Bank will stick to inflation targeting
ON THE face of it, there was nothing new in the Reserve Bank’s monetary policy review this week. It highlighted the difficulties which the Bank will face making interest rate decisions in the months ahead, describing the process as "a fine balancing act".
But dig a little deeper and it is clear that the Bank has signalled that it will stick to its inflation targeting mandate, even though the mandate has become "flexible". This is a reassuring message to the markets as it suggests that the Bank’s credibility will not be called into question if SA’s growth remains modest while inflation soars.
There has been speculation that the Reserve Bank could keep interest rates steady in that scenario, to support job creation and investment, which are both lacklustre. Local markets are pricing in a certain interest rate hike at the Bank’s policy meeting in November, and its rhetoric this week suggests that this is a real possibility.
It all depends on the trajectory of inflation, and the extent to which price pressures are driven by the rising cost of oil, electricity and food — described as "cost-push factors".
Bank governor Gill Marcus said at the release of the biannual monetary policy review that there was little that monetary policy could do to stifle inflation driven by these factors. But the review repeated the mantra of the Bank’s last monetary policy meeting — it would not hesitate to take "timeous" action if inflation moved out of its official 3%- 6% target range on a "sustained basis". "Timeous action" at this point is code for interest rate hikes.
When asked what a "sustained" breach of the inflation target meant, Ms Marcus said inflation would have to "continue to move away" from its target range.
The Reserve Bank has predicted that inflation will breach its target in the first quarter of next year, reaching a peak of 6,3% in that period.
So the remarks suggest two things would trigger a rate hike: first, the Bank’s forecasts for inflation will have to be revised up once again. Second, it would have to exceed the limit for longer.
So, if either happens and the Bank doesn’t raise rates, its credibility will be tarnished — Ms Marcus has nailed her colours to the mast.
Upward revisions to inflation would be likely to stem from so- called "second-round" effects — a term for price increases in other parts of the economy, which the Bank wants to nip in the bud.
If food prices do not run away and oil prices hover at current levels, these may not materialise.
The wild card, as always, is the volatile rand.
The currency’s strength has been the bane of manufacturers as it makes their exports less competitive. But it has been a boon for inflation, helping to mute the effect of soaring oil prices.
This week, the rand weakened beyond R7 to the dollar — a trend which may continue.
If that happens, it would put upward pressure on inflation by making imports more expensive.
The Bank’s review cited potential "adjustments" to the exchange rate as one of the key risks to inflation this year — a subtle shift from its previous stance. Before that , its officials had pointed out the benefits of rand strength for inflation. This was the first warning about fallout from a weaker currency this year.
In theory a weaker exchange rate would make it easier for the Bank to raise interest rates as it boosts the "carry trade" appeal of the rand. Investors buy the rand for the returns from its higher yield, which exceed other assets.
By the same token, a strong rand makes it harder for the Bank to raise interest rates because it would boost demand for the currency further, making it much too strong for the comfort of local exporters.
The Bank would be in a very difficult position if the rand weakened so much it added significantly to inflation pressures. Its credibility and commitment to its inflation target mandate would be in jeopardy if it did not raise rates at that point.
Greek and Swazi parallels
HOW much of a risk is the fiscal crisis in Swaziland to SA and the Southern African Customs Union (Sacu)? In some ways, the Swazi fiscal crisis is to Sacu what Greece is to the European Union. Economically, it is small, but a dramatic failure could start a chain reaction.
As far as one can tell, the Swazi crisis is worse than the Greek crisis. Swaziland’s budget deficit stands at more than 14% of gross domestic product, or $565m for 2011, for example. In Greece’s case, there has been speculation about dropping out of the euro, but the line from the European Central Bank, the International Monetary Fund and Greece itself is that this won’t happen. Not so in Swaziland, where the World Bank, no less, has already warned of currency devaluation.
The consequences of doing so would be enormous. Sacu has existed for over a century. Whether it helps or hinders the BLNS countries (Botswana, Lesotho, Swaziland and Namibia) is debatable, but since none has dropped out of it, presumably they recognise some value in the union.
However, in other ways, the comparison between Swaziland and Greece does not follow. In Europe there is a string of countries that have fiscal crises of their own. By contrast, within Sacu all but Swaziland, and perhaps Lesotho, are fiscally stable.
The politics are also different. The euro area is a grand experiment and its members have a huge incentive to see it succeed. On the other hand, SA’s government, one suspects and hopes, is sensitive to the public protests taking place in Swaziland, and about the need for political reform.
The other difference is that the fiscal crisis in Swaziland is rooted in the customs union arrangement, the opaque formula by which the proceeds of imports and exports are divided between Sacu members. Although it’s hard to tell how the formula works, what is clear is it constitutes at least half the kingdom’s government revenue. This revenue is also many times more than its pro rata share of trade.
Because of this dependence on the customs union, Swaziland’s finances are geared to regional trade, which declined during the recent economic downturn. As far as one can tell, SA has up till now been generous and increased regional revenue by more than the BLNS pro rata share. But faced with fiscal problems of its own, this attitude has apparently changed.
That might be fiscally laudable, but it has thrown Swaziland into a financial crisis, which Swazi authorities are trying to borrow their way out of by appealing to the African Development Bank for a $100m loan. But that will only cover deficits for a few years, so spending must decrease. Mass retrenchment of public servants could follow soon and the government has cut public servants’ pay by 10%. Understandably, there will be more protests.
Swaziland needs a holistic solution that includes political and economic reforms. SA has to be a key player in that process, but for that to happen, the government needs to be more attentive to the problem than it apparently has been up till now.
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