Presentation to the Parliament Committee on Finance

The South African economy: recent developments and monetary

policy

Presentation to the Parliament Committee on Finance

The South African economy: recent developments and monetary

policy Ben Smit

BUREAU FOR ECONOMIC RESEARCH

UNIVERSITY OF STELLENBOSCH

28 March 2007

OutlineOutline

Overview of the March 2007 SARB

Quarterly Bulletin

The MPC statement of 15 February 2007

The performance of Monetary Policy

Overview of the March 2007

SARB Quarterly Bulletin

Overview of the March 2007

SARB Quarterly Bulletin

The SA economy continues to produce quite high and stable economic growthThe SA economy continues to produce quite high and stable economic growth

-6

-4

-2

0

2

4

6

8

1980 1985 1990 1995 2000 2005

% c

han

ge

Ave 1985-94:0.8% pa

Ave 1995-04:3.1% pa

5.2%

Growth in the 4th quarter supported by all the main production sectorsGrowth in the 4th quarter supported by all the main production sectors

2006 Share of GDP

Q1 Q2 Q3 Q4 Year 1994 2006

Primary sector -9½ -7¼ -4 1 -4½ 11,9 10,6

Agriculture -18¾ -30 -15 -8½ -13 4,6 2,7

Mining -5½ 3½ ¼ 4½ -¾ 7,3 7,9

Secondary sector 4¾ 7¼ 5½ 8½ 5¾ 27,7 23,0

Manufacturing 3¼ 6¼ 4¾ 8¼ 4¾ 20,9 18,2

Tertiary sector 7¼ 6¼ 4¾ 5¼ 6 60,4 66,4

Total 5 5½ 4½ 5½ 5 100 100

While both household consumption expenditure and gross fixed investment contributed strongly to expenditure

While both household consumption expenditure and gross fixed investment contributed strongly to expenditure

(constant 2000 prices)

-10

-5

0

5

10

15

94 96 98 00 02 04 06

% c

hange

Household consumption exp Gross fixed investm

Household consumption expenditure supported by real disposable income …..Household consumption expenditure supported by real disposable income …..

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Y.o

.Y. %

change

Real household consumption expenditure Real disposable income

…. and by credit extension…. and by credit extension

Household debt as % of disposable income

30

35

40

45

50

55

60

65

70

75

80 82 84 86 88 90 92 94 96 98 00 02 04 06

… and by consumer confidence… and by consumer confidence

-40

-30

-20

-10

0

10

20

30

inde

x

FNB/BER CCI 3m mov ave

2006Q4

1994 election WC soccer bid

announcement

Gross fixed capital formation increased in all three institutional sectors, led by the public corporations

Gross fixed capital formation increased in all three institutional sectors, led by the public corporations

(constant 2000 prices)

80

100

120

140

160

180

200

00 02 04 06

General Govt Public corps Priv enterprises

RMB/BER Business Confidence Index

0

20

40

60

80

100

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

The upbeat overall economic conditions is reflected in, and supported by, continued high business confidence ……The upbeat overall economic conditions is reflected in, and supported by, continued high business confidence ……

•To 81 in 07Q1 from 83 in 06Q4

•Manufacturing ( 78(75))

•Building (90(90))

•New vehicles ( 72(71))

•Retail ( 87(91))

•Wholesale ( 76(88))

Employment continues to recover(BER Surveys: net balances)Employment continues to recover(BER Surveys: net balances)

Wholesale: Gowth in number of people employed

-80

-40

0

40

80

00 01 02 03 04 05 06 07

Manufacturing: Number of factory workers

-80

-40

0

40

80

00 01 02 03 04 05 06 07

Retail: Gowth in number of people employed

-80

-40

0

40

80

00 01 02 03 04 05 06 07

Building Contractors: Growth in employment

-80

-40

0

40

80

01 02 03 04 05 06 00

0

3

6

9

12

15

18

21

J-80 J-85 J-90 J-95 J-00 J-05

CPIX actual 36m mov ave

3-6% target range

CPIX inflation increases but remain in target rangeCPIX inflation increases but remain in target range

