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How Sarb aims to help grow the ailing economy

Aug 26 2016 17:29
Lameez Omarjee

Johannesburg – The South African Reserve Bank (Sarb) will be focusing on achieving price and financial stability, for long term growth said Daniel Mminele, deputy governor of the bank.

Mminele delivered an address at the University of KwaZulu-Natal’s fourth Business Management Conference, in Durban on Friday.

He explained that the “best contribution” the central bank can make towards growth is to implement policies that provide a stable environments for the economy and financial markets.  

The Sarb estimates potential growth to remain under 2% until 2018. Price and financial stability alone cannot create growth. But they provide a platform that enables medium and long-term growth, said Mminele.

“The finance sector has become an increasingly important contributor to growth,” he said. The sector contributed 22% to GDP in 2015, up from 17% in 2000. “Stability in this sector is thus important to the South African economy as a whole, and also supports a more efficient transmission of monetary policy.”

Achieving price stability means that investors are guaranteed a competitive and predictable inflation environment. This leads to greater certainty over future business conditions and lower long-term interest rates, explained Mminele. 

Meeting the 3% to 6% inflation target will ensure price stability. The success of inflation targeting depends on the ability to manage inflation expectations. Since committing to targeting inflation in 2002, the rate has averaged around 5.9%, compared to levels of 11.2% between 1970 and 2000.

Managing inflation expectations

“The inflation rate remains structurally high. Higher, in fact, than in other emerging markets and in the countries of rival exporters,” said Mminele. This drives a greater need to manage expectations.

Inflation has spiked outside the target range in some instances. Subsequently inflation expectations had shifted upwards, from an average of 5% from 2004 to 2007, to an average of 6.1% between 2011 and 2013. “They have remained stable since then, but are unfortunately stable right at the top of the target range,” he said.

If expectations are lower, the target range would be more resilient to price shocks which would allow for more flexibility for the monetary policy, he explained. If second-round effects occur as a result of a shock, this will set off a chain of price increases in the economy, that would possibly drive inflation higher.

Current hiking cycle

The current hiking cycle has intended to prevent second-round effects. This would mitigate the risk of a steeper and rapid interest rates at a later stage, he explained.

“If price makers in the economy trust the central bank to maintain medium-term inflation within the target range, then they expect exogenous shocks to be temporary and are less inclined to increase their prices in response.”  However if they do not trust the central bank’s ability to contain inflation within the target range, then they will react by raising prices.  

The Sarb lowered its forecasts in May and July. But inflation is expected to remain above the targeted range until the middle of 2017. It is expected to peak in fourth quarter of 2016 at 7.1%.

The MPC increased the repo rate by a cumulative 200 basis points since January 2014 to the current level of 7%. In July the Sarb allowed for a pause in its hiking cycle.

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