PETER ATTARD MONTALTO: Why Reserve Bank policy is still a cut above alternative suggestions

Posted in: i-Blog, SOEs, South Africa on April 8, 2019

Decreasing interest rates will not necessarily put SA in a better situation

This column was first published in Business Day

In some ways I preferred the period of 2005-2008, when Cosatu would march to the Reserve Bank and make demands to the governor. They were simpler times, with simpler demands.

The debate is growing again about the Bank “mistakes” and “outrage” being expressed at a lack of cuts. This of course is occurring within a larger dual-track debate over the role of the Bank — with some looking to weaken the institution for state capture purposes while others are simply concerned with stuck old records about neoliberalism.

A sensible debate can certainly be had with people who want an alternative vision for the Reserve Bank. But those who want to weaken it for rent-extraction purposes and remove the blockage during the state capture years need to be called out aggressively.

Setting aside the issues of constitutional mandate, nationalisation and overall politicisation, the broad argument for an alternative Bank modus operandi within the existing monetary policy committee (MPC) mandate is that lower rates would support growth without much impact on inflation.

This is broadly the view in the market among foreign but particularly local investors, and the so-called Sandton Consensus of interest market makers. We need to stress-test the current monetary policy setting in several ways to see if it really is deficient.

First, what successes is monetary policy currently having?

Inflation expectations that used to be so volatile above target have, since 2014, become less volatile and slowly converging towards 4.5%. This is a key success of monetary policy as broadly conceived, which is a mixture of the interest rate set and the communications around it.

The “steady as she goes” thoughtfulness of the MPC, the strong string of common rhetoric between MPC meetings and indeed between governor Lesetja Kganyago and former governor Gill Marcus has sunk in to economic agents.

Lower inflation expectations reduce uncertainty for retailers who can then run tighter margins to the benefit of consumers. Meanwhile inflation pass-through from a range of factors has been at historic lows. This includes from the exchange rate into core inflation, from the VAT and other tax hikes, from oil price rises via petrol into wider prices. It is still too early to tell the impact of minimum wage hikes into wider prices but beyond the service sector pass-through here may be somewhat muted as well.

This is a significant success for the Bank and increases the welfare of consumers. While wider structurally lower growth may be partly an aid, previous bouts of low growth over history have not impacted pass-through to such a strong degree.

There are arguably two routes that price formation can take during heightened policy uncertainty such as under the Zuma years: either become more volatile as uncertainty rises if monetary policy is not credible, or become less volatile with lower pass-through as credible monetary policy.

The Bank has also helped itself (and currency volatility) by having a firmer, clearer line on currency intervention. The Bank has been increasingly clear since 2008 on its policy that it will only intervene where a breakdown of the orderly functioning of the balance of payments is occurring and not regarding levels of the currency. Once this had eventually sunk in, arguably currency markets become more efficient without the dead-weight loss of excessive speculation of Bank intervention. This in turn likely helped indirectly to anchor inflation further.

We need to also consider what good a rate cut would do and balance the costs and benefits. In isolation, it could be argued that a cut in rates would have no impact on inflation and help growth given pass-through is low.

However, a cut in rates in an environment of increasing political pressure on the institution would have a serious credibility impact and risk losing that low pass-through over time — it would also act as a ratchet effect with pressure for one cut followed by another.

It is also doubtful that small cuts would have any significant impact on current growth here. While the argument that short-term rates do not affect long-term potential, growth has become embedded and the Bank has largely won the argument with consistent communications on this issue, the short-run argument is less well rehearsed.

There is very little evidence that low growth has anything to do with monetary policy. The World Bank and World Economic Forum as well as various consultancy surveys point to a vast array of other issues, including the lack of structural reforms, political and policy uncertainty, labour market problems and lack of electricity, as all far higher on the list of concerns.

Banks have broadly saturated the economy with as much credit as they can, given the current structural problems in the economy, and would not adjust supply simply because of rate cuts — customer credit quality would not change.

Demand for credit would increase slightly after a rate cut but arguably, especially investment decisions, are being made on much larger structural issues rather than a 25-basis-point difference in the cost of credit.

In areas such as renewables technology, cost compression is driving much more than cost of credit changes, with a lack of political leadership the blockage on that front.

The current policy setting is based off a long-term view of inflation anchoring. Yet the current stance that says policy is broadly fine here and no future large moves are expected (subject to watching the data) while policy is slightly loose gets a lot of flak despite broadly making sense. This will be the key communications battleground for the Bank at next week’s monetary policy review.

The criticism is that current real policy rates are far too high at around 2.45%. Yet such a view is bizarrely short-termist, looking only at current interest rates and current inflation rates, which monetary policy cannot affect. If one looks at inflation about 18 months out, then real rates are actually 1.65%.

Markets then criticise the Bank for not cutting rates when the long end of their inflation forecast is at the centre of target of 4.5%. Yet it is only there before the Bank artificially massages it there with a hike.

The fact that the MPC is not hiking as the model says shows that they think the long-term risks of inflation being just a little bit higher are acceptable and so while aiming strongly for the centre of target are not overzealous.

The Bank’s ultimate problem is the fact it is so forward-looking versus a market that is so “now now” (or even backward-looking at data). Mix this in with a little risk aversion and the lack of much point in moving rates in either direction and so the current monetary policy stance seems entirely appropriate.

If the market spent half as much time fretting about education or health policy settings as it does for monetary policy settings, SA could well be in quite a different place, with a greater impact on growth.

• Attard Montalto is head of Capital Markets Research at Intellidex.

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