfully into the future. The future requires not only a 1 Brazil, Russia, India, China, South Africa Page 1 of 12 different skills set, but also a different way of learning, a commitment to lifelong development, with young people at the coalface of this change. Against this brief background, I would like to share with you a few thoughts about how the future of work is changing the world of work, and some initiatives of international organisations such as the G202 in this regard. I would also like to explore some of the implications for central banking. What is ‘the future of work’, and how is it changing the world of work? One could argue that a country’s experience of the Fourth Industrial Revolution depends on certain socio- and macroeconomic fundamentals, such as the level of its development and the skills set of its labour force, among other things. But this does not change the fact that preparedness is essential. For many emerging markets, structural impediments have hindered development to such an extent that artificial intelligence is not an immediate possibility, and the adaptation of new technology to local conditions in these economies is therefore likely to be slower. Nonetheless, adaptation is inevitable. There appears to be a great deal of emphasis on the Fourth Industrial Revolution currently taking place, perhaps more so than was the case with the previous three industrial revolutions. Many are asking: why is there so much hype, and what makes this revolution different? Like the first three industrial revolutions, the Fourth Industrial Revolution will have significant transformative impacts on society. However, this time, the systemic impact is expected to be much more intense, as new technologies are developing at exponential speed, with much wider coverage given a far more integrated and globalised world. 2 Group of Twenty Page 2 of 12 Furthermore, it is not just a matter of manual tasks being overtaken by automation. Rather, technology is developing tacit knowledge and completing cognitive tasks. It is not only the low-skilled jobs or tasks that are at risk of being eliminated, but also the more highly qualified professional jobs like those of financial analysts. There was a time when ideas like driver-less cars and talking robots were only found in sci-fi movies, and seemed so imaginative and unrealistic. These are no longer things of the distant future; they are becoming part of our lives and will become increasingly common in the coming years. Indeed, there are conflicting views about the impact that such automation will have on jobs, skills and wages. A McKinsey report3 estimates that, by the year 2030, at least one-third of the activities of 60% of all the occupations could be automated. This implies that, globally, up to 375 million people may need to change jobs or learn new skills within the next 12 years. As Professor Klaus Schwab, the founder and Executive Chair of the World Economic Forum, notes: these shifts mean that we live in a time of great promise and of great peril. The positive aspects include the ability to connect billions more people through digital networks, improving the efficiency of organisations dramatically. There is also the capacity to reduce costs significantly, to reduce the necessity for businesses to have a physical presence, and to create opportunities for new, small-scale producers to enter the increasingly globalised markets. If harnessed correctly, technological change can bring about immense economic opportunities, new and better ways of doing business, the creation of new industries, new and better-quality jobs, higher GDP4 growth, and improved living standards. The current technological developments have the potential to lift growth and productivity, thereby raising living standards over the longer term. However, if organisations and governments fail to embrace new technologies to capture the benefits they bring, changes in labour markets may instead contribute to rising inequality, as the middle-skilled jobs relative to both high- and low-skilled jobs 3 Mc Kinsey Global Institute. Jobs lost, jobs gained: what the future of work will mean for jobs, skills and wages. December 2017 4 Gross domestic product Page 3 of 12 are lost and the real wages decline among the lower-skilled workers in some countries. These developments could aggravate income inequality both within and between countries.5 If left unchecked, security concerns and threats may also increase, compromising governments, businesses and individuals. For the ladies in the audience, I should note that the World Economic Forum believes that women tend to possess more of the human characteristics that should give them an advantage in the new jobs of the Fourth Industrial Revolution. These characteristics include, among others, the capacity for empathy, creativity, listening skills, learning ability and collaboration (instead of competition). The Fourth Industrial Revolution, and our ability and willingness to respond to the everevolving needs of the workplace, is particularly important for a continent such as Africa, because of its rapidly growing and dynamic population. How we deal with the changing African demographics will make the difference between having either a ‘dividend’ of young producers and consumers, or a growing unemployment problem.6 Why is this so important for Africa in particular? Africa emerged from each of the previous three industrial revolutions lagging behind much of the rest of the world. We have not kept pace with the move from the mechanisation of production to mass production, and finally to the computer age. Now that we are entering the Fourth Industrial Revolution, Africa will unfortunately do so on the back foot once again. Sub-Saharan Africa (SSA) has the second-largest working-age population, accounting for 13% of the world’s total. Furthermore, more than 60% of its population is under the age of 25, and it is estimated that, by 2030, SSA will be home to more than one-quarter of the world’s total under-25 population.7 5 Taken from “The Future of Work: Trends, Impacts and the Case for G20 Action”, March 2018 6 The ‘fourth industrial revolution’: potential and risks for Africa, The Conversation 7 World Economic Forum. The Future of Jobs and Skills in Africa, Preparing the Region for the Fourth Industrial Revolution. May 2017 Page 4 of 12 However, SSA does not make optimal use of its human capital potential. The World Economic Forum’s Human Capital Index8 indicates that SSA captures, on average, only 55% of its full human capital potential, compared to a global average of 65%. The World Economic Forum asserts that the region’s capacity to adapt to the requirements of future jobs, relative to the region’s exposure to these future trends, leaves little space for complacency. On a bigger scale, urgent efforts are needed to close the continent’s skills gap. SSA is therefore relatively underprepared for the impending disruption to jobs and skills brought about by the Fourth Industrial Revolution, and needs to take action quickly. The G20 approach to the future of work As I have already alluded, the future of work has become a topic of international focus. Under Argentina’s presidency – as part of achieving its objective of strong, sustainable, balanced and inclusive growth – the G20 has recognised the importance of focusing on the Fourth Industrial Revolution, understanding that it has an important role to play in devising policy responses to deal with the ramifications of the future of work. The G20 has also recognised that policy consistency across its members, especially where there are spillovers, can strengthen the effectiveness of individual members’ policy efforts and increase the benefits of international collaboration. In addition, through international cooperation, the opportunities presented by the Fourth Industrial Revolution can be better exploited to ensure that none are left behind in the process. With this in mind, the G20 has considered the economic and social impacts of technological changes on the future of work. Under the Framework Working Group, the G20 Finance Track has devised a menu of policy options that member countries can draw on when responding to the impacts of technological change – specifically in 8 Measures the extent to which countries and economies optimize their human capital through education and skills development and its deployment throughout the life-course Page 5 of 12 the areas of tax, public expenditure and transfers, competitive conditions, and measurement and data. The menu is structured around four overarching objectives: (i) harnessing the benefits of technology for growth and productivity; (ii) supporting people during transitions and addressing distributional challenges; (iii) securing sustainable tax systems; and (iv) ensuring the best possible evidence to inform decision making. Countries are encouraged, when devising their growth strategies9, to identify policy actions as well as areas of potential international cooperation. South Africa is an active member of the G20 and has been contributing to the debate on this topic, and will include, in its growth strategy, an outline of South Africa’s policy approaches to this priority area. The future of work and central banking Much of the research being conducted on the future of work in relation to the Fourth Industrial Revolution revolves around issues directly related to fiscal policy. Beyond this, many of the policy areas being affected, such as skills and competition, are outside of the direct ambit of central banks. However, insofar as the future of work could have an impact on the macroeconomy – through its effect on labour, aggregate demand and supply, prices and therefore the equilibrium interest rate – it certainly could influence the conduct of monetary policy. Monetary policy could be affected through various channels. Prices could be lowered, for example, as retail sales become digitalised, as many already are. As a result, inflation could decelerate because online retailers face much lower operational costs than traditional businesses. Anders Borg, Sweden’s former Minister of Finance, also notes that feed-through from exchange rate depreciations might be less than it has 9 Under Australia’s G20 Presidency in 2014, all G20 countries were asked to prepare medium-term growth strategies to provide a systematic framework for addressing policies and priorities in the growth agenda. The strategies prepared are comprehensive in scope, spanning macroeconomic policies and structural reforms to promote strong, sustainable, and balanced growth. Page 6 of 12 been historically. The theoretical starting point is that a permanent depreciation should be fully absorbed by consumer prices. In a digital world, currency depreciation could imply that the profit-margin squeeze is accelerating. The recent limited impact of dollar appreciation on inflation in some of the emerging markets shows that this could be at least one underlying factor.10 Monetary policy will also be affected by labour demand and supply. One can assume that, during a transition, jobs will be lost. However, should the displaced workers be unable to find other jobs, the equilibrium rate of unemployment could increase, shifting the Phillips curve11 outwards. Inflation could decelerate if we assume that the productivity of robots will be greater than that of humans, causing a decline in the wages of the remaining workforce. However, the shape of the Philips curve can also be affected if, for example, trade union power is reduced or the expected disinflation is not realised because firms decide to increase mark-ups, cancelling out the impact of lower wage growth. The macroeconomic impact of these developments remains uncertain. What is clear, however, is that monetary policy will have to keep pace with, and be cognisant of, any potential changes in this regard, and adjust accordingly. An area where technological advancement is indeed having a profound impact on central banking is in the financial technology (fintech) space. Fintech architecture, with which some central banks are currently experimenting (e.g. blockchain and distributed ledger technology (DLT) solutions), is making it possible to manage massive numbers of transactions as well as the transfers and settlements of large sums of money. However, in many ways this is a technology that is still in its infancy, and the extent of efficiency benefits still have to be demonstrated. But further developments could certainly see much greater efficiencies and a reduction in costs. The South African Reserve Bank (SARB) recently launched Project Khokha, which had as its scope the trial of interbank wholesale settlement using DLT. This was South 10 World Economic Forum. How will the Fourth Industrial Revolution affect economic policy? 28 January 2016. 11 The Phillips curve, named after William Phillips, describes the historical inverse relationship between rates of unemployment and corresponding rates of wage increases that are evidenced within an economy. According to the theory, faster economic growth leads to higher inflation, which in turn leads to more jobs and less unemployment. Page 7 of 12 Africa’s first DLT initiative, whose aim was to contribute to the global initiatives that assess the application and use case for DLT. Project Khokha was successful in that it proved that the typical daily volume of the South African payment system could be processed in less than two hours with full confidentiality of transactions and settlement finality. This demonstrated to us that DLT has potential, but it has also become evident that there is a long road ahead before large-scale adoption can be considered.12 New technology is increasing the efficiency of key banking functions through enabling the creation of new financial services. In terms of lending and borrowing, for example, ‘crowd-funding’13 and online ‘peer-to-peer lending platforms’14 are buzzwords. These applications are closely related to financial intermediation, a core and heavily regulated element of financial institutions. The fintech applications in this field are still a small fraction of overall credit, but are growing very rapidly in some jurisdictions. This requires ongoing monitoring by central banks. Fintech also provides opportunities to increase financial inclusion, and provides unbanked households and firms with access to loans and savings. Low‐income countries still have a large part of the population lacking access to services that are widespread in high‐income countries, such as formal savings in financial institutions. Greater competition in the banking sector, concentration risks, and greater security of remittances are added benefits which ultimately mean reduced costs for participation in the formal economy and easier access to public services based on improved government databases. However, while new technology provides opportunities, it also poses a number of challenges, including financial stability risks and cyber security risks. The more financial systems depend on electronic platforms and digital records, the more exposed they are to cyberattacks, which can disrupt the flow of funds across the Some of the considerations relate to the interlinkages and cost-speed-and-scale comparative analysis with current systems, and the fit with current legal and regulatory requirements. 13 Crowdfunding is the practice of funding a project or venture by raising small amounts of money from a large number of people, typically via the Internet. 14 Peer-to-peer lending, also abbreviated as P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders with borrowers. Page 8 of 12 economy and create financial instability. Therefore, a robust cyber-resilience and cyber-risk framework is crucial to creating an enabling environment for financial services innovation.15 One area which has been receiving increasing attention in central banking circles relates to so-called crypto-currencies. The rapid pace of usage, and the complexities of such crypto-assets, have forced central banks to reassert some fundamentals relating to the definition of money, its characteristics, and the role of the central bank in this regard. There is a broad consensus that crypto-assets do not meet the traditional definition of money, as they are not a means of exchange, a store of value, nor a unit of account. At the very least, as explained by Augustin Carstens, the General Manager of the Bank for International Settlements16, they lack the characteristics of ‘good money’ as what constitutes ‘good money’ is the level of trust and credibility that the public has in the currency, and that trust has to be earned and supported. Central banks, however, are exploring the use of central bank digital currencies, which could be of more benefit and would likely be safer. As part of its fintech Programme, the SARB has taken cognisance of the investigatory studies done on crypto assets, and has placed high emphasis on monitoring the developments in this area. It has adopted a ‘back to basics’ approach by focusing on the underlying economic function or activity being performed (deposit taking, payments, lending and investments) rather than the specific technology. The SARB’s position on crypto-assets is that these are not recognised as currency or legal tender in South Africa, and that only the SARB is allowed to issue legal tender. Any merchant or beneficiary has a right to refuse crypto-assets as a means of payment. Although the Financial Stability Board has concluded that there are currently no immediate financial stability risks arising from crypto-assets, there are other potential risks arising with respect to consumer and investor protection, market integrity, tax The SARB undertook a cyber-crisis simulation exercise last year, with assistance from the World Bank. The simulation included three different but related cyberspace incidents, namely failure to settle Treasury bills, a failure of the stock exchange, and an attack on a small bank paying out social grants. Much was learnt from this exercise. It also allowed authorities to test the strength of their crisis communication arrangements, coordination and decision making under critical situations, including recovery and resolution strategies. 16 Augustin Carstens, Money in the digital age: what role for central banks?”BIS, February 2018 Page 9 of 12 evasion, money laundering and terrorism financing, which require ongoing monitoring. We therefore need to ensure that as these technologies evolve, we robustly assess in parallel dimensions such as legal, governance, risk and operational frameworks. I have said much about how the Fourth Industrial Revolution could be changing the world of work and the implications that it might have for central banking, from monetary policy to financial stability, currency operations and payment systems. Recent monetary policy developments At the conclusion of its most recent meeting about two weeks ago, the SARB’s Monetary Policy Committee (MPC) decided to leave the repurchase rate unchanged at 6.5% per annum. This was judged to be consistent with a still accommodative stance of monetary policy given the current weak state of the economy. The MPC did, however, note with concern that the risk profile to both the growth and inflation outlooks had deteriorated when compared to the observations at its previous sitting in May 2018, and this was reflected in the Bank’s forecasts. A number of risks that had been highlighted in previous meetings had either materialised or still persisted, in an environment that continued to be characterised by heightened uncertainty. While the external environment has had a more dominant influence on the outlook, domestic factors also played a role. Headline inflation is now expected to average 4.8% in 2018 (down from 4.9%) before increasing to 5.6% in 2019 and decreasing again to 5.4% in 2020 (up from 5.2% in both years). The forecast for core inflation is expected to average 4.6% in 2018 (up from 4.5%), 5.5% in 2019, and 5.3% in 2020 (up from 5.1% in both years). Although the forecasts suggest that inflation outcomes will remain within the inflation target range, the MPC is concerned that they are drifting further away from the midpoint of the target band. The MPC deemed the key risks to the inflation outlook to be higher oil prices, a more depreciated exchange rate, and higher electricity prices. Although oil prices have retreated from the recent high levels of around USD80 per barrel, they are expected Page 10 of 12 to still remain at relatively elevated levels over the forecast period. Together with the depreciation of the domestic currency, upside risks to domestic fuel prices and ultimately to inflation remain. The nominal effective exchange rate of the rand has depreciated by almost 9% and exhibited increased volatility from the first quarter of 2018 to the second quarter. The increased volatility resulted from a deterioration in sentiment towards emerging markets, owing to the combined headwinds of tightening financial conditions, weakening economic growth, and rising trade tensions, which resulted in capital outflows. The rand is likely to continue to be vulnerable to these developments. In addition, electricity prices continue to pose a further upside risk given the uncertainty around the speed at which Eskom will adjust electricity tariffs. Should these risks materialise, it may become necessary to adjust monetary policy settings in the future to ensure that inflation remains more comfortably inside the target range and closer to the midpoint, and to ensure that inflation expectations are anchored towards the midpoint of the target range. The MPC will not hesitate to act when deemed appropriate. However, in line with flexible inflation targeting, the MPC will also continue to be careful not to overreact to initial price pressures and be guided by its assessment of second round effects of any price pressures, which could contribute to inflation moving too far away from the mid-point of the range, or even exceeding the target range, on a sustained basis. The SARB’s forecast for GDP growth for 2018 was revised down from 1.7% to 1.2%, while the forecasts for both 2019 and 2020 were slightly higher at 1.9% and 2.0% respectively. Following the broad-based contraction of 2.2% in the first quarter of 2018, indications based on high frequency data suggest continued sluggish performance of the economy in the second quarter, but with a likelihood that a technical recession will be avoided. As indicated previously, with South Africa having no fiscal space and monetary policy similarly currently not being able to provide further stimulus, the attention needs to firmly shift towards fully restoring confidence and urgent implementation of structural reforms to help lift the potential rate of growth of the South African economy. Page 11 of 12 Conclusion Let me conclude by reiterating the remarks made by Robert Shiller of Yale University on the subject of the Fourth Industrial Revolution: “You cannot wait until a house burns down to buy fire insurance on it. We cannot wait until there are massive dislocations in our society to prepare for the Fourth Industrial Revolution.” Indeed, it is up to us whether we succeed in the Fourth Industrial Revolution – whether it will be a time of great promise or a time of great peril, both for the continent and for our country. New technologies will transform the world we live in. The exponential speed and scope of this transformation brings with it the potential for unlimited possibilities and endless opportunities, but also massive challenges. Educational institutions need to understand the implications of the Fourth Industrial Revolution in order to better prepare their students for this new future. Our fate is in our hands. We cannot afford to be left behind, and institutions such as the University of Zululand have an important role to play in ensuring that we are not left behind. Thank you for your attention. Page 12 of 12
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Public lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Nelson Mandela University, Port Elizabeth, 1 August 2018.
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A public lecture by Lesetja Kganyago, Governor of the South African Reserve Bank, at the Nelson Mandela University Port Elizabeth 1 August 2018 Inequality and monetary policy in South Africa Introduction Good afternoon, ladies and gentlemen. Debates about inequality have kicked into a higher gear in recent years – in academia, in policy circles, and in the broader political space. For central banks, especially those in advanced economies, inequality has become an inescapable issue, and experimental policies like quantitative easing are being blamed for making it worse. In South Africa, we have had very high inequality for a very long time, so for us, these debates are not new. Nonetheless, there are new ways of thinking and new data to help us understand the issue better. Today, I would like to make a couple of points to clear up some misconceptions that people may have about inequality and, more specifically, about the interactions between inequality and monetary policy. Page 1 of 15 First: although everyone knows that inequality within countries has been rising, inequality between countries has actually been coming down. This is thanks to sustained growth in emerging markets, which are not as far behind the rich countries as they used to be. Second: in South Africa, inequality has been persistently high – but the composition of inequality has changed. Inequality among black South Africans has increased since the end of apartheid, so that South Africa’s inequality story is now about class as much as it is about race. Third: people often don’t know where their family fits in South Africa’s income distribution, chiefly because people who are relatively better off often do not realise how much poorer most other South Africans are. And that helps explain my fourth point, which is that the relationship between inequality and monetary policy does not work the way people usually think. Lower interest rates typically worsen inequality. I’m going to spend a large portion of my speech today explaining the four most important channels through which monetary policy affects inequality – namely inflation, borrowing costs, asset prices and employment coupled with growth – to show how this works. Page 2 of 15 Inequality at the global level But let me start with the global environment. Over the past few decades, global inequality has either risen sharply or begun to moderate, depending on how you look at it. Inequality has risen in the sense that inequality within countries is often higher than it used to be. As Thomas Pikkety and others have shown us, for example, inequality in the United States (US) has been rising since the 1970s, and is now at levels last seen nearly a hundred years ago, in the 1920s.1 Similar trends are visible in many other countries. This increase in inequality has captured many headlines, and has also been cited as an explanation for political developments like Brexit or the outcome of the last US presidential election. This rise in inequality is usually attributed to changes in technology, productivity and the skills of workers, where the return on higher and newer skills has accelerated faster than the returns to less-skilled workers. However, inequality has also fallen since the 1970s – if we look at the gaps between countries. Fifty years ago, the gap between rich countries and poor countries was very clear. Nowadays, there are a lot more middleincome countries. There are also many more rich and middle-class people in countries that used to be almost universally poor. To take one example: fifty years ago, even rich people in China were typically worse off than poor people in the US. See Capital in the twenty-first century by Thomas Piketty (2013). Page 3 of 15 That is no longer true: the rich in China are now rich from a global perspective, thanks in part to several decades of strong economic growth. The same thing is now happening in India, which is also catching up with richer countries because its economy is growing at around 8% a year (while advanced economies are growing at around 2%). This decline in worldwide inequality is a big change, reversing a trend of steadily higher inequality between countries that has held since the Industrial Revolution.2 The reduction in inequality is driven by some big trends: better economic policymaking, growth in world trade, the spread of technology and finance, and more education. However, the fact that people in poorer countries have been catching up with those in richer countries doesn’t mean that the world has become equal. In fact, the world as a whole is probably more unequal than almost any one country on its own. For instance, while there are now more middle-class Indians than ever before, the country has also become more unequal internally. Estimates suggest that the Gini coefficient of the whole world is around 0.7. To put that in perspective, a relatively equal country like Sweden has a Gini coefficient a bit below 0.3; the coefficient for the US was around 0.35 in 1950 and is a little over 0.4 today; Brazil is at 0.6. South Africa is around 0.7, which makes it one of the most unequal countries in the world, and certainly the most unequal large country. See Global inequality by Branko Milanovic (2016), especially Chapter 3, titled ‘Inequality among countries: from Karl Marx to Frantz Fanon, and then back to Marx?’. Page 4 of 15 Inequality in South Africa South Africans know that theirs is an extremely unequal country. However, there are some aspects of this inequality which are not well understood. One is that inequality is no longer as completely determined by race as it used to be. Historically, of course, inequality in South Africa was fundamentally a racial story, with access to economic as well as political rights and opportunities based on skin colour. Since the end of apartheid, however, this has begun to change.3 Inequality within the African portion of society has risen, as some black people have moved into the middle and upper classes while others have stayed very poor. As a result, inequality among black people is higher than for the other racial categories in South Africa.4 The Gini coefficient among Africans is above 0.6 – about the same as Botswana, and close to Lesotho and Swaziland – countries which are less racially diverse than we are but still very unequal. Another aspect of inequality that people tend to get wrong is the contribution of monetary policy. I am often struck by the comment that higher inflation reduces inequality by benefiting poorer South Africans. The core of this argument is that higher inflation creates more jobs that go to poorer people. Leibrandt et al. (2010), Employment and inequality outcomes in South Africa, p. 21, available at https://www.oecd.org/employment/emp/45282868.pdf. As of 2016 data, the Gini coefficient for the black population in South Africa was 0.65. It was 0.58 for coloured South Africans, 0.56 for Indians / Asians, and 0.51 for whites. The number for South Africa as a whole was 0.68. Page 5 of 15 Another part of the argument is that – because most households are highly indebted, and because poorer households are the most indebted – interest rate cuts will disproportionately improve the welfare of those people. I would like to assess those arguments, as well as a couple of other monetary policy channels that are less discussed, in an effort to get at a deeper understanding of how monetary policy affects inequality. I will discuss the four main channels through which monetary policy affects inequality: borrowing costs, asset prices, employment and growth, and finally inflation. I will demonstrate that a decision to go for a loose monetary policy is likely to worsen inequality and make it more extreme. Interest rates and borrowing costs What South African households borrow for, and at what rate of interest, depends mostly on their jobs and income. We can break these households down, very roughly, into two groups: the top 20% of the income distribution and the bottom 80%. A team at the University of Cape Town has built an online Income Comparison Tool which tells you where your household actually fits in, and which I suggest everyone should try.5 To give away the punchline, however: if your family income exceeds R173 000 a year, or about R14 400 a month, then you are in the top 20% of households. Getting into the top 10% of the income distribution requires See http://www.saldru.uct.ac.za/income-comparison-tool/. Page 6 of 15 just under R270 000 a year, or R22 500 a month.6 The average government salary is R335 000 a year, which is within the top 10%.7 Compare those income levels to a household in the poorest 10% of South Africans, which is getting less than R17 721 per year. That is under R1 500 per month. That’s roughly a tenth of what a family just within the top 20% is getting. These income differences play out in the amount of debt households can take out and the interest rates they pay. When the Monetary Policy Committee (MPC) moves the repurchase rate (or repo rate), households immediately see the difference in their mortgage payments or their car payments. But what does this do for inequality? The reflex answer is that, in South Africa, there are both rich and poor people, and the poor borrow from the rich, so higher interest rates increase inequality while lower rates, or looser policy, reduce it. But this is misleading. South Africans in every income bracket tend to have a lot of debt. The National Credit Regulator reports that there were a bit more than 25 million ‘credit active’ people in South Africa at the end of last year, which compares with around 16 million people who have some sort of employment. These decile figures are used by Statistics South Africa for the consumer price index. See http://www.statssa.gov.za/publications/P0141/P0141April2018.pdf, p. 10. The precise threshold for decile 10 is R296 903 and for decile 9 it is R173 023. See National Treasury (2017), Medium Term Budget Policy Statement, Annexure B, p. 62, available at http://www.treasury.gov.za/documents/MTBPS/2017/mtbps/Annexure%20B.pdf. Page 7 of 15 However, South Africans borrow for different things through different parts of the financial system. Most mortgages for homes, and vehicle loans, are taken out by that 20% of households earning the most income that we talked about earlier. Lower down the income ladder, the composition of debt changes. Mortgages and vehicle loans more or less disappear. In their place, we see more high-cost debt, like store cards or informal loans. These kinds of debts carry much higher interest rates. Crucially, these higher-rate debts are also much less closely tied to monetary policy. When we move the repo rate, which is the rate at which commercial banks borrow from the central bank to fund their reserve requirements, the decision has a direct and strong effect on the prime rate, which is the rate at which commercial banks lend to their safest customers. This, in turn, changes the loans that are tied to prime, such as mortgage loans or vehicle loans. To put numbers on this, we currently have the repo at 6.5%. The prime rate is at 10%. The average interest rate on a new mortgage is also 10%, and the average rate on a vehicle loan is almost 12%. As you can see if we reduce the repo rate by 25 or 50 basis points, people with mortgages and vehicle loans get a nice saving. But the same repo rate move has little or no effect on a microloan, which has an interest rate of roughly 30%, or an informal loan, at an even higher rate. As a result, there is almost no relationship between the repo rate and the interest rate on high-cost debt. Put these two facts together, and we get an interesting implication: changes in monetary policy have a much stronger impact on the top 20% of households than they do on the rest of the population. That is not because poorer households don’t borrow. Rather, it is because they Page 8 of 15 borrow at interest rates that are shaped by factors other than monetary policy, including higher costs of offering loans, higher risk of default, and lack of information about income. When interest rates go down, therefore, the more highly indebted and wealthier households save much more on interest costs than the poorer households do borrowing at microloan rates. This, by itself, worsens inequality. Interest rates and asset prices Now consider asset prices – a channel which is often poorly understood. As with borrowing costs, people tend to think that higher interest rates reward rich people who have savings. Again, this intuition is misleading. In fact, much of the global debate about inequality and central banking rests on the exact opposite claim: that very low interest rates exacerbate inequality.8 This is because lower interest rates raise asset prices, and an increase in asset prices benefits those people who already have assets. We have seen this play out in advanced economies following the global financial crisis: as central banks cut interest rates as low as possible, house prices, equity markets and bond prices all soared. The winners were the people who had already invested in those assets. Those who lost out were younger people who couldn’t afford expensive homes, as well as savers who had their money in interest-bearing accounts. For example, see Bridges and Thomas (2012), ‘The impact of QE on the UK economy – some supportive monetarist arithmetic’, Working Paper No. 442, available at https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2012/the-impact-of-qe-on-the-ukeconomy-some-supportive-monetaristarithmetic.pdf?la=en&hash=81412E5177BCE802F2D37ECF42D20144EEB9513D. Page 9 of 15 As you can see, what really matters for the asset price / inequality channel is the distribution of wealth. Who has assets? In many advanced economies, the middle classes tend to have substantial stocks of housing wealth, even if most stocks and bonds are owned by richer people. This means that higher asset prices don’t necessarily raise inequality, because enough people have assets to start with.9 In South Africa, the situation is different: most assets are owned by people at the top of the income ladder. As one researcher has commented, ‘10% of the population owns more than 90% of all wealth while 80% have no wealth to speak of; a propertied middle class does not exist’.10 For this reason, a low interest rate policy that pushes up asset prices will only magnify inequality. This may also explain why some asset managers are opposed to interest rate increases and publish angry articles in newspapers when we decide to raise rates. Interest rates, employment and growth In fairness, asset managers aside, most people who argue for lower interest rates do not really take these effects into consideration. Instead, they are focused on employment. As they rightly observe, reducing South Africa’s extraordinarily high unemployment rate is crucial to fighting poverty and moderating inequality. As argued, for instance, by Josh Bivens (2015) in Gauging the impact of the Fed on inequality during the Great Recession, available at https://www.brookings.edu/wpcontent/uploads/2016/06/Josh_Bivens_Inequality_FINAL.pdf. Available at http://www.redi3x3.org/sites/default/files/Orthofer%202016%20REDI3x3%20Working%20Paper%201 5%20-%20Wealth%20inequality.pdf, pp. 3-4. Page 10 of 15 The problem for us at the central bank, however, is that interest rates are not the right tool for addressing South Africa’s unemployment problem, and especially not the joblessness among the poorest households. In undergraduate economics classes, students are usually taught simple models in which there is a short-term trade-off between inflation and employment – the so-called ‘Phillips curve’. One explanation of the Phillips curve relationship is that lower interest rates create more demand, which in turn creates more jobs but also more inflation, hence the trade-off. Another explanation is that higher inflation destroys the value of people’s wages, so they become cheaper to hire and employment rises.11 The empirical evidence for the Phillips curve, however, is just not there – as researchers have repeatedly reminded us.12 In fact, South Africa tends to get stronger economic growth and more job creation when inflation is low, in part because of demand effects but mostly from stronger productivity growth and investment. It is the wisdom of the inflationtargeting framework: that we focus on something within our control, something which is important for balanced and sustainable growth over the long term. As discussed in Banerjee et al. (2006), Why has unemployment risen in the new South Africa?, p. 6, available at https://www.hks.harvard.edu/sites/default/files/centers/cid/files/publications/facultyworking-papers/134.pdf. Fedderke and Liu (2016), ‘Inflation in South Africa: an assessment of alternative inflation models’, South African Reserve Bank Working Paper 16/03, available at http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7275/WP603.pdf. As these authors observe: “A core feature of the South African empirical studies has been a resolute search for a Phillips curve type of trade-off between prices and demand-side inflationary pressure associated with real economic activity. A second constant that emerges from the empirical literature is the consistent failure to successfully support the Phillips curve trade-off.” See also Vermeulen (2017), ‘Inflation and unemployment in South Africa: is the Phillips curve still dead?’, Southern African Business Review, Vol. 21, available at https://www.ajol.info/index.php/sabr/article/viewFile/154882/144463. Page 11 of 15 Targeting employment and not inflation could worsen inequality even more, especially if we were specifically trying to target employment for the poorest South Africans. This is because poorer households are more disconnected from labour markets. In fact, as data from Statistics South Africa tell us, jobs are not even the primary source of income for the poorest 30% of households in South Africa. Instead, these households rely heavily on grants. For the poorest 10%, which is around 1.3 million households, 60.9% of income is from grants and just 13.9% from work. 13 People tend to use the term ‘working class’ to mean poor people, but the poorest third of South Africans mostly are not working. Joblessness is fundamentally a structural problem, explained by factors such as quality of education, skills shortages and settlement patterns – people aren’t living near jobs. These are not problems that monetary policy can solve. If we did have the ability to create jobs generally, that would be a powerful tool for reducing inequality. But in fact, as a central bank, our ability to create jobs for anyone is weak in the short run and non-existent in the long run. If we were in a skills-rich country like the US, with flexible labour markets, there would be a respectable argument that low interest rates could help ease inequality by bringing down unemployment caused by a recession.14 But that’s not the economy we’ve got, and that’s not the labour market we’ve got, so this isn’t an option for monetary policy here. See table 3.7 of the 2014/15 Living Conditions Survey, p. 18, available at http://www.statssa.gov.za/publications/P0310/P03102014.pdf. See, for instance, Ben Bernanke (2015), Monetary policy and inequality, available at https://www.brookings.edu/blog/ben-bernanke/2015/06/01/monetary-policy-and-inequality/. As discussed in Banerjee et al. (2006), Why has unemployment risen in the new South Africa?, p. 6, available at https://www.hks.harvard.edu/sites/default/files/centers/cid/files/publications/facultyworking-papers/134.pdf. Page 12 of 15 Interest rates and inflation The final channel I’d like to discuss is inflation. Inflation is a problem from an inequality perspective because it tends to hurt poor people more. One reason for this is that poorer people have less choice over spending. Poor people’s consumption baskets are mostly taken up with a few basic items, especially staple foodstuffs and shelter. Richer people buy many more kinds of things, so they have more room to adjust away from items that get too expensive.15 A second reason why inflation exacerbates inequality is that it is harder for poorer people to protect their wages and savings against inflation. If you have a job where you get a cost-of-living increase every year, or if you have some assets which keep their real value despite inflation, like Krugerrands or a house, then you can avoid much of the pain of inflation. But if you are not in a position to negotiate with your boss, or if your savings are in cash, inflation can hurt you badly. Given these factors, a monetary policy stance that lowers inflation can actually increase the expenditure of the poorest South Africans – even as it reduces the buying power of richer South Africans. The conventional wisdom about a short-term growth-inflation trade-off therefore needs to be supplemented with the knowledge that this also poses a growth-inequality trade-off. Or, to put the point more simply, any decision to tolerate a bit Bhorat and Oosthuizen (2005), The relative inflation experience of poor urban South African households, available at https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/346/Relative%20inflation %20experience%20of%20poor%20urban%20SA%20households.pdf. Page 13 of 15 more inflation for the sake of a little extra growth is also a decision to make inequality a bit worse.16 Unfortunately, South African inflation has tended to be quite high, and it has been even higher for the poorest South Africans. Our inflation target is a range of 3-6% for headline inflation. Since 2010, inflation has been above 6% for 28 months, just over a quarter of the time. Meanwhile, the inflation rate for the poorest 10% of households has been above 6% for 51 months, which is about half the time. With an inflation rate of close to 6%, on average, South Africa has become a relatively high-inflation country – almost three quarters of the world’s countries have lower inflation rates than we do. This suggests that we haven’t taken the battle against inflation seriously enough. We hope to remedy this by anchoring inflation nearer 4.5% – the midpoint of our target range – as we have repeatedly said in MPC statements and in speeches. The poorest South Africans should be among the biggest beneficiaries of that policy. Inequality and macroeconomic policy To conclude, monetary policy affects inequality through several channels. Low interest rates tend to push up asset prices, helping those who have assets already. Low interest rates also reduce borrowing costs, but mainly for borrowers at the high end of the income spectrum. Interest rates have weak and limited effects on employment, especially for the third of International Monetary Fund (2018), ‘Annex VIII. The distributional impact of inflation’, South Africa 2018 Article IV Consultation, available at https://www.imf.org/~/media/Files/Publications/CR/2018/cr18246.ashx . Page 14 of 15 households which are not closely connected to labour markets or which are disadvantaged by having less education. Where monetary policy tolerates higher inflation, this tends to reduce spending power, especially for the poor. Put together, all this suggests that a more inflationary monetary policy is likely to make inequality worse. As the guardians of the value of the currency in South Africa, it is important that we at the South African Reserve Bank bear all this in mind when we make monetary policy decisions. The richest 20% of South Africans can make themselves heard quite easily. They let us know when our raising of rates pushes up their bond repayments. They do a good job of getting a cost-of-living adjustment every year. They often don’t realise how many poorer people there are out there, because they assume they are roughly in the middle of the income distribution, not close to the top. But we as the central bank have to think about everyone in South Africa, including the other 80% of households. I hope that today I have left you with a clearer sense of what monetary policy does, and what it cannot do. At the simplest level, we know that low inflation has many benefits, so that’s what we aim to deliver. But there are also many other policies and agencies that affect South Africa’s worst problems, including poverty, unemployment and inequality. Our contribution as the central bank is just one part of the fight against these evils. Thank you. Page 15 of 15
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Remarks by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the annual dinner in honour of the Ambassadors and High Commissioners to the Republic of South Africa South African Reserve Bank, Pretoria, 31 July 2018.
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Remarks by Lesetja Kganyago, Governor of the South African Reserve Bank, at the annual dinner in honour of the Ambassadors and High Commissioners to the Republic of South Africa South African Reserve Bank, Pretoria 31 July 2018 Introduction Dean of the Diplomatic Corps, Ambassadors, High Commissioners, Counsellors and Diplomats, ladies and gentlemen – a very good evening and a warm welcome to the South African Reserve Bank (SARB). I would like to extend my heartfelt gratitude to you for accepting our invitation to this annual event. This year, we celebrate the 100th anniversary of the birth of Nelson Mandela. Earlier this month, for the first time in the nearly 100-year history of the SARB, we issued a commemorative banknote series as well as a third commemorative R5 circulation coin in honour of the life of former President Mandela. Tonight, I would like to briefly reflect on what we can learn from Tata Madiba’s legacy, both as a statesman and as a champion of institutions. After all, it was under Nelson Mandela’s presidency that the defining characteristics of South Africa’s foreign policy and trade policy, as well as our interaction with foreign investors, were established. Madiba had a vision that South Africa should be ‘ready to play a role in fostering peace and prosperity in the world that we share with the community of nations’. In 1993, a year before he became president, Nelson Mandela highlighted that ‘our foreign policy will rest on the belief that economic development depends on growing Page 1 of 6 regional and international economic cooperation in an interdependent world’.1 Since Madiba’s presidency, the foundation of all of South Africa’s interactions with the rest of the world has always been strong domestic institutions and a robust macroeconomic framework that provides policy certainty, supported by our participation in multilateral institutions and forums that are transparent and fair. Looking at the state of the global and domestic economies today, it is worth reflecting on the importance of institutions in managing risks and dealing with crises. Reflecting on the global economy The global economy today looks very different from a year ago. Last year, the backdrop for South Africa and other emerging markets was generally constructive, as the recovery of the advanced economies continued on a steady path. The stronger demand supported higher commodity prices, while expectations of a moderate withdrawal of monetary stimulus in the advanced economies were supportive of strong capital flows to the emerging markets. However, this favourable setting did not last long. A number of key risks have since emerged that threaten to unsettle the global economy. During the early part of 2018, growing expectations of a faster pace of monetary tightening began to emerge, as the stronger pace of United States (US) growth was sustained and fiscal policy became more expansionary. Growth in Europe and Japan has slowed, while the strengthening of the dollar has resulted in a reversal of capital flows from the emerging markets. In addition, concerns about the rise in protectionism have materialised, thus contributing to an escalation in trade tensions. Concerns about a possible trade war have contributed to uncertainty about world trade, which could derail the global economic recovery that policymakers have been working hard at since the global financial crisis. We are already witnessing the adverse effects. In April, for example, we saw the largest decline in world trade since May 2015. 1 ‘South Africa’s future foreign policy’, an article by Nelson Mandela in Foreign Affairs, Vol. 72, No. 5, November / December 1993, African National Congress Page 2 of 6 Trade wars are, in effect, a ‘zero sum’ game. Small open economies suffer the most, as they rely on trade with the advanced economies and large economies - who are the price setters. Addressing these risks at both country and global level requires strong institutional frameworks and a commitment to cooperation and coordination. The rising interconnectedness has widened the set of shared problems that are more effectively addressed through a global agenda. In this respect, collaboration is essential. This includes, among other things: reaffirming the open and rules-based multilateral trade system; strengthening the global financial safety net; addressing the excess external imbalances; completing the financial regulatory reform agenda; and reaching the 2030 Sustainable Development Goals. These issues are central to the agendas of the Group of Twenty (G20), the Financial Stability Board, the Bank for International Settlements, the International Monetary Fund, and the World Bank. South Africa is an active participant in all these institutions. As you may be aware, the 10th BRICS2 Summit, this time under South Africa’s presidency, concluded a few days ago. Its theme was ‘BRICS in Africa: collaboration for inclusive growth and shared prosperity in the Fourth Industrial Revolution’. Since the beginning of 2018, the SARB has actively driven a number of initiatives among the BRICS central banks. This has included initiatives directed at enhancing the research capacity of the Contingency Reserve Arrangement (CRA), further work on the establishment of the BRICS Bond Fund to support the development of local-currency bond markets in the other BRICS countries, and a stocktake exercise on financial technology as it relates to crypto-assets and the regulation thereof. Finally, and very significantly, the BRICS central banks have, for the first time, conducted a test run of the CRA with an actual transfer of funds. This exercise commenced on 3 July and was completed successfully today. 2 Brazil, Russia, India, China, South Africa Page 3 of 6 Building strong institutions on the African continent is also very important to support development and improve the continent’s resilience to shocks. The SARB – through its chairing of the Association of African Central Banks and as the Chair of the Committee of Central Bank Governors in the Southern African Development Community – has been involved in a number of activities in support of economic and financial integration on the continent. These initiatives have spanned, among other things, the areas of banking supervision, strengthening central-bank independence, regional payment systems, financial-market deepening, financial stability, and financial inclusion. Other issues that require urgent attention include the negative impact of the withdrawal of correspondent banking relationships on trade flows and remittances, as well as the limits to domestic revenue mobilisation due to illicit flows. The South African economy South Africa’s growth outlook remains challenging. At the most recent meeting of the SARB’s Monetary Policy Committee earlier this month, the growth forecast for 2018 was revised downwards to 1.2% from 1.7% in May. The growth forecast for 2019 is 1.9% and 2.0% for 2020, both of which are significantly lower than the levels required to generate employment and to reduce inequality and poverty rates. While we consider the current monetary policy stance to be broadly supportive of the economy, inflation risks are to the upside, and our fiscal framework is vulnerable. Faced with similar conditions back in 1996 under Nelson Mandela’s leadership, the South African government had to make some really difficult decisions. It was resolved to make the required policy choices and strengthen macroeconomic institutions. This garnered investor confidence and placed South Africa on a strong economic footing in the early 2000s. Recent research conducted by the SARB3 suggests that the collapse in the levels of confidence over the past few years had shaved off around 1 percentage point from 3 Theo Janse van Rensburg and Erik Visser, 2017, ‘Decoupling from global growth – is confidence becoming a scarce commodity?’, South African Reserve Bank Occasional Bulletin of Economic Notes, October Page 4 of 6 growth in both 2015 and 2016. In the months since December 2017, we have seen a rebound in business and consumer confidence. However, a cyclical recovery based on a rebound in confidence will not be enough to grow the economy lower levels of poverty, reduce inequality, generate much-needed employment, and boost government revenues. Given the weak medium-term growth prospects, structural reforms and appropriate fiscal policies are critical to boosting potential growth and sustaining confidence levels, by raising productivity and promoting human and physical capital, and enhancing inclusiveness. Underlying the subdued growth performance of the South African economy has been the weak trend in gross fixed capital formation, particularly by the private sector. We need to reverse the downward trend in the ratio of gross fixed capital formation to gross domestic product, which had declined to 18.7% in 2017, down from a peak of 23.5% in 2008. This is some way off the 25% target set in the National Development Plan. The role of the South African Reserve Bank Achieving higher potential output growth is not within the power of the central bank. The SARB can, however, contribute to an improved environment in a number of ways. For some time, ratings agencies and investors had identified South Africa’s institutional strength as one of the stand-out features of its economy. Unfortunately, the past few years have seen a steady erosion of some of our key institutions. Fortunately, there is now a renewed focus on reversing this negative trend. In fact, this renewed focus is part of the reason forwarded by Moody’s for retaining the country’s investment grade rating. The SARB, specifically its independence coupled with its mandate on price stability and financial stability, is seen as an important part of the institutional strength of the country. We have vigorously and successfully defended attempts to undermine our independence and integrity, and we will continue to do so. Page 5 of 6 Conclusion To sum up, here is what I have learnt from Madiba’s legacy: To occupy its rightful place in the global economy, South Africa must first get its own house in order. We must start by implementing those policies that we have identified for growth and the development of our people. To protect ourselves from external shocks, we must build buffers by allowing our institutions to work as they were intended to work. As a small open economy, securing future growth requires us to work with our neighbours and trading partners, directly and through multilateral institutions. Let me conclude by quoting from a speech that Nelson Mandela delivered to the diplomatic corps in 1999: “I do need to say to each and every diplomatic representative this evening that whilst our achievements – like our hope for the future – would not be possible without the patience, sacrifice, commitment and determination of all our people. Our task has been made easier because we have been blessed and sustained by the goodwill and support of our subregion, our continent and the global community. For this we are very grateful to you all.4 Thank you, and enjoy the evening. 4 http://www.mandela.gov.za/mandela_speeches/1999/990205_diplomat.htm Page 6 of 6
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Speech by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, on the occasion of the announcement of the winners of the Monetary Policy Committee (MPC) Schools Challenge, Pretoria, 17 August 2018.
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Speech by Governor Kganyago on the occasion of the announcement of the winners of the Monetary Policy Committee (MPC) Schools Challenge 17 August 2018 Programme Director, Honourable Minister of Basic Education, Ms Angie Motshekga, Deputy Governors, Heads of Department, Guest Speaker, Aisha Pandor, Colleagues from the South African Reserve Bank and the Department of Basic Education, Parents, Representatives from schools, Distinguished guests, Ladies and gentlemen I am honoured to be standing here this afternoon as we pay tribute to some of the most outstanding Economics learners in the country. The Monetary Policy Committee (MPC) Schools Challenge was launched as a pilot programme in 2012 by the South African Reserve Bank (SARB) in conjunction with the Gauteng Department of Basic Education (DBE). The challenge is a competition for Grade 12 Economics learners, which exposes them to how the MPC sets the repurchase (repo) rate. It also aims to increase the level of interest in Economics as a subject of choice among high school learners, and to encourage learners to pursue a career in Economics. The SARB has since expanded the challenge to other provinces, as follows: in 2014, to Limpopo Province; in 2015, to the Free State Province; in 2016, to Mpumalanga Province; and in 2017, to the Eastern Cape, North West and Northern Cape provinces. Today is a major milestone in the history of the MPC Schools Challenge. This is the first time that schools from all nine provinces have participated in the challenge. In July 2017, the Minister of Basic Education, Ms Angie Motshekga and I launched the national roll-out of this challenge at a media conference here at the SARB where it was announced that the KwaZulu-Natal and Western Cape provinces would be participating in the challenge from 2018, effectively opening the challenge to schools in all nine provinces for the first time. The number of participating schools has since risen from 70 (seventy) in 2012 to 813 (eight hundred and thirteen) in 2018 – impacting 3 212 (three thousand two hundred and twelve) learners. The SARB believes the competition will raise the level of understanding of monetary policy, and contribute directly and indirectly to broad public economic education. The students who participate in the MPC Schools Challenge will also have a better understanding of the role of the SARB. At the onset, we must commend our school finalists (in alphabetical order): Empucukweni Secondary School, Mpumalanga Province; Krugersdorp High School, Gauteng Province; Mariathal Combined School, Kwazulu-Natal Province; Orhovelani High School, Mpumalanga Province; Potchefstroom Gimnasium, North West Province; Ridge Park College, Kwazulu-Natal Province; and Springs Girls Schools, Gauteng Province. We are indeed privileged to be in the midst of future governors and deputy governors of the SARB. I am certain that you will all join me as I say: ‘well done’ to all the participants. They are all worthy finalists and deserve a round of applause. Credit must also go to the other schools that put up a brave fight but, unfortunately, did not make it to the finals. We are very proud of the hard work and effort the learners put in to prepare for the challenge. This occasion is also about celebrating young minds that have given us a glimpse of the incredible talent and intellectual capital at the disposal of our nation. Given the quality of data analysis and conclusions drawn by these young people, I can assure you, without any fear of contradiction, that tomorrow’s economy is in safe and capable hands. As we celebrate the winners of today, we must also celebrate a partnership between the SARB and DBE. Through this programme, we are investing in the nation’s human capital. As former President Nelson Mandela said: “Our children are the rock on which our future will be built, our greatest asset as a nation”. The SARB took the decision to embark on the MPC Schools Challenge based on our conviction that it will enhance our learners’ understanding of the role of monetary policy and of economics; build relationships between the SARB, schools and learners; and generate interest among our schools and learners in Economics as a subject. We believe that the economy of our country will rise in the hands of our future leaders. Our minimum responsibility is to prepare them for their future roles. The MPC Schools Challenge is a humble contribution towards building a solid foundation for their future leadership roles in the economy. As we prepare to announce the winning teams, let me take this opportunity to invite the winning school as well as their Economics educator and principal to spend the day of 20 September 2018 at the SARB as my special guests. You will have the opportunity to watch me delivering the MPC statement during a live media conference. We are confident that all these experiences will empower you to understand how economic theory is translated into practice. Thank you
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 5th Business Management Conference of the College of Law and Management Studies of the University of KwaZulu-Natal, University of KwaZulu-Natal, Durban, 23 August 2018.
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An address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 5th Business Management Conference of the College of Law and Management Studies of the University of KwaZulu-Natal University of KwaZulu-Natal, Durban 23 August 2018 Economic and policy challenges in Africa Ladies and gentlemen, good morning. Allow me to thank you for the opportunity to address this conference that explores a very important issue facing the economies of Africa today: ‘The role of urbanisation, and how the cities of the future will be structured and managed amid economic and policy challenges in Africa’. Of course, the growth and future of African cities is interdependent with the economic evolution of the continent in the next few decades, and how policies will shape that economic outlook. I therefore propose to discuss the external and internal challenges that the continent’s economy faces as it strives to move to a stronger, more inclusive pace of growth, and how policy – in particular monetary policy – can assist in that respect. Finally, I will look at whether the South African experience can inform future choices of the other countries in sub-Saharan Africa. Africa’s performance in the global context The 2000s was a rather good period for the continent. After several decades when it had generally failed to ‘catch up’ with the more advanced regions and therefore converge towards the technological frontier, sub-Saharan Africa outpaced the world Page 1 of 11 economy and other emerging regions, save East Asia and the Pacific.1 According to data published by the International Monetary Fund (IMF), the region’s economy grew by an annual average of 5.7% versus 3.9% for the world economy and 6.1% for emerging markets during that period. Furthermore, economic growth became more diversified. The services sector in particular contributed strongly to the overall expansion, including retail, financial services and telecommunications. More generally, the private sector played a growing role in driving investment in productive capacities, while the sources of international financing became increasingly diverse too. Importantly, what some analysts described as ‘a continent on the mend’ proved fairly resilient to the global financial crisis of 2008-09, even if this was (in part) due to the relatively loose linkages of African countries to the world’s major financial centres. In 2009, growth in sub-Saharan Africa slowed to ‘only’ 3.9% versus 2.8% for the emerging world as a whole and a 0.2% contraction for the global economy. As the present decade started, the region continued to grow strongly, helped by a rebound in commodity prices and strong growth in China, which had over the previous decade turned into Africa’s largest and fastest-growing trading partner. However, this pace of growth hit a ‘snag’ in 2016, when real gross domestic product (GDP) increased by a mere 1.4%, thus decoupling from emerging-market and global norms. The negative impact from the 2014-15 collapse in oil prices on some of the continent’s major oil exporters played an important part. However, the deceleration was relatively broad-based2 and exposed several underlying fragilities that had accumulated in earlier years, including the rise in external or fiscal account constraints. Where do we stand now? Economic growth has recovered since the abrupt deceleration of 2016, and major international institutions now forecast a moderate pickup into 2019. For example, the World Bank, in its June 2018 Global Economic Prospects, projects real GDP 1 If one excludes China, sub-Saharan Africa actually outpaced growth in all the other major regions in the 2000s. 2 Out of 43 countries, 23 witnessed a deceleration in growth in 2016, according to World Bank data. Page 2 of 11 growth of 3.5% next year, after 3.1% in the current year and 2.6% in 2017. However, this gradual pace of expansion still falls short of what the continent experienced, on average, in the previous decade. Furthermore, economists agree that, with per capita GDP growth rising by only about 1% a year, it will not make a major dent in poverty and inequality. The imbalances that have built up over the past decade have not disappeared. The region’s current account deficit, which had peaked at an elevated 6% of GDP in 2015, narrowed to 2.6% last year. However, the IMF expects that it will widen moderately again this year and the next, to around 3% of GDP. Furthermore, this aggregate hides the disparate performances across countries. The recovery in Brent crude prices has helped to alleviate the external pressures for oil exporters, but in countries whose strong growth has been heavily dependent on import-intensive public infrastructure investment, current account deficits remain high and, in many cases, are rising. In any event, external debt (expressed as a share of GDP) for sub-Saharan Africa as a whole is rising, with the servicing cost of that debt representing a growing chunk of export earnings – a clear sign that there is no room for complacency. ‘Twin deficits’ have become the norm across the region over the past decade. SubSaharan Africa’s government balance was in surplus, on average, between 2004 and 2008, but the region posted a deficit in excess of 4.0% of GDP from 2015 to 2017. Admittedly, most of the countries have now taken steps towards fiscal consolidation, and official forecasters expect a narrowing of that public deficit. Nonetheless, publicdebt ratios are projected to continue rising in 2018, and the IMF has recently highlighted the concerning rising trend in debt-servicing costs as a percentage of national budgets. There are indications already that public deficits are, in some cases, starting to ‘crowd out’ financing for private-sector projects. The 2016 slowdown in the region’s economies was compounded by a broad-based depreciation in most of its free-floating currencies, which triggered faster inflation and forced central banks to raise rates, sometimes aggressively. Thankfully, such negative forces largely reversed in 2017: in an environment of rising global investor appetite for risk, recovering commodity prices and softness in the United States (US) dollar, most of the liquid, tradable African currencies either stabilised or recovered against the Page 3 of 11 dollar. This improved performance, helped in some cases by a shift to a tight monetary stance – in particular, in the large oil exporters like Angola and Nigeria – allowed a broad-based decline in inflation rates. In fact, in most of the largest economies of the continent, inflation in the early part of 2018 has been close to central banks’ targets, or within such targets, when the central bank targets an inflation range as opposed to an inflation point. This has allowed several central banks to reduce interest rates in the past year or so – in some cases by a moderate amount (Angola, Kenya), and in others more substantially (Ghana, Mozambique, Tanzania, Uganda, Zambia). It is encouraging to note that many in the latter group of countries had in earlier years been forced to hike aggressively to combat inflation pressures; this policy tightening thus appears to have borne fruit. The ongoing challenges of development Several factors point to a moderately improved short-term growth, inflation and monetary outlook for sub-Saharan Africa. Nonetheless, as I have mentioned earlier, the growth levels projected for the next year or two remain insufficient to engineer a serious reduction in poverty as well as the other social or economic ills that typically accompany it, such as crime, malnutrition and illiteracy. The strong growth over 20002014 did help to alleviate both the incidence and the depth of poverty. For example, statistics compiled by the World Bank show that the percentage of people living below US$1.9 a day fell from 58% in 1999 to 42% in 2013, the latest year for which data are available. Nonetheless, this indicator has not declined near as fast anywhere else, and remains well above the similar indices for Latin America, South Asia and East Asia – even though, in the last-mentioned, poverty incidence was higher than in sub-Saharan Africa back in 1990. This unfavourable comparison highlights the urgent need for sub-Saharan Africa to restart the ‘high growth spells’ which had characterised the pre-2015 period – yet which, according to IMF research, tended to be shorter in duration and more vulnerable to an eventual crash than in other regions.3 According to that same research, both exogenous and internal factors influence the shift to a higher growth 3 See the article titled ‘Restarting sub-Saharan Africa’s growth engine’ in the IMF’s Regional Economic Outlook published in May 2017 (Chapter 2). Page 4 of 11 path and the duration of these growth spells. These factors include global financial conditions, changes in the terms of trade, low inflation, flexible exchange rates, and policy stability, including prudent fiscal management and well-managed debt dynamics. I would therefore like to dwell for a moment on the external environment that subSaharan Africa is likely to face in the coming years, as well as on the role that domestic policies can play in fostering renewed development. However, before I move on to these topics, allow me to highlight the importance of economic growth for African cities – for this is, after all, the subject of this conference, and the economic implications of and for urbanisation need to be better understood. Many economists point out the long-term benefits of urbanisation for economic growth: by living in a large city, individuals can access the type of job opportunities, and can participate in such business networks, that are not available in a rural setting, or much less so. Economies of scale are also generally understood to be larger in urban areas. Hence, it may not come as a surprise that, in most countries, a higher degree of development generally coincides with a higher share of the population living in large conurbations. However, those of us who frequently travel to African cities are also appalled at the problems that seem to come with the continent’s fast rate of urbanisation, namely the prevalence of slums, poor sanitation, squalor, traffic congestion, and high levels of insecurity. Why does this happen? An exhaustive study published by the World Bank last year offers some explanations.4 According to the authors, Africa’s cities suffer from poor spatial organisation that raises the costs of both living and doing business – and, as a consequence, businesses remain ‘trapped’ in low-value-added, non-tradable economic activities. In a word, African cities are not ‘economically dense’ and hence fail to benefit from those regional or global growth opportunities which, in other continents, become available to new urban dwellers. 4 See Africa’s cities: opening doors to the world published by the World Bank in 2017. Page 5 of 11 How can these problems be remedied? If, as the report’s authors suggest, they can be traced to poor spatial organisation, lack of proper urban infrastructure and excessive costs, it would appear that those policies which encourage higher investment in both physical capital (including public infrastructure) and human capital, which lower the costs and risks associated with doing business, and which allow economies of scale should take priority. Facilitating access to networks, in particular information technology (IT) networks (including the roll-out of broadband access to individual homes and small businesses), will need to receive special attention. While all layers of government will have to be involved in the reforms that facilitate the economic growth of cities, it is the municipal authorities that should be at the forefront of spatial development, the provision of infrastructure, and educational or social cohesion programmes. This stresses the need for African municipalities to create the necessary fiscal space for the provision of such services – and highlights, in turn, the crucial role that both fiscal and monetary policy can play in facilitating economic and urban development, which I will elaborate on shortly. While not the focus of our interaction today, we should not neglect the development challenges that rural areas face, which also deserve attention. Appropriately designed and targeted policies for rural development are similarly important. Potentially, a more challenging external environment First, though, let me discuss how the global outlook is likely to influence Africa’s economic and policy framework in the next few years. At present, as I have indicated earlier, most official and private forecasters appear confident of a moderate acceleration in economic growth in the coming two to three years. However, several ‘warning bells’ suggest that the unusually benign environment that the world faced in late 2017 – with a combination of upside growth surprises in most of the major economies, supportive global financial conditions, moderately rising commodity prices, and low financial market volatility – has already started to fade. Page 6 of 11 First, global economic growth is becoming less synchronised. While the US economy registered strong growth of 4.1%5 in the second quarter of 2018, buoyed by fiscal stimulus and a continued strong performance of the labour market, activity in the eurozone and Japan failed to return to the surprisingly strong pace seen late last year, despite the rebound from a poor, weather-affected first quarter. High-frequency confidence indicators confirm that shift to a slower, albeit still-dynamic, pace of growth. In the eurozone, the political risks which most market participants thought had faded have, to some extent, come back after this year’s Italian election. In the United Kingdom, the elevated uncertainties around the Brexit process seem to be weighing on corporate investment decisions. In China, activity lost some momentum in the first half of the year amid lesser fiscal support and tighter financial regulation, and while Chinese authorities now seem more willing to relax the policy stance somewhat, the potential conflict between ensuring a stable growth path and allowing highly leveraged sectors to reduce debt will continue to pose some risks to growth in the years to come. Second, growing trade tensions – not just between the US and China, but also between the former and other key trading partners such as the European Union, Canada and Mexico – have the potential to undermine global expansion. So far, it is too early to tell whether the selected imposition of tariffs has had an impact on trade flows. However, survey evidence already suggests that businesses are becoming more circumspect in investing and hiring, especially in those sectors that rely on international demand. And while sub-Saharan Africa is not directly involved in the present trade conflicts – in large part because it is not a strong direct competitor to US manufacturing producers, and also because its countries do not run large bilateral surpluses with the US – the region would still be vulnerable to a structural shift in global trade growth, as are most small economies with limited internal markets that rely in part on exports for development. Greater restrictions to global trade would also limit the ability of African countries to become more integrated in global value chains, and hence gradually reduce their dependence on commodity exports – which remains a source of vulnerability. 5 Seasonally adjusted, annualised Page 7 of 11 Third, the current global financial conditions are not as loose as they were at the start of the year. Following a strong performance in the latter part of 2017, most of the major equity markets are down from their January 2018 peaks, and dividend yields have increased. At the same time, while benchmark government bond yields remain quite stable despite the higher US policy rates, investment-grade corporate bond spreads in the US and some of the other advanced economies have widened from the earlyyear levels, as have emerging-market sovereign spreads. While this move remains muted for the time being, and while measures of market volatility like the widely watched Chicago Board Options Exchange Volatility Index (VIX) index are still at low levels, its impact on emerging-market financing is being compounded by US dollar appreciation, with the US Federal Reserve’s broad trade-weighted dollar index up by 3.8% from the start of the year. Tighter global financial conditions can be a particular challenge for those sub-Saharan African countries which have relied on private offshore investors, and especially Eurobond investors, to finance their ‘twin deficits’ in recent years. In 2017, following a period of declining investor appetite for ‘frontier markets’, African Eurodollar bond issuance rose to US$7.9 billion6, second only to the record of US$8.5 billion in 2014. The trend gathered pace in the first seven months of 2018, with no fewer than six African sovereigns tapping the market for a combined amount of US$13 billion. However, sovereign Eurobond spreads have widened again since March 2018, and while they remain relatively low by recent historical standards, African sovereigns may find it harder, or at least more costly, to cover their external funding needs if global risk aversion rises significantly further. What should the policy response be? It would therefore appear that sub-Saharan African countries cannot solely rely on external dynamics to shift to a higher, more durable pace of growth. Domestic policies will have to play an important part too. However, as I have already discussed, the room for manoeuvre for fiscal policy has become very limited. While the debt-to-GDP ratios have not reached crippling levels yet, countries in the region will want to avoid a repeat of the over indebtedness of the 1970s and 1980s, which had forced many of them into 6 This is equivalent to 0.5% of sub-Saharan Africa’s GDP. Page 8 of 11 socially and economically painful adjustment programmes. It is more likely that the challenges for fiscal policymakers in the coming years will be of a structural nature, such as broadening the tax base and improving taxpayers’ compliance, reducing fiscal revenue dependency on natural resources, and re-prioritizing expenditure away from wasteful, inefficient interventions. But can monetary policy step in and provide support? Before attempting to answer this question, I would first like to stress what monetary policy cannot do – and that is: run an overly stimulative stance for a prolonged period of time in the hope of engineering a sustained pickup in growth. Such an approach would only result in excess demand, and as it could not be met by the domestic supply of goods and services, it would only generate inflation, external imbalances and, in the end, an economic crisis. Of course, in recent quarters, lower inflation in many African countries has allowed central banks to reduce interest rates. However, history shows that inflation can pick up quickly again. In fact, the average volatility of inflation in the region’s countries is rather high by international standards, owing in part to the large weight of volatile items like food and fuel in consumer price index baskets. This suggests that the central banks in the region need to further focus on reducing both the volatility and the average level of inflation, the latter also remaining high by global standards. Such an approach is likely to prove beneficial to long-term growth: in the IMF report cited earlier, the authors estimate that a durable reduction in inflation can increase the expected length of a ‘growth spell’ by up to 5.5 years. Intuitively, one can understand how a greater anchoring of price expectations can reduce uncertainties for decision-makers and savers alike, how it can reduce the risk premium required by investors in both financial assets and the real economy, how it can help develop financial instruments available for development, and how it can lead to more stable employer-labour relations. Looking at the South African experience Can anything be learnt from the South African experience in that respect? Some of the constraints I reflected on earlier – of poor spatial development, inadequate infrastructure provision, and barriers to entry for emerging entrepreneurs – have presented major challenges for South Africa and its major metropolitan areas. In fact, Page 9 of 11 in addition to the ‘normal’ issues faced by an emerging economy, our country has also had to deal with the legacies of the apartheid system which had, for decades, and for political reasons, contributed to raising these constraints. South Africa’s post-1994 democratically elected government thus had to place particular emphasis on the alleviation of spatial and infrastructure constraints in the previously disadvantaged areas. South Africa has registered tangible progress in many areas, including electrification, water and sanitation, mobile telephony or Internet access, health and literacy improvement. To give a few examples, the share of households with access to electricity rose from 64% in 1984 to 84% by 2016. Similarly, between 2000 and 2016, cell phone subscriptions jumped from 18 to 147 per 100 people. However, progress in these development indicators has slowed – and in some cases stalled – over the past decade, as a structural slowdown in economic growth has undermined private investment in future productive capacities and has reduced (together with a sub-optimal allocation of resources) fiscal space for the roll-out of better infrastructure, education and health facilities. One cannot deny that recent economic growth in South Africa, which averaged only 1.5% over the past five years, is far too low to deal with the country’s long-lasting problems of high unemployment, poverty and inequality. The answer to these growth challenges often lies in structural, long-term policy approaches. Clearly, many of these are outside the remit of monetary policy. Nonetheless, for the past few decades, the South African Reserve Bank (SARB) has strived to ensure a more stable monetary and financial environment, so as to facilitate the attainment of longer-term growth and development goals. Following decades of high and volatile inflation, the adoption in the early 2000s of a 36% inflation target has allowed, first, the sustained decline of consumer price gains into single-digit territory, and then, over time, increased compliance with price stability goals. Inflation expectations have also become better anchored over the years, albeit at levels that are still uncomfortably close to the upper end of the target range. Page 10 of 11 Over time, not just inflation but also economic growth and, importantly, policy rates as set by the SARB have become less volatile, while greater transparency of monetarypolicy decisions – including, in recent times, the publication of the SARB’s macroeconomic projections – has increased policy predictability. A more stable monetary environment has also contributed to the soundness of the banking system, the liquidity of financial markets, and the ability of government to lengthen the maturity of its liabilities. Conclusions To conclude, let me say that the challenges being faced by the continent, and in particular by its cities, are real – and that policy answers cannot be deferred. Africa’s population is growing, and within the next few decades, a growing share of that population will be migrating towards its already-large urban areas. Infrastructure, education and network development needs will continue to grow. The answer to these inevitable challenges does not just lie in betting on a strong global environment, even if Africa’s increased integration into the world economy will bring benefits. The answer also lies in an appropriate policy environment underpinned by strong political will. And, perhaps more than ever, sound fiscal and monetary policies form a crucial part of that framework. Thank you. Page 11 of 11
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Welcome address and opening remarks by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the Innovation and Cybersecurity Conference, Johannesburg, 28 August 2018.
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A welcome address and opening remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Innovation and Cybersecurity Conference Sandton Convention Centre, Johannesburg 28 August 2018 Good morning, Governor, fellow Deputy Governors, fellow regulators (in particular our colleagues form National Treasury, the Financial Sector Conduct Authority and the Financial Intelligence Centre), our colleagues from numerous neighbouring central banks, distinguished guests, ladies and gentlemen. The South African Reserve Bank (SARB) is pleased to welcome so many of you who have decided to join us at this conference. We appreciate the great interest in this event, both from domestic and from international stakeholders. We remain fully committed to engaging and cooperating with all our stakeholders on crucial policy matters and the changes in our shared landscape. We hope that the next three days will offer great insights and will spark beneficial conversations on the themes and topics of this conference. Introduction We are undoubtedly facing an epoch of unrivalled change that is far more exponential than the Cambrian Explosion that Andrei Kirilenko will make reference to in his presentation later today. This era offers many opportunities, and government agencies in collaboration with business and the wider society can play a critical role in leveraging these opportunities to the benefit of all humankind. In this regard, Frans van Houten is quoted as having said: “Government should seek more strategic approaches to develop dynamic, resilient infrastructure. Business must be more creative in offering financing solutions as partners with government, and people must support sustainable innovation as a public policy priority.” Page 2 of 5 Conferences such as these are part of a collaborative effort in our mission to deepen our insights into and understanding of innovation and cybersecurity. We hope that you too will benefit from these proceedings and will emerge from this conference with an expanded knowledge on these critical issues that we will be covering over the next three days. The genesis of this conference dates back to 2016 when the SARB organised and hosted its first Cybersecurity Conference. That conference underlined the importance of cybersecurity and cyber-resilience. In 2017, the SARB hosted the first Payments Innovation Conference in collaboration with domestic and international payments stakeholders. This Payments Innovation Conference sought to develop more profound insights into the innovations emerging in the payments ecosystem, while facilitating a better understanding of the role of innovation and regulatory frameworks in the payments industry. However, we cannot engage in conversations about the remarkable amount of innovation taking place in the financial services industry without addressing the cyber-threats that we also face. It was therefore prudent for the SARB to, this time, merge the two conferences into one. This Innovation and Cybersecurity Conference will focus on the following five themes: Emerging innovations Leveraging new technologies Innovation and the regulator – challenges and opportunities Cybersecurity trends The South African journey – getting to harmonisation and action I will now make some brief introductory remarks before handing over to the Governor of the SARB, Mr Lesetja Kganyago, to deliver the opening address on ‘Disruptive innovation and cybersecurity: the South African Reserve Bank’s perspective and response’. Page 3 of 5 Innovation It is becoming evident that the ever-accelerating pace of emerging technological innovation, notwithstanding all its advantages, is disruptive to the financial services being offered by financial institutions, and it also poses some challenges for regulators. Innovation introduces new players to the financial services industry and enables incumbent industry participants to expand the scope of their financial offerings. Innovation generally leads to the expansion of markets and greater efficiencies, and could potentially result in lower costs for the end user of financial products and/or services. Regulators taking positions to enable innovation and competition stand to benefit, among others, consumers. In PricewaterhouseCoopers’ (PwC) 21st Chief Executive Officer (CEO) Survey1, both cyber-threats and the speed of technological change make it into the top six anxieties that keep CEOs awake at night. Through this Innovation and Cybersecurity Conference, we will, for example, explore, in a round table discussion with industry leaders moderated by Governor Kganyago, ‘how exponential technology will drive change in the current financial sector landscape’. This topic is particularly relevant because exponential technology has the ability to threaten the survival of firms that are highly successful today, even if they spend large amounts on innovation initiatives. It was Steve Jobs who said: “Innovation has nothing to do with how many R&D dollars you have. When Apple came up with the Mac, IBM was spending at least 100 times more on R&D. It is not about money. It’s about the people you have, how you’re led, and how much you get it!” Financial institutions must keep pace with what is happening in the technological sphere if they are to remain relevant and are to survive. Environmental forces such as innovation invariably create both threats and opportunities for all the role players, no less so than in the financial industry. There is an adage that says: “Adapt quickly to change or perish seamlessly without change in the 21st century.” 1 See PwC’s 21st CEO Survey, The anxious optimist in the corner office, available at https://www.pwc.com/gx/en/ceo-survey/2018/pwc-ceo-survey-report-2018.pdf. Page 4 of 5 Cybersecurity As financial institutions and infrastructure service providers evolve to keep up with the pace of technological change such as application programming interfaces, distributed ledger technologies, artificial intelligence and cloud-computing, just to mention a few, sophisticated cybercriminals continue to target banking and payment systems, with the potential to disrupt their operations and potentially cause harm to the broader financial system and even the entire economy. But it is not only technological progress and innovation that increase cyber-risk; cyber-threats may also undermine innovation. It was James Comey, the former FBI2 Director, who said: “The diverse threats we face are increasingly cyber-based. Much of America’s most sensitive data is stored on computers. We are losing data, money, and ideas through cyber-intrusions. This threatens innovation.” It is thus essential that these kinds of risks are well understood and that all financial institutions and market infrastructures are secured against cyberattacks. The financial services industry should strive to have cybersecurity practices in place that are agile and responsive to emerging cyberspace activities and developments. Through this Innovation and Cybersecurity Conference, we will learn more about the emerging types of cyber-threats and cyberattacks facing the financial ecosystem. We will discuss the risk management practices, controls and defence mechanisms that the financial sector should adopt to deal with these cyber-threats and cyberattacks. This conference is also a platform to collaborate on cyber-resilience through national and industry-specific cyber-response structures in the interest of financial stability and financial security in South Africa. Closure Allow me to extend a special word of thanks to speakers and panellists, both local and those from abroad, who have agreed to participate in this conference and to share their insights and experience with us. 2 Federal Bureau of Investigation (United States) Page 5 of 5 I hope that the focus of the next three days will be on coordinating efforts, establishing response structures, and creating regulatory certainty in this disruptive environment where innovation and cybersecurity converge. Thank you. Page 6 of 5
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the RMB Morgan Stanley Investor Conference, Cape Town, 25 September 2018.
