The South African Reserve Bank’s Monetary Policy Committee (MPC) yesterday made the unanimous decision to keep the repo rate unchanged at 3.5%.
The SA Reserve Bank (SARB) would likely prefer to support the fragile economic recovery with low rates for as long as prudently possible. Prior to the recent unrest, the SARB was planning to revise their 2021 growth forecast higher but say that the impact of the riots has “fully negated” the better growth results seen in the first half of the year.
The SARB’s model therefore reflects an unchanged GDP forecast from the May meeting. SA’s economic recovery will be delayed due to slow vaccination progress, Delta (and other) COVID-19 variants and riot damage.
While recent rhetoric coming from the SARB suggests that neutral interest rates should be closer to 6% – 7%, the process of moving back there will be gradual. The SARB would rather take their foot off the accelerator slowly than slam their foot on the brakes in three years’ time when inflation may have spun out of control. In South Africa, a limited energy supply means that there is upward inflationary pressure on administered prices like electricity, water, and municipal tariffs, which are passed onto the consumer.
While the SARB’s quarterly projection model suggests one rate hike in Q4 2021, SARB Governor Lesetja Kganyago asserts that they cannot “outsource” their role to a model. If the MPC feel that the model’s suggestions are not appropriate, they will not act on them.
Interest rates and SA’s fiscal consolidation prospects
Communication from the SARB suggests that even though its primary goal is inflation targeting, it is also watching South Africa’s fiscal consolidation prospects and thinking about the role that rates can play. An important “growth-friendly” policy that has emerged from the fiscus is the budding liberalisation of the electricity industry and co-generation of electrical power. Another solid victory could take the form of policies to address our high unemployment by way of labour market reforms. Where low interest rates can support such a path is via the mechanism of reducing the cost of borrowing and encouraging local corporates to roll out capital expenditure projects. For individuals, too, lower cost of capital has seen first-time house buyers emerge in force in 2020, which could have the knock-on effect of stimulating the construction sector.
Impact on money market investors
While South Africa’s June inflation print at 4.9% is cause for concern for money market investors, keep in mind that base effects are very much at play given that this is a year-on-year calculation. In 2020, our inflation plummeted to just shy of 2%, as economic activity took a nosedive through the unfolding lockdowns. The fact that SA’s policy rates are negative on an inflation-adjusted and forward-looking basis is well acknowledged by Kganyago. This means that short-term SA deposits will not fully compensate an investor for inflation erosion until rates are hiked.
Against this backdrop, investors must continually re-evaluate their ability to take on risk if appropriate to their situation. There is no one size fits all. For the extremely risk-averse, it may make sense to stay in a money market fund or in a fund with very low volatility. However, for real long-term growth, some exposure to riskier asset classes is essential.
By Thalia Petousis, portfolio manager at Allan Gray