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Rate hike first step to stability - economist

Jan 29 2016 11:58
Carin Smith

Cape Town - The repo rate hike by the SA Reserve Bank (Sarb) on Thursday is but one step amid broader policy tightening, according to Arthur Kamp, investment economist at Sanlam Investments.  

"Amid waning liquidity, higher funding costs, rand weakness and rising inflation South Africa needs a decisive policy response," said Kamp.

He regard the 50 basis point repo rate hike to 6.75% per annum as the first step needed to maintain macroeconomic stability.

"Waning foreign capital inflows have been insufficient to cover the current account deficit, culminating in a weak rand. Although the feed-through effect from rand weakness into inflation has been modest in recent years, it would be a surprise if the rapid decline in the currency since October 2015 does not cause a marked increase in inflation," said Kamp.

In addition to the collapse in commodity prices, the root cause of SA's poor gross domestic product (GDP) growth performance is to be found mainly in weak productivity levels and infrastructure constraints.

"When an economy’s supply side is not functioning efficiently, there is little the monetary authorities can do to lift growth," said Kamp. "Rather, the task at hand for the Sarb is to contain inflation expectations and maintain a relatively stable, low inflation rate (between 3% and 6%) over the medium to long run."

Sarb has indicated that further interest rate hikes seem likely, although the extent of this will depend on the future behaviour of the currency, actual inflation outcomes and inflation expectations.

"Tightening monetary and fiscal policy can be expected to inflict pain on the economy in 2016, but the alternative appears worse. Foreign savings are needed to fund investment," said Kamp.

"Should the policy response fall short, South Africa is likely to struggle to fund its current account deficit, which implies economic growth cannot lift. If so, we risk slipping into a prolonged stagflation environment of elevated inflation and low growth."

In his view, SA requires material structural economic reform to lift productivity and growth meaningfully.

READ: Rand cheers steep rate hike

The sluggish economy means that many consumers will have to tighten their belts this year in anticipation of slow growth and rising costs, cautioned Jeanette Marais, head of client service and distribution at Allan Gray.

"Rising interest rates must be looked at in conjunction with inflation, to ascertain the real impact on one’s savings,” explained Marais. Investments have to grow by more than inflation each year before one can expect to achieve any real return.

The half percentage point increase may seem small, but it will have far-reaching effects on both business and wage-earners, according Janine Myburgh, president of the Cape Chamber of Commerce and Industry.

"The increased interest rates should be seen as part of a downward spiral in economic activity and, as the cost of living rose, business should prepare for new and probably unaffordable wage demands later this year," she warned.

David Crosoer, head of research and investments at PPS Investments, anticipates that, despite the rate hike, a number of variables outside their control could still lead to inflation edging higher than Sarb anticipates. These variables include further electricity hikes, a potential VAT increase and an even greater pass through effect from the weak rand.

READ: Sarb hikes interest rate by 50bps

Sanisha Packirisamy, economist at MMI investments and savings, said Thursday's hike has likely entrenched the Sarb’s credibility.

"They have shown a firm commitment to their inflation targeting regime by reacting pre-emptively to a rising inflation trajectory. In our view, a higher inflation profile, stubbornly-high inflation expectations and a sizeable current account deficit still point to the need for a further rise in interest rates," she cautioned.

She expects rates to rise by a further three increments of 25 basis points each over the course of 2016-2017.

Andrew Rissik, managing director of Sable Forex, said the hike might arrest decline of the rand in the very short term, however, to raise rates to curb inflation seems rather pointless to him when inflation is in fact being driven by what he calls "structural deficiencies in the way the economy and state owned enterprises are managed".
 
"Inflation is not a demand drive, so using a rate hike to cool something that is already cold will further stump any economic uptick," he said.

ALSO READ: Interest rates could hit 7% at end-2016

sarb  |  interest rates  |  sa ecnomy

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