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An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the RMB Morgan Stanley Investor Conference The Vineyard Hotel, Cape Town 25 September 2018 Distinguished guests, ladies and gentlemen. It is a pleasure to be with you today and to share the stage with such an illustrious group of speakers. Today, I would like to discuss what has been a recurring theme in our economic discourse for the past decade – the pursuit of structural reforms in the interest of inclusive growth. It is top of mind for investors, businesses, labour unions, academics and policymakers alike, including the Monetary Policy Committee (MPC). It has also attracted a wide range of research and analysis, most prominently the National Planning Commission’s diagnostic report, and has been central to the proposed government policy interventions as captured within the National Development Plan (NDP). First, I will share my thoughts on this critical topic, and second, I will touch on the role of the South African Reserve Bank (SARB) in relation to structural reforms. Introduction Structural reforms are policies mainly undertaken to improve the supply side of the economy by reducing constraints on the production of goods and services. These may include policies to reduce ‘red tape’, curtail monopoly power, raise the efficiency of key public services, and even amend taxes and public spending programmes with the intention of ensuring fiscal sustainability. Underlying these reforms is often an attempt Page 1 of 12 to strengthen the institutional fabric of the economy by ensuring that ‘the rules of the game’ incentivise individual behaviour that contributes to the common good. The need to lift productivity and growth through structural and institutional reforms has received a significant amount of attention – not just domestically, but internationally. Indeed, it is a challenge faced by economies of all income levels in many different parts of the world. For example, in its latest Global Economic Prospects report, the World Bank notes that both advanced and emerging market economies have experienced a decline in their growth potential over the past decade. In a reference to the global economy, the report emphasises ‘an urgent need to press ahead with growth-enhancing policy adjustments – including reforming product and labor markets, raising investment in human capital, and building the policy buffers needed to allow an appropriate countercyclical response to shocks when they materialize’.1 This policy recommendation for the global economy applies equally to South Africa. Our growth challenges are thus not unique, but they are certainly a cause for concern. Similarly, the pressure to enhance the inclusiveness of economic growth in South Africa is also being felt in many other parts of the world. While income inequality between countries has fallen over the past 20 years, amid a rising middle class in many emerging market economies,2 within-country inequality has increased in many countries.3 The recent rise in populist rhetoric internationally appears to be, at least in part, a reflection of rising inequality and a sense that economic gains are neither equally nor widely shared. This perception was exacerbated by the global financial crisis which, like many large crises, affected the poorest in society the worst. The power of inequality and perceived economic injustice as contributing factors towards political outcomes is being demonstrated in advanced and emerging 1 World Bank. 2018. India – Systematic country diagnostic: realizing the promise of prosperity: Global Economic Prospects: the turning of the tide? Washington, DC: World Bank. 2 Milanovic, B. 2012. ‘Global income inequality by the numbers: in history and now’. World Bank Policy Research Working Paper 6259. Washington, DC: World Bank. 3 Atkinson, A, Piketty, T and Saez, E. 2011. ‘Top incomes in the long run of history’. Journal of Economic Literature 49(1): 3–71. Page 2 of 12 economies alike. The consequences of these outcomes have been profound. In particular, decades of global economic integration, so widely held to be beneficial, are now at risk of being reversed. A key implication of this reaction is that the policies targeted at increasing gross domestic product (GDP) growth must also aim to be inclusive if they are to be sustainable in the long term. Considering South Africa’s challenges in moving to a more equitable economy, it is disconcerting to observe the notable moderation in the potential rate of growth over the past decade. Part of this moderation can be attributed to the legacy of the global financial crisis and a lower level of growth in some of South Africa’s export-partner economies. However, a significant share is self-inflicted, reflecting slow gains in productivity, policy uncertainty and a lack of investment in key sectors. At the current level of potential GDP growth – which the SARB estimates to be between 1.0% and 1.4% over the next three years – the economy is not able to generate real per capita income gains on a sustained basis. This is because population growth is currently at about 1.6% per year.4 Achieving a more equitable distribution of income is particularly challenging if it is not possible to grow the economy faster than the rate of population growth. In such an environment, difficult conversations about redistribution are unavoidable. However, if we could meaningfully lift the GDP growth rate, redistribution could take place more easily through the sharing of the additional gains. Reforming the economy has therefore become imperative, particularly if the standard of living is to be improved for all South Africans. Government has put substantial effort into the development of the NDP, which provides a clear and holistic structural reform framework. This plan has received support from across the political spectrum. However, implementation has been disappointingly slow. 4 https://www.statssa.gov.za/publications/P0302/P03022017.pdf Page 3 of 12 The recent change in political leadership gave rise to a renewed sense of optimism around the structural transformation agenda – not least because the President was the Deputy Chair when the National Planning Commission drafted the NDP. Encouragingly, the new administration has started to implement a number of reforms aimed at improving governance, tackling corruption and reducing pressure on the fiscus. Despite the improvements in business and consumer confidence earlier this year, the short-term economic outlook has remained subdued. Some analysts have noted that the reform progress has not been sufficiently rapid to ignite economic activity. With the economy now in a technical recession, following two consecutive quarters of contracting economic activity, concerns about the implications of low growth for employment creation, government finances and poverty alleviation have intensified. The governance and fiscal reforms currently being implemented are better thought of as improving institutional strength and the resilience of the economy. While they may not meaningfully lift short-term growth, they are important in reducing downside risks over the medium term and providing a degree of confidence to the private sector. Embedding a sound institutional environment is essential for creating the virtuous cycle in which iterative structural improvements are self-perpetuating. To raise the growth potential of the South African economy, additional reforms are required, specifically aimed at lifting productivity and increasing the efficiency of product and labour markets. Structural reforms, even when small, have in the past brought tangible benefits to our economy. The licensing of mobile phone operators in the 1990s brought down the costs of land lines and moved South Africans to near universal access to a telephone – over 90% of adults have had access to a land line or mobile phone since 2016.5 In addition, allowing for private sector participation in the electricity sector since 2010 has enabled the connection of 3776MW6 to the electricity grid and increased private sector investment, and minimised the negative impact of 5 Independent Communications Authority of South Africa (ICASA). 2018. Third Report on the State of the ICT Sector in South Africa. Pretoria, ICASA. 6 Department of Energy. 2018. Opinion piece by Minister Jeff Radebe, ‘Renewable energy independent power producer agreements will benefit South Africa in the transition to an environmentally sustainable economic future’, 27 July. Page 4 of 12 power shortages in 2015/16. There is room for more reforms which, as articulated in the NDP, can lower the cost of living and improve the competitiveness of our exports. Indeed, National Treasury has recently estimated that the potential growth rate of the economy could be doubled by, among other things, releasing broadband spectrum, increasing the skill levels in the economy, and addressing anti-competitive practices.7 Other analyses show that there is a positive correlation between the employment of skilled workers and unskilled workers. In this regard, measures to increase the number of workers with critical skills, including higher university throughput, the training of artisans and easing visa regulations for individuals with critical skills, could be beneficial. While some of these reforms will take time to show in the growth numbers,8 more immediate gains can be achieved by addressing the policy uncertainty that has constrained private investment for some time now. In fact, providing a clear and consistent message about the reform agenda will be as important as the agenda itself. Former United States (US) Treasury Secretary Larry Summers has often been quoted as saying that ‘confidence is the cheapest form of stimulus’.9 However, in an environment of rising inflation and fiscal constraints, it is also likely to be the most effective stimulus currently available. In this regard, further clarity on the modalities of the recovery package recently announced by the President will be important. Over the medium term, it is important to emphasise that while the rate of growth in the economy is set to rise only gradually, with a faster uptick contingent upon further reforms, South Africa’s macroeconomic framework and strong set of institutions continue to display remarkable resilience under challenging conditions. This is no accident. South Africa’s Constitution was carefully drafted to provide for an independent judiciary, free media and democratic accountability – all of which are underpinned by an active civil society. Meanwhile, the macroeconomic framework has 7 http://www.treasury.gov.za/documents/national%20budget/2018/review/FullBR.pdf 8 Rodrik, D. 2016. ‘The elusive promise of structural reform’. The Milken Institute Review 2: 26–35. 9 https://www.washingtonpost.com/news/wonk/wp/2015/11/02/larry-summers-where-paul-krugman- and-i-differ-on-secular-stagnation/?noredirect=on&utm_term=.68d0b3a3e284 Page 5 of 12 been designed to ensure, among other things, that the exchange rate can effectively absorb shocks from abroad without transmitting instability, alongside other automatic stabilisers. I would now like to discuss the role of the SARB in South Africa’s institutional landscape and what we are doing to contribute to the country’s macroeconomic resilience and growth. The South African Reserve Bank’s role in South Africa’s institutional landscape The primary role and the independence of the SARB are clearly articulated in South Africa’s Constitution. It calls for the central bank to ‘protect the value of the currency in the interest of balanced and sustainable economic growth’, and states that the SARB ‘must perform its functions independently and without fear, favour or prejudice’.10 Central bank independence in the context of the SARB refers, at the minimum, to instrument independence, that is, the SARB has the flexibility to use any and all of the tools at its disposal to achieve the set inflation target range. The SARB communicates regularly with the public, trade unions, civil society, parliament and representatives of government to explain and discuss economic developments, as well as what informs the monetary policy stance. Through this process, the SARB remains accountable to the South African public. The SARB’s independence, however, allows it to avoid the trap whereby monetary policy is being constrained by short-term political motives. I wish to emphasise that the current shareholding structure of the SARB has no bearing on its policymaking. Furthermore, the independence that the central bank enjoys is unrelated to its shareholding structure as policymaking is the responsibility of the four governors that are appointed by the President. Thus, the recent discussions about government potentially changing the shareholding structure of the SARB are 10 http://www.justice.gov.za/legislation/constitution/SAConstitution-web-eng.pdf Page 6 of 12 largely inconsequential to the way in which the central bank operates. Nevertheless, should the independence of the SARB come under threat for any reason, we will make full use of all the legal avenues available to protect the independence of the SARB as it is a very important pillar for monetary policy credibility. To illustrate this point, allow me to briefly outline a temptation which is described in the literature as a key reason for central bank independence. The temptation is known as ‘time inconsistency’. It simply means that there is always an incentive for a central bank to surprise the market with a more lax policy than is implied by its historical behaviour. The incentive exists because unexpected stimulus will initially give rise to an uptick in the economy. This is because prices are fixed in the short run, so the stimulus will translate directly into higher output. However, the economy will soon run into a capacity constraint, meaning that the higher demand caused by a lax monetary policy will result in businesses marking up their prices and unions raising their wage demands. As this occurs, the growth boost will give way to higher inflation and job losses. The unexpected monetary policy shock will dent the credibility of the central bank, as economic agents will be forced to reassess the central bank’s reaction function. This, in turn, will result in higher inflation expectations, while the medium-term growth prospects will, at best, be no better than they were before. It is easy to see why this type of behaviour could be attractive to a government in search of short-term growth. However, if repeated, it can lead to escalating inflation and a loss of confidence in the currency. One only needs to glance at the recent news headlines to observe that such calamities are not confined to the history books. The adoption of the inflation targeting framework was a significant structural shift for South Africa following periods of persistently high inflation. Since the introduction of inflation targeting in 2000, the SARB has worked hard to anchor inflation expectations and to embed the inflation target range in the minds of South African citizens. We have achieved hard-won credibility by avoiding the time inconsistency problem. Page 7 of 12 Nevertheless, we believe that it is possible to do better. In particular, we are aware that inflation expectations have been anchored towards the upper end of the 3–6% inflation target range rather than at the midpoint. This, in turn, has resulted in headline inflation outcomes that have been uncomfortably close to 6% in recent years. When inflation settles near the 6% mark, exogenous shocks, such as exchange rate depreciation, can easily push inflation outside of the target range. The SARB operates a flexible inflation-targeting regime. The MPC therefore looks through the initial impact of supply-side shocks, with the aim of reacting to any second-round effects that these shocks may cause. However, the flexibility of the SARB to do this is constrained when such shocks quickly push inflation outside of the target range. Therefore, we are, as part of an ongoing effort, attempting to steer inflation expectations towards the midpoint of the inflation target range. To increase transparency, the MPC has begun to publish a more detailed list of forecasts as well as the endogenous repurchase rate path that is generated by our macroeconomic model. Over time, the policy actions and communiqués of the SARB are expected to anchor inflation expectations (and inflation itself) closer to the 4.5% level. The benefits of such an outcome include increased policy flexibility, a lower inflation differential between South Africa and its major trading partners (implying less pressure on the exchange rate), lower long-term interest rates and, of course, a smaller annual erosion of purchasing power, which is particularly beneficial to the poor. We are aware that, in the short term, there will be a trade-off between inflation and growth, which implies that the transition to a lower inflation path will not be without costs. To minimise these costs, the MPC will gradually guide expectations lower through clear communication and appropriate policy-rate adjustments, as deemed necessary. As with many important policy transitions, the long-term benefits will significantly outweigh any short-term costs. An expanded mandate Over and above the primary mandate of price stability, the SARB has also recently been given an explicit mandate to oversee financial stability. This mandate is provided Page 8 of 12 for in the Financial Sector Regulation Act 9 of 2017 (FSR Act), which was signed into law last year. The FSR Act is the most fundamental reform of the South African financial sector regulatory architecture in more than three decades. The mandate for financial stability calls for the SARB to take steps to prevent systemic events from occurring and to mitigate the adverse effects of a systemic event if and when one does occur. The tools necessary for addressing system-wide risks are commonly known as macroprudential tools. Since the global financial crisis, it has become apparent that even if individual financial institutions appear sound, there may still be a risk of broader financial instability due to either excess leverage across the system or a high degree of common exposures to a particular risk. Thus, the microprudential tools that have commonly been used to safeguard individual banks, such as minimum capital and liquidity ratios, need to be supplemented with a macroprudential approach to regulation. The SARB is currently researching a variety of potential macroprudential tools and financial stability risk indicators to improve the resilience of the broader financial system. The SARB’s Financial Stability Committee has been set up to protect and enhance financial stability. It is tasked with considering qualitative assessments of the conjunctural assessments of risks to, and imbalances in, the broad financial system and formulating policy action to mitigate identified threats, as well as considering the appropriateness and adequacy of resolution policies and measures for crisis management. The SARB’s toolkit is continually being refined and includes the ability to deploy a countercyclical capital buffer for banks. This provides the SARB with the means to raise aggregate bank capital buffers during upswings in the financial cycle, and allows for the release of these buffers during downswings. Currently, given the modest level of credit growth, the countercyclical capital buffer is set at zero. The FSR Act has also established a Twin Peaks approach to financial regulation, which means that prudential and market conduct regulation are now managed by two separate entities. The SARB, as the prudential regulator, has received expanded oversight responsibilities extending beyond banks, to include insurers and financial market infrastructures. Meanwhile, a new entity, called the Financial Sector Conduct Page 9 of 12 Authority, has been established as the market conduct regulator. The FSR Act meaningfully builds on South Africa’s institutional strength within the financial sector by ensuring that the regulatory architecture is in line with best practices globally. In particular, establishing a clear separation between prudential and conduct regulation is an important reform because it ensures that there is adequate oversight of both the soundness of financial institutions and the fair treatment of clients. Over the longer term, we believe that centralising financial regulation within the SARB will generate economies of scale and improve our ability to monitor risks across South Africa’s highly interconnected financial sector.11 As I mentioned earlier, some important structural reforms do not show in the GDP data. The financial sector reforms that I have been describing are an example. Avoiding systemic crises does not necessarily result in a higher growth trajectory, and hence its benefits are less apparent. One would need to consider counterfactuals to determine the value of a stable financial sector. While this type of analysis is difficult, we need only to observe the persistent effects of the global financial crisis to appreciate the importance of a stable financial system. Certainly, the benefits extend beyond the avoidance of economic losses and include a more stable social and political environment. The fact that South Africa has not had a large-scale banking crisis since attaining democracy serves to demonstrate the resilience of our financial sector.12 Other structural reforms that have been critical for South Africa’s economic expansion include the significant liberalisation of the capital account and the development of the domestic bond market, which have deepened our financial markets. I provide these examples to highlight that structural reforms can be varied but all have an important role to play. 11 Kemp, E. 2017. ‘Measuring shadow-banking activities and exploring their interconnectedness with banks in South Africa’. South African Reserve Bank Occasional Paper 17/01. Pretoria: South African Reserve Bank. 12 Reinhart, C and Rogoff, K. 2012. ‘Banking crises: an equal opportunity menace’. NBER Working Paper 14587. Cambridge, MA: National Bureau of Economic Research. Page 10 of 12 At the SARB, we believe that price and financial stability are complementary goals, which together contribute towards creating an enabling environment for economic growth. These goals reinforce each other because neither one is possible without the other. And while we are working hard in both areas, we also recognise that our contributions provide the necessary, but not sufficient, conditions for achieving sustained, higher levels of growth. A final point that I would like to touch upon is the work currently underway at the SARB in the area of financial technology (fintech). Fintech is a key regulatory priority, but also a potential area of growth for the economy – we do not have to look further than Estonia and Singapore to realise the growth and transformational potential that the use of technology may hold. As such, we have set up a unit focused solely on understanding and utilising emergent fintech developments. Despite being in its infancy, this unit reached a remarkable milestone recently by collaborating with various banks to demonstrate that the domestic real-time gross settlement of interbank payments can be decentralised and executed through distributed ledger technology. We are anticipating many exciting developments in the fintech space over the coming years, and will attempt to remain as close to the frontier in this domain as possible. Concluding remarks South Africa’s economy is expected to stage a gradual recovery over the next two years, as both domestic investment and export growth are forecast to rise. However, a modest cyclical rebound of this nature is insufficient to address the high levels of unemployment and inequality in our country. In order to reach more transformative growth rates, as envisioned in the NDP, government will need to act decisively on the recent reforms. The SARB will remain focused on achieving its price stability and financial stability mandates and, in concert with other regulators, it will continue to work towards further improvements in the soundness and efficiency of the financial sector. Our efforts to enhance what we do form part of a broader thrust towards an even stronger and even more resilient institutional architecture in South Africa. Page 11 of 12 Thank you. Page 12 of 12
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Central Banking Seminar of the Federal Reserve Bank of New York, New York City, 2 October 2018.
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Address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Central Banking Seminar of the Federal Reserve Bank of New York New York 2 October 2018 The impact of a changing global environment on African economies and policy Introduction Ladies and gentlemen, good afternoon. Thank you to the New York Fed for again inviting me to address this prestigious annual seminar where major topical issues are discussed. This year is no exception. The theme of ‘less accommodative policy amid questions about the global order’ has been a key focus of investors and policymakers alike for quite a while already, and clear answers are still not forthcoming. Are we just witnessing a temporary correction of financial markets amid an otherwise benign economic environment, or are disruptions large enough to challenge global expansion, especially in emerging economies? If more severe challenges were to occur, would there be sufficient global cooperation to deal with them in a cohesive manner? I certainly will not pretend to have clear answers to these questions, but will try to provide some perspective, looking specifically at how the changing in global environment is affecting South Africa and South African Reserve Bank’s (SARB) reaction thereto. I will also pay attention to the challenges facing the rest of Sub-Saharan Africa and what to possibly expect next. In some aspects, the global outlook does not appear to have changed fundamentally from earlier this year. The International Monetary Fund is yet to release its October 2018 World Economic Outlook, but the last time it published an update to its forecasts in July, its 2018 and 2019 global growth projections were unchanged from the previous forecasting exercise, at 3.9% for both years. The Bloomberg consensus of economists delivers a similar message of stability in expectations. The forecast for 2018 gross domestic product (GDP) growth is presently at 3.8%, unchanged from two quarters ago. At the same time, the normalisation of monetary policies in advanced economies from the unusually loose stance that had prevailed since the end of the global financial crisis has proceeded largely along the pace which policymakers had signalled, and investors had expected, at the start of the year. Yet, a closer look at the details of the global environment suggests that the outlook may be becoming more challenging as some risks previously identified have begun to materialise. First, economic expansion has become less synchronised than in the ‘sweet spot’ of 2017, when most economies experienced upside growth surprises without too much inflation. While GDP growth in the United States (US) is still strong on the back of a buoyant labour market and fiscal stimulus, activity has slowed since the start of the year in the eurozone, Japan and China. Second, some policy developments have contributed to either increasing such de-synchronisation – such as fiscal stimulus in the US – or raising overall growth uncertainty, as in the case of rising trade conflicts. One key consequence of such economic and policy developments has been renewed upward pressure on the US dollar, which has benefitted from the further rise in interest rate differentials (nominal and real) between the US and other major advanced economies, and from the outperformance of US equities. The combination of rising growth and policy uncertainties, weaker commodity prices – with the notable exception of oil – from March to August 2018 and a stronger dollar has hit emerging countries’ financial assets particularly hard. Since it peaked in February 2018, and despite some recovery in September, the JPMorgan emerging markets foreign exchange index has declined by 13%. Over the same period, the MSCI index of emerging market equities has shed 13% and the Emerging Markets Bond Index Plus (EMBI+) sovereign spread over US Treasuries has widened by 60 basis points. However, performances across the emerging world have been very disparate, ranging from severe financial stress to near-stability. Judging by these different reactions, it appears that the less favourable global backdrop has led investors to refocus on relative country vulnerabilities, specifically with respect to the rising external liabilities of governments and large corporations, fiscal trends, exposure to global trade and value chains and, in some cases, the level of inflation and the degree of anchoring of inflation expectations. How the changing environment has affected South Africa If one excludes the most dramatic sell-offs experienced by the Turkish lira and the Argentine peso, the South African rand has been among the most affected emerging market currencies this year – losing 13% on a trade-weighted basis since its 26 February peak. This depreciation, together with the 98 basis point increase in the yield on the R186 benchmark government bond and the 60 basis point widening in the country’s five-year credit default swap spread illustrate the vulnerability of South African financial assets to the changing world environment I have just described. Why has this happened? In contrast to some of its emerging market peers, South Africa has managed to keep its foreign currency-denominated external liabilities relatively under control. While the ratio of external debt to GDP has risen from a low of 18% in the mid-2000s to 46% as at the first quarter of 2018, the majority (about 55%) of that debt is denominated in rand, and includes government bonds held by offshore portfolio managers. Importantly too, the short-term component of foreign currency-denominated external debt did not exceed 8.5% of GDP, and the bulk of these liabilities consists of either trade finance or domestic banks’ foreign currency deposits, which in the latter case are more than offset by foreign currency assets. Inflation patterns do not appear to be the cause of the market sell-off. Over the past 12 months, consumer price readings have been below consensus expectations seven times (including in the past month), and the average inflation rate (of 4.4%) for the second quarter also fell short of what the South African Reserve Bank’s (SARB) model projected 6 or 12 months earlier. The extended period of sub-par growth in demand appears to be limiting the pass-through to prices of higher input costs, including those related to exchange rate depreciation. Indeed, recent survey indicators suggest that companies’ pricing power, especially in the retail sector, is increasingly being eroded. At the same time, some modest signs of slower wage and unit labour cost growth have also emerged in the past year or two. However, some several of South Africa’s fundamentals are fragile enough to keep the country at risk of portfolio flow reversals in periods of rising risk aversion. Among those is the persistence of ‘twin deficits’. While the current account deficit has declined, on average, in recent years – it stood at 3.3% of GDP in the second quarter of the year, down from a high of 5.8%, on average, in 2013 – it nonetheless appears elevated for an economy with weak demand and a negative output gap. Domestic savings remain low, illustrating the risk of renewed deficit widening if demand, especially muchneeded investment demand, picks up. At the same time, the budget deficit has remained in excess of 3% of GDP in the past few years, despite repeated tax increases, resulting in a continued rise in the debt-to-GDP ratio, compounded by an increase in contingent liabilities linked to state-owned enterprises. Real economic growth has also been disappointing. At a year-on-year growth rate of only 0.5% in the second quarter of 2018, South African GDP growth was one of the weakest among the large emerging countries. In the second quarter, the South African economy entered what is commonly called a ‘technical recession’, as GDP growth contracted for a second successive quarter. In many ways, hopes that domestic political developments at the start of the year would translate into a quick boost to activity proved to be excessive. Business confidence quickly retraced most of its early 2018 gains, and the South African rand, which had rallied at the time on the back of such hopes, fell back in sympathy with corporate sentiment (but also on account of the factors already mentioned). Even as domestic financial markets came under pressure, some assets showed relative resilience, in particular long-term domestic bonds that sold off by a lesser amount – relative to the degree of rand depreciation – than in previous episodes of market stress, for example the 2013 ‘taper tantrum’. Continued and relatively benign inflation readings probably helped limit the upward drift in bond yields, highlighting the importance for central banks of keeping price expectations solidly anchored, if the impact of market stress is to remain limited – in both length and scope. How the South African Reserve Bank is reacting The SARB has had to acknowledge the risks that the changing global environment is posing to the domestic inflation outlook. Earlier this year, a decline in both actual and forecast inflation – relative to what the SARB’s models had been projecting – had allowed the Monetary Policy Committee (MPC) to ease policy moderately, by 25 basis points in March, in an environment of weak domestic demand. However, the outlook for inflation has since deteriorated, even though actual inflation readings generally remained benign and the impact of the increase in the value-added tax rate from 14% to 15%, in particular, seemed relatively muted. Exchange rate depreciation as well as the rising trend in world oil prices and uncertainties about future electricity tariff increases pose the main upside risks to the outlook. While inflation is still expected to remain within the 3–6% target range over the forecasting period, according to the latest forecasts from the SARB’s Quarterly Projection Model (QPM), inflation will peak at 5.9% year on year in the second quarter of 2019, before eventually settling at 5.4% in the last few quarters of 2020. Core inflation is expected to follow a relatively similar, though smoother, profile, peaking at 5.6% year on year during the course of 2019. Given the volatile environment, the risk of an overshoot of the target, given the balance of risks, should not be underestimated. Furthermore, an extended and sizable deviation in inflation from the midpoint of the target range would raise the risks of medium-term inflation expectations drifting back to, if not above, the top end of the range. The SARB’s QPM model projects that in order to bring inflation back towards the target midpoint in the long run, five interest rate increases of 25 basis points each will be needed by the end of 2020. It is important to reiterate that the QPM projection is not a pre-commitment to a future rate path. It is a broad policy guideline that can and will evolve as economic conditions change. At its most recent meeting about two weeks ago, the MPC opted to leave the repurchase rate unchanged at 6.50%, cognisant that downside risks to the growth outlook had partly offset the upside risks to the future inflation profile. The output gap remains negative and unlikely to close until late 2020, suggesting that risks of demand-led price pressures should remain low over the forecasting period. Nonetheless, the MPC will need to remain vigilant and ready to act against any sign of second-round price effects from the recent rand exchange rate and oil price shifts. The exchange rate of the rand has been the subject of much debate recently, given its depreciation and heightened volatility in reaction to a combination of fundamental drivers, external risk factors and a general reallocation of capital away from emerging markets. A number of emerging markets have more recently resorted to intervention in the foreign exchange market, informed by their own country-specific circumstances. The SARB has allowed the exchange rate to act as a shock absorber and adjustment mechanism, and maintained its policy of not intervening in the foreign exchange market with a view of supporting the currency. However, as previously stated, this does not mean that we are totally indifferent to exchange rate movements. It also does not mean that there cannot be circumstances where the cost of not intervening to dampen excess volatility or abrupt and disorderly adjustments, could be higher than that of intervening. This suggests that policy flexibility requires that foreign exchange intervention continues to be part of the monetary policy toolkit to support economic and financial stability. As previously stated, our preference has been to deploy this tool if there are signs of the orderly functioning of markets being threatened, rather than to go against the grain of a market, which is realigning and repricing on the back of the factors mentioned above. Recent developments in domestic foreign exchange markets have not been judged to have been of such magnitude and nature that they required any intervention from the SARB. Challenges in the rest of sub-Saharan Africa A changing global environment is equally as important for the rest of the African continent. A decade or so ago, the conventional view was that, apart from the demand for exports and the impact of commodity price fluctuations on the terms of trade, African countries were relatively insulated from global financial shocks, as their economies were less integrated into the world financial system and thus less vulnerable to portfolio outflows or cutbacks in banks’ cross-border loan portfolios. This proved true, to some extent, in the global financial crisis, when the sub-Saharan African region experienced a less pronounced growth downturn than other major regions. However, this too is changing. Greater integration of sub-Saharan Africa into global financial flows has brought access to new resources for the financing of investments and economic development. It has also, however, ushered in a greater vulnerability to potential capital outflows. So far this year, with a few exceptions, currencies in sub-Saharan Africa have depreciated by only a moderate amount against the US dollar. The recovery in oil prices appeared to help energy exporters, while other countries benefitted from continued, relatively stable economic growth. However, other segments of their financial markets have not performed as well. In particular, yields on eurobonds – which have grown in size as a funding instrument in recent years as sovereigns took advantage of the global ‘search for yield’ – have increased. In most cases, such yields are up by 100 to 150 basis points from early 2018 lows, reversing a significant part of the previous two years’ rally. At the same time, ‘frontier’ equity markets are displaying a stronger correlation with larger emerging markets than before, illustrating the vulnerability of earlier gains in still-small African stock exchanges. Furthermore, several fundamental economic trends in sub-Saharan Africa are a growing source of vulnerability. Current account imbalances are rising in a majority of the continent’s countries, which are largely non-resource exporters, and contributing to a rising trend in external liabilities relative to GDP. Government budget deficits remain fairly high, pushing public debt ratios higher. And while economies continue to grow in real terms, the experience of the past few years – in particular, their abrupt slowdown in 2015 – highlights the region’s vulnerability to external developments, such as swings in resource prices or a rebalancing of China’s growth path towards less commodity-intensive demand. Finally, while inflation in the first half of 2018 was reasonably benign in the majority of African countries, the sensitivity of consumer price trends to prices of oil and food commodities, and to exchange rate swings – because of the high share of consumer goods that are imported – is a strong reminder that such stability cannot be taken for granted. What will happen next? How will the emerging market situation evolve over the next few months and quarters? In the past couple of weeks, pressure on emerging currencies and other assets has abated to some extent, helped by signals from several central banks indicating that they would not tolerate durable upward shifts in inflation. However, it is too early to predict a stabilisation in emerging market assets, and too early to say with confidence whether the recent market correction will, or will not, turn into a more severe adjustment that could severely undermine growth prospects, and possibly strain corporate and bank finances in emerging countries. At present, many economists are of the opinion that emerging market assets, and especially currencies, are more fairly valued than they were at the start of the year. However, historical experience tells us that ‘overshoots’ can often happen, following adjustments similar to what has just been witnessed, and financial assets can face an extended period of volatility before settling around new ‘equilibrium’ values. There are, however, some encouraging factors which should limit the risk of a further, severe adjustment. First, as I indicated earlier, growth in advanced economies has remained relatively resilient, much as risks seem tilted to the downside. Even in emerging markets, with the exception of Argentina, Turkey and South Africa , growth forecasts have not significantly changed since early 2018; hence, the risk that financial market stress in emerging countries could negatively ‘spill back’ into the advanced economy growth outlook still appears, for now, to be low. Importantly, too, much as the risk remains, we are not witnessing the kind of inflation pressures that might force the world’s major central banks into a significantly faster pace of policy tightening – potentially derailing economic expansion. While both headline and core inflation are at present higher in the US, eurozone and Japan than, on average, in the past few years, few economists anticipate a prolonged overshoot of inflation targets – in the event that these targets are reached in the near future, which may not always be the case. And, while tighter labour markets are finally pushing wage growth higher, this is in part offset by some acceleration in productivity, implying limited upward pressure on prices from unit labour costs. Equally, just like it has not led to a strong build-up of price pressures in advanced economies, the prolonged period of stimulative monetary policies has not led to the kind of broad-based private sector (especially financial sector) leveraging that would threaten an early and abrupt end to what is now an extended period of economic expansion. Admittedly, in some large emerging countries, in particular in China, private sector liabilities have risen sharply in the past decade as a share of GDP, raising the risk of a future adjustment that may, at some stage, have adverse consequences on not just local but also global economic growth. However, in the short term, the steps recently taken by Chinese authorities – including some mild loosening of their monetary, fiscal and regulatory stance – indicate that they do not see the deleveraging of specific segments of the economy as incompatible with a relatively stable pace of economic expansion. This said, several factors of uncertainty are likely to persist in coming quarters, implying an ongoing strong need for vigilance by central banks, especially in emerging countries such as South Africa that enjoy open and liquid capital markets. The first factor to mention is the recent escalation in trade conflicts between the US and China, with both nations announcing an increase in tariffs on a broader range of goods than initially targeted. While earlier tariff announcements in the second quarter of 2018 appear to have not yet had major negative effects on economic activity, concerns remain that a broader, longer conflict could undermine global trade flows, corporate investment and, ultimately, economic growth. More generally, a move away from the multilateral approach to international relations followed in recent decades – not only in trade but also in financial, regulatory and even military matters – could create a more complex environment for emerging countries relying on open markets and stable external relationships for economic development. Turning to financial matters, one factor of uncertainty is the future path of risk-free, ‘neutral’ real interest rates in coming years, and how this will continue to affect global investors’ appetite for risk and, in turn, the cost and accessibility of foreign funds for emerging economies. In the decade following the global financial crisis, several factors tended to depress these risk-free rates, including low productivity growth, higher precautionary savings, and continued reserve accumulation by emerging countries with large current account surpluses. However, these factors have started to fade, albeit gradually. Finally, geopolitical issues remain a concern. In the past few years, commentators and investors have mostly focused on growing voter frustration of low growth and rising job insecurity in advanced economies. However, one should not forget that such challenges persist in emerging economies too, in particular in Africa. Failure to address issues of persistent inequality and poverty, insufficient job and skills development opportunities, and poorly planned urbanisation could easily increase social unrest and reverse earlier gains towards a more stable, rules-based policy environment. And while most of the policy responses fall outside the remit of central banks’ mandates, their contribution to price and financial stability remain essential if development goals are to be achieved. Conclusion Acknowledging the impact of the downside risks, especially the escalating of trade tensions and the tightening of global financial conditions, to global growth and inflation, it goes without saying that global coordination and cooperation to deal with these challenges is necessary. In part this would mean that authorities should consciously implement policies and reforms that will weather the financial markets volatility as well as protect global expansion. This kind of coordination and cooperation has served the global economy well during the last global financial crisis and we should work hard to improve on that. Thank you.
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the ABSIP (The Association of Black Securities and Investment Professionals) National Conference, Johannesburg, 19 October 2018.
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Lessons from the economics of populism Governor Lesetja Kganyago’s address at the ABSIP National Conference Johannesburg Friday 19 October At the end of the road one cannot avoid wondering whether the mistakes of past populist regimes can be internalized by policymakers, politicians, and the population at large and, thus, be avoided in the future. Quite clearly, [history] suggest[s] that, in general, there is very little capacity (or willingness) of learning from other countries’ experiences. Indeed, one of the most striking regularities of these episodes is the insistence with which the engineers of the populist programs argue that their circumstances are unique and thus immune from historical lessons from other nations. - Rudiger Dornbusch & Sebastian Edwards My speech today is about populism, about its appeal and its weaknesses. Populism wins supporters in part because it speaks to ordinary people about real problems – problems other leaders can be too embarrassed or nervous to confront. For instance, when Hugo Chávez attacked corruption and inequality in Venezuela, he wasn’t just making trouble. He was confronting some longstanding problems of Venezuelan society. But populism also has a bad side: it pretends there are easy solutions, even where there are none – where the problems are in fact very difficult. Often the easy solutions have unintended effects, impacts that populists ignore or are unaware of. It is these unintended effects that usually end up hurting the people those easy solutions were meant to help. Populist governments tend to be especially weak on economics, which is a common reason why their projects fail. In my speech today, I will explore what it is about economics that populism get wrong, and what we can learn from that. The knowledge I will detail is mostly drawn from Latin America, a place where populism has flourished over the past century. This experience is relevant for us because these economies closely resemble ours. In particular, they are middle income countries with high levels of inequality. Of course, every country is different. But the populist experience has been so similar, across so many countries and time periods, that we can pull together a few clear lessons relevant to our times and circumstances. Economic populism starts with deep dissatisfaction.1 Too much unemployment, too much inequality, too much poverty. The populist solution is to start spending – push as much demand as possible into the economy, without consideration of constraints. The argument is that more spending will make people better off. More demand encourages more supply, meaning more jobs and more investment. It’s supposed to be a virtuous circle. So the government starts spending money – as much as possible. It borrows from people’s pension funds. It borrows from the central bank and demands it buys its debt – which means printing money. It spends the foreign exchange reserves. And at first sight, it works. As scholars of populism have noted, the immediate consequence of these policies tends to be an economic boom. People who warn that populism is a disaster will look foolish. There is more growth and big wage increases and more jobs. But it doesn’t last. Time and time again, the boom turns to bust. Inflation shoots up and growth collapses. Some populists realise their strategy has failed and change course. Others put their countries through even greater pain. During the 1950s, the Argentine president Juan Perón effectively aborted his populist programme when inflation neared 50%.2 In Peru, Alan García abandoned his stimulus programme in 1988, with inflation well over 1000%.3 In Venezuela, inflation is expected to reach one million percent this year,4 and people are fleeing the country to find food, but the policy direction still hasn’t changed. What is it about the populist recipe that goes wrong? The literature focuses on two kinds of constraints: inflation and the balance of payments. Now these are things populists probably don’t see coming. They don’t understand the causes of inflation very well. And they may not even know what the balance of payments is. But these are powerful forces, and ignoring them doesn’t mean they will leave you alone. The inflation problem is fairly simple. If a government wants to stimulate demand, it will want low interest rates, and it will demand that the central bank print money to buy its bonds. This extra money does a couple of things. It raises demand, and with the economy running hot, firms and workers put up their prices. It causes the exchange rate to depreciate. And because people see the government is printing money, they start to put a lot of time and effort into figuring out where inflation is going, and raising their prices to keep ahead of it. This process then gets worse over time. In the first year, you get a fair amount of growth and a bit more inflation. In the second year, you get even more inflation and less growth. A few years in, inflation is running at very high levels – there are cases of inflation exceeding several thousand per cent a year, including Peru and Brazil, and as Zimbabwe showed us, there are many more zeroes that can be added after that. This is poison to an economy – it destroys people’s savings and shuts down longer-term credit markets. It also interferes with the 1 This discussion of populist macroeconomics draws on the seminal essay by Rudiger Dornbusch and Sebastian Edwards (1990) “The Macroeconomics of Populism” in The Macroeconomics of Populism in Latin America, University of Chicago Press 2 Paul H. Lewis (1990). The Crisis of Argentine Capitalism, University of North Carolina Press 3 John Crabtree (1992) Peru Under García: An Opportunity Lost, University of Pittsburgh Press 4 Alejandro Werner (2018, July 23) “Outlook for the Americas: A tougher recovery” Available at: https://blogs.imf.org/2018/07/23/outlook-for-the-americas-a-tougher-recovery/ everyday business of buying and selling goods and services. So what starts with a nice growth bump ends in a deep depression, and a large increase in poverty. The other constraint is the balance of payments. When a populist government starts to push up spending, it increases domestic demand. That doesn’t change foreign demand so you don’t get more exports. In fact, local producers will probably be so worried about policy consistency and rising inflation that exports will stagnate. But the import bill still rises as demand booms, and that import bill needs to be paid somehow. Populists may hope that new demand will all go into domestic production, but they are invariably proved wrong. There are no modern economies that produce everything they need locally, from oil to machinery to food to smartphones. And foreigners like to be paid in hard currency, not an inflation and depreciation-prone currency. The shortage of forex therefore becomes a constraint – a bottleneck. No matter how much demand you push into the economy, you don’t get more supply because you can’t finance enough imports. In economic terms, the import-intensity of demand means an economy can overheat even when other factors of production are lying idle, with high unemployment or factories operating below capacity. The symptoms of this foreign exchange constraint will be a widening current account deficit and strong depreciation pressure on the currency. So long as there are foreign exchange reserves left, or there are people willing to lend you dollars, the boom can go on. But as financing dries up, the government ends up going to the only lender who will still take its calls, the IMF. Of course, the IMF isn’t interested in funding an unsustainable spending programme. So this means accepting the kind of spending cuts populists started out rejecting. There is also a third kind of constraint on populism, which moves a bit slower but may be the most dangerous of all. I’ll call it the “know-how” constraint, and it is fundamentally about the sources of wealth. In the populist narrative, that story is simple. They say, our country is rich. If the people are poor, that must be because someone else has hoarded these riches – like foreigners, or elites. The solution, then, is to redistribute the wealth to the people. In practice, however, although populists reliably point to sources of great wealth that they plan to redistribute – oil, land, gold, or something else – they invariably run into macroeconomic trouble. The wealth doesn’t cover the extra spending they want to do. And they don’t appreciate that their antimarket rhetoric and policies disrupt production and kill off investment. As a result, they can deliver temporary consumption booms, but not lasting improvements in welfare. Redistributing an existing stock of wealth does not mean that that stock of wealth can be built again. Perhaps the most profound meditation on why this happens comes from Ricardo Hausmann, a Venezuelan economist and former finance minister currently teaching at Harvard. Professor Hausmann has, of course, had personal experience of a country that seems rich but whose people are nonetheless persistently poor. Accordingly, his analysis emphasises the value of know-how, of expertise.5 Lasting wealth, by this account, isn’t in a country’s soil but in its citizen’s heads. Countries get rich because people develop specialised skills, and because they find ways to cooperate so they can do things much too complex for any individual to do alone. To handle all this complexity and specialisation, people gather in firms, and firms interact in markets. The state can help with this whole process, for instance through investing in education, guaranteeing security and providing other public goods. But if the state declares war on market mechanisms and condemns rich people, it starts to break the machine that generates wealth. It kills off investment. It scares skilled people away. In this world, natural resources don’t get used effectively, no matter how abundant they are, and the economy doesn’t develop other kinds of industries either. This theory helps explain why resource wealth does not always generate national prosperity. Certainly, there are countries with natural resources that are either very rich, like Norway, or that are reasonably prosperous, like Botswana. But there are also countries with the exact same resources that are poor, like Angola with oil or Sierra Leone with diamonds. And while there are countries that lack extraordinary natural resource endowments and are poor, like Malawi,6 there are also countries that are resource-poor but highly developed, like South Korea or Germany. Clearly, there is more to wealth than winning the commodity lottery. This message doesn’t appeal to populists. For instance, populists do not want to hear about how a resource like oil is difficult to extract, that it requires highly qualified people and carefully maintained infrastructure and well-organised firms to manage the whole process. More broadly, populists aren’t really interested in the hard work of development, the patient progress whereby you grow incomes by a few per cent a year, until after a generation you’ve become a developed country. For them, the country is already rich, and because the country is rich, the problem must be that someone is stealing the wealth. Unfortunately, people fall for ‘get rich quick’ schemes all the time, and countries can fall for them too. There is abundant evidence that the economic strategy of populism leaves people worse off than they were before. Yet somehow, the same ideas show up time and again, as if no-one ever learned from past mistakes. The disaster playing out in Venezuela at the moment is no surprise to anyone who knows anything about Latin American history. We have seen the same basic story in Argentina, Brazil, Chile, Peru and elsewhere. But all these economic disasters on Venezuela’s doorstep couldn’t spare that country from doing the same terrible things to itself. Yet it is perhaps too strong to conclude humans never learn. Venezuela aside, other countries have learned from populist mistakes, and constructed defences against repeating those errors. The fundamental mistake of economic populism is failing to understand constraints. Accordingly, the 5 Hausmann, R., (2016). Economic Development and the Accumulation of Know-how. Welsh Economic Review. 24, pp.13–16. Available at: http://doi.org/10.18573/j.2016.10049. See also Hausmann (2017, March) “Das Knowhow Kapital” available at: https://www.project-syndicate.org/commentary/south-africa-zumaknowhow-shortage-by-ricardo-hausmann-2017-03 6 For a discussion of the Malawian example, see Paul Collier (2007) The Bottom Billion, Oxford University Press fundamental solution countries have adopted is building constraints into their policy framework. Instead of madly insisting there are no limits, no constraints, that everything is possible, policymakers look for what freedom of manoeuvre they enjoy within economic reality. In a sense, they design their macroeconomies to have brakes and airbags, not just accelerators. Of course, accelerators are still useful. Modern policymakers almost universally acknowledge that there are times and places where policy stimulus is appropriate. But those tools are for smoothing output over the cycle. They can’t deliver long-run development, and they won’t work in the presence of bottlenecks. If a government is facing rising inflation and a binding balance of payments constraint, stimulus is precisely the wrong strategy – as Turkey’s financial crisis is once again reminding us. Denying this reality just makes reality more painful. So what are the policy frameworks countries use to accommodate reality? Latin American economists like to talk about a policy tripod, comprising inflation targeting, a floating exchange rate, and measures to protect fiscal sustainability. The first part of the tripod, inflation targeting, directly tackles the problem of the inflation constraint, without sacrificing flexibility. If an economy is struggling and inflation is low, it’s an easy call to cut rates. If inflation expectations are well-anchored in line with the target, it’s easy to look through temporary supply shocks, such as oil or food price spikes. And if inflation is rising and inflation expectations are getting out of control, the policy framework will tell you it’s time to tighten, and an independent central bank will have the means to do so. If twenty years ago Venezuela had embraced inflation targeting and central bank independence, today they would have low and stable inflation, not hyperinflation. And they would be richer for it, even though they would at some point had to raise rates and made themselves unpopular. It is better to have unpopular central bankers from time to time than hyperinflation and expanding poverty. The second leg of the policy tripod is a floating, market-determined exchange rate. Again, this sends everyone the right signals. If the currency is depreciating, it tells importers to cut back, and it tells exporters to raise production. By contrast, a fixed exchange rate helps everyone hide from economic realities too long – leading an economy to rely too much on imports, and to borrow too much in foreign currency. Fixed exchange rates create the appearance of stability, but they are so brittle that when they fail, they fall apart completely, doing tremendous damage. By contrast, floating exchange rate regimes are volatile, but resilient – they give you bad news immediately and help you deal with it, instead of storing it up for later. The final leg of the tripod is some kind of fiscal rule, to protect government’s solvency even when short-term pressures to spend more and borrow more are very high. Chile, for example, has built systems to save copper income in good times, so when bad times come they don’t have to slash spending at the worst possible moment. Brazil has a fiscal responsibility law, which is meant to guarantee a primary budget surplus except in emergencies, so debt levels stabilise over the economic cycle. Unfortunately, fiscal rules have proven easy to break. The result is that countries can slip back into unsustainable fiscal policies, as has happened in Brazil, even as the other parts of the tripod stay standing. In South Africa, we have implemented a policy of fiscal transparency, so everyone can see what fiscal policy is doing and what we expect it to do. This has prompted a clear message from analysts, investors, the ratings agencies, international organisations and others that South Africa needs to maintain budget responsibility and get State-Owned Enterprise risks under control. This is a priority government has reiterated in successive Budget documents. This macroeconomic tripod is not perfect. Unfortunately, there is no constitutional autopilot that can be written into law and will then produce national prosperity. That said, a sound macroeconomic framework can prevent a lot of pain. This is important, because the temptation to do the wrong thing is clearly strong. This is evident from all the economic mistakes countries have made in history, and continue to make today. But I also know it is true because I often hear people in South Africa contemplating these temptations. People ask, wouldn’t it be worth taking big risks, having more inflation, borrowing as much as we can get away with, if only we could get some growth and some jobs? They even say, in a highly unequal country like South Africa, wouldn’t it be politically safer to take macroeconomic risks to try and get poverty and unemployment lower? But this is wrong, for two reasons. First, this only seems attractive until you’ve actually tried it. Macroeconomic stability is like oxygen. You don’t miss it until you haven’t got it, and then it’s all you can think about. People who want to engineer a short term boom and ignore the long term costs won’t like it when the long-term shows up, which history suggest normally starts after about two years. If you don’t think inflation matters, go try some. Or ask all the Zimbabweans or Venezuelans who had to leave their countries when their economies collapsed. Unorthodox policies have totally orthodox consequences, as those people can confirm. Second, countries with difficult social foundations need to be more careful about macroeconomic stability, not more reckless. That’s because a macroeconomic crisis is an incredibly wrenching social experience, and you need a very strong society to get through one peacefully. When a country blows up its own macroeconomy, its policy options narrow, to the point where all the choices are bad ones. If you can get anyone to lend to you, it will be the IMF. One way or another, you will end up doing real and brutal austerity. What we have had in South Africa over the past few years isn’t anything like this. We have interest rates close to all-time lows – the repo rate is at 6.5% currently – and government spending has been increasing every year, faster than inflation. Real austerity is having interest rates at 65%, as in Argentina at present, and cutting pensions and grants and firing government employees. We should avoid reckless economic policies unless we want to risk putting our society through that pain and stress. This brings me to end of my speech. In conclusion, I would like to leave you with four principles for confronting populist economic policies, drawn from the ideas I have discussed today. First, rich countries don’t make rich people. If your development strategy is to return the wealth of the country to the people, you don’t have a development strategy. Real, lasting wealth is about knowhow, not natural resources. Second, if you hear someone urging stimulus and going for growth, ask how they plan on dealing with the macroeconomic constraints. What’s the plan for inflation? How are they going to meet the import bill to avoid a balance of payments crisis? If they don’t have a serious answer, they aren’t serious. If they do have a serious answer, expect it to include policies like inflation targeting, a floating exchange rate and measures for keeping the fiscus solvent. These things cannot be ignored. South Africa’s stimulus and recovery package does take these into account. Third, acute challenges of inequality, poverty and unemployment are not reasons to gamble on macroeconomic stability. South Africa’s social challenges mean we need to be extra careful about managing the system carefully so it doesn’t blow up – not that we need to run the system as hot as we can get it and hope for the best. Finally, don’t ignore populists completely. They are very good at tapping into social frustrations – in a way, they are uncannily good instruments for detecting where society is hurting most. They aren’t very good at economics, so their ideas routinely end in disaster, but that doesn’t mean they are altogether foolish. Rather, they are a reminder to better informed, more responsible people that things have to change. We cannot just say the populist path will end in disaster. It will. But we still have to point out another path. You cannot just be against populism – you need to be for something too. We need to talk about how we are going to get back to real and sustainable growth in South Africa. Thank you.
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Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at UBS's Ninth Annual Economics Conference, Cape Town, 19 October 2018.
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An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at UBS's Ninth Annual Economics Conference The Radisson Blu Hotel, Cape Town 19 October 2018 The monetary policy outlook and challenges in South Africa Distinguished guests, ladies and gentlemen. Thank you for having me here today. During my speech, I will discuss the outlook for the South African economy and the current stance of monetary policy. I will also touch on recent trends in the global economy and the influence that these are having on South Africa. Global economic developments Global economic developments can increasingly be characterised as asynchronous and risk-prone. Growth in the United States (US) appears to be diverging from that of other advanced economies. The International Monetary Fund (IMF) projects growth in the eurozone, the United Kingdom (UK) and Japan to be slower in 2018 than in 2017, moderating to 2.0%, 1.4% and 1.1% respectively.1 Meanwhile, US economic growth is forecast to accelerate this year to 2.9% from an already strong level of 2.2% in 2017. The opening up of a significant growth gap is, in part, related to the fiscal stance of the US relative to other large advanced economies. The US budget deficit for 2018 is 1 International Monetary Fund. (October 2018). World Economic Outlook. Page 1 of 8 expected to rise to 4.7% of gross domestic product (GDP) – the largest in six years. Conversely, Germany is expected to record its largest budget surplus in a decade, while Japan is forecast to narrow its deficit to 3.7% of GDP. The UK has recently moved to a slightly more stimulatory stance, with its 2018 deficit rising marginally to 2% of GDP, but this remains a small budget shortfall relative to every other year of the past decade.2 A strong fiscal impulse in the US alongside low levels of unemployment and gradually rising inflation is providing the justification for further US monetary policy tightening. One could argue that US monetary policy has been diverging from that of other large advanced economies for a number of years. But, with the latest fiscal stimulus, this divergence looks set to widen further. As of last month, the Federal Reserve (Fed) had hiked its benchmark interest rate eight times in less than three years – on each occasion by a quarter of one per cent. Meanwhile, the so-called ‘dot plot’ published by the Fed’s Federal Open Market Committee indicates that the measured pace of US interest rate increases is likely to continue in 2019. In Japan, the benchmark interest rate is in negative territory and large-scale asset purchases remain underway. The European Central Bank is gradually becoming less accommodative as it tapers its asset purchase programme, but it is guiding for its benchmark deposit rate to remain slightly below 0% for at least another year. The UK, meanwhile, has hiked its benchmark interest rate twice since last year when it was at its lowest level of the cycle. Thus, two important trends are apparent. First, monetary policy in the advanced economies is becoming less accomodative overall. Second, the US is far more advanced in its tightening cycle, no longer describing its policy stance as accommodative. As a result, global financing conditions are tightening. 2 International Monetary Fund. (October 2018). World Economic Outlook Database. Page 2 of 8 It has historically been the case that upswings in the US interest rate cycle have given rise to growth and financial stability risks in the emerging markets. On the whole, emerging markets appear to be relatively more resilient today than they were in the 1990s, for example, when rising US interest rates precipitated a widespread crisis. This resilience has in part been supported by the development of domestic capital markets (which reduces reliance on external debt), a movement towards more flexible exchange rate regimes, and increased self-insurance through the build-up of substantial foreign-currency reserve buffers. Nevertheless, US policy continues to meaningfully affect financial conditions elsewhere due to the widespread use of US Treasury bonds as a global risk-free benchmark as well as the dominant role that the dollar plays in global trade and finance. Furthermore, it has recently been estimated that countries representing more than half of global GDP have principally anchored their currencies to the US dollar3, which implies a link between the monetary policy of these countries and that of the US. For many emerging markets, the tightening global financing conditions are giving rise to capital outflows. While the forecast for emerging market and developing economies is one of gradually accelerating growth over the medium term1, these capital outflows are exposing vulnerabilities in some countries. Moreover, they are giving rise to currency weakness and, in turn, higher inflation across a number of emerging economies. South Africa has been no exception. Global financial market volatility is being exacerbated by trade tensions between the US and various other large economies, in particular China. Increased tariffs, if they persist, threaten to reduce global trade volumes and disrupt complex supply chains. The recent rise in oil prices is a further challenge, driving up inflation and weighing on the trade balance of oil-importing countries. The price of Brent crude oil has doubled since early 2016, but remains well below the high of approximately US$154 reached 3 Ilzetzki, E., Reinhart, C. and Rogoff, K. (2017). Exchange arrangements entering the 21st century: which anchor will hold? National Bureau of Economic Research Working Paper 23134. Page 3 of 8 in 2008. However, when priced in the currencies of emerging markets like Brazil, Mexico or South Africa, Brent crude oil is back near its historical highs. Notwithstanding these concerning developments, global growth on aggregate remains relatively strong and is expected to moderate only marginally over the medium term. This trend is also reflected in the forecasts for South Africa’s major trading partners where, on average, GDP growth is expected to slow slightly from 3.6% in both 2017 and 2018 to 3.5% in both 2019 and 2020. South Africa faces two key external risks over the coming months. The first is a possible sharp and sustained drop in capital inflows, as US interest rates increase. The second is a further substantial rise in oil prices. The two could also conceivably occur simultaneously. If so, South Africa would face increased inflationary pressure and a further drag on household disposable income. Domestic economic developments The domestic economy has substantially underperformed in 2018 relative to expectations formed at the beginning of the year and the longer-term trend. Indeed, the technical recession recorded in the first half of the year surprised most economic analysts. At the January meeting of the Monetary Policy Committee (MPC), we had forecast GDP growth of 1.4% for this year. By the September MPC meeting, this was revised down to 0.7%. The weakness in economic activity witnessed in 2018 reflects a combination of transitory factors and more persistent constraints. Poor weather conditions exacerbated the fall in agricultural output from 2017’s elevated level. Meanwhile, ongoing policy uncertainty and weak domestic demand resulted in a lack of business investment and hiring. Moving into 2019, we are anticipating an economic rebound driven largely by an export recovery and improved growth in fixed investment. Household and government spending growth is projected to remain stable. We believe that the relatively weak level of the exchange rate, alongside firm global growth, will provide support to the export Page 4 of 8 sector over the coming quarters. This, in turn, is projected to gradually lift privatesector capital formation. Furthermore, as the transitory shocks of 2018 fade, the low base that they would have established will support the 2019 growth rate somewhat. In order to determine whether the economy is operating with spare capacity, we estimate a level of potential output and compare it to the actual level of output. Based on our estimates, potential growth has fallen substantially: from levels in excess of 4% per year in the mid-2000s to an average of 1.2% since 2015. This reflects, among other things, a sharp slowdown in the growth of fixed investment, skills constraints, and weak productivity gains. Even with an unusually low level of potential growth, the South African economy has consistently failed to reach its potential. This has been underscored by the recent recession, which produced a more negative output gap estimate of -1.5% of GDP for the second quarter of 2018 – the widest gap in a decade. Given the weak starting point, the output gap is now projected to close only in the final quarter of 2020 – a full six months later than the MPC had predicted at its July meeting. The relatively large output gap, alongside low food prices and the effect of an exchange rate appreciation in 2017 and early 2018, has constrained inflation. For example, in August, core inflation had moderated to 4.2% year on year. This was the 11th straight month in which core inflation had remained at, or below, the 4.5% midpoint of the South African Reserve Bank’s (SARB) inflation target range. However, headline inflation that same month was higher at 4.9% year on year. Much of the gap between these two measures reflects demand-insensitive administered price growth, which in August stood at 12.1% year on year. In this regard, it must be highlighted that greater restraint over the rise of administrative prices, to the extent that it is within the control of the relevant price-setters, could serve to provide the MPC with increased monetary policy flexibility and potentially with room for a relatively more accommodative stance than would otherwise be the case. As monetary policy operates with a lag, the level of inflation that the MPC must consider is that which is expected to prevail over the coming 12-24 months. Page 5 of 8 Unfortunately, the inflation forecast is far less benign than the levels currently being experienced. Headline inflation is expected to increase from an average of 4.8% in 2018 to 5.7% in 2019 and 5.4% in 2020. This includes a forecast peak of 5.9% in the second quarter of 2019. The upward trajectory of inflation is driven by the pass-through from the recent exchange rate weakness, rising food and oil prices, a narrowing output gap, and our expectation that nominal wage growth will remain above the upper end of the inflation target range over the forecast horizon. The SARB’s Quarterly Projection Model (QPM) forecasts inflation simultaneously with the repurchase rate (repo rate) as part of its general equilibrium framework. Given the outlook for the exchange rate, the output gap and inflation, the QPM forecasts five interest rate hikes of 25 basis points each by the end of 2020. All other things being equal, if monetary policy tightens by less than the model predicts, inflation may come out higher than is currently expected. The repo rate forecast of the QPM is merely a guideline and does not fully account for the balance of risks or for the uncertainty around the variables, both included in and excluded from the model. The MPC may well diverge from this endogenously generated interest rate path. Nevertheless, the key point is this: if the inflation forecast plays out as expected, monetary policy tightening will be required to stop inflation, and potentially also inflation expectations, from moving outside of the SARB’s target range for an extended period of time. The likelihood of slightly higher nominal interest rates over the medium term must be put in context, however. Monetary policy has been, and remains, accommodative. Had the economy not been so weak, the policy stance would in all likelihood have been different. It is also worth bearing in mind that it is the real repo rate that is relevant when thinking about the policy stance. Thus, monetary policy can remain accommodative of the large negative output gap, even as the nominal interest rate rises, if it is rising alongside higher expected inflation. Page 6 of 8 From this discussion, it should be clear that the MPC faces a challenging outlook. It is difficult to balance the large negative output gap and downside risks to growth against the rising inflation trajectory and upside risks to inflation. This is further complicated by significant uncertainty around the forecast for key variables, including the oil price and the exchange rate, not to mention the possible consequences of escalating trade tensions. During periods such as the one we are currently in, calls for much easier monetary policy become more common, for understandable reasons. However, as we have been at pains to point out, the main drivers of the current weakness in economic activity are structural in nature. Monetary policy is rather constrained in the support it is able to provide under such circumstances. Indeed, it would be imprudent to provide additional monetary stimulus in the face of elevated inflation projections, emerging market turbulence, and a domestic environment characterised by policy uncertainty and lofty risk premiums. Under these conditions, the growth benefits of such a stimulus would likely be muted. But, more importantly, monetary easing would raise the spectre of an upward inflation spiral. This is not merely theoretical; there are numerous examples of such outcomes among emerging markets today. We simply will not allow our hard-won credibility to be squandered in that way. Those who call for increased monetary accommodation often do so in the name of the poor. However, recent IMF research shows that the poor benefit most when inflation is low and they are least adversely affected by rising interest rates.4 This is because the poor are less able to shield themselves from the effects of inflation and tend to have lower exposure to floating interest rate debt. Therefore, a loose monetary policy is not likely to be pro-poor, nor would it be a net benefit to the economy over the longer term. In fact, the loss of central bank credibility, especially in cases where their independence is questioned, comes with high social costs over the longer term. This 4 International Monetary Fund. (2018). South Africa Article 4 Consultation. Page 7 of 8 is because very dramatic steps are required to contain inflation and stabilise the economy once market confidence in a central bank is lost. The recent steep tightening in the policy rates of Argentina and Turkey, to 73% and 24% respectively, serves as a stark reminder that the erosion of central bank credibility and independence comes at a steep cost. Monetary policy is far better utilised as a tool to anchor inflation expectations and ensure that all South Africans are provided with a degree of certainty about prices in the future. Indeed, this is the only way in which it can positively contribute to long-run investment and growth, and thus fulfil its constitutional mandate of ‘protecting the value of the currency in the interest of balanced and sustainable economic growth in the Republic’. Concluding remarks The MPC faces a difficult balancing act. We do not want to unduly constrain an already weak economy, but we must also ensure that the average South African’s purchasing power remains intact. Hence, the repo rate may rise gradually over the medium term, in a manner consistent with keeping inflation inside the target range. However, we are not bound to any particular path of action. Rather, the MPC will continue to conduct policy commensurate with the forecast and the balance of risks as these stand at the time of each meeting. Thank you. Page 8 of 8
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Risk South Africa Conference, Cape Town, 23 October 2018.
