Ahead of the mini-budget on Thursday (11 November), to be delivered for the first time by new finance minister Enoch Godongwana, the South African Reserve Bank continues to play its cards close to its chest, notes Thalia Petousis, fund manager at Allan Gray.
Interest rates in South Africa are poised for lift-off, but the South African Reserve bank (SARB) is reticent to provide guidance, she said, adding that South Africa should prepare for interest rate hikes given the rising inflationary pressures and global energy shortage currently unfolding.
“To arrive at South Africa’s neutral level of interest rates, the quarterly projection model used by the Monetary Policy Committee (MPC) implies a rate hike in November 2021 and at each meeting in 2022 and 2023, lifting the repo rate to roughly 6.5%,” said Petousis.
“Whether the MPC follows the guidance of the model remains to be seen.”
South Africa’s central bank held its benchmark interest rate for a seventh straight meeting in September’s monetary policy committee, keeping the repurchase rate at 3.5%.
The MPC is scheduled to meet mid-November to decide on the fate of the current levels of interest rates. Petousis said that while the MPC continues to express agreement via their unanimous vote count to keep rates on hold, they convey divergence in their informal forward guidance for rates.
“SARB Governor Lesetja Kganyago has indicated his preference for targeting the lower end of the inflation band, or 3% – 4.5%, saying that higher inflation begets higher interest rates, and vice versa. He would like to adopt structurally lower national interest rates going forward,” the fund manager said.
She added that targeting an inflation level of 3% and setting interest rates accordingly could filter into the real-world economy via some mechanisms.
“Rental agreement escalations often bake in the targeted inflation number. Employers will set their wage agreements to escalate at 3%, which will inform the additional spending power of consumers each year. This will feed into demand, which in turn will influence prices. The mindset of the economy shifts to expect lower inflation and, as with many things in life, it is those expectations that can become self-fulfilling,” she said.
However, Petousis said that other members of the MPC continue to anchor around higher guidance – asserting that inflation at 4.5% with a 2% real uplift implies interest rates at 6.5%.
“Locally, our insufficient national energy supply is perhaps too great a structural impediment to South Africa realising permanently lower inflation and rates. Adding to the complexity is the many inflationary factors outside of the MPC’s control, such as ambitious US spending packages, the potential for a global energy shortage, the rising cost of food and labour, and a developed world transition to decarbonisation utilising more expensive green energy.
“Multiple supply shocks that persist for longer than expected are harder to look through,” Petousis noted.
She said the MPC’s quarterly projection model is programmed to align with such thinking, but what is telling is that the model is no longer charitably referred to by the Governor as a “trusted additional member of the committee” – he now maintains that he will not outsource the role of the SARB to a mere forecasting tool.
“Rates will need to rise from current levels, and the lifejacket offered to indebted consumers will begin to deflate, meaning the beginning of better interest rates for savers. That said, some members of the MPC continue to highlight that they do not want to damage the fragile economic recovery by pre-emptively raising rates. Either way, monetary policy is a blunt instrument that cannot address economic nuances like the collapse of the hotel and leisure industry.
“In terms of how aggressive the rate hiking cycle will be, and where rates ultimately land, we will have to wait and see,” said Petousis.
Bernard Drotschie, chief investment officer at Melville Douglas says that the government can play a central role as a catalyst for a more favorable business environment in South Africa.
“The government, with the help of the National Treasury, the Reserve Bank and the private sector, is on track to focus on areas that will make a difference in the private sector’s willingness to invest, ultimately resulting in job creation and improving the general well-being of the population.”
Drotschie said that progress has been made in certain sectors, such as renewable and subsistence energy production, giving companies greater flexibility in their day-to-day planning, production, and investment activities.
Privatisation efforts within some state-owned companies such as Eskom and Transnet, with an emphasis on improving infrastructure services, should also be celebrated, he said.
In many cases, however, he said that the delivery has been too slow, and more needs to be done to regain consumer and business confidence and increase SA’s potential growth rate, which has been declining for over a decade now.
“The much-discussed spectrum license has still not been awarded and leads to excessive network costs for the end-user, and the long-awaited change to the country’s visa regime remains unresolved. These are initiatives that would make a significant difference in attracting foreign skills and boosting the tourism industry, one of the largest employers in the country.”
On the plus side, Drotschie said that the country has returned to level 1 in Covid-19 mitigation, meaning one of the biggest obstacles to recovery has been lifted, at least for now, and key economic indicators point to a brighter future.
“If all goes according to plan, SA will be taken off the UK’s red list, which will give a huge boost to the fortunes of the tourism and leisure industry.
Drotschie noted that the local economy has also benefited from low-interest rates and income support measures that have supported consumer spending. In addition, positive trading conditions resulting from high precious and base metal prices have benefited the trade balance, fiscal position, inflation and rand value.
New year, same problems
Heading into 2022, the investment specialist said that the economy will face headwinds in the form of slowing global economic growth dynamics, falling commodity prices and a less accommodative Reserve Bank, as global monetary policy is poised to tighten.
“However, it is important to keep things in perspective. While the outlook for global growth has deteriorated, growth remains robust, and most economies are expected to grow beyond their long-term potential next year.”
Drotschie said that the challenge for the economy and policymakers is how to sustain the economic recovery, which in the case of South Africa is not yet over, if monetary and fiscal policy support is withdrawn and the global context eases. “High metal prices have greatly benefited the mining sector and its suppliers, and above-average rainfall has supported the agricultural sector, but this will not last indefinitely given the cyclical nature of these industries.”
The economy is expected to grow more than 5% this year and earnings growth will exceed 50%. Low-interest rates and rising prices for our exports have played an important role in supporting the cyclical recovery and public finances, the investment lead said.
“It is therefore crucial that South Africa becomes less dependent on the vagaries of the global economy by ensuring that the announced growth reforms continue to gain momentum, including by lowering the cost of doing business and diversifying revenue sources.”