To cut or not to cut, that is the Reserve Bank's question
- Paul Berkowitz
- 22 Sep 2011 (South Africa)
The Reserve Bank’s Monetary Policy Committee (MPC) is meeting this week to decide whether to keep interest rates steady or cut them in the face of a worsening economic outlook. PAUL BERKOWITZ looks at the arguments for and against a rate cut and decides that, ultimately, it doesn’t really matter what the MPC does if the country as a whole isn’t prepared to face up to much bigger problems.
The Reserve Bank’s Monetary Policy Committee is holding its bimonthly meeting this week. These meetings usually stretch over two days and culminate in a press statement from the Reserve Bank governor. The governor will typically hold court for about an hour, summarising the macroeconomic outlook for the country, the forecast risks to growth, inflation and the exchange rate, and then deliver the money shot (pardon the pun) to the throng of financial journalists in attendance: what decision the MPC has taken on the repurchase (repo) rate.
The Bank’s repo rate is the rate at which the Bank lends money to the commercial banks, and it affects the cost of credit for the entire economy. The commercial banks will fix their prime rates at 350 basis points (3.5 percentage points) above the repo rate, which in turn will influence the bond rate on property, the overdraft rate on credit cards, the interest paid on deposits and so on. Everyone with debt to pay off (i.e. most South African adults) or some form of interest income (too few South Africans) has a vested interest in the MPC’s decision.
The repo rate is currently at its lowest level in decades. Most of the talking heads in finance, until recently, had predicted that the repo rate would be left unchanged for a few more months before rising in response to higher consumer inflation. However, in the past few weeks the global economy has gone into meltdown faster than Nonhle Thema’s Twitter feed, prompting speculation that another rate cut could be in the offing.
World-renowned economist Dr Nouriel Roubini is claiming that a second global recession is already here and the evidence of this is pretty irrefutable. The economies of the US and much of Europe are struggling under decades-high unemployment, poor growth and few prospects on the horizon. The South African economy has barely recouped the output losses sustained during the 2008 recession and it has definitely not created enough new jobs to compensate for those lost during 2008 and 2009.
What should the Reserve Bank do? In my opinion, that’s the wrong question to ask. The right question is: what *can* the Reserve Bank do? The answer to that question is “precious little”.
What would a rate cut achieve at this point? It wouldn’t create new jobs and investment, because investment decisions are made over a longer time horizon than a few months, or even a couple of years. The past few months have seen jobs and businesses destroyed, particularly in the manufacturing sector. This destruction is due to a number of factors which include: a microeconomic framework that is hostile to small businesses; weak local and global demand for manufactured goods, and a gentlemen’s agreement between big business and organised labour to enforce wage increases that smaller firms cannot afford to absorb.
Lower interest rates also won’t do much to spur consumer demand and domestic consumption, which was the engine of growth during the consumption-led boom of 2004-2007. The rules have fundamentally changed since then. The property market is in the toilet. Households are busy paying off the debt they accumulated during those years of plenty. The commercial banks appear to be shell-shocked by the bad debt cycle and don’t want to lend – a prominent estate agent was lamenting this fact on radio just this week, claiming that potential borrowers aren’t being granted bonds even in cases where they’re willing and able to secure a 30% deposit.
Ironically, just as there is little upside to cutting rates, there’s also little to lose. Fears of inflation are a bit overdone: CPI has ticked higher in recent months but most of the inflationary pressures are supply-side related. Higher administered prices, petrol prices and food prices are the chief threats to the inflation target, and these aren’t affected by lower interest rates. There’s also little evidence – at this stage – of any second or third-round pressures from higher fuel prices or wage settlements.
Could lower interest rates lead to a weaker rand and subsequent imported inflation? In theory, yes, but the rand has already lost some 15% of its value in the past month as foreign investors have sold off South African assets and fled back to their home countries. How much worse can it get at this point and how conclusively could you link any further weakness to a rate cut?
Since South Africa adopted the orthodox monetary policy model of inflation targeting via a fixed, centralised interest rate, we’ve fallen into the same trap of other countries. We have expected too much from monetary policy and we’ve downplayed the role of sensible fiscal and microeconomic reforms. We’ve become confused about the role of inflation targeting in achieving economic growth; we’ve pretended that it’s a sufficient condition to achieve growth when we should have known that it’s a necessary, but not sufficient, condition.
So we repeat this media circus every two months, reading the tea leaves of the forward rate agreement curve and scouring the media for scraps of economic data that might divine in which direction interest rates are likely to move. We place little office bets on the outcome of the MPC meeting and we calculate how much money we can save on the house and car repayments every month if Ms Marcus delivers an early Christmas present.
The MPC meetings have become a very sophisticated bread-and-circuses exercise for the economically literate. Unfortunately, just like their lowbrow World Cup/Big Concerts counterparts, we wake up the following morning to the same economic and societal problems we’ve been ignoring for so long. DM
- A Comparison of Jibar Futures & Forward Rate Agreements (FRAs), JSE publication.
- The repo rate over the last four years, Reserve Bank website;
- The rand-dollar exchange rate (30 days), x-rates.com.
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