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Keynote address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Risk South Africa Conference Cape Town 23 October 2018 Transitioning to new interest rate benchmarks: Why is this important for financial policy? Good afternoon, ladies and gentlemen. I would like to thank Risk South Africa for inviting me to speak at this conference. After a long day of speeches and presentations, I hope I manage to keep you engaged over the next few minutes, well aware of the fact that I stand between you and a cocktail function. I have been asked to make some remarks about the reform of the London Interbank Offered Rate (Libor), specifically what the future of Libor entails and what the reform of interest rate benchmarks in general means for market participants. Given the recent work done by the South African Reserve Bank (SARB) on this topic, I thought I would use this opportunity to also talk about how we are thinking about the reform and the overall design of interest rate benchmarks in South Africa. Background to the reform of Libor There is extensive literature on the reform of interest rate benchmarks globally, and the SARB published a consultation paper on selected interest rate benchmarks in South Africa on 30 August 2018. Page 1 of 13 The literature goes a long way in explaining what various international organisations1 have done, and are still doing, to encourage the reform of interest rate benchmarks and to inform global markets about the benchmark reform objectives and about progress in this regard in the Official Sector Steering Group (OSSG) countries as well as the non-OSSG jurisdictions. By and large, the global drive to reform interest rate benchmarks is a coordinated response by international regulators and central banks to cases of actual and attempted manipulation of global interest rate benchmarks and declining liquidity in key underlying unsecured funding markets. These responses focus on initiatives to improve the resilience and transparency of interest rates benchmarks used as reference rates. Given the lack of confidence in, and the declining credibility of, the major interest rate benchmarks after the Libor incidents became public in 2012, these initiatives culminated in recommendations on how to strengthen the key interbank offered rates (collectively referred to as ‘Ibors’) and use risk-free rates (RFRs) for derivative markets. This was also informed by the systemic nature of the risk that major interest rate benchmarks posed to the global financial system, A key component underpinning all the reference rate reforms is the International Organization of Securities Commissions (IOSCO) principle of a waterfall approach to rate determination, which the OSSG has endorsed. According to this principle, benchmarks should be based on, in order of preference, actual transactions, live tradable prices, and expert judgement. Another key recommendation, this time proposed by the OSSG, is that derivative contracts should reference a RFR rather than the current practice of referencing an Ibor, which contains bank credit risk. Keeping these two key recommendations in mind, let me now provide a brief recap on the progress in the reform efforts of Libor. 1 Such as the Bank for International Settlements (BIS), the International Organization of Securities Commissions (IOSCO), and the Financial Stability Board (initially through the Market Participants Group (MPG) and since July 2014 through the Official Sector Steering Group (OSSG)) Page 2 of 13 Alternatives for Libor Libor, being the most widely referenced Ibor, has been the centre of attention. The scale of its use is estimated to be in the hundreds of trillions of US dollars. Yet, the volume of transactions that underpin Libor is nowhere near the gross notional value of financial products referencing the rate. In fact, the Alternative Reference Rate Committee (ARRC) in the United States (US) has published a report showing that, while exposure to Libor has grown, the volume of transactions underlying Libor has been declining.2 The scarcity of underlying transactions has been viewed as rather problematic, as it has already resulted in increased conduct risk, despite efforts to strengthen governance processes around benchmark determination. Furthermore, as the ratio of underlying transactions to the gross notional value of financial contracts referencing Libor continues to dwindle, the risk that Libor will not be sustained over the long term increases. From a policymaker’s perspective, this mismatch poses risks to the stability of the global financial system, especially given the systemic importance of Libor. Cognisant of these risks, Libor currency areas have moved to identify alternative reference rates to replace Libor amid growing consensus that, at some point, Libor will cease to exist – not least because the Financial Conduct Authority has already made it known that it will not persuade or compel banks to submit Libor beyond 2021. And somebody has jokingly changes the lyrics of the famous song “Killing me softly with his song” to ‘killing it softly with Bailey’s song’. Finding and agreeing on new reference rates has proved to be a long and difficult road. In the US, the ARRC, which is sponsored by the Federal Reserve Bank of New York (New York Fed), has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative for US dollar Libor. SOFR, which the New York Fed began publishing earlier this year, is a secured overnight rate based on a much larger universe of repo transactions than in any other segment of the US money market. 2 See https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-Second-report. Page 3 of 13 In the United Kingdom (UK), the Working Group on Sterling Risk-Free Reference Rates, operating under the auspices of the Bank of England (BoE), has identified a reformed version of the Sterling Overnight Index Average (SONIA) as the UK’s preferred alternative for the sterling Libor. Like SOFR, SONIA is based on a larger transaction universe, which includes bilaterally negotiated as well as brokered unsecured deposits. What is next? And what are the implications for local market participants? Instead of discussing these relatively well-known developments at length, allow me to rather spend more time talking about the future and give my views on what market participants should be doing to prepare for it. But before I do this, I must state the obvious. In the words of Albert Einstein: “The future is an unknown, but a somewhat predictable unknown.” Thus, I can only make predictions about the path that regulators and policymakers across the world are likely to follow. These predictions are, however, based on the seeds that regulators have been planting in the recent past (including through all the reforms I have just discussed), highlighting the need for and importance of transitioning to a more robust and reliable interest rate dispensation. While the transition to alternative interest rate benchmarks is still somewhat uncertain, given how resolute regulators and policymakers are about the need for reform, and considering the steps they have already taken to give effect to that, I can comfortably predict that the future of a new or reformed set of benchmarks will come soon enough. It is worth reflecting on some of the transitioning issues being faced in the reform of Libor. It is understood that Libor is mostly entrenched in derivative markets. The ARRC has estimated that about 95% of the US dollar Libor market footprint in the US is in derivatives, both over-the-counter and exchange-traded. The OSSG, which has coopted the services of the International Swaps and Derivatives Association (ISDA) on how to deal with the risks associated with the discontinuation of the major Ibors, is expected to provide some guidance on transitioning. Page 4 of 13 This transition issue is now officially the third major initiative of the OSSG, which is aimed at improving contract robustness to address the risks of Libor being discontinued among the list of widely referenced interest rate benchmarks. Already in July 2018, ISDA launched a market-wide consultation on certain aspects of fall-backs for the derivatives referencing these major Ibors. The subject of the consultation was options for adjustments that would become applicable in the event of an Ibor being permanently discontinued.3 For those market participants that have large exposures to Libor, there is a considerable amount of work to be done – even more so in instances where existing Libor exposures have maturities beyond 2021. The very first area of contention is the potential risk of value transfer from one party to another given the differences between the currently referenced Ibors and their respective alternatives. If alternative reference rates differ markedly from Libor or other reference rates which they seek to replace, a mere adjustment for that spread is unlikely to be sufficient, particularly because, from a behavioural point of view, secured and unsecured interest rates do not necessarily exhibit similar trends in times of market stress. The year 2021 – the date towards which market participants seem to be converging in marking the end of Libor – may seem like a distant future, but the amount of preparatory work to be done leading up to that time will make it seem sooner than it seems at the moment. It is therefore important to start preparing now. For new contracts that are being written with maturity dates beyond 2021, careful consideration must be given to how these contracts are designed. To allow for contract robustness, participants must already build in provisions that allow for a relatively easier adjustment to a fall-back arrangement. All this pertains to preparing for a somewhat predictable future. But there is also a need to prepare for the unpredictable future. In this regard, there remain a number of unanswered questions. The first is whether market participants will migrate to a single rate, given all the differences between the existing Ibors and their alternatives. As is well understood, the preferred alternative rates in most jurisdictions are either risk-free or near-risk-free, and most of them are overnight rates. 3 See https://www.isda.org/2018/07/12/isda-publishes-consultation-on-benchmark-fallbacks/. Page 5 of 13 Barclays points out in a research report recently published that ‘there are key differences between instruments linked to Ibors and overnight risk-free rates in terms of market convention and operation. […] These differences are a major impediment to seamless adoption and in facilitating a smooth transition to risk-free rates’.4 Secondly, the transition is not expected to take place at the same time – some jurisdictions will probably move ahead of others. Thirdly, Intercontinental Exchange Benchmarks Administration (IBA) has also moved to evolve its Libor determination process to make it more compliant with the international standard for financial benchmarks. The IBA’s evolution of its Libor determination process could mean that the ICE Libor becomes an alternative reference rate. All this points to a complicated transition process that will require infrastructure providers and benchmark administrators to change processes and, in some instances, run parallel processes. Risk management practitioners will also have to carefully manage all the risks associated with the transition. Preparations for the upcoming changes should become prominent features of management discussions, leading to the development of strategies on how to manage their respective institutions and customers through this transition. Given that there is also a risk of value transfer, communicating transition plans and strategies, and negotiating with affected parties, will be of utmost importance. My comments thus far referred to the work that needs to be done by both local and international market participants in respect of Libor, much of which will at some point be applicable to the transition that we envision also taking place in South Africa. Let me now turn to what we are doing and how we are thinking about the design of interest rate benchmarks in South Africa. 4 Barclays, ‘Beyond Ibors: the next generation’, Barclays Interest Rate Research, 14 September 2018 Page 6 of 13 Interest rate benchmark reform initiatives in South Africa On 30th August 2018 the SARB published a consultation paper on selected interest rate benchmarks in South Africa, which is currently out for public comment. The consultation paper represents a culmination of various initiatives, both local and international, aimed at strengthening the credibility and robustness of key interest rate benchmarks. In the context of what was happening globally, and as part of the normal governance arrangements in the SARB, various collaborative initiatives between the SARB and other local financial market participants were undertaken in recent years to establish the extent to which South Africa’s main overnight and term interest rate benchmarks remain accurate, reliable, and representative of the economic realities of the underlying interest they measure. In the past two years, these reviews focused on the most widely used three-month Johannesburg Interbank Average Rate (Jibar), which the SARB has estimated is used as a reference for over R40 trillion worth of rand-denominated financial contracts.5 This, along with the reliance on Jibar as a key input used to determine the Short-Term Fixed Interest (STeFI) Index, has highlighted to us the extent to which Jibar is entrenched in the domestic money market. Given its systemic importance as a key reference interest rate, the SARB has decided there is a need for a fundamental review of Jibar, especially after the reviews conducted between 2015 and 2017 found that: (i) There is an increasing volume mismatch between the transaction universe upon which Jibar is based and the total book of financial assets and liabilities that reset against the rate. (ii) Jibar is, in fact, not representative of the cost of funding for banks. (iii) Insofar as the global standard for financial benchmarks is concerned, Jibar is not based on actual traded prices. The reviews also focused on the overnight interest rate benchmark: Sabor6. With Sabor, we were concerned about the representativeness of the rate as a measure of overnight unsecured funding costs for banks. 5 This finding is based on the results of a data collection exercise conducted by the SARB and refers to the notional value of outstanding contracts of selected banks as at 31 August 2017. 6 South African Benchmark Overnight Rate Page 7 of 13 The SARB’s research included consultations across different types of market participants, seeking to gauge their stance on the problems identified as well as on how these shortcomings could be addressed. While market participants recognised and acknowledged the shortcomings with Jibar and Sabor, and the former’s inherent vulnerability to manipulation, there was general consensus that the current governance arrangements limited the scope for untoward behaviour. Notwithstanding this position, the SARB still felt it was appropriate to reconsider the design of these benchmarks, and thus published a consultation paper with proposals for their redesign. As you may have seen, the consultation paper went further: proposing the adoption of additional benchmarks to enable market participants to have choices of different reference rates that are fit for purpose. In formulating these proposals, we considered all the findings I just mentioned relating to Jibar and Sabor. Furthermore – in line with our endorsement of the coordinated efforts by global regulators and central banks to ensure that interest rates are credible, accurate, and trusted by consumers and financial market participants – we also sought to align our proposals to the objectives of the IOSCO principles as well as European Union (EU) benchmark regulations. I will first deal with the reform proposals contained in the consultation paper, then the thinking around the multiple-rate approach, before concluding with remarks on why this is important for financial policy. Reform proposals The reform proposals for Jibar and Sabor seek to anchor both benchmarks to a broader universe of transactions while also adapting the respective calculation methodologies to make them more robust. With respect to Sabor, it is recommended that: Sabor be reformed to a Sabor Money Market, which will reflect a broader range of overnight unsecured wholesale rand deposits with all domestic banks. The proposed Sabor Money Market would include interbank deposit funding raised at the prevailing repo rate, but exclude all rand funding raised in the foreign exchange swap market. Page 8 of 13 Within the universe of overnight deposits, it is proposed that all corporate call deposits of R20 million and larger be included in the benchmark calculation instead of just focusing on the top 20 corporate deposits. It is also proposed that the transactions of all banks be included rather than just the five largest banks, as is currently the practice. With respect to Jibar, it is recommended that: the current Jibar calculation methodology be phased out and replaced with a transaction-based rate, comprising a combination of negotiable certificates of deposit (NCDs) and non-bank financial corporate deposits; and the current Jibar calculation methodology be changed such that the reformed Jibar is measured as a volume-weighted average rate of all the eligible transactions, to make the rate less sensitive to erroneous or potentially manipulative trades. While we acknowledge the differences between NCDs and deposits, both from a regulatory treatment point of view and, consequently, from a pricing point of view, the ‘hybrid’ approach to derive Jibar is recommended as a viable improvement for the current Jibar. At a fundamental level, it is unsustainable that at least R40 trillion worth of financial contracts are priced off a three-month reference rate derived from daily indicative prices of a market that, on average, is underpinned by only R66 million worth of transactions. In addition to such thin volumes, an analysis conducted at the SARB has found that, between July 2015 and June 2017, no actual eligible NCD transactions took place on almost 90% of the days. The lack in frequency of actual transactions makes the current methodology severely problematic – and makes its reform imperative. The multiple-rate approach The SARB’s reform agenda also sought to promote the multiple-rate approach, in which multiple secured and unsecured interest rate benchmarks are developed and coexist to enable market participants to have choices that are fit for purpose. Where such multiple rates exists and are deemed credible, it is envisioned that this will encourage market participants to move away from the current practice where derivative contracts reference risk-inclusive benchmarks (i.e. Jibar in South Africa) to Page 9 of 13 one where they reference an RFR. We regard a credit-based interest rate benchmark as appropriate for typical credit products, as it provides a hedge against any adverse changes in the credit risk embedded in the underlying instrument. However, for other purposes, especially derivative contracts, an alternative reference rate that is closer to being risk-free may be more appropriate. In the consultation paper, the SARB has also set out a road map for a transition from the current reference interest rate dispensation to an environment that comprises multiple rates. To give effect to this arrangement, the SARB has proposed the following: A term deposit benchmark, comprising all deposit categories, should be introduced. Market participants would have a choice between this benchmark and the reformed Jibar for use as a reference rate for credit products. For derivative contracts, there are various options. For the overnight tenor, there would be an option to use a government bond (GB) repo rate as a reference or, alternatively, a secured financing rate derived from the GB repo market as well as supplementary repos conducted with the central bank. Another alternative would be to use a composite interbank overnight deposit rate, to be referred to as the South African Interbank Offered Rate (ZARibor), which could be considered for designation as a near-risk-free rate subject to predefined credit and liquidity risk characteristics. The development of, and transition to, credible interest rate benchmarks may take some time, mainly due to the structural impediments and liquidity conditions in the markets where we intend to derive these benchmarks. The SARB has established a joint private- and public-sector body, the Market Practitioners Group (MPG), to manage this process. The MPG will also facilitate decisions on the choice of the interest rate benchmark to be used as references, and will advise on issues of transition and the operationalisation of final proposals. As you can imagine, and considering my earlier remarks, dealing with transitioning issues is going to be a mammoth task and, as is the case with our international peers, an unknown future that I cannot predict with absolute certainty. Page 10 of 13 The relevance of interest rate benchmarks for monetary policy and financial stability Why is all this important for policymakers? The essence of it is this: insofar as it serves as a reference for a large number of contracts, any short-term benchmark rate plays a key role in the transmission of monetary policy decisions to the cost of (and remuneration of) capital in the broader economy. To the extent that short-term rates assist with the timely and accurate measurement of financial risk, they also play a crucial role in maintaining financial stability. Both of these speak directly to the mandate of the SARB, which is to achieve and maintain price stability in the interest of balanced and sustainable economic growth in South Africa while, together with other institutions, playing a pivotal role in ensuring financial stability. To a large degree, the extent to which Jibar is entrenched in the domestic money market makes the rate an important aspect of monetary policy transmission. The money market is one of the main conduits through which changes in the policy rate are transmitted to the economy and, ultimately, inflation. In some instances, the approach to monetary policy implementation has shifted away from a classical cash reserve system to a framework where a target is set for shortterm unsecured overnight interest rates. In such cases, effective monetary policy implementation is measured by the central bank’s ability to keep market rates aligned to the operational target. If there is no transparency, measuring the effectiveness of policy becomes rather challenging. Operating targets thus provide guidance to the implementation of monetary policy on how and when to conduct their open-market operations. In policy frameworks that target the price of money, open-market operations are conducted when overnight rates diverge from the operating target. As long as such open-market instruments are easy to implement and effective, and as long as the central bank’s target is made clear, there should only be limited, short-lived deviations of the overnight rates from the target, as is the case for the US federal funds rate. Page 11 of 13 Developing multiple rates and improving the existing set of benchmarks also has benefits for financial stability policy decisions. It is our view that, where such benchmarks provide a more accurate reflection of the interest they measure across the term structure, they can enhance existing frameworks for systemic risk identification and monitoring. An important aspect of our assessment of financial stability risks at the SARB focuses on monitoring both time-varying risks and cross-sectional risks at any point in time. In both instances, we monitor risk factors that could amplify or propagate the levels of vulnerability in the financial system as a whole, or in individual financial entities. This assessment depends on reliable and efficient measures of credit and market risk, some of which depend on benchmark rates that measure the cost of funding in the financial markets. For cross-sectional risk, our financial stability analysis also considers, among other things, the network structure of the South African overnight interbank market, by employing measures from network theory as well as the Network Systemic Importance Index (NSII) that assess the systemic importance of individual banks in South Africa. The NSII measures each bank’s size, interconnectedness, and substitutability by employing network theory. We believe that the development of interest rate benchmarks such as the ZARibor, which provide a clearer picture of an otherwise opaque overnight interbank market, will assist us further in understanding the interconnections in this segment of the market and the risks embedded therein. Concluding remarks In conclusion, I think it is clear that the transition to new interest rate benchmarks is still uncertain, but the process has started to develop transition plans. While the timing of implementation might be uncertain, and while the plans might be fraught with complications, benchmark regulators are unlikely to reverse the decision to reform rates. It is therefore in the interest of all stakeholders to start positioning themselves for a new interest rate benchmark dispensation instead of adopting a wait-and-see approach. Page 12 of 13 While the transmission of monetary policy is effective in South Africa, as policymakers we also care about enhancing the credibility and transparency of money market interest rates because that offers us an opportunity to have greater clarity on the dynamics of the transmission mechanism. In the context of monetary policy frameworks that target short-term unsecured interest rates, the sooner we embed these new interest rate benchmarks, the sooner the effectiveness of those price-based frameworks can be enhanced. Interest rate benchmarks are also relevant for financial stability policy, including through effective risk sharing and transfer when risk can be measured more clearly. We believe that, with the assistance of the private sector through the MPG, we will be able to create a more robust financial market structure that will not only reduce systemic risk, but also add to transparency and allow for more efficient implementation of monetary policy. Thank you. Page 13 of 13
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the South Africa Tomorrow Conference, New York City, 1 November 2018.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the South Africa Tomorrow Conference, New York, 1 November 2018 South Africa’s adjustment path Good morning, ladies and gentlemen. Thank you for the opportunity to share a few thoughts with you today. Last year, we had a Goldilocks global economy. Inflation started picking up in the advanced economies, and in emerging markets, it was generally in line with targets. Growth was stronger, but without much evidence of overheating. Growth was also widely shared – most economies were accelerating. The world economy felt just right. As you know, at the end of the Goldilocks story a family of bears comes home. Our Goldilocks tale has taken the same direction. The synchronisation of global growth has broken down this year, with the United States (US) surging ahead while other countries slow down. With unemployment at very low levels, the Federal Reserve has been raising rates, just as they told us they would. The combination of stronger US growth and higher rates has appreciated the dollar. This combination of factors has posed challenges for emerging markets. It has interrupted capital flows and prompted wide-scale currency depreciation. Countries with substantial stocks of foreign-currency debt have seen their balance sheets deteriorate. Inflation pressures have generally intensified. Unlike Goldilocks, however, most of us in emerging markets weren’t caught napping when the bears showed up. We had frameworks in place to handle such challenges. In particular, most of us could rely on flexible exchange rates to absorb the initial Page 1 of 8 shock. This works best when countries have avoided contracting excessive foreigncurrency debt, as in the South African case. In these circumstances, the best thing one can do is to leave the foreign exchange markets to find its equilibrium. It is well understood that currency depreciation creates inflationary pressures. But many emerging market countries have strong central banks who can deal with this problem. Given the credibility accumulated by these institutions, inflation expectations have stayed anchored in most emerging markets.1 Emerging markets have also been buffered by substantial stocks of foreign exchange reserves. It is clear that most countries are vastly better positioned than they were during the 1997/98 crisis. Certainly, a few countries have been sorely tested by events this year, and the International Monetary Fund has been called into action. Most emerging markets, however, should be able to get through without experiencing financial crises or crippling sudden stops. The more difficult question is this: how will countries adjust to the ever-changing global circumstances, and what does this mean for their growth and development trajectories? Let me set out some challenges/difficulties. First, a number of countries are running sizeable deficits on their fiscal and current accounts. Countries with larger deficits have tended to experience more currency depreciation this year, which speaks to their vulnerability to changing global financing conditions – especially higher interest rates. Reducing this vulnerability will require deficit reduction, as well as changes in the composition of spending that benefit longrun growth and therefore improve countries’ future capacity to repay debt. This adjustment process is likely to be difficult, both for political economy reasons and because macroeconomic adjustment can hurt short-term growth, specifically via reduced demand or through import compression. Rebalancing is therefore inevitable…. 1 This point was made in the latest International Monetary Fund World Economic Outlook, chapter 3. See https://www.imf.org/en/Publications/WEO/Issues/2018/09/24/world-economic-outlook-october2018#Chapter%203. Page 2 of 8 Second, there are pockets of prominent emerging market countries where growth has stalled. Looking back over the past two decades, the 2000s were an era of unprecedented growth for emerging markets. The share of economies converging on rich-country living standards also reached new highs, demonstrating that this was more than simply ‘a China story’ or ‘an India story’ – important though those countries are. This record of success survived the global financial crisis, but only by a few years. From approximately 2013, emerging markets began to slow steadily, and some experienced protracted recessions. Outside of Asia, the emerging market story is now largely about subdued growth, and some countries are talking about lost decades. We need to find a way back to growth. The third problem follows when politics catch up with economics. In advanced economies and emerging markets alike, dissatisfaction with economic outcomes has generated political developments that would have been very unlikely, if not unthinkable, even half a decade ago. Sometimes these reactions have made things worse, or threaten to do so, creating a vicious circle of bad economic decisions and further political disaffection. These problems – macroeconomic disequilibria, stalled growth and political feedback loops – add up to a difficult set of circumstances for the emerging markets. Today, I would like to talk about how we might navigate them. Given my brief, I am going to focus on South Africa’s experience and outlook, although I think that this framework is useful for thinking through the broader emerging market challenges. Macroeconomic rebalancing Since the 2013 ‘taper tantrum’, South Africa has undergone a substantial macroeconomic adjustment. In particular, the current account has narrowed from nearly 6% of gross domestic product (GDP) in 2013 to 2.4% last year. This change came largely from the trade account, which has registered surpluses in 8 of the past 10 quarters. Our services account has followed a similar trend, and is now roughly balanced. Page 3 of 8 By contrast, our income and current transfers account has remained in deficit. This is in part because of transfers to our neighbours in the Southern African Customs Union, amounting to roughly 1% of GDP annually. The balance reflects income payments, driven by high yield differentials on our foreign liabilities when compared with our foreign assets. A growing stock of sovereign debt held by foreigners has been an especially important contributor to these income payments. The overall income deficit stands at about 3% of GDP, of which close to 1.5 percentage points is coming from interest payments on sovereign debt. The fiscal balance has changed less than the current account deficit, at least at a headline level. The latest Medium Term Budget Policy Statement indicates a fiscal deficit of 4% of GDP for the 2017/18 financial year. This is better than the 2012/13 figure of 5%, but it is still large – both in absolute terms and relative to previous projections. The change in the primary balance has been more dramatic, narrowing from 2.3% of GDP in 2013 to 1% in the latest financial year. But this number is still negative, so the debt stock is not yet stabilising. As a central bank governor, I try not to say too much about fiscal policy – not least because I would like to reciprocate the courtesy that other authorities show us by respecting the independence of monetary policy. Let me therefore just reiterate three crucial points made by our Minister of Finance, Mr Tito Mboweni, in his recent address to Parliament.2 To quote directly: We must choose a path that stabilises and reduces the national debt. We cannot continue to borrow at this rate. We must choose to reduce the structural deficit, especially the consistently high growth in the real public-sector wage bill. New fiscal anchors may be required to ensure sustainability, in addition to the expenditure ceiling. We must choose public-sector investment over consumption. This is an extremely clear statement of intent to improve the fiscal balance, and to do so in a way that favours investment and is therefore good for longer-term growth. We are clearly well past the point where we could hope to crowd in investment simply by raising spending and boosting demand. 2 See http://www.treasury.gov.za/documents/mtbps/2018/speech/speech.pdf. Page 4 of 8 With rising long-term interest rates, credit rating downgrades and tax increases, the case for fiscal stimulus based purely on spending aggregates is well past its sell-by date. Government cannot keep on dissaving. Ultimately, South Africa remains a low-saving economy. We can improve savings rates, especially through fiscal policy, but we are not going to be a high-saving economy for the foreseeable future. For this reason, we need to get to a position where we can safely and sustainably fund investment demand in excess of local savings. Instead of bemoaning a weak current account, we need to develop a strong capital account. Getting there is likely to require larger capital inflows into equities and direct investment, and less into government bonds. One attraction of these investments is that when growth weakens, profits decline and outflows diminish, which keeps the current account under control in low points of the business cycle. Another, perhaps more critical, advantage is that these kinds of inflows help growth. Attracting investment of this nature is central to the President’s growth vision, as was articulated most recently at the Investment Summit he had convened last week in Johannesburg. Reducing government’s appetite for borrowing is a priority for our new Finance Minister. To sum up this discussion: South Africa is still a country with significant twin deficits. They are smaller than they were in 2013, but they are still relatively large. Their scale is a source of vulnerability, as is their composition. Going forward, we need to reduce our fiscal deficits, and we need to ensure that our borrowing is more productive. We are not saying we need to keep our current account deficit as small as possible. One does not come to an investor conference in New York to say that capital inflows are a source of vulnerability and that we don’t want them. If I believed that, I wouldn’t need to be here. Rather, we want to get to a position of capital account strength, in which South Africa attracts investment because it has good growth prospects and because it provides an institutional environment that gives investors security and predictability. Page 5 of 8 The challenge of stalled growth South Africa’s economy is likely to grow by just 0.7% this year. Earlier in the year, we expected growth to be meaningfully stronger. The SARB’s March forecast was for 1.7% growth, and the MPC’s assessment was that the risks to this forecast were to the upside. In the short term, those hopes have been disappointed. More fundamentally, 2018 is likely to be our fifth consecutive year of negative per capita growth, given population growth of about 1.6%. These sorts of growth rates are well below our longer-run average of 3% or so, let alone the rates of above 5% targeted by the National Development Plan. Some of the blame for this weak growth can probably be attributed to global factors, including the declines in commodity prices and weak growth in our traditional trading partners. However, domestic growth has remained subdued despite a cyclical upturn in the global economy. The South African economy has also failed to accelerate despite a large improvement in our terms of trade, which reached an all-time high late last year. This suggests that the causes of weak growth are chiefly domestic in nature. Some degree of blame attaches to shocks like drought or strikes in specific sectors, but these cannot explain why growth has stayed low for several years. Instead, one of the primary causes of weak growth has been the severe decline in South African governance in recent years – a period of political decay which is only now coming to an end. This episode – known throughout South Africa as ‘state capture’ – involved a hollowing out of institutions and, in many cases, the looting of public resources for private gain. One of its many consequences was a large decline in business and consumer confidence. This, in turn, has contributed to investment stagnating over the past five years. ‘State capture’ has also been a major factor in our fiscal woes, both because it burdened the state with corrupt and fruitless expenditure, and also because it is seriously undermining its capacity to collect taxes. As the Commissions of Enquiry conclude their work we will draw lessons regarding vulnerabilities in our institutional and governance frameworks and work towards further strengthening of our institutions. Page 6 of 8 There are several reasons to expect better growth over the medium term. One is the backlog of investment I have just referred to: our investment levels are now under 20% of GDP, and it would make sense for firms to begin investing more, in the first instance simply to catch up with depreciation, now that the domestic environment has improved. A second pro-growth factor is better household balance sheets. Unlike its emerging market peers, but like many advanced economies, South Africa had a housing boom in the mid-2000s. This has left households carrying a large debt stock – a burden which has been weighing on their ability to consume. However, households have achieved significant deleveraging since then, and the debt-to-income ratios are now back to 2006 levels and close to longer-term averages. Although it is very difficult to specify when we will pass the tipping point, we are probably close to, or even at the end of, the deleveraging cycle. A third factor favouring growth is the scope for further reforms. We have already seen a great deal of energy and initiative from government around key issues such as raising employment and investment. As an economy, we are still a long way from the efficiency frontier in a range of areas, perhaps mostly in our network sectors. This, to mix metaphors, leaves an impressive amount of low-hanging fruit available, should we develop an interest in picking it. Interactions between politics and economics This brings me to my third and final topic: the interaction of politics and economics. As you all know, forecasting economic events is hard, but predicting the interactions between political and economic events is all but impossible. Once something has already happened, we are all quite good at stitching together a causal narrative that makes that outcome seem inevitable. Sadly, our ability to explain the past is much stronger than our capacity to prophesy the future. One of the great challenges is guessing what will happen politically when a country’s growth stalls. A plausible outcome is that bad economic performance, and all that it entails, will produce a populist rejection of incumbent elites and policies. Page 7 of 8 Another plausible outcome is that bad economic performance will empower the reformers already in government, who are therefore known quantities. This seems to be the way South Africa is going. Of course, South Africa has its share of populists who want to do radical things. But it is increasingly clear that the centre will hold. We have strong institutions, and we have the better arguments. We cannot stop some people from saying populist things, but we can win the policy debates – and we are winning. Bad economic outcomes, in this case, seem to be supporting better policies. Conclusion In conclusion: this is a difficult moment for emerging markets. After a long run of success, we are now confronting a range of serious challenges, including excessive macroeconomic imbalances, stalled growth and difficult politics. As all of you will know, from your years of experience investing in emerging markets, the asset class is marked by volatility. You are here because the returns can be high, but you also acknowledge that there can be low moments. Had you been more riskaverse, you would have the good returns emerging markets offered. In truth, and as has been said in other contexts, we are probably not as good as we look when we are winning, but we are also not as bad as we seem when we are losing. The past few years have been difficult ones for South Africa, as for many other emerging markers, but there is a respectable case to be made that things will get substantially better. We can achieve macroeconomic rebalancing that favours investment and growth. We aspire to growth rates nearer our historical trend levels, and once we achieve that, we can get ambitious about faster growth rates. We are recovering from a period of self-inflicted injuries, and there are good growth opportunities that we can exploit when we have recovered our health. Our politics have taken a reformist turn, which should permit a constructive response, rather than a destructive reaction, to the disappointments of the recent past. I am confident that South Africa tomorrow will be better than South Africa today. Thank you. Page 8 of 8
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Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the National Payment System Department's annual end-of-year cocktail function, Centrurion, 5 November 2018.
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An address by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the National Payment System Department’s annual end-of-year cocktail function Kleinkaap Boutique Hotel, Centurion 5 November 2018 Good evening, ladies and gentlemen, colleagues. It gives me great pleasure to welcome you to the annual National Payment System Department’s (NPSD) cocktail function. This has been a year in which we had more reason to celebrate, as 2018 marked the 20-year anniversary of the South African Multiple Option Settlement (SAMOS) system. Also of significance was the fact that the Southern African Development Community (SADC) RTGS system, previously known as the SADC Integrated Regional Electronic Settlement System (SIRESS), turned five this year. Consequently, my address will firstly reflect on the journey of the SAMOS and SADC RTGS systems, respectively, focusing on highlights and also outlining the goals that we plan to achieve. Thereafter, I would like to reflect on the opportunities offered by financial technology (fintech). The SAMOS system In April 1994, the South African Reserve Bank (SARB) launched a project to reform the South African national payment system (NPS) and formulated a strategy that would enable South African banks and other intermediaries in the payment system to align the needs of the domestic economy with developments in the international community. Page 1 of 10 A strategy-formulation team, consisting of representatives of the SARB and the banking community, was established, and a collaborative consensus-building approach was adopted. The SARB acted as facilitator and, in a period of 14 months, produced the first draft of the document titled The South African national payment system: framework and strategy, commonly known as the Blue Book. A number of projects were initiated to realise the envisaged goals of the NPS framework, as documented in the Blue Book. One of the key projects, and the cornerstone of the new payment processing infrastructure, was a project to implement a new RTGS system that would enable settlement between participating banks in central bank money with finality and irrevocability. On 9 March 1998, the SAMOS system was implemented, on time and within budget. Considering the complexity and multi-organisational nature of the project, this was indeed a remarkable achievement. The new settlement arrangements facilitated by the SAMOS system placed South African settlement practices on par with international best practice and presented many opportunities to the banking and non-banking sectors. Among others, these included: • the enablement of open access and participation of all the registered South African banks in the system; • the provision of facilities to participating banks to monitor their exposures in real time by having access to balances in settlement and intra-day-loan accounts, as well as a view of the utilisation of collateral; • the enablement of the SARB, through various system facilities, to ascertain when banks in the system are experiencing difficulty in meeting their payment obligations, and the ability to provide early-warning signals of a potential systemic crisis (resulting in the SARB being able to proactively take steps to address a potential systemic crisis); • the achievement of payment settlement finality through the SAMOS system, providing an opportunity to synchronise the delivery of scrip after confirmation of payment, thereby creating a safe and secure financial markets environment; and • the enablement of payer-to-beneficiary fund transfers in real time. Page 2 of 10 The SAMOS system has evolved over the years, adapting to market needs through the implementation of improvements that have optimised liquidity utilisation and collateral management, embracing international best practice, and providing monitoring facilities for regulators within the central bank to effectively execute their mandates. The SARB is currently working with the payment industry to replace the existing RTGS system with a new-generation RTGS solution that will address current business functionality and cater for evolving business and technical requirements. Some of these requirements stem from advances in the fintech field and related innovation, regulatory changes, as well as the ever-evolving business landscape. The new system must enable modular design, quicker development turnaround times, and reduced time to market for changes in the payment environment and cater for multi-currency functionality. The new system will offer rich message content utilising the ISO 1 20022 message standard. The South African banking industry has shown that it has the capacity, both in terms of business knowledge and in terms of technology skills, to progress our payment system. NPS stakeholders have not only contributed skills; they have also had to make substantial investments in back-office systems and technology to enable them to fully participate in the system throughout the years. The opportunity for banks and non-banks to cooperate and collaborate to leverage the potential of the SAMOS system ushered in the dawn of a new era in the provision of payment products and services. The SADC RTGS system (formerly SIRESS) The SADC RTGS system, formerly known as SIRESS, was developed as a catalyst to support the regional financial integration agenda towards the realisation of SADC’s aim of facilitating trade and investment in the region. Prior to the implementation of the 1 International Standards Organization Page 3 of 10 SADC RTGS system, regional cross-border transactions were settled via correspondent banking arrangements, which are prone to counterparty risk, lags in the settlement of these transactions on a T+1 or T+2 basis, and short cut-off times. The system was implemented through a public-private partnership between central banks and the commercial banking industry. The role that other partners played in the project – partners like the Finmark Trust, the European Union, the World Bank, the Bill and Melinda Gates Foundation, and the International Monetary Fund (IMF) – is also appreciated and valued. The system currently settles transactions for 82 participating banks drawn from 14 countries across the SADC region. Since July 2013, it has settled over 1.2 million cross-border transactions and a cumulative peak value of R5 trillion, which was reached in October 2018. A project is currently underway to replace the SADC RTGS platform with a solution based on modern technology, which will provide, among other things, multi-currency capabilities, flexible settlement windows per currency, and re-engineered business processes to support the possible future business needs that could utilise distributed ledger technology (DLT). Vision 2025 It is imperative that we continue to build on our legacy in our quest to enhance the safety, efficiency and accessibility of the NPS in a manner that promotes competition and minimises risk to the payments ecosystem. As outlined in Vision 2025, we will pursue this objective by leveraging technological developments to extend the availability of digital payment services to all sectors of society while meeting domestic, regional and international requirements for the benefit of all members of South African society. The NPS affects the lives of all South Africans. Essentially, it exists to serve the economy and, through it, the people of South Africa. It is a crucial enabling factor for Page 4 of 10 economic activity among consumers and businesses. Payment systems can, for example, enable seamless links to public transportation. A recent study by Visa titled The cashless cities: realising the benefits of digital payments 2 reveals that, should Johannesburg reach a state where 100% of transactions are digital, the city would gain just under US$500 million in net benefits cumulatively for consumers, business and government per year. The study further suggests four main long-term benefits over the next 15 years: an increase in employment, an increase in the gross domestic product (GDP), and marginal increases in wages and productivity. The emergence of fintech, the Fourth Industrial Revolution and the continuing shift from the industrial to the digital economy all hold significant benefits and could materially contribute towards lifting the growth potential of our economy. I would like to demonstrate this by referring to examples of other countries that have not only embraced technology, but that are reaping the fruits from their foresight. The potential of fintech According to Financial Sector Deepening Africa, a development finance organisation, fintech is expected to contribute at least US$40-150 billion 3 to sub-Saharan Africa’s economic output by 2022. In a similar vein, Accenture’s Pivoting with AI report 4 states that embracing artificial intelligence, in-process automation and augmenting human capabilities could potentially double the size of South Africa’s economy in a few decades. However, the most compelling evidence for the potential of fintech comes from some small countries in Europe and many from the East. The Digital Revolution has increased the growth potential in these countries. 2 Compiled by evidence-based economics research firm Roubini ThoughtLab based on 2016 data and published in 2018 3 https://techcentral.co.za/fintech-seen-adding-150-billion-to-africas-gdp/83628/ 4 https://www.accenture.com/za-en/_acnmedia/PDF-85/Accenture-Pivoting-With-AI-POV-Brochure.pdf#zoom=50 Page 5 of 10 Estonia A country leading the charge in embracing fintech and setting the pace towards the digital economy is Estonia. It is a small country, with minimal natural resources. In 2018, there are only three things you cannot do online: get married, get divorced, and buy real estate. Everything else largely happens digitally. Estonia has introduced e-identity, digital signatures, e-Residency and i-Voting. The Estonian Entrepreneurship Growth Strategy 2020 outlines the strategy for the Estonian economy for the next seven years, focusing on three main challenges in order to increase the wealth of Estonia: increasing productivity, stimulating entrepreneurship, and encouraging innovation. Allow me to quote some resounding statistics marking the success of some of Estonia’s efforts. Savings and efficiency: • At least 2% of GDP is saved due to the collective use of digital signatures. • Every year, 840 years of working time is saved thanks to data exchange. • The time to establish a business has been reduced from 5 days to 18 minutes. Financial indicators: • 98% of Estonian companies are established online. • 99% of banking transactions are online. • 95% of tax declarations are filed online – it takes only 3 minutes! e-Government indicators: • 98% of Estonians have a national identity card. • Over 30 000 people have applied for e-Residency. • Over 30% of Estonian voters from 116 countries use i-Voting in Estonian elections. Page 6 of 10 Healthcare: • 97% of patients have countrywide-accessible digital records. • 99% of prescriptions are digital. • There are 500 000 queries by doctors and 300 000 queries by patients every year. These are just some examples of how a small country can gain competitive advantage by embracing digital enablers that lay a foundation to rapidly move towards the digital economy. Singapore Another good example is Singapore. Singapore has adopted a Smart Nation policy, which means that they embrace technology in all their processes and encourage technological innovation and adoption. The Monetary Authority of Singapore (MAS) has identified 10 enablers to shift towards the digital economy. One of these, similar to Estonia and India, is the ability of citizens to store their basic identification electronically. In Singapore, this initiative is called MyInfo. MyInfo is a one-stop data repository that saves time in not having to capture basic information over again. It is a single online personal data platform. It includes your personal information, such as your unique identification number, name, gender, age etc. It can also include your education, employment and income information. Such access enables quicker completion of digital online artefacts by using the application programming interfaces (APIs) of MyInfo. The MAS has also released its Industry Transformation Map (ITM) for financial services. Their vision is to be a leading global financial centre in Asia. The ITM aims to achieve real value-added growth of 4.3% and productivity of 2.4% annually in the Page 7 of 10 financial sector. The ITM also aims to create 3 000 new jobs in financial services and an additional 1 000 new jobs in the fintech sector annually. China Digitisation has also reshaped financial services in China. Less than a decade ago, the Chinese e-commerce retail transaction value accounted for less than 1% of the global value. This figure has risen to almost 40% today as a result of the efforts by giant fintech firms such as Alibaba, Tencent and Baidu. In 2016, mobile payments for goods and services in China totalled US$790 billion – 11 times more than in the United States. Research by the IMF 5 shows that a 1 percentage point growth in the digitalisation of China’s economy is associated with a 0.3 percentage point growth in its GDP. The examples from Estonia, Singapore and China signal the potential of fintech and the shift towards a digital economy. They are also examples of the role that governments and central banks can play in creating an enabling environment for fintech. There are predictions that such efforts can add significantly to the GDP of an economy. Some anecdotal estimates are between 0.5% and 1.5% of GDP. Toomas Hendrik Ilves, a former President of Estonia, has signalled how such results could be achieved. He has emphasised: “It is not about focusing on the technology itself; it is about the political will, vision, policy, laws and regulations … in that order.” 6 The potential in South Africa In South Africa, economic growth has been stagnant. The issues of growing inequality, rising unemployment and increasing poverty are major challenges. 5 https://www.imf.org/external/pubs/ft/fandd/2018/09/asia-digital-revolution-sedik.htm 6 http://www.imf.org/external/pubs/ft/fandd/2018/03/trenches.htm Page 8 of 10 I would suggest that it is not only time that we do something differently; it is time that we do things digitally. The financial services industry has strong potential and capability to come together and collaborate towards building and influencing shifts towards a digital economy. To name a concrete example, Project Khokha provided a glimpse of this potential to work together, embrace new exponential technologies, and jointly explore future opportunities. It is time that we leverage this strength in working jointly for the greater good of SA Inc. At the inaugural workshop of the Intergovernmental Fintech Working Group in April 2018, the participants highlighted that a South African digital identity may result in increased financial inclusion and deepening by making it easier for South Africans to access financial services. 7 This provides just one opportunity for the respective authorities and the industry to possibly pursue in order to build a digital foundation and contribute towards the longer-term digital well-being of South Africans. The workshop also highlighted the need for a national innovation policy framework. I would suggest that such a policy would equally contribute towards a vision and an enabling framework propelling a digital economy. It could be one aspect of helping us to improve our position on the World Economic Forum’s Global Competitiveness Index. 8 We have dropped from being ranked 49th in 2015/16 to being 61st in 2017/18. Aligned to Vision 2025 and centred on leveraging innovations in the fintech environment, the SARB will host a workshop next year for regulators, overseers, policymakers and government that will focus on unlocking any inefficiencies within our current processes and platforms to stimulate economic growth. The workshop will provide an opportunity for parties to gain deeper insights into the various innovations available, including open banking and APIs, and will take advantage of the SARB’s relational capital to start a debate and craft a national strategy that will journey South Africa into the digital future. 7http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/8641/IFWG%20Reports ml%205%20July%202018.pdf 8 http://www3.weforum.org/docs/GCR20172018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf Page 9 of 10 The workshop, while designed to facilitate a unified vision around our digital future, is also intended to form the foundation on which the annual Innovation and Cybersecurity Conference will further expand. Closing The SARB would like to thank all of you for the role that you have played in creating this world-class payment system, and hopes that you will also join us as we collectively continue in our endeavour to design and create a better NPS for all. I would like to conclude with a quote from Adam Smith: “No society can surely be flourishing and happy of which by far the greater part of the numbers are poor and miserable.” I modestly add to this by saying: embracing fintech and moving towards a digital economy holds the potential for growth and collective prosperity. Thank you. Page 10 of 10
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Remarks by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Finovate Conference, Cape Town, 27 November 2018.
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Remarks by Francois Groepe, Deputy Governor of the South African Reserve Bank, at the Finovate Conference The Westin Cape Town, Cape Town 27 November 2018 Fintech: reflections on the phenomenon and its future potential Good afternoon, ladies and gentlemen. There is no doubt that we are facing a period of rapid technological advancement and innovative disruption, not least in the area of financial services, with financial technology (fintech) likely to disrupt and redefine both payments and banking value chains. Given these rapid advancements of fintech, I would like to focus my remarks on two areas. The first is an appraisal, from a central banking perspective, on the fintech phenomenon, given that we as the South African Reserve Bank (SARB) have been closely observing what has been happening in this space. Second, I would like to reflect on fintech’s potential to advance our South African migration towards a digital economy by reviewing some select examples from a few countries. I firmly believe that fintech has the potential to meaningfully contribute to the growth of our economy. Page 1 of 9 Fintech: 10 years on It has been 10 years since Satoshi Nakomoto published his famous paper titled ‘Bitcoin: a peer-to-peer electronic cash system’. The paper was both timely and ironic, in that we had just begun to experience the impact and unintended consequences of innovation in financial services that had largely escaped the regulatory radar. Over-the-counter derivatives such as credit default swaps exposed the impact of the types of innovation where there are information asymmetries, misaligned incentives and opportunistic behaviour, highlighting what can go wrong systemically when financial engineering and innovation is not subjected to appropriate regulatory oversight. The results included failure by lenders to robustly assess whether borrowers had the ability to meet their obligations. Furthermore, risk transfer through the so-called originate-to-distribute models resulted in severe consequences, amplified by the interconnectedness of our financial system. Yet, the solutions that are so often touted by proponents of an alternative to the ‘traditional’ financial system suggest that peer-to-peer exchange largely outside of the regulatory purview is the way to prevent future financial crises. So, what have we observed as central bankers as we critically reflect on what’s happened over the last decade? And how can these insights assist us as we move towards an efficient and safe digital economy? The three defining fintech trends: teaming up, new threats, and trials by central banks I have three observations from the perspective of central bankers related to fintech trends. I position these as ‘the 3 Ts’: teaming up among authorities, the new threats arising from fintech, and lastly trials by central banks. Page 2 of 9 Teaming up First, the fintech phenomenon has brought central banking and the larger regulatory community closer in working together on analysing and appraising new innovations. We have a long history of working together. This collaboration is strengthened as a result of the nature of the technology-inspired innovations not bound by physical topographies. This is the age of platforms. These can be centralised, as in the case of online peer-to-peer lending or some mobile payment platforms. Platforms can also be decentralised and distributed, as in the case of crypto-assets and initial coin offerings. They can scale with ease using technology such as cloud-computing, and adoption across geographies can happen rapidly. Some can on-board customers due to their digital on-boarding in a matter of minutes. Download an app, upload your payment details, and you could be hailing a taxi anywhere in the world. Collaborating and working together to understand the impact of innovations that can scale services across borders is important to ensure that there are harmonised approaches and that a regulatory ‘race to the bottom’ is prevented. This collaboration by central bankers through bodies such as the Bank for International Settlements (BIS), the Financial Stability Board, the International Monetary Fund (IMF) and the World Bank has produced significant analysis in the fields of crypto-tokens, central-bank-issued digital currencies (CBDCs), artificial intelligence and distributed ledger technologies, to name a few. There have also been contributions on fintech more broadly, raising awareness of the fact that fintech is not just crypto-assets. Such work has also drawn out both the monetary policy and the financial stability implications of fintech innovation and the issues that merit regulatory attention. So, as central banks, we have not been sitting idle in the face of these technological advancements. Whereas in the past regulators often played catch-up, this time around it is noticeable that regulators have adopted a far more collaborative and proactive approach. We see partnerships like Project Stella between the Bank of Japan and the European Central Bank exploring the impact of distributed ledgers. Just recently, the Bank of Canada, the Monetary Authority of Singapore and the Bank of England released a report on alternative models that could enhance cross-border payments Page 3 of 9 and settlements. 1 This teaming up and collaboration will stand us collectively in good stead as robust analysis is conducted on complex issues, not least due to the cross-border implications of many of these developments. In South Africa, a FinTech Unit has been established within the SARB. National Treasury, along with the SARB, the Financial Sector Conduct Authority and the Financial Intelligence Centre (FIC), have jointly established an Intergovernmental Fintech Working Group. These are evidence of the importance being attached to staying close to and leveraging the fintech phenomenon. And this will continue to happen in a responsible and proactive manner. We will continue to strive to keep abreast of fintech developments and endeavour to apply a balanced analysis to the fintech phenomenon, thus contributing towards a conducive environment in which fintech, regtech and suptech can thrive in support of our country’s progress and economic development for the benefit of all South Africans. New threats My second observation is that it has become clear to central bankers that the fintech phenomenon is not a passing fad and that it does hold significant transformational potential. However, while there may be benefits, new risks may also manifest. On the positive side, fintech firms are often obsessed with being customer-centric, focusing on the needs and pains of the customer, and providing simplified, convenient, on-demand digital services. As has been noted by Professors Chuen and Teo, given their ‘legacy-free and asset-lite’ operating models, fintech firms can innovate speedily through agile approaches. 2 And while there are inefficiencies in any financial service value chain, fintech firms can address these by applying exponential technologies and finding new and innovative ways of providing services. 1 http://www.mas.gov.sg/News-and-Publications/Media-Releases/2018/Assessment-on-emerging-opportunities- for-digital-transformation-in-cross-border-payments.aspx 2 H M Treasury, 2016, UK FinTech, ‘On the cutting edge: an evaluation of the international FinTech sector’, available at https://www.gov.uk/government/publications/uk-fintech-on-the-cutting-edge Page 4 of 9 On the other hand, new threats can be introduced through fintech-inspired innovations. Loans can be issued in a matter of minutes using, for example, new scoring techniques by fintech platforms. They leverage social media and apply new techniques such as network analysis, sentiment analysis and natural language processing to unstructured data sources to assess default risks differently. However, in applying new artificial intelligence and machine-learning techniques, concerns arise about the reliability, validity and transparency of the decision-making process. What goes on inside the so-called ‘black box’ of new computational learning algorithms? We have all heard about the significant failures of Internet finance companies such as Ezubao in China. Ezubao had been set up as an online peer-to-peer lending scheme in July 2014. It attracted funds of about 50 billion yuan (US$7.6 billion) from 900 000 investors. It ceased to trade in December 2015, just a year and a half later. 3 We have to be vigilant of the new threats that may arise as a result of the application of novel technologies. Turning to other innovations such as crypto-assets, there are numerous examples over the last few years of exchanges being hacked and invested funds being lost. As has been reported to the Japanese regulator, 5 966 bitcoins were stolen and hackers managed to steal 5 billion yen (about US$44.5 million) of crypto-tokens. 4 We have recently seen increased attention by South Korean and Japanese regulators to this domain as a result of these ever-increasing cyber-incidents. With initial coin offerings, the lack of clarity and transparency, with numerous White Papers attempting to raise funds quickly through token sales, is another area of concern. So while these new business models may bring benefits, their longevity may be challenged if financial, business and/or operational risks materialise. The provision of financial services is a heavily regulated industry. The main reason for this is not just the protection of consumers. As services and systems evolve and become more interconnected, the spillover effects of risks to the financial sector and ultimately to the real economy increase. We’ve seen these contagion issues during the global financial crisis. I would therefore encourage that our assessment of both the potential and the 3 Gough Neil, 1 February 2016, The New York Times 4 https://cointelegraph.com/news/japanese-cryptocurrency-exchange-hacked-59-million-in-losses-reported Page 5 of 9 new risks be both honest and realistic. And while innovators put forth the benefits of their innovations, let’s engage in a truthful and sober reflection on the familiar and new threats being introduced. Trials by central banks My third observation is that central banks are not immune to the impact of fintech. Our role as operator or provider of particular services, as well as how we conduct our supervisory roles, will be affected by the advancement of exponential technologies. On the provision of services, such as a platform for high-value payments typically processed through a real-time gross settlement system, we have seen waves of experimentation by central banks. Projects such as Jasper in Canada, Ubin in Singapore, and our own Project Khokha have been initiated to understand the impact of new technologies on such service provision. Some of these projects are in their third phase, trialling securities and cross-border payments on a blockchain. Other central banks, such as the Swedish Riksbank and the Bank of Uruguay, have already experimented with CBDCs, or are considering a more retail-focused or general-purpose CBDC. Of course, as each of these central banks has noted, the issues are much broader than just technological considerations. The policy considerations are weighty. As the BIS has indicated, careful consideration needs to be given to the impact on financial intermediation and financial stability, and to the unintended consequences of such solutions. To stay on the front foot, so to speak, the SARB is considering hosting a focused workshop on CBDCs in the coming year. We aim to attract the world’s leading thinkers on the topic to inform our own policy thinking on CBDCs. Also, several stakeholders are enquiring about Project Khokha’s Phase 2, and many have submitted suggestions. We are giving careful consideration to all of this, and hope to make a definitive announcement early next year. Page 6 of 9 Conclusion: the fintech potential going forward (digitally) To conclude, I’d like to share a few thoughts on the potential of fintech, looking forward. The emergence of fintech, the Fourth Industrial Revolution and the continuing shift from an industrial to a digital economy affords us, as a country, the opportunity to leverage these innovations towards lifting the growth potential of our economy. There are anecdotal estimates that such efforts could contribute 0.5 - 1.5% to gross domestic product (GDP). Digitisation, for example, has reshaped financial services in countries such as China, Estonia and Singapore. Less than a decade ago, the Chinese e-commerce retail transaction value accounted for less than 1% of the global value. This figure has risen to nearly 40% today and, in 2016, mobile payments for goods and services in China totalled US$790 billion – 11 times more than in the United States. Research by the IMF shows that a 1 percentage point growth in the digitisation of China’s economy is associated with a 0.3 percentage point growth in its GDP. Estonia is a small country, with minimal natural resources, but it is leading the charge in embracing digital enablers across various sectors. An astounding 99% of Estonian companies are established online, reducing the time it takes to establish a business from 5 days to 18 minutes. In Estonia, 97% of healthcare patients have country-wide accessible digital records, with 99% of all prescriptions issued digitally. At least 2% of Estonia’s GDP is saved due to the collective use of digital signatures. In Singapore, citizens have the ability to store their basic identification such as their unique identification number, name, gender, age etc. electronically on a one-stop data repository known as MyInfo. This enables faster completion of online information requirements such as e-Government or banking services. The examples from China, Estonia and Singapore demonstrate the potential of technological innovation and fintech. If South Africa had to adopt a similar technology, it could be used to administer social grants and could potentially result in significant Page 7 of 9 cost savings. A further application could see the simplification and streamlining of compliance with the FIC Act. As the SARB, we have kept a close eye on fintech developments as we appreciate the developmental potential they hold. There is, for example, sufficient evidence to suggest that the pursuance of common infrastructure such as digital identity platforms, or basic citizen demographics being housed digitally (such as MyInfo in Singapore), can promote progress towards electronic transactions and financial inclusion. In India, their unified payments interface allows one to make payments simply by knowing a person’s unique yet simple proxy address. 5 All these capabilities have demonstrated that digital authentication platforms form the foundation for other financial services. In moving towards a digital economy, identifying new threats, including cyberspace threats, becomes increasingly important. This is why two-factor authentication is mandatory in many jurisdictions for transactions performed online, as is the case for transactions in South Africa. A national digital identity platform enables multi-factor authentication and reduces the cost for each provider doing so on their own. In closing, fintech holds great potential which can meaningfully lift the growth potential of our economy and significantly improve efficiencies. To nurture this technology, we would, however, need to be alive to the new threats that it may introduce. Hence, we need to team up and collaborate, especially given the cross-border implications of many of these services. Furthermore, as the SARB, we are committed to ensuring that we make a concerted effort to understand technological changes in an effort to regulate smartly. We will continue to conduct further trials. We will also continue to create an ever more enabling environment by creating innovation facilitators. E.g. ‘francois@abc’ Page 8 of 9 As a central bank, we are therefore committed to contributing and being part of this journey towards a more inclusive and digitally enabled economy while ensuring that financial stability is maintained. Thank you. Page 9 of 9
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bloomberg FX'18 Johannesburg: South Africa Economy in Focus event, Johannesburg, 28 November 2018.
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Keynote address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the Bloomberg FX’18 Johannesburg: South Africa Economy in Focus event Johannesburg 28 November 2018 Recent developments in emerging economies’ foreign exchange markets Good afternoon, ladies and gentlemen. This year has certainly been another challenging one for the foreign exchange (FX) market. The emerging market (EM) currency complex has just emerged from one of the steepest corrections since the taper tantrum of 2013. Some of the worst-hit currencies have recovered from their year-to-date lows, including the Argentine peso, the Brazilian real, the Turkish lira, and the South African rand. But the broader EM basket, as measured by the JP Morgan Emerging Market Currency Index, remains close to its lowest levels on record. As we enter the final weeks of this year, it seems apt to reflect, and to share some perspectives on recent developments in EM FX markets, including developments in the local foreign exchange market. I will also touch briefly on some of the initiatives that have been undertaken to improve governance in the domestic FX market. But before I share my pearls of wisdom with you, let me remind you what one Winston Churchhill said in the House of Commons, on 29 September 1949: “There is no sphere of human thought in which it is easier to show superficial cleverness and the appearance of superior wisdom than in discussing questions of currency and exchange.” Page 1 of 8 Or the famous words of former Fed Chairman, Alan Greenspan, who in 2004 observed that “Nonetheless, despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin. I am aware that of the thousands who try, some are quite successful. So are winners of coin-tossing contests”. Recent developments in EM FX So far this year, the JP Morgan EM Currency Index has declined by more than 10%, and losses among the major EM currencies have ranged between a tenth of a per cent (Hong Kong dollar) and 49% (Argentine peso). This is the first year since 2015 that EM currencies as a group have depreciated by this much on a cumulative basis. A number of factors contributed to the recent sell-off. The most important one was probably the tightening in global financial conditions. Much has already been said about global policy tightening so I will not add to the debate here. But to paraphrase Warren Buffett, the tightening of global financial conditions was synonymous with a tide that receded and revealed who was swimming naked. Without pointing fingers, if you consider who has weak policy and institutional frameworks, and who has not done their homework in the area of structural reform implementation, and enhancing resilience, it will become clear who was found to be swimming naked. The EM FX weakness in 2018 can also be attributed to the strengthening of the dollar on improved macroeconomic performance in the United States (US), more signs that the synchronised recovery in the global economy was fragmenting, geopolitical events, including sanctions on Iran and Russia, which also contributed to higher oil prices. Another factor that contributed to the sell-off was the growing trade tensions between the US and its major trading partners, and the subsequent imposition of tariffs, which threaten global economic and financial integration. Besides the possible negative impact on global trade and economic growth, this situation also has negative consequences for business and financial market sentiment. This, in turn, could further undermine investment and international trade, ultimately lowering global productivity Page 2 of 8 levels by disrupting global supply chains and slowing the development of new technology. The fact that growth in China, the world’s second-largest economy, is already slowing down on the back of structural reforms makes the possible consequences of the trade war particularly concerning for EMs. Signs of an adverse impact on the global economy through a further weakening in demand from China for commodities such as metals and other raw materials could weigh further on commodity prices and therefore on export-oriented countries. Policymakers need to tackle all these developments through a multilateral, rulesbased and coordinated approach. History has shown time and again that there are no winners in trade wars. The depreciation of EM currencies, which had started in April, worsened during the third quarter of the year. And as it worsened, much of the market commentary claimed that this was a highly correlated sell-off, despite the long-standing realisation that EMs, as an asset class, are not homogeneous. In times like these, it becomes harder for some investors to ignore the risk of contagion in EMs. In fact, at the height of the sell-off, an opinion piece was published on the Bloomberg platform titled ‘We may be facing a textbook emerging market crisis’.1 The article expressed the view that, given the fundamental problems in EMs in general, EMs as an asset class were likely to come under pressure. Weakening currencies, it was feared, would drive foreign investors away, hurting all assets.2 Much to our relief, these fears did not materialise. Despite this, our conversations with global and local investors reiterated the view that differentiation, informed by a top-down assessment of the overall economic environment in EMs, had increased over the years. This appears to suggest that investors were increasingly reassessing their investments in EMs on a selective basis. We have also found evidence to suggest that the distribution of performance this year across the EM FX complex was one of the most differentiated sell-offs since the global 1 Bloomberg, ‘We may be facing textbook emerging crisis’, Satyajit Das, 3 September 2018 2 Ibid Page 3 of 8 financial crisis.3 However, as idiosyncratic and geopolitical risks became more prevalent, market players also started to consider the ‘tail risk’ of a more generalised risk asset sell-off. Notably, EMs with higher external debt and current account deficits, coupled with high sensitivity to monetary policy normalisation in the US, witnessed severe market losses. By contrast, EMs in Asia showed more resilience to the recent market turmoil, which is being attributed to their relatively sound economic fundamentals as well as solid external balances. In this volatile environment, policy actions by monetary authorities varied, depending on their mandates, their level of independence, and how their economies were affected by the recent economic and financial developments. The central bank of Argentina increased the benchmark policy rate to 60% and sold significant amounts of FX reserves to stabilise the peso. In addition, the Argentinian government unveiled austerity measures and secured a bailout facility with the International Monetary Fund. The central bank of Turkey, in turn, increased its policy rate to 24% and implemented other measures to stabilise the exchange rate of the lira. Recent developments in the rand exchange rate Similar to other EM currencies, the rand depreciated against the US dollar for most of the year. According to Bloomberg, the local currency depreciated by 28% from late February to early September, ‘peaking’ at R15.70 to the dollar on 4 September. Despite the fact that there were no events unique to South Africa that could have triggered weakness of such magnitude, the local unit ranked among the worstperforming EM currencies during that period. Many reasons have been put forward for why this was the case, such as the fact that the rand is a high-beta currency and is used as a proxy hedge for other EM currencies. But attention also needs to be drawn to the starting point of the depreciation, as the rand had appreciated significantly towards the end of last year, and in early 2018, on the back of improved perceptions This view is informed by our study of EM FX return statistics such as skewness of returns, differences between average and median returns, as well as differences in average returns of different quartile ranges. Page 4 of 8 around domestic political risks. This resulted in portfolio inflows which contributed to the relative strength of the rand. According to data from the Johannesburg Stock Exchange, non-residents purchased R48.4 billion worth of bonds and equities during the first quarter of this year. However, in the second quarter, non-residents sold R85 billion worth of bonds and equites as expectations for global financial conditions tightening increased and risky assets came under pressure. The vast majority of this selling was in government bonds. The selling of South African financial assets continued in the third quarter, with R62.5 billion worth of bonds and equities being sold. But more recently we have seen some slowdown of outflows and some resumption of inflows. This contributed to the rand recovering some of its losses, to the current level of R13.9 against the US currency, although this still represents an 11.6% depreciation since the beginning of the year. The rand also weakened on a trade-weighted basis, and its real effective exchange rate declined below its long-term average. According to the SARB’s equilibrium exchange rate model, the real effective exchange rate of the rand moved from being overvalued at the beginning of the year to currently finding itself at an undervalued level. The forecast presented to the MPC at its meeting last week showed the implied starting point for the rand against the US Dollar at R14.50. According to the Quarterly Projection Model, this undervaluation is expected to persist through 2019, as the local currency is expected to only gradually revert to its equilibrium level. 2018 has also seen a significant pick up in volatility with the 3-month option implied volatility for the rand rising from 11.8 per cent in April to peak at a level of 23.6 per cent on 5 September before receding to the current level of around 16.7 per cent. This has gone along with reduced turnover in the South African FX markets, which saw the total average daily turnover in the rand market reducing from an average of US$12.5 billion in 2017 to an average of US$9.9 billion in the first 10 months of 2018, caused mainly by lesser activity by non-residents and thus partly reflecting risk-aversion towards emerging markets. What the future holds remains uncertain. The continued tightening in global financial conditions, a change in investor sentiment towards EMs, escalating trade conflicts and geo-political developments, together with some idiosyncratic risks, remain the key Page 5 of 8 risks to the local currency. As such, it is likely that the rand, along with other EM currencies, will remain volatile. As a consequence of the recent volatility, exchange rate forecasts remain widely dispersed. Between this quarter and the third quarter of 2019, the exchange rate of the rand is expected to average R14.50 to the US dollar – this is according to Bloomberg median forecasts.4 However, the difference between the most optimistic and the most pessimistic survey participants on the exchange rate forecast for the first quarter of 2019 is almost R3.00 – I have little doubt that one of the participants somewhere within that range will be correct! Such a wide dispersion around the median forecast over such a short forecast horizon is representative of the uncertainty that has become an inherent part of our lives. And this uncertainty adds significant complexity to the conduct of monetary policy, the most recent outcome of our monetary policy meeting and the finely balanced decision being a good case in point. As regards the exchange rate and monetary policy, allow me to reiterate that forwardlooking and medium-term oriented monetary policy within a flexible inflation targeting framework, requires us to look through volatility and to focus on macroeconomic fundamentals, as we stated in our most recent Monetary Policy Review. In this vein, we will continue to allow the exchange rate to absorb the initial shocks, and focus our policy actions on addressing second-round price effects, much as at times it can become difficult to distinguish first and second round effects in the wake of extended or multiple supply side shocks. However, it is important that policy decisions should not be informed by short-run market developments in either direction. Before I conclude, let me briefly touch on some initiatives to strengthen governance issues in the domestic FX market. The South African Foreign Exchange Committee During the past year, we have made further progress in promoting high ethical and professional standards in support of fairness, integrity and thus the reputation of our foreign exchange market. 4 Bloomberg median forecast as at 12 November 2018 Page 6 of 8 Following the establishment of the Global Foreign Exchange Committee (GFXC) in 2017, of which South Africa is a member, the SARB facilitated the establishment of a stand-alone local foreign exchange committee, the South African Foreign Exchange Committee (SAFXC). This forum consists of a wide range of key professionals involved in the domestic wholesale FX market (including Authorised dealers, the interdealer broker community, the Association of Savings and Investment South Africa, the Banking Association, and others). Its purpose is aligned to that of the GFXC, which is to promote a robust, fair, liquid, open and appropriately transparent FX market, in which a set of diverse participants is able to transact confidently and effectively at competitive prices that reflect available information, and in a manner that conforms to acceptable standards of behaviour.5 The key activity in giving effect to this is providing guidance to the local FX market by endorsing and upholding the FX Global Code (Global Code), and encouraging adherence to it. The SAFXC has launched various outreach programmes aimed at creating public awareness and promoting the Code to the broader FX market community. Members of the SAFXC have been reaching out to their respective constituencies in the FX market (and hopefully to all of you here present), encouraging them to endorse the Global Code and commit to it by publishing a Statement of Commitment. To date, all the SAFXC members have endorsed the Global Code and have published their respective Statements of Commitment. By way of leading by example, since 01 September 2018 in its foreign exchange operations, the SARB only deals with counterparties, both local and offshore, that have endorsed the Global Code through the issuance of Statements of Commitment. The outreach programmes by the SAFXC should be viewed as a collaborative initiative by the public and the private sectors aimed at strengthening the integrity and effectiveness of the domestic wholesale FX market, and should be supported by all of us. If your institution is an active participant in the FX market but has not endorsed the Global Code yet, I would like to encourage you to review your FX market operation practices and align them with the principles of the Global Code so that you too are able to publish a Statement of Commitment. 5 See https://www.globalfxc.org/ for more detail. Page 7 of 8 In conclusion, the road ahead for EMs remains fraught with risks despite the recent stabilisation in market sentiment. The prospects of further US monetary policy normalisation, financial market volatility and less certain global trade environment coupled with weak economic fundamentals suggest that the EM currencies will remain volatile. This will require vigilance and prudent decisions by policy makers. Thank you. Page 8 of 8
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 14th BCBS-FSI high-level meeting for Africa on "Strengthening financial sector supervision and current regulatory priorities", Cape Town, 31 January 2019.
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Address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the 14th BCBS-FSI high-level meeting for Africa on ‘strengthening financial sector supervision and current regulatory priorities’ Cape Town, South Africa, 31 January – 1 February 2019 Introduction Good morning, ladies and gentlemen. I am pleased to once again welcome you to South Africa, Cape Town for the 14th Basel Committee on Banking Supervision (BCBS) – Financial Stability Institute (FSI) high-level meeting for Africa on ‘Strengthening financial sector supervision and current regulatory priorities’. Allow me to first thank you all for attending this meeting, which has become an important annual event for the South African Reserve Bank, BCBS, FSI as well as representatives from other various sub-Saharan African central banks and supervisory authorities. I hope that this meeting will be as successful as the past meetings we have had over the years. Importance of financial sector regulation Before we get bogged down in very technical discussions around financial sector regulation and our regulatory priorities, it is important that we first remind ourselves of the policy imperatives behind the need to continuously strengthen the regulation and improve the resilience of our financial systems. The financial sector plays an important intermediation role in the economy – by allocating capital from savers to borrowers, managing financial risks, facilitating trade, as well as offering access to the payment system. Financial intermediaries and financial markets play this role by moving funds throughout the economy that in turn affect businesses and the production of goods and services1. A financial system is therefore the lifeblood of a modern economy. Inclusive growth and sustainable development objectives would not be achieved without a stable and well-functioning financial system. The 2008 global financial crisis highlighted the strong connection between the financial sector and the real economy and the extent to which challenges in the financial sector can have negative effects on the real economy. While the financial crisis originated in developed countries, it negatively impacted on most of the emerging market and developing economies, in very significant ways. On our continent, the effects were “Reforming the Financial System in Sub-Saharan Africa: the (long) Way Ahead”, Peter Gakunu, 2007 particularly felt through reduced foreign investment, trade and remittances. The crisis exhibited itself in growing budget and trade deficits, currency impacts, higher rates of inflation, increasing public debt and dwindling currency reserves 2. So to reiterate, a stable and well-regulated financial sector is vital for the achievement of our long-term sustainable economic growth and developmental objectives. Given the growing interconnectedness of financial markets, international financial stability has become a global public good. Despite governments, central bankers and regulatory bodies mainly operating in their respective jurisdictions, we need to recognise that some of the decisions we make in our own jurisdictions can have global reach. In order to achieve a stable global financial system, coordination and cooperation becomes important. Our gathering here is one such form of coordination and cooperation towards the strengthening of our financial sector supervision and contributing towards a more resilient and safer global financial system. The interactions here, the sharing of ideas and experiences as well as the fostering of professional relationships will make the regulation of our financial sector better. Financial sector development in Africa The financial system in Sub-Saharan Africa is generally bank based and somewhat less sophisticated than our developed country counterparts, with countries on different levels of development. However, there has been remarkable progress over the past two decades. While the emergence of non-bank financial institutions and other alternative sources of capital, such as stock markets has been noticeable, with the exception of a few, financial systems are still dominated by informal finance and traditional banks, most of which are state or foreign-owned. The banking sector in Africa is undergoing reforms focused on privatisation and other forms of restructuring with respect to state-owned banks, with a view of improving the quality of the banks3. A review of the Sub-Saharan Africa banking system published4 by the IMF in 2013 makes the following observations: banking systems account for the preponderance of financial sector assets and activities; the depth and coverage of financial systems – as measured by the ratios of broad money (M2) and private sector credit to GDP – have been gradually increasing over the past decade, albeit from a low base; the scale of financial intermediation in the region remains significantly lower than in other developing regions of the world; access to financial services is also relatively low, reflecting a combination of low income levels, small absolute size, and infrastructure weaknesses; 2 The Economics Student Society of Australia, Julia Pham, 2017 3 “Review African financial systems: A review”, Franklin Allen etal, Finance Department, The Wharton School, University of Pennsylvania, 4 Banking in Sub-Saharan Africa: The Macroeconomic Context, Montfort Mlachila, Seok Gil Park, and Masafumi Yabara, Washington DC, IMF, 2013 most banking systems are small in absolute and relative size, characterised by low loan-to-deposit ratios; large shares of assets are held in the form of government securities and liquid assets; lending is mainly short-term in nature, with about 60 percent of loans having a maturity of less than one year; and market structures are typically oligopolistic, as indicated by the high share of total assets accounted for by the three largest banks, which tends to constrain the intensity of competition. I am highlighting these key elements of our financial system in Sub-Saharan Africa, to ensure that we have context. The structure of our regional financial system and development should also play a role in informing and shaping our regulatory priorities. This context matters, particularly in light of the discussions we are going to have around proportionality of regulation and institutional reforms. Furthermore, according to the report published by the IMF I have just alluded to, the SubSaharan Africa banking systems were well positioned to handle the 2008 financial turmoil given: low leverage; generally healthy capitalisation levels; ample liquidity; little reliance on external funding; and limited or no exposure to either foreign and/or toxic financial assets. Ladies and gentlemen, while the Sub-Saharan Africa region was broadly able to weather the shock from the 2008 global financial crisis, without suffering severe banking failures as was experienced in other parts of the world, this is not a reason to be complacent. In the main, the banking systems in Sub-Saharan Africa came under pressure indirectly via international trade linkages, as the global economic turmoil fed into reduced exports; slower domestic economic growth and rising unemployment. This in turn adversely affected borrowers and contributed to increased default risk as well as higher levels of nonperforming loans. No one can claim to know the exact nature, origin and timing of the next financial crisis. We then need to ensure that we continuously strengthen and enhance our regulatory and supervisory frameworks to ensure that they are current and sufficiently robust. This is not necessarily aimed at reducing the probability of failure by individual institutions, the reform agenda is targeted at allowing orderly resolution of failing institutions in order to safeguard stability and depositor interests. Financial sector regulation post the global financial crisis Let me now say a few words about the overarching regulatory priority reforms that the G20 put in place in the aftermath of the global financial crisis. I will be quick to say that most of the policies are largely in place and – even more relevant to our gathering today– I will also touch on the specific Basel Committee reforms. The comprehensive financial sector reform programme was put in place in order to build a safer and more resilient global financial system. The G20 reform package included, among other key reforms; ending too-big-to-fail, building resilient financial institutions, making derivative markets safer and enhancing resilience of non-bank financial intermediation. The Financial Stability Board was tasked with coordinating the implementation of these reforms. As a member of the G20, South Africa has made significant progress in implementing these reforms and we continue to make progress. Some of the major highlights are as follows: we implemented the Twin Peaks regulatory approach to strengthen our regulatory framework – my colleague, Unathi Kamlana will touch on that in greater detail during the session on ‘institutional arrangements for financial institutions’; we have developed and implemented our macro-prudential toolkit to strengthen and embed our financial stability mandate; the process of adopting a resolution framework for dealing with banks and non-bank SIFIs is at an advanced stage – the reform package includes the establishment of a Deposit Insurance Scheme as well as seeing the South African Reserve Bank becoming the Resolution Authority; work for the implementation of margin requirements for non-centrally cleared overthe-counter (OTC) derivative transactions, is at an advanced stage; and development of a regulatory framework for financial conglomerates is ongoing – my colleague, Denzel Bostander will also touch on this in one of the next sessions. Colleagues, we are committed to implementing all the G20 financial reforms that are applicable to our financial system. We are duty-bound to improve the resilience of our financial sector to make sure that it is safe and prudentially sound. Turning to specific reforms in the banking sector, the Basel III framework, announced in 2010 is a fundamental response by the Basel Committee to the global financial crisis. As you are aware, the framework was put in place in order to address a number of weaknesses that were identified during the financial crisis and provides a basis for a more resilient banking system. This first phase of the reforms focused at achieving the following: improving the quality of regulatory capital; increasing the level of capital requirements; enhancing risk capture by revising areas of the risk-weighted capital framework; adding macroprudential elements to the regulatory framework; specifying a minimum leverage ratio requirement to constrain excess leverage; and mitigating excessive liquidity risk and maturity transformation. Implementation of these reforms is progressing well, driven by a broad-based consensus to reduce the negative spillovers emanating from deep financial crises like the one we saw ten years ago. The finalisation of the remaining elements of Basel III in 2019 also marked the completion of the post-crisis reforms. The amendments were put in place to restore credibility in the risk based capital framework as well as address weaknesses identified with the use of internal models for the calculation of regulatory capital. The 2017 improvements seek to improve the comparability of banks’ capital ratios by: enhancing the robustness and risk sensitivity of the standardised approaches for credit risk, credit valuation adjustment risk and operational risk; constraining the use of the internal model approaches – by placing limits on certain inputs used to calculate capital requirements under the internal model approach and removing the use of internal models in some cases; introducing a leverage ratio buffer – to further limit the leverage of global systemically important banks; and replacing the existing Basel II output floor with a more robust risk-sensitive floor based on the revised Basel III standardised approaches. Emphasis is now being placed on complete and timely implementation of the reforms in a consistent manner in order to secure the benefits of a more resilient financial system. In the case of South Africa, the implementation of Basel III is largely in place and we are currently busy with implementing the remaining elements of the Basel III reform package as articulated above. I am sure there is going to be interesting discussions around these matters over the next day and a half. Addressing the unintended consequences of the reforms Let me turn to another matter which is of great importance especially to emerging markets and developing economies. Given the progress made with the implementation of the G20 reforms, an analysis of the unintended consequences of these reforms is becoming possible. To this end, the FSB has already developed a Framework for Post-Implementation Evaluation of the Effects of G20 Financial Regulatory Reforms to guide analyses of whether the reforms are achieving their intended outcomes, and to help identify material unintended consequences that might need to be addressed, without compromising the objectives of the reforms. The evaluation is motivated by the need to better understand the effects of the reforms on the financing of real economic activities. Unintended consequences of the reforms on specific areas such as trade finance, infrastructure finance, SME finance and market liquidity may lead to sub-optimal social outcomes. The reforms aimed at ensuring that the global financial system is safe and stable should be balanced with the need to ensure that the financial sector continues to play its important role in the economy. A very stable financial sector that plays no meaningful role in economic development is not beneficial – as such, there is a pressing need to consider and understand the costs versus benefits of regulatory reform. This should be done fully appreciative of the fact that an unstable financial system poses a significant risk of reversing the short terms gains emanating from unsustainable growth in the economy. These are trade-offs that require a careful balancing act. Banks can only effectively and efficiently serve the public interest when they are safe and sound. A collapse of the financial system has dire consequences on the economy with negative effects on the general welfare of households. In the letter to the G20 leaders in November 2018, the former Chair of the FSB, Mark Carney, pointed out that “In assessing what is working as intended and addressing any inefficiencies or unintended consequences, the FSB is tailoring not tapering. It is critical that this process of evaluation and adjustment does not compromise overall system resilience. Safeguarding progress does not mean defending all aspects of reform at all costs”. This is a very key message to keep at the back of our minds as we have robust discussions around this matter. Evaluation of the effects of regulatory reforms is an important aspect of any regulatory reform process. As you might be aware, there are some jurisdictions that have already signalled to alter post-crisis reforms should they find that they have unintended consequences to their financial systems. It is an issue that we cannot ignore. However, we have agreed at the FSB level that any assessments and possible adjustments thereof need to be ‘evidence-led’ and implemented in a coordinated manner across all relevant jurisdictions. The local adjustments are often as a result of “one size fits all” approach that requires small players to comply with rules that are designed for larger institutions like Global Systemically Important Financial Institutions. With increased financial sector regulation, shadow banking has also been on the rise. The regulatory gap in respect of shadow banking was also particularly felt during the global financial crisis. We subscribe to the notion that the regulation of shadow banking should be a priority in order to reduce regulatory arbitrage and prevent the shifting of risks from the regulated financial institutions to unregulated parts of the financial system, compromising financial stability. The issue of proportionality when looking at regulatory reforms also becomes an important consideration to ensure that different financial institutions are regulated proportionately according to the size, scope and complexity of regulated financial institutions and/or activities. The evolution of the financial sector and emergence of new risks I would also like to turn to a very topical issue these days on the increasing use of technology in the financial sector. The financial sector has evolved over time and continues to evolve. The adoption and use of technology in the provision of financial services has been at the centre of innovation in the financial sector and is changing the way financial service providers operate and deliver products and services to their consumers. The accelerating pace of technological change has real implications not only for the regulated sector but also for policy makers and regulators. The evolution of the financial sector requires that our regulatory and supervisory frameworks also evolve to ensure adequate and effective regulation of the sector. I am aware of the work that has been conducted by the Basel Committee to provide insight into the fast-growing adoption of financial technology (FinTech) specifically by banks. We appreciate the contributions made by the Basel Committee and others in the official sector to get a better handle of developments in this area. FinTech has helped to reduce costs, manage risks better, create new business opportunities, improve people’s lives and has even assisted authorities to achieve public policy objectives such as financial inclusion and competition in the financial services sector. Like all positive developments, FinTech has also brought with it new risks and new challenges for supervisors and regulators. While financial innovation fosters competition in the provision of financial services, regulations must apply equally to all types of market players, banks, non-banks and electronic platforms offering services similar to those offered by financial institutions. This will ensure that we avoid pushing the market towards a particular structure (regulatory arbitrage). The same innovative technologies that are driving FinTech are now also being used by financial institutions to ensure that they implement the latest regulatory changes, monitor compliance and report correctly to the various supervisory bodies, through Regulatory Technology (RegTech). RegTech has been necessitated by increasing levels of regulation and a greater focus on data and reporting. Adoption of RegTech means improved data quality that can be shared quickly and securely with various entities as well as improved compliance, both of which are positive for the stability of the financial system. Financial innovation is changing traditional banking business models, structures and operations as well as the nature and scope of banking risks. Key risks associated with the emergence of fintech include strategic risk, operational risk, cybersecurity risk and compliance risk. It has also become important for supervisors to assess their current staffing and training programmes to ensure that the knowledge, skills and tools of their staff remain relevant and effective in supervising the risks of new technologies and innovative business models. There has been increased use of technology by supervisors and regulators to support the supervision of financial institutions through Supervision Technology (SupTech). SupTech is currently found primarily in two areas: data collection and data analytics and helps supervisory authorities to digitise reporting and regulatory processes, resulting in more efficient and proactive monitoring of risk and compliance at financial institutions. FinTech, RegTech and SupTech are all new innovations that we need to embrace. While we harness the benefits of new financial technologies we need to ensure that the risks posed by such innovations, particularly to financial stability are adequately managed and mitigated. The rise in cybersecurity-risk Financial innovation has also led to an increase in cybersecurity risk, which is slowly becoming a major concern than before. The remote access of financial services by customers through electronic gadgets has presented an opportunity for hackers and other cyber-criminals. Financial institutions need to ensure that they have effective IT and other risk management processes and control environments that effectively address cybersecurity risk. This is one of the issues that are very close to my colleague Deputy Governor Francois Groepe and I am sure he will discuss this matter with you in greater detail during the relevant session on this topic. Conclusion As we enter the second decade following the global financial crisis, the strides we have made in developing the financial sector regulatory reforms geared towards addressing the identified weaknesses are under constant scrutiny. With the finalisation of the Basel III reform package in 2017, which marked the completion of the post-crisis reforms, emphasis has now shifted to implementation and evaluation of the effectiveness of reforms and to address any unintended consequences. This is a critical step in the process if we are to ensure that we build a safe and resilient global financial system. As we engage with each other today and tomorrow, let us learn from each other’s experiences and strive to make our financial system better to serve our citizens and deliver our developmental aspirations. Please engage robustly and enjoy the meeting. Thank you
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the S&P Dow Jones Indices South African Seminar, Johannesburg, 12 February 2019.
