The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) is meeting again – 21 July 2020 to 23 July 2020 – to discuss policy matters.
The central bank lowered interest rates by a cumulative 275 basis points in the year so far, most recently making a 0.5 percentage point cut in lending rates on May 21.
This total reduction is much larger than an emerging market median of 100 basis points and took the repo rate to the lowest level on record.
A very favourable inflation environment and outlook enabled the SARB to provide significant monetary policy stimulus to the South African economy during the first half of the year as the domestic impact of a local lockdown and global economic slowdown hit businesses and consumers.
Policymakers have unanimously supported four rate cuts in 2020
Source: PwC calculations based on SARB publications
*MPC votes are split between cut, hold and hike, with percentage distribution listed on the left-hand y-axis. The actual repo rate is listed on the right-hand y-axis.
Global economic decline worsens
The ‘Great Lockdown’ is a crisis like no other.
The global recession has deepened over the past few months:
- first-quarter gross domestic product (GDP) was generally worse than expected;
- consumers were not digging into savings as much as during previous crises; and
- mobility data highlighted that retail, transport and workplace activity was still depressed in many economies.
Due to increased workplace stoppages, working hour losses increased from 5.4% in the first quarter to 14.0% in the second quarter. In upper-middle-income countries (like South Africa), an average of 12.6% of working hours were lost during the April-June period.
COVID-19 had a larger negative impact on activity in the first half of 2020 than it anticipated in April. As a result, the multilateral organisation now expects a 4.9% contraction in global GDP during 2020.
This outlook includes an 11.9% drop in global trade volumes – including 9.4% decline in imports by and exports from emerging market and developing economies. South African exports, for example declined by a cumulative 5.2% during the first five months of 2020, while imports fell by a cumulative 9.1%.
Domestic recession continues into 2020
Recently released GDP data confirmed that the South African was in a three-quarter recession during the second half of last year and the first quarter of 2020.
The economy was 0.1% smaller in 2020Q1 compared to the same period a year earlier. The IHS Markit South Africa Purchasing Managers Index (PMI) indicated that the private sector has been in contraction since May 2019 and continued on this trend during the January-March 2020 period.
In the pre-COVID-19 period, this was due to an extensive list of long-standing structural constraints, including electricity supply (and cost) challenges and policy uncertainty in several industries, amongst many other factors.
The PMI declined in March this year and plunged in April and May owing to an unprecedented collapse in business conditions. The June PMI reading looked better but was still deep in negative territory.
We currently expect GDP to decline by 9.6% this year. Our baseline scenario takes into account the current level of the lockdown as well as prospects for further easing towards year-end.
However, with risks to this outlook resulting from the steady increase in the local COVID-19 infection rate, it is possible that at least some areas could see a reversal of recent easing.
If, for example, Gauteng (the country’s economic heartland) were to return to a Level 4 lockdown for one month, this could deepen the recession to 10.1%. This would place an additional 75,000 jobs at risk on top of the 1.43 million job opportunities in jeopardy under our baseline scenario.
Subdued global inflation environment
The weak global economy is resulting in very muted inflation conditions. The IMF expects consumer price inflation in advanced economies to decline from 1.4% last year to 0.3% in 2020.
The IMF forecasts inflation in emerging market and developing economies to ease from 5.1% in 2019 to 4.4% this year. A strong influence on this outlook is the forecast 41.1% drop in the average oil prices this year.
Oil is amongst several commodities – also including coffee, sugar, cocoa and maize – that are currently cheaper compared to a year ago.
The drop in global commodity prices since mid-February has benefited emerging market economies. The cost of South African imports, for example, declined by 10.6% y-o-y in April. Consumer goods like pharmaceuticals (-15.4%), footwear (-14.9%) and televisions (-25.6%) were significantly cheaper compared to a year earlier.
Another positive contributor to imported deflation is lower ocean transit rates. The Baltic Dry Index – representing the price of moving major raw materials by sea – is currently 13% lower compared to a year ago.
Local inflation falls to 15-year low
A slowdown in the domestic economy and price deflation on import goods resulted in a significant decline in local consumer price inflation.
