South Africa's Reserve Bank (SARB) is playing a dangerous game with the South African Economy
Category: Financial markets and economics
Date: 12 April 2023
Date: 12 April 2023
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South Africa's Reserve Bank (SARB) is playing a very dangerous game with the South African economy. On 30 March 2023 they raised interest rates by 50 basis points while ZERO of the 21 economists surveyed by Bloomberg predicted a 50 basis point hike. They are playing chicken with the SA economy and we tell you why below.
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Image courtesy of Bloomberg
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Mandate of the South African Reserve Bank
Lets start at the begining. According to the South African Reserve Bank's website the following is the primary mandate of the South African Reserve Bank (SARB). "The primary mandate of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth."
You will notice it says absolutely nothing about inflation targeting or inflation in its mandate. And this is important to remember as we go along in this artcile.
You will notice it says absolutely nothing about inflation targeting or inflation in its mandate. And this is important to remember as we go along in this artcile.
So why inflation targeting and interest rates?
SARB is saying that they are following an approach called "inflation targeting". The basic idea behind the inflation targeting is that the central bank would like to keep inflation in the country stable and between 3% and 6%. . The worry about inflation is that if it gets out of control the buying power of citizens reduces quickly and R100 today is worth far less in say a year from now. And this could spiral out of control where one sees hyper inflation, as was experienced in Zimbabwe, Argentina and Venezuela. Hyper inflaton is when inflation increases by 50% a month. So an item that cost R100 in Janaury costs R150 in February.
While inflation targeting is not a bad thing, the problem arises when inflation is caused by factors outside of the control of the reserve bank or citizens/businesses in South Africa, Add to that the bulk of the Monetary Policy Committee (MPC) members can be grouped as inflation hawks, a term used to define economists who is very and sometimes overly concerned about levels of inflation.
If you have inflation that is caused by external factors such as rising oil prices, war (as the one in Ukraine which is affecting the prices of basic food crops as Ukraine was a big exporter) and supply chain bottlenecks (a hangover from Covid-19) then it really makes no sense to raise interest rates locally to reduce consumer demand and slow the economy down and hoping and praying that this will reduce the levels of inflation in South Africa. The inflation caused by the external factors is called "cost push inflation". This is where the prices of products are going up due to the input costs going up. Raising interest rates will have little to no effect in reducing cost push inflation.
Raising interests is far more effective in bringing down and curtailing demand pull inflation. This is caused when excess demand by consumers leads to rising prices, as retailers and businesses realise there is excess demand for products and because of the elevated demand they can raise prices a little more to make more profit. This causes an upward trend in inflation. Now this kind of inflation can be controlled a bit more by raising interests to curb demand and slow down demand pull inflation. But as mentioned before it does very little to nothing when it comes to addressing cost push inflation.
While inflation targeting is not a bad thing, the problem arises when inflation is caused by factors outside of the control of the reserve bank or citizens/businesses in South Africa, Add to that the bulk of the Monetary Policy Committee (MPC) members can be grouped as inflation hawks, a term used to define economists who is very and sometimes overly concerned about levels of inflation.
If you have inflation that is caused by external factors such as rising oil prices, war (as the one in Ukraine which is affecting the prices of basic food crops as Ukraine was a big exporter) and supply chain bottlenecks (a hangover from Covid-19) then it really makes no sense to raise interest rates locally to reduce consumer demand and slow the economy down and hoping and praying that this will reduce the levels of inflation in South Africa. The inflation caused by the external factors is called "cost push inflation". This is where the prices of products are going up due to the input costs going up. Raising interest rates will have little to no effect in reducing cost push inflation.
Raising interests is far more effective in bringing down and curtailing demand pull inflation. This is caused when excess demand by consumers leads to rising prices, as retailers and businesses realise there is excess demand for products and because of the elevated demand they can raise prices a little more to make more profit. This causes an upward trend in inflation. Now this kind of inflation can be controlled a bit more by raising interests to curb demand and slow down demand pull inflation. But as mentioned before it does very little to nothing when it comes to addressing cost push inflation.