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A keynote address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the S&P Dow Jones Indices South African Seminar Johannesburg 12 February 2019 Understanding the core drivers of inflation in South Africa Introduction Ladies and gentlemen, good morning, and thank you to S&P Dow Jones Indices for inviting me to deliver the keynote address at this conference, which brings together a broad spectrum of investment management and other financial market professionals to discuss, among others, key drivers of South Africa’s reinvention of itself to stimulate economic growth. The topic chosen for this address, ‘Understanding the core drivers of inflation in South Africa’, is of high relevance today – not just because of the key influence that price developments have on the economy in general, and on corporate investment decisions in particular, but also because of the growing debate, both at home and globally, about the mandate of central banks and what exactly they should be responsible for. Within the context of today’s theme, I thought it might be useful to first provide some insight into how inflation has ended up relatively high in South Africa, the challenges in bringing it lower, and how the South African Reserve Bank (SARB) sees the recent encouraging developments, and its outlook for consumer prices over the near to medium term. I will conclude my address by highlighting the SARB’s policy response to this inflation outlook and the risks thereto. Page 1 of 9 A brief history of inflation challenges in South Africa In recent years, South African consumer price inflation has regularly exceeded the median levels for both the world and large emerging markets. But this was not always the case. In the three decades or so that followed the Second World War, South African inflation was largely in line with that of its main trading partners. The decoupling occurred mostly from the 1980s onwards, when central banks – in the advanced world at first, though later also in emerging markets – took effective steps to root out high inflation. By contrast, the 1980s saw South Africa experience high and volatile inflation in an environment of growing supply constraints, disinvestment and sanctions, and a loosening of the fiscal stance by a government facing increasing pressure for political reform. The advent of democracy in 1994 saw increased focus on price stability as a necessary condition for growth and development, which is why the drafters of the Constitution enshrined, in the country’s fundamental law, the SARB’s mandate of achieving and maintaining price stability in the interest of balanced and sustainable economic growth, and its independence. For the remainder of the 1990s, in contrast to the previous two decades, the SARB’s policy of positive real interest rates brought inflation sustainably within single-digit territory. In 2000, the introduction of inflation targeting helped to clarify the mandate of the SARB, providing a policy anchor and introducing greater transparency in policy decisions. This policy has brought clear results. Since inflation targeting began, annual consumer price inflation has averaged 5.7% (and 5.3% so far in the present decade), compared to 10% in the 1990s and as high as 15% in the 1980s. As the inflation-targeting regime has gradually grown in credibility, South African inflation has also become less volatile. The standard deviation of monthly year-on-year inflation readings has fallen to 0.9 percentage points so far in this decade, from 3.1 percentage points in the 2000s. Yet, as I mentioned earlier, South African inflation is still relatively high by global standards: its 2018 average of 4.6% placed it around the 80th percentile of a sample of 58 large advanced and emerging economies. Page 2 of 9 This brief recap of the recent history of inflation in South Africa reminds us of how the level and volatility of inflation can have a crucial impact on the decisions of both real economy and financial investors. The high and volatile inflation in the 1980s and early 1990s, resulting in high-amplitude interest rate cycles, coincided with a large decline in fixed investment as a share of gross domestic product (GDP), especially in the private sector. That decline only started reversing in the 2000s, after inflation targeting was adopted. Still, investment levels remain insufficient to trigger the kind of sustained acceleration in economic growth that is necessary to meaningfully reduce unemployment and poverty. It is true that low and stable interest rates provide a conducive opportunity for investment, but the issue lies in where these funds are channelled. While other factors contributed to the low investment rates of earlier decades, it is not difficult to understand why high and volatile inflation can cripple capital formation. Uncertainty about future nominal returns makes a business more reluctant to commit capital, except for the more profitable projects. At the same time, high inflation discourages domestic savings, thus increasing reliance on foreign investors who are more likely to prove risk-sensitive and demand a premium because of inflation volatility. High uncertainty premiums can, in turn, result in misallocation of capital, with small and medium enterprises (SMEs) in particular struggling to access funding. Why has South Africa’s inflation struggled to decline? What are the drivers of this still relatively high rate of inflation? And why has it not declined more after so many years of sub-par growth? There are several factors, but the role of inflation expectations cannot be neglected. As often happens in countries with a long history of relatively high inflation, these expectations are in part adaptive – that is, private economic agents are often sceptical about the authorities’ ability (and, possibly, willingness) to keep inflation low, because their experience indicates otherwise. The rand’s long-term depreciating trend, caused by positive inflation differentials with trading partners as well as a structural current account imbalance, has fuelled such expectations: it has directly impacted on the prices of consumer goods, as a large fraction of them is either imported or subject to import parity pricing. Page 3 of 9 The relatively rigid wage- and price-setting process has also resulted in upward shocks to prices proving relatively persistent, for instance after a large-scale exchange rate depreciation. In South Africa, the coexistence (especially during recessions) of largescale job losses and high real salary increases bears witness to the fairly high degree of rigidity in wage demands. It has been argued that high wage gains are a key tool to redress past income inequalities; and also that there is a trade-off between inflation and employment gains. While there is no denying the large levels of inequality in South Africa, it is doubtful that high wage gains can do much to reduce income disparities when they get absorbed by inflation or come at the expense of large job losses. Equally, experience suggests that tolerance of higher inflation only has a short-term boost to employment at best, with negative consequences in the long run. Other supply-side rigidities have probably also contributed to the persistence of relatively high inflation in South Africa. High mark-ups in several segments of the South African economy, barriers to entry for small businesses, and the relatively slow response of domestic producers to depreciation in the exchange rate, all suggest limits to competition in the private sector. In turn, this prompts rigidity in upward price adjustments. At the same time, tariff hikes by municipalities and state-owned enterprises (for example, electricity tariffs, which are receiving particular attention at the moment) have often exceeded the headline rate of inflation and have added to the upside cost pressures for private businesses. It also does not help that many of these increases affect the regular, high-frequency expenses of households, and therefore contribute to perceptions of high inflation among the general public. The recent encouraging signs in price trends This is not to say, however, that price-formation patterns in South Africa are completely static. In fact, the last two years or so have seen some encouraging developments. From 5.3% so far this decade, average headline inflation fell to 5.0% in the last two years and further to 4.6% in 2018, showing some gradual easing towards the midpoint of the 3-6% target range. Core consumer price inflation has followed similar patterns. After remaining stuck above 5% for four whole years to February 2017, it has now been in the 4.0-4.5% Page 4 of 9 range for more than a year. True, the 2016 rand recovery did favour the decline in both headline and core inflation, yet the trend persisted even as the rand experienced volatility in 2017-18. Indeed, of the last 24 monthly consumer price index (CPI) releases, 14 came out below the consensus expectation of economists polled by Bloomberg, versus only 3 that came out higher. Why did market economists – and indeed, the SARB’s own econometric models – fail to anticipate the extent of this inflation slowdown? Some particular factors stand out, which were highlighted in the last issue of the SARB’s Monetary Policy Review. First, the decline in food inflation that began in early 2017, as crops recovered from a drought-induced plunge a year earlier, lasted longer than most projections had anticipated. Part of this positive surprise reflected a continued decline in global food commodity prices. Second, the impact of the 1 percentage point value-added tax (VAT) hike implemented in April 2018 proved lower than expected. Possibly, retailers and service providers trimmed their margins to avoid too negative an impact on sales volumes. Third, housing costs, incorporated into the CPI through actual and owners’ equivalent rents, slowed markedly in 2018. In many regions, rents had been slowing for several years already, amid a lacklustre property market and downbeat building activity. However, the national average was long distorted by an acceleration in the Western Cape, which only reversed in the past year, in line with other regional trends. However, the jury is still out on several of the potential causes of this latest disinflationary trends, and whether they will last. I will first mention the pass-through of foreign exchange movements to domestic goods prices. In several components of the CPI, it has been less pronounced of late than in earlier cycles. Yet economists are still assessing the full range of causes of this lower pass-through. It is conceivable that the long persistence of a negative output gap has made price-setters more sensitive to the weakness of demand than was the case in Page 5 of 9 the past. But will this pattern persist or will it fade once demand finally picks up again and the output gap starts to close? More observations may be needed before we conclude that the pass-through is now structurally lower or simply ‘slower’ because of unusually weak demand conditions. Equally, the signs of a moderation in private-sector wage inflation over the past year or so are not yet fully understood. Remuneration per worker in the private sector slowed to an average of 5.0% year on year in 2017 and the first half of 2018, compared with 6.7% in the previous five years. As a consequence, unit labour cost growth slowed to as low as 3.6% year on year in the second quarter of 2018 – the lowest reading since early 2007 and a far cry from the double-digit readings seen at the start of the decade. Yet it is hard to establish whether this moderation is a consequence of prolonged cyclical demand weakness, whether the labour market has become structurally more responsive to the business cycle, or whether wage-setters’ inflation expectations have inched permanently downwards. The inflation outlook improved since the November 2018 Monetary Policy Committee meeting In light of these uncertainties, how does the SARB see the outlook for inflation over the next two to three years? Encouragingly, at the time of our Monetary Policy Committee (MPC) meeting last month, our econometric models indicated a significant improvement from the earlier projection exercise in November last year. The SARB now expects inflation to average 4.8% in 2019 (down from 5.5% in the November projection) and 5.3% in 2020 (slightly below the previous forecast of 5.4%). Arguably, the lower assumptions for the dollar price of oil explain a large part of the lower inflation profile for 2019. The real effective exchange rate of the rand has also recovered somewhat, while world agricultural prices are expected to provide more of a drag on domestic food inflation. Importantly, core inflation forecasts have been revised downwards too. Projections for 2021, published for the first time in January, show both headline and core inflation falling back below 5% in this end-part of the forecast. Furthermore, the SARB’s Quarterly Projection Model (QPM) shows a continued convergence of inflation Page 6 of 9 expectations, which are already off their near-6% ‘perch’ of the earlier part of the decade, and seem to be steadily moving towards the midpoint of the target range. In addition, the gap between nominal unit labour cost growth and CPI inflation is expected to gradually fade over the forecasting period, reducing one lasting source of upside pressure on inflation. Risks to the inflation outlook that may still be skewed to the upside Still, when we met in January to assess the risks to this downwardly revised inflation outlook, the MPC found that, on balance, they were still skewed to the upside. This is not to say that further downside surprises may not occur, of course. After all, demand remains weak and credit creation is sluggish, and in many countries these would be sufficient conditions for inflation to fall further. Equally, many risks, both external and internal, could result in higher inflation should they materialise. Among the former, exchange rate volatility remains a key factor of uncertainty in light of South Africa’s reliance on portfolio flows to fund what is, by emerging market standards, and its current level of growth, a relatively large current account deficit. The rand has been quite stable over the past few months, thanks in part to reduced expectations of interest rate hikes in the United States (US) and the subsequent moderate retreat of the US dollar. But such a situation can change if market expectations of the future US rate path need to be revised upwards again or, conversely, if the world economy slows faster than expected, triggering a new wave of investor aversion towards ‘riskier’ assets. The implications for capital flows towards emerging markets of global central banks’ balance sheets, some of which are currently contracting after nearly a decade of expansion, are also not clear yet. Equally, the oil price outlook remains uncertain amid persistent geopolitical tensions. On the domestic front, the MPC is cognisant of the upside risks to administered prices, especially electricity and water, in light of the challenges that utilities have faced for years to contain costs, and in light of the pressing maintenance needs if supply safety and quality are to be secured. The MPC also sees risks of a pickup in food prices in the outer years of the forecasting period. In addition, any unresolved domestic policy uncertainties could trigger exchange rate volatility even in the absence of external shocks. Page 7 of 9 The South African Reserve Bank’s reaction and policy mandate Following its decision to hike the policy rate by 25 basis points at the November 2018 meeting, the MPC felt that the inflation backdrop and outlook had improved sufficiently enough to warrant keeping the policy rate unchanged at the January meeting. While the MPC still judged the policy stance as broadly accommodative, the endogenous rate path generated by the QPM now only entails one hike of 25 basis points in the policy rate, to 7.0% by the end of 2021. As previously indicated, this does not represent policy guidance nor commitment. The MPC will remain alert to any possible secondround price effects of potential shocks and stands ready to act accordingly should data indicate a shift in the inflation outlook and the risks thereto in either direction. It has at times been suggested that the SARB should place greater emphasis on growth and employment objectives, or even that its mandate should be modified to make such objectives clearer. These suggestions may miss the key channels through which monetary policy best serves the goal of long-term economic development. South Africa’s monetary policy framework is not one of rigid inflation targeting, but a flexible one, which takes full account of the outlook for real economic growth and how it is likely to affect inflation over the forecasting period. For instance, when demand is weak and exerts downward pressure on prices, the SARB has far more latitude to ‘see through’ external price shocks than in an environment of domestic ‘overheating’. However, as I mentioned earlier, trying to ‘kick-start’ economic growth and employment through a larger dose of monetary stimulus would probably have only a short-lived impact on activity. By contrast, its implications for the current account, policy uncertainty and inflation expectations would most likely be negative. Over time, therefore, the consequence would probably be higher, rather than lower, interest rates. International and local experience does suggest that it is a stability-oriented monetary policy framework, focused on reducing price volatility and risk premiums on financial assets, that has the best chances of delivering lower interest rates and stronger economic growth, amid sustainable investment, over the longer term. Page 8 of 9 Conclusion Allow me to end my address by reiterating that in line with its constitutional mandate, the SARB will continue to seek to ensure that the purchasing power of our currency is protected. Monetary policy cannot contribute directly to stronger economic growth and employment creation in the long run, but by ensuring a stable financial environment, monetary policy fulfils an important precondition for the attainment of growth and development. Monetary policy in South Africa considers all factors driving inflation, including output growth and the external environment. Monetary policy has an important role to play, but it needs to be part of a carefully defined overall macroeconomic policy mix. Thank you. Page 9 of 9
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Public lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at Stellenbosch University, Stellenbosch 6 March 2019.
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A public lecture by Lesetja Kganyago, Governor of the South African Reserve Bank, at Stellenbosch University, Stellenbosch 6 March 2019 Independence and policy flexibility: ‘Why should central banks be independent?’ Good evening, ladies and gentlemen. Thank you for your kind invitation to come and speak at Stellenbosch University today. At a time when our country is embarking on a course of political and economic renewal, I would like to focus for the time that I am here with you on the public good enshrined in our Constitution that concerns monetary policy. In particular, I would like to talk about why central bank independence matters for that broader public good and how it relates to achieving our inflation-targeting objective. The constitutional mandate and independence Our Constitution provides the mandate for the South African Reserve Bank (SARB): protect the value of the currency in the interest of balanced and sustainable growth. The Constitution sets our mandate in this way for a simple reason: it is an expression of a public good. When we attain that public good, it helps us to reach the kind of economic growth we want. It does not mean that achieving our mandate alone will Page 1 of 11 necessarily generate that outcome. But it is necessary for achieving it. Many other policies and behaviours play similar and necessary, but not sufficient, roles. Having been given a mandate, the central bank needs to achieve it. This requires setting out an operationally relevant policy target and ensuring that the institution has the powers to achieve it. Central bank independence is really just about giving the SARB the institutional freedom to get on with those two things. But, of course, hitting an inflation target is not a simple matter of declaring a target and then browbeating economic actors to set prices and wage demands in line with this target. For those actors, the gains of higher (or lower) inflation exceed the costs they experience, but they do not exceed the costs to society as a whole. This is a common political economy problem; it arises in many areas of policy. And because of it, nearly all countries choose monetary policy frameworks with clear and simple targets, and with targets that imply balanced growth. I will return a bit later to the issue of alternative policy frameworks. However, ensuring that independence delivers good, socially optimal outcomes also requires that it is conditioned by a complementary framework which ensures transparency and accountability. Paul Tucker, a former Deputy Governor of the Bank of England, sets it out in this way in his recent book: central bank delegation should have the following principles, namely ‘a clearly articulated regime, simple instruments, principles for the exercise of discretion, transparency that is not deceptive, engagement with multiple audiences, and, most crucially, testimony to legislative committees’.1 In line with those principles, and in order to get to low inflation, central banks need to explain to the public what they are doing and how they are doing it. And they also need to be held accountable for their efforts. Independence is the flip side of accountability; a central bank cannot be easily held to account if private and/or political actors have 1 Tucker, P. 2018. Unelected power. Princeton, New Jersey: Princeton University Press. Page 2 of 11 the ability to sway its decisions. Nor can a transparent target be easily manipulated to show success when there is in fact none. Our mandate is implemented by targeting an inflation rate, which is interpreted not as literal price stability (an inflation rate of 0%) but as a low and stable growth rate in the price level. Our targeted inflation rate, set in consultation with government, is a range of inflation between 3 and 6% on an ongoing annual basis. In other words: we target a monthly, year-on-year inflation rate of not lower than 3% and not higher than 6%. In practice, we aim for inflation to come out near the middle of our target range, at around 4.5%. This gives scope for variation and shocks to hit the economy. These shocks move inflation above and below 4.5% but, by the design of our framework, they do not necessarily require policy adjustments. This is the meaning of ‘flexible’ inflation targeting, and it allows us considerable leeway in looking through or past temporary shocks to the inflation rate. Since the beginning of the inflation-targeting period, which started in 2000, our average annual inflation rate has been 5.5%, a full percentage point higher than the midpoint. This points to mixed success in the history of our inflation management. Inflation has stayed moderate, well below the high levels of the 1980s and 1990s. But inflation has not really been sufficiently low to get our high long-term interest rates lower, and this creates an economic cost that weighs more heavily on job creation as time goes on. We have indicated that a consistently lower rate in the near term, at the midpoint of our target band (4.5%), would lower long-term interest rates and be more supportive of balance in the economy. What do we mean by balance? First, let me say what it is not. Balance is not about achieving an inflation rate that meets the demands of some groups of people but not others. And it is not about reaching an inflation rate that causes economic damage – neither too low nor too high. Page 3 of 11 Rather, balance is about supporting competitiveness and job creation in the export industries and about reducing the bias to growth in the non-tradeables sectors caused by high inflation. As it happens for most countries, emerging and advanced, that inflation target is between 2 and 3%.2 Our trading partners and competitors typically have lower inflation than we do. It is also about getting the balance right between saving and investing; inflation should be at or around a rate which maximises both the supply of credit and the demand for it. So why would anyone want higher inflation? Prices rise at different rates. Some sectors may see stronger rises than others, giving them stronger revenue growth relative to those not seeing the same price increases. This implies redistribution. For example, some businesses like higher inflation because, via currency depreciation, it increases the prices of the goods they sell faster than the cost of production. Of course, the costs eventually catch up as inflation rises in response to the weaker currency, but while these prices are catching up, exporters get a small and temporary gain. In this instance, higher inflation redistributes a little from exporters in other countries that compete with ours. But, more importantly, it redistributes from domestic consumers and producers to those gaining from higher prices. Once costs rise, however, the economy is where it started in the first place. Along similar lines, debtors prefer higher inflation because, over time, it reduces the real value of their debt. A particular example I like to think about is those who want higher inflation because they like to borrow to make their living out of short-term activities, often in the financial markets. Their frequent criticisms are always the same: we worry too much about inflation, both now and in the future, and, if we didn’t worry so much, we could all enjoy lower short-term interest rates today. The catch here is that when lower short-term rates today push up inflation in the long run, then borrowing for investment is skewed away from the long term to the short 2 For details, please see ‘Box 4: South African inflation: an international perspective’ in the Monetary Policy Review published by the South African Reserve Bank in October 2016, available at http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7504/MPROctober2016.p df. Page 4 of 11 term. We shouldn’t be surprised if this also skews job creation away from the types of jobs that are sustained over the long run. That is not a trade-off that we believe is consistent with the public good mandate set out in the Constitution. The real test of monetary policy is not the short-term interest rate but what happens to the long-term rate. We should by now be able to recognise the problem with allowing inflation to go up in ways that benefit some groups: the gain is temporary and costs other groups. To claim back what they have lost, the losers want compensation, which creates additional negative distortions. And, because the advantage is temporary, the beneficiaries want policy to give them the gain again and again. Giving in to this desire, trying to conjure up temporary gains, lies behind many, if not most, historical instances of macroeconomic failure. Let me turn now to the losers from high inflation. There are three social groups that we should all worry quite a lot about, for both economic and ethical reasons. The first are younger people. Higher inflation and higher interest rates make it more expensive (and often impossible) to start borrowing for housing, education or transport, or starting new businesses. The second group are workers. Here it is often argued that more inflation would create more jobs for blue-collar workers. This is the old idea of the Phillips curve which has proven, except in very particular circumstances, to be wrong. First, some basic facts. For South Africa, the economy grows more strongly when inflation is low. If you don’t believe me, take a look at the historical data series yourself.3 3 Simple correlations show that, since 1990, growth has always been lower when inflation was higher. Page 5 of 11 Second, some empirics. The original Phillips curve idea worked as follows. If there are suddenly higher prices, businesses will believe that this is stronger real demand. They will respond to this demand by increasing production because they think they will be able to sell more and because their return is higher relative to the cost of production. But this is not ‘time-consistent’. When workers respond to their real loss of income (higher inflation minus last year’s wage level), they ask for higher wages and the cost of production rises. Suddenly, the business is not more profitable anymore, cannot sell more of its product, and retrenches. In macroeconomic policy, the temporary gain of the Phillips curve is illusory. You end up with less employment and higher inflation. Your ‘misery index’ increases – and yes, there is such a thing, invented by Arthur Okun, and it measures exactly that. Finally, I would like to note that the third group that gets hurt the most by higher inflation includes those that cannot defend themselves from it: the poor. Without the power to demand higher compensation for inflation, the poor and those living off fixed nominal incomes, pensioners in particular, are most vulnerable. It is for these people, above all others, that low inflation is both morally and economically right. At the end of the day, central bank independence allows the SARB to hear what different interest groups have to say, but gives it the policy space to make decisions about inflation that on balance benefit all. By having an inflation target range, we make a commitment to explaining transparently how we have achieved that target. Monetary and fiscal policy coordination Independence also matters for ensuring effective monetary and fiscal policy coordination. Page 6 of 11 Much monetary theory involves figuring out how to avoid high inflation and its impoverishing effects. Sometimes high inflation is caused by the excessive ambitions of sovereigns to spend fiscal resources on projects that do little to generate long-run economic growth. Continuous fiscal deficits reflect those ambitions, and because those deficits are financed with debt, they create a tax liability for citizens in the future. When debt rises too rapidly and above certain levels, our borrowing today both constrains what future generations of South Africans can do (as they are forced to repay our debt) and undermines their own living standards (as they pay the higher taxes). All of this directly generates pressure to allow inflation to rise. We cannot blame future generations for this. It is a function of the choices we make now. Some of you may disagree with this and argue that governments need to address social deficits and therefore will always run large deficits. But while I certainly agree that those social deficits need to be rectified, it has to be done sustainably and with a critical emphasis on spending public funds on those things that raise the potential growth rate of the economy. If our spending does not do this, then we will end up not being able to spend more in the future. Future generations might simply end up having to pay more interest and more tax. Another important argument for ensuring central bank independence is avoiding what is called ‘fiscal dominance’, which is the need for monetary policy to prevent the sovereign from going bankrupt because of excessive spending on current consumption. Inflation targeting as an expression of the mandate Let me now turn to a discussion of how inflation targeting is a good expression of our constitutional mandate to support balanced and sustainable growth. The independence of central banks gives them the opportunity to keep on top of global research and use human capital to best understand how to achieve their mandates. Page 7 of 11 Oftentimes, criticism of their independence is really about not liking the objective set out in the Constitution. If the SARB had no independence, then other objectives could be imposed on it. But what are those other objectives, and where do they come from? Have they been researched and understood properly? Or are they wishful thinking? Perhaps they do reflect good intentions and legitimate aspirations. But the test of whether they are the right or even useful objectives has to be based on analysis and research, comparative assessment, and technical know-how. Inflation targeting has, in recent times, become a popular policy framework mainly because it has proven successful in achieving good outcomes where other approaches have failed. Nonetheless, it is always useful to consider alternatives. Dual-mandate frameworks are one alternative. But even the central banks with multiple mandates tend to act as if they were inflation targeters because low inflation helps to keep interest rates low, and the two together help to maximise employment. The mandate is achieved because the rate of inflation determines the sustainable outcome of the other two objectives. For this reason, the move to include employment creation as a mandate alongside inflation targeting for the Reserve Bank of New Zealand has proven less eventful than its political sponsors had advertised. Why? One reason is that employment levels are determined by many different things, so putting a specific target on it for the central bank to try and achieve is unrealistic and can result in unintended consequences. Say, for example, that inflation is rising and employment is falling because of adverse technological change. In this instance, there is little monetary policy can do to increase employment levels. But responding by cutting rates, which seems like the right thing to do, only increases inflation further and eventually undermines job creation further as well. Like other central banks, we already include concern about growth and employment in our Taylor rule. And because we apply the framework flexibly, we don’t respond with policy to every upward move in inflation. The difference between a flexible inflation target and a dual-mandate central bank just isn’t very meaningful. Over time, keeping Page 8 of 11 inflation expectations low and well-anchored is the clearest and most effective way of helping the economy to achieve full employment. Another alternative is to target the exchange rate directly. Keeping it perfectly stable would, at least on the surface, suggest a better fit with the letter of the mandate in the Constitution. But it is often not well understood just what maintaining a fixed currency actually means, or what this requires in terms of policy. In a nutshell, fixing the currency requires fixing it against another currency or a basket of currencies. Then, our monetary and fiscal policies are required to adjust regularly to keep the rand’s value stable against those currencies. But those third currencies keep moving, and this means that we need to move our policies in line with their moves, even when the economic cost may be high. To give you a concrete example of how problematic this can be, let’s consider the case of Argentina in the early 1990s. Argentina had pegged its currency to the US dollar. But Argentina was not as productive as the United States (US), despite the peg giving them a similar inflation rate. Eventually, Argentina could not afford to maintain the peg, as the peso’s value was under pressure to fall and the country had no reserves left. The peg was dropped and the economy fell into a deep recession, with very high inflation, massive job losses and a sharp rise in poverty. You may think that Argentina is an extreme case, but it demonstrates how a country’s policies can become subordinate to, and ultimately determined by, the actions of other countries. Our inflation-targeting framework and floating currency means that we have considerable freedom to set our policies in line with the inflation outcome that we want to achieve. Some commentators have suggested that this freedom to float the currency means that our monetary policy works against export-led growth. Our currency is too strong in this view. It is worth reminding ourselves of what the International Growth Panel, led by Prof. Ricardo Hausmann, suggested to us back in 2006. They showed us how a more export-led growth strategy needs to be predicated on a more competitive Page 9 of 11 exchange rate achieved by running a fiscal surplus to create space for lower interest rates, and supplemented by an effective inflation-targeting framework.4 In fact, under inflation targeting, excessive exchange rate appreciation has been rare and short-lived. These discrete periods occurred when capital flowed in as a result of high commodity prices, sustained public borrowing, and low yields in advanced economies – not because of inflation targeting. All else being equal, the inflationtargeting framework has lowered inflation and rates, reducing the pull on hot money in recent times. In fact, a fundamental objective of inflation targeting has always been to achieve a more competitive exchange rate, and the best way to achieve this is to get inflation to be permanently low. Conclusion The Constitution recognises and expresses the public good which is price stability because it helps societies to achieve balanced and sustainable economic growth. It is necessary but not sufficient. Like the mandate, central bank independence is also not a static, ivory-tower concept. It is a living and breathing idea. It is an idea that is practical. It gives life to the mandate set out for the SARB by the Constitution. This independence means that the SARB can make the case for how best to achieve that goal, in consultation with government and with full transparency to the general public. As an institution, we have worked with government to identify the inflationtargeting framework as the best way of achieving the mandate, for all the reasons I have set out today. We believe that the case for the existing framework is very strong. We have achieved a historically low rate of inflation and, as a direct consequence of this, historically low 4 For the Panel’s recommendations, please see Ricardo Hausmann’s Final recommendations of the International Panel on Growth, available at http://www.treasury.gov.za/comm_media/press/2008/Final%20Recommendations%20of%20the%20I nternational%20Panel.pdf, especially pages 6 and 12-13. Page 10 of 11 interest rates. Of course we would like to improve on this track record and edge both inflation and interest rates lower on a sustainable basis. This is the most important contribution that monetary policy can make to full employment, economic growth and the well-being of our society. Thank you. Page 11 of 11
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Remarks by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the annual Financial Markets Department cocktail function, Johannesburg, 7 May 2019.
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Remarks by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the annual Financial Markets Department cocktail function Johannesburg 7 May 2019 Introduction Good evening, ladies and gentlemen. It is that time of the year when we have the pleasure of welcoming you to the Financial Markets Department’s (FMD) annual cocktail function. Thank you for joining us. When we agreed the date for this function, we did not know that we would be meeting on the eve of a rather crucial day for our country. Allow me to remind you that voting is an important responsibility of citizenship. This event allows the South African Reserve Bank (SARB), and specifically FMD, to convey our appreciation for the working relationships we have developed with you, our counterparties – whether it be through the execution of open market operations or by engaging with you on the ever-increasing complexities of financial markets through our regular meetings or access to your research. These engagements make an important contribution to enriching our understanding of financial market developments in support of the formulation and implementation of monetary policy and financial stability policy. We also value that we get to network a little less formally at this event than at our various official forums. Allow me to take stock of what has again been a rather eventful year in international and domestic financial markets since we last met for the annual cocktail function. And, as it has now become tradition, I will also provide an update on some of FMD’s key initiatives, especially those that relate to financial market development and thus have Page 1 of 9 a direct bearing on your work. I will try to be brief, and heed the words of Josh Billings: “There’s a great power in words, if you don’t hitch too many of them together.” The global financial markets backdrop The past year has been characterised by a mixed environment for asset prices. The significant shifts that we have observed were mainly influenced by both the adopted and expected policy stances of major central banks. Initially, growing divergence between the US economy and major trading partners, coupled with increasing trade tensions and perceived higher geo-political risk, placed upward pressure on the US dollar (USD). The USD had also found support from the US Federal Reserve (Fed) continuing with its gradual path of monetary policy normalisation, while other major central banks lagged behind by keeping policy rates constant. US equities also outperformed their European and Japanese counterparts. These developments resulted in emerging markets with relatively weak fundamentals, compounded by spill over effects from developments in Argentina and Turkey, seeing their currencies and financial assets coming under pressure, South Africa being no exception. There was a discernible change in the final quarter of 2018 when indications of slowing economic activity in the US (against the background of already weak growth outside the US) led the market to anticipate a slower pace of Fed policy tightening and some downward pressure on the USD. Concerns around a stronger than anticipated slowdown in global growth, together with geo-political developments, then led to a sharp increase in volatility and a correction in equity markets. The Chicago Board Options Exchange Volatility Index rose to a nine-month high of 36 index points in late December, while the S&P 500 fell by 9.2% during the same month. The MSCI All Country World Index, which includes both developed and emerging markets, also ended up recording its worst year in a decade by posting an 11.2% loss (although it has posted a 14% recovery year-to-date). Around the same period, yields on 10-year bonds in the US and Germany declined, the latter to two-year lows as safehaven demand increased. Turbulence in markets, alongside the expected fading effect of US fiscal stimulus, and slower growth in the eurozone, contributed to the significant change in monetary policy Page 2 of 9 forward guidance given by the Fed and European Central Bank (ECB). This has resulted in some easing in financial conditions and has been supportive of a rebound in risk assets in recent months. The Fed has pledged to be patient in respect of any further interest rate increases (with some market participants predicting the next move to actually be a cut), and to adjust the pace of balance sheet normalisation, while the ECB also changed course, delaying any previously envisaged interest rate adjustments to 2020 and committing to offer banks a new round of cheap loans to help revive the eurozone economy. In addition, multilateral institutions have recently downgraded their economic growth projections. The International Monetary Fund (IMF) has, in its latest World Economic Outlook report1, pencilled in a 3.3% global growth forecast for this year, with an expected pickup in 2020 predicated on Chinese stimulus measures, improved market sentiment, dissipating temporary drags on euro-area growth, and stabilisation in certain stressed emerging market economies. However, there are still uncertainties which will keep policymakers and market participants awake. Policy and political uncertainty will include geo-political developments, a possible disorderly Brexit, escalating trade tensions, and a sudden renewed tightening in financial conditions. The IMF has also flagged vulnerabilities stemming from China’s financial imbalances, volatile portfolio flows to emerging markets and fiscal challenges in some highly indebted European countries. However, the expectation overall, even with the generally limited policy space, seem to be for a soft landing of the global economy rather than a recession. Developments in domestic financial markets Domestic financial markets have been influenced by a combination of global developments and domestic idiosyncrasies. The local unit was not immune to the broad sell-off in the emerging market foreign exchange (FX) complex, which began last April and accelerated into September. The rand reached a ‘peak’ of R15.42 against the US dollar on 5 September 2018, while the nominal effective exchange rate depreciated to an over two-year low of 53.81. 1 See https://www.imf.org/en/Publications/WEO/Issues/2019/03/28/world-economic-outlook-april-2019 Page 3 of 9 It is interesting to note that, despite the rand’s depreciation of roughly 16% against the US dollar since we last met, the sell-off in domestic bonds was not as pronounced relative to the currency depreciation as was the case during previous periods of market stress. The yield on the R186 bond has increased by approximately 24 basis points since last April. Lower inflation outcomes have gone some way in capping the rise in bond yields, underscoring the importance of central banks keeping inflation expectations anchored. Moody’s recent credit opinion, stating that it expects South Africa’s credit profile to remain in line with those of similar Baa3-rated sovereigns, has also provided some relief to local bond markets. However, elevated government debt and contingent liabilities related to state-owned enterprises, as well as persistently low growth, are credit constraints. While the JSE All-Share Index looks relatively unchanged to when we last met, this masks some volatility, with declines in the latter half of 2018 and a subsequent recovery this year. South Africa has not been immune to the volatility in flows to emerging markets. Nonresidents sold R112.4 billion worth of domestic equities since May last year, with outflows of R27.5 billion reported on a calendar year-to-date basis. For bonds, net non-resident outflows totalled R86.1 billion over the last year, although some stability has returned with bond inflows of R26.3 billion since the start of this year. In response to new developments and changing risks, monetary policy continued to keep its focus on maintaining inflation comfortably within the target range and anchoring inflation expectations closer to the 4.5% midpoint of the inflation target band. It is a stable price environment which contributes towards broader macroeconomic stability and protects the purchasing power of all South Africans. While the MPC assessed the risks to the inflation outlook as more or less evenly balanced, the most recent developments in relation to oil prices and the exchange rate, along with other previously identified risks, such as electricity and water tariffs, and food prices, show that vigilance and data dependency must remain the order of the day. Page 4 of 9 As previously indicated, appropriate monetary policy settings need to be complemented by prudent fiscal and budgetary policies to help raise potential growth and lower the cost structure of the economy. Key domestic initiatives Let me now touch on some initiatives undertaken by the SARB to strengthen domestic financial markets. Firstly, I would like to make a few remarks on the reform of the major interest rate benchmarks, which needs to be framed in the context of global developments. Many of you will know by now of the work to reform interbank offered rates, collectively referred to as ‘IBORs’. For the major IBORs, reform efforts have focused on strengthening their resilience and reliability, including ensuring that they are underpinned by transaction data to the greatest extent possible. But what is perhaps most pertinent is the looming 2021 deadline for when the Financial Conduct Authority will no longer compel banks to contribute to the London Interbank Offered Rate (LIBOR). There are worries about the possible end of LIBOR, the most notable being the transition of legacy LIBOR-linked contracts to the new reference rates. Elsewhere in Europe, methodological changes have been made to the Sterling Overnight Index Average to strengthen the benchmark, while the method used to calculate the Euro Interbank Offered Rate will be overhauled by 2020. Progress has, however, been made in identifying risk-free rates (RFRs) and other alternative reference rates in currency areas reliant on major IBORs. The focus is now shifting to efforts to manage what is bound to be a complex transition to these alternative reference rates. Industry bodies such as the International Swaps and Derivatives Association have been consulting with stakeholders regarding contract fallback options, with the aim of agreeing ex ante rather than ex post, on any fallback arrangements. For cash markets, the Bank for International Settlements suggests that floating-rate instruments could be converted to fixed-rate contracts or to an adjusted RFR-based term rate, similar to the option for derivatives contracts. We could also see some issuers recalling LIBOR-linked debt instruments and replacing them with those linked to the new benchmarks. Indeed, the Intercontinental Exchange (ICE) has Page 5 of 9 proposed a US dollar ICE Bank Yield Index. ICE Benchmark Administration anticipates launching the Bank Yield Index2 in early 2020 should there be a favourable market response. Evidently, a blanket solution for benchmark rates does not exist. The ultimate outcome of transitioning may feature the coexistence of multiple rates and/or benchmarks. It is important for those of you that have exposures to Libor to not leave it too late in making appropriate arrangements. For South Africa, the SARB’s publication of a consultation paper3 on selected interest rate benchmarks last August marked a key step towards the reform of existing interest rate benchmarks. The consultation paper proposes the adoption of new benchmarks with the aim of enhancing transparency in the domestic money market while also enriching the framework for the monitoring and identification of systemic risk. Extensive research into the robustness and sustainability of the Johannesburg Interbank Average Rate (Jibar) and the South African Benchmark Overnight Rate (Sabor) had revealed shortcomings. Specifically for Jibar, the insufficient number of transactions in negotiable certificates of deposit means that this rate does not meet the International Organization of Securities Commissions’ requirements on data sufficiency. The SARB has decided to follow a ‘market choice’ approach to identifying an alternative reference rate to replace Jibar. By way of clarification: when we talk about reference rates in the domestic market, we mean benchmark rates that are used in the pricing of derivative and other financial contracts, while benchmark rates provide price indications in the general market. To facilitate market choice, the Market Practitioners Group4 (MPG) was formed. The MPG is a joint public and private sector body, which I have the privilege of chairing, with the aim of guiding final decisions on the choice of alternative reference rates and the operationalisation of proposed reforms. The MPG has recently established work streams for the purpose of executing 2 See https://www.theice.com/iba/Bank-Yield-Index-Test-Rates 3 See http://www.resbank.co.za/Publications/Detail-Item- View/Pages/Publications.aspx?sarbweb=3b6aa07d-92ab-441f-b7bfbb7dfb1bedb4&sarblist=21b5222e-7125-4e55-bb65-56fd3333371e&sarbitem=8722 4 For further information, see http://www.resbank.co.za/Markets/MPG/Pages/default.aspx Page 6 of 9 its mandate. These work streams will also advise on transition and other implementation issues. Allow me to take this opportunity to thank those of you who have provided comments on our consultation paper. We plan to publish a report on 24 May 2019 reflecting key takeaways from the public consultation process, together with our responses and adopted positions in respect of the reforms. The SARB is as resolute as other international regulators and policymakers about the need for reform. All final decisions regarding the reform project will be published in a technical paper later in 2019, which will detail the benchmark interest rates to be published in the future. Given the identified shortcomings of Jibar, it is our expectation that the reform of Jibar will be prioritised by the MPG and its work streams. The interim reform measure that will ultimately be decided on shall become effective from a future date that will recognise all data collection and transitioning considerations. Another collaborative effort – this time between National Treasury (NT), the Financial Sector Conduct Authority (FSCA) and the SARB – was establishing the Financial Markets Review Committee (FMRC) to develop recommendations aimed at reinforcing conduct standards in wholesale financial markets. The earlier review by the Foreign Exchange Review Committee had recognised room for improvement in conduct and governance related to the over-the-counter fixed income, currency, commodities and derivatives markets. In September 2018, the FMRC released a draft Financial Markets Review5 for public comment. You will be relieved to hear that I do not intend to discuss all 43 of its recommendations in this speech, but that I would only like to highlight a few which hold particular relevance for this audience. The first is the development of a general code of conduct for financial market participants that would be pre-empted by the formation of a Financial Markets Standards Group. This group, led by senior market professionals, would provide a forum to discuss compliance issues and to resolve conflicts in standards of market practise. Another recommendation is that the necessary data to carry out cross-market 5 See http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/8743/2018%20FMR%200 7.pdf Page 7 of 9 monitoring and surveillance could be collated via trade repositories, aiding both market discipline and transparency. Regulation covering conflicts of interest and market abuse will also be considered. And in addition to our review of benchmark interest rates, regulators may also investigate ways to expand the repurchase market and encourage technological innovation to aid the competitive landscape. A final version of the review is being deliberated and will be handed over to the Financial Markets Implementation Committee comprising representatives from the NT, FSCA and SARB, to give effect to the recommendations. Finally, of specific interest to the audience here tonight, may be the progress that the SARB has made in accommodating collateral substitution in its operations. Changes to our systems will allow banks to replace or substitute assets used as collateral in the main repurchase auction, in line with international best practice. In particular, the SARB will be transitioning the current Master Repurchase Agreements into the Global Master Repurchase Agreement (GMRA) to allow for this substitution. System changes are in progress, and full functionality for market participants is anticipated around midMay. Once the GMRAs have been signed, our counterparties will be able to substitute collateral posted at the SARB. Collateral substitution is expected to ease some of the demand for high-quality liquid assets through a more efficient use of such assets. More information on these and other initiatives is contained in the FMD newsletter6, accessible on the SARB website, with some printed copies available here as well. Concluding remarks Let me conclude by once again extending, on behalf of FMD and the SARB, our appreciation to all market participants for your continued support and cooperation, which has aided the orderly functioning of our markets. A further thank you to those who participate in our various consultative structures; taking part in these groups is See http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/9229/FMDUpdate%20Ma y%202019.pdf Page 8 of 9 crucial as we strive to increase the transparency and efficiency of South Africa’s financial markets within an increasingly complex environment. Last but not least, I would like to thank team FMD for the sterling work they perform for the SARB and in the interest of our financial system. We also owe thanks to the SARB protocol and events team, who have temporarily taken over liquidity management operations from the FMD. Please enjoy our hospitality, but do save some energy for casting your ballot tomorrow. Thank you. Page 9 of 9
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Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, to the Rand Business Club dinner, Johannesburg, 28 May 2019.
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An address by Daniel Mminele, Deputy Governor of the South African Reserve Bank (SARB), to the Rand Business Club dinner Johannesburg 28 May 2019 The role of the SARB in the context of growth and development in South Africa Introduction Ladies and gentlemen, good evening, and thank you for allowing me the honour to address this dinner hosted by the Rand Business Club. Our country has gone through general elections in the past month. With it came and went the usual debates about what the results would mean for South Africa over the next five years. What is unlikely to go away, however, is the debate over the policy priorities for the years ahead, and what authorities should focus on to lift the country from what increasingly looks like a ‘slow growth trap’. Monetary policy is already part of that debate, and is likely to remain there. Hence the relevance of the topic chosen for tonight’s address: The role of the South African Reserve Bank (SARB) in the context of growth and development in South Africa. I thought it might be useful to first address the SARB’s mandate, its independence in fulfilling that mandate, and why it often seems misunderstood. I will then look at how our institution has performed over the years in the fulfilment of that mandate, and what tasks still lie ahead, before tuning into the current debates on whether central banks Page 1 of 11 in general, and the SARB in particular, should reassess or broaden their mandates and strategy, looking specifically at the context of South Africa’s development needs. On the SARB’s mandate, independence and ownership The issue of the SARB’s mandate, as I have said earlier, is a topic that often raises emotions, partly because some people do not fully appreciate what the central bank can and cannot do, what the role of its private shareholders is, and how its accountability is ensured. When South Africa’s Constitution was adopted in 1996, the drafters of our fundamental law insisted that the primary objective of the SARB was to ‘protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic’. They further said that the SARB, in pursuit of that goal, had to ‘perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the [SARB] and the Cabinet member responsible for national financial matters’. It is not by chance that these words were inscribed in our Constitution. Such wording was in line with international best practice at the time. Following the failure of many countries to deal with stagflation problems in the 1970s, the global trend was to give central banks increased independence from political authorities in their search for price stability. But the South African context also played a key part. By the time of the 1994 democratic elections, South Africa had experienced two decades of high and very volatile inflation – even as economic growth gradually came to a halt. Monetary policy, in the absence of both a clear framework and a political pledge of noninterference, had struggled to contain these price gyrations. But central bank independence never meant that the SARB would have completely free reign; neither did it mean lack of accountability. As indicated in Article 224 of the Constitution, which I have just quoted, there has to be (and there is) regular consultation between the SARB and National Treasury. Page 2 of 11 It is also this consultation that produced the SARB inflation targeting range – the ‘yardstick’ against which we would measure the achievement of price stability. The SARB has operational independence in how to best achieve its policy goals, but does not unilaterally shift these goalposts. Put differently, the SARB is independent within the overall system of economic governance, but not independent of it. Furthermore, accountability extends beyond consultations with National Treasury. The Governor and senior staff meet periodically with members of parliamentary committees, and the SARB also submits an Annual Report to Parliament. Consultations with the general public, in the form of publications as well as Monetary Policy Forums, have also become the norm, as the SARB seeks transparency in explaining the rationale for its policy decisions. The SARB’s ownership structure has also raised concerns, albeit misplaced ones, about control and accountability. Admittedly, the SARB is one of only a handful of central banks in the world with private shareholders. Yet these shareholders do not have the power to amend the SARB Act1, which can only be done by Parliament. Neither can they appoint the Governor and Deputy Governors, who are responsible for monetary policy, because that is a presidential prerogative. Through their representatives on the Board of Directors, these private shareholders merely exercise oversight over the SARB’s governance. There is no way in which they can interfere with monetary policy or financial stability policy decisions, prudential supervision, or the SARB’s other day-to-day responsibilities. The SARB’s performance: price and financial stability? But how well has the SARB delivered on this mandate set by the Constitution? Let us first recall how the technical modalities of the mandate evolved over the years. From the more eclectic approach that was in place in the 1990s, including a framework for monetary aggregates, the yardstick for the measurement of price stability moved to an inflation target in 2000. 1 SARB Act 94 of 1989 Page 3 of 11 South Africa’s situation at the time, including the sensitivity of inflation to swings in energy and food prices as well as the structural changes the economy was undergoing (such as the effects of an earlier reduction in tariffs and capital controls), led authorities to select a 3-6% inflation target range. It was always understood, however, that this target was not cast in stone and could be reviewed if justified. The 2008-09 global financial crisis then taught us that achieving price stability was not enough. Many countries had witnessed a significant growth in financial imbalances even as inflation remained muted. These countries faced major economic adjustments as these imbalances unwound. While South Africa’s banks and its financial system had remained sound during the crisis, and domestic financial markets had kept functioning properly, the SARB felt that it would be wise to follow international best practice and place greater emphasis on monitoring the stability of the financial system while developing tools against the potential build-up of severe imbalances. The inflation-targeting approach has yielded gradual yet significant results over the years. So far in this decade, targeted consumer price inflation has averaged 5.2%, down from 6.8% in the previous decade (the first of the inflation-targeting regime). Inflation volatility has declined too. The standard deviation of year-on-year consumer price changes since 2010 stands at 0.9 percentage points, compared with 2.4 percentage points between 2000 and 2009. Importantly, in the present decade, inflation has exceeded the 6% upper end of the target range for only 26 months, compared to 70 months in the previous decade. Inflation expectations, as measured by the quarterly survey of the Bureau for Economic Research, have also become more stable over the years, and while they remained stuck at around 6% from 2012 to 2017, they are now showing an encouraging decline towards the midpoint of the target range. Meanwhile, our financial system continues to enjoy stability. South Africa’s banks remain sound and appropriately capitalised. Growth in credit to the private sector has not deviated significantly from nominal GDP2 growth in the past few years. 2 gross domestic product Page 4 of 11 In fact, expressed as a deviation from its trend, the credit-to-GDP gap currently stands at a negative 3.9%. In contrast to many other emerging markets, inflows of nonresident capital (be they portfolio flows or bank loans) have not spilled over into excessive domestic credit growth. Equally, residential property prices have been subdued since the global financial crisis. Where does South Africa stand at present? Improved policy performance towards the goals of price and financial stability has resulted in lesser volatility of interest rates, which in itself is good for long-term economic growth as it helps to smooth economic cycles and reduces the uncertainty that investors face when they assess capital spending opportunities. Between 2014 and 2016, the policy rate increased by 200 basis points over a period of 26 months. By contrast, the previous tightening cycle, which began in 2006, saw the repo rate rise by 500 basis points over a period of equal duration. Nevertheless, because of the nature of South Africa’s economy – which is a relatively small and open one, vulnerable to external shocks, yet one where the domestic price and wage formation process is fairly rigid – the fight to stabilise inflation is far from over. Throughout 2018, the SARB was concerned that the depreciation of the rand, together with higher oil prices, was skewing inflation risks to the upside and raising the odds of an overshoot of the target. This balance of risks informed the decision of the SARB’s Monetary Policy Committee (MPC) to raise the policy rate by 25 basis points in November 2018, reversing a cut of a similar magnitude in March of the same year. In subsequent months, though, the combination of downside inflation surprises, continued softness in global food prices, and the stabilisation in the exchange rate led the SARB to revise downwards its inflation projections. As of the MPC meeting in May 2019, the SARB projects headline inflation to average 4.5% in 2019, 5.1% and 2020 and 4.5% in the fourth quarter of 2021. Inflation should thus remain within target over the forecasting period. Page 5 of 11 Meanwhile, core inflation is expected to average 4.8% in 2020 (compared with a forecast of 5.5% six months ago) and 4.5% in 2021. The MPC assessed the overall risks to the inflation outlook to be more or less evenly balanced. The recent downward trend in inflation outcomes were welcomed. As previously indicated, the MPC prefers inflation to inflation to stabilise at around the midpoint of the target range. Future adjustment the monetary policy stance will be informed by a careful assessment of the balance of risks to the inflation outlook. While oil prices, electricity prices and the rand continue to pose upside risks to the inflation outlook, these are offset by the downside risks emanating from the weakness in demand and the projected inability of sluggish economic growth to close the output gap even by the end of the forecasting horizon. Beyond the volatility of GDP from one quarter to the next, economic activity has disappointed over the past year. From 1.9% six months ago, our model’s projection for GDP growth in 2019 has now been revised to just 1.0%. And while an acceleration is expected over the next two years, the projections for 2020 and 2021 (1.8% and 2.0% respectively) only indicate, at best, a sluggish recovery in the absence of implementing reforms to restore confidence, attract investment, support growth, and rebuild buffers. Should the policy framework be reviewed? As economic growth continues to disappoint, some observers might feel that the SARB is not doing enough to help kick-start economic activity – or, in a word, that the inflation-targeting framework may be less appropriate now than it was in the previous decade, when growth was dynamic and inflation cycles were more demand-driven than is currently the case. This debate does not occur in isolation. In many countries, economists and policymakers are questioning the surprising lack of sensitivity of inflation to shifts in demand and unemployment, the trend decline in neutral real interest rates, and the efficacy of monetary policies as central banks get closer to the effective lower bound on interest rates. Page 6 of 11 The mix of subdued demand growth, low inflation and low interest rates is keeping alive talk of ‘secular stagnation’, although economists disagree on whether this is a temporary phenomenon linked to post-crisis adjustments or a more permanent one. It is, however, important to take into account the differences between countries and be wary of ‘one size fits all’ recommendations. Some people, for example, look at the rigidity of expected and actual inflation in the advanced economies, and question whether monetary policy should more formally incorporate real economic targets in its framework. In South Africa, however, the period of relative stability in inflation expectations has been much shorter than in economies like the United States, Germany or Japan. There have been, admittedly, some encouraging developments of late, like the lower pass-through of exchange rate variations to prices and the moderation in unit labour costs. But these dynamics are not yet fully understood, and the SARB cannot therefore be sure whether they indeed represent a structural, permanent shift towards lower and more stable inflation. Consequently, alterations to the monetary policy framework at this stage would create the risk of confusion among economic agents and market participants. At worst, it could mean de-anchoring inflation expectations and reversing the gains of the past few years. For now, it appears to us that a strategy of limiting inflation volatility and hence the risk premium embedded in the cost of capital in South Africa is the best approach to support medium-term economic growth. Our internal research, for example, suggests that the country could benefit from somewhat lower borrowing costs if inflation expectations were credibly anchored at around 4.5%. But because of its structural current account deficit, South Africa has to compete with peers to attract international capital. Such gains, therefore, cannot be neglected. Some people might also wonder whether our current inflation target range of 3-6% is too high or not wide enough, and whether it consequently imposes unnecessary constraints on the economy. However, as I have alluded to earlier, the standard deviation of inflation since 2010 has been 0.9 percentage points. Page 7 of 11 This suggests that the current band is wide enough to allow for normal cyclical fluctuations in inflation while limiting target misses to the minimum, provided that expectations are anchored close to the target’s midpoint. It is also important to note that many of South Africa’s emerging market peers have lower or narrower inflation target bands than our country, yet their trend economic performance has been better over the past few years, with no evidence of undue constraints from the monetary policy framework. Equally, alternative anchors to the inflation target would be difficult to implement in South Africa. Prior to inflation targeting, the SARB, like many other central banks at the time, used monetary aggregates as a key guideline. However, the relationship between money growth and inflation became too erratic to validate the role of the former as a reliable lead guide to the latter. Private credit growth, which is the main counterpart of money supply, does at times play a role in driving inflation, yet economic and financial cycles do not always coincide, and the latter generally has a longer duration. Excess focus on credit growth in a monetary policy framework would therefore risk missing key cyclical influences on inflation. Finally, using a currency anchor in an open economy like South Africa, with its large commodity share of exports resulting in strong terms-of-trade variations, would bring unnecessary real economic costs in the pursuit of exchange rate stability. The SARB’s role in South Africa, a developing state But does all of this mean that, under the current framework, there is little that monetary policy can do to assist in the build-up of stronger, sustainable and more inclusive growth? We do not think so. Admittedly, the poor economic performance of the past few years highlights the urgency for South Africa to boost its growth rate and deal with the problems of high unemployment, poverty and inequality. Investment needs, both in public infrastructure and in the private sector, are large, and the need for capital to be adequately channelled to fund these needs is obvious. But in South Africa, like on the rest of the continent, many capital spending requirements can probably be met by a more efficient use of existing capital, stricter procurement processes, and the reduction in wasteful expenditure. Many of these policies fall outside of the remit of a central bank. Page 8 of 11 Politicians may sometimes query why central banks (like the SARB) do not play a greater role in funding development needs, especially in those sectors where the level of risk and the duration of projects make it a highly risky investment for private lenders. But public development finance institutions already exist in South Africa, and their role can be leveraged through more efficient partnerships with the private sector. Involvement of the central bank, by contrast, would risk creating conflicts with its other mandates and eroding its trust with the public. What a central bank like the SARB is best placed to do, however, is to create the appropriate conditions for the flow of savings to investment in the economy. Price and financial stability are indeed crucial to building the confidence of households, especially lower-income households, for them to accumulate savings, as they are less likely to fear future capital losses. At the same time, properly functioning financial markets and a sound banking system would ensure that risk is fairly rewarded and, as such, this would reduce the risk of capital misallocation. Whereas the SARB fully comprehends that it should carry out its mandate in the interest of sustainable growth for our economy, it also understands that inclusive growth and financial inclusion are prerequisites for sustainable growth. While the SARB does not currently have an explicit financial inclusion mandate (although the Financial Sector Regulation Act of 2017 (FSR Act) mandates the Prudential Authority (PA) to ‘support’ financial inclusion), as stated in the SARB’s National Payment System (NPS) Vision 2025,3 financial inclusion is viewed as a ‘cross-industry public policy initiative’. Collaboration is therefore imperative as it helps to drive the interoperability and ubiquity of payment services. It also enables payment services to meaningfully leverage new channels (such as mobile phones), new functionality (such as instant payments), and new technologies (such as application programming interfaces (APIs) and distributed ledger technology (DLT)). Available at https://www.resbank.co.za/RegulationAndSupervision/NationalPaymentSystem(NPS)/ Documents/Overview/Vision%202025.pdf. Page 9 of 11 From a payments perspective, measures such as (a) promoting competition, (b) enhancing access to payment systems, (c) making the regulatory environment more enabling, and (d) promoting collaboration are therefore identified as being the most helpful in advancing financial inclusion. In line with this, one of the recommendations in the policy paper on the Review of the National Payments System (Act 78 of 1998) also advocates for the enablement of nonbank institutions to provide payment services that involve the pooling of funds (e.g. emoney, remittances, transactional accounts and others) independently and without the need to partner with banks. This is with a view to establish a level playing field for both banks and companies that offer money transfer services and/or transactional services while also establishing a regulatory framework that will address the pooling of funds by non-banks when they provide such payment services. While central banks need to remain alive to changes in their operating environment and stay relevant to their context, the German Development Institute made some interesting observation that can serve as guiding principles when considering challenges that may come with mandating central banks with developmental objectives: Trade-offs between developmental and stabilisation objectives: central banks are likely to struggle if they are mandated to achieve too many objectives but have too few policy instruments to pursue these objectives. A wider mandate may give too much power to institutions that have limited accountability: often when central banks seek to play a promotional role, the performance of relevant developmental policies is not systematically evaluated and regularly reported on. Central banks with a wider developmental mandate may face significant political pressure to pursue developmental policies at the expense of stability. Conclusion To conclude, allow me to reiterate a few important issues: The South African Reserve Bank certainly has a role to play in the context of growth and development in South Page 10 of 11 Africa, and I would submit that it is indeed playing its appropriate role, in line with its assigned mandate. The SARB’s mandate forms an integral part of economic and development policy, and this is what our founding fathers and mothers envisaged when they drafted the Constitution. It is important to not conflate issues of mandate, ownership and independence. The current monetary policy framework has served the SARB and South Africa well, and while continuous improvements and refinements should be welcomed, any fundamental changes to the policy framework would need to be underpinned by a convincing problem statement. The SARB serves development best by doing what it knows it can do well, and that is what forms part of our mandate. At a time when central banks, somehow against their will, became ‘the only game in town’, in Mohamed El-Erian’s words, trying to reach beyond their mandate would probably trigger too big a risk of a loss of legitimacy. Not well-considered broadening central mandates will likely complicate the trade-off between independence and accountability, whilst also complicating the conduct of monetary and financial stability policies given likely tension that may arise with developmental policies. Thank you. Page 11 of 11
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the African Economic Research Consortium, Cape Town, 2 June 2019.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the African Economic Research Consortium Cape Town 02 June 2019 Growing with Debt in African Economies – Options, Challenges and Pitfalls Good morning ladies and gentlemen. I would like to thank the African Economic Research Consortium for inviting me to introduce this important topic. I hope you will indulge me while I reflect the opportunities, challenges and pitfalls presented by debt to developing economies in sub-Saharan Africa. Economic growth in sub-Saharan Africa (SSA) has been improving from the low base in the early 1990s and is set to continue. Real GDP is projected to pick up to 3.5% in 2019 and 3.7% in 2020. However, this remains well below the averages of the 2000s. There are also growing questions about macroeconomic stability given the weakening of fiscal positions in a number of low income developing countries (LIDCs) in recent years. According to the IMF, debt burdens and vulnerabilities of LIDCs have risen significantly since 2013, reflecting a mix of factors, including exogenous shocks and loose fiscal policies. This calls for a reflection on the role played by public debt in economic development. It is broadly accepted that governments resort to borrowing because taxation alone cannot provide sufficient funds for economic development. The challenge is to ensure that debt financing is done in a sustainable way. At the turn of the 21st century, billions of dollars’ worth of debt was wiped clean across sub-Saharan Africa. South Africa was instrumental in pushing for debt relief and we succeeded in late 1990s when the HIPIC programme was agreed through the Development Committee of the World Bank and International Monetary Fund. At the time, the solution appeared simple – wipe off the debt and allow countries space to get their affairs in order and growth and stability will follow. For a time, we saw significant improvements in the continent, with many countries strengthening their macroeconomic frameworks and institutions. A number of countries also gained market access. In 2018, international bond issuances in the region reached a new high, totalling more than USD17 billion, with the average issuance rising to nearly USD3 billion 1. As the IMF has observed, SSA has been the World Bank Africa Pulse, April 2019 Page 1 of 4 region with the fastest debt growth in recent years across a group of low income and developing countries. In 2018, about 16 SSA countries were at high risk of debt distress – more than double the 2013 levels. Average public debt across the region rose close to 56% of GDP at the end of 2018, with wide disparities in debt dynamics across countries. For example, in 2018, public debt-to-GDP stood at 72% in Zambia and 100% in Mozambique. Debt servicing costs have also risen sharply, with the median interest payment burden doubling to about 10% of revenue between 2011 and 2018. While debt levels is not as high as they were in 1990s, there is growing concern that Africa is at risk of landing in debt traps once again. In their 2010 paper, titled “Growth in a Time of Debt”, Reinhart and Rogoff argue that high debt could create uncertainty, deter investment and innovation, and the literature shows that it could have a negative impact on growth. I am inclined to agree with them. In addition, unsustainable debt burdens and rising debt service costs crowd out spending in key development areas such as education, health and infrastructure. These were exactly the lessons learned during the African debt crisis of the 1980s and 1990s, and which justified debt relief. Consequently, badly managed debt could now reverse some of the developmental progress made over the past twenty years. The financial landscape has also been changing, not only because of easier global financial conditions but also the increasing share of borrowing from non-traditional lenders and the types of debt instruments in the market. The share of borrowing from non-traditional lenders has risen to about 15% of global GDP. Financing instruments such as collateralised sovereign loans are also gaining prominence. The terms of these loans are often complex and typically only revealed after countries experience debt distress as was seen in Chad and the Republic of Congo recently 2. This increased reliance on non-traditional creditors has raised borrowers’ exposure to market risk, while at the same time posing additional challenges to the sustainability of external debt in the region. For instance, in the case where countries find themselves in debt distress, it may be harder to come to a rescheduling agreement with a large number of private creditors than when you had, in the past, a relatively small number of public creditors (Paris Club) or commercial bank lenders (London Club). In Chad, for example, collateralisation also made debt restructuring more complex since it reduced the room for manoeuvre for sovereign borrowers 3. We can also think of the problems recently faced in Argentina, where bondholders refused to accept restructuring terms. Data from the World Bank shows that the region’s foreign currency-denominated debt as a share of total debt reached approximately 60% in 2017. Most of the increase in foreign-currency debt can be attributed to the increasing issuance of Eurobonds. A 2In 2014, Glencore had lent Chad’s oil company around USD1,45 billion, in a move to secure access to the country’s oil. However, the decline in the oil price later that year left the sovereign struggling to meet the repayment schedule. By the end of 2016, Glencore held 98 per cent of Chad’s external commercial debt. Eighty-five per cent of Chad’s oil proceeds – its primary source of revenue – was directed towards paying Glencore back. Mustapha S. and Prizzon A., “Africa’s rising debt – How to avoid a new crisis”, October 2018 Page 2 of 4 large amount of these Eurobonds are set to mature in 2019-2020 and in 2024-2025, which may pose substantial refinancing risks in the foreseeable future, especially if countries’ fiscal positions remain weak4. Nearly 90% of the region’s Eurobonds are denominated in US dollars, which further raise currency and interest rate risks and the potential for tighter global financial conditions in global settings clouded by significant downside risks. It is also important to consider fiscal risks posed by state-owned enterprises (SOEs). In some instances, SOE liabilities have reached worrisome levels of 10% of GDP or more in countries such as Cameroon, Ghana and South Africa, threatening government’s debt sustainability and potentially crowding out social spending (Botswana, Cabo Verde, Madagascar)5. The dominance of SOE debt in the banking system is a considerable financial stability risk in countries that don’t have deep financial markets. These challenges also highlight the need for countries to strengthen debt management practices and improve transparency, which is fundamental to sustainable financing. Addressing these challenges would require countries to make tough fiscal choices to prevent debt burdens from becoming unsustainable. Fast-growing countries that face elevated debt vulnerabilities would also need to prioritise rebuilding buffers, including through structural reforms and improvement in fiscal frameworks. There is wide consensus that countries need to raise more domestic revenue to make debt financing more sustainable. There also needs to be a greater focus on improving the efficiency of public spending in such a way that it helps to improve economic growth. While the primary responsibility for avoiding the build-up of unsustainable debt lies with the borrower, creditors also have a role to play in encouraging greater transparency. Irresponsible borrowing ultimately contributes to unsustainable debt burdens. In closing, I wish to reiterate that public debt has an important role to play in financing development, particularly in augmenting government budgets. However, it should be clear that debt is not a replacement for domestic revenue mobilisation. Meanwhile, debt levels have to remain sustainable so as to not undermine market confidence. To ensure that debt plays a meaningful role, it must be utilised for revenue generating activities that increase the productive capacity of the economy. Countries in the region could benefit from the slower-than-expected monetary policy normalisation in major economies to build additional buffers, preferably aimed at increasing fiscal space and setting development priorities on course. The international community is eager to help. Early in May, the G20 called a high-level conference on 4 Mustapha S. and Prizzon A., “Africa’s rising debt – How to avoid a new crisis”, October 2018 5 In Madagascar, for instance, large subsidies and transfers to troubled state-owned enterprises (SOEs) such as the electricity utility JIRAMA and Air Madagascar to cover debt obligations have increased government liabilities. The IMF, in its 2018 Article IV assessment, highlighted that unexpected losses at SOEs or delayed reforms in public spending could crowd out pro-growth priority spending in Madagascar. In Ghana, the government also faces significant contingent liabilities from the energy SOEs, which continue to face challenges. Page 3 of 4 Sustainable debt for sustainable growth (the Paris Forum). The key objective is to assist countries with debt management capacity and improve debt transparency. The key conclusion of the Paris Forum was not to say that countries should borrow less but that they should be assisted to “borrow smarter”, by ensuring that borrowers are equipped with expertise to understand their real needs, to secure good terms and to effectively manage their debt, while holding creditors to higher standards on transparency and sustainability. I also want to take this opportunity to congratulate the AERC for continuing to have a policy-oriented research programme that remains relevant for policy makers. Today’s programme is filled with the right mix of policy practitioners and academics to give us for food for thought. Thank you Page 4 of 4
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the launch of the SA25 commemorative circulation and collectable coins, Johannesburg, 5 June 2019.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, At the launch of the SA25 commemorative circulation and collectable coins Constitution Hill, Johannesburg 5 June 2019 Honourable Ministers, Justices of the Constitutional Court esteemed guests, fellow South Africans. It is both a pleasure and a privilege to be here at Constitution Hill on this very special day. It is indeed an honour for me to be addressing you from the Constitutional Court, a deeply symbolic and significant place in our constitutional democracy. The Constitution, which this Court zealously guards, has been a moral compass guiding all of us on this journey we embarked on 25 years ago. It is only fitting that we are gathered here today to commemorate our robust and youthful democracy. I am reminded of a quote by former President Thabo Mbeki at the opening of the Court, who then said: “The Court represents the conversion of the negative, hateful energy of colonialism, subjugation and oppression into a positive, hopeful energy for the present and the future; a celebration of the creative potential of our people that has given us an architectural jewel.” Page 1 of 4 I should say that, if time permits, please do take a walk around Constitution Hill. It serves not only as a sobering reminder of a dark past, but also as an awe-inducing monument of the great things that can happen if people come together. The Constitution has an important place in the work of the South African Reserve Bank (SARB). One of the principles on which the Constitution is based says: “The independence and impartiality of a Public Service Commission, a Reserve Bank, an Auditor-General and a Public Protector shall be provided for and safeguarded by the Constitution in the interests of the maintenance of effective public finance and administration and a high standard of professional ethics in the public service.” The Constitution also outlines the primary mandate of the SARB: protecting the value of the currency in the interest of balanced and sustainable growth. It is tradition for the SARB to issue commemorative circulation coins to mark both key moments in our history as well as the individuals who helped to shape it. This past year, as the SARB leadership was considering the most significant way to mark 25 years of democracy, we were left with only one answer: the Constitution. The enhancement in basic human rights – the rights to housing, health care, basic services such as water and electricity, the rights of workers, the rights of civil organisations, the accountability of the executive to Parliament, the transformation of public finance management, the independence and competence of the judiciary, the independence and mandate of the SARB – all come from the Constitution. Page 2 of 4 This is a happy occasion for the SARB as it marks the culmination of a project that started last year with the South African Mint, in which we capture some of the essential elements of our Constitution in coins. We honour the vision of the architects of our Constitution with the new SA25 commemorative circulation and collectable coins that the SARB is launching here today. The team at the South African Mint tapped into the perspectives of young South Africans and the creativity of various artists for the themes and designs of the SA25 ‘Celebrating South Africa’ coins. It is, in fact, the first time in the history of the SARB and the South African Mint that South Africans were consulted to this extent in developing coin themes and designs. I am told that, during the engagement with young South Africans, ‘our constitutional rights’ came up several times, which made this the overarching theme that we decided to depict on the coins. These perspectives were brought to life by some of the country’s most talented young artists who not only poured passion into the project but also captured the essence of the theme. One of the main functions of the SARB is to ensure there is a sufficient supply of high-quality banknotes and coins. This is the one function of the SARB that puts it in the pockets and wallets of all South Africans. It is only fitting that the money we use reflects the identity of our country. It is also the responsibility of the SARB to ensure the integrity of the banknotes and coins in circulation. We have to ensure that banknotes and coins remain a secure method of payment, a unit of account, and a store of wealth. Let me repeat: a banknote is but a piece of paper, and a coin is but a piece of metal. Both derive their worth from the trust that the citizens Page 3 of 4 of a country have in the country’s currency. The confidence that South Africans have in their banknotes and coins is based on trust that the banknotes and coins are authentic, and trust in the institution that issues them. Working on this project, and in fulfilling our constitutional mandate, we at the SARB and all our subsidiaries continue to be inspired by the Constitution and strive to ensure that we continue to function in the public interest. To conclude, I would like to thank my colleagues at the South African Mint for their expertise and their ability to rally all South Africans, which is evident on the SA25 range. I would also like to express my gratitude to the young South Africans who contributed ideas; I am humbled by their understanding of the Bill of Rights. It reflects on both the circulation coins and the collectable coins, which I am sure will be highly appealing both to the general public and to coin collectors. The SARB takes great pride in the issuing of such commemorative coins. It is an important element of our public service role, and a unique way to pay tribute to individuals and events of national importance. I am delighted to officially present these coins to you. I now hand you over to the Programme Director. Thank you. Page 4 of 4
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Remarks by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the annual dinner for the Heads of Foreign Missions accredited in South Africa, South African Reserve Bank, Pretoria, 12 June 2019.