Headline inflation dropped from 4.6% y-o-y in February to 2.1% y-o-y in May: the first reading below the 3%-6% SARB target range since 2005.
A big contributor to the disinflation this year was a sharp decline (during the January-May period) in local petrol and diesel prices. With global oil prices significantly lower compared to the start of the year, and imported crude petroleum costing 34.7% y-o-y less by April, local fuel was 25.9% y-o-y cheaper in May.
We expect inflation to average just 3.4% this year – this would be the lowest annual mean since 2004.
Headline inflation dropped to a 15-year low in May
Sources: Stats SA, SARB
Revised interest rate outlook
The MPC said in May it sees room for two repo rate cuts of 25 basis points each during the second half of 2020 – this would take the benchmark lending rate to 3.25%.
SARB Governor Lesetja Kganyago said in a speech on June 18 that financial market expectations anticipate the repo rate to stay above 3.0% over the next few years and that the SARB’s projections ‘show much the same’.
In other words, the 3.25% level was most recently seen by the SARB as the bottom of the monetary policy easing cycle.
Of course, the MPC can change its mind. We believe that the central bank’s forecast in May for a 7.0% recession this year was too conservative and that a revision to this number next week could see the SARB increase its forward guidance for more (or deeper) rate cuts in the short term.
Furthermore, with inflation averaging 2.6% y-o-y in April and May versus a SARB forecast of 2.8% for the third quarter, an even more benign inflation environment could be materialising. This too would give the MPC room for additional monetary policy easing.
We do not, however, expect any change in the repo rate this month. The MPC has in recent months implemented rate cuts according to its regularly updated modelling processes but these have most likely not seen much impact on the economy.
Due to the adverse impact of the lockdown on the normal flow of the economy, the influence of rate cuts has been delayed – the SARB has acknowledged this in public. As such, we believe the SARB will take a wait-and-see approach in July and keep the repo rate on hold at 3.75%.
It is more likely that further rate cuts will resume in September once more is known about the state of the economy during the second quarter. For example, by the time the MPC meets again in two months from now, they would have GDP data for the second quarter on which to base decisions.
Structural reforms needed to boost long-term economic growth
The SARB cannot cut lending rates indefinitely – and certainly not towards the 0% level seen in some developed economies.
Kganyago and the MPC often reiterated that monetary policy cannot on its own improve the potential growth rate of the economy. This, the MPC correctly argued in May, should be ‘addressed by implementing prudent macroeconomic policies and structural reforms that increase investment opportunities, potential growth and job creation’.
Finance Minister Tito Mboweni wrote about such structural reforms in a Business Day opinion piece published on July 14, defining them as resistant to cyclical changes in economic activity (e.g. a downturn in the global economy) and to sudden shocks to supply and/or demand (e.g. the COVID-19 pandemic and associated lockdown).
The reforms, commented the finance minister, ‘are meant to strengthen the country’s resilience to cyclical changes by addressing the underlying structural elements that contribute to low growth’.
Minister Mboweni noted in the Supplementary Budget Review 2020 (released on June 24) that the government ‘envisions a package of economic reforms that will improve productivity, lower costs and reduce demands of state-owned companies on the public purse’.
These measures include unbundling Eskom, modernising ports and rail infrastructure, licensing of spectrum, lowering the cost of doing business, reducing red tape, improving access to development finance for SMMEs, enabling growth in labour-intensive sectors (e.g. agriculture and tourism), reducing the skills deficit by attracting skilled immigrants, and undertaking a range of reforms in basic education and the post-schooling environment to improve outcomes for workers.
Of course, this list is familiar to anyone who has read the ‘Economic Transformation, Inclusive Growth, and Competitiveness: Towards an Economic Strategy for South Africa‘ document released by the National Treasury in August 2019.
There has been limited impactful progress on these factors; put differently, progress to date has been too little to have a meaningful impact on the South African economy.
Progress has been slower still when considering that many of these envisioned structural reforms were listed in Minister Mboweni’s first budget address in October 2018. To be fair, it is not the finance minister’s job to put these reforms in place.
He is merely the carrier of news about how the government expects to improve economic growth. The execution of these reforms sits elsewhere within the top level of government decision-making.