SARB should do everyone a faour and tell them they are raising interest rates to try and get the Rand stronger so we dont "import" inflation due to a weaker exchange rate. Import inflation you ask? This is when the price of an item being imported increases not due to inflation or any other pressures but purely because of a weaker exchange rate. And SARB can argue that since we are a very open economy and we import a large number of items, a stronger Rand is required to ensure we dont push up our local inflation rate due to importing inflation.
But if that is their primary concern, raising interest rates is like using a hammer to paint a brick wall. Basically interest rates is not the right tool for the job. They are currently raising interest rates, hoping the Rand will strengthen due to higher returns offered by interest bearing assets in South Africa. And higher yield seeking cash will come flowing into SA and stronger demand for Rands will lead to a stronger Rand. But there are SO many factors that has an impact on a country's currency that SARB can surely not think that raising interest rates will make the Rand stronger. A few other factors that has an impact on the currency:
Of the 5 factors mentioned above raising interest rates will negatively impact economic growth and future stock market returns (as consumers will spend less and firms will make less in profits so stock market returns will be weaker. So these two factors could counteract any gains made by the exchange rate from additional funds flowing in to chase higher yields. Just proving again that raising interest rates is not the silver bullet SARB thinks it is.
The only way this whole scenario is heading towards is a weaker exchange rate (we can already see after the strong reaction from the Rand following the interest rate hike the Rand has weakened substantially since then), a weaker economy (as credit demand will slow, consumers will spend less, governement will earn less in taxes, firms will make less profits, higher unemployment, more people dependent on the state, deteriorating infrastructure) and we will still have presistently high levels of inflation, as inflation drivers are outside what South Africans, South African Businesses and the South African Reserve Bank can control.
What the SARB can control is the level of interest rates, which based on the economic performance, the unemployment rate and moderately temporary high levels of inflation is far above what it needs to be, and this will have significant long term implications for the South African economy that has been treading water for years. Its clear the obsession with inflation targeting and trying to protect that Rand, that SARB forgot about the last part of their mandate that speaks to the pursuit of balanced and sustainable growth. At the current rate and interest rates there will be no growth. And having no growth is not sustainable either.
SARB MPC members are sitting in their Ivory Towers and fancy palatial homes, totally out of touch with the average household and person in South Africa, much like our politicians.
But if that is their primary concern, raising interest rates is like using a hammer to paint a brick wall. Basically interest rates is not the right tool for the job. They are currently raising interest rates, hoping the Rand will strengthen due to higher returns offered by interest bearing assets in South Africa. And higher yield seeking cash will come flowing into SA and stronger demand for Rands will lead to a stronger Rand. But there are SO many factors that has an impact on a country's currency that SARB can surely not think that raising interest rates will make the Rand stronger. A few other factors that has an impact on the currency:
- Economic growth outlook
- Future stock market fortunes
- Political stability/instability
- Investor sentiment towards emerging economies vs developed economies
- Taxes on interest and dividends earned
Of the 5 factors mentioned above raising interest rates will negatively impact economic growth and future stock market returns (as consumers will spend less and firms will make less in profits so stock market returns will be weaker. So these two factors could counteract any gains made by the exchange rate from additional funds flowing in to chase higher yields. Just proving again that raising interest rates is not the silver bullet SARB thinks it is.
The only way this whole scenario is heading towards is a weaker exchange rate (we can already see after the strong reaction from the Rand following the interest rate hike the Rand has weakened substantially since then), a weaker economy (as credit demand will slow, consumers will spend less, governement will earn less in taxes, firms will make less profits, higher unemployment, more people dependent on the state, deteriorating infrastructure) and we will still have presistently high levels of inflation, as inflation drivers are outside what South Africans, South African Businesses and the South African Reserve Bank can control.
What the SARB can control is the level of interest rates, which based on the economic performance, the unemployment rate and moderately temporary high levels of inflation is far above what it needs to be, and this will have significant long term implications for the South African economy that has been treading water for years. Its clear the obsession with inflation targeting and trying to protect that Rand, that SARB forgot about the last part of their mandate that speaks to the pursuit of balanced and sustainable growth. At the current rate and interest rates there will be no growth. And having no growth is not sustainable either.
SARB MPC members are sitting in their Ivory Towers and fancy palatial homes, totally out of touch with the average household and person in South Africa, much like our politicians.