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Remarks by Lesetja Kganyago, Governor of the South African Reserve Bank, at the annual dinner for the Heads of Foreign Missions accredited in South Africa South African Reserve Bank, Pretoria 12 June 2019 Introduction Dean of the Diplomatic Corps, Ambassadors, High Commissioners, Counsellors and Diplomats, ladies and gentlemen – good evening. Thank you for accepting our invitation to this annual dinner hosted in honour of the Ambassadors and High Commissioners appointed to the Republic of South Africa. We use this dinner to share our thoughts on the developments in the South African economy, and to highlight issues of importance in the area of global and bilateral cooperation. Tonight, I would like to focus my remarks on two important issues that are increasingly coming under threat globally, namely multilateralism and central bank independence. The impact of technological advances on global value chains, rising inequality, extreme weather conditions related to climate change, increased cross-country migrations and escalating trade tensions have all brought multilateralism under closer scrutiny, as nationalistic tendencies and inward-looking policies gain traction. On the other hand, the difficulties related to sustaining the global growth recovery have resulted in a discourse that many believe requires broader mandates and increased action from central banks. Page 1 of 7 As with other calls for change in recent economic history, all this was spurred by a crisis. Key global developments and international cooperation During the most recent global financial crisis, efforts to avert a second Great Depression saw international cooperation reach a new high. Central banks acted decisively and in a coordinated manner to shore up liquidity in financial markets. In the face of continued and significant volatility and vulnerabilities in sovereign debt markets, the financial resources of the International Monetary Fund (IMF) were significantly increased and the IMF revisited its lending toolkit, making it more relevant and more effective. However, while the global financial crisis brought forth new and stronger cooperation, the post-crisis recovery has not been as strong as was hoped. Globalisation is therefore increasingly being blamed for the lacklustre recovery in some countries and for the significant negative spillovers of the crisis across borders. Many are blaming globalisation for the lack of inclusive growth, both within and across countries. In some countries, significant numbers of people have been lifted out of poverty and new industries have been created. In others, there have been increased job losses, especially among the middle class. Some countries have also experienced elements of deindustrialisation. Consequently, there has been a move towards populism and elected politicians are increasingly turning to protectionist policies as a solution. Unfortunately, trade wars and protectionism are not the panacea some believe them to be. The IMF has estimated that the current and threatened United States (US)China tariffs could cut the global gross domestic product (GDP) in 2020 by 0.5% – or about US$455 billion. To put this into perspective, the estimated loss is larger than South Africa’s annual economic output. 1 1 Financial Times, ‘Lagarde warns of trade war’s “self-inflicted wounds”’, 5 June 2019 Page 2 of 7 We are already seeing the impact of trade tensions reflected in weaker trade volumes, declining investment levels, and worsening investor sentiment. The manufacturing sectors in the Organisation for Economic Co-operation and Development (OECD) countries, which have strong links to the global value chain, have been significantly influenced by the recent tariff measures. In addition, uncertainty around future trade developments is expected to reduce OECD’s business investment growth from 3.5% in 2017/18 to around 1.7% in 2019/20. As long as these trade tensions persist, the downside risks to global growth will increase. Before more damage is done, a more integrated, cooperative and coordinated approach is required, incorporating the principles of multilateralism. Protectionist and isolationist approaches to dealing with global challenges will simply not take us very far. In October last year, IMF Managing Director Christine Lagarde called for a ‘new multilateralism’ – one that is dedicated to improving the lives of all citizens, one that ensures that the economic benefits of globalisation are shared much more broadly, and one that focuses on accountable governments and institutions that work together for the common good. This ‘new multilateralism’ is key to providing the foundation for global cooperation to tackle the many transnational challenges, including managing the risks related to, among other things, climate change, cybercrime, increasing conflict and refugee flows, failures of governance, and illicit finance flows. An essential component of global cooperation relates to the global financial safety net (GFSN). Today, the GFSN includes international reserves, bilateral swap lines, regional financing arrangements, IMF resources and market-based instruments. While the size of the GFSN is larger than it was before the global financial crisis, the adequacy and coverage of the GFSN as well as its capacity to handle future economic and financial crises continues to be debated. Page 3 of 7 South Africa and the South African Reserve Bank (SARB) have continued to be active participants in international efforts to promote constructive dialogue as we seek global solutions to global challenges. As part of this work, we interact with many of the countries that you represent, be it as a member of the IMF, the G20 2, BRICS 3, the Southern African Development Community (SADC), the Association of African Central Banks, and various standard-setting bodies and regulatory forums. The initiatives that the SARB has been involved in since we last met include the following: • There have been ongoing discussions about providing adequate resources to ensure that the IMF can fulfil its role at the centre of the GFSN. • Enhancing the effectiveness of the BRICS Contingency Reserve Arrangement (CRA) has also remained top of the agenda. The CRA is a self-managed contingent reserves arrangement instituted to forestall short-term balance of payments pressures, provide mutual support, and further strengthen financial stability. • Another priority has been strengthening the macroeconomic research capability to support the CRA. • In the region, the SADC Real Time Gross Settlement System 4 has continued to gain momentum. Between July 2013 and February 2019, more than 1 million transactions were settled on the platform, representing a value of R5.5 trillion. • In addition, we have successfully collaborated with the European Central Bank, the Bank of England and the Bundesbank to develop certain skills of SARB staff members and to share and transfer knowledge in areas related to the SARB’s domestic and regional work. 2 Group of Twenty (Finance Ministers and Central Bank Governors) 3 Brazil, Russia, India, China, South Africa 4 Previously known as the SADC Integrated Regional Electronic Settlement System (SIRESS) Page 4 of 7 The independence of central banks and the South African Reserve Bank’s role in the South African economy Another topic that has been prominent over the past two years or so, and which seems to be gaining momentum, relates to central bank independence. In the words of Kenneth Rogoff, ‘with the global rise of populism and autocracy, central bank independence is under threat’. 5 This applies to many countries, developing and advanced, including South Africa. South Africa’s disappointing economic performance over the past 10 years has contributed to growing calls for the expansion of the mandate of the SARB to directly stimulate growth and address unemployment. The SARB’s mandate, which is to achieve and maintain price stability in the interest of balanced and sustainable growth, is enshrined in the Constitution. In this regard, by keeping prices stable, the SARB creates the necessary economic environment for sustainable growth and development. An economy with stable inflation provides certainty, improves planning, and therefore supports consumer, business and investor confidence, which are essential in driving economic activity that facilitates growth and employment creation. Lower prices also support South Africa’s competitiveness in global trade. The inflation-targeting framework has served South Africa well. It has helped us achieve lower inflation and therefore lower interest rates. It has also increased the transparency of monetary policy, and made the SARB more accountable for its actions. We have come a long way from the days when the Governor could decide on interest rates in his office on a Friday afternoon, and not even publicise his decision, let alone his goals or reasons. In terms of inflation, South Africa has joined many other emerging markets in getting inflation down to fairly low single-digits. In the 1980s our average inflation rate was 15%. It was nearly 10% through the 1990s. Since the introduction of inflation targeting, 5Kenneth Roggof (2019, April) “How central bank independence dies” Available at: https://www.project-syndicate.org/onpoint/how-central-bank-independence-dies-by-kenneth-rogoff-2019-05 Page 5 of 7 in 2000, inflation has averaged just over 6%, at the top of our target range but still substantially lower than in the preceding decades. It has also fallen further in recent years, to about the middle of our target range – the average last year was 4.6%, and we expect 4.5% this year. Lower inflation means we can have lower interest rates. This is an economic relationship that makes a lot of sense, because lenders expect to be compensated for inflation, but it is often underappreciated in debates about inflation and the inflation target. The historical experience shows us we should take this point seriously: in the 1980s the SARB’s average policy rate was around 13%. In the 1990s it was nearly 16% - with a lot of volatility, including spikes over 20%, because policymakers sometimes tried targeting the exchange rate, which is a much more difficult target than inflation. The repo has averaged 8% over the inflation targeting period, and just 6% since the Global Financial Crisis. As I always remind people, if you want lower rates, you need lower inflation. We see this process working once again at the moment: our forecast model indicates inflation will be close to 4.5% over the next few years, which is where we want it – in the middle of our target range. Given the weak economy, our model suggests we might have room to cut rates over the next year or so. While the SARB recognises the role that macroeconomic policy has to play in the economy, the primary contribution monetary policy can make to growth is smoothing output fluctuations over the business cycle. The current challenges constraining economic growth are primarily structural in nature. To ensure that monetary policy settings have a sustained positive impact on growth, they should be appropriately supported by other macroeconomic policies. The longer-term costs of higher inflation and a deterioration in inflation expectations have potentially adverse impacts on policy credibility, consumer purchasing power, borrowing costs, and the global competitiveness of South African firms. To make a marked impact on potential output and employment levels, what is required is the implementation of prudent macroeconomic policies underpinned by credible structural policy initiatives. Tough times call for tough actions. Page 6 of 7 Monetary policy is not a substitute for structural reform. Price and financial stability is, however, key to ensuring that any structural reform agenda is successfully implemented. The SARB remains committed to fulfilling its mandate in this regard. Conclusion Allow me to conclude. Many of the existing and emerging challenges confronting the global economy today require the strengthening of cross-border cooperation. We therefore need to strengthen our resolve to seek rules-based multilateral solutions. In a highly interconnected world, unilateral action, especially in the systemically relevant economies, is not the solution to fixing trade imbalances. Instead, it undermines confidence, increases adverse spillover effects, and ultimately reduces global growth. Central banks and monetary policy have come under increased attention around the world recently. There are expectations that monetary policy should shoulder more responsibilities in addressing growth constraints. However, these expectations need to be based on the constitutional or legislative mandates of central banks. They also need to acknowledge the merits of central bank independence in safeguarding macroeconomic and financial stability, which is key in ensuring that the economy is on a sustainable growth path. In this regard, I would like to reiterate that the SARB remains committed to fulfilling its primary mandate of maintaining price stability in the interest of balanced and sustainable economic growth. In addition, we will pursue this objective ‘without fear, favour or prejudice’, as the Constitution calls upon us to do so. Thank you. Page 7 of 7
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Keynote address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 2019 BNP Paribas Global Official Institutions Conference, Paris, 19 June 2019.
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Keynote address by Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the 2019 BNP Paribas Global Official Institutions Conference Paris 19 June 2019 The global backdrop and monetary policy in emerging markets Introduction Ladies and gentlemen, good afternoon. Thank you to BNP Paribas for allowing me the honour to deliver the opening keynote address at this prestigious gathering of global official institutions. Also allow me to commend the organisers of this event for their foresight in coming up with diverse and well-balanced topics that have risen to the top of the global agenda. There is no doubt in my mind that, at the present moment, uncertainty in the global macroeconomic environment, including rising geopolitical uncertainties, elevated trade tensions and rising debt levels, dominate the discussions of most global investors and policymakers. In my remarks today, I will discuss the implications of these developments for emerging market economies and the possibility of further risk from market volatility, before I conclude by touching on the policy options at our disposal to navigate through these rather turbulent times. Page 1 of 10 An uncertain global economic environment Investors and policymakers alike have had a nervous last few months. It is often said that expansions do not die of old age. Yet, as they lengthen in duration, reaching nearrecord periods in some cases, observers increasingly worry about whether the trigger of the eventual downturn is already there. Are we in such a case at present? In his foreword to Global Economic Prospects published earlier this month, World Bank President David Malpass writes that ‘global growth has continued to weaken and momentum remains fragile’1. Compared to its January forecast, the World Bank has this month downgraded its forecast for global growth in 2019 by 0.3 percentage points to 2.6%. Furthermore, it sees only a mild recovery ahead, to 2.8% by 2021. Revisions to this year’s forecasts are broad-based, across both advanced and emerging economies. Private sector consensus forecasts have similarly been scaled down in recent months. In some countries, a moderation was expected after the strong momentum observed in late 2017 and early 2018. In the United States (US), for instance, economists anticipated that the boost to private spending from the fiscal stimulus of the first half of 2018 would eventually fade. This has indeed happened, although the US economy remained dynamic at the start of 2019, rising by a surprisingly strong 3.1% when annualised, despite a temporary shutdown of government services. But the deceleration in other countries, amid a slowdown in global trade flows, surprised many by its magnitude. The eurozone slowed from 2.4% in 2017 to 1.8% last year, as weakening exports to Asia, the United Kingdom (UK) and Eastern Europe took a toll on business confidence. The World Bank now only expects a 1.2% increase in the eurozone’s gross domestic product (GDP) this year. China has also lost momentum, as earlier policy tightening curtailed lending by the non-bank financial sector and the tariff increases of 2018 weighed on exports. By late 2018, these negative economic surprises had reached levels ample enough to trigger a bout of risk aversion in financial markets, which particularly affected equities 1 Media Call on the June 2019 Global Economic Prospects Report, World Bank Group, Washington DC, United States Page 2 of 10 and corporate bonds (although emerging market currencies and fixed-income markets were relatively sheltered). Global financial conditions tightened. This tightening, however, proved short-lived, as the continuation of benign (and, in some cases, soft) inflation developments allowed major central banks to pause, or delay, the start of their normalisation process. In the US, in particular, indications by the Federal Reserve (Fed) that it could be patient before making any policy decisions helped equities and corporate bonds to recover their earlier losses. Nonetheless, many threats to global expansion remain unresolved, and in some cases risks previously identified have begun to materialise. First and foremost among these are the trade tensions between some of the world’s major economies. In the wake of the recent increases in US tariffs on selected Chinese imports, and in light of the potential for broader tariff increases, analysts are already anticipating a bigger drag on global growth from what increasingly looks like a protracted trade conflict. In its most recent Surveillance Note for the G20 Finance Ministers and Central Bank Governors, for the meetings in Fukuoka, Japan, 10 days ago, the IMF noted these additional tariffs would “dampen trade and weigh on confidence and financial sentiment, adversely impacting investment and productivity and growth.” Separately, the UK’s Parliament is struggling to agree on the terms for leaving the European Union, with negative consequences for growth and investment and some spillovers to continental Europe. Financial markets have displayed sensitivity to these developments. At the same time, a number of geopolitical tensions continue to simmer, especially between Iran, the US and its Middle East allies. While the G20 observed that global growth appears to be stabilising more recently and may pick up into 2020, downside risks overall are still perceived to be tilted to the downside. What does this backdrop imply for emerging markets? Against such a global backdrop, emerging countries are facing conflicting pressures. And the experience of the past 15 months shows that it is not just the monetary policy Page 3 of 10 path in the major economies, but also the divergences (or not) between these policies, that can have major consequences for emerging markets. At first, and for a large part of 2018, an ever-widening growth gap between the US economy and its major partners, coupled with budding trade tensions, boosted the US dollar. The Fed continued to normalise policy rate levels while other major central banks stayed put. The resulting widening in the interest rate divergence in favour of the US contributed to dollar appreciation. The mix of rising US interest rates, a stronger dollar and overweight investor positions (at the time) in the so-called ‘risky assets’ weighed on the currencies and bonds of those emerging markets that exhibited frail external and fiscal balances. Specifically, financial stress in Argentina and Turkey, amid the need to roll over a large amount of short-term debts and a de-anchoring of inflation expectations, precipitated a sell-off in emerging market assets, although with important differentiation across countries. The situation changed in the fourth quarter of 2018, when indications of slowing economic activity in the US led financial markets to anticipate lesser tightening by the Fed, resulting in some downward pressure on the dollar and a decline in US Treasury yields. The prevailing mix allowed for some recovery in emerging market assets and a resumption of capital flows to these countries. Additional factors also helped, including the decline in oil prices, the tightening of monetary policy in a large number of emerging countries that had restored wider rate differentials with the advanced economies, and, in several countries, a lesser-than-feared pickup in inflation in response to currency depreciation. During the early stages of this year, we have seen a significant change in monetary policy forward guidance given by major central banks, the Fed and ECB in particular, which delivered some easing of financial conditions, particularly in advanced economies, but in emerging markets as well, although to a lesser degree. Page 4 of 10 Yet the situation remains fluid, as illustrated by the recent downward pressure on emerging currencies in response to the renewed flare-up in trade tensions – even if, again, rising market expectations of lower US interest rates are cushioning the blow. In summary, the last few years have continued to teach us that, in a world of open capital accounts and elevated debt levels, global capital flows display cycles that remain heavily influenced by the monetary policy of the advanced economies. Furthermore, the Fed retains its key role in driving these flows, owing to the dollar’s role as a funding currency for both portfolio flows and bank loans. Indeed, the desynchronisation of policy cycles between the Fed and other major central banks can accentuate the capital flow cycle, especially if it leads to dollar appreciation. That said, cross-border investors and lenders continue to differentiate between specific emerging markets. Those with elevated foreign exchange (FX) liabilities, twin deficits and poorly anchored inflation expectations remain the most vulnerable. Looking ahead, the relative synchronisation of major economies’ central banks, insofar as they all experience a lack of inflation pressures, provides some reason for optimism, as does the success of these central banks in reversing the undue tightening of financial conditions in late 2018. However, any indications that the advanced economies are slowing faster than expected as risks materialise could trigger renewed capital outflows from the emerging markets. Additional risks from geopolitical uncertainties and trade tensions Allow me to briefly discuss, albeit in more detail, how trade tensions, and more generally geopolitical uncertainties, can affect the environment for emerging markets. Countries with open capital markets and floating currencies are exposed to swings in the international perceptions of risk – and the factors I have mentioned influence these perceptions. Hence, even if a specific emerging country is not directly exposed to higher tariffs, or if it is not in the region where a geopolitical issue is flaring up, it can experience capital outflows as investors will require a higher premium on its assets. Page 5 of 10 There are more direct channels through which emerging markets can be affected by geopolitical issues. These include, of course, upward pressure in oil prices. We saw, up to a few weeks ago, that tensions in the Persian Gulf were keeping the price of crude elevated, even as global growth showed signs of slowing. In addition, business confidence will typically suffer if the geopolitical tension affects prospects for trade with the region concerned. If the endgame is military conflict and infrastructure destruction, a consequence will be migratory flows. These, if uncontrolled, can cause both fiscal pressures and socio-political tensions in the country receiving the displaced populations. Finally, conflict can also increase the cost of, and the potential restrictions to, international merchandise trade, for instance if it affects an area that is important for maritime traffic. Of course, we talk here of linkages that relate to ‘severe’ geopolitical events like conflicts – and there is thankfully no certainty that these will happen. Nonetheless, emerging countries have also in the past been affected by ‘milder’ events that weigh on global demand and make investors less willing to increase exposure to the ‘riskier’ emerging market assets. As far as trade tensions are concerned, negative consequences for emerging markets will emerge if these countries are involved in specific stages of the affected global value chains, or if they export commodities that are used at the beginning of these value chains. The IMF G20 Surveillance note mentioned earlier indicated that based on simulations conducted by the IMF, recently announced tariffs, together with previously announced ones, could reduce global GDP by 0.5 per cent in 2020. Are emerging economies at risk of further market volatility? This leads me to addressing the issue of how emerging countries can navigate the current turbulent waters, and in particular how they can deal with potential financial market volatility. Page 6 of 10 As I have argued earlier: the experience of the last year shows that portfolio investors and other lenders, including banks, do differentiate between emerging markets, largely according to the strength of their macroeconomic and policy fundamentals. For instance, while currencies like the Argentinian peso and the Turkish lira depreciated by 48% and 32% versus the US dollar in the first 10 months of 2018 respectively, others barely depreciated, losing less than 5% over the same period (such Thai baht, Malaysian ringgit or Peruvian sol). These discrepancies illustrate the major influence of external and fiscal imbalances (the proverbial ‘twin deficits’), as well as the degree of endogenous inflation dynamics in response to external shocks. Does this mean that emerging market assets will again experience widespread differences in performance this year and the next? While such a risk is indeed elevated, several factors should nonetheless help to insulate these markets better than in earlier crises. First, most emerging countries enjoy better coverage ratios from their FX reserves, even if historical experience reveals that, when other fundamentals are weak, high reserves may not offer much protection against market volatility. Second, inflation expectations now appear better anchored in a broad range of emerging countries, as a direct consequence of the growing credibility of inflationtargeting regimes. In several cases, public debt is also better managed than in the past, with countries extending the average maturity of their debt and increasingly relying on local currency-denominated issues. Finally, the real effective exchange rates appear to be mostly fairly valued or even undervalued after their widespread depreciation in 2018. This said, endogenous sources of vulnerability to future global market turbulence still exist in emerging countries. They need to be addressed if future bouts of local market volatility are to reduce in both size and duration. I would like to mention, in particular, the growing indebtedness of the corporate sector and, to a lesser extent, also of the household and government sectors, which means that, for most of the emerging Page 7 of 10 countries, total debt (public plus private) is now well in excess of the levels that prevailed before the global financial crisis. Similarly, an increase in FX liabilities (mostly by the private sector) and, in several cases, growing mismatches between FX-denominated assets and liabilities poses risks in some countries. Indeed, even if there is no such mismatch at present, the levels of both FX assets and liabilities are often large relative to GDP, which means that any changes in valuations can quickly generate important swings in a country’s net international investment position. Finally, the experience of South Africa also highlights the dangers linked to an increased financial fragility of state-owned enterprises (SOEs), as the hard-currency liabilities of SOEs can rise quickly, eventually turning into additional credit risks for the sovereign. Policy options to deal with turbulent times In the beginning of these remarks, I pointed to the support which emerging market currencies and fixed-income assets have received from the rising expectations of US interest rate declines and the fall in long-term bond yields, both in the US and in other advanced economies. Such developments ensure that the yield differentials between emerging countries and their advanced counterparts remain relatively wide, offering some buffer against capital outflows. However, this equilibrium is fragile. If the world economy proves more resilient than expected, bond yields can easily reverse part of their recent decline, especially if the recent US inflation softness proves transitory, as most economists indeed anticipate. Conversely, if global growth data surprise on the downside, emerging markets could suffer from a ‘flight to safety’ and renewed appreciation of the US dollar. Last year’s events, just like the ‘taper tantrum’ of 2013 or the ‘investment recession’ of 2016, show that if global financial conditions become less favourable, all the emerging countries will be affected to some extent, although those with stronger fundamentals will show greater resilience. Building resilience thus appears to be a necessary task for governments and central banks alike. In particular, it is important to ensure that Page 8 of 10 inflation expectations remain well anchored and that, as a consequence, the lower exchange rate pass-through to inflation observed in the recent cycle remains the norm. But authorities should also keep the growth in FX-denominated liabilities under control, so as to allow exchange rate depreciation to play its role as an ‘adjustment variable’ and minimise any impacts from external currency and asset price shifts onto private sector balance sheets. They also have the option of using the available macroprudential tools should conflicts emerge between the respective goals of price and financial stability, including risks to these balance sheets. Resilience also depends on limiting dependence on foreign capital to meet domestic funding needs. It is therefore important for governments to ensure, through a mix of prudent fiscal policies and an environment that is conducive for private savings, the absence of any major mismatches between the domestic supply and demand of debt securities. Hence, when non-residents eventually reduce their bond holdings, these net sales will be more easily absorbed by domestic investors, and the domestic market for securities will remain liquid. Appropriate, sophisticated market tools to hedge against currency and interest rate risk can only help in the deepening of domestic markets. These tools I have just mentioned deal more specifically with currency- and capital flow-related risks. Nonetheless, the list is not exhaustive. Resilience also depends on the way in which investors perceive the institutional and governance quality of the recipient country, the existence of checks and balances, and the depth and quality of its political debate. And, as South Africa’s experience shows, financial resilience also depends on real economic resilience. South Africa’s inflation expectations may be better anchored than they were in the past, its FX liabilities may be relatively low, its banking sector may be solid, and its domestic capital markets may be deep and liquid. Yet it’s domestic GDP growth performance has been weak, contributing to relatively high fiscal and current account deficits and a relative vulnerability of South African assets. Consequently, emerging market policymakers should also focus on measures that increase the ability of domestic private agents to adjust to external shocks, including the mobility of labour and capital across sectors. These measures include lowering the Page 9 of 10 constraints to doing business, creating opportunities for laid-off workers to ‘retrain’ and find jobs in alternative industries, ensuring that infrastructure is appropriate for business to respond to relative price shifts, and allowing for sufficient economic and export diversification. This way, heavy reliance on specific commodities, markets or segments of value chains will not become a major risk if those particular sectors face global shocks. Conclusion In conclusion, let me again point out that while the global environment remains challenging for investors and policymakers alike, much progress has been made over the years to better insulate the emerging economies from unavoidable global shocks, and authorities have additional tools at their disposal to increase that resilience over the medium to long term. Central banks can also play their part in the build-up of that resilience, both through the execution of their price and financial stability mandate, and through their management of official reserves – even though the current low-yield environment makes it difficult to earn good returns on their financial assets. But central banks also face limitations in what they can achieve. Strengthening a country’s economic and financial architecture is everybody’s task. Thank you. Page 10 of 10
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Public lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of South Africa, Pretoria, 24 July 2019.
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Public Lecture by Lesetja Kganyago, Governor of the South African Reserve Bank, At the University of South Africa, Pretoria 24 July 2019 Delivering on our mandate: Monetary policy, inflation, and balanced and sustainable growth Good morning, ladies and gentlemen. Today, I would like to talk about the South African Reserve Bank’s (SARB) mandate: what it is, how we interpret it, and where we are in our national conversation about the SARB. Although central banking has a global reputation for being boring, in South Africa it has been getting a lot of attention. Much of this is welcome: it is largely a useful opportunity for improving public understanding of what the SARB does, while we at the SARB also learn and benefit from our interactions with people all over South Africa. However, some parts of the discussion are problematic because they distract us from more pressing priorities. As Mr Tito Mboweni, the Finance Minister, has pointed out: this ‘obsession’, to use his phrase, is getting in the way of a more fundamental discussion about economic growth, job Page 1 of 14 creation and dealing with inequality. 1 This economy used to grow at 3% or 4% a year, but now it grows at about 1%. As we in the SARB have tried to communicate: the growth problem in South Africa is mainly structural in nature, beyond the reach of monetary policy alone. Perhaps part of the problem is that whenever we get a new gross domestic product (GDP) statistic, the news bulletins and the newspaper articles end up talking about what it means for the next Monetary Policy Committee (MPC) meeting. Given this pattern, you might well assume that interest rates have large growth consequences. But we need some perspective. If we reduce rates by 25 basis points, and there are no other reforms in the economy, our modelling tells us that growth will be about 0.1 percentage points higher, one year later. That’s all. Remember that when we cut rates, borrowers have more spending power but lenders have less. Exporters may do better from a weaker rand, but firms that use imports do worse. Investment may pick up, but that depends on long-term rates, not just the repurchase rate (repo rate) – in addition to many non-monetary factors. So the growth effects of a rate cut are small. And if we as a country obsess about the SARB and monetary policy as the only answer to our growth problems, we will fail to discuss the difficult but vital reforms that might actually rescue us from our growth malaise. 1 Lindeque, M. 10 June 2019. Eyewitness News (EWN). Retrieved from EWN: https://ewn.co.za/2019/06/05/what-is-this-obsession-with-the-reserve-bank-mboweni-sets-recordstraight-again. Page 2 of 14 Failing to get that conversation about growth going has further repercussions, because it feeds the notion that the SARB’s private shareholding matters to the policy framework we have and the decisions made on policy. And again, this shareholding debate is more damaging to our economy than it should be. It sends a signal to investors, both here and abroad, that our macroeconomic framework is at risk, making the cost of debt higher than otherwise and undermining confidence. Who loses from all this? One of the biggest hits is to indebted households and the beneficiaries of public spending, who pay the price for skyrocketing interest costs on our public debt as the resources to spend are squeezed. These very serious problems aside, the fact that South Africans want to engage with the SARB and its mandate is welcome, and we applaud it. Of course, not everyone agrees with us 100% of the time. A certain amount of disagreement is normal, in central banking, as in so many other things. Indeed, not only is public engagement and discussion of monetary policy appropriate. When it is based on evidence, it is something we encourage. In the old days, central bankers did everything in secret, and any public statements were deliberately complicated. Nowadays, we try to be open and transparent. We have learned that monetary policy works better with communication. An economy is populated with people. If these people understand what the central bank is trying to do, they adjust their behaviour, which in turn helps the central bank to achieve its policy goals. Furthermore, we appreciate that having independence creates a duty to be transparent and accountable; we are not, and do not want to be, exempt from democratic principles. 2 2 Kganyago, L. 2019. ‘Principled agents: reflections on central bank independence.’ 19th annual Stavros Niarchos Foundation lecture. Washington D.C.: Peterson Institute for International Page 3 of 14 This talk is a contribution to the discussion on our mandate. So let us talk about the SARB’s mandate. The Constitution, in section 224, instructs the SARB to protect the value of the currency in the interest of balanced and sustainable growth. This mandate reflects an understanding that protecting the value of the currency is a critical foundation for achieving lasting growth. Clearly, the mothers and fathers of our Constitution did not want us to let inflation run. We might have got more growth but it would have been unsustainable. As many countries have discovered, after a temporary boom, we would end up in stagflation, with weak growth and high inflation. The framers of our Constitution also cared about macroeconomic imbalances, which might, for example, result from a debt boom, or if we spend well in excess of what we produce, with imports running too far ahead of exports. The Constitution tells us what to do, but it is not explicit about how we do it. We had to figure out a monetary policy framework for ourselves. In fact, it took us a few years to arrive at the approach we use now: the Constitution was passed in 1996, but we only started inflation targeting in 2000 – after a false start using the so-called ‘eclectic approach’ that included a failed attempt to control the exchange rate. Economics. Retrieved from the SARB: http://www.resbank.co.za/Lists/Speeches/Attachments/550/Principled%20agents%20Reflections%20 on%20central%20bank%20independence.pdf. For a scholarly treatment: Tucker, P. 2018. Unelected power: the quest for legitimacy in central banking and the regulatory state. Princeton University Press. Page 4 of 14 The inflation target, agreed between the SARB and National Treasury, was initially set at 3-6% before being shifted to 3-5%. The emerging market crisis of 2001 led to the reinstatement of the 3--6% target, and it has remained since then. More importantly, the target created a clearer framework for decision making and enhanced public understanding of the SARB’s monetary policy objectives. But this choice of target also left important questions open. In particular, because the 3-6% we ended up using is a wide range, it created uncertainty about the SARB’s true objective. I recall that a consultant helped us with some educational materials, including for our website, who wrote that with a 3-6% target the SARB would cut rates when inflation was under 3% and hike rates when it was over 6%. That was a logical interpretation, but it was completely wrong. The fact is that during the inflation-targeting era, the SARB has not seen targeted inflation below 3%. We have nonetheless cut rates on many occasions. In fact, these rate cuts have typically happened with inflation over 5%, already in the top end of the target range. Various analysts and academics have spent a lot of time trying to estimate the SARB’s de facto target, and they have tended to conclude it has been close to 6%.3 Four years ago, we took a critical look at our monetary policy and reflected on our shortcomings. We realised we had let underlying inflation, and inflation expectations, drift to the very top of our target range. This wasn’t a problem of supply shocks or demand shocks; it was a problem of the 3 Examples include: Klein, N. July 2012. ‘Estimating the implicit inflation target of the South African Reserve Bank’. International Monetary Fund (IMF) Working Paper 12/177 and Miyajima, K. and Yetman, J. 2018. ‘Inflation expectations anchoring across different types of agents: the case of South Africa’. IMF Working Paper 18/177. Page 5 of 14 trend inflation rate. The analysts and academics were right: we had ended up with a 6% target. This meant we had a high inflation rate relative to other countries. We found that about three-quarters of other countries had lower inflation. In addition, with ‘normal’ inflation already near 6%, every new adverse price shock would push us outside of the target range. This would force us to act, rather than be flexible, or would cost us credibility, ensuring a higher inflation rate. To make matters worse: because everyone was used to inflation around 6%, indexation had set in – prices and wages across the economy were locked in to grow at this pace. This left us in a trap: nominal interest rates had to be high because inflation expectations were anchored at around 6% but high interest rates meant there was always pressure to cut. Meanwhile, the indexation bias meant that inflation never fell much, and so in turn interest rates stayed structurally high. The paradox is that we have often been accused of being hawkish and keeping interest rates too high, when in reality we have often tolerated as much inflation as we can, ignoring the bottom half of our target range. This is the main reason why our interest rates haven’t fallen further. We tend to spend a lot of time comparing ourselves to low inflation and low interest rate economies, when we really are not in that particular picture frame. 4 Given this analysis, we decided to make some changes. We could better achieve permanently lower interest rates if we were clearer about where exactly we want inflation to be, within our range. 4 See also Mnyanda, L. 22 July 2019. ‘Reserve Bank should clarify inflation target’. Business Day. Page 6 of 14 The simplest and most honest option would be to emphasise the middle of our target range, 4.5%, as our goal. By analogy, we began to think of the 3-6% target range as the lines on a road. When you’re driving down the road, you try to steer between the lines. You don’t drive along the yellow line or the centre line, unless you’re a bad driver. Of course, you can’t keep the car dead-centre in the middle of the road all the time, but every time you start to drift towards the lines, you correct, aiming back for the middle of the lane. For monetary policy, the 4.5% midpoint is the middle of the lane in this metaphorical road, and 3-6% are the lines. When we decided on this adjustment, we were aware that using interest rates to move inflation expectations from the top of the target to 4.5% could be costly. For this reason, we started with some communication, expressing our preference for inflation expectations moving towards 4.5% over time. We also began more detailed work on ‘sacrifice ratios’, which is the term economists use for how much growth it costs to lower inflation. These exercises generated a range of estimates, but, broadly speaking, they suggested we would have to do a series of rate increases, lifting the repo rate to 8% or higher, to get inflation to 4.5% – assuming everything else in the economy was normal. The estimated output sacrifice ratio was in the range of 1-1.5% of GDP. However, while we were studying this problem, a fortunate thing happened. Inflation began to slow, falling to around the middle of the target range by the middle of 2017. This occurred mainly because of positive supply shocks. In particular, food price inflation declined to unusually low levels, around 3%, compared with a long-term average nearer 7%. The exchange rate also stabilised: after depreciating every year from 2011 to 2016, it began trending sideways, which helped to moderate inflation for imported goods. We also like to think our communication made a difference. People were seeing inflation around Page 7 of 14 4.5%, and they were hearing the SARB say that’s where we planned to keep it, so they used that information in setting prices and wages. All of this happened without us having to adopt a tight policy stance – we started with the repo rate at 7%, and we never had to go above that. Put simply, we got a good opportunity to get inflation lower, and we used it. Did we do the right thing? Again, I appreciate that informed people disagree, and these are good-faith disagreements. People who understand economics and genuinely want what is best for South Africa, take different views. But let me make two points about our decision. First, what we are doing is completely consistent with our target and our mandate. Some people tell a story that in February 2010 there was a letter from the Minister of Finance changing the SARB’s target and how the SARB is now ignoring that letter.5 It is strange for me to be told what that letter was about, because at the time I was Director-General in the Treasury, under Minister Pravin Gordhan, so I should know the content of that letter. It did not establish a new target close to 6%. Rather, it reaffirmed the 3-6% target range, and it reaffirmed the SARB’s practice of pursuing this target in a flexible way. Flexibility means the SARB should avoid excessive volatility in growth and interest rates. In other words: if an inflation shock moves inflation outside of the target range temporarily, the SARB doesn’t have to hike interest rates to return inflation to target immediately. The SARB just needs to do enough to get inflation to return to target over time. The Minister’s letter specifically recognised that inflation expectations need to be anchored, 5 Gordhan, P. 16 February 2010. National Treasury. Retrieved from National Treasury: http://www.treasury.gov.za/comm_media/press/2010/2010021701.pdf. Page 8 of 14 and that well-anchored inflation expectations under credible monetary policy are good for growth. The approach we are taking now, emphasising the 4.5% midpoint, is our best attempt at implementing the 3-6% target framework optimally. As I have noted earlier, the SARB and National Treasury had originally agreed to lower the target range to 3-5%. With hindsight, by postponing it to some unannounced future date, we made a mistake. We should have announced we would get to 3-5% more slowly, instead of reverting to 36%. If we reformed the target now, in consultation with National Treasury, we would likely go to either 3% or 4%, with a tolerance band of maybe 1 percentage point on either side. This is where most of our peer emerging markets are already, or where they are heading. For instance, this is where inflation targets are for Brazil, Chile, China, Colombia, India, Indonesia, Mexico, Russia and various other peer countries.6 But we never reformed our target, so we are still using 3-6% and we are making policy target that range as best we can. The second question I would like to tackle is whether emphasising 4.5% is an optimal monetary policy for South Africa? My view is that this is a key macroeconomic accomplishment. We have positioned South Africa to have permanently lower inflation. This is valuable progress. Critics will say we could have cut rates to get higher growth. But, as I have noted earlier, South Africa’s growth problem is caused mainly by structural 6 Unlike the other countries mentioned, China’s monetary policy approach is not always classified as pure inflation targeting. Nonetheless, the authorities have specified an inflation target of around 3%. Page 9 of 14 factors, like a constrained electricity system as well as policy uncertainty. Given these constraints, a monetary policy that tolerated higher inflation for the sake of more demand would have yielded, at most, relatively small and temporary benefits, at the price of long-term costs. As an exercise, we have modelled what would happen if the MPC started aiming for a 6% target again. If we cut rates by about 100 basis points, growth would be half a percentage point higher, at its peak, and about a third of a percentage point higher the year after that. That isn’t much growth, and certainly not a game-changing growth recovery. The exchange rate would depreciate, the output gap would close, and inflation expectations would start shifting higher. Core inflation would hit 6% after about two years. By around this point, growth would slow once again; there would be no permanent increase in output. Interest rates, however, would be permanently higher, given the implicit 6% target. Higher inflation begets higher interest rates. If the country needs long-lasting low interest rates, then we must have lower inflation. This last point is something you should bear in mind whenever you hear someone arguing for a higher inflation target. Many of you are students, so it matters for you as much as for anyone else. A higher inflation target would mean higher interest rates. Over the short term, one or two years, tolerating more inflation can allow a looser stance. But this effect is temporary. If we decide to tolerate more inflation now, by the time you graduate and go to work, you are going to face higher interest rates. Your student loan repayments will be higher. A car payment will be more difficult. A mortgage will be costlier. All this will have real implications for your incomes. Page 10 of 14 This does not mean the SARB should avoid all rate cuts. Rather, we should avoid cutting if the price of doing so is permanently higher inflation. We can cut rates if we feel confident we can keep inflation under control over time. Our modelling framework balances growth and inflation over the medium term using a Taylor rule. If the model sees growth underperforming the economy’s potential, the rule suggests a looser policy stance. If inflation is simultaneously higher than the target, it compromises, aiming both to hit the inflation target and to move growth back to potential over the forecast period, of two to three years. Given this process, the MPC decided to reduce rates at its July meeting, because growth is underperforming and inflation appears to be under control. So this is one responsible way to do rate cuts. You may wonder why we say ‘growth’ instead of ‘employment’. Of course, the two are linked. Better growth generally means more jobs. But we don’t refer to employment because of technical issues with our employment data, making them difficult to interpret. For example, despite the negative GDP growth in the first quarter of the year, the Quarterly Employment Survey told us that the economy had created an extra 49 000 jobs. That was probably not a signal the economy was picking up. Unfortunately, the data throw up these kinds of puzzles all the time, making it hard to rely on them as guides for monetary policy. At a more fundamental level, it doesn’t make much difference if we use growth or employment in our Taylor rule, a point made by academics assessing our policy decisions. Page 11 of 14 They find that the SARB cares about jobs as well as growth, and does not behave as if it cared about inflation and nothing else. 7 We can also measure our policy stance with reference to something called a ‘neutral real interest rate’, which in recent years has increased. This makes it more difficult to cut rates without inducing inflation. A part of the rise in our neutral rate has come from higher global rates, which affect us because we have to borrow from foreigners to finance our current account deficit. A larger part of the rise comes from an increasing risk premium. The risk premium is the price that lenders demand for putting their money here in South Africa instead of somewhere else they perceive as safer. Our risk premium has increased by about three-quarters of a percentage point over the past five years. If risk subsides again, perhaps because we borrow less or invest more to grow faster, we will have more monetary space and might cut rates responsibly. Ladies and gentlemen, to conclude, let me make a point frankly. We don’t have balanced and sustainable growth in South Africa. With annual GDP growth rates under 1%, we barely have any growth. Indeed, adjusting for the increase in our population, we have been getting poorer for half a decade. We also don’t have balance or sustainability. Government’s debtto-GDP ratio is moving steadily higher, and with bailouts for state-owned enterprises, there are real risks we will soon have one of the highest debt levels amongst our emerging market peers. Because we have borrowed so much from abroad, we pay a rapidly rising amount of interest to nonSouth African creditors, and this is contributing to a large current account deficit – again, one of the biggest in our peer group. 7 Bold, S. and Harris, L. April 2018. ‘Identifying monetary policy rules in South Africa with inflation expectations and unemployment’. SA-TIED Working Paper 7. Available at: http://satied.wider.unu.edu/sites/default/files/pdf/WP-7-2018-Bold.pdf. Page 12 of 14 There are real limits on what monetary policy can do to help. By anchoring inflation expectations at lower levels, we lower long-term interest rates, supporting investment and helping government to finance a growing debt burden. By maintaining a credible monetary policy and a short-term interest rate that compensates investors for risk, we help to maintain capital flows into South Africa. Our repo rate setting is accommodative relative to our estimate of neutral, and it is low compared with historical averages. Rate cuts, like the one we’ve just decided on, provide some help on the margin, but inflation shows few signs yet of further moderation. There is a healthy debate about where exactly we need to go with the repo rate. But we see no monetary policy stance that would single-handedly transform South Africa’s prospects. And as our economic circumstances get more difficult, I worry that more people will choose to avoid making hard choices and pretend they do not need to be made, as if the SARB could just cut rates enough and all will be well. The facts are, central bankers care about growth and employment, and the SARB is no exception. But we do not face a permanent trade-off between inflation and growth. There are short-term trade-offs involving growth, but after a while, inflation and interest rates are the things that permanently increase. The SARB can deliver low and stable inflation. But balanced and sustainable growth also requires contributions from many other parts of government and society. As a country, we need to maintain prudent macroeconomic policies and we have to make further progress on a range of structural issues. Ultimately, prosperity cannot be created by an MPC Page 13 of 14 setting interest rates. We are but one part of the orchestra; we are not soloists. We are doing our best but we can’t put on a show alone. Thank you. Page 14 of 14
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, to the ninety-ninth annual ordinary general meeting of the SARB shareholders, Pretoria, 26 July 2019.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank (SARB), at the ninety-ninth annual Ordinary General Meeting of the SARB shareholders South African Reserve Bank, Pretoria 26 July 2019 Global economic conditions The past year began with significant challenges for emerging markets, including South Africa. In contrast to the synchronised pickup in economic growth of 2017, which had surprised most observers by its magnitude, the major economies began to display divergent growth patterns in 2018. While the United States (US) maintained a strong pace of growth amid a sizable fiscal stimulus and a buoyant labour market, the eurozone and Japan lost some momentum. Chinese demand felt the negative impact of earlier monetary and regulatory tightening. Growth in world trade volumes also began to slow, a move that was exacerbated by a flare-up in trade tensions as the US slapped tariff increases on certain imports. This confluence of factors, together with negative current account and price developments in countries like Argentina and Turkey, resulted in downward pressure on emerging market currencies and fixed-income assets. This move was compounded by the appreciation of the US dollar, as investors anticipated a further normalisation of US monetary policy and a widening of interest rate differentials with other major economies. By early July 2018, the South African rand had depreciated by 12% against the US dollar from its earlier peak of mid-February, a decline that extended to 25% when the rand reached its trough in September 2018. So what has changed since then? Page - 1 - of 9 Some of the concerns about global growth that prevailed in mid-2018 have proved accurate. Business confidence, trade flows and economic activity have continued to lose momentum in most of the major economies. Now that the impact of the 2018 fiscal stimulus has started to fade, the US is not immune to those trends. The trade tensions that sprang up more than a year ago remain unresolved, despite the June ‘truce’ between China and the US that prevented an immediate tariff escalation. Geopolitical tensions, especially in the Middle East, are adding to a climate of uncertainty that weighs on business investment decisions globally. In this month’s update on the World Economic Outlook, the International Monetary Fund (IMF) is projecting global economic growth of 3.2% this year, compared to a forecast of 3.9% a year ago. Support for the global economy and financial markets, however, has come in the form of a quick ‘change of tack’ by the world’s major central banks, as they shifted from a gradual removal of stimulus to indicating renewed easing, at least in the US and the eurozone. The lack of inflation pressures provides room for such an approach. In fact, core inflation in both the US and the eurozone is currently short of its 2% target, while oil prices, amid slowing global demand, are off the highs reached in October 2018. Meanwhile, in China, the authorities have loosened both fiscal and monetary policies in an attempt to limit the pace of economic deceleration. Against such a background, emerging market assets have rallied, and with inflation generally showing only a limited response to last year’s currency depreciation in several emerging countries, the scope for their central banks to provide at least some accommodation has increased. Domestic economic conditions This less favourable global growth and trade environment has added to South Africa’s economic concerns at a time when the domestic drivers of growth were already stuttering. Addressing this audience a year ago, I highlighted how the rebound in business optimism following changes in political leadership had already started to erode in the second quarter of 2018. Page - 2 - of 9 This erosion has unfortunately continued over the past 12 months. Both the Rand Merchant Bank (RMB) / Bureau for Economic Research (BER) survey of businesses as well as other indicators, such as the Absa Purchasing Managers’ Index (PMI) and the Sacci Trade Conditions Indicator, are signalling low business confidence amid a challenging environment in all sectors. Such low business confidence, coupled with uncertainty about future economic growth, has weighed particularly heavily on private sector fixed investment, which contracted by 2.5% year on year in the first quarter of 2019 and, overall, has stagnated over the past half-decade. Weak private sector fixed investment has indeed been a key cause of the disappointing performance of South African gross domestic product (GDP) growth. Much has been said and written about the sharp contraction in first-quarter GDP growth – 3.2% on an annualised basis – and whether it was a true reflection of the state of the economy. There is no denying that, from quarter to quarter, GDP has been quite volatile of late. Indeed, the SARB’s internal econometric models estimate that activity will recoup part of that first-quarter decline in the second quarter of the year. That said, the less volatile year-on-year comparison shows that GDP growth slowed to zero in the first quarter of the year, which was the weakest performance in exactly three years and one that was indeed consistent with other indicators of activity. And while our models envisage an improvement in the remaining quarters of the year, the SARB projects GDP growth of only 0.6% in 2019 after 0.8% in 2018. This means that in both years, as indeed in all but one of the past four years, real GDP would grow slower than the population growth rate of 1.6%, thus contracting on a per capita basis. Weak economic growth does not just hinder efforts to reduce poverty and inequality; it also weakens public finances. For the current fiscal year, National Treasury projects that the consolidated government deficit will rise to 4.5% of GDP and will only decline to 4.3% next year. By contrast, in the 2018 Budget, projections were for a deficit of only 3.6% of GDP for both fiscal years. Page - 3 - of 9 Inflation In a constrained economic environment, it is not unexpected that some voices argue that monetary policy could do more to support economic growth. But what exactly is the SARB’s margin of manoeuvre, bearing in mind that any policy move must comply with our mandate of price and financial stability? Encouragingly, the past year has seen several favourable developments on the inflation front. First, headline consumer price inflation averaged 4.6% between July 2018 and June 2019, and stood at 4.5% over the past month. Overall, this is a more benign pace of increase than the SARB had projected a year ago, even against a background of higher oil prices, significant rand depreciation, and a 1 percentage point increase in the rate of value-added tax (VAT) in 2018. Second, the SARB’s Quarterly Projection Model (QPM) now forecasts average inflation of 5.1% in 2020 and 4.6% in 2021, both well within the target range. In fact, our projections for the less volatile core inflation rate are even closer to the midpoint of that range. Finally, several measures of inflation expectations, including the quarterly BER survey of inflation expectations among analysts, businesses and unions as well as the bond market-based metrics, have shown a steady decline over the past year, after many years of remaining uncomfortably close to the top end of the target range. Faced with rising longer-term upside risks to the inflation outlook, the SARB felt that it was appropriate to act against such risks, especially in light of policy normalisation in advanced economies – which would most likely imply a higher neutral real interest rate for a small and open economy like South Africa’s. Hence, in November 2018, the Monetary Policy Committee (MPC) decided to raise the repurchase rate (repo rate) by 25 basis points, reversing the cut that had been implemented in March of the same year. By early 2019 though, inflation performance was more benign than anticipated and the risks to the inflation outlook had eased sufficiently enough for the SARB to maintain an unchanged policy stance. Page - 4 - of 9 At the time of its latest meeting held on 18 July 2019, the MPC felt comfortable enough with the recent downward trend in inflation outcomes, as well as the ongoing decline in inflation expectations, to lower the repo rate by 25 basis points. Overall, when looking back at the last few years, it is important to acknowledge the progress that has been made in reducing inflation volatility in South Africa, including in response to exchange rate shifts, and how this has allowed for a better anchoring of inflation expectations and, in turn, how this has also limited the need for sharp monetary adjustments. Since 2016, surveyed inflation expectations have declined by 100 basis points. A more stable and predictable path of interest rates will enhance the environment for sustained economic growth, as the experience of many advanced economies and, increasingly, also the emerging economies has shown. The persistence of such gains is, however, not certain, meaning that the MPC will continue to exercise vigilance in the years ahead. Financial stability With the implementation of the Financial Sector Regulation Act 9 of 2017 (FSR Act) in April last year, the SARB was provided with an explicit statutory mandate to protect and enhance financial stability. The FSR Act further requires the SARB to monitor and keep under review the strengths and weaknesses of the financial system, as well as any risks to financial stability. To this end, the SARB has developed frameworks for identifying, monitoring and mitigating systemic risks. On the whole, the SARB currently assesses the financial sector to be strong and stable. Nevertheless, potential vulnerabilities exist, as we have observed a few emerging trends over the past year, particularly in the banking sector. While South African banks remain adequately capitalised and profitable, the implementation of the new expected credit loss accounting standard, namely the International Financial Reporting Standard 9 (IFRS 9), has resulted in a deterioration in the quality of credit on bank books. Furthermore, as persistently low domestic economic growth starts to Page - 5 - of 9 have an increasingly tangible impact on the balance sheets of both households and corporates, credit quality may be expected to deteriorate further. During the course of 2018, the SARB undertook stress tests on six major banks to assess the resilience of the banking sector to hypothetical yet extreme macroeconomic shocks. The outcome of the 2018 common scenario stress test exercise suggests that, at an aggregate level, the South African banking sector would be able to withstand the possible materialisation of a confluence of the main financial stability risks. With respect to solvency, the banks were assessed to be capable of maintaining their capital levels above the minimum capital adequacy requirements, under the adverse macroeconomic scenarios considered. The SARB also discovered that no material risks were emanating from the liquidity positions of the six major South African banks. The SARB regularly conducts an assessment of the prevailing financial stability risks. These assessments are reported to the Financial Stability Committee (FSC) and published biannually in the Financial Stability Review (FSR). The risks identified since the second quarter of 2018, which currently form part of the SARB’s assessment, include: a deteriorating domestic fiscal position, exacerbated by, among other things, weak domestic growth, a poor revenue outlook, and the fragile financial positions of SOEs; spillovers from weaker global economic growth; the possibility of renewed and unexpected tightening in global financial conditions and the subsequent potential rapid repricing of risk; and rising cyber-dependency and security risks attributed to the ever-increasing digital interconnection of people, systems and organisations. The identification and monitoring of financial stability risks, while important, would be rendered ineffective if we did not have the necessary tools at our disposal to mitigate the occurrence and/or the impact of these risks. Over the past few years, the SARB has been actively developing a macroprudential policy framework, complete with tools and instruments. This past year, work continued to enhance the framework and the financial stability toolkit. Page - 6 - of 9 There is a saying about the best-laid plans ‘of mice and men’. Thus, while the SARB ultimately aims to mitigate systemic risks, it also needs to plan for potential crises and how to deal with them. In this regard, the SARB has taken a number of significant steps towards strengthening South Africa’s resolution framework over the past year. Two separate but related projects were initiated in this area, namely to implement a resolution framework and a deposit insurance scheme. The resolution framework, once promulgated into law, will bring South Africa’s resolution framework in line with the Financial Stability Board’s Key Attributes for Effective Resolution Regimes. This framework will also formalise the SARB’s role as the resolution authority, and will outline the responsibilities with respect to the orderly resolution of designated financial institutions. Meanwhile, the imminent establishment of the Corporation for Deposit Insurance (CDI), as a subsidiary of the SARB, will provide explicit guarantees to protect depositors should a bank ever fail. As a result, not only will depositor confidence in the banking system be enhanced; the CDI will also assist government that, in the past, may have compensated depositors with taxpayers’ money. Financial sector supervision and regulation As you will recall, the FSR Act lays the foundation and the financial system regulatory architecture of the Twin Peaks model. The Twin Peaks regulators, being the Financial Sector Conduct Authority (FSCA) and the Prudential Authority (PA), work alongside the SARB and other regulatory bodies to ensure the stability of our financial system for the well-being of all South Africans. The PA was established on 1 April 2018 and has been operating within the administration of the SARB, as prescribed by the FSR Act. While much of its first year was spent on refining and implementing the integrated framework for supervision, including assuming responsibility for the insurance industry and market infrastructures, the PA also had to complete the resolution of VBS Mutual Page - 7 - of 9 Bank. On 25 June 2019, the PA released its first Annual Report, which reflects all its activities for the 2018/19 financial year. The proposed nationalisation of the South African Reserve Bank The debate about the proposed nationalisation of the SARB continues in the public domain, fuelled by perceptions that private shareholders have control over the central bank. The SARB has clarified, on a number of occasions and through various communication channels, that its private shareholders participate as preference shareholders and do not own or control the SARB, nor do they influence monetary policy or any of the other regulatory functions. Let me reiterate what I have repeatedly been saying in the public domain: the Board of the SARB focuses on governance issues, while policy and regulatory decisions are the preserve of the Governor and Deputy Governors. The South African Reserve Bank Act 90 of 1989 (SARB Act) provides for 15 Board directors, eight of which are appointed by the President, including the Governor and three Deputy Governors. The remaining seven directors are elected by shareholders. As shareholders of the SARB, you are fully aware that the SARB Act prescribes that no shareholder or their associates are allowed to beneficially hold more than 10 000 shares. A fixed annual dividend of 10c per share is issued if profits are made, resulting in the potential total annual dividend payout to shareholders by the SARB being limited to R200 000. After setting aside contingencies, reserves, tax and the like, 90% of any remaining surplus accrues to government. Celebrating 25 years of democracy This year, we marked 25 years of democracy in South Africa through the launch of new commemorative circulation and collectable coins under the theme ‘SA25’. This series includes six new commemorative circulation coins: five themed R2 coins and a themed R5 coin. Through these coins, we celebrate the Constitution, more specifically the Bill of Rights, which is considered to be the cornerstone of our democracy. Page - 8 - of 9 We picked this theme because, aside from being the most iconic feature of our democracy, the Constitution provides for independent institutions, including the SARB. It defines our price stability mandate. The inflation-targeting framework aims to ensure that inflation remains low to preserve the purchasing power of households and the competitiveness of firms. We have endeavoured to ensure that the financial system remains safe and that our policies aim to bolster the resilience of the economy. Conclusion As the public debate about the role of central banks continues, the SARB has ensured that it continues to execute its mandate in the public interest. In this regard, we have endeavoured to be transparent in the execution of our duties, including by providing clear reasons for our decisions and clarifying the limitations in our ability to influence long-term economic growth. In all our decisions, we must consider the trade-offs between short-term and long-term gains. Anchoring inflation expectations, gaining credibility, and building institutional capability are all important elements in enhancing the resilience of the South African economy. Thank you. Page - 9 - of 9
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Public lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of the Free State, Bloemfontein, 4 March 2020.
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Public lecture by Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of the Free State Bloemfontein 4 March 2020 Sound policy is an imperative for growth Good evening, ladies and gentlemen. Thank you for inviting me here today to speak about the South African economy. I am going to focus on how we should see macroeconomic policy and its role in our economic growth problem. There is a principle in economics, known as Dornbusch’s Rule, that a crisis takes longer to happen than you expect, but then occurs faster than you can believe. It is the macroeconomic version of the old rule about how you go bankrupt: slowly, then quickly. The point is that you get a lot of bad data before the system breaks. Experts will warn about a crisis, and after a while, these warnings will become part of the background noise. But when the crisis comes, its timing will still surprise everyone. In South Africa, we are getting used to talking about a crisis. Every time the Minister of Finance presents a new Budget or MTBPS1 to Parliament, the press calls it a ‘make or break’ event, or the most important budget since the dawn of democracy. I have been answering questions about a Moody’s downgrade for years. We are even discussing distant possibilities, like an IMF programme, as if they were imminent. Actually, while our debt to GDP ratio has more than doubled over 10 years, it is still in the region of the emerging market average, which is 55%. Our debt has a long maturity profile, and is mostly denominated in rands, which minimises the risk of losing market access and being forced to ask the IMF for help. The debt problem is not where we are. The problem is where we are going. 1 Medium Term Budget Policy Statement A debt-to-GDP ratio of 60% isn’t a disaster. But our fiscal deficits are over 6% of GDP, and National Treasury expects a deficit of nearly 7% of GDP for 2020/2021.2 At that rate of borrowing, it doesn’t take long to get to a dangerous level of debt. Some analysts suggest we could get to a 100% debtto-GDP ratio within a few years. In that scenario, lenders might give up on us. Or we could see our interest bill claim even more of our scarce resources. But we haven’t locked in that path yet. We are suffering the consequences of past mistakes, but we still have time to make better decisions. It’s crucial we use this time wisely. In economic terms, our problems can be addressed. But there is a real danger of getting our narrative wrong, so we end up having the wrong discussion, we don’t solve our problems, and we learn our mistake the hard way, by having a crisis. This talk is my contribution to prevent that, by getting the narrative right. Let’s start with the macroeconomic stance. I only have responsibility for one part of the macro mix, which is monetary policy, but the Constitution enjoins me to consult regularly with the Minister of Finance, so that fiscal and monetary policies are in sync. It’s therefore important that we understand what fiscal policy is doing and how it interacts with monetary policy. Accordingly, we as the SARB have invested considerable time and effort in this task. By our calculations, the fiscal impulse to growth was around 0.6% last year.3 This estimate excludes bailouts for state-owned enterprises as well as interest payments. A positive fiscal impulse shows that policy is not austere. And yet overall growth was just 0.2%, suggesting that the economy experienced a contractionary fiscal expansion – despite the fiscal impulse, the growth rate of the economy slowed. This combination of looser fiscal policy and worse growth points to policy sideeffects that cancelled out the fiscal impulse, leaving the economy poorer overall. What are these indirect effects? One is confidence. We can see in surveys that both household and business confidence is near long-term lows at the moment. People have seen taxes go up, they see debt rising, but they do not see this spending producing better services. It is a discouraging picture. Businesses are still investing, but they are not ramping up production. Households are holding off on major purchases. There is also evidence more highly skilled people are leaving the country.4 2 The 2020 Budget projects 6.8% for 2020/21. 3 This calculation is based on the methodology developed by the Hutchins Center at the Brookings Institution, described here: https://www.brookings.edu/interactives/hutchins-center-fiscal-impact-measure/ 4 Faulkner, D and Mosadi, T. 11 November 2019. South Africa: the economic implications of high-skill emigration. Available at https://www.research.hsbc.com/R/20/7gNXQNqHnC2d. See also Kaplan, D. 3 October 2019. Packing for Perth: skills flight is a reality, and we must plan for it. Available at https://www.dailymaverick.co.za/article/2019-10-03-packing-for-perth-skills-flight-is-a-reality-and-we-mustplan-for-it/. A second indirect effect is through long-term interest rates. As you know, we at the SARB have reduced the repo rate lately, with cuts in July 2019 and January 2020. We have also tried to steer inflation expectations lower, towards the middle of our target range – and we have seen results, with all measures of inflation expectations declining. Both these changes would normally have shifted long-term interest rates lower. As financial analysts would say, they should have lowered the whole yield curve. Unfortunately, the yield curve has actually steepened: the gap between short rates and long rates is now the widest on record.5 This is the result of country risk. It is the markets sending a message that there is too much borrowing. It is not about tight monetary policy. As I have explained, lower short rates and lower inflation expectations, which are the main channels between monetary policy and long-term rates, have both been working to reduce rates. Indeed, if it weren’t for these factors, the long-term rate would likely be around 100-200 basis points higher than it is now, making our interest costs even more burdensome. As it is, interest costs are reducing the real money available for government to spend – reducing the real value of budgets. And these costs have also doubled in the past five years, to nearly 5% of GDP. Furthermore, a higher risk premium has spread through the rest of the economy, disincentivising investment by raising the cost of capital. Simply put, our fiscal situation isn’t a problem of austerity. It isn’t about tight monetary policy. It isn’t because growth just mysteriously slowed down. Weak growth is endogenous in our fiscal problems. We cannot keep doing what we’re doing and just hope that growth will recover and save us. Growth is low, in large part, because of unsustainable policies. My friend, the Finance Minister Tito Mboweni is a man who says things that are true even when they are unpopular. His message is that we have to reduce spending, and he is right to put this at the centre of our macroeconomic debate. We can all shout at him and resist his proposals, and in the end he will at least have the satisfaction of being proved right. Or we can follow his advice, solve this problem, and avoid a crisis. Now let me move to my core responsibility, which is monetary policy. Once again, I’d like to start with a major misunderstanding, one which has plagued us for many years. It is the deep-seated belief that there is a trade-off between growth and inflation. This conviction has exposed us to something economists call ‘stagflation’ – in other words, economic stagnation – low growth – and high inflation happening at the same time. 5 Based on the gap between the 2021 and the 2048 instruments. The yield curve is also unusually steep comparing other instruments, such as the 2-year and 10-year bonds. At the SARB, we have often had to fight against the tide of opinions which says: let’s cut interest rates, we need more growth, so let’s just tolerate more inflation. The tragedy is that this instinct has left us looking in the wrong direction. In fact, there is a better space, one that many other countries have reached, where inflation is low, where interest rates are therefore lower, and where central banks can be more sensitive to growth precisely because inflation is better anchored. In this space, you don’t need to choose between growth and inflation. You can have growth without high inflation. Over the past few years, we at the SARB have undertaken a major strategic initiative to get closer to this good space. Our starting point was stagflation. In 2016, growth had slowed to 0.4%, but we also had inflation outside of our target range, above 6%, and core inflation was nearly 6%, having trended steadily higher over the preceding five years – even as the economy decelerated. To return inflation to target, we had raised rates, to a peak of 7% in 2016. Then, as inflation began moderating, we were patient, and we communicated that we would prefer to see inflation stabilise at around the middle of the target range. Inflation has since largely cooperated: over the past three years, it has averaged 4.6%. Progress has been somewhat more rapid than we had expected, in part due to lower food prices and an exchange rate recovery, which helped to bring down underlying inflation. That has created extra space to lower the repo rate. With the January MPC cut, the repo rate is now down to 6.25%, its lowest level since 2015. The key point is, we are now in a place where we have got inflation lower, and we have been able to cut rates without sacrificing our credibility. This is how monetary policy is meant to work: you cut rates from a position of strength, because you have inflation under control, not out of weakness, because you have given up trying. That’s the good news. The bad news is that monetary policy alone cannot turn this economy around. As yesterday’s GDP figures reminded us, the supply-side of this economy is in deep trouble. We experienced a technical recession in the second half of the year, and growth for 2019 as a whole was just 0.2%, the worst rate since the Global Financial Crisis. Analysts have focused on electricity shortages as an important contributor to these bad outcomes, with good reason. Unfortunately, these kinds of growth constraints are beyond the reach of monetary policy. The scope for monetary policy is also limited by the fact that inflation has stayed relatively high. In South Africa, we tend to think inflation has collapsed when it’s below 4.5%, but in much of the rest of the world, this is not considered low inflation. The median emerging market had inflation of 2.9% last year, compared to our 4.1%. Brazil, a country much like South Africa, but with a history of significantly higher inflation, was at 3.8%. Advanced economies are lower still; the United States (US), for example, was at 1.5% in 2019.6 If South African inflation were to moderate further, we would have more space to lower interest rates. But even with extremely low growth, inflation does not appear to be slowing further, and we see almost no risk of inflation missing our target from below, which has been a problem for many other countries. Given that inflation does not appear to be falling much further, gaining more space for interest rate cuts means we would need to reduce the impact of country risk. Global rates are low, and that helps. But South Africa borrows heavily from the world. Our current account deficit, which is equal to the foreign savings that come into South Africa, is close to 4% of GDP. Almost all our peer countries borrow less. If we try to cut rates too far, despite the country risk, investors won’t have enough reason to be in South Africa. They would be better off investing in less risky places. So we need to become less risky, to enjoy more of the benefits of low global rates. Key public-sector drivers of inflation, like the public sector wage bill and administered prices, could also help ease inflation. This is where fiscal and monetary policies need to be in sync. Finally, and more fundamentally, we need to appreciate the limits on what any monetary toolbox can do for growth. Let me give you the example of Italy. Italy is part of the euro zone. Euro area inflation has been very low, and the European Central Bank has made a major effort to push it back up again, with policies including negative interest rates and quantitative easing. But Italy has a large debt burden. It has problems of political and fiscal policy uncertainty. Over the past five years, Italy has had average growth of less than 1%. Germany, with the exact same monetary policy, has had average growth closer to 2%. Spain, which, like Italy, was a major victim of the 2011-2012 euro crisis, has averaged nearly 3%.7 Clearly, the tailwind of easy monetary policy was not enough to overcome the headwinds of Italy’s other challenges. Of course, South Africa is a different country. But what you should take away from this is that there is much more to growth than monetary policy, and it is still possible to stagnate with the loosest monetary policy imaginable. The fact of the matter is, South Africa has not made itself a high-growth country. We do not save enough to fund adequate levels of investment. We invest less than 20% of GDP; to sustain strong growth, we should have investment of at least 25% of GDP. We have focused on domestic the Federal Reserve’s targeted measure of inflation. 7 The exact averages are 1.7% for Germany, 0.9% for Italy, and 2.9% for Spain, for the period 2015-2019. The data are drawn from the IMF World Economic Outlook database. 6 This number refers to the change in the Private Consumption Expenditure deflator, consumption as a growth driver, on the grounds that it is the largest part of the economy. This effort has raised household consumption to its highest ever share of GDP.8 But we are growing more slowly than ever. We have accumulated debt faster than almost all our peer countries, on the grounds that fiscal policy has to be supportive of growth. But growth stimulus works for smoothing out business cycles; it’s not a long-run growth strategy. Long-run growth is about savings, investment and exports. It is about raising productivity. We in South Africa have deliberately run down savings, focused on consumption, and pulled in imports. Our productivity growth is exceptionally low, perhaps negative. We should therefore not be surprised that growth has stagnated. Ladies and gentlemen, to conclude: we in South Africa have got to reform. It will involve some pain, but the longer we delay, the more painful it will be. We can tell ourselves comforting stories about how there are pain-free alternatives, but these narratives are misleading. We have spent a lot of time searching for easy options. These schemes don’t stand up to scrutiny. Here’s what we can really do about mitigating the pain of necessary reform. First, we can take the edge off with the interest rate tool. Provided we have lower inflation, and if country risk comes down, we can keep rates low, and maybe go lower. Second, we can devise a credible plan for making things better again. In macroeconomics, as in so many things, it’s not about where you are, so much as where you’re going. The story of the last few years has been that South Africa is drifting into a crisis. This has been the South African story before. We have, in the past, been able to change the narrative. South Africa has many friends, and there is a lot of money out there desperate for good growth economies to invest in. We can be one of those winning countries again. Thank you. 8 In the third quarter of 2019, household consumption reached 62.1% of GDP (using real, seasonally adjusted and annualised data). Over the past 20 years, the average has been slightly below 60% of GDP. Investment and government consumption are also above long-run averages, while net exports are lower.
