South Africa’s rising country risk is putting upward pressure on interest rates, even as inflation expectations are dropping, with credit-rating companies contributing to the negative sentiment, according to the Reserve Bank.
Moody’s Investors Service cut its 2020 economic growth forecast for South Africa to 0.7% from 1% on Monday and said the country’s relatively high real interest rates are constraining expansion.
The ratings company is the only major one that still considers South Africa’s debt investment grade and after it changed its outlook to negative in November, that assessment is at risk.
Credit-rating companies are contributing to a view in financial markets that South Africa is riskier than in the past, Chris Loewald, a member of the bank’s Monetary Policy Committee and head of economic policy development and research at the Reserve Bank, told lawmakers in Cape Town on Tuesday.
Based on credit-default swaps, markets are already pricing in South Africa as below investment grade.
“The higher South African premium creates upside pressure on rates, which is difficult to ignore,” Loewald said. “Lower risk would create space for lower rates.”
The inflation-targeting central bank has often drawn criticism from politicians and labor unions who say it should be doing more to bolster an economy stuck in its longest downward cycle since at least 1945 and reduce unemployment that’s at 29%.
While the MPC reduced its key interest rate by 25 basis points in January, the real rate, which adjusts for price growth, remains above 2%.
Africa’s most-industrialized economy hasn’t expanded at more than 2% annually since 2013 and neither the central bank nor the National Treasury see it reaching that level by 2022.
A government report on Wednesday will probably show inflation quickened to the fastest pace in more than a year in January. Still, it remains close to the 4.5% midpoint of the target range. South Africans are getting used to lower inflation and price-growth expectations are coming down, Loewald said.
“The trajectory of inflation, the risk factors, feed into the way monetary policy is thought about,” he said. “South African growth challenges go far beyond monetary policy.”