January 2007

CPI = 6.0

CPIX = 5.3

PPI = 9.8

… but production prices have increased substantially during 2006… but production prices have increased substantially during 2006

-15

-10

-5

0

5

10

15

20

2000 2001 2002 2003 2004 2005 2006

Yo

Y %

ch

an

ge

SA produced goods Imported goods Total

The deficit on the current account increased to very high levels …….The deficit on the current account increased to very high levels …….

-10

-8

-6

-4

-2

0

2

4

6

8

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

% o

f G

DP

Current account: Including / excluding oilCurrent account: Including / excluding oil

-8

-6

-4

-2

0

2

4

6

8

10

1980 1985 1990 1995 2000 2005

% o

f G

DP

Current account Current acc ex oil

The exchange rate has broadly stabilizedThe exchange rate has broadly stabilized

0

2

4

6

8

10

12

75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07

R/$

R/$ PPP (1970; PPI)

Monetary Policy Committee Decision

15 February 2007

Monetary Policy Committee Decision

15 February 2007

The decision:The decision:

“….the MPC is satisfied that the inflation outlook has

improved somewhat and expects inflation to remain

within the target range for the forecast period. As the

mandate of the Bank is to keep inflation within the

target range, the MPC has decided to leave the repo

rate unchanged for now at 9 per cent per annum.”Statement of the Monetary Policy Committee

15 February 2007 p4

MPC Statement: June 06 – Feb 07MPC Statement: June 06 – Feb 07

Causal factors / Motivation Decision

Inflation outlook

Breach target

Strong demand

Current account deficit

Oil price Repo rate

MPCA 8/06 Deteriorate Q107 Yes Concern Concern +0,5

MPCS 3/08 Deteriorate Q107.Q207 Yes ConcernLess

concern+0,5

MPCS 12/10 Upside riskAround 6% Q2-Q407

Yes ConcernLess

concern+0,5

MPCS 7/12 Improved Q207 YesDeficit

improve somewhat

Concern +0,5

MPCS 15/02 Improved No YesSharp

deterioration (but oil)

Less concern

0

MPC statements on the BoP current account deficitMPC statements on the BoP current account deficit

1. “In previous statements the MPC expressed concerns about the expanding deficit on the current account of the balance of payments. Current account deficits are a reflection of higher domestic expenditure and in themselves inflationary. There is however a possible risk to the exchange rate if the deficits are perceived to be unsustainable, particularly if the deficits are reflecting higher consumption expenditure.”

MPCS 3/08/07

2. “We have explained on a number of occasions that the MPC does not have a target for the current account, nor does the MPC view deficits on the current account to be inflationary in themselves. The mandate to the Bank is to maintain inflation within the target range of 3 to 6 per cent. The risk to inflation arises if the market perceives a particular level of the current account to be unsustainable, which could have implications for the exchange rate and, consequently for the inflation rate. To date the current account deficit ….. Has been adequately financed. Current developments appear to indicate that the current account deficit will continue to be adequately financed given the coherent macroeconomic policy framework of the country and positive growth prospects.”

MPCS 15/02/07

Current account vulnerabilityCurrent account vulnerability

Balance of payments as % of GDPBalance of payments as % of GDP

-10

-8

-6

-4

-2

0

2

4

6

8

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

% o

f G

DP

Current account balance as % of GDP – 2005 relative to EM countriesCurrent account balance as % of GDP – 2005 relative to EM countries

-8 -6 -4 -2 0 2 4 6 8 10 12 14

TURKEY

PANAMA

SOUTH AFRICA

EL SALVADOR

PAKISTAN

URUGUAY

THAILAND

COLUMBIA

TUNISIA

DOMINICAN REPUBLIC

ECUADOR

MEXICO

CHILE

AVERAGE

MOROCCO

INDONESIA

PERU

ARGENTINA

BRAZIL

EGYPT

PHILIPPINES

CHINA

NIGERIA

2006

X (-6,4)