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Lecture by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Wits School of Governance, Johannesburg, 18 June 2020.
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Lecture by Lesetja Kganyago, Governor of the South African Reserve Bank, at the Wits School of Governance Johannesburg 18 June 2020 The South African Reserve Bank, the coronavirus shock, and ‘the age of magic money’ Good afternoon It is now clear that the COVID-19 outbreak will produce the worst economic downturn in a century. We expect that ‘the great lockdown’ will cause output to contract by about 7% this year. The last time a figure of that magnitude appears in our data is 1931, during the Great Depression, when output fell by 6.2%. It had declined by 6.1% in 1930. The South African Reserve Bank (SARB) has responded flexibly, quickly and aggressively to this crisis. So far, these actions have improved market functioning, and are supporting economic activity. However, the larger economic outlook remains uncertain. We are watching the data closely, and we are ready to act as appropriate, in accordance with our mandate. Fortunately, central bank governors tend to get a lot of advice, and I have been particularly well-supplied with suggestions for SARB policy recently. Allow me to add to the national public debate today. I will cover four main points. Page 1 of 16 First, the bond-buying programmes fall on a spectrum, running from limited to larger interventions. Conducting any of them successfully is made possible by our inflationtargeting framework and the flexible approach we take to it. Second, the scale of asset buying we do should follow from a clear sense of why markets have been malfunctioning. I’ll distinguish between liquidity and sustainability problems. Central banks can provide liquidity, while challenges like fiscal sustainability are best dealt with elsewhere. Third, we need more clarity around the mechanics of central bank asset purchases, quantitative easing (QE), and the ‘zero lower-bound’. These concepts are pretty hard to understand. It is easy, for example, to take the mistaken view that QE is ‘free money’. Finally, I will reflect on the utility of inflation targeting for addressing the current economic conditions and potential depression-type conditions. The intellectual heritage of inflation targeting traces back to the study of the Great Depression, so we can say that depression fighting is ‘in its genes’. As a starting point, it is perhaps worth reviewing what we have done to date. Our five most important measures have been as follows. 1. We have lowered interest rates. At the March meeting of the Monetary Policy Committee (MPC), we reduced the repurchase rate (repo rate) by 100 basis points. We then held an emergency MPC meeting in April, using new forecasts that incorporated the lockdown, and cut the repo rate by another 100 basis points. In May, we cut it by a further 50 basis points. Including our January cut, the cumulative reduction in the repo rate for 2020 now stands at 275 basis Page 2 of 16 points.1 To compare, the emerging market median is 100 basis points.2 The repo rate is now at its lowest level on record, and below zero in real terms. 2. We have made liquidity abundantly available to banks, through a range of facilities in addition to our usual weekly repo auctions, with take-up peaking at R83 billion in March. 3. We have provided regulatory relief to the financial sector, to help maintain the flow of credit in the economy despite the temporary payment problems for firms and households caused by the COVID-19 shock.3 4. We have offered funding for small and medium enterprises (SMEs), starting at R100 billion, with an option to scale up to R200 billion over time, or about 4% of gross domestic product (GDP). This facility is backstopped by a guarantee from National Treasury. 5. We have been buying government bonds in the secondary market, to improve market functioning. The total of new purchases now stands at around R25 billion, which is an increase in our bond portfolio of about 0.6% of GDP from pre-crisis levels. This is comparable to purchases by emerging market peers.4 1 The cumulative reduction in the repo rate stands at 300 basis points since July 2019. 2 As of 4 June 2020, based on a sample of 66 emerging markets. Large cuts from high starting points, as in Argentina (-1 200 basis points, from 50%), distort the mean change, making the median a better representation of the central tendency of the data. 3 For details, see the Prudential Authority’s ‘Press release on regulatory relief measures and guidance to the banking sector in response to COVID-19, published on 6 April 2020, available at https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/9842/Prudential%20Auth ority%20Media%20Release%20%20Regulatory%20relief%20and%20guidance%20to%20the%20banking%20sector.pdf. 4 The Bank for International Settlements (BIS) gives data for bond purchases by seven emerging markets. Of these countries, four have purchased bonds worth 0.2% of GDP or less, Thailand is at 0.6% of GDP, Colombia at 0.8% of GDP and Chile at 2.8% of GDP (in Chile, the policy rate is now at its ‘technical minimum’, according to MPC minutes). The SARB’s purchases to date, as of the latest published data, are at 0.6% of GDP. See Yavus Arslan, Mathias Drehmanm and Boris Hofman, 2 June 2020, ‘Central bank bond purchases in emerging market economies, Bank for International Settlements Bulletin No. 20, available at https://www.bis.org/publ/bisbull20.pdf. Page 3 of 16 Of these interventions, it is the last one that has prompted the most discussion, so it deserves extra attention. A spectrum of bond buying In responding to the COVID-19 crisis, a whole range of central banks, both in advanced economies and in emerging markets, has launched bond-buying programmes. These programmes should be thought of as sitting on a spectrum, measured by what the various central banks are trying to do. Some are buying huge quantities of assets to provide stimulus despite the constraint of the zero lower-bound. Others are conducting more limited purchases, to improve market functioning. Many advanced economies sit on the far side of the spectrum. Some emerging markets, like Brazil, and us, sit at the near end: we are aiming to improve market functioning.5 Recognising this distinction, the Bank for International Settlements (BIS) has referred to emerging market operations as ‘Bond Purchase Programmes’, or BPPs.6 Others have put the term ‘QE’ in quotation marks, to convey the nuance. Sometimes I think that if we just told people our asset purchases were QE, they might stop complaining that ‘the SARB is conservative’ – a criticism that has somehow survived despite surprise at how much the SARB has already done. We should not, however, simply assume that our conditions require full-blown QE, or that we can pull it off without creating unintended and damaging consequences down the road. Rather, any decision to move along the spectrum needs to be embedded in our inflation-targeting framework. Getting the inflation forecast right gives us credibility to shift along the bond-buying policy spectrum without tipping into higher inflation. If inflation is collapsing and existing policy measures prove not enough to bring it back to target, we can move further. Judging by the recent moderation in long-term rates and lower inflation levels, it appears we have got the overall policy effort about right 5 Bryan Harris, 8 June 2020, ‘Brazil central bank chief resists using new QE powers’, Financial Times, available at https://www.ft.com/content/e6eb0759-3a14-47ec-9835-a0b5d509b97c. 6 Yavus Arslan, Mathias Drehman and Boris Hofman, 2 June 2020, ‘Central bank bond purchases in emerging market economies’, Bank for International Settlements Bulletin No. 20, available at https://www.bis.org/publ/bisbull20.pdf. Page 4 of 16 for the moment. But we are in an environment of unprecedented uncertainty, and we will adjust this policy effort, along that spectrum, as economic conditions and forecasts change. The South African Reserve Bank’s bond purchases When the SARB began intervening in the South African government bond market, on 20 March, we had seen trading thin out, with even small transactions causing bond prices to move abruptly. By purchasing bonds in the secondary market, the SARB has helped restart price discovery and has encouraged the re-entry of private sector participants. We continue to monitor the government bond market and to buy bonds where we observe signs of stress at different maturities of the yield curve. This will continue as needed to restore normal market functioning. Up to now, it appears our interventions have worked. Volatility has subsided, and bond yields have largely normalised. While we are not targeting yields specifically, the fact that the benchmark 10-year yield is back to where it was in February suggests that stress in the system has eased. We are not the only country experiencing liquidity problems in its bond market. Indeed, at the height of the crisis, even the ultra-deep and liquid United States (US) Treasury market was disrupted, which just goes to show that, in a major crisis, even the best borrowers can have liquidity problems.7 Solving these problems is one of the oldest duties of central banks; such practices are literally centuries older than the term ‘quantitative easing’. The trouble is that liquidity problems are not the only factor affecting the domestic bond market. There are also problems of fiscal sustainability in the mix, which requires us to act, and to communicate, with caution. We need to avoid what one expert has 7 Jeffrey Cheng, David Wessel and Joshua Younger, 1 May 2020, ‘How did COVID-19 disrupt the market for US Treasury debt?’, available at https://www.brookings.edu/blog/up-front/2020/05/01/howdid-covid-19-disrupt-the-market-for-u-s-treasury-debt/. Page 5 of 16 called ‘the mother of all sudden stops’8 turning into a permanent, and specifically South African, problem. In general, I avoid commenting on fiscal issues, but it is difficult to discuss sustainability without mentioning some fiscal facts. The most important ones are these. When the COVID-19 shock hit, South Africa was already running crisis-level deficits – over 6% of GDP in 2019. Our debt stock was on a rising trajectory.9 Unfortunately, the coronavirus is now forcing an additional fiscal deterioration. This has resulted in South Africa losing its last investment-grade credit rating. Marketbased measures of sovereign risk, such as credit default swaps, have deteriorated further, both in absolute terms and relative to peers. This increase in sovereign risk has, in turn, further raised the return on bonds asked by investors, shifting up longterm rates for the whole economy, despite a very low repo rate. As many economists have pointed out, sustainability concerns have to be addressed at a fiscal level. This means that the debt-to-GDP ratio has to stabilise, and those projections need to be realistic. If debt sustainability can be assured, with high probability, then near-term borrowing will be more readily available. In these circumstances, were government still to experience financing disruptions, we would feel confident that these were liquidity problems which the SARB could help address. However, presently, sustainability is not assured, which makes large-scale sovereign bond buying potentially inflationary. 8 Barry Eichengreen, quoted in Enda Curran and Michelle Jamrisko, 2 April 2020, ‘The same stimulus that rich countries lean on could worsen poor economies’, Bloomberg Quint, available at https://www.bloombergquint.com/global-economics/a-mother-of-all-sudden-stops-leaves-emergingmarkets-in-crisis. 9 Philippe Burger and Estian Calitz, 24 February 2020, ‘Soaring deficits and debt: restoring sustainability amidst low economic growth’, available at https://www.econ3x3.org/article/soaringdeficits-and-debt-restoring-sustainability-amidst-low-economic-growth. Page 6 of 16 The proposals on the table for more bond buying are not modest. I have seen one call for a trillion-rand fiscal stimulus financed by the SARB10, and another for SARB bond purchases of R10-20 billion per week to continue until ‘economic recovery is well underway’11. These numbers imply that the SARB would be buying, more or less, all new debt for the foreseeable future. Such interventions would crowd pension funds and other institutional investors out of the bond market. Worse, we would be sending a dangerous signal. The crisis of the euro area, a few years back, showed how damaging it can be for countries to send mixed messages about their future monetary arrangements – the so-called ‘re-denomination risk’. In South Africa, the risk is that the domestic currency will no longer be issued by a credible, inflation-targeting central bank, but by one that is fully financing the public sector instead. Should we be going this way, some bondholders would probably be enthusiastic about a large bond purchase programme so they could dump their bonds on the SARB and minimise their losses. And why shouldn’t they be looking for a way out? Imagine the situation: we would be taking over public sector financing, with no clear plan for how to stop buying a potentially ever-larger issuance of bonds. And although I have heard it suggested that we should do QE with conditions, we need to keep in mind that we are a national central bank.12 The Constitution tells me the SARB must protect the value of the currency, and that we must have regular discussions with the Finance Minister. Nowhere does it say I can set conditions. As such, the SARB cannot take responsibility for solving a fiscal sustainability problem, nor can it jeopardise the value of the currency by agreeing to inflationary money printing. 10 Owen Willcox, 2020, ‘Macroeconomic response to COVID-19’, available at https://www.tips.org.za/policy-briefs/item/3798-macroeconomic-response-to-covid-19. 11 Andrew Donaldson, 9 April 2020, ‘Monetary management, financial markets and public debt: responding to COVID-19 and the economic standstill’, Policy Brief #3, available at https://covid19economicideas.org/2020/04/09/monetary-management-financial-markets-and-publicdebt-responding-to-covid-19-and-the-economic-standstill/. 12 It is relevant to note here that when the European Central Bank (ECB) announced its programme of Outright Monetary Transactions, to give effect to Mario Draghi’s famous ‘whatever it takes’ commitment, it still insisted on ‘strict and effective conditionality’ through ‘an appropriate European Financial Stability Facility / European Stability Mechanism (EFSF/ESM) programme’. The ECB did not itself take on the design or enforcement of conditionality arrangements. See https://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html. Page 7 of 16 Money creation, inflation and sterilisation But why is it that monetary financing of the fiscus could be inflationary? As I have said elsewhere, I am not worried about high inflation this year, especially given the recent collapse of oil prices. But the fact that 2020 inflation is likely to be low in no way guarantees that inflation will stay low, and therefore that we can stop worrying about it permanently. In fact, if we commenced large-scale QE with a significantly positive inflation rate, we would have to do one of two things: either sterilise the QE purchases by absorbing those Rands back onto our balance sheet, or let interest rates fall below the MPC target, ultimately to zero. The problem with setting the repo rate too low is inflation. The problem with sterilisation is the cost. QE proponents in South Africa have not appreciated the inescapability of this choice. Let me explain how this works in more detail. When the central bank creates money, we create one very specific type of money, which is bank reserves, also called base money. The base-money system is a closed loop, which means that the central bank, as the monopoly provider of new base money, is the only institution that can change the total supply in the system. This is the basis for monetary policy, because it confers the power to set the price of bank reserves.13 When a central bank conducts a QE operation, or any other kind of asset purchase, it pays in base money, which it deposits into the central bank account of the seller, be it government or a commercial bank. This changes the total supply of bank reserves in the system. The change in supply, in turn, affects the price. The crucial implication is that unsterilised asset purchases are, in the words of two economists, ‘tantamount to 13 On this point, and for a broader review of how different parts of the money supply are created, see ‘Money creation in the modern economy’, especially pp. 21-25, in the Bank of England Quarterly Bulletin Q1 of 2014, available at https://www.bankofengland.co.uk/-/media/boe/files/quarterlybulletin/2014/money-creation-in-the-modern-economy. Page 8 of 16 an easing of interest rate policy’14. As I’ll explain in more detail later, this is the main reason such policies can be inflationary. During this crisis, we at the SARB have already expanded the supply of central bank money, and although we have seen some deviation of short-term rates from the repo target, these have not been too large or persistent. In practice, we have a deposit rate set at 200 basis points below repo, which functions as a floor for the system – it is essentially a sterilisation instrument.15 As predicted by theory, we have therefore seen actual short-term rates fluctuate between the repo rate and this deposit rate, although they have mostly stayed close to the repo rate. Of course, our interventions have not been going on too long, and this has been a period of severe stress in financial markets. Were we to implement a large, long-term increase in bank reserves, as would be required for a big QE programme, we would need to sterilise more aggressively to keep the actual overnight rate close to the repo target. To do this, we could use various techniques. For instance, we could issue SARB debentures to soak up Rands, or we could pay banks to deposit their reserves back with us. Most of these policies would end up looking functionally equivalent to National Treasury funding itself at the short end of the curve,16 benefitting from the low rates set by monetary policy, which is already happening. Importantly, none of these scenarios would be a free lunch: instead of Treasury paying interest, the costs would show up at the SARB, as the price of doing sterilisation operations. 14 Claudio Borio and Piti Disyatat, November 2009, ‘Unconventional monetary policies: an appraisal’, available at https://www.bis.org/publ/work292.pdf. These authors also discuss, as an alternative inflation driver, the possibility that public narratives about central bank actions will also have economic effects. 15 This point is equivalent to the one made for India by former Governor of the Reserve Bank of India, Raghuram Rajan, in his widely circulated LinkedIn post titled ‘Monetization: neither game-changer nor catastrophe in abnormal times’, specifically point 5. 16 Claudio Borio, 8 November 2019, ‘Wise fiscal policy is not about helicopter money’, available at https://www.bis.org/speeches/sp191108.htm#:~:text=A%20more%20balanced%20policy%20mix,rate s%20further%20into%20negative%20territory Page 9 of 16 These costs would also be large. If we as the SARB bought R500 billion of government bonds, at par, and then sterilised them at the repo rate, we would be insolvent in about a year.17 For this reason, taking the perspective of the broader public sector balance sheet, these operations would add to National Treasury’s already large need to borrow. As such, a big QE operation wouldn’t lift the budget constraint. Instead, it would end up saddling Treasury with yet another bankrupt government enterprise asking for a bailout. The only exception to the rule that asset purchases entail sterilisation costs is if interest rates reach the zero lower-bound. This happens if even a zero interest rate is not enough to achieve a central bank’s objectives, like hitting an inflation target. In this case, central banks can create enormous quantities of bank reserves, which just pile up on their balance sheets without creating any further downward pressure on overnight rates. The reason for this is that banks with excess reserves will have no incentive to lend them out for less than 0% interest. This has been the exact situation of major advanced economies for much of the past decade, and it has given these central banks almost unlimited scope to buy assets. Given this extraordinary situation, one economist has described this as ‘the age of magic money’.18 This is not, however, the situation in most emerging markets. For us, a persistent and unsterilised increase in bank reserves would create downward pressure on interest rates. If this pressure were not released through sterilisation, it would force overnight rates to zero and keep them there. This is likely to be inflationary, even in a weak economy. Creating extra reserves lowers the effective short-term interest rate compared to the repo rate set by the MPC, whether demand in the economy is weak or not. The trick, therefore, is to figure out what the appropriate short-term rate for South Africa is. Market expectations are that it will remain above 3% over the next few years. Our projections show much the same, and that this will be enough to return inflation 17 The SARB’s capital and accumulated reserves were R20 billion as of 2018/19. Sterilisation costs for R500 billion would be around R19 billion a year. 18 Sebastian Mallaby, July/August 2020, ‘The age of magic money’, Foreign Affairs, available at https://www.foreignaffairs.com/articles/united-states/2020-05-29/pandemic-financial-crisis. Page 10 of 16 to the 4.5% target midpoint. Even some proponents of SARB QE have acknowledged that a zero repo rate is too low for South Africa, and that it should at least be the rate ruling in the developed world plus a risk premium.19 Credit and saving behaviour is part of the story here, but we also need to consider the exchange rate effects, in addition to the inflation expectations channel. Remember: because we have inflation several percentage points higher than in the advanced economies, our real rates can go quite a bit lower than theirs. If we really need to create extra inflation, we can set the repo rate to be minus 2% or minus 3% in inflationadjusted terms, and then we’ll get inflation led by the exchange rate. Inflation targeting in a crisis This raises a really interesting question, however, about whether we are heading into another Great Depression, in which case such radical policies might become appropriate. There is no agreed definition of a depression, but the outstanding characteristics of the last Great Depression were large and sustained falls in both output and prices. To be clear: this is not our baseline forecast, nor is it the outlook according to all available quantitative projections. Nonetheless, we understand that we live in a highly uncertain world, and that conditions could deteriorate further. It is therefore worth contemplating how the SARB would react in a depression scenario. One of the extraordinary things about the Great Depression is that our understanding of what went wrong, and why, has evolved dramatically over the ensuing decades. The popular contemporary view, which still features in high-school accounts of the Depression, is that it was caused by a stock market crash. But the US stock market crashed many times, both before and after 1929, with much less disastrous results. Another popular explanation is that the Depression was caused by a collapse in demand, which was only ultimately resolved by active New Deal fiscal policies. But 19 See, for instance, Christopher Malikane, 17 May 2020, ‘Why arguments against quantitative easing hold no water’, Business Day, available at https://www.businesslive.co.za/bd/opinion/2020-05-17-why-arguments-against-quantitative-easinghold-no-water/ Page 11 of 16 this explanation is also given secondary status by most modern scholars, who emphasise, instead, the role of central banks.20 As former US Federal Reserve (Fed) Chairman Ben Bernanke once said: “Regarding the Great Depression … We did it. We’re very sorry … [W]e won’t do it again.”21 By this account, the major mistakes were threefold. First, central banks permitted large-scale bank failures, destroying credit intermediation and contracting the money supply. Second, and largely in response to the first factor, countries fell into deflation, which pushed up the real value of debt, bankrupting borrowers. For instance, in the US, prices fell by almost 10% a year in the worst years of the Depression. Finally, central banks stuck to fixed exchange rates via the gold standard, which required some badly timed interest rate increases, such as the Fed’s decision to raise rates by 200 basis points in October 1931. Imagine raising rates with negative inflation and real rates already in double digits! It was precisely these sorts of central bank mistakes that turned sharp downturns into depressions, and then prolonged those depressions. When these mistakes were reversed, countries recovered.22 This is relevant because modern central banks, including the SARB, have policy frameworks to avoid precisely these errors. We have symmetric price stability mandates, expressed in inflation targets, which tell central bankers to avoid too high and too low inflation. We have floating exchange rates which absorb shocks rather than magnifying them, and our accumulated credibility is now such that we can slash interest rates despite large exchange rate depreciations. We have financial stability 20 These points are drawn from Ben S. Bernanke, 2 March 2004, ‘Remarks by Governor Ben S. Bernanke: money, gold, and the Great Depression’, available at https://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm. 21 Ben S. Bernanke, 8 November 2002, ‘On Milton Friedman’s ninetieth birthday’, available at https://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/. 22 See Liaquet Ahamed, 2009, Lords of Finance, especially chapter 20, titled ‘Gold fetters’. Page 12 of 16 mandates to ensure that the financial system keeps functioning under stress, and that too-big-to-fail institutions don’t. In sum, far from being irrelevant in a depression scenario, our frameworks incorporate the most profound lessons of the Great Depression. If we start to go down this path, our frameworks will immediately guide us to take remedial action. This fact alone should protect us from another Great Depression. Conclusion Frankly, rather than 1929 repeating itself, I am more worried about a different scenario. As a country, we have got ourselves into a lot of trouble. We are struggling to learn the lessons of these mistakes, and to achieve the consensus to fix them. And we are running out of time. We have just completed our worst growth decade on record – worse than the 1980s or the 1990s. On a per capita basis, South Africans have been getting poorer since 2013. In the world, we are slipping backwards. In 1960, South African incomes were around 26% of those in the US. They are now down to 13%. They were 128% of Brazil’s in 1960, a country to which we are often compared; they are now down to 65%. Rather, we risk following Argentina’s path, where ideological conflicts and unstable macroeconomic policies produced a steady economic decline.23 In much of the period after 1994, we in South Africa surprised everyone by cooperating despite our differences, and delivering robust and sustainable macroeconomic policies. But those accomplishments have faded. Instead, we now find ourselves sitting on the highest debt pile in our history, arguing about printing money and waving ideological banners at each other. 23 For a quick review of this experience, see ‘The tragedy of Argentina: a century of decline’, 17 February 2014, The Economist, available at https://www.economist.com/briefing/2014/02/17/acentury-of-decline. Page 13 of 16 It seems imperative that we work hard to define a new approach for the future. We have used up the legacy of low debt levels. Fortunately, we have achieved low inflation. We cannot squander that achievement on the quixotic belief that if we just engineer higher inflation, somehow growth will permanently rise. Our own experience shows that belief to be wrong, and we can set out now on a new path with low interest rates if we guard and value them. We have nearly all the ingredients needed to get permanently stronger economic growth, create jobs, and rid ourselves of poverty and inequality. But we need to choose, as a society, to do these things. First, let’s make sustainable choices that get us past the COVID-19 pandemic and help us grow in future. Second, let’s open up for investment to increase our productivity. Finally, let’s work together, pragmatically, to choose the reforms that will create jobs and prosperity. Thank you. Page 14 of 16 Supporting charts Central bank bond-buying programmes* 2.8 2.5 % of GDP 1.5 0.8 0.6 0.6 Thailand South Africa 0.5 0.01 0.1 0.13 South Korea Mexico 0.2 Bolivia India *Announced March/April 2020. Sources: BIS & SARB 2020 General government balance projections 0.0 Percent of GDP -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 -14.0 -16.0 Source: IMF Fiscal Monitor, Apr 2020 Page 15 of 16 Colombia Chile EM debt stocks: Change between 2009-19 Estimated term premium: 10y bond 29.8 % -10 -20 -1 -2 Source: IMF EM 10y govt bond yields: Change from 1 Jan - 17 Jun EM 5y CDS spreads: Source: Bloomberg Source: Bloomberg Page 16 of 16 Turkey Brazil South Africa -100 Colombia -80 Mexico -60 Indonesia -40 China -20 Basis points Chile Malaysia Basis points Change from 1 Jan - 17 Jun Russia Source: SARB Thailand pp of GDP
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 100th annual ordinary general meeting of the SARB shareholders, Pretoria, 31 July 2020.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank (SARB), at the 100th annual Ordinary General Meeting of the SARB shareholders South African Reserve Bank, Pretoria 31 July 2020 Global economic conditions We mark the 100th annual Ordinary General Meeting (AGM) of the South African Reserve Bank (SARB) at a time when the world is facing one of the most disruptive and challenging crises in recent memory. The COVID-19 pandemic has placed significant pressure on the global as well as domestic economies, and the livelihoods of citizens. The unprecedented restrictions imposed by countries to try and contain the spread of the virus have contributed to plunging economic activity, ending the global economic expansion that had started in 2010. In its latest update on the World Economic Outlook, the International Monetary Fund (IMF) estimates that global gross domestic product (GDP) will contract by about 4.9% in 2020. The World Bank highlights that this will be the deepest global contraction since 1945, with a record 93% of the world’s economies expected to experience economic contraction this year. The decline in global GDP has been compounded by increased risk aversion and extreme volatility in financial asset prices, with sharp and deep market selloffs. Business and consumer confidence has also fallen as uncertainty levels reached Page - 1 - of 9 new highs. Resource-exporting economies and countries with a high reliance on debt markets for funding will become even more vulnerable if capital continues to flow out of emerging market economies. The global policy response has matched the magnitude of the crisis. Fiscal authorities have contributed by delivering stimulus packages that are estimated to be larger than the response to the global financial crisis of 2008 and 2009. This stimulus has provided support to the health sector and to vulnerable households and businesses. Central banks around the world responded swiftly by lowering interest rates and providing liquidity to maintain market functioning. These response measures have helped to ease global financial conditions, allowing governments and companies to continue accessing domestic and international financial markets, and thus being able to sustain business operations and provide support to households. As a consequence, the high-frequency indicators suggest that the gradual lifting of lockdown restrictions in the major economies (first China, then Europe) has seen a rebound in manufacturing production and retail spending. While major economies in Asia and Europe appear to be on the road to recovery, the United States (US) and most of the emerging world are still very much in the midst of the crisis. Many countries – especially in Africa, Latin America and South Asia – are still experiencing increases in new COVID-19 infections. This has resulted in a delay in economic reopening or, in some cases, has led to renewed lockdown restrictions. As the pandemic persists, it is clear that some sectors of the economy, like travel and recreation, will experience a prolonged drop in demand. Households may continue to maintain high precautionary savings, and uncertainty is likely to weigh on business capital spending plans. For many countries, the room for additional fiscal stimulus is limited should there be a ‘second wave’ of infections, resulting in significantly higher debt-to-GDP ratios as well as higher costs of accessing finance. Page - 2 - of 9 Domestic economic conditions In South Africa, the COVID-19 crisis appeared at a time when our domestic economy was already vulnerable and in a technical recession. Real GDP had contracted at an annualised rate of 0.8% and 1.4% respectively in the last two quarters of 2019. This decline accelerated to an annualised rate of 2.0% in the first quarter of 2020, despite the nation-wide lockdown only coming into effect in the last few days of March. This was due to falling export demand, weak business confidence and investment, and the return of load-shedding. While second-quarter GDP data are not yet available, there is sufficient evidence to confirm that the lockdown has exerted a drag on economic activity. For example, mining and manufacturing production plunged by 37% and 44% month on month, respectively, in the month of April. And while there are signs of recovery in some sectors, much uncertainty remains. The COVID-19 outbreak is having major health, social and economic impacts, which presents challenges in forecasting. The SARB expects that the lockdown will cause output to contract by 7.3% in 2020. The last time a figure of this magnitude appeared in our data was in 1931, during the Great Depression, when output fell by 6.2%. In line with a partial global recovery, we expect economic activity in South Africa to start recovering as lockdown measures are gradually eased. Our projections for 2021 and 2022 are for GDP to recover to 3.7% and 2.8% respectively. Due to global economic and financial conditions, as well as country-specific factors, South Africa experienced an increase in capital outflows and significant currency weakness between March and April. The South African rand depreciated by 22% between February and the end of April. Over the same period, the yield on the 10-year government bond rose by more than 200 basis points, and money market liquidity was thin. Although many of these moves have been reversed, on balance, capital inflows remain below those of our emerging market peers. Page - 3 - of 9 Inflation has moderated since the beginning of the year. Consumer price inflation fell to as low as 2.1% year on year in May, down from 4.6% three months earlier. Longerterm inflation expectations have continued to decline towards 4.5%, which is the midpoint of the inflation target range. Inflation expectations for 2020 are at around 3.9%, the lowest in recorded history. Consequently, the SARB’s inflation forecast now sees core inflation remaining within the lower half of the target range for the remainder of the forecast period, that is until the end of 2022. The SARB expects headline inflation to average 3.4% in 2020, and 4.3% in both 2021 and 2022. This benign inflation outlook has allowed the Monetary Policy Committee (MPC) room to reduce the repurchase rate (repo rate). The South African Reserve Bank’s actions during the COVID-19 crisis As a reminder, let me briefly outline the measures undertaken by the SARB since March. Monetary Policy Committee decisions The MPC has reduced the repo rate by a cumulative 275 basis points, to 3.50% per annum. Four repo rate cuts have been made since March 2020, as follows: a 100 basis points cut in March 2020; a 100 basis points cut at a special MPC meeting in April 2020; a 50 basis points cut in May 2020; and a 25 basis points cut in July 2020. Domestic money market liquidity management The SARB acted swiftly to ensure the continued smooth functioning of financial markets. Revisions to liquidity management operations comprised four elements. Page - 4 - of 9 First, we put in place Intraday Overnight Supplementary Repurchase Operations (IOSROs) aimed at providing liquidity support to commercial banks. Second, we introduced a three-month term repo facility, which is offered in addition to the weekly main refinancing operations. The SARB has indicated its willingness to offer longer-term repo facilities of up to 12 months, subject to liquidity conditions in the market. Third, the end-of-day lending rate on the Standing Facility was reduced from repo plus 100 basis points to the repo rate. At the same time, the borrowing rate on the Standing Facility, which is the rate at which the SARB absorbs liquidity, was also adjusted lower. Commercial banks’ deposits at the SARB now earn interest based on the repo rate less 200 basis points, compared to the repo rate less 100 basis points previously. This measure is meant to discourage banks from depositing money at the SARB, and to encourage money market liquidity. Lastly, as an extra measure to add liquidity and promote the functioning of the bond market, the SARB commenced with a programme of purchasing government securities in the secondary market. More than R30 billion worth of government bonds has been bought since the commencement of the programme in March this year. Regulatory and supervisory relief measures Since the 2008/2009 global financial crisis, South Africa has implemented reforms to strengthen its regulatory framework for financial institutions and improve the resilience of the financial system. This has enabled the Prudential Authority (PA) to deliver temporary regulatory relief for banks in a manner that is consistent with internationally agreed regulatory standards. The PA has provided guidance covering accounting matters and imposed a limit to the payment of dividends and bonuses by banks and insurers to ensure the conservation of capital and retained capacity in an environment of heightened uncertainty caused by COVID-19. Page - 5 - of 9 Expected impact of the South African Reserve Bank’s response The SARB’s policy responses are an important element of providing support to the economy. Interest rate decisions are expected to play an important role in replacing displaced income. The relaxation of certain regulatory measures has enabled banks to provide support to households and businesses through continued lending activities, alongside the government loan guarantee scheme. In addition, the liquidity operations have supported market functioning, which is important for financial stability. While there is limited information to assess the impact of interest rate adjustments and other regulatory measures, the decline in indicators of bond market frictions and the improvements in money market liquidity conditions testify to the positive impact of the SARB’s liquidity management measures. Financial stability The SARB has a statutory mandate to protect and enhance financial stability in South Africa by monitoring global and domestic conditions, using various indicators to identify the risks and vulnerabilities which may impact on the financial system. During the past year, the main risks to financial stability were identified as weak and deteriorating domestic macroeconomic conditions, government’s fiscal position, cyberattacks on key financial infrastructures, and climate change. The COVID-19 pandemic has placed all of these risks at the centre of the financial system. Government’s debt issuance is higher; the deteriorating economic conditions have increased the credit risks faced by financial institutions; periods of market stress and volatility have placed a higher strain on market infrastructures. In addition, the prolonged period of remote working has increased cybersecurity risks. Page - 6 - of 9 The SARB continually monitors for signs of stress in the system, and will continue to act as appropriate to mitigate any risks. Our assessment to date finds that the financial system remains resilient. COVID-19 and South African Reserve Bank operations It would be amiss of me not to reflect on how the SARB itself is managing the impact of the pandemic. After all, everything we do is through our people. While the focus has been on monetary policy, coupled with regulatory and liquidity management measures, it has been essential for the SARB to ensure that key functions in the economy are not negatively affected by any disruptions to the national payment system and our currency operations. The SARB initiated a process in January to monitor the effects of the pandemic on its operations, including the operations of its subsidiaries. A Joint Operational Committee (JOC) was established in February to lead the SARB’s response and ensure business continuity. Since March, the majority of our staff has been working remotely. We have also prioritised the implementation of medical and wellness protocols throughout the South African Reserve Bank Group (SARB Group). The SARB’s key operations have not been affected by the remote working arrangements. To ensure the continuity of the cash supply chain, an industry forum was established to monitor the availability of cash in circulation in the economy, along with the ongoing production of new currency. Conclusion Let me conclude with some key points for reflection in the ongoing discourse about the role of the SARB in the economic recovery. Page - 7 - of 9 The COVID-19 pandemic has demonstrated the extent of interconnectedness of the global economy through production value chains, trade, financial markets, travel, and the exchange of knowledge. Within the central banking community, the actions of major global central banks have provided space for the SARB to respond to our unique domestic conditions. We have also seen the value in being part of a global community through the contributions that we were able to make through our advocacy in global forums, strengthening the global financial safety net. As we move towards economic recovery, the opening up of global trade channels will be important for South Africa as a small open economy. However, as policymakers, we must ensure that our economy is well placed to take advantage of improving global conditions. To place our economy on a sound and sustainable growth path, the SARB stands ready to provide support to the economy within its mandate. Lower longer-term inflation outcomes are important for maintaining purchasing power, containing the costs of living and of doing business, and supporting our country’s global competitiveness. However, as we have indicated in the past, improving the potential growth rate of the economy cannot be left to the central bank alone. Coupled with prudent macroeconomic policies and structural reforms, a lower cost of capital can support growth in long-term investment. The recovery of the South African economy requires a multi-pronged policy approach. As we navigate through this COVID-19 storm, the SARB will continue to deploy its tools, as appropriate, in accordance with its mandate, to provide support to the South African economy. Page - 8 - of 9 This is not a time to despair. Neither is it a time to venture into policies or instruments that have proved a failure in economic history. There are tough choices for us to make as a society. Thank you. Page - 9 - of 9
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the University of Pretoria, Pretoria, 12 August 2020.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank University of Pretoria, Pretoria 12 August 2020 In the shadow of COVID: lessons from 20 years of inflation targeting Good afternoon, ladies and gentlemen. This speech is about 20 years of inflation targeting. For two decades, we have been part of a great international experiment in getting monetary policy right. Inflation targeting has delivered a long period of price stability, comparable to the best years of the post-War Bretton Woods system, and should be considered a success for South Africa and for many other countries. To understand how we got to where we are now, looking back at 20 years of inflation targeting, we can start further back: with a speech from 1979, titled ‘The anguish of central banking’, by Arthur Burns, who was Chair of the US Federal Reserve for most of the 1970s. This was a period of high inflation, in the US and globally. Burns asked why inflation was ‘proving so stubborn’, and why central bankers were failing to stop it. He offered a remarkable confession: that the Fed could have stopped this inflation at any time, but didn’t because it lacked the will to do so. 1 To quote from the speech directly: 1 This text paraphrases the following: “Viewed in the abstract, the Federal Reserve System had the power to abort the inflation at its incipient stage fifteen years ago or at any later point, and it has the power to end it today. At any time within that period, it could have restricted the money supply and created sufficient strains in financial and industrial markets to terminate inflation with little delay.” Inflation came to be widely viewed as a temporary phenomenon – or, provided it remained mild, as an acceptable condition. ‘Maximum’ or ‘full’ employment, after all, had become the nation’s major economic goal – not stability of the price level. That inflation ultimately brings on recession and otherwise nullifies many of the benefits sought through social legislation was largely ignored. 2 During Burns’ tenure at the Fed, inflation averaged nearly 7% in the US, well above the 2% levels of the preceding two decades. 3 Indeed, the decade ended in tears, with high inflation giving way to falling investment and growth, and eventually a sharp and persistent increase in unemployment, which took years to resolve. How easily could we have made the same mistakes! We could have said that – with high unemployment, and such great economic demands after apartheid – it was just not possible to control inflation. And then we would have ended up with no social benefits – no more growth, no extra jobs – but with high and stubborn inflation instead, just as it did for Burns. But the story of South African central banking, in the democratic era, is not one of regret. The 1980s and early 1990s made it very clear that high inflation creates uncertainty, destroys savings, and undermines growth. The growth/inflation trade-off doesn’t work. We realised that inflation targeting, as a transparent and accountable policy framework, provided our best shot at price stability with growth. In fact, the inflation-targeting era has been one of lower inflation and lower interest rates than prevailed previously. Following our mandate, inflation has been kept under control. 4 Even now, at this very difficult time for the economy, we can see the inflationPlease see Arthur Burns, 30 September 1979, ‘The anguish of central banking’, available at http://www.perjacobsson.org/lectures/1979.pdf, p. 15. 2 Ibid, p. 13. 3 Precisely, CPI inflation averaged 6.5% during Burns’ tenure as Fed Chair (February 1970 – March 1978). For the 1970s as a whole, inflation averaged 7.1%. For the 1960s, it was 2.3%. For the 1950s, it was 2.1%. (Data from the St Louis Fed FRED database.) 4 For this period, inflation has averaged 5.9%. The volatility of growth, inflation and interest rates has also been lower. Specifically, for the periods 1970-2000 and 2000-2020, the standard deviation of growth has declined from 4.3 to 2.6, the standard deviation of inflation has fallen from 3.9 to 2.4, and the standard deviation of interest rates (the lowest SARB lending rate) has gone from 4.9 to 2.5. The pattern of lower volatility following the introduction of inflation targeting also holds when contrasting 1980-2000 with 2000-2020 (i.e. two 20-year windows). targeting framework functioning properly, delivering historically low interest rates in the context of low inflation. What are the chances, 20 years from now, that we will still have price stability and low interest rates? Will we be agonising, 20 years from now, over how we lost control of inflation? Today, there is a new generation coming of age, in very difficult circumstances. They have many questions – about the economy in general, and about how monetary policy fits into the picture. Some of the questions are asked in a fiery tone, and I think that young people are right to be angry. Not only have they been unlucky, reaching adulthood during one of the worst economic disasters in modern history. They are also now discovering that, over the past 10 years, South Africa has been accumulating debt at a rapid pace, faster than any big emerging market except Argentina. So, while the economy struggles to grow, and job creation remains elusive despite the spending, there is a heavy burden of debt for future generations to carry. Justified though this anger is, we need to channel that energy into positive action. We also need to guard against making policy mistakes that could sink us into deeper trouble. Perhaps, in the audience here today, there are future macroeconomic policymakers, future reserve bank governors and finance ministers. There are surely many people who will be leaders in this country, in one role or another. This speech is primarily for you. You will decide much of our economic future, through your choices and the ideas behind them. We are giving you many problems, but at least we have achieved price stability. It will be up to you to keep it. Here are some lessons we have learned to help you do that. The first lesson has to do with Arthur Burns’ problem, which is about losing track of your mission and living to regret it. Perhaps the most common criticism of inflation targeting, over the past two decades, has been that South Africa needs a more growthfriendly monetary policy. Burns, however, learned the hard way that there is no permanent gain to growth from short-run increases in inflation. While we would all like South Africa to reach permanently high growth, this is beyond the powers of a central bank. As we have often communicated, most of our growth problems should be addressed through structural reforms and confidence-boosting measures. To give just one example, the central bank cannot stop electricity loadshedding with interest rates. The South African Reserve Bank (SARB) can be held accountable for achieving low and stable inflation. But economic growth requires collaborative effort. It is simply not within the power of one institution to deliver. It is a team sport. It needs contributions from education, from the development finance institutions, from the private sector, and from many other players. Our emphasis on growth as a team sport, however, does not crowd out our concern for the specific growth problem we can address, which is weak demand. Right now, demand has been badly damaged by the coronavirus lockdowns. In technical terms, we think the output gap is deeply negative. This feeds into our policy stance: we have slashed interest rates to support aggregate demand and the spending power of South Africans. In doing this, we are supporting that part of growth in the near term which we can influence. We have become clearer about this in recent years, as part of adopting the Quarterly Projection Model (QPM) as the main forecasting tool for the Monetary Policy Committee (MPC) back in 2017. The QPM sets out a proposed path for interest rates, which it gets from a so-called ‘Taylor rule’. That rule responds to the output gap as well as inflation. Indeed, because the output gap also affects the inflation rate, the rule responds to weak growth twice. The output gap gives us a measure of slack – and that gap, in turn, has an impact on inflation. Would it make sense to add growth or employment to the mandate of the SARB, alongside the price stability mandate? 5 I doubt this would change policy much. After 5 See also Lesetja Kganyago, 25 April 2017, ‘Monetary policy: why we target inflation’, available at https://www.resbank.co.za/Lists/Speeches/Attachments/492/Address%20by%20Governor%20Kganya all, we already include growth in our models and decision making – through the output gap, a comprehensive measure of economic slack. 6 The problem is that formally adding an extra mandate, in the context of our propensity to stagflation, could encourage policy mistakes and weaken credibility. South Africa’s growth and employment problems are bigger than monetary policy. 7 For instance, even when the economy was booming, unemployment stayed above 20%. As with growth, the bedrock of this problem is structural, not cyclical. In this case, it’s the legacy of Bantustans, apartheid education, and the failure to fix those problems. Our labour markets have also historically raised the cost of hiring people even when the economy is weak and people are losing jobs. This cost inflation has further undermined job creation even when growth picks up. For these kinds of structural reasons, an employment mandate is unlikely to be effective. More likely, we would find ourselves in Arthur Burns’ shoes: we would not get unemployment permanently lower, but we would be stuck with higher inflation, making our growth and jobs challenges even worse. We want to be crystal-clear that we won’t make that mistake. With inflation well anchored, moves to lower interest rates should get us more real growth than inflation. And this is exactly where we are now. But doesn’t everyone have low inflation now? Isn’t this due to the coronavirus, not monetary policy? This brings me to the second common argument we have heard, which is that lower inflation has been a global phenomenon, not an accomplishment of inflation targeting. go%20at%20UKZN%20Graduate%20School%20of%20Business%20and%20Leadership.pdf, especially pp. 7-9. 6 Employment could be used in place of an output gap, but this would be a less comprehensive assessment of how strong or weak the economy is, and the data are even more difficult to use than output gap estimates. 7 For a detailed discussion of this subject, see Lesetja Kganyago, 24 August 2016, ‘Inflation, but no jobs or growth’, available at https://www.resbank.co.za/Lists/Speeches/Attachments/478/Address%20by%20Governor%20Kganya go%20at%20the%20Labour%20Law%20Conference%20-%2024%20August%202016.pdf. There’s no doubt that global factors affect inflation. Globalisation and low-cost manufacturing have made many goods cheaper. The recent collapse in oil prices has been a big disinflationary shock. But we also have good evidence that countries with independent, inflation-targeting central banks have lower and less volatile inflation. 8 And we can see that there are still countries with high inflation rates, despite low global inflation. The easy examples of this are the hyperinflation cases, like Venezuela and Zimbabwe. But there are less extreme cases that show the value of sensible monetary policy. Consider Turkey, a middle-income country like South Africa. In June this year, Turkish inflation was 12.6%. In South Africa, it was 2.2%. Both these economies had low growth, of less than 1%, before COVID-19 hit. Both countries have experienced big currency depreciations this year. Both are major importers of oil, and have benefitted from its price collapse. So why are their inflation rates so different? The point here is that the independence of the central bank matters, with the experience of other emerging and developing economies bearing testimony to this. 9 Since 2015, Turkey’s inflation rate has averaged 11.6% against a target of 5%. For the same period, South African inflation has been within our 3-6% target range, averaging 5%. Examples like this make it crystal-clear that low inflation is not just a worldwide fact that countries can have ‘for free’. If individual countries don’t make an effort, they can easily get stuck with high inflation. The third argument is that inflation targeting is a rich-country policy, inappropriate for an emerging market like South Africa. In fact, inflation targeting has been adopted 8 Jongrim Ha, Ayhan Kose and Franziska Ohnsorge, eds., 2020, Inflation in emerging and developing economies, available at https://www.worldbank.org/en/research/publication/inflation-in-emerging-anddeveloping-economies, p. i13. 9 See, for instance, ‘Turkey’s president removes head of central bank’, available at https://www.nytimes.com/2019/07/06/business/erdogan-removes-turkey-governor-central-bank.html, published in the New York Times on 6 July 2019. widely by emerging markets. This makes sense, as many of us have learned from bitter experience that tolerating inflation isn’t developmental – it just creates instability. It is worth noting that there are more developing-country inflation targetters, about 25, compared to 11 among the advanced economies. 10 And while New Zealand gets the credit for being first to implement inflation targeting, the second country was an emerging market: Chile. 11 Differences between advanced and emerging economies tend to be reflected in target designs that are not ‘one size fits all’. Most rich countries have found they like a 2% target, but emerging markets have used other sizes, often 3% or 4%. More recently, critics of monetary policy here in South Africa have flipped by 180 degrees. The SARB was originally accused of wrongly importing a first-world policy to South Africa. But now we are told to follow major advanced economies and launch a big Quantitative Easing (QE) programme. So much for the claim that richcountry policies don’t work in developing countries! This brings me to the next part of my speech, which is about new challenges to inflation targeting. In South Africa, there is a surprising amount of interest in QE. From being arcane jargon, many people have suddenly developed passionate views about it, and it gets lots of media interest. Given all this, let me summarise where we are in this conversation. As I explained in a recent speech at Wits University, QE will become appropriate when interest rates are at the zero lower bound and there is deflation risk. While inflation has eased and created space for lower rates, I am not aware of any professional analyst who projects deflation in South Africa. Our own SARB forecasts are in line with this consensus. 10 Klaus Schmidt-Hebbel and Martín Carrasco, 2016, ‘The past and future of inflation targeting: implications for emerging-market and developing economies’, Monetary Policy in India. 11 Klaus Schmidt-Hebbel and Matías Tapia, 2002, ‘Inflation targeting in Chile’, North American Journal of Economics and Finance, 13, p. 125. Nonetheless, should deflation take root, we would be prepared to deploy the tools at our disposal, as appropriate, to achieve our mandate. Our inflation-targeting framework would help us make that decision, and would underpin the credibility of any steps we might need to take. In the current circumstances, however, we think that a QE programme doesn’t make much sense for South Africa. Some advocates of QE argue that it is a free way of financing government deficits. This is not true. The funds created to buy bonds would flow into the interbank money market, lowering the cost of funding. This cost of funding is in fact the repurchase rate (repo rate), which is our main monetary policy tool. To ensure that the repo rate stays where the MPC wants it, despite the extra funds in the system, we would have to borrow those funds back ourselves, which could be costly. To repeat: QE would not be ‘free money’. Nonetheless, there are still claims that QE could work because the SARB could buy long-term bonds at a high interest rate, in the region of 9%, and then pay sterilisation costs equal to the repo rate, at 3.5% currently, and profit from the spread. Borrow at 3.5% and lend at 9% – what a great business model! Fortunately, the SARB is driven by public interest and not by profit. And, clearly, there are some risks embedded in this pricing, or private buyers who do look for profits would have eaten this ‘free lunch’ already. In fact, if we intervened to bring down long yields, we would be transferring risk back to the public balance sheet, while also removing incentives for new lending to the public sector. One of South Africa’s fiscal advantages is that the average maturity of government debt is unusually long relative to its peers. At the start of this year, it was a bit over 12 years. The whole point of borrowing long-term like this, even though it costs a bit more, is to share risk with investors. This means that when things like the coronavirus and credit rating downgrades happen, bond prices fall and borrowing costs go up – but this debt need not be rolled over at higher interest rates, because government has already received the funds, long-term, at the old interest rates. The risk is shared. Should the SARB start doing QE, however, by buying bonds on the secondary market, then investors could shift risk back onto the public sector’s balance sheet, at a higher price. In other words, it would be a private sector bailout, arranged by the SARB. Worse, QE would reduce the incentives for new investors to come and buy long-term sovereign debt, because there would not be enough yield or compensation for the longer-term risks now visible. What happens with QE, instead, is that public borrowing switches to the short-end of the curve. As the central bank buys longer-term bonds, it also sells, to the private sector, short-term instruments in their place, with the net result that the only new debt the private sector ends up with is that short-term debt. Given that our short-term instruments, like SARB debentures, are much like Treasury bills, it turns out that QE is much less exciting than it looks. Not only can National Treasury effectively make its own QE by funding itself through Treasury bills, but it is actually doing so. 12 Its precrisis borrowing strategy was astute: it left room in the short-end of the yield curve to borrow in an emergency. Lower inflation and a lower repo rate have made that borrowing cheaper than it otherwise would have been. In these circumstances, it’s not at all clear what a SARB QE programme would add. Rather than trying to supplant private investors or taking away the risk of investing, we have focused on liquidity. Specifically, we have been buying bonds in the secondary market, at different maturities, in the context of a sudden stop in global capital flows. As the central bank, we have unique powers to provide liquidity, and we have used them to restore market functioning. These interventions have been helpful so far. Yields have fallen. We didn’t set out to lower yields, specifically, but it turns out that market dysfunction was part of the reason why yields were so high. Putting all the pieces together, this monetary-fiscal mix allows more spending in the context of a major emergency. We are helping by setting low interest rates, and by ensuring that the government bond market remains liquid. National Treasury is able 12 As two economists at the Bank for International Settlements have put it, ‘almost any balance sheet policy that the central bank carries out can, or could be, replicated by the government’. See Claudio Borio and Piti Disyatat, November 2009, ‘Unconventional monetary policies: an appraisal’, available at https://www.bis.org/publ/work292.pdf, p. 2. to sell its debt to investors. This approach is going to deliver a historically high level of government spending this year, even adjusting for population growth and inflation, and excluding interest costs. 13 National Treasury is not cutting spending in the middle of a crisis; they are raising it, to the highest levels on record. However, we also need to think about the next few years. National Treasury is already planning to run deficits of 14.6% of gross domestic product (GDP) this year, 9.3% of GDP next year, and 7.7% the year after that. 14 In this context, high long-term interest rates are a critically important signal about what savings are available. We should be listening to this message, not trying to temporarily suppress it through SARB interventions, which really just switch long-term debt for short-term debt. We are in very difficult circumstances, but QE isn’t the answer. We need to focus on real solutions. Our discussion of QE takes me to the final part of my speech, which is about new challenges to the inflation-targeting paradigm. As Mervyn King has noted, all previous monetary policy paradigms have fallen, sooner or later. 15 The current one will also be replaced, eventually, by one that works better for future circumstances. What might change? In many of the advanced economies, inflation targeting is facing large challenges. Inflation has been below their inflation targets for many years now. Policy rates have been stuck at zero. And instruments like QE and forward guidance have not been powerful enough to solve this problem. It is now hard to explain why the Bank of Japan, or the European Central Bank, has been unable to push inflation to targeted levels of around 2% despite aggressive monetary policies. 13 The data underpinning this claim go back to 2002. 14 These numbers are drawn from National Treasury, 24 June 2020, Supplementary Budget, specifically Table 4.1 on p. 35, available at http://www.treasury.gov.za/documents/National%20Budget/2020S/review/FullSBR.pdf. 15 Mervyn King, 2016, The end of alchemy: money, banking and the future of the global economy, Chapter 2. At this stage, there is little consensus on the answers, and even less on policy solutions. There are two basic sets of explanations for why inflation has stayed so low in advanced economies, and why central banks have been unable to lift it. One set emphasises factors beyond the control of central banks, such as changes in labour markets or demographics. For instance, in an aging society, people want to save, and they don’t want to take risks, so demand is limited and interest rates are low. 16 This explanation works well for places like Japan. Another kind of explanation puts the emphasis on debt. Where borrowers have too much debt, even small interest rate increases have large effects on demand, while large rate cuts do little to boost it further. As one paper in this literature puts it, the ‘black hole’ of debt is inescapable, pulling down inflation and interest rates permanently. 17 An alternative version is that low interest rates encourage financial risk-taking, which leads to crisis, depressing the economy, lowering inflation, and generating even lower interest rates. 18 In these cases, too loose monetary policy eventually causes very high debt levels that smother economic growth, or it ends up causing financial crises. I don’t think South Africa has these problems yet. Right now, we don’t have the high inflation and high interest rates of the past, but we also don’t have the zero rates and close-to-zero inflation of the rich countries. The inflation-targeting paradigm is working pretty well. Given all the challenges facing South Africa, we should recognise that monetary policy is the last place where we should consider risky changes. We have a well-established 16 Joseph Kopecky and Alan M. Taylor, April 2020, ‘The murder-suicide of the rentier: population aging and the risk premium’, available at https://www.nber.org/papers/w26943.pdf. 17 Atif Mian, Ludwig Straub and Amir Sufi, 26 March 2020, ‘Indebted demand’, available at https://scholar.harvard.edu/files/straub/files/mss_indebteddemand.pdf, especially p. 4. 18 For instance, see Paul Volcker with Christine Harper, 2018, Keeping at it, p. 227. inflation-targeting framework, which is delivering low interest rates and low inflation. This is the most functional part of the macroeconomic framework. Unfortunately, getting monetary policy right isn’t going to be enough. South Africa’s debt situation is critical. And our rebound from lockdown is looking weak compared with other countries. 19 As a country, we need to find a path back to fiscal sustainability and growth. We can borrow from new creditors; we can shift our debt towards shortterm borrowing; we can move things around different balance sheets – but this is not a recovery strategy; it is just a way to buy time. If public sector borrowing were the way to achieve sustained growth, the last 10 years of debt accumulation should have been enough. The real task now is restoring our fiscal credibility and implementing structural reforms so the economy has a way to become more efficient and grow. In many ways, as a country, we seem to be depressed, unable to get out of bed. Yes, it’s winter, and it’s cold. But we can’t live like this. Spring is coming, and inflation and interest rates are low. We need to focus on the opportunities, get up, and get to work. Thank you. 19 Based on consensus forecasts, three-quarters of countries will have output back to 2019 levels by 2022. This includes 12.9 pp expected to have net positive growth this year, 18.3 pp which will be above 2019 levels in 2021, and 44.1 pp expected to get there in 2022. South Africa is in the remaining quarter of countries expected to recover to 2019 levels of output only after 2022.
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Opening address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the fourth Annual Distributed Sovereign Debt Research and Management Conference University of Pretoria, Pretoria, 7 September 2020.
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An opening address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the fourth Annual Distributed Sovereign Debt Research and Management Conference University of Pretoria, Pretoria 7 September 2020 Good afternoon, ladies and gentlemen. All protocols observed. I would like to thank the International Development Law Unit at the Centre for Human Rights at the University of Pretoria for inviting me to deliver the opening address at this fourth Annual Distributed Sovereign Debt Research and Management Conference, or DebtCon. DebtCon was launched at Georgetown in January 2016, and its mission is to engage scholars and practitioners across geographical, disciplinary and institutional boundaries to help solve sovereign debt problems. I think this is a very opportune time to bring together the brightest minds to consider the African debt conundrum. Before I proceed, I should remind you that I am a central banker. Experience since the global financial crisis suggests that whenever central banks are called upon to discuss sovereign debt issues, countries are in real trouble. Today, I’ll be making some remarks on the sovereign debt situation from an African central bank perspective. But first, I should preface my remarks by highlighting that while debt has a very important role to play in economic development, one should also reflect on the challenges and pitfalls presented by debt to developing economies in sub-Saharan Africa (SSA). Experience has shown that unsustainable debt burdens and rising debt- Page 1 of 11 service costs crowd out spending in key development areas such as education, health and infrastructure. These were exactly the lessons learnt during the African debt crisis of the 1980s and 1990s, which justified debt relief. Consequently, badly managed debt can potentially reverse some of the developmental progress made over the past 20 years. The key is how the funds are utilised and how the debt is managed. Now for some context. The advent of the coronavirus disease 2019 (COVID-19) pandemic since the beginning of 2020 has underpinned a surge in sovereign indebtedness globally. The magnitude, pace and spread of the build-up in debt obligations has raised macroeconomic and financial stability concerns, especially for emerging and developing economies (EMDEs). Rising debt levels have increased the vulnerability of the global financial system to financial market stress. Since 2008, global debt has risen to 230% of gross domestic product (GDP), and EMDE debt rose to an historic high of 170% of GDP in 2019.1 In addition, more than 25% of corporate debt in EMDEs is denominated in foreign currency. There is also renewed concern about the sustainability of rising debt levels on the continent. The World Bank’s 2020 International Debt Statistics2 has designated SSA as the region with the fastest-growing debt levels in the world, the pace of increase raising concerns about debt sustainability on the continent. According to the International Monetary Fund (IMF), about 40% of countries on the continent are currently at distressed levels. A reflection on conjectural policy challenges At the global level, the COVID-19 pandemic forced a strong fiscal response by many countries in an effort to avert lasting structural damage to the economy. However, the 1 World Bank, June 2020, Global Economic Prospects. 2 World Bank, 2020, 2020 International Debt Statistics, available at https://datatopics.worldbank.org/debt/ids/region/SSA. Page 2 of 11 recessionary conditions, coupled with the significant deterioration in the economic outlook in many countries, have refocused our attention on the record-breaking debt metrics. Global debt, both public and private, increased to US$253 trillion in the first quarter of 20203, with the public sector accounting for around 60% of these issuances. By way of comparison, global debt amounted to US$291 trillion at the end of the fourth quarter of 2008. According to the age-old adage that ‘history serves as a mirror so that we can avoid past tragedies’, such is the didactic character of debt oscillations. With each wave of debt comes a composite reflection of causes, consequences and possible lessons for market participants and policymakers alike. A recent publication by the World Bank, titled Global Waves of Debt: Causes and Consequences4, is instructive in this regard. According to the World Bank, there have been four debt waves in the post-Bretton Woods period. The first wave was fuelled by a low-interest rate environment and rapid growth in syndicated loans, which induced governments to accumulate high levels of debt during the 1970s and 1980s. This had negative implications for the health of the banking sector in lending countries, mainly the United States (US), and culminated in a debt crisis, which was followed by a prolonged debt relief and debt restructuring episode. The second global debt wave emerged between 1990 and the early 2000s, and occurred against a backdrop of financial liberalisation and innovation that enabled banks and corporations in the East Asia and Pacific region, as well as governments in Europe and Central Asia, to borrow heavily in foreign currencies. Predictably, this debt wave also ended with a series of crises, between 1997 and 2001, when a change in investor sentiment sparked a widespread sell-off. 3 Institute of International Finance, July 2020, Global Debt Monitor: Sharp Spike in Global Debt Ratios, available at https://www.iif.com/Publications/ID/4008/Global-Debt-Monitor-Sharp-Spike-InGlobal-Debt-Ratios. 4 Kose, M A, Nagle, P, Ohnsorge, F and Sugawara, N, 2020, Global Waves of Debt: Causes and Consequences, available at https://openknowledge.worldbank.org/handle/10986/32809. Page 3 of 11 This was followed by a resumption of investor confidence, which set the stage for the third debt wave. The build-up of private sector borrowing lasted several years, until it culminated with the global financial crisis in 2007-09. Emerging from the global financial crisis, history was about to repeat itself. A fourth wave of a debt cycle followed, marked with similarities to the previous oscillations. It was fuelled by low global interest rates, a rise in regional banks, increased demand for local currency-denominated bonds, and increased demand for EMDE debt issued by an expanding non-bank financial sector. African countries have been, and continue to be, active participants in the new debt wave. According to the IMF’s Fiscal Monitor, the average general government debt ratio for low-income SSA countries increased from 22% of GDP in 2010 to 43% of GDP in 2019. Even before the shock of COVID-19, public debt ratios were on the rise in the region. However, the COVID-19 pandemic, the global growth shock, the plunge in commodity prices, reduced growth outcomes and lower revenue collections will further exacerbate the already increasing sovereign indebtedness across the continent. Economic theory can assist in framing the conjectural policy challenges and options to address the high and rising levels of sovereign debt in Africa. First, the ‘debt overhang’ theory postulates that future growth could be in jeopardy when a country’s debt-service costs exceed its ability to repay.5 In such cases, the absence of concessions by creditors exacerbates the fiscal constraint and adversely impacts on the growth potential, especially for poor and developing economies.6 Krugman, P. 1988. Financing vs forgiving a debt overhang. Journal of development economics. P253-268. 6 Ajayi, R, 1991, On the Simultaneous Interactions of External Debt, Exchange Rates, and Other Macroeconomic Variables: the Case of Nigeria, available at https://msuweb.montclair.edu/~lebelp/CERAFRM026Ajayi1991.pdf. Page 4 of 11 Second, does the level of indebtedness matter for economic growth? Reinhart and Rogoff7 argue that growth rates decline significantly when public debt ratios exceed 90% of GDP. This assertion set in motion the ‘threshold debate’, with some critics pointing out that Reinhart and Rogoff’s findings were modestly inflated 8,9. A decade later, concerns about rising debt metrics have resuscitated the ‘threshold debate’. The IMF10 and later papers by Reinhart and Rogoff have concluded that increased debt does indeed lower the level of economic growth, albeit with a somewhat lower impact than was stated in earlier studies.11 As Claessens et al. point out, large external debt and its associated service obligations can affect economic performance through the ‘crowding out’ effect, the impact on a country’s ability to access international financial markets, and its impact on confidence levels.12 It is worth pointing out that the ‘crowding out’ effect also applies to localcurrency public debt, especially where banks end up recycling depositors’ money into government bonds rather than on-lending for productive investment purposes. Finally, it would be remiss of me not to highlight that high indebtedness also presents risks to the implementation of monetary policy and financial stability. A high level of public debt also raises the risk of fiscal dominance. This is where monetary policy is subordinated to keeping the debt servicing burden manageable, at the expense of price and financial stability. We are faced with a myriad of challenges that require a delicate balance between novel ideas and solutions on the one hand, and the prudence required for sustainability on the other hand. 7 Reinhart, C M and Rogoff, K S, 2010, ‘Growth in a Time of Debt’, American Economic Review, 100(2): 573–78. 8 Wray, L R, 20 April 2013, ‘Why Reinhart and Rogoff Results are Crap’, EconoMonitor. 9 Mencinger, J, Aristovnik, A and Verbič, M, 2014, ‘The Impact of Growing Public Debt on Economic Growth in the European Union’, Amfiteatru Economic 16(35): 403–414. 10 International Monetary Fund, April 2013, World Economic and Financial Surveys, World Economic Outlook (WEO), ‘Hopes, Realities, and Risks’, available at http://www.imf.org/external/pubs/ft/weo/2013/01/index.htm. 11 Reinhart, C M, Reinhart, V R and Rogoff, K S, 2012, ‘Public Debt Overhangs: Advanced-Economy Episodes since 1800’, Journal of Economic Perspectives, 26(3): 69–86. 12 Claessens, S, 1996, Analytical aspects of the debt problems of heavily-indebted poor countries, available at https://trove.nla.gov.au/work/174652. Page 5 of 11 The African story Allow me to elaborate on the most recent African experience with debt. At the turn of the 21st century, billions of dollars’ worth of debt was wiped clean across the SSA region. South Africa was instrumental in pushing for debt relief, and succeeded in the late 1990s when the Highly Indebted Poor Countries programme was agreed on through the IMF and the Development Committee of the World Bank. At the time, the solution appeared simple: wipe off the debt and allow countries space to get their affairs in order, and growth and stability will follow. For a time, significant improvements were observed, with many countries strengthening their macroeconomic frameworks and institutions. A number of countries also gained market access. With the advent of lower global interest rates, countries also had the opportunity to increase their debt issuance. By 2018, international bond issuances in the region reached a new high, totalling more than US$17 billion, with the average issuance rising to nearly US$3 billion.13 About 16 SSA countries were at high risk of debt distress – more than double the 2013 levels. Average public debt across the region rose close to 56% of GDP at the end of 2018, with wide disparities in debt dynamics across countries. For example, in 2018, public debt to GDP stood at 72% in Zambia and 100% in Mozambique. Debt-service costs rose sharply, with the median interest payment burden doubling to about 10% of revenue between 2011 and 2018. By the end of 2019, economic growth in SSA was seen to be improving from the low base of the early 1990s. Real GDP was projected to increase by 3.7% in 2020. But this was still well below the averages of the 2000s. In mid-2019, however, there was a growing number of voices raising concerns about macroeconomic stability given the weakening of fiscal positions in a number of lowincome developing countries. According to the IMF, the debt burdens and 13 World Bank, April 2019, Africa Pulse. Page 6 of 11 vulnerabilities of these countries had risen significantly since 2013, reflecting a mix of factors, including exogenous shocks and loose fiscal policies. The continent’s total external debt burden reached nearly US$500 billion in 2019, but governments have been pressured into further borrowing to counter the effects of the COVID-19 pandemic. In part, this has been due to the low returns on most financial assets worldwide triggering an appetite for frontier markets’ assets. Debt levels have been increasing considerably during 2020 with the interplay between various factors, most notably the need to manage the impact of the COVID-19 pandemic. As mentioned earlier, various international bodies have indicated that SSA is the region with the fastest-growing debt levels in the world, the pace of increase raising concerns about debt sustainability on the continent.14 … While in South Africa Let me use the case of South Africa to reflect on some of the costs of rising debt. National Treasury has pronounced on the trajectory for the South African fiscal position in the 2020 Budget Review that the outlook is bleak, which would be the main source of weakness for the domestic sovereign bond market. Well-developed local-currency bond markets allow governments to tap debt markets at potentially favourable terms to counter real economic shocks. South Africa’s localcurrency bond market – which has undergone significant growth since the late 1970s in achieving its level of depth, liquidity and sophistication – has enjoyed these benefits. South Africa’s sophisticated level of the local-currency bond market was made possible through a concerted effort by National Treasury to implement a clear debt management strategy. 14 World Bank, 2020, 2020 International Debt Statistics, available at https://datatopics.worldbank.org/debt/ids/region/SSA. Page 7 of 11 The strategy entails reducing borrowing costs and risks through increasing liquidity, managing maturity profiles, diversifying funding instruments, increasing transparency and information flows, and building credibility among market players. National Treasury took specific actions to achieve these price and maturity benefits. One of the first steps was the consolidation of government bonds into benchmark bonds, as well as the development of the yield curve. There was also a deliberate focus on deepening the secondary market for government securities, where the South African Reserve Bank (SARB) played an important role by acting as a market maker and a funding agent in a number of benchmark government bonds. At its peak, the SARB’s participation in the secondary market accounted for an estimated 30% of total bond turnover. By the late 1990s, the secondary market was judged to be sufficiently mature for the SARB to reduce its involvement and to improve efficiency and transparency. When the global financial crisis hit in 2008/09, South Africa had been running small budget surpluses. The debt-to-GDP ratio was under 30%. This allowed for increased government spending, part of which was initially justified as countercyclical stimulus, but which was not subsequently reversed. Persistent fiscal deficits have since caused a dramatic increase in the debt-to-GDP ratio, which incidentally is larger than that of other emerging markets, except Argentina. Some attempts at fiscal consolidation were made over the decade. However, these were underpinned primarily by tax increases, while aggregate spending kept growing or at least failed to decline as a share of GDP. The main drivers were above-inflation growth in the public sector wage bill, rising interest costs, and bailouts for insolvent state-owned enterprises (SOEs). In short, the domestic fiscal position was already highly challenging before the COVID-19 crisis, with the 2019/20 fiscal deficit being 6.7% of GDP and the debt-to-GDP ratio at 63.5%. The COVID-19 shock is now projected to result in a budget deficit of 14.6% of GDP, and is widely expected to increase the debt stock past 80% of GDP for the current fiscal year. As is pointed out in the revised Budget, there are significant risks of debt Page 8 of 11 exceeding 100% of GDP in a passive scenario over the next few years – unless government implements strong corrective measures to stabilise the debt by 2023/24. South Africa has now lost its investment-grade credit rating from all the major ratings agencies. Government bond yields are unusually high, with inflation-adjusted yields in the region of 4-5%. With the steepening of the yield curve, National Treasury has had to shorten the maturity of its debt to limit borrowing costs. However, this raises risks, as redemptions are not spread out over as long a period as previously. In addition, capital inflows to South Africa have declined. With the government deficit approximating the supply of private domestic savings, the implications for private investment spending are bleak. While real, non-interest spending is budgeted to increase further this year, in large part to fund COVID-19 relief measures, South Africa needs a substantial fiscal adjustment, complemented by strong structural reform policies, to minimise the impact on medium-term growth. Some implications for policy Let me conclude by making a few remarks on the policy implications associated with the current debt dynamics on the continent. Interest payments constitute the highest expenditure item of the government budget for many SSA countries.15 Current estimates indicate that SSA faces a US$44 billion debt-servicing bill in 2020.16 This is due to a combination of interest rate and exchange rate effects.17 African countries face high borrowing costs. For example, their 10-year government bond yields range between 5% and 10% compared to near-zero or negative rates in some developed economies. 15 Sallant, S, July 2020, ‘External debt complicates Africa’s COVID-19 recovery, debt relief needed’, Tralac, available at https://www.tralac.org/news/article/14827-external-debt-complicates-africa-scovid-19-recovery-debt-relief-needed.htm. 16 Jones, M and Arnold, T, May 2020, ‘Private creditors push back against blanket debt relief for Africa’, Reuters, available at https://af.reuters.com/article/topNews/idAFKBN22R20E-OZATP. 17 For example, Sudan has 95% of its public debt denominated in foreign currency, and has the highest debt ratio in Africa at 207% of GDP. Mozambique follows closely, with public debt at 108% of GDP, 85% of it being issued in foreign currency. South Africa, on the other hand, has about 90% of its public debt denominated in its domestic currency, while 10% is held in foreign currency. However, a large proportion of this debt is held by foreigners. Page 9 of 11 The increased reliance on non-traditional creditors has raised borrowers’ exposure to market risk, at the same time posing additional challenges to the sustainability of external debt in the region. For instance, where countries find themselves in debt distress, it may be more difficult to come to rescheduling agreements with a large number of private creditors than when you had, in the past, a relatively small number of public creditors (Paris Club) and/or commercial bank lenders (London Club). Challenges such as these highlight the need for countries to strengthen debt management practices and improve transparency, which is fundamental to sustainable financing. However, addressing these challenges would require countries to make tough fiscal choices to prevent debt burdens from becoming unsustainable. A prudent debt management strategy is thus key to tackling this challenge. There is wide consensus that countries need to raise more domestic revenue to make debt financing more sustainable. There also needs to be a greater focus on improving the efficiency of public spending in such a way that it helps to improve economic growth. While the primary responsibility for avoiding the build-up of unsustainable debt lies with the borrower, creditors also have a role to play in encouraging greater transparency. Irresponsible borrowing ultimately contributes to unsustainable debt burdens. More recently, the Debt Service Suspension Initiative (DSSI), which was endorsed by the Group of Twenty (G20) finance ministers and central bank governors on 15 April 2020, has come under renewed focus as a means to addressing the debt burden on the continent.18 The DSSI seeks to grant debt-service suspension to the poorest countries to mitigate the impact of the COVID-19 pandemic. Its objective is to 18 World Bank. Undated. Debt Service Suspension Initiative: Q&As. World Bank. Joint Statement World Bank Group and IMF Call to Action on Debt of IDA Countries states that : with immediate effect—and consistent with national laws of the creditor countries—the World Bank Group and the International Monetary Fund call on all official bilateral creditors to suspend debt payments from IDA countries that request forbearance. This will help with IDA countries’ immediate liquidity needs to tackle challenges posed by the coronavirus outbreak and allow time for an assessment of the crisis impact and financing needs for each country. Page 10 of 11 create fiscal space for countries to increase their social, health and economic spending in response to the crisis. The suspension, and the resumption of repayments, will be over a period of three years, with a one-year grace period. Some see benefits associated with the DSSI, while others have indicated that an application for DSSI participation might send a negative signal about countries’ creditworthiness.19 The three major credit rating agencies have indicated that private sector participation on G20-comparable terms could have negative rating implications for the participants (both the recipients and the providers of the relief). More recently, Moody’s placed four African countries on review for a downgrade for their participation in the DSSI, stating that this raised the risk of losses for investors in the countries’ bonds. This presents a dilemma. How can we ensure that debt-service relief does not lead to sovereign downgrades and thus does not compromise the attainment of debt sustainability over the medium term? This is an issue that is receiving increasing attention on the G20 agenda. Conclusion In closing, I would like to reiterate that public debt has an important role to play in financing development, particularly in augmenting government budgets. However, it should be clear that debt is not a replacement for domestic revenue mobilisation. Meanwhile, debt levels must remain sustainable so as not to undermine market confidence. To ensure that debt plays a meaningful role, it must be utilised for revenuegenerating activities that increase the productive capacity of the economy. I’m looking forward to hearing some of the novel ideas that will be shared in the next session on how we can tackle the debt-related challenges confronting the continent. Thank you. 19 World Bank. Undated. Debt Service Suspension Initiative: Q&As. World Bank. https://www.worldbank.org/en/topic/debt/brief/debt-service-suspension-initiative-qas Page 11 of 11
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Keynote address by Ms Fundi Tshazibana, Deputy Governor of the South African Reserve Bank, at the virtual Absa Annual Fixed Income Conference, 7 October 2020.
