The bright side of the Reserve Bank’s decision to hike rates

 ·4 Apr 2023

While the South African Reserve Bank’s latest decision to raise interest rates by 50 basis points will undoubtedly put pressure on debt holders, there are definite positives to the move, says Thalia Petousis, portfolio manager at Allan Gray.

One positive is that the higher rate makes South Africa a much more attractive destination for investors, Petousis said. Another is that it shows that South Africa’s central bank is not asleep at the wheel when it comes to executing its mandate.

On the first point, Petousis said that the South African money market is fast becoming a saver’s haven.

“The overnight repo rate of 7.75% as at end-March is in fact its highest level in almost 14 years. Per the SARB, the extent to which it will keep adjusting the repo rate higher will depend on how confident it is that SA consumer price inflation (CPI) is getting closer to its target of 4.5% year-on-year, with the latest data print for February CPI at a still-elevated level of 7%,” she said.

“As the impact of load shedding bleeds into an elevated cost of production and wreaks havoc on food retailers’ business operations, food inflation is also garnering more attention. The SARB has remarked on several occasions that SA food price inflation is rising much faster than their models suggested, most recently at 14% year-on-year in February.”

Key in the SARB’s decision to keep raising rates has also been the dismal state of the country’s trade balance, which measures the value of exports, less imports.

“This has swung sharply into deficit given the decline in SA exports as platinum group metal prices weaken and mining production volumes are hampered by load shedding and rail failures,” Petousis said.

A “trade deficit” or “current account deficit” implies that more currency is being spent via imports than those brought into the country via exports, and it requires foreign financing to plug the gap.

This, in turn, requires the SARB to be sensitised to the factors that drive foreign capital flows into the country – perhaps the most important of which is the attractiveness of SA interest rates as an investment destination.

“Against the interest rates of Mexico and Brazil at 11% and 13.8% respectively, it implies that the SARB has had some wood to chop to get SA in the running. On a real (inflation-adjusted) basis, SA’s overnight rate of just 0.75% is also meek versus those of Mexico (3.4%) and Brazil (8.2%).

“As a result of the SARB’s interest rate hikes, one-year bank money market instruments traded to as high as 9.1%, helping our Money Market Fund to raise its weighted average yield,” she said.

Taking action

Speaking to the second positive, Petousis noted that the SARB has done what it can, within its mandate, to tackle high levels of inflation, and hasn’t simply been muddling along or playing catch-up with global markets.

The central bank has been quick to acknowledge that South Africa is experiencing the lowest growth period in its modern history, marked most recently by the widespread failure of basic infrastructure such as electricity, roads, rail and water.

South Africa’s problems arise from structural constraints to growth and are not issues that the blunt instrument of monetary policy can address, the investor noted.

The SARB has an inflation-targeting mandate and must act to protect the rand and inflation so that the incomes of the neediest are not eroded. In this respect, the bank has been taking decisive action.

By contrast, the US Federal Reserve plays with a very different set of variables. Until recently, the US Fed had kept on a hiking path until a major crash happened within its financial markets – when Silicon Valley Bank collapsed.

Despite the other factors at play – such as the bank’s poor risk management frameworks – the market concluded that the impact of rising interest rates on US Treasury holdings was simply too much to bear, and has subsequently priced for the Fed to begin cutting interest rates, Petousis said.

However, South African banks, by contrast, remain well capitalised, hold sizeable buffers of high-quality liquid assets, and have large interest rate hedging programmes alongside robust risk management practices, Petousis said.

“South African banking regulations require our banks to adhere to far more stringent risk limits than those required of the US regional banks that have found themselves in troubled times,” Petousis said.

This has given the SARB room to act independently and also focus on local factors, instead of simply following the global trends.

“While some would comment that South Africa simply ‘follows’ the interest rate moves of the US, the SARB in fact began hiking interest rates more than a quarter ahead of the Fed back in 2021.

“While the SARB remains sensitised to the level of South Africa’s real rate of interest within the context of global financial rates, it retains independence of thought from offshore central bank players and is ahead of the curve in terms of acknowledging the risks of inflation persistence.

“Ours is not a central bank to be caught sleeping at the wheel, and we should be proud of it,” Petousis said.

Read: The Reserve Bank’s load shedding nightmare

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