Whose the culprit?Trade balance & services and income balance as % of GDPWhose the culprit?Trade balance & services and income balance as % of GDP

-8

-6

-4

-2

0

2

4

6

8

10

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

% o

f G

DP

Trade blance Services balance

(Disappointing) export and (booming) import volume indices and the Terms of Trade(Disappointing) export and (booming) import volume indices and the Terms of Trade

95

105

115

125

135

145

155

165

175

00 01 02 03 04 05 06

Exports Imports Terms of Trade

2000 -2006

Exports: 100 121.4

Imports: 100 171.3

ToT: 100 113.6

Saving and investment as % of GDPSaving and investment as % of GDP

13

14

15

16

17

18

19

20

21

2000 2001 2002 2003 2004 2005 2006

% o

f G

DP

Savings Investment

2000 -2006

Saving % GDP: 15.8 13.9

Investment % GDP: 15.9 20.3

Does the current account matter?

Empirical evidence

Does the current account matter?

Empirical evidence

Size of deficits (Edwards (2004,2005))

– 157 countries, 1970 – 2001

– >50% of countries, deficits >3,1% of GDP

– >75% of deficits (3rd quartile) ≤ 7,2% of GDP

– 26 of 157 countries experienced high deficits for 5 years or longer once

Reversals

– Edwards (2005)

Incidence 9,2% (11,8%)

– Milesi-Ferretti and Razin (1997)

116 reversals in 60 countries (1974 – 1990)

– Output cost of reversals

SA’s resilience to sudden stop/reversalsSA’s resilience to sudden stop/reversals

Floating currency

Borrowing small part of inflows

Rand denominated foreign debt (“original

sin”)

Forex reserves improve

MPC – The right decision?MPC – The right decision?

Trade-off between improved inflation outlook and continued strong domestic demand and the associated balance of payments deficit.

Choice determined by judgment of risk of deficit becoming unsustainable and associated exchange rate, inflation and output consequences and of strong demand fuelling inflation.

Performance of Monetary PolicyPerformance of Monetary Policy

Inflation recordInflation record

1

2

3

4

5

6

7

8

9

10

11

12

00 01 02 03 04 05 06 07

CPIX

Anchoring inflation expectationsAnchoring inflation expectations

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

2003Q1 2004Q1 2005Q1 2006Q1

Average Analysts Business Labour

2006Q4

Handling of supply shocksHandling of supply shocks

“The response of monetary policy to supply shocks

appears to be countercyclical, i.e. dispelling somewhat

the idea that monetary policy may have been overly

procyclical in response to supply shocks.”

Frankel, Smit & Sturzenegger (March 2007):

Macroeconomic challenges after a decade of success, p68

Policy transparencyPolicy transparency

“Central bank transparency in South Africa has improved

greatly under inflation targeting, from a score of 5 in

1994, to 9 in 2004 (out of a possible 15)”

Aaron and Muellbauer (March 2007):

Transparency, Credibility and Predictability of Monetary Policy in South Africa, Mimeo, p5

Forecast accuracyForecast accuracy

“… no other forecasting agency consistently produced

more accurate inflation forecasts than the Bank in the

period May 2003 to December 2005.”

SA Reserve Bank (Nov 2006):Monetary Policy Review, p31

Other issuesOther issues

Contribution to output and price stability

Room for the “pursuit” of other goals

such as exchange rates/Bop, growth

Overly conservative / too high interest

rates

Bureau for Economic Research

Economic information that works for you

Bureau for Economic Research

Economic information that works for you

Website: www.ber.sun.ac.za

E-mail: hhman@sun.ac.za

Tel No: 021-887 2810

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