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‘The interest rate cycle during and after the COVID-19 pandemic’ Keynote address by Ms Fundi Tshazibana, Deputy Governor of the South African Reserve Bank, at the Absa Annual Fixed Income Conference, 7 October 2019 1. Introduction Ladies and gentlemen, thank you very much for allowing me the opportunity to deliver the keynote address at your Fixed Income Conference. While, sadly, I do not have the pleasure of standing in front of you today − the COVID-19 pandemic is not allowing it this year − I am nonetheless confident that this conference will stimulate pertinent and challenging discussions. The pandemic has changed many aspects of our life in 2020, and interest rate setting is one of them. The rate decisions taken by both the South African Reserve Bank (SARB) and its global counterparts in the past nine months are set in broad macroeconomic trends that have been in place for years, and which have made this speedy and sizable reaction to the COVID-19 pandemic possible. Now, will these trends remain in place in the coming years? Will the pandemic exacerbate them or, on the contrary, will it usher in structural changes that call for a different calibration of monetary policy in the future? These are some of the issues I will attempt to address today. 2. A long trend towards lower interest rates The start of the long-term downtrend in global interest rates can be traced back to the early 1980s, in the wake of the United States (US) Federal Reserve’s (Fed) decision to tighten policy sufficiently to uproot what was, at the time, seen as structurally high inflation. As US inflation started its long decline, so did interest rates: from averaging 10.0% in the 1980s, the federal funds rate declined to averages of 5.1% in the 1990s and 2.9% in the 2000s. As other countries, first in the developed and then increasingly in the emerging world, followed the US example and made price stabilisation a priority, a global trend towards lower interest rates set in. The Reserve Bank of New Zealand was a pioneer in the field of inflation targeting in 1990; 20 years later, the majority of advanced and large emerging economies had a similar framework in place. This not only allowed for lower average inflation around the world, but also for lower dispersion of inflation rates across countries. Global drivers of inflation gradually gained in importance at the expense of domestic factors, allowing for a broader international diffusion of major economies’ disinflationary trends.1 The shift towards lower trend, or equilibrium, interest rates continued in the wake of the global financial crisis, although it could not be solely attributed to better control of inflation and inflation expectations. In fact, in several advanced economies, central banks for the first time struggled to raise average inflation towards targeted levels, and undershooting became the norm. In this context, the use of unconventional policy tools to circumvent the effective lower bound did succeed in lowering longer-term interest rates, flattening yield curves and compressing risk premiums; yet it failed to lift most countries out of their low-growth, below-target inflation paradigm. Several explanations have been sought for what economists increasingly referred to as ‘secular stagnation’, including demographic trends; a growing propensity to save, exacerbated by rising income inequalities; a structural break in investmentto-gross domestic product (GDP) ratios in dynamic Asian economies; widening productivity gaps between ‘high-tech’ firms and others; and a growing investor preference for safe assets.2 What seems likely is that most of these factors contributed to structurally lower interest rates, not just in advanced economies but also in the emerging world – even though many emerging markets and developing countries are still far from the ‘technological frontier’ and could be expected to grow faster. See for instance ‘Understanding global inflation synchronization’, in Inflation in emerging and developing economies: evolution, drivers and policies, The World Bank, 2019, pp 93−141. These topics are discussed, among others, in L Rachel and T D Smith, ‘Secular drivers of the global interest rate’, Bank of England Working Paper No. 571, December 2015. South Africa was no exception to these trends: in the past decade, our policy rate averaged 6.1%, down from 15.4% in the 1990s and 9.9% in the 2000s. On the positive side, greater compliance with the 3−6% inflation target range3 and lower inflation volatility have allowed for lower average policy rates and lower volatility of the monetary policy cycle. On a less favourable angle, the trend in real GDP growth lost momentum throughout the past decade, a pattern which is only partly attributable to global trends but mainly reflects domestic supply constraints such as limits to the availability of electricity or critical skills. 3. The COVID-19 pandemic required lower interest rates It is important to recall the macroeconomic and financial trends that pre-dated the COVID-19 crisis, as they informed the ability of central banks to deliver a speedy and large enough response to the crisis. When compared with the onset of the global financial crisis about 12 years earlier, as of July 2008, the average inflation rate in advanced economies had climbed as high as 4.6%, from 1.8% a year earlier; the average for large emerging countries had followed a similar trend, albeit at higher levels. Many central banks were still tightening policy even as the crisis was setting in. The SARB was one of them: in July 2008 the Monetary Policy Committee (MPC) had raised the repurchase (repo) rate as high as 12.0% − a total increase of 500 basis points over 26 months − to fight an inflation rate that had reached doubledigit levels on the back of rising food and fuel prices and strong credit growth. By contrast, a large number of countries – South Africa included – entered the COVID-19 crisis with inflation rates that were not only stable but also below, or within, target levels. Consequently, central banks in those countries did not have to first unwind restrictive policy stances before pushing for monetary stimulus. They were also able to quickly utilise tools, such as asset purchases programmes that had been ‘tried and tested’ in the previous crisis. And indeed, a quick response was warranted, especially as the combined health and economic shocks associated with the pandemic and subsequent lockdowns threatened at first to be accompanied by Since 2010, monthly inflation readings have been within target 78% of the time versus 40% in the previous decade. a disruptive financial shock. In late March 2020, Bloomberg’s measure of US financial conditions stood about six standard deviations in restrictive territory; major equity markets had shed between 25% and 35% in the space of five weeks; and commodity prices had plunged, with Brent crude, in particular, falling as low as US$17 per barrel, from an average of US$64 per barrel in January. The strong global response of both fiscal and monetary authorities allowed a quick normalisation of financial conditions. Equity market and commodity prices have rebounded; corporate and sovereign spreads have narrowed; funding conditions in offshore dollar markets have improved, helped by bilateral swap lines made available by the Fed; and most emerging market currencies have stabilised, even though they remain much weaker than pre-crisis levels. South Africa is no exception: the South African rand is currently trading at about R17.00/US$, weaker than the January 2020 average of R14.40/US$ but much improved from early April lows of R19.00/US$. Shorter-dated government bond yields are now trading lower than at the start of 2020, though yields on longer-dated bonds are higher, probably reflecting higher credit risk and debt issuance. 4. Interest rates are likely to stay low over the next two years The economic shock from COVID-19, however, will probably take longer to subside than its financial counterpart, despite the combination of fiscal and monetary support provided. Global activity has rebounded from the lows of April (when most of the world faced a strict lockdown), as restrictions on economic activity and people’s mobility have been lifted. But activity indicators are still significantly below pre-crisis levels, and as activity gradually converges towards ‘normal’ levels, the pace of convergence slows. Some commentators argue that the harder part of the economic normalisation begins now. In most countries, private and official institutions, on balance, do not project a return of real GDP to pre-COVID-19 levels until late-2021 or even late-2022. Negative output gaps are expected to be the norm. With respect to unemployment, the consensus view is that normalisation will take even longer. South Africa has been gradually lifting restrictions on economic activity since late April; both fiscal and monetary policies were eased significantly to help facilitate the economic recovery. On the monetary front, the SARB’s MPC lowered the repo rate by a cumulative 275 basis points between March and July; the bulk of the reduction (250 basis points) occurred between the March and May meetings − a fast response by the standards of large emerging markets. To facilitate the flow of credit to cashconstrained businesses and individuals, the SARB injected liquidity in money markets through larger and more frequent repo operations. It also temporarily relaxed some regulatory capital requirements for banks. Finally, the SARB purchased government bonds in the secondary market to ensure liquidity and the smooth functioning of the bond market. Nonetheless, the plunge in second-quarter economic activity, when real GDP fell at an annualised rate of 51%, could not be reversed. Base effects, admittedly, will result in spectacular growth rates in both the third quarter of 2020 and 2021 as a whole. But they can be misleading. In level terms, our model only expects real GDP to gradually converge back towards pre-COVID-19 levels. At the time of the September MPC meeting, the Quarterly Projection Model (QPM) pointed to a large output gap that will only gradually narrow over the remainder of the forecasting period and remain negative even in 2022. The combination of ongoing economic slack, an undervalued real effective exchange rate and a recent decline in medium-term inflation expectations suggest that inflation should not be a problem for the next two years or so. The QPM projects that both headline and core inflation rates will remain largely within the lower half of the target until the end of 2022, with the exception of a short-lived spike in the headline inflation rate in the second quarter of next year as a low base distorts energy price inflation. Baring materialisation of upside risks, this benign inflation outlook should allow the SARB to maintain an accommodative stance for most of the coming two years, and only withdraw stimulus in a gradual fashion, as the output gap slowly closes. Indeed, the latest QPM projections are consistent with a rise in the policy rate to 4.0% by the end of 2021 and 5.0% in 2021, which would still be 100 basis points below the average of the past decade. 5. Can there be a new paradigm in the long run? In summary, there appears to be a growing consensus – both among forecasters and policymakers – that the interest rate cycle in the next couple of years, both globally and in South Africa, is going to be one of gradual normalisation. But towards which levels are interest rates going to normalise, and what is going to be their average over the longer term – say, a horizon of five years or longer? Few economists presently seem willing to make forecasts over such a horizon, at a time when it is not yet clear how long the pandemic will be with us. Will the past few decades’ trends towards lower equilibrium interest rates persist or, on the contrary, will COVID-19 usher in structural changes that are consistent with higher interest rates over time? Economic theory tells us that equilibrium interest rates should reflect potential real GDP growth, inflation expectations and a risk premium that varies with the term of the loan and the creditworthiness of the borrower. The outlook for all three appears, at present, to be marred with varying degrees of uncertainty. Many are concerned with downside risks to global potential growth, which would be highly relevant for the trend in the growth outlook in an open economy such as South Africa. Uncertainty about the longer-term impact of the pandemic may in itself result in lower global capital accumulation, especially at a time when corporate profit rates are declining and global trade, which is historically a driver of investment, is still contracting.4 Indeed, supply concerns experienced at the height of the pandemic – for example, in the procurement of medication or personal protective equipment – may entice authorities to reduce reliance on global value chains, or at least reduce the length in the supply chains and reliance on single suppliers. Some economists also highlight the possibility of durable labour market ‘scarring’, which would risk the permanent loss of skills, and make it more difficult to match labour supply and demand in the future.5 Admittedly, other shifts could be more positive for potential growth. The sudden imposition of the lockdowns certainly forced many firms to speed up their adaptation to different ways of work and of doing business, which, if implemented on a larger scale in the coming years, could See ‘Productivity and GDP prospects: some gain, much at risk’, Global Economic Outlook and Strategy, Citi Research, August 2020. See J Kozlowski, L Veldkamp and V Venkateswaran ‘Scarring body and mind: the long-term belief-scarring effects of COVID-19’, 2 September 2020. boost productivity. Automation, e-commerce and remote working are all likely to play a greater role in economic activity in the coming years. Yet it is not clear whether all economic sectors would benefit equally from such changes and, also, whether these changes in the ways of work could be implemented as easily in emerging economies that still rely more heavily on primary and secondary industries.6 And what about inflation? Economists at a large global investment bank recently reviewed major ‘regime shifts’ in the inflation of key economies over the past century, and found that common drivers are a combination of supply-side constraints or reforms, exogenous shocks, fiscal issues and institutional changes.7 At present, central banks across the world remain, by and large, committed to inflation targeting, and when changes are being made to the framework, these are generally moderate and aim to correct durable undershoots of targets rather than to ‘shift the goalposts’.8 However, several of the potential influences on real economic growth I just mentioned could also alter inflation in the future. Productivityenhancing shocks such as automation and e-commerce may further weigh on prices; at the same time though, further trends towards deglobalisation, as well as more active policies to reduce inequality, mean that some of the major disinflationary forces of the past few decades could wane. Rising government debt levels also present a risk to equilibrium interest rates in the future. Up to now, public debt has risen in most jurisdictions over the past decade, without seemingly affecting the level of interest rates. Perhaps, as Larry Summers and Lukasz Rachel argued in 2019, rising public debt just prevented equilibrium real interest rates from falling even lower.9 Nevertheless, in countries whose currencies are not reserve currencies, the risk of fiscal dominance – even if it is not strong enough to meaningfully lift inflation expectations – may raise the risk premium that investors require on longer-term interest rates. Consequently, Potential long-term structural implications of the COVID-19 pandemic are analysed in ‘The post-COVID economy’, Equity Gilt Study, Barclays Research, July 2020. ‘Could COVID-19 trigger an inflation regime shift? An historical perspective’, Focus Europe, Deutsche Bank Research, 15 July 2020. ‘New economic challenges and the Fed’s monetary policy review’, Speech by Chair Jerome H Powell at the Jackson Hole Symposium, US Federal Reserve, 27 August 2020. L Rachel and L H Summers, ‘On falling neutral real rates, fiscal policy, and the risk of secular stagnation’, Brookings Papers on Economic Activity, March 2019. countries with vulnerable public finances may face permanently steeper yield curves. 6. Implications for future South African interest rates All the long-term drivers of interest rates I just discussed have implications for South Africa. However, determinants of the equilibrium interest rate would be somewhat different in an open economy such as ours, with a structural current account deficit, than in a large and relatively closed advanced economy where most drivers of equilibrium rates are internal. When a country is dependent on external financing, it requires an equilibrium interest rate that attracts foreign as well as domestic savings to finance investment. Indeed, the SARB’s models link the domestic neutral real interest rate to both its global counterpart and a South Africa-specific risk premium. Hence, a lower global equilibrium interest rate would – everything else being equal – imply that the policy rate should also be lower, on average, in South Africa. Equally, in a world where global drivers of inflation have, over time, played a greater part in influencing country-specific price developments, continued moderation in global inflation may make it easier for inflation expectations to remain low and stable in South Africa. However, there is no certainty that the risk premium which investors require on South African assets will remain low over the medium term. Of course, the major central banks in advanced economies have indicated they are in no rush to raise rates from very low levels, or reverse the continued increase in the size of their balance sheets. As they did in the aftermath of the global financial crisis, these policies should provide incentives for global fund managers to seek higher returns outside traditional ‘safe’ markets, encouraging capital inflows towards emerging market securities. In light of the size and liquidity of its markets, South Africa should benefit from these trends. Yet the COVID-19 crisis has exposed differences in vulnerability between emerging market countries − those countries that enjoy stronger public finances have been able to respond more effectively to the macroeconomic shock and, hence, have been able to potentially limit medium-term economic losses. Some economists are also arguing that in a world where globalisation forces are on the decline, the economic and financial cycles of respective countries may become less synchronised.10 In that respect, the unfavourable debt/growth dynamics of South Africa11 may reflect in the country’s sovereign risk and potentially perceived risks of fiscal dominance. Furthermore, South Africa’s loss of its investment-grade status could expose us to greater volatility of non-resident capital flows in the future, with a higher risk premium required to compensate for such volatility. 7. Conclusion In conclusion, I would again like to stress that decades of gains in stabilising inflation and inflation expectations, both in South Africa and abroad, have assisted central banks in responding quickly to the COVID-19 pandemic, limiting financial sector spillovers that would otherwise have made the economic recovery even more challenging and lengthy. As we enter a new decade, fraught with uncertainties about whether and how the pandemic will have lasting consequences on key macroeconomic and financial variables, an important tool in enhancing the resilience of our economy is for the SARB to ensure that we retain this monetary margin of manoeuvre in the future. This involves a continued anchoring of inflation expectations around the midpoint of our target range in the coming years and ensuring that financial markets are functional. At present, achieving our goals appears consistent with a relatively low level of interest rates, in the next year or two, compared with the average of earlier cycles. But we must remain vigilant and watch for potential changes in drivers of equilibrium interest rates in the future. See Barclays Research, op. cit. The International Monetary Fund is projecting a rise in South Africa’s gross government debt/GDP ratio from 62.2% in 2019 to 85.6% in 2021, the largest among major emerging economies. See Fiscal Monitor, International Monetary Fund, April 2020.
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Opening remarks by Ms Fundi Tshazibana, Deputy Governor of the South African Reserve Bank, at the Market Practitioners Group Forum, 7 November 2020.
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Opening remarks by Ms Fundi Tshazibana, Deputy Governor of the South African Reserve Bank at the Market Practitioners Group Forum 6 November 2020 Ladies and gentlemen, good morning and welcome to the Market Practitioners Group (MPG) Forum. The MPG is a joint public and private sector body that was established by the South African Reserve Bank (SARB) to facilitate decision-making on matters relating to the reform of interest rate benchmarks in our country. Since its establishment in October 2018, the MPG has had various interactions with industry stakeholders and has set up substructures to craft the design of alternative interest rates in South Africa. The MPG also leads South Africa’s transition to a new and more robust interest rate dispensation. Importantly, the work of the MPG and its substructures, which I will allude to and contextualise shortly, forms part of a global agenda to strengthen existing interest rate benchmarks and identify alternative near risk-free rates. Let me now briefly provide some context for those who may not be aware of the origins of the work on the reform of interest rates. In the major financial markets, reference rates, such as the London Interbank Offered Rate (Libor) and Euro Interbank Offered Rate (Euribor), are widely used as benchmarks for a large volume and broad range of financial products and contracts. These rates encountered episodes of attempted market manipulation and false reporting. This, together with the decline in liquidity in interbank unsecured funding markets after the global financial crisis (GFC), undermined confidence in the reliability and robustness of existing interbank benchmark interest rates. Page 1 of 4 These developments meant that the lack of integrity in the determination processes of some critical reference rates represented a serious source of vulnerability and systemic risk. As such, the Financial Stability Board undertook a fundamental review of major interest rate benchmarks. In line with global developments, the SARB established the MPG following the publication of the ‘Consultation paper on interest rate benchmarks in South Africa’. The consultation paper, among other things, considered whether there was a case for the reform of the Johannesburg Interbank Average Rate (Jibar) and explored the development of new benchmarks. The case for reforming the Jibar, which is the most widely used reference rate in South Africa and is therefore of systemic importance, was informed by a number of concerns, including that: i. the Jibar is currently not underpinned by a large number transactions, which is a desirable and an essential characteristic of a benchmark interest rate according to the principles for financial benchmarks developed by the International Organization of Securities Commissions (IOSCO); ii. market activity in three-month negotiable certificates of deposit (NCDs), which forms the basis of the most widely referenced three-month Jibar, has declined both in nominal terms and as a share of wholesale bank funding − currently, threemonth NCD volumes make up less than 5% of NCD issuance; and iii. the current calculation methodology for the Jibar is vulnerable to potential manipulation. In addition to strengthening benchmarks to guard against potential malpractice, the SARB has also been cognisant of the role interest rate benchmarks play insofar as they serve as reference rates for a large number of financial contracts. This implies that they have a key role to play in the transmission of monetary policy decisions and the cost of (and remuneration of) capital in the broader economy. While the SARB was initially at the forefront of the development of proposals on how this reform could be achieved, the mandate for determining a market-preferred choice of a reference rate to replace the Jibar was given to the MPG. The MPG was then organised in such a way that it comprises users of reference rates from different Page 2 of 4 pockets of the market, including members of the savings industry, corporate treasuries, the banking sector and the official sector. The MPG established five work streams, focusing on the different aspects of the project. These work streams include: i. the Unsecured Reference Rate Work Stream, chaired by Mr Deon Raju from Absa; ii. the Risk-Free Reference Rate Work Stream, chaired by Mr Andries du Toit from FirstRand; iii. the Data Collection and Infrastructure Work Stream, chaired by Mr Ruan Roux from the SARB; iv. the Transition Work Stream, chaired by Mr Paul Burgoyne from Standard Bank; v. the Governance Work Stream, chaired by Ms Elmarie Hamman from the Financial Sector Conduct Authority; and recently vi. the Communications Work Stream, chaired by Mr Zafar Parker from the SARB. Collectively, the effort of these work streams and the Financial Markets Department of the SARB has culminated in an important body of work that will underpin South Africa’s transition to alternative reference rates. We see this transition process as one which entails multiple and carefully sequenced steps, beginning with the stabilisation of the Jibar to secure the transition period. This is followed by the establishment of new rates and foundations for new markets, and then by the adoption of those rates before full transition takes place. Thus far, the work of the MPG has largely focused on strengthening the current Jibar framework in line with the first step, as well as on finding new alternatives. This work has now been completed and the project is proceeding to the next phase which entails thinking about the most suitable transition approach to be adopted by South Africa. As its work is advancing, the MPG intends to keep all stakeholders informed of its progress and the next steps, and this is why we are here today. Thus, the purpose of today’s MPG Forum is twofold: Page 3 of 4 first, to report on and inform stakeholders of key decisions, considerations and recommendations made by the MPG in relation to the reform of the Jibar and the choice of an alternative overnight reference rate for South Africa; and second, to outline the envisioned transition process to an overnight rate as a key reference rate for the South African financial market. As we engage in this conversation, I wish to reiterate the position the SARB has taken regarding the future of the Jibar. Earlier, I alluded to deficiencies in the current Jibar framework, which have led to the SARB taking a decision to reform the Jibar. The Unsecured Reference Rate Work Stream and later the Jibar Task Team have done commendable work in this regard, to ensure that the Jibar framework is strengthened to enhance its robustness. However, changes to the Jibar framework should not be understood as implying that the Jibar will continue indefinitely. The SARB, as the benchmark administrator of the Jibar, has decided that the Jibar will cease at some future point. The enhanced framework will remain in place for a limited time, after which South Africa will transition to alternative reference rates. In the new interest rate dispensation, we expect that the key reference rate will be an overnight near risk-free rate, which may or may not co-exist alongside a risk-based term rate. At this point I would like to hand over to my colleagues to share with you the decisions that have been taken thus far, their motivations as well as the trade-offs we have had to manage leading up to those decisions being taken. Thank you. Page 4 of 4
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Keynote address by Mr Rashad Cassim, Deputy Governor of the South African Reserve Bank, at the 3rd Annual HSBC Africa Conference, 30 November 2020.
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‘Lessons from the crisis and the post-COVID-19 outlook for monetary policy’ Keynote address by Dr Rashad Cassim, Deputy Governor of the South African Reserve Bank, at the 3rd Annual HSBC Africa Conference 30 November 2020 1. Introduction Good afternoon and thank you for inviting me to address you at your 3rd Annual HSBC Africa Conference on monetary policy as we, and the rest of the world, grapple with the devastating health and economic effects of the coronavirus disease 2019 (COVID-19) pandemic. I will start by briefly recapping how and why the South African Reserve Bank (SARB) responded at the onset of the COVID-19 crisis, and move on to discuss what challenges we may face in the next two years, or to stretch it a bit and say what a possible postCOVID world means for the SARB and monetary policy, in particular. I use the word ‘possible’ because it may be ambitious or premature to talk about a post-COVID world at this stage, notwithstanding some encouraging recent successes in vaccine trials. 2. The SARB’s response to the COVID-19 crisis South Africa entered the COVID-19 crisis on the back of a technical recession combined with mounting fiscal stress, growing public sector debt, and a downgrade to junk status in March 2020. Given this backdrop and the wide-ranging impact of the COVID-19 crisis on financial markets, commercial banks and economic activity, we, like many central banks, used the full arsenal of our tools to respond to the crisis. Our response was characterised by a simultaneous and swift implementation of policies consistent with our mandates of price and financial stability, and our responsibility for prudential regulation of the banking and insurance sector. I will not spend too much time on the details of these interventions, as much has been written about them,1 other than emphasise that our liquidity operations consisted of providing additional liquidity to commercial banks, and purchasing government bonds in the secondary market across the maturity spectrum of the yield curve to address stresses or dysfunction in this market. The aim of our liquidity operations was to ensure that our monetary policy transmission mechanism was not compromised by ensuring that the financial sector remained stable, and banks continued to have an ample and stable source of refinancing. As a prudential regulator of the banking sector, we went further by relaxing capital and liquidity requirements for banks so that their financial intermediation role, so critical to everyday economic activity, was not impaired. Lastly, we assisted National Treasury in setting up and administering government’s Loan Guarantee Scheme, aimed at providing lending support to qualifying businesses. As we reflect on South Africa’s response to the crisis, we should remember that we have an important conventional monetary policy tool, the overnight interest rate, at our disposal. This is in contrast to most advanced and a few emerging economies that operate largely at the zero lower bound of their policy interest rates and had to rely on large-scale quantitative easing (QE) – defined as central bank purchases of longer-term financial assets – as their main monetary policy tool to ease financial conditions and provide economic stimulus.2 However, QE is a second-best alternative to stimulating the economy, and less relevant for a country such as South Africa. We entered the COVID-19 crisis with our policy rate at 6.25% and were, as such, able to reduce it significantly by 275 basis points to 3.5% in a short pace of time. Even with this large reduction, we are still far from the zero lower bound and can still rely on interest rates before having to consider QE-type measures, should economic conditions 1 SARB media release, ‘Changes to the money market liquidity management strategy of the South African Reserve Bank’, 20 March 2020, available here SARB media release, ‘Further amendments to the money market liquidity management strategy of the South African Reserve Bank and additions to the Monetary Policy Portfolio’, 25 March 2020, available here Prudential Authority media release, ‘Regulatory relief measures and guidance to the banking sector in response to COVID-19’, 6 April 2020, available here South African Reserve Bank, ‘Note on South Africa’s liquidity measures in response to the COVID-19 pandemic’, Quarterly Bulletin, June 2020, available here 2 See B S Bernanke, ‘The new tools of monetary policy’, American Economic Association Presidential Address, Brookings Institution, 4 January 2020, available here deteriorate and inflation moderate further down towards the lower end of the inflation target. 3. Medium-term outlook for monetary policy While our policy response to the COVID-19 crisis has helped in stabilising financial markets and containing risks of a financial crisis, the near-term outlook for the economy remains very uncertain, even though we predict a strong recovery in third-quarter gross domestic product (GDP) from the second quarter’s low base. There is still some risk of resurgence in volatility and risk-aversion in global financial markets, depending on sentiments around the evolution of the pandemic and perceptions around the efficacy of policy interventions. This would have significant implications for capital flows to emerging markets, and in turn their currencies and inflation outlook. In our November Monetary Policy Committee (MPC) meeting, we assessed the overall risks to the growth outlook as balanced, but acknowledge this as a tentative assessment, which is open to adjustment given the wide range of shocks hitting the economy, uncertainties involving the effectiveness of policy, and the sensitivity of sentiment to news flow. We revised our 2020 growth forecast marginally upwards from a contraction of 8.2% projected at our September meeting to a contraction of 8% on the assumption of a stronger recovery in the third quarter of this year. We further expect the economy to grow by 3.5% and 2.4% in 2021 and 2022 respectively. Our Quarterly Projection Model (QPM) also points to a large output gap that will only narrow over the remainder of the forecast period but still remain negative in 2022. The main drag on medium-term growth is that we expect negative growth in investment this year and next year in both the public and the private sector. Admittedly, this is only a forecast, but if it holds, it will have profound implications for the future productive potential of our economy. Structural issues, such as electricity supply challenges and a constrained fiscal environment, also remain key obstacles to the economic recovery in the medium term. The overall risks to the inflation outlook at this time appear to be to the downside in the near term and balanced over the medium term. One of the key factors explaining the projected downward movement in core inflation is the lower increase in medical insurance prices in 2021. However, we noted that evidence points to this reduction as temporary and likely to reverse in 2022. Some internal work done by our Economic Research Department shows that medical schemes built up significant cash surpluses under lockdown, as members were avoiding hospitals and other medical facilities except for emergency treatments. To reduce these surpluses, most medical schemes are implementing smaller price increases for 2021. Our engagements with medical schemes suggest larger increases will resume in 2022, once the excess reserves from the lockdown are depleted. Rentals and owner-occupied rentals have also been on a downward trend, although this has been factored into our forecast. Furthermore, our projections of unit labour costs, which in the past were an important contributory factor to why inflation was persistently at the upper end of our inflation target, are likely to remain below the midpoint of the inflation target. This means that underlying inflation will remain moderate, unless there are unforeseen supply shocks that spill over into core inflation. We also noted in our November meeting that electricity and other administered prices remain a concern. Moreover, while risks to inflation from currency depreciation are expected to stay muted as pass-through remains low, additional exchange rate pressures in the medium term, as a result of heightened fiscal risks, continue to be on our radar. This is perhaps an appropriate time to make one or two comments about how the MPC incorporates fiscal concerns into its reaction function. Having read various analysts’ reports over the past two years, most rightly point out that the risks from the fiscus put some constraints on monetary easing. Many of you continue to ask for more clarity on how we incorporate fiscal concerns into our thinking. Fiscal developments matter for monetary policy in different ways. The most obvious channel through which fiscal policy affects monetary policy is the exchange rate. To what extent do growing fiscal deficits and public debt generate more uncertainty for foreign investors, and in the process create more volatility in the exchange rate? This is a question that preoccupies us all the time, bearing in mind that we do not target the exchange rate but monitor its impact on prices as well as second-round effects. What also concerns us is that, while pass-through is relatively low, there may well be non-linearities in pass-through coefficients. In other words, if we were to see significant downward movements in the exchange rate, the effects on inflation could be a bit more serious. This is, however, a low probability scenario, but it could have a high impact. And if anything, COVID-19 has taught us to take low probability, high impact shocks seriously. Lastly, and linked to the above, is the impact of fiscal policy on the country’s risk premium. For a small open economy such as South Africa, with a strong dependence on external funding, the deterioration in fiscal metrics, such as a strong rise in the debt-to-GDP ratio, raises sustainability concerns and, in turn, the premium which investors require on government bonds. This is currently the case, as we are seeing elevated long-term government bond yields even after short-term rates were reduced. The result of this is that the natural rate of interest will rise, and this is something we cannot ignore when we set monetary policy. 4. Post-COVID-19 outlook for monetary policy Let me now move on to a final discussion of the post-COVID-19 outlook for monetary policy. Once again, I would like to remind you that I am using the word ‘post’ with great caution as we are all acutely aware of the long-lasting health and economic effects of the pandemic. Over the past few years, the SARB has repeatedly reminded the public about how the blurring of what is considered cyclical and structural growth factors has made it more difficult to pin down precisely how effective monetary policy can be. This problem of the disentanglement of cyclical and structural factors may even become more serious in the next few years, given the effect of COVID-19 on the economy, particularly its possible impact on productivity and potential growth. Let me focus a bit on potential growth and output gaps. One of the main challenges the MPC will face now and in the next few years is whether we will have to reduce our potential growth estimates, as we were forced to do after the global financial crisis. Our revisions to both potential and output growth at the September 2020 MPC meeting were a surprise to several SARB watchers. From what I have gathered from our interactions with many of you, it was not the downward revisions that were a surprise, but the timing and approach that were of greater concern. In reaction to these concerns, the SARB’s October 2020 Monetary Policy Review devoted a box to the detailed explanation of these revisions. The essence of our approach is characterised by significant movements in the output of the economy, and there is no predetermined date in deciding when to make these adjustments. We, however, know that the methodological treatment of these concepts is always fraught with difficulties. As such, while potential output and output gaps have always been important in guiding our monetary policy stance, they have been used with great caution by most central bankers, owing to their measurement uncertainty. The large-scale disruptions to the economy as a result of COVID-19 have pushed this measurement uncertainty to a new level. The impact of the lockdown means that response rates to surveys have been lower than usual, and more uncertainty in data, from which potential output is derived, just adds a further layer of uncertainty. In addition, there are still businesses that are temporarily closed or operating at much lower capacity as a result of the crisis, and it is still unclear if and when they will return to their normal operations, for example those in the hospitality and tourism sectors. It will likely take some time before we are able to fully determine, with great certainty, how many permanent business closures will result from the crisis, which makes it difficult to accurately measure the supply-side of the economy. Notwithstanding these uncertainties, several views are emerging globally that may be of relevance to South Africa. The nature of the pandemic is expected to bring about various changes to the economy, including much slower capital accumulation than in the past and a change in tastes and preferences that will lead to reallocation effects in the economy.3 Some argue that, given the nature of the crisis, some capital will become obsolete very quickly and this has significant implications for the long-term productivity of the economy.4 Expectations of the potential long-term impact of the COVID-19 crisis on economic growth, along with rising levels of public debt, are also particularly concerning for a country such as South Africa, given our large dependence on external financing as a result of our structural current account deficit. These unfavourable growth/debt dynamics could result in a change in global investor sentiment towards South Africa, 3 See, International Monetary Fund, World Economic Outlook, October 2020; Bank of Canada, Monetary Policy Report, October 2020; and Bank of England, Monetary Policy Report, November 2020. 4 See J Kozlowski, L Veldkamp and V Venkateswaran, ‘Scarring body and mind: the long-term belief-scarring effects of COVID-19’, 2 September 2020. even as investors turn towards riskier assets such as emerging markets in search of higher returns. This may, in turn, affect capital flows to South Africa and/or increase the risk premium investors require, particularly given that they already held an overweight investment position in South Africa going into the crisis. A key consideration in this regard is whether we will see investor differentiation between emerging markets, with preference for those with strong growth and fiscal metrics. 4. Conclusion and key lessons from the COVID-19 crisis Let me end with a few concluding remarks and some key lessons from the crisis. Many central banks, particularly in advanced economies, had to largely resort to QE with speed and vigour to stimulate their economies. At this stage, we are able to rely on conventional monetary policy, which implies that we still have room to provide further accommodation before having to consider QE-type measures, should economic conditions deteriorate and inflation moderate further down towards the lower end of the inflation target. The SARB, like many central banks that are not at the zero lower bound of their policy interest rates, used its balance sheet not to stimulate the economy but as a crisis management tool, in line with its financial stability mandate. We will continue to use these tools in the future in the same spirit if need be. Another lesson from the COVID-19 crisis is that, unlike the great financial crisis in 2008 where inflation was high, which required interest rate hikes even as the crisis was unfolding, we entered the COVID-19 crisis with stable and low inflation rates, and moderate inflation expectations. This allowed us room to respond to the crisis quickly with significant interest rate cuts. Despite our cuts, inflation still seems to be moderating further below the midpoint of the target. Needless to say, the most important post-COVID challenge is that when the economy starts recovering and inflation begins to drift upwards, we have to make sure that we are able to find the right balance in our monetary stance that, at one level, would not result in a premature tightening of monetary policy while also guarding against a delayed response that would reverse a sustained downward trend in inflation expectations. An additional challenge is to ensure that we are able to come to grips with the role of monetary policy relative to what we think potential growth is. This will serve as an important backdrop to opportunities or constraints that will exist for monetary policy in the future. However, as noted earlier, our medium-term projection for real potential and real GDP growth suggests that the output gap will remain negative throughout our forecast period. This should allow us to keep interest rates relatively accommodative over our forecast horizon and only normalise rates as the output gap closes. I should, however, emphasise that, given the high uncertainties about the current crisis, the SARB will continue to remain data-dependent in its policy decision-making. Thank you.
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Opening address by Mr Rashad Cassim, Deputy Governor of the South African Reserve Bank, at the World Fintech Festival, organised by the Monetary Authority of Singapore, virtual, 8 December 2020.
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An opening address by Rashad Cassim, a Deputy Governor of the South African Reserve Bank, at the World Fintech Festival 8 December 2020 Challenges facing fintechs and opportunities to respond Good day to our South African financial technology (fintech) community and to all our fintech colleagues connecting to the World Fintech Festival in South Africa. The Intergovernmental Fintech Working Group (IFWG) is honoured to be part of this year’s Singapore Fintech Festival. We would like to commend the Monetary Authority of Singapore for organising a virtual festival which is testament to the immense possibilities that are unlocked when we embrace technology in the way we work and interact. My understanding is that we are likely over 100 000 people connected to this event. Before we begin today’s programme, I would like to talk, very briefly, about the significance of fintech, particularly in the context of COVID-191, and reflect on some of the challenges that fintech continues to face. For fintech to continue making inroads into financial services, it may be important for the ecosystem to overcome some of these challenges. Many of these reflections will be explored further by esteemed expert speakers in the panel discussions. I realise that any discussion of fintech raises a dilemma for many of us, given that it is a complex and multifaceted subject involving topics as diverse as, among others, regulatory barriers, the nature and use of technology, and its social and economic impact, be it economic efficiency or financial inclusion. COVID-19 has also opened up a whole new set of issues and challenges for fintech firms. 1 coronavirus disease 2019 Page 1 of 9 While I would like to focus my talk specifically on four challenges facing the fintech industry – drawing, in part, from the South African experience – let me say a few things about what COVID-19 means for fintech firms. Although the pandemic has placed significant stress on all businesses, including fintech firms, many of them, specifically those with established consumer bases, have managed to pivot. There are growing examples of fintech firms helping small, micro and medium enterprises (SMMEs) in ‘going online and digital’. The ‘going online and digital’ phenomenon is propelled by the pandemic. This is not only as a result of waning demand during periods of lockdown, but also because of shifting consumer behaviour. Heightened consciousness of social distancing and avoidance of physical interaction has thrust fintech further into action, with more people adopting digital financial services. South Africa is no exception, with nearly 80% of surveyed South Africans reporting that they used contactless payment methods as a perceived safer way to pay since the COVID-19 outbreak.2 To meet the increased demand for digital payments, there has been a resurgence of innovation in digital payment products and channels, including cheaper and more convenient point-of-sale (POS) devices for small businesses as well as the strengthening of apps and platforms that enable consumers and businesses to make payments.3, 4, 5 In addition to digitising payment at POS, merchants are also adopting online sales (or e-commerce), which provides more safety and convenience to customers while also expanding customer reach. In South Africa, for example, one of the largest payment gateways has reported a surge in online payments, recording a 2 MasterCard, April 2020, Global Consumer Study, available at https://newsroom.mastercard.com/mea/press-releases/mastercard-study-shows-south-africanconsumers-make-the-move-to-contactless-payments-for-everyday-purchases-seeking-touch-freepayment-experiences/. 3 Tom Jackson, 14 September 2020, ‘SA fintech start-up Ozow launches new payments platforms, zero-rates data costs’, available at https://disrupt-africa.com/2020/09/sa-fintech-startup-ozowlaunches-new-payments-platforms-zero-rates-data-costs/. 4 Staff Reporter, 29 October 2020, ‘Yoco launches new stand-alone card machine for small businesses’, available at https://www.iol.co.za/business-report/companies/yoco-launches-new-standalone-card-machine-for-small-businesses-f59ed3e8-c60f-4333-908f-5254bae139e9. 5 Ishani Chetty, 29 September, ‘New payment tool launches for local SMEs’, available at https://ventureburn.com/2020/09/new-payment-tool-launches-for-local-smes/. Page 2 of 9 year-on-year increase of almost 90% in total new business account registrations since the lockdown began.6 Possible structural challenges facing fintechs Allow me to turn our attention to possibly more structural challenges facing fintech firms today. I have distilled these challenges to the primary challenge of access, and have tagged it as challenges around four R’s, namely: i. access to regulators; ii. access to rule-making; iii. access to resources; and iv. access to refined financial services data. Access to regulators Incumbent firms in financial services have a long history with regulators. By virtue of being regulated, and often highly regulated, incumbents have access to regulators. For these incumbents, when new products or services are conceived, it is often mandatory to ensure engagement with regulators to gain approval for new innovations. This is to assess fit with regulations and compliance frameworks. This required engagement has strengthened further after the 2008 global financial crisis, and especially as technology reshapes how financial services are delivered. New cloud propositions, robo-advice services and even the application of artificial intelligence (AI) often warrant deeper engagements with regulators. In contrast to incumbents, fintech firms may operate on the regulatory periphery. They often create services different from existing platforms. Cases in point are cryptoassets, initial coin offerings, and Internet finance such as peer-to-peer lending and crowd-funding platforms. Fintechs tend to focus on services close to the front-end and the consumer interface. They are, again, likely to be on the outer periphery of highly 6 PayFast, 27 April 2020, ‘PayFast sees spike in new business registrations spurred by COVID-19 lockdown’, available at https://www.payfast.co.za/blog/payfast-sees-spike-in-new-businessregistrations-spurred-by-covid-19-lockdown/. Page 3 of 9 regulated value chains such as payment systems. Unlike the core players in clearing and settlement that are highly regulated, fintechs may have ‘light touch’ or no regulations applied to them. Based on this, our experience is that fintech firms may often not be in the direct regulatory purview of authorities, and may therefore have less formalised and less frequent meetings with regulators. The first possible structural challenge, then, is access to regulators. This is an important challenge to resolve. Our laws and regulations have historically been crafted for financial services intermediaries, long in the domain. The legal and compliance frameworks may be hard to interpret for fintech firms who may be tech-savvy start-ups with limited compliance know-how or competencies. Access to regulators, and know-how of which authorities to connect with for particular types of queries, is important. Our regulatory architecture can be complex, with multiple financial services authorities, ranging from prudential and conduct-focused, through credit-related, to financial intelligence-related regulators. Access to this network is important in order to reduce any potential barriers to entry from a legal, regulatory and compliance perspective. This is why we have seen a rapid emergence of innovation centres, hubs and guidance units across the globe: in recognition of the importance of increasing access to regulators, by fintech firms in particular. Access to rule-making Rule-making in financial services can be complex. The ‘rules of the game’ can be embedded in legislation and regulations, and through related instruments such as directives, position papers and standards. A good example of this complexity can be seen in the regulation of payment systems. Often, primary regulations set the conditions or criteria based on which stakeholders Page 4 of 9 can have access to clearing and settlement systems. Such primary regulations position the overarching principles and objectives of providing legal certainty, deepening financial inclusion, and ensuring the general safety and efficiency of payment systems. However, at a ‘lower level’, rules related to how payment schemes operate are equally important in setting specific conditions or criteria related to a payment system. As an example: direct credit systems will define clearing time-frames, and debit systems will define charge-back rules or conditions. These types of rules are often called the ‘rule books’ in jurisdictions like Canada and the United Kingdom (UK). There are ‘rule books’ publically available for schemes such as the Single European Payments Area (SEPA) Credits in Europe or, in the UK, the Faster Payments Scheme. In South Africa, we have found that, due to legacy reasons, some of the rule-making processes, especially in the payment system space, have traditionally been the domain of incumbents. Based on some of the cases reviewed, our sense is that broader input into the rule-making processes by those impacted across the value chain would benefit from obtaining a variety of competing perspectives. The voice of fintech firms in this process is important. This kind of ever-increasing access to influence rulemaking is vital to ensuring that the best policy and regulatory stances are adopted. Even more importantly, the ‘rules of the game’ must not create barriers to growth for fintechs. We have identified a few scenarios where this may be the case. Authorities have to ensure that the approach to, and governance of such processes, is transparent and robust. Access to resources Two significant resource challenges facing fintechs are access to capital and access to skills sets. Unlike incumbents who generally have reasonable access to finance, fintech firms and specifically fintech SMMEs may experience significant additional challenges accessing finance. While consumer credit is likely well-served in South Africa, SMMEs Page 5 of 9 continue to struggle to access critical funding to sustain themselves and even grow. This is despite the significant contribution that these businesses make to gross domestic product (GDP) and employment. The inability of SMMEs to raise funds is caused by a number of demand- and supplyside factors, such as the lack of financial records and the inability of lenders to tailor their loan terms to match the business needs. According to a 2019 report by one of the large banks in South Africa, few fintechs manage to secure start-up capital, with the general sentiment indicating that funding seems to be readily, but not openly, available. More broadly speaking, SMMEs also operate in a mostly informal, invisible and cash-based economy. Addressing this challenge is related to the broader need to digitise these businesses and ensure that they are included in the digital economy. Turning our attention to the importance of access to skills: although much emphasis is placed on the technologies in the fintech domain, it is the people, the skills and the talent that create the innovation and propel the change. This is evidenced across the fintech value chain: from the data scientists who unearth customer behaviour patterns, needs and ‘pain points’, through the software developers and engineers who develop the solutions, to the business heads who craft growth strategies based on an emerging technology. However, similarly to most countries, particularly developing countries, South Africa has a shortage of technical skills. The 2019 South African Information, Technology and Communication (ICT)7 Skills Survey found that the Fourth Industrial Revolution (4IR) has not had a significant impact on the South African ICT skills landscape yet. According to the report, the skills associated with the current set of emerging technologies – such as AI, the Internet of Things, blockchain, automation, data science and programming – were the scarcest.8 This leads to a race for talented and skilled individuals such as data scientists, programmers, software developers and design thinkers. The challenge, of course, is not specific to fintech firms; it also affects us as regulators. However, based on our discussions with fintech firms, the race for acquiring such skills sets is pronounced for fintechs, especially if they are still in their 7 Information and Communication Technology 8 Johannesburg Centre for Software Engineering (JCSE) (Wits University) and the Institute of Information Technology Professionals South Africa (IITPSA), 2019, South African ICT Skills Survey Page 6 of 9 early phases of development and/or maturity. It is less so for big-tech firms with wellestablished markets. Access to refined financial services data Finally, we turn to the importance of data, specifically refined and granular data. It has become cliché to say that ‘data is the new oil of the economy’. As the digital economy continues to be embedded through the use of mobile devices, the use of social media platforms, and generally increasing activities over the Internet and online commercial platforms, we will increasingly create and leave behind ‘digital bread crumbs’ of unprecedented volumes. Never before have we seen such volumes of data. And for the first time in human history, we also now have evolving tools and techniques at our disposal through cloud-computing, AI and machine-learning methods to handle such volumes of data. However, in this new digital economy, the availability of, and access to, data related to, for example, transactional payments or specific customer behaviour, has become a key competitive driver. Access to both structured and especially unstructured data can provide significant competitive advantages to those who own it. Fintechs in particular are exploring the use of Big Data to produce new services such as product comparisons and tailored solutions based on consumer-specific data. While Big Data presents new opportunities, the scope of available data, and how to govern access to that data, poses new challenges for the financial services industry and regulatory authorities around the world. As a result of the above, access to refined data is a key issue that regulatory authorities have to deal with. Examples of addressing it through Open Banking and Open Finance efforts are increasing in many jurisdictions. For South Africa, it is important to land on the policy imperatives for such efforts. There are a number of open questions for authorities. These include (but are not limited to): Should incumbents be required to share their data with fintechs? Page 7 of 9 Should the standards for sharing data be developed by the regulators or by the market? How is customer data protection being ensured, and what commercial arrangements might arise from owning that data? When dealing with such large data sets, what measures are in place to detect, respond to and recover from cyberattacks? Addressing these and other open questions is important in moving the fintech dial forward. In South Africa, numerous fintech firms applied for our Regulatory Sandbox process to trial new Open Banking models. To make progress within this space, we require incumbents and fintech firms to work together to shape our policy thinking and policy stances. Any unaddressed solutions will possibly continue to see fintech firms using methods that may pose an increased operational risk. The solutions of open Application Programming Interfaces (APIs) are therefore pressing. The industry should actively engage with fintech firms on this long-standing matter. We also need to learn from jurisdictions that have already traversed this path, and modestly take from their emerging lessons. Conclusion Allow me to conclude. The South African regulators recognise the role they can play in addressing these access challenges. The IFWG aims to demystify the regulatory landscape, provide space for safe experimentation, and actively advance innovation. We do this through the Innovation Hub, launched earlier this year, and its three facilitators: the Regulatory Guidance Unit, the Regulatory Sandbox and the Innovation Accelerator. Page 8 of 9 Since launching the Innovation Hub, we have received nearly 100 queries in the Regulatory Guidance Unit and over 50 applications to the Regulatory Sandbox. These numbers show just how vibrant and dynamic the South African fintech ecosystem is. Most importantly, though, they are a positive sign of increasing access to regulators and rule-making for fintechs, which enables us to hear more of those divergent and new voices. In addition, the Innovation Accelerator is a space for us to drive both internally oriented and market-facing innovation initiatives. We focus particularly on those initiatives that address the challenges faced, and have the potential to deliver benefits across the regulatory and broader financial services landscape. We currently have eight initiatives under the Accelerator, looking at important topics such as digital platforms, cryptoassets, financial markets innovation, Open Banking, non-traditional data and big tech in fintech. What makes this unique is that regulators are journeying along to co-create an understanding of the major issues facing fintechs, including co-developing policy stances. The fintech phenomenon is here to stay, and will continue to grow. In the end, however, it is not about fintech but about creating vehicles to support innovation in the economy and the financial sector. It turns out that fintech firms just happen to be the key agent through which we are moving towards a more dynamic financial sector. I trust you will enjoy the deliberations today, and would like to end by congratulating the IFWG and the Monetary Authority of Singapore for arranging this event. Thank you. Page 9 of 9
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the virtual 100th anniversary celebration of the South African Reserve Bank, 30 June 2021.
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Lesetja Kganyago: Address at anniversary celebration of South African Reserve Bank Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the virtual 100th anniversary celebration of the South African Reserve Bank, 30 June 2021. * * * Good afternoon, ladies and gentlemen On this day, 100 years ago, at Church Street east, the first Governor of the South African Reserve Bank (SARB), Mr William Henry Clegg, and 14 other men opened the doors of the SARB to the public. The world had just emerged from World War I, leading to unusual financial and monetary conditions. In establishing the SARB, the primary objective was simple: to restore and maintain order in the issue and circulation of domestic currency, and restore the gold standard to the pre-World War I rate of exchange. From the archives, the first Board meeting minutes, dated 29 July 1921 at 10:00, disclose that the first order of business entailed “the purchase of property in Pretoria for £7 000 and the first orders of banknotes”. The former was finalised in the late 1920s, while the first batch of banknotes ordered from England was issued to the public on 19 April 1922. The monetary policy framework adopted at the SARB’s founding was the gold standard, linking banknotes to gold. However, the Great Depression and its link to weaknesses in the gold standard ushered in a period of monetary policy reform. A new policy direction linked the value of the South African pound to the British pound sterling, and the further decision to join the Bretton Woods agreement in 1946 as a leading member of the international monetary system. Other currency reforms were initiated in subsequent years. In the 1950s, the Decimal Coinage Commission recommended that South Africa formally introduce a decimal system, which eventually led to the introduction of the rand in 1961. This occurred at the same time that South Africa became a republic. Despite the introduction of the rand, the 1960s was a period of rising inflation at home and globally. In 1967, anti-inflationary measures were introduced to slow the rise in the price level. These gains proved short-lived, however, as inflation again picked up in the 1970s on the back of US dollar depreciation (as the US removed parity to gold), major fiscal expansions, and the first oil price crisis. By the end of the decade, oil prices had tripled and inflation reached post-war highs around the world. The early 1960s, amid the introduction of a new currency, also saw signs of inflation, resulting in anti-inflationary measures that, by 1967, slowed the rate of price increases. These troubles ushered in a period of economic policy reform that eventually led us to the modern approaches to monetary and fiscal policy that we see today. Leading up to the 1980s, South Africa was in deep political and economic turmoil. At the height of the anti-apartheid struggle, inflation hit a high of 18.4% in 1986, and annual growth slowed to 1.6% for the decade. Significant capital outflows resulting from the debt default and economic sanctions saw another policy reform: exchange controls. The SARB adopted a broadly defined money supply (M3) growth target framework. Inflation gradually slowed towards the end of the decade, averaging 12.9% in 1989. The SARB Act of 1944 was replaced by the South African Reserve Bank Act 90 of 1989, which contained the revised primary objective wording of “monetary stability and balanced growth”. The 90s ushered in a renewed spirit among South Africans with the advent of democracy. Continuity amidst the change was crucial for the smooth transition to democracy and gaining international investor confidence. This led to President Mandela asking Dr Chris Stals to continue serving as Governor. A critical pillar to this was ensuring that the SARB as an institution was stable, by retaining institutional memory and the requisite skills, while at the same time preparing 1/3 BIS central bankers' speeches to transform the organisation. The SARB debuted its ‘Big Five’ banknote series, and introduced a R5 coin, commemorating the inauguration of our first democratically elected President, Nelson Mandela. We have continued the tradition of reflecting on our history and today we are releasing a newly designed R5 coin commemorating our centenary. The adoption of our Constitution in 1996 saw the SARB bestowed greater responsibility in the rebuilding of our economy. The SARB’s primary objective reads, “to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic”. Moreover, “in pursuit of its primary object, [the SARB] must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters”. Central bank independence emerged as an effective way of ensuring that monetary policy focused on the key objective of keeping prices stable. To ensure that the SARB could pursue that objective independently and effectively, the late 1990s was marked by further enquiry into monetary policy frameworks. The early 2000s saw our biggest policy shift, the adoption of the inflation-targeting framework. At the time, South Africa was the 13th country to introduce this policy framework. The Governor at the time, Tito Mboweni, was tasked with guiding the SARB through this uncharted territory. Our inflation target, set by the Minister of Finance in consultation with the SARB, is between 3% and 6%. The adoption of inflation targeting saw a radical change in the way in which the SARB communicated with the public, focusing on transparency through communication, and ensuring that independence and accountability worked hand in hand. The flexibility of the inflation-targeting framework and its anchoring of public expectations about inflation assisted the country to weather the global financial crisis in 2008 and 2009. With the critical role of financial institutions in that crisis underscored, Governor Gill Marcus helped expand the SARB’s mandate to explicitly include financial stability. In doing so, a Financial Stability Committee was formed and resources expanded for its work. The early 2010s also saw Cabinet approve the move towards the Twin Peaks model. The Financial Sector Regulation Act was signed into law on 21 August 2017, paving the way for the formation of the Prudential Authority. In April 2018, the Prudential Authority was officially launched, amalgamating the SARB’s Bank Supervision Department, the Insurance division of the Financial Services Board and the Supervisory team of the Co-operative Banks Development Agency. The SARB was born at a time when the world was exiting the devastating impact of the 1918 Spanish flu pandemic. As we approached our centenary year, the world began grappling with the great flu pandemic of our time, the coronavirus disease 2019 (COVID-19) pandemic. As COVID19 cases began to rise, South Africa, like many other countries, mandated forceful containment measures to abate the human cost associated with the virus. While these measures minimised the impact on human lives, they came at a great cost to the economy. South Africa’s real gross domestic product contracted by a substantial 7.0% in 2020. This was the second-largest annual contraction since 1920, and about five times larger than the contraction following the global financial crisis in 2009. Unemployment recorded its highest level since Statistics South Africa began measuring unemployment. Both headline producer and consumer price inflation recorded historic annual average lows of 2.5% and 3.3% respectively for 2020. In anticipation of the economic shock that would ensue, the SARB responded quickly and aggressively with a broad array of actions to limit the economic damage. The SARB’s policy responses encompassed monetary policy instruments, interventions in financial market operations, regulatory tools as well as collaborations with other entities to provide relief to the economy and enable the financial sector to help customers in need. In addition, through its participation in global forums, the SARB contributed to the strengthening of the global financial safety net. 2/3 BIS central bankers' speeches South Africa entered the COVID-19 crisis with stable and low inflation rates and moderate inflation expectations, giving the SARB significant policy space to provide support to households and firms, primarily through the reduction in the repurchase (repo) rate. The repo rate was cut by a cumulative 275 basis points between March and July 2020. At the current rate of 3.5% (from 6.5% on 1 January 2020), the repo rate is at an all-time low, while the prime rate, at 7.0%, is at a 54-year low. The economic recovery is still on track, but there will be pitfalls along the way, as illustrated by our shift back to a Level 4 lockdown. There is no question that our recovery will progress and our sound policy frameworks will continue to allow flexible approaches while building confidence. The SARB is a solid institution that all South Africans can be proud of. The women and men who staff this institution have proved their mettle, repeatedly rising to the challenges they are faced with. With this strength, we face the future, optimistic that we will continue to play our vital role in supporting our economy through maintaining price and financial stability. 3/3 BIS central bankers' speeches
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 101st annual ordinary general meeting of the SARB shareholders, Pretoria, 30 July 2021.
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Address by Ms Fundi Tshazibana, Deputy Governor of the South African Reserve Bank, at the Nelson Mandela Bay 2021 Leadership Summit, 28 July 2021.
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A public lecture by Mr Lesetja Kganyago, Governor for the South African Reserve Bank, at Stellenbosch University, virtual, 8 September 2021.
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south african reserve bank
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Opening address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Project Khokha 2 Report Launch, Pretoria, 6 April 2022.
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Opening address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the launch of the Project Khokha 2 report 6 April 2022 Good day, ladies and gentlemen. Welcome to the virtual public release of the Project Khokha 2 (PK2) report. The project was launched in January 2021 as an initiative under the Innovation Accelerator of the Intergovernmental Fintech Working Group (IFWG) led by the South African Reserve Bank (SARB) through its Fintech Unit. PK2 explored the implications of tokenisation in financial markets through a proof-ofconcept (PoC) that issued, cleared and settled SARB debentures using distributed ledger technology (DLT). In doing so, PK2 built on Project Khokha 1 (PK1), which many of you are familiar with. PK1 was our initial financial technology (fintech) policy exploration and technical trial in the use of DLT for interbank settlements; it explored the use of DLT for interbank settlements by successfully replicating some functions of the South African real-time gross settlement (RTGS) system on DLT. Innovation in financial services in general, and in digital financial services in particular, has made significant progress since the launch of the PK1 report in June 2018. One of the most noteworthy trends affecting financial markets over the last half-century is what is referred to as ‘dematerialisation’. Following advances in computer technology since the 1960s, financial markets started to move away from recording Page 1 of 6 securities ownership in a physical ledger to recording ownership on centralised digital ledgers. Over time, this led to centralised financial market infrastructures such as central securities depositories and central counterparties evolving to play a critical role in recording the ownership of assets and, by extension, managing the risks involved in the process of recording the transfer and ownership of value. Building on this initial convergence towards the digitalisation of financial markets, tokenisation goes one step further by representing different forms of traditional assets (such as money and securities) as tokens on DLT-based platforms. Such DLT-based platforms move the recording of transfer and ownership of value from individual ledgers kept by centralised financial market infrastructures to shared distributed ledgers. DLT-based infrastructures may require fit-for-purpose money which is appropriate for such DLT-based platforms. This has resulted in several central banks opting to further explore the viability of tokenised central bank money in financial markets. Such exploration – although largely conceptual at this stage – is important given the growth in technological innovation and the use of new forms of payment instruments facilitated by the rapid pace of innovation. In our experimentation during PK2, two forms of tokenised money were created to allow for settlement. The first form of money was a tokenised form of central bank money which was a liability of the central bank issued onto a specific DLT owned and operated by the SARB in the PoC. This form of money was used to purchase SARB debentures in the primary market. The second form of money was issued by commercial banks as a stablecoin and used for purchasing SARB debentures in the secondary market. In this way, PK2 explored and expanded on how settlement in central bank money and commercial bank money can happen on DLT. Page 2 of 6 The debenture token market benefitted from having a riskless settlement asset in the form of a wholesale central bank digital currency (wCBDC) used for settlement. This reduced the settlement risk, particularly that payment might fail or might be uncertain due to riskiness in the settlement asset. The wCBDC prototype developed in PK2 was also the preferred asset in other instances. It served as the reserve asset guaranteeing the value of the wholesale stablecoin issued by commercial banks, and it was used to make payment to debenture token holders upon the maturity of the debenture. The role of the central bank in the tokenised debenture token market was therefore similar to the current role played by the central bank. Our attempts to learn more about the relevant technology have been guided by a few principles that can also be referred to as ‘the five Ps of fintech policy exploration’. Purpose-driven projects From a central banking perspective, practical exploration should always be conducted with a purpose. Central banks should therefore ‘play’ to learn and gain deeper insights into technology-based innovation and its potential impact on their mandate as well as on any relevant policy and regulatory frameworks in the financial system. I refer to the term ‘playing’ deliberately because our exploration with technology often happens in a controlled environment, whether it is a PoC such as Project Khokha or whether it is a ‘regulatory sandbox’ in the event of live transactions on a confined basis. Since DLT-based innovation is still quite nascent, it is difficult to reach definitive conclusions on its potential implications. In this way, practical experimentation helps inform our thinking about different scenarios which may arise in the future. PK2 was an experimental research project. It followed an exploratory approach, which enabled the PoC to contribute to the complex discussion surrounding tokenisation in financial markets. Page 3 of 6 PK2 does not signal support for any particular technology, nor does it signal any specific shift in policy direction. The project was not about replicating the status quo. Rather, it was about challenging our thinking around designing for a different future. Playing in collaboration This has been a guiding principle for much of our work has been the following African proverb: “If you want to go fast, go alone, but if you want to go far, go together.” The technical teams are continuing to explore how they can build different applications in addition to the ones built for the prototypes during the main phase of PK2. This is to ensure that we can get the maximum shared learning out of our collaboration. The PK2 report is the SARB’s contribution to broader discussions surrounding the regulatory treatment of crypto-assets and financial market innovation. We hope that it provides meaningful insight to the discussions taking place between policymakers and regulators as they continue to consider the most appropriate way to amend the existing domestic legal and regulatory frameworks. We recognise that digital currency innovation cannot be explored in isolation. The SARB continues to draw on the insights emerging from various initiatives, including (but not limited to) our ongoing study into the feasibility, desirability and appropriateness of a retail central bank digital currency (CBDC), to enrich our understanding of digital currency implications. It is also important to acknowledge the inherently borderless nature of DLTs and the critical importance of international collaboration. The SARB was a proud participant in the Bank for International Settlements (BIS)-led Project Dunbar, which considered how a multi-CBDC platform could be used for international settlements. The Project Dunbar report was released two weeks ago, and I would like to strongly encourage you to read it, as it provides insightful supplementary views and information to the PK2 report. Such initiatives further emphasise the need to consider interoperability and integration between various digital currency and transfer-of-value platforms. Page 4 of 6 Pondering the outcomes This outcome explores the implications of DLT-driven innovation through practical exploration. Such exploration leads to practical insights which require further analysis, research and dialogue. However, pondering on the lessons learnt and the insights gained should not lead to ‘analysis paralysis’ or unnecessary pontification. It is important to interrogate the efficiencies and benefits that new technology may introduce. In the context of DLT-based platforms in financial markets, potential efficiencies relate to: • increased transparency in the holding of securities; • reduction in costs due to automation; and • the removal of multiple manual reconciliation processes across a network of intermediaries. One of the primary risks stems from the lack of regulatory certainty as the existing legal and regulatory frameworks for financial markets were not designed for trading, clearing or settling on DLT. Promoting responsible innovation This looks at how innovation should be done in a way that the financial system is taken forward to benefit society as a whole. This includes contributing to achieving objectives such as: • improving efficiency; • lowering barriers to entry for financial activity; and • addressing any challenges restricting access to meaningful financial services. Policy and regulatory implications The insights gained through practical exploration should lead to greater regulatory clarity – both for innovators and for regulators – and should be in the broader interest of ensuring a level playing field for all market participants. As financial services regulators in South Africa, we follow an activity-based and technology-neutral approach, although we are not technology-blind. It may well be that innovation enabled by DLT may change the risks involved in a particular business Page 5 of 6 process, for instance reducing or even eliminating counterparty risk, which may in turn require us to reconsider the appropriateness of specific regulations. Regulators need to move with caution when considering developments before they implement any regulatory changes. They should be fully appreciative that regulated entities require clarity before fully committing to entering DLT-based markets. Conclusion As I conclude, some may ask whether central banks and regulators will still be relevant in a world based on some of the decentralised principles explored in Project Khokha. From a regulatory perspective, I think it is unlikely that decentralised markets will be suitable in all instances or that decentralisation will guarantee the achievement of public policy objectives such as consumer protection, financial stability as well as safety and soundness, which fall within the mandates of central banks and regulators. The role of central banks, regulators and policymakers should, however, evolve with financial markets to ensure that we continue to fulfil our mandates in future financial markets. Central banks, regulators and policymakers can – and indeed must – play an active role in shaping a potential move to DLT-based markets through playing with purpose, playing in a collaborative way, pondering the implications of innovation, promoting responsible innovation for the public good, and informing an appropriate policy and regulatory response. Thank you. Page 6 of 6
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Keynote address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the African Insurance Exchange 2022 Annual Insurance Conference, Sun City, 25 July 2022.
