| OPINION/ ANALYSIS
|
New central bank chief should focus on demand
November 17, 2009
By Brian Kantor
This is not an easy time to be taking over the reins at the Reserve Bank, but more important is that there seems little sign of any imminent recovery in the private sector spending on which the economy must depend if growth is to be resumed.
For technical reasons the third-quarter gross domestic product (GDP) numbers might look better because exports declined less than imports and the run down in inventories was at a slower pace than it was in the second quarter, when an extraordinary reduction in inventories took as much as 10 percent off the GDP growth rate.
But such numbers will indicate just how weak the economy is and there will be little consolation to be found in the trends in spending by the private sector.
Despite the very weak state of the economy, the Reserve Bank's monetary policy committee found reasons at its last two meetings not to lower interest rates or to ease quantitatively.
The arguments that would have supported such inaction would presumably have included the notion that real interest rates in South Africa were already very low.
The argument would also have been made that inflation in South Africa remains unsatisfactorily high and that elevated inflationary expectations could continue to have an unwelcome self-fulfilling effect on inflation itself.
New governor Gill Marcus would do well to question the validity of such arguments, which helped raise interest rates to recession-producing levels in the first place and restrained their reversal long after it was clear that the growth in spending by households, particularly on interest-sensitive durable goods, was falling sharply.
As argued before, the weakness in South Africa's economy was of our own making. The global credit crisis made it harder to escape from recession and so added to the case for Reserve Bank activism.
Let us therefore address the level of real interest rates in South Africa. Real interest rates may be defined as the difference between borrowing costs and inflation. By reference to consumer price index (CPI) inflation, now 6.1 percent annually and money market interest rates, which are about 7 percent a year, real interest rates in South Africa may indeed appear very low.
But if prices realised by producers, represented by the producer price index (PPI), are taken as the point of reference, real interest rates have increased to exceptionally high levels of more than 10 percent. The reason for this difference is that while consumers in South Africa still face high inflation, producers are having to deal with significant and dramatic deflation.
Prices being realised at the factory farm and mine gates are well below where they were a year ago and producer inflation is significantly negative.
The simple idea behind the importance attached to real interest rates is that higher prices charged for goods sold offset the interest costs of borrowing. In an extreme case, if the prices firms can charge for their goods or services rise faster than interest rates, then doing no more than borrowing (cheap) money to fill up a warehouse with stuff that is bound to increase in value becomes a highly profitable business. For a household taking a loan to buy goods, the prices of which will rise as fast as the interest rates they are charged, may also seem like a good idea.
But South African households are not responding to the prospect of more inflation by borrowing more, even when banks or retailers remain willing to lend. They are borrowing less because the prices of the homes, cars and furniture are not expected to rise at anything like their cost of borrowing. They will know that the rising prices they are forced to pay are for goods and services they cannot hope to store - for electricity and other municipal services.
The firms that might ordinarily be encouraged to borrow funds to add to stocks and work in progress and to their complement of workers, or to add more plant and equipment, are facing deflation rather than inflation. For them the idea that their real costs of borrowing have declined is risible. Their real cost of borrowing - the real interest rates they are paying - have risen dramatically. This is why they are running down inventories, reducing working capital and employing fewer workers.
The further reality is that higher taxes paid by customers and themselves for services and the higher wages they have been forced to pay unionised staff have made it harder for them to raise prices in response to higher costs. They have been forced to reduce profit margins to stay in business.
The strong rand has made it more difficult for them to compete on the local or export markets. They have less, not more, pricing power because of the rising trend in CPI and wages that are not of their own making but forced on them.
The notion that in these circumstances producers will not only expect more inflation but that such expectations could be self-fulfilling, leading to ever higher prices, is a false notion. In the absence of accommodating demands for goods and services, inflationary expectations (in current circumstances, expectations of more supply side shocks for the economy in the form of higher electricity prices) cannot lead to ever higher prices. The weak demand for goods and services sets severe limits to pricing power. Supply-side-driven inflation will, however, lead to less output and employment given demand weakness.
The Reserve Bank should be doing what it can to ease rather than add to the punishment caused to businesses and staff by the higher charges imposed by fiat on essential goods and services.
The bank needs to make clear the distinction between the inflation it does have influence over (demand-led inflation) and supply-side shocks that cause inflation and even expected inflation to rise - over which it has no direct influence and which reduce spending on other goods and services.
Judging the right level of interest rates for South Africa without full regard to this distinction can prove very damaging to the economy. Interest rates influence the spending decisions of households and firms without necessarily having a predictable influence on prices. The unpredictable link between interest rate changes and the exchange rate makes it even more difficult to know how interest rates will influence the inflation rate in South Africa.
Marcus would do well to recognise these difficulties for the practice of monetary policy in South Africa. She should also be under no illusions that the only problem for the Reserve Bank to focus its attention on for now is the very weak state of demand, not the rate of inflation.
Brian Kantor is an economist and strategist at Investec Private Client Securities
|
|
|
Social bookmarking allows users to save and categorise a personal collection of bookmarks and share them with others. This is different to using your own browser bookmarks which are available using the menus within your web browser.
Use the links below to share this article on the social bookmarking site of your choice.
Read more about social bookmarking at Wikipedia - Social Bookmarking
|
|
|
News
Markets
Technology News
Company News
International
|