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African Insurance Exchange (AIE) 2022 Annual Insurance Conference Opening ceremony keynote address by Lesetja Kganyago, Governor of the South African Reserve Bank, The role of financial institutions and insurance in the economy 25 July 2022 Good morning, Programme director and distinguished guests. Thank you for the warm introduction. It is an honour for me to accept the President’s Award bestowed upon me by the Insurance Institute of South Africa and the South African Insurance Association. This award is not mine alone. I share it with over 2 000 colleagues at the South African Reserve Bank who help to ensure that we achieve our mandate of price stability in the interest of balanced and sustained economic growth. Over the last two years, we have become so accustomed to engaging via virtual platforms, that we missed out on the enriching networking opportunities that an event of this nature affords us. Today I will be reflecting on the major risks that the non-life insurance sector has had to face these past few years, how we have weathered the storm, the risks that we face in the current environment and how the Prudential Authority is considering these in its supervisory frameworks. But first, it’s important to acknowledge the critical role that the non-life insurance sector plays in the South African economy. The Geneva Association, in its paper titled – The Social and Economic Value of Insurance – explains that: “Insurance should be perceived not only as a protection mechanism, but more importantly as a partnership that allows individuals and businesses to spread their wings and go where they might otherwise not have dared to go.” The paper further highlights insurance as a mechanism for: • reducing and mitigating risk – supporting citizens and social protection systems; • promoting financial stability and economic growth; and • advancing the development of financial services. The sector also forms an integral part of South Africa’s financial sector ecosystem and is impacted by global and domestic risks and vulnerabilities. It is over two years since the onset of the COVID-19 pandemic. The pandemic has brought about the worst economic and social crisis in recent times, and will no doubt be with us for years to come. The global economy continues to recover from the hardship caused by the pandemic. The recovery was largely supported by extraordinary monetary and fiscal policy responses, together with widespread vaccine rollouts. Business interruption policies The onset of lockdowns brought with it a series of new challenges to the non-life insurance sector and tested the provisions of business interruption insurance. Traditionally, business interruption insurance covered physical damage to assets, which impacted the operations of a business. The impact of the pandemic on businesses meant a significant increase in claims which did not relate to physical damage. From a non-life insurance perspective, this was a big challenge that resulted in regulatory uncertainty. Due to the various legal interpretations of these business interruption policies, legal certainty had to be provided by the South African courts. It would not be an exaggeration to coin this as a significant misstep in managing insurance risk, which had a significant reputational consequence for the non-life insurance sector. However, we acknowledge in progressing to obtain legal certainty, a small number of non-life insurers provided interim payments to support struggling sectors of our economy. The Prudential Authority will continue to monitor the payment of business interruption claims. Furthermore, we also observed the total withdrawal of nonphysical damage business interruption cover in South Africa, which creates a significant insurance protection gap. I will return to my views on the insurance protection gaps later. Reflecting on some of our learnings, in particular how the non-life insurance sector can strengthen its level of preparedness in the face of similar external shock events, the Prudential Authority has observed the following during its supervisory oversight: • insurers have embarked on better planning and management for crisis events; • many have been able to cross-skill their staff – which will ensure a more agile working environment and ability to deploy staff where channel overload is experienced; and • a process of critical review of policy wording has been undertaken to ensure that there is no ambiguity in the cover provided to policyholders. The Prudential Authority will continue to monitor these developments through 2022, and stay abreast of any potential risks and what they could pose for the sector, including those presented by electricity supply constraints. July 2021 riots As we were recovering from the impact of the COVID-19 pandemic, our country was hit by a wave of riots in July 2021, characterised by widespread looting of businesses, and the burning and destruction of public facilities and private property, mostly in the provinces of KwaZulu-Natal and Gauteng. Insurance claims in excess of R30 billion were recorded by the South African Special Risks Insurance Association (SASRIA) as a result of this devastating event. The non-life insurance sector must be applauded for its collaboration with and support to SASRIA, especially in assisting to expedite the claims process and to ensure economic activity was restored. Unfortunately, not all businesses have resumed to full or even partial activity following the riots. Of concern was the significant number of affected businesses that were uninsured or under-insured and many were forced to shut down their operations. It is estimated that close to two million people were left unemployed by the July 2021 riots. This highlights the concerns around the insurance protection gap. In light of this, I would like to challenge this sector to develop products that will enable better protection and to ensure economic recovery post events of this nature. Some learnings from these events, and which require further work include: • improved consumer education initiatives that clearly spell out what is covered and what is excluded under an insurance policy; • clear proposals to address the insurance and risk protection gap, not only as a sector but also in partnership with the government; and • the development of insurance products and solutions that take into account this changing landscape. The current economic outlook The domestic economy experienced rapid growth during 2021, after a sharp contraction in 2020. Despite the steep contraction in GDP during the third quarter of 2021 due to the riots in KwaZulu-Natal, the domestic economy grew by 4.9% during 2021. GDP growth which would have surpassed pre-COVID-19 levels in the first quarter of 2022 was hampered by the January and March 2022 floods in KwaZuluNatal, the sharp correction in commodity prices and intensified load-shedding. The SARB forecasts GDP growth of 2% in 2022 and 1.3% in 2023. Global inflation has been on the rise since the first quarter of 2021, largely driven by the recovery in the oil price and consumer demand since the low levels experienced during the pandemic. Inflationary pressures were exacerbated by the renewed lockdowns in China as well as the war in Ukraine. This not only heightened uncertainty but also caused supply bottlenecks and disrupted food and energy markets. As a result of the combination of these adverse shocks, global growth is projected to slow down. Central banks in advanced economies have begun with policy normalisation as they potentially face double-digit inflation over the next few months. Emerging and developing economies are not exempt from the rise in inflation and now also face capital-flow and exchange-rate risks in the face of monetary policy normalisation. South Africa’s headline inflation has also been rising, with the latest inflation number averaging 7.4%. The SARB now projects headline inflation of 6.5% in 2022, and 5.7% in 2023. The Monetary Policy Committee has therefore moved to normalise rates, raising the repo rate by a cumulative 200 basis points since November 2021. The Committee will continue to monitor inflation developments closely and respond appropriately to ensure inflation expectations remain relatively anchored. This current conjuncture adds a new layer of risk to the non-life insurance sector through its impact on costs and growth prospects. However, looking ahead, large risks loom on the horizon, namely climate-related risks and cyber-risks. Climate-related risks and opportunities Over the past few years, there has been growing prominence of climate-related risks, including their effect on lives and livelihoods; health; economic, social and cultural assets; infrastructure and services. These risks have an impact on the environment in which the non-life sector operates, the financial system at large and the economy. Thus, understanding climate-related risks and opportunities will help us highlight the areas where the non-life insurance sector can play a crucial role in helping to protect livelihoods, and enhance the resilience of the financial system. The Prudential Authority has embarked on a journey to better understand the impact of climate-related risks, and to inform potential regulatory and supervisory action where necessary and appropriate. A working group was formed to coordinate climaterelated work and initiatives across the SARB. Current initiatives include focusing on areas such as risk assessments and developing supervisory guidance, and support regarding disclosure requirements and taxonomies. The work will result in the promulgation of various types of regulatory instruments over the next five years that aim to enhance the resilience of supervised institutions and the financial system as a whole. Internationally, the International Association for Insurance Supervisors (IAIS), through its support of the Sustainable Insurance Forum, has published, among others, an Issues Paper on the Implementation of the Recommendations of the Task Force on Climate-related Financial Disclosures in 2020, as well as an Application Paper on the Supervision of Climate-related Risks in the Insurance Sector in 2021. Recognising the importance of the topic and the continuation of work in this space, the IAIS has also established the Climate Risk Steering Group (CRSG), whose work includes the development of supporting material which will be consulted on next year. Although the Insurance Core Principles (ICPs) are sufficiently broad to capture climate-related risks, and while insurers should already be seeking to integrate climate risk into their enterprise risk management frameworks, the IAIS believes further guidance and support would enhance supervisory effectiveness and help inform appropriate regulatory requirements. We can no longer ignore the impact of climate change; the impact of climate-related events has become palpable over the last few years, both globally and domestically. KwaZulu-Natal floods Severe flooding and landslides caused by heavy rainfall in April 2022, left thousands of South Africans destitute and impacted a number of businesses. This was the second occurrence of floods in the region in this year, after heavy rainfalls battered the province in January 2022. The non-life insurance sector was able to step in and mobilise quickly to support people and communities in affected areas. However, the economic losses were significantly more than the insured losses, which highlights the high level of uninsured or under-insured people and businesses in South Africa. Lastly, let me turn to cyber-risk in the non-life insurance sector and the work that the Prudential Authority and the International Association of Insurance Supervisorsare doing to ensure that the insurance sector is addressing this matter: Operational and information technology risk (including cyber-risk) The interconnectedness of the financial ecosystem and the exponential rise of cyberthreats have attracted the attention from both the financial sector and the PA to address these risks. As insurers start to digitalise underwriting, creating insurance ecosystems, claims and administrative processes, we observed a proliferation of cyber events. The PA is in the process of developing and enhancing various regulatory and supervisory practices. Some initiatives that have been undertaken over the past year include: • a cybersecurity and cyber-resilience standard that was issued for public consultation in December 2021; • prudential cyber meetings with supervised entities and other supervisory interventions which aim to strengthen the work on cyber-risk; and • a cyber-risk underwriting thematic review. The IAIS is using its vantage point as an international standard-setter to assess the risks to the sector and develope material to support supervisors with regard to risks associated with IT third-party outsourcing, and insurance sector cyber-resilience more broadly. The PA will also participate in this work and will consider it in the development of its own supervisory and regulatory tools. Conclusion It is clear that, as we emerge from the COVID-19 crisis, there remains uncertainty and challenges ahead. In order for you, as insurers, to provide the safety net required in our economy and to society at large, proactive management of the risks is required. In this regard, strengthening risk management within institutions as well as our collective thinking on mitigation of emerging risks will be crucial. The financial sector as a whole has remained resilient, despite the multiplicity of shocks over the past two years. The Prudential Authority, much like many of you at this conference, remains resolute in contributing to the resurgence, resilience and revival of the insurance sector through clear supervisory guidance and providing regulatory certainty. In this regard, we will continue to collaborate with the Financial Sector Conduct Authority and industry associations to enhance the resilience of the sector. Thank you again for the opportunity to address you this morning, and to the Insurance Institute of South Africa and South African Insurance Association for honouring me with this award.
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the 102nd annual ordinary general meeting of the SARB shareholders, Pretoria, 29 July 2022.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank (SARB), at the 102nd annual Ordinary General Meeting of the SARB shareholders South African Reserve Bank, Pretoria 29 July 2022 Introduction Good morning, ladies and gentlemen. We convene our annual Ordinary General Meeting (AGM) virtually for the third time in a row – and hopefully for the last time in this format. We have managed our way through the severe and tragic global calamity of Covid19. Mobility and activity restrictions, public health, fiscal and monetary efforts, in South Africa and abroad, have been unprecedented. In the early days of the pandemic, the South African Reserve Bank (SARB) cut the repurchase (repo) rate to an all-time low of 3.5%, pulling the prime rate down to a 54-year low of 7.0%. The successful vaccine roll-out, the repeal of COVID-19 protocols and the opening of borders have propelled the economic recovery forward, recreating jobs, and raising output back to above pre-pandemic levels. Given the size of the pandemic shocks to our economies, with hindsight, it should not surprise us that the aftermath has been tumultuous. Recovery has not progressed in a neat, linear way, but rather has been slowed by unforeseen constraints. The reconnection of global supply chains has been halting and subject to shifting policies and priorities, contributing to high prices for many goods and commodities. Page - 1 - of 13 Political surprises have also emerged in the form of heightened geopolitical risks that, together with the ever-present threat of new COVID-19 variants, casts a pall over the rosy recovery of much of the past year. During the year under review, even as our domestic recovery progressed, a range of setbacks occurred, contributing to economic and financial market volatility, weaker than expected growth outcomes and higher inflation. As we cross the mid-point of 2022, the International Monetary Fund warns of further downside expectations for economic growth. Fiscal authorities, having extended policy aggressively during the crisis to support their economies, face strictly limited policy space caused by high debt levels and rising debt service costs. And central banks around the world focus more intently on the need to return inflation to much lower rates. Our response to the inflation threat has been measured, taking into account the moderate inflation of the past year and the acceleration of inflation that we see now. The repo rate was raised gradually from November 2021. In the May and July meetings, larger repo rate steps were taken to ensure that we prevent inflation expectations from becoming unanchored, and generating much higher future inflation. South Africans must be protected from the threat to living standards and jobs that inflation causes. This is, after all, our constitutional mandate. Let me now reflect on recent economic developments. Global conditions: from recovery to stagflation The global economy largely weathered the COVID-19 pandemic, making a good recovery in 2021 and into 2022. The initial recovery phase was underpinned by supportive fiscal and monetary policies as well as widespread vaccination. Advanced economies experienced the strongest growth over the past year, while the recovery in emerging markets has been more mixed. Page - 2 - of 13 At a global level, fully extended fiscal and monetary policies pushed recovery forward, with expansionary policies extended through 2021 and into this year. In tandem with a build-up of savings, aggregate demand expanded aggressively, eventually adding fuel to the fire of supply shortages, and giving fresh impetus to the inflation shock that currently besets the world economy. The fiscal expansions and accommodative monetary policies that underpinned the 2021 recovery boosted demand for goods at a time when supply chains remained constrained due to COVID-19-related lockdowns. The pandemic-induced mobility restrictions meant that demand shifted from services to goods, exacerbating the demand-supply imbalance in the goods markets. Together with the strong recovery in oil and food prices, as well as tightening labour markets, this created a perfect storm for global inflation, which rose sharply during the second half of 2021 and into 2022. Inflationary pressures were spurred further by the renewed lockdowns in China as well as the Russia-Ukraine war, which not only heightened uncertainty, but also exacerbated supply bottlenecks and disrupted food and energy markets. Oil prices rose sharply in response to the invasion, touching above US$130 per barrel in early March before subsiding somewhat. As a result, inflation has risen to levels last seen in the 1980s in some of the advanced economies. The combination of these adverse shocks is expected to markedly slow global growth. Prospects are worsened by the expected high global interest rates as central banks respond to keep inflation expectations anchored. Although the International Monetary Fund’s (IMF) July 2022 World Economic Outlook (WEO) expects the global economy to have registered robust growth of 6.1% in 2021, the IMF has adjusted its forecasts for global growth lower: to 3.2% in 2022 and 2.9% in 2023. This is 0.4 and 0.7 percentage points lower for 2022 and 2023 respectively than was projected in the April 2022 WEO. With inflation more persistent, the United States (US) Federal Reserve (Fed) has moved to tighten monetary policy. After raising rates by 25 basis points in March, the Fed ramped up the pace, increasing the Fed funds rate by 50 basis points in May and by 75 basis points in both June and July. It also began quantitative tightening in June. Page - 3 - of 13 Fed communication points to further large rate hikes this year. The market now expects the Fed funds rate to peak around 3.4% early in 2023. The pace of monetary policy normalisation is much faster than was expected last year. Inflation dynamics have been somewhat different in the European Union (EU). Inflation in the EU has been largely supply-driven. The war in Ukraine and the resulting economic sanctions on Russia have led to an energy crisis in Europe, where gas prices have soared more than 400%. The European Central Bank (ECB) raised its policy rate by 50 basis points for the first time in over a decade at its July meeting as it works to contain inflation of 8.6% – well above its 2% target rate. Emerging economies, including sub-Saharan Africa (SSA) economies, will be impacted by these global developments on multiple fronts. First, higher food and oil prices pose risks to inflation and social stability. Second, slower global growth softens demand and the prices of export commodities from the region, and emerging markets (EM) in general, with adverse impacts on growth. Third, faster policy normalisation in the advanced economies influences capital flows and puts pressure on EM exchange rates, and thus inflation. Domestic conditions On the domestic front through 2021 and into 2022, South Africa’s economic recovery was underpinned by buoyant consumption spending, robust terms of trade gains from high global commodity prices and a return to positive private investment growth. The domestic economy grew by 4.9% in 2021 – its fastest pace of growth since 2007 – after the sharp contraction of 6.4% in 2020. An even better growth outcome for the year might have been achieved however, had local shocks not obstructed growth in July of last year and through much of April, May and June of this year. Social and political unrest in July 2021 in Gauteng and KwaZulu Natal, as well as the subsequent catastrophic floods in KwaZulu-Natal this year, caused immeasurable damage and added to the plight of communities in the hardest-hit areas. These Page - 4 - of 13 weather-related events also impacted on insurers and brought to the fore the challenges that the financial sector faces in relation to climate change. In recent months, loadshedding became more extensive and intensive, imposing high costs on economic activity levels. Fiscal and monetary policy throughout the year supported economic activity through positive real spending and rising credit demand. Spending by households also benefitted from a rebound in wages, a recovery in net wealth and increased social transfers. The sharp increase in private savings occasioned by the drop in consumption during the hard lockdown helped drive the current account into surplus, and together with revenue windfalls, provided relatively cheap financing to public spending. The country’s current account, which reached 3.7% of GDP in 2021, supported the rand, and contributed to less inflationary pressure than had been expected when the crisis first unfolded. Despite borrowing requirements remaining high, South Africa’s fiscal ratios improved markedly, underpinned by revenue overperformance. Commodity export prices and a strong terms of trade have played a critical role in the economy’s adjustment to the pandemic and recovery. As a result of these developments, domestic output has now recovered to prepandemic levels, surpassing the 2019 gross domestic product (GDP) level in the first quarter of 2022, on the back of strong growth during the quarter. Our economy grew by 1.9% of the quarter-on-quarter seasonally adjusted rate (sar) in the first quarter of 2022. This followed an upwardly revised 1.4% growth (previously 1.2%) in the fourth quarter. The first-quarter growth was broad-based, underpinned by manufacturing, trade and the finance sector. The broad-based growth reflects the easing of lockdown restrictions during the period as well as improving domestic demand. Nonetheless, important sectors of the economy – construction, tourism, and hospitality – remain well below 2019 levels of output, with major consequences for employment levels. These Page - 5 - of 13 sectors will recover, but it will take time, and some of their recovery depends on further weakening of the economic costs of the pandemic. Continuing with our sectoral view of the economy, we have also seen ongoing volatility in output in mining, construction, and manufacturing, reflecting loadshedding, logistical bottlenecks and blockages, and other shocks. From a production point of view, South Africa has struggled to capitalise on sharply higher export commodity prices. Unfortunately, the growth momentum from the first quarter is not expected to carry through to the second quarter. The flooding in KwaZulu-Natal in April heavily impeded economic activity and loadshedding has intensified. Additional headwinds to growth include a sharp correction in commodity prices, rising inflation and increased strike activity. South Africa’s commodity export price basket has moderated in recent weeks as metals prices have declined. Despite the implied weakening of the terms of trade, we still expect the current account surplus to extend into 2023 as import demand continues to recover slowly. A critical determinant of South Africa’s economic fortunes in recent years has been an ongoing weakening in investment spending, across the private and public sectors. Gross fixed capital formation in the past year reached 14% of GDP. For this reason, it is encouraging that private investment has strengthened by more than expected in the rebound from the pandemic. Increasing the potential growth rate of the economy, however, requires a sustained further improvement in all forms of investment. Recent moves to open the energy sector to investment by private firms are to be encouraged, accelerated, and hopefully replicated in other network industries. GDP is projected to contract by 1.1% in the second quarter but to expand again by 0.7% in the third quarter. Though growth for 2022 has been revised higher to 2.0%, up from 1.7%, the Bank’s expectations for economic growth in 2023 and 2024 have been revised down to 1.3% and 1.5% respectively as these adverse supply side effects take their toll. Page - 6 - of 13 Total employment has continued to recover, although at a slower pace than GDP. The official unemployment rate fell by nearly a full percentage point to 34.5% in the first quarter of 2022 as total employment increased (by 370 000) while unemployment declined (by 60 000). As noted earlier, some labour-intensive sectors have been slow to recover from the pandemic as they depend critically on high levels of human mobility, such as international travel, among other factors. Household spending has been a key driver of the recovery, growing by about 2.5% in real terms in 2021 on the back of rising disposable income. With rising inflation, however, consumption by households is likely to come under increasing pressure. Inflation breached the upper limit of the target range in May, accelerating to 6.5%. Early impetus came from food and fuel, but inflation pressures have since broadened. Goods inflation has risen sharply over the past few months, reflecting high global inflation, rising production and distribution costs, and a weaker rand exchange rate. Services price inflation still remains moderate, but has about doubled in recent months and poses a risk to the inflation outlook. After several years of subdued pass-through of intermediate costs to consumer prices, margin pressure appears to be reversing. Alongside stronger economic growth than expected, these developments raise the prospect that higher import prices feed through more directly to consumer prices. Wage settlements during the first half of this year have come in above inflation1, further squeezing margins of firms and raising the prospect of more entrenched wage inflation. The SARB’s Monetary Policy Committee (MPC) has moved to normalise rates, raising the repo rate by a cumulative 200 basis points since November 2021. The hiking cycle began gradually with a 25 basis point adjustment at the November MPC meeting, but has since accelerated to include a 50 basis point increase in May, and a 75 basis point increase in July, as inflationary pressures intensified. The path for the repo rate however remains supportive of credit demand in the near term, even as rates rise in 1 The average level of settlement in Q1 was 6.3% for all sectors bar utilities in which no agreements had been reached by the end of Q1. Notable agreements concluded in Q2 included Eskom (7%), Implats (6.5%) and Sibanye Stillwater (5.1%). Page - 7 - of 13 line with the current view of inflation risks. When adjusting for inflation, real interest rates relative to real productivity and income growth remain low. Monetary policy needs to be forward-looking to maximise its effectiveness. For that reason, policy needs to respond to future expectations of inflation held by economic agents and the inflation forecast served to the MPC by Bank staff. The MPC will continue to monitor inflation developments closely and will respond appropriately to ensure that inflation expectations remain anchored. Let me now focus on the SARB’s other mandate and operational matters. Securing financial stability Besides ensuring price stability, the SARB is also tasked with maintaining stability in the financial system. Despite the shock of the COVID-19 pandemic, South Africa’s financial sector remains resilient. During the year under review, a few financial stability risks and vulnerabilities emerged. These included the low growth environment, rising inflation, the cost implications of the July 2021 unrest for the financial sector, climate-related risks, and the geopolitical tensions between Russia and Ukraine. Work towards crisis preparedness and resolution is continuing. The Financial Sector Laws Amendment Act 23 of 2021 (FSL Amendment Act) was enacted earlier this year. The FSL Amendment Act gives the SARB the powers to act as a resolution authority and establishes the Corporation for Deposit Insurance (CODI). The establishment of a deposit insurance scheme will contribute to improving confidence in banking institutions. This will also put South Africa on par with its international peers and further align its financial sector to the principles of international standard-setting bodies. Operational matters The national payment system forms a core part of the financial intermediation infrastructure that enables financial institutions, businesses and consumers to make Page - 8 - of 13 payments and settle their obligations seamlessly. The review of the applicable legislation and the modernisation of payment system infrastructure has been in the pipeline and forms part of the payment system’s Vision 2025. The evolution of payment technologies over the last few years has made the modernisation of both retail and wholesale system infrastructures a key priority. A number of initiatives are currently underway, including a review of the National Payment System Act 78 of 1998 and the payment system modernisation initiative. This initiative encompasses the payment settlement system renewal programme and the retail payment system reforms that include the rapid payments programme. The launch of the real-time gross settlement (RTGS) system renewal programme aims to reform and modernise both domestic and regional payment settlement services. The programme will facilitate wider access to the payments system, improve efficiency by leveraging new technology, and address the security risks posed by cyber-threats. It will also enhance payment services provision and address the challenges of access, speed, cost and transparency of payments for both payment service providers and consumers. Financial technology (fintech) has advanced significantly, and we are seeing a wave of innovation in the provision of financial services that in many instances falls outside of the purview of regulatory agencies. Responding to these developments is a fine balancing act. While continuing to focus on their monetary policy and financial stability mandates, central banks also need to respond to market developments that can potentially introduce risk into the broader financial system. In a quest to embrace innovation in the fintech space, the SARB is working on several collaborative efforts under the auspices of the Intergovernmental Fintech Working Group (IFWG). Initiatives include participation in exploratory work on ‘open finance’, collaboration with innovators in the ‘regulatory sandbox’, and work on multiple central bank digital currencies (CBDCs) for international settlement through Project Dunbar. The SARB is also committed to bringing crypto-assets into the regulatory ambit given the growth and proliferation of these assets and the resulting risks they pose in the Page - 9 - of 13 form of illicit financial flows, among others. In June 2021 the IFWG released a position paper on the need to regulate crypto assets in a phased and structure manner. As a member of the Financial Stability Board, we have been participating in discussions for the need to coordinate these efforts globally. In April 2022, the Project Khokha 2 (PK2) report was released- the culmination of work involving experimentation with distributed ledger technology (DLT). It explores the impact of tokenisation of financial assets through the issuance of a SARB debenture – or debt security - on DLT, and highlights a number of legal, regulatory and policy implications when applying this technology in financial markets. Climate change Climate change has emerged as a key threat to economic and financial stability and a lived reality for millions of people, domestically and globally. The floods that wreaked havoc in KwaZulu-Natal in January of this year and again in April represent a tiny fraction of the climate-related destruction visited on the global economy in the year under review.2 Greater rainfall in the eastern parts of South Africa and less in the west are clear developments that our economy will need to adjust to. Catastrophic weather events occur more frequently, and with greater damage. Important projects on climate change are taking place within the SARB. These projects are being implemented through various policy and support areas. The Economic Research Department is assessing the implications of climate related shocks for monetary policy execution and implementation. Climate change and the transition to a greener economy have the potential to generate larger, longer and often more frequent economic and financial shocks, with disruptive effects for economic activity and high inflation. During 2021 extreme weather events including a deep winter freeze, floods, severe thunderstorms, and heatwaves, contributed to annual insured losses from natural catastrophes of an estimated US$105 billion, the fourth highest since 1970, according to global reinsurer Swiss Re. The World Economic Forum’s 2022 Global Risks Report has identified extreme weather and climate action failure among the risks that have worsened the most since the start of the COVID-19 crisis. Page - 10 - of 13 Financial institutions play an important role in climate change adaptation and mitigation through the provision of funding. The work of the Prudential Authority and the Financial Stability Department is focussed on improving the resilience of the financial sector to climate related risks and on incorporating climate related information in funding and insurance decisions. Climate change indicators, disclosure and taxonomy rules will become part of the prudential framework. During 2021, an inaugural sensitivity stress test was conducted of the insurance sector. The results of the stress test were encouraging – an indication that large insurers would have sufficient financial resources in the event of an adverse scenario. Staff matters The hybrid way of working that the SARB initiated during the pandemic will stand us in good stead as we kick-start the renovation of the Head Office building in Pretoria. The renovations are necessary to overhaul ageing infrastructure and perform a muchneeded upgrade of our facilities. With the planned addition of a museum, the expanded precinct is intended to enhance public accessibility and become a place of knowledgesharing and a window onto our country’s economic and financial history. The Bank has started with these renovations, and has appointed a contractor for the redevelopment and secured temporary office space. It is envisaged that the temporary office space will be ready for occupation by 1 October 2022. A project of this nature does not come without hurdles. With key project and stakeholder management processes in place however, we anticipate project completion of the Head Office precinct by the end of 2024. Our vaccination programme has yielded some positive results, with a total of 61% of SARB Group staff (including the currency producing subsidiaries and three cash centres) having received the primary dose of the available vaccines. A total of 11% of staff are considered to be fully vaccinated under the new definition, which includes the primary dose and a booster shot. Page - 11 - of 13 In a quest to create a workplace that is more representative of the public we serve, we embarked on a Diversity and Inclusion (D&I) journey in September 2020. Fostering a more inclusive workplace allows people from all walks of life to thrive, for diverse views to flourish and builds a more resilient organisation, founded on a richer set of skills and expertise. Conclusion Our staff are the ‘engine room’ of this institution, and employee well-being is of utmost importance. Since the pandemic, we have put in place interventions to assist those impacted by the disruption caused by the pandemic and working from home. I would like to express my sincere gratitude to all the staff members in the SARB Group. They have soldiered-on under difficult conditions, and their agility and resolve in continuing to deliver high-quality outputs through virtual platforms and supporting each other while discovering new ways to collaborate is testament to living the SARB values of integrity, accountability, open communication and excellence daily. Despite the challenges we have faced in the past year, the achievements have been heartening. We are now in year three of our strategy, and although we have achieved our strategic objectives for the year, we cannot rest on our laurels. Central banks are faced with new challenges which require us to be proactive and responsive. We remain committed to serving the economic well-being of South Africans by delivering on our mandates of price stability and financial stability. We have made great strides in engaging our stakeholders through investor sessions, monetary policy and financial stability forums, economic roundtables and publications. Our monetary policy stance is shifting to better confront the challenges of higher inflation and to guide inflation back to the mid-point of the target band. Monetary policy alone is not capable of solving the deep-seated constraints to economic growth, but it can create an enabling environment and the stability needed for other policies to have a greater impact. Page - 12 - of 13 We remain acutely aware that our role in rebuilding this economy is but part of a broader agenda that is supported by other government institutions as well as the private sector. We remain resolute in delivering on our mandates without fear or favour in the interest of the citizens of South Africa. As we continue on our purposeful journey, it is incumbent on each one of us to remain hopeful. We have pulled through the most severe pandemic since the early 1900s. We will ultimately recover and rebuild from the current storm in which we find ourselves. Thank you. Page - 13 - of 13
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Address by Ms Fundi Tshazibana, Deputy Governor of the South African Reserve Bank, at the Nedgroup Investments 11th Annual Treasurers' Conference, Johannesburg, 25 August 2022.
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An address by Fundi Tshazibana, Deputy Governor of the South African Reserve Bank (SARB), at the Nedgroup Investments 11th Annual Treasurers’ Conference Central banking in an era of stagflation risk: a view from the MPC 25 August 2022 Introduction Good afternoon and thank you for the invitation to address you today. Nowadays it feels very strange to be in front of a live audience, instead of a screen. Three years ago, when I spoke at this conference, the world was a different place. When the COVID-19 crisis started, we all said that everything was different. Two years later, everything is different again. Trying to figure out these ‘new differents’ certainly feels like I’m lost in the multiverse or my daughter’s version of the ‘upside-down world’. In October 2021, Wordle took the world by storm as people tried to guess the letters that made up the 5-letter word of the day. The most popular game back in 2020 was also about letters… specifically which letter shape would describe the economic recovery. o Would it be a V-shape, with a quick downturn and equally quick rebound? o An L-shape, with a collapse to a persistently lower level of output? o Or a K-shape, with a recovery for the rich and an ongoing recession for the poor? Everyone had their favourite letter. Despite all the imagination that went into crafting these scenarios, I don’t recall anyone warning of global stagflation. But nowadays, everyone is worried about that toxic mix of high inflation and weak growth. I’m not sure what letter could have denoted this outcome. Page - 1 - of 8 The journey since 2020 So how did we get here? And where are we going? Advanced economies went into the COVID-19 crisis on the back of a decade of subdued growth and below-target inflation. Central bankers invested heavily in strategies to deal with the zero lower bound on interest rates to avoid getting stuck in Japan-style ‘lowflation’. Worries about high inflation were often considered as dated and alarmist. This was particularly the case in the United States. New fiscal thinking also emphasised taking advantage of interest rates that were low relative to growth rates. All of this suggested that macroeconomic stability was secure and there was ample scope for aggressive policy action to manage the COVID-19 crisis. In emerging markets, the situation looked very different. Few of us had to worry about too low inflation. We read the new fiscal literature with interest. For emerging market countries, including South Africa, interest rates were clearly above our growth rates. But none of us were complacent about macroeconomic stability. Many emerging markets also confronted low-trend growth rates, well below those achieved a decade before. As a result, we had started diverging from advancedeconomy-living standards, after a prolonged period of convergence. These circumstances called for stability-oriented macroeconomic policies, coupled with growth-boosting structural reforms. The South African perspective Let’s move closer to home. At first sight, the COVID shock changed everything. It was often said it would be better to do too much rather than too little. Indeed, South Africa joined in the global response with aggressive fiscal and monetary policy action. Page - 2 - of 8 Given strong monetary policy credibility, our policy rate cuts were particularly large relative to peer countries. Despite our large monetary response, the SARB fielded many questions about the possibility of much lower inflation, or even deflation. We also heard various calls for more extreme SARB action, extending beyond rate cuts to policies such as Quantitative Easing. As policymakers, we agreed that there was high uncertainty, but as the SARB, we also explained that much lower inflation was unlikely. We further communicated that South Africa probably would not need unconventional tools such as QE, given both minimal deflation risk and the fact that we still had ample firepower with our regular repo rate tool, which was nowhere near the zero lower bound. While we agreed on the need for strong policy support to manage the impact of COVID-19, we saw the distinction between boldness and recklessness. Well, were we on the right track? Inflation for 2020 ended up averaging 3.3%, vindicating the SARB’s assessment about a prolonged target undershoot or even deflation. The actual outcome was close to our April 2020 emergency MPC meeting forecast, where we projected 3.4% inflation for the year. From that point, inflation largely played out as expected. Inflation also normalised at a fast pace in the next year, averaging 4.5% for 2021 as a whole, precisely in the middle of our target range. As for growth, South Africa’s recovery was slow relative to our peers’, with progress repeatedly interrupted by shocks such as flooding, riots and load-shedding. That said, growth outcomes in 2021 and early 2022 generally surpassed expectations. Revisions to our MPC growth forecasts were therefore consistently to the upside – in contrast with the pre-COVID period, where we were generally revising growth downward. For instance, at that unscheduled April 2020 MPC meeting, we envisioned growth of 2.2% in 2021, a number we eventually marked up to 4.9%. Our estimates of slack in the economy also narrowed over time, mainly because of better-than-expected growth. Page - 3 - of 8 In these circumstances, the view of the MPC was that we had provided about the right amount of policy support. Our assessment was also that it would be appropriate to start moving away from emergency-level interest rates during the course of 2021. By the fourth quarter of 2021, we had a whole new different. Fortunately, unlike some of the advanced economy central banks, we had not committed to forward guidance on interest rates. Nor had we changed our framework in ways that made it more backward looking, for instance through average inflation targeting. We also did not have to worry about the sequencing of balance sheet policies, a factor which appears to have complicated timely policy adjustments elsewhere. The path to policy normalisation We started the normalisation cycle with a relatively modest 25 basis point increase at the November 2021 MPC. This was, incidentally, only a few days before Fed Chair Powell said he was retiring the term ‘transitory’ for inflation. The SARB’s gradual pace of normalisation continued with interest rate increases in January and March of this year. From May, we started seeing evidence of inflation persistence. Thus, we accelerated the pace of tightening, to 50 basis points, and then stepped it up further in July, hiking by 75 basis points. Those decisions were shaped by a deteriorating inflation forecast, with a strong likelihood of a sustained target breach, starting with the unexpectedly high May print, at 6.5%, as well as the June outcome of 7.4%. The rand had also begun weakening after a period of resilience. Furthermore, inflation expectations were clearly rising, both in survey results and as implied in financial market variables. Now that we have got rates back up from 2020’s record lows, the question we face is how quickly we need to get to positive real rates, and ultimately a more neutral stance. In turn, this depends on just how persistent higher inflation will be. Here’s how I assess the main factors. Upside risk from higher price passthroughs, higher wage settlements, currency corrections driven by interest rate differentials. But also moderating such as lower oil prices, moderating food prices and the large gap between headline and core inflation. We don’t see much demand pressure in this economy. At the same time, it seems firms can put through price increases and have Page - 4 - of 8 them accepted. This is consistent with a small or zero output gap – an economy that does not have a lot of slack but also isn’t overheating. We appear to have moved past the phase when we were getting disinflationary pressure from spare capacity in the economy, to a space where this factor is broadly neutral. On the labour market, South Africa’s high unemployment rate is clearly not an important determinant of inflation. If it was, we would’ve been in deflation by now, given the massive downward pressure on wages from labour market slack. Instead, what we have seen between the first quarter of 2021 and the first quarter of 2022 is average compensation growth in the region of 5%. This is reasonable given the underlying inflation rate and productivity growth. The risk, however, is that this number could accelerate. The structure of our labour market is such that some parts of the workforce are privileged. They are protected either by labour laws that favour insiders, or by skills shortages that confer market power. These segments of the workforce tend to demand full cost-of-living adjustments, over and above any productivity growth they achieve. This tends to drive up inflation for everyone else. We are alert to this threat. On the exchange rate, the rand had been resilient through much of the first half of this year, despite the stronger dollar. We saw a range of advanced economy currencies depreciate, including the Japanese yen and the euro, but a group of emerging market currencies, including the South African rand, seemed to be immune to the strong dollar. However, this trend suffered a breakdown in June. We are no longer in the space where we can have low policy rates without currency weakness. There are too many other countries offering higher policy rates, and we are getting less support from export commodity prices than we did previously. Although exchange rate dynamics are always unpredictable, the SARB’s baseline forecast is that we are seeing some exchange rate pressure to inflation, but timely rate increases keep this from being a major source of pressure. Set against these considerations, the good news is that oil prices seem to be easing again, and there is also some tentative progress on the food price front. We have a large gap currently between our headline and core inflation measures – 3 Page - 5 - of 8 percentage points, with core at 4.4% and headline at 7.4%. If headline starts to move back towards core, we won’t have low inflation, but we will at least be closer to the midpoint of our target. Even taking into account these moderating factors, we would still want to get back to ‘normal’ interest rates, but there would be less urgency to get there fast. On the whole, our policy stance remains accommodative. The 75 basis-point hike in July might have been the largest hike since 2002, but our starting point was very low, and the repo is still below the inflation rate. Indeed, if you apply a simple Taylor rule to the data, where the policy rate is a function of normal or neutral rates adjusted for deviations from the inflation target and full output, you will certainly get an outcome above 5.5%. This applies even when you are looking at next year’s inflation, past the 12-month impact of the Ukraine war price shock. Let me conclude, by stepping back a bit to see the bigger picture. I’d like to offer two comparisons. The first has to do with South Africa’s performance relative to other countries. It is still early days, and I don’t want to signal complacency, but given the size of the global shock underway, it is fortunate that South Africa has a good chance of getting through this without particularly high inflation or high interest rates. Our July QPM projection, which is a reasonable baseline, shows inflation peaking during the current quarter and then moving back towards our midpoint target during the rest of the forecast period. Meanwhile, the QPM’s endogenous policy rate moves moderately higher, but the stance is never tight. For instance, the average repo rate is about the same as it was in the pre-COVID period, when it was between 6% and 7%; the QPM has repo averaging 6.5% next year and 6.75% in 2024. This compares well with what has happened in many other countries. I hope you have all taken time to appreciate the fact that South Africa’s inflation has been below the inflation rates of the United States, the United Kingdom and even Germany, in recent months. Perhaps more relevant, we have not seen target misses of the scale experienced by many of our peers, and unlike those countries, we have Page - 6 - of 8 not had to raise rates well into restrictive territory. The SARB is not happy about our target breach, but given what is happening to the world, neither our inflation rate nor our interest rates look especially onerous. It’s actually a reasonable outlook, given the worst global inflation shock in a generation. My second observation is an historical comparison. A decade ago, during the global taper tantrum, South Africa was one of the most-affected countries. For instance, we were included in the grouping known as the ‘Fragile Five’. In 2020, during the onset of the COVID-19 shock, South Africa was once again identified as a vulnerable country. For example, Adam Tooze published a widely read essay in Foreign Policy describing the coronavirus as the ‘biggest emerging market crisis ever’, which included the claim that, and I quote, “At the head of the list of vulnerable countries is South Africa”. This year’s financial market storm has hurt a wide range of countries. The experiences of the worst hit, like Sri Lanka, have reminded us once again that macroeconomic stability is precious. It’s striking, however, that of the Fragile Five from 2013, only one country, Turkey, is in danger of an acute macroeconomic dislocation today. Yes, South Africa remains vulnerable to external shocks, and this keeps us awake at night. But South Africa’s resilience during this stress episode is very welcome. We have benefitted from some good luck, mainly from higher commodity prices. In large part, the macroeconomic choices of the past few years have also reduced fragility. This reflects necessary fiscal policy decisions, especially around the public sector wage bill, as well as a prudent monetary policy. There are many accounts being written now of what central banks got wrong, that made the ongoing inflation surge possible. Reading them, I realise that despite the criticisms – we at the SARB are sometimes attacked for not being adventurous – it is clear that when central banks do become adventurous the consequences can be even more unpopular. Page - 7 - of 8 Conclusion To conclude, looking back over the past – very exciting – three years, the SARB probably did about the right amount of stimulus in 2020, and we probably started withdrawing stimulus at about the right time, in late 2021. Obviously, the war in Ukraine was an unexpected shock. But South Africa’s inflation profile was not too problematic prior to that shock. Looking ahead, and all else being equal, we have a reasonable chance of getting through this current ‘different’ without high interest rates. But life is never straightforward in central banking. Conditions remain highly uncertain, so we cannot be precise about where interest rates are going. Before this crisis, there was a strong preference, globally, for forward guidance, but recent events are really testing central bank communication. We’ve all been reminded that forecasts are flawed and that circumstances change fast. Plans that looked measured and reasonable at one point can look wholly inappropriate at another. As the MPC, we’ve not made any promises about future policy rates. Our approach remains risk-based and data-dependent. Our objective is to get inflation back to target over the medium term, and we will continue to do what it takes to achieve that, adjusting our plans as we get new information. We have been urging structural reforms for many years, but this year it feels like we may finally be nearing a tipping point. We need to lift our potential growth. Fortunately, we have the base of macroeconomic resilience and the private-sector balance sheet strength, and with the right reforms, we really could have balanced and sustainable growth again. Thank you. Page - 8 - of 8
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Speaking notes by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the MPC Schools Challenge Winners Announcement, Johannesburg, 31 August 2022.
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MPC Schools Challenge Winners Announcement Wednesday, 31 August 2022 Speaking notes for Lesetja Kganyago, Governor of the South African Reserve Bank (SARB) Good afternoon esteemed guests, Bank officials, learners, and those join us online. I wish to acknowledge the presence of colleagues from the Ministry of Basic Education led by Minister Angie Motshekga. We are grateful for the privilege of working in partnership with the Department of Basic Education (DBE) on the MPC Schools Challenge. As usual, representatives from all Provincial Departments of Education collaborated with us from the very beginning, culminating in today’s announcement of the winners of the competition. This year, for the very first time we also extended an invitation to independent schools through the Independent Examination Board (IEB), and I am happy that they too could join us here today. As some of you may recall, in 2021 we suspended the Challenge due to the COVID pandemic. In 2021, we hosted the entire process virtually. This year we introduced a hybrid approach, something we hope to continue to do going forward. We are pleased that 225 schools attended the briefing sessions for learners and teachers, and 102 schools submitted essays that are required to proceed to the next level of the competition. These essays are prepared in the same format as the SARB MPC statement. The statement must reflect global and domestic economic conditions and factors and reflect the decision of the learners on its Monetary Policy stance. It’s pleasing to note that essays were received from all provinces, confirming that this is indeed a national competition. Assessment of candidates The essays received were subjected to a rigorous marking and moderation process. Bank economists, representatives from the DBE and IEB participated in this process. Eight schools made the final cut and had to present their MPC Statement to a panel of judges – this part of the Challenge was done in person. The judging panel was composed of senior staff of the Bank’s Economic Research Department. Representatives from the DBE and IEB remained in the venue throughout all learner presentations and deliberations by judges about the ranking of finalists – a transparent and inclusive process. Over the years, a trend has been forming. Girls seem to make up the majority of finalists. This year 26 out of 32 finalists are female, so that makes it more than 80% female. This is a trend worth noting, particularly during the month of August. Officials were also happy with the quality of presentations as well as the confidence displayed by our finalists. If those presentation are anything to go by, the future of Central Banking and Monetary Policy in South Africa will be in good hands. You can see snippets of their presentations in a video that we will play at the end of the event. I would like to pay special tribute to all the teachers who supported the learners. We are aware that you invested a lot of effort and hard work into this project. Congratulations to schools whose learners reached the final stages of the competition. Your support and encouragement exposed learners to a rare experience that will leave an indelible mark in their memories. We salute both the teachers and principals for making a difference MPC Challenge Objective achieved The main purpose of the MPC Schools Challenge is to promote interest in economics and deepen the understanding of Monetary Policy. The quality of your essays and presentations is evidence that the objective of expanding the understanding of monetary policy is being achieved. To our learners, remember that nothing of value comes without an effort. Your presence here as finalists bears testimony to your commitment, hard work and dedication. We encourage you to pursue careers in the field of economics and central banking. To the judges, moderators, markers, economists and the MPC Schools Challenge core team, congratulations on a job well done. Thank you.
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Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the Centre for Education in Economics (CEEF) Africa, Johannesburg, 28 September 2022.
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An address by Lesetja Kganyago, Governor of the South African Reserve Bank, at the Centre for Education in Economics (CEEF) Africa Johannesburg, 28 September 2022 Reflections of macroeconomic policy since 1995, from NICE to VICE – and back again? Good evening Thank you for inviting me to speak today. This is an unusually challenging moment for the global macroeconomy. Who would have believed, even a year or two back, that US inflation would be at 8.3%, that euro area inflation would be at 9.1%, or that UK inflation would be at 9.9%?1 Who would have thought that major central banks would be raising interest rates at the fastest pace in a generation? Or that the euro and the British pound would be at parity with the dollar? Just over a decade ago, it was common to talk about a Great Moderation in global macroeconomic conditions. Mervyn King, a former Bank of England Governor, called it the NICE period: an acronym for Non-Inflationary, Consistently Expansionary. Today it would be more appropriate to talk about VICE: a Volatile, Inflationary and Contractionary Economy. This regime change in global conditions was reflected at last month’s Jackson Hole Economic Policy Symposium, an annual gathering of central bankers hosted by the Data are all for August 2022, for consumer price inflation, year-on-year. Kansas City Fed of the US Federal Reserve System. The theme of this year’s meeting was ‘Reassessing Constraints on the Economy and Policy’. Given the humbling economic developments of the past year or so, the tone of the discussion was very different to that of previous occasions. No longer were we talking about the challenges of low inflation, or how higher debt levels are sustainable if interest rates are low, or the social benefits of running economies hot. Instead, there was a broad appreciation that macro policy settings had been far too loose in 2021, contributing to high inflation rates and with them, a cost-of-living crisis. Everyone recognised that exogenous shocks, including Russia’s war in Ukraine and supply chain problems, had accelerated inflation. But expansionary policy settings had left the system highly exposed to these supply shocks. Just as with supply chains, running the economy hot to achieve slightly better short-term results came at a high price. The system then failed under stress. Fortunately, there has been pragmatic recognition of the problems, and a willingness to change course. At Jackson Hole, Chairman Jerome Powell invoked the legacy of Paul Volcker, who decisively stabilised inflation after the policy errors of the 1970s. His point was very clear: the Fed will do what it takes to bring inflation down, and to keep it down.2 Nobody would choose to play the Paul Volcker role. It would have been much better if the Fed had not fallen behind the curve, letting inflation get out of control. But now the course has changed, the approach needs to be about disinflation. Jerome Powell. 26 August 2022. “Monetary policy and price stability” Available at: https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm A relevant excerpt is, “we must keep at it until the job is done… The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year”. As the Fed well knows, the alternative is the route taken by Volcker’s predecessors, who did not want to hurt growth.3 Those policymakers made the great mistake, all too common in macroeconomics, of avoiding the pain of short-term adjustment in the hope that things would just come right. Unfortunately, with no one taking responsibility for inflation, firms and households learnt that they couldn’t rely on money to keep its value. So, they became more vigilant, quickly raising their own wage and price demands in response to new inflation pressures. As this inflationary psychology set in, the pain of getting back to low inflation kept rising. The result was a steadily worse trade-off between the objectives of full employment and stable prices. For this reason, history and public opinion have reflected poorly on Volcker’s predecessors.4 By contrast, Volcker is remembered as a dedicated public servant with a commitment to doing the right thing, even if it was unpopular.5 Listening to Powell, as a South African I was impressed by the engagement with history as well as the determination to act on the lessons of historical experience. Of course, South Africa’s history is different. But as the saying goes, history doesn’t repeat itself, but it often rhymes. Our history too has a theme of macroeconomic failure, followed by difficult and ultimately successful reforms that built the foundation for a long boom, followed by decay and the return of the old challenges. The late 1980s and early 1990s was a period of macroeconomic excess and near collapse. We achieved stability and growth through reforms conducted from 1994 through to 2009. We now once again find ourselves in profound social and economic trouble. Ben Bernanke. “Inflation Isn’t Going to Bring Back the 1970s” New York Times. 14 June 2022. https://www.nytimes.com/2022/06/14/opinion/inflation-stagflation-economy.html Ben Bernanke. Twenty-first century monetary policy. Chapter 2, ‘Burns and Volcker’. W W Norton & Company: New York. 2022 Binyamin Applebaum and Robert D Hershey. “Paul A Volcker, Fed Chair Who Waged War on Inflation, Is Dead at 92” New York Times. Available at: https://www.nytimes.com/2019/12/09/business/paul-a-volckerdead.html Unfortunately, we are struggling to achieve consensus on the proper response to our current challenges. This weakens our ability to act decisively. Too many people are unfamiliar with the history of economic policy in South Africa. Worse, those who know their history cannot seem to agree if the reforms of the late-90s were helpful or not. In my speech today, I hope to contribute to a better consensus, by revisiting our own macroeconomic history and highlighting its lessons. Let me start with the big picture. In the nearly three decades since our transition to democracy, we have had one Non-Inflationary, Consistently Expansionary, or NICE, period sandwiched between two bad ones. We can see these phases most clearly in the growth of GDP per capita, which is the total amount of economic output divided by population. This measure was negative during the dying years of apartheid, which means living standards were falling. It turned positive in 1994 and mostly stayed positive for two decades, apart from the crisis years of 1998 and 2009. From 2014 onwards it has mostly been negative again, with living standards once again in decline.6 It is tempting to say that this just reflects trends in global growth. But even relative to the world economy, we have gone from lagging, to outperforming, to lagging once again. Obviously, world growth fluctuated over this period too. But when we were doing well, we were pulling ahead, not just keeping up with the world average. And when we did badly, we slipped behind, as we did before 1994 and as we have done again in our latest slump.7 Over the past two years our growth rate has been 2.4% below the global rate, the worst spread since the 1980s. There are many similarities between the economic conditions of the mid-1990s and conditions today. Apart from low growth, these also include high and rising government debt, elevated inflation, and growing unemployment and inequality. In the 1990s, the new democratic government faced considerable scepticism that it Using data from the Penn World Tables, GDP per capita grew by -2.2% for the five years ending 1990; -1.5% for the five years to 1995; 1.1% to 2000; 2.5% to 2005; 1.8% to 2010; 0.6% to 2015 and -2.0% to 2020. Again, using data from the Penn World Tables, and the same five-year buckets described in the previous footnote, SA GDP growth minus world GDP growth was -2.1% for the five years to 1990; -1.5% for the five years to 1995; -0.9% for the five years to 2000; 0.6% to 2005; 0.3% to 2010; -0.8% to 2015 and -2.4% to 2020. This last figure is the most negative spread to world growth on record. could turn this around. Critical voices argued that higher debt and inflation were inevitable and would ultimately provoke a crisis.8 But they were wrong. To the lasting credit of the democratic government, these challenges did not trigger a downward spiral. Instead, they inspired a series of reforms that modernised South Africa’s macroeconomic framework. These reforms steered the country through the emerging market crises of 1998 and 2001. They then underpinned the longest period of unbroken growth in South Africa’s history. Finally, they created policy space for countering the Global Financial Crisis in 2008. There were three main building blocks to these reforms. One was fiscal restraint, which allowed debt to stabilise and helped create a virtuous cycle of lower interest payments, more social and physical investment, and lighter tax burdens. A second was a floating exchange rate, which liberated the country from costly and unsuccessful exchange rate interventions and created scope for a more competitive currency. A third was inflation targeting, which opened the way to lower and more stable prices and therefore also lower and less volatile interest rates. These reforms were implemented over a relatively short time span. Although nowadays South Africa has developed a reputation for being good at planning and bad at implementation, in this case the whole macro architecture was modernised within about five years. In turn, this renovation created space for the private sector to contribute to South Africa’s development. It also put the public sector in a position of strength, by shoring up the fiscal position and being realistic about capabilities. The result was that government could succeed at the tasks it attempted, rather than overextending itself. In other words, the reforms delivered an overarching framework for making economic policy choices. One example among many is as follows: “There is almost no power on earth which will prevent politicians (and certainly not ANC politicians) from taking large bags of money if their constituency is frantic for houses and jobs and the money is on offer. There will, in other words, be almost inexorably a debt-led boom, with money pouring into black housing, education, and welfare, into an increased public sector and, of course, into politicians‘ bank accounts.” RW Johnson, quoted in Princeton Lyman & Patricia Dorff. Beyond Humanitarianism. Council on Foreign Relations Press. New York. p. 51. Unfortunately, many of these reforms divided people at the time, and despite their successes, they have remained unpopular in some quarters. For instance, I have frequently heard it claimed that these policies were undertaken with an ulterior motive, as a form of class warfare, a so-called ‘neoliberal’ attack on an alternative, allegedly progressive or social-democratic alternative. But these criticisms have never made sense to me. For a start, I have never understood why anyone confuses practical considerations with conspiracy theories. In 1994, the democratic government found a macroeconomy in shambles. A debt trap loomed, with debt recorded at 60% of GDP.9 The leadership did not want to see interest payments crowd out their spending goals, and a debt crisis would have caused serious economic hardship and a loss of policy sovereignty.10 We further recognised the need to alleviate the balance-of-payments constraint. With low savings, we were in the position that stronger growth necessitated an unsustainable level of capital inflows. This led to rand weakness, higher interest rates and again, slower growth. As a result, the economy could not take off – it could only achieve short periods of growth, and then stall again. These were real constraints, and the challenge for macroeconomic strategy was to find ways to deal with them rather than fall into a debt trap, with zero fiscal space, and no growth. There was no way to deliver social progress without macroeconomic sustainability. Subsequent re-estimations of GDP lowered the peak debt ratio to about 50% - see the discussion in Philippe Burger et al. Fiscal sustainability and the fiscal reaction function for South Africa. IMF Working Paper. 11/69. 2011. https://www.imf.org/external/pubs/ft/wp/2011/wp1169.pdf p. 4, footnote 4 On the composition of reforms, see the analysis of Thabo Mbeki’s biographer, Mark Gevisser: “… the left might have accused Mbeki of selling out to the agendas of international capital, but the reason why he embraced the policy with such fervour in the first place was precisely because he was following his lodestar of self-reliance... Third World basket cases slide, as if programmed, into neo-colonial debt... [Mbeki] he was never entirely comfortable with the underpinnings of GEAR; this was evidenced by the way he did not pursue structural reform, such as privatisation, as vigorously as he might have. But – the son of struggling black traders – he was determined to survive independent of white creditors or paymasters. He would do anything to avoid hocking the shop”. In addition, despite the language used by the critics, it is difficult to recognise some neo-liberal model in what South Africa actually did in the 1990s and 2000s. There was a degree of trade liberalisation, but it was relatively short-lived and not especially ambitious. Labour market reform was proposed but never implemented. Some state assets were sold, but privatisation was very limited, leaving a large portfolio of state-owned enterprises on the public balance sheet, including Eskom and South African Airways. The early to mid-1990s featured rapidly rising inflation and collapsing economic growth. So, for good reason, the South African Reserve Bank (SARB) aimed to lower inflation. The inflation targeting framework, in addition to providing more flexibility than other policy frameworks – a point lost on most critics of it – when implemented also featured a high and wide inflation target. Relative to most peers, this proved to be too flexible, too high and too wide. The result was a tripling of the price level since 2000, the year we adopted inflation targeting. This hardly qualifies as an inflexible obsession with price stability, nor a framework inappropriate to our growth ambitions. As for fiscal policy, debt was reduced and there was even a small fiscal surplus in 2006. But again, steering clear of a debt crisis, and later running a fiscal surplus during the biggest boom in modern history, seem like acts of sanity rather than ideological excesses. We should also recognise that this period saw significant increases in social spending. Total transfers to households rose from about 11% of total spending to 15% during the 2000s, and social benefits increased from under 10% of total spending to 13%.11 If we discard the ideological viewpoint, and look back at this reform period objectively, how should we assess it? At the time, there was a sense that we had done many good things, but with underwhelming results. In one of the International Growth Advisory Panel papers we commissioned back in 2008, for instance, Dani Rodrik wrote that, These figures are drawn from National Treasury, ‘Table 5: Consolidated funds expenditure’. These items grew through the 2000s and were stable in the 2010s. Transfers to households were 10.9% of total spending in 2000/01; 15.2% of spending in 2009/10, and 15.6% in 2019/20. Social benefits were 9.4%, 13.1% and 14% of total spending for those same three fiscal years, respectively. Economic policy has been conducted in an … exemplary manner, with South Africa turning itself into one of the emerging markets with the lowest risk spreads… If the world were fair, political restraint and economic rectitude of this magnitude would have produced a booming South African economy operating at or near full employment. Unfortunately, it has not turned out that way.12 With the perspective of another decade, maybe that disappointment was overdone. Certainly, higher growth was desirable. But at least we were growing fast enough to raise living standards. We were creating jobs. The glass was at least half full. The main reason we did not get higher growth was probably the failure to match the macroeconomic progress with equally exemplary microeconomic policies. This point was made in repeated diagnoses of our economic problems, by a range of top local and international economists. Sadly, that advice did not translate into further reforms. Still, these disappointments are minor compared with those of the period since 2009. We went from having the glass half full to having it nearly empty. Understanding how this happened is an important first step towards fixing it. When South Africa’s slowdown commenced, shortly after the financial crisis, we did not at first understand the extent of the problem. Economists generally expected a rebound in GDP growth, and when it did not occur, the blame was often laid on temporary factors, such as droughts or strikes. But these explanations were not enough to explain a decade-long growth decline. As is often the case, it is only with hindsight that we have been able to put together a more comprehensive analysis. The most complete study to date is due to a Harvard team, led by Ricardo Hausmann and Federico Sturzenegger.13 They interrogate three accounts of the slowdown. One emphasizes global factors, and particularly weaker commodity Dani Rodrik. “Understanding South Africa’s Economic Puzzles” Economics of Transition. Vol. 16(4). 2008. Available at: https://scholar.harvard.edu/files/dani-rodrik/files/understanding-south-africa.pdf Ricardo Hausmann et al. “Macroeconomic risks after a decade of microeconomic turbulence: South Africa 2007-2020” February 2022. Available at: https://sa-tied.wider.unu.edu/article/macroeconomic-risks-afterdecade-microeconomic-turbulence-south-africa-2007-2020 prices. The second is about macroeconomic policy, and specifically the possibility that low growth was due to tight monetary and fiscal policies. The third focuses on microeconomic effects, chiefly the productivity damage of state capture. The paper is well worth reading. But let me give away the ending. They largely dismiss the first two arguments and embrace the third. Our problem was not the global environment. It was not about fiscal austerity or tight monetary policies – those were just scapegoat arguments, to deflect blame. It was about a fundamental deterioration in public sector management, such that the productive capacity of the country stagnated. Macroeconomics is often complex and difficult for non-experts to follow, but in this case the logic doesn’t require much explaining. If you borrow huge sums of money to invest in power stations, but much of the money is stolen so the stations do not work, and the economy keeps running out of power, then it is hard to grow.14 As the Zondo Commission of Inquiry into Allegations of State Capture reported, this was not something happening in the power sector only: it was across the government sector. And it had profound and lasting consequences. As everyone else in the economy realised what was going on, and 2015’s Nenegate was a catalyst here, people changed behavior. For businesses and households, confidence collapsed.15 Government and state-owned enterprises became smothered in debt and ran short of expertise – because state capture had prompted the departure of many skilled staff – the overall result was a sharp fall in investment. SARB economists have also written on this explanation for low growth. Their work shows that if South Africa had used its capital and labour as efficiently as it did previously, growth would have been around 3% – roughly double the actual outcome. See T Janse van Rensburg, D Fowkes and E Visser, ‘What happened to the cycle? Reflections on a perennial negative output gap’, SARB Occasional Bulletin of Economic Notes, Pretoria: SARB, July 2019. Available at: https://www.resbank.co.za/content/dam/sarb/publications/occasional-bulletin-ofeconomic-notes/2019/9345/Bulletin.pdf The RMB/BER Business Confidence Index shows an inflection point at the start of 2016, moving from roughly neutral levels to depressed levels and remaining weak through the rest of the decade. The FNB/BER Consumer Confidence is similarly lower following Nenegate, although it has a temporary rebound in 2018. Indeed, in recent years investment has been so low that it has been fully funded from domestic savings, with spare savings left over to export, giving us a current account surplus. The balance-of-payments constraint which had shaped macro strategy in the reform era was no longer binding, simply because the economy stagnated. There was no confidence for even a temporary boom. However, if we can start growing again the old constraints will re-emerge. Like it or not, this means we will need to re-engage with the reform lessons of the 1990s and take a different approach to policy. First, we once again face a situation of rising debt and excessive tax burdens. In the 2000s, we generally had revenue a little under 25% of GDP and spending slightly over 26% of GDP. Now we raise less than 24% of GDP in revenue, despite higher taxes, and then spend about 29% of GDP.16 This is an unsustainable situation, not least because the efficiency of government spending has been low.17 Much as I wish we had a strong state that could deliver high quality public goods at reasonable prices, the facts reflect otherwise. Relative to the 2000s, we have a weaker state, spending a larger share of GDP. The result is an economy barely capable of growth faster than 1%, with a shrinking tax base and a weak outlook. In these circumstances, trying to deal with social needs simply through more spending, more debt and higher tax doesn’t really cure the patient, but rather limits the pain while accepting continued decline. Living standards cannot rise materially without growth. The problem goes deeper. If investment did rebound, and government borrowing continues at around current levels, we would then hit a binding balance-of-payments constraint. We have had an investment rate of around 14% of GDP recently, against For 2001 to 2009, revenue averaged 24.8% of GDP and expenditure averaged 26.2% of GDP. For 2012 to 2021, revenue averaged 23.9% of GDP and expenditure averaged 28.9% of GDP. These periods correspond to the most recent ten years as well as the preceding decade. Alternative samples yield comparable results. Theo Janse van Rensburg, Shaun de Jager and Konstantin Makrelov. “Fiscal multipliers in South Africa after the Global Financial Crisis” SARB Working Paper. No. 21/07. Available at: https://www.resbank.co.za/en/home/publications/publication-detail-pages/working-papers/2021/fiscalmultipliers-in-south-africa-after-the-global-financial-cr a savings rate of 15% of GDP.18 A reasonable investment rate would be over 20% of GDP, and for fast growth probably 30%.19 But given savings levels, this implies borrowing between 5% and 15% of GDP from the world – very large sums. Current account deficits of those magnitudes would simply become too unsustainable, if not impossible, as in the UK currently. To achieve balanced growth, rather than just recover a boom-bust cycle, we therefore need better longer-term savings rates. As in the late 1990s, this is going to require fiscal restraint, as a necessary self-control measure to enable the financing of stronger and more efficient investment. The classic objection to this course is that fiscal consolidation slows growth, hurting revenues, which makes cut-backs self-defeating. However, there is good evidence that the composition of consolidation matters.20 Empirically, spending cuts tend to be more growth friendly than higher taxes. Furthermore, a fiscal consolidation that reduces fiscal and sovereign risk would also create more room to support demand with lower interest rates, including at the longer end of the yield curve, where South Africa’s risk premium is largest, and where long-term investment is often financed.21 De-risking the economy, through fiscal consolidation, does not therefore need to be contractionary.22 Both gross savings and investment have fluctuated in a range of 13-16% of GDP in recent years. IMF WEO data for the period 2019-2022 (which includes a forecast for 2022) show average savings at 15.1% of GDP and average investment at 14.1% of GDP. It is unusual for SA savings to be higher than investment; the 2010-2019 averages are 17.3% of GDP for investment and 14.5% of GDP for savings. On the desirability of investment rates at 30% of GDP, see Enoch Godongwana. “Keynote address by Minister of Finance, Enoch Godongwana, at the GEPF annual leadership conference”. 15 September 2022. Available at: http://www.treasury.gov.za/comm_media/speeches/2022/2022091501%20SPEECH%20BY%20MINISTER%20E NOCH%20GODONGWANA%20AT%20THE%20ANNUAL%20GEPF%20CONFERENCE%202022.pdf Alberto Alesina, Carlo Favero and Francesco Giavazzi. Austerity. Princeton University Press: Princeton, New Jersey. 2019. Christopher Loewald, David Faulkner and Konstantin Makrelov. “Time consistency and economic growth: a case study of South African macroeconomic policy” SARB Working Paper. No. 20/12. 25 November 2020. Available at: https://www.resbank.co.za/content/dam/sarb/publications/workingpapers/2020/10421/WP%202012.pdf Roy Havemann and Hylton Hollander. “Fiscal policy in times of fiscal stress” WIDER Working Paper. No. 52/2022. Available at: https://www.wider.unu.edu/publication/fiscal-policy-times-fiscal-stress Fiscal consolidation would also have important implications for our longer-run ability to protect the value of the rand, which is a central concern for us as the SARB. One of the papers discussed at Jackson Hole this year was about the relationship between fiscal and monetary policy, and it offered the following warning: When fiscal imbalances are large and fiscal credibility wanes, it may become increasingly harder for the monetary authority to stabilise inflation around its desired target. If the monetary authority increases rates in response to high inflation, the economy enters a recession, which increases the debt-to-GDP ratio. If the monetary tightening is not supported by the expectation of appropriate fiscal adjustments, the deterioration of fiscal imbalances leads to even higher inflationary pressure. As a result, a vicious circle of rising nominal interest rates, rising inflation, economic stagnation, and increasing debt would arise.23 A central bank can do a great deal for price stability. It can nurture a reputation for controlling inflation. It can also accumulate foreign exchange reserves, to help protect the solvency of the country.24 But central banks are not immune to fiscal outcomes. If we are to maintain moderate levels of inflation in South Africa, we will need a macro strategy that delivers fiscal sustainability. There have been some signs of progress lately, but we are still running fiscal deficits near 6% of GDP, despite record commodity prices. We have seen before, and we know high commodity prices do not last forever. At some stage, the commodity prices will correct, and we had better be prepared for it. For monetary policy, our immediate priority is to guide inflation back towards the middle of our target range. Our larger strategic goal, however, is to undo the error of Francesco Bianchi and Leonardo Melosi. “Inflation as a fiscal limit” 19 August 2022. Available at: https://www.kansascityfed.org/Jackson%20Hole/documents/9037/JH_Paper_Bianchi.pdf Agustin Samano. “International Reserves and Central Bank Independence.” Policy Research Working Paper. No. 9832. World Bank, Washington, DC. Available at: https://openknowledge.worldbank.org/handle/10986/36483 20 years ago, when we gave up on lowering the inflation target.25 A recent review of monetary policy conducted by Athanasios Orphanides and Patrick Honohan makes a compelling case for a lower inflation target of 3%.26 This target would be in line with our peers. It would allow for lower interest rates. It would also make inflation less of a concern in the everyday lives of South Africans. Low inflation is like reliable electricity: good policy means most people don’t have to worry about it. Unfortunately, just as we have load-shedding, so our high and wide inflation target means the currency suffers persistent value-shedding. We would like this to end. To conclude, globally the big macro news is a newfound focus on economic constraints. There are still a few people who embrace a naïve economic policy model, where growth is guaranteed so long as monetary and fiscal policy are aggressive enough. But this recipe creates serious vulnerabilities to shocks in even the strongest economies, such as the United States, and it is untenable in emerging markets like South Africa. For South Africans who are serious about development, the main effort should be doing the hard microeconomic work of raising productivity, which means nurturing expertise to solve problems, one by one, with the private and public sectors each contributing what they can. But this essentially microeconomic mission needs to be set in a macroeconomic framework that is resilient enough to sustain growth, without succumbing to balanceof-payments constraints, debt distress or high inflation. It is hardly a magic formula. There are no shortcuts to development. The real trick is to look the problems squarely in the face, figure out a strategy for dealing with them, and implement it. We have no shortage of plans. After nearly a decade of going backwards, I hope we can find the resolve to reform once again. For a fuller discussion of lowering the inflation target, see Lesetja Kganyago “Inflation targeting at 21 – Lessons for the future” 8 September 2021. Available at: https://www.resbank.co.za/content/dam/sarb/publications/speeches/speeches-by-governors/2021/govkganyago/A%20public%20lecture%20by%20Lesetja%20Kganyago%20Governor%20of%20the%20South%20Afri can%20Reserve%20Bank%20at%20Stellenbosch%20University.pdf Patrick Honohan and Athanasios Orphanides. “Monetary policy in South Africa: 2007-21” SA-TIEd Working Paper. No. 208. Available at: https://sa-tied.wider.unu.edu/article/monetary-policy-south-africa-2007-21 Thank you.
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