SARB threat underestimated, warns economist

Cape Town - The SA Reserve Bank (SARB) is at risk of becoming a scapegoat for low growth into 2019, emerging markets economist Peter Attard Montalto of Nomura said on Friday.

"The ANC is currently struggling to gain traction with the narrative that the country’s low growth is the fault of the global economy or the domestic private sector. As the 2019 elections approach, we expect the SARB to be set up to take the blame, facing criticism for keeping monetary policy too tight since 2008, being too inflation-focused and not targeting growth or job creation enough," he explained.

"We agree with the SARB that most of the low growth is due to political, policy and regulatory uncertainty as well as a failure to push forward meaningful structural reform – not the fault of monetary policy which we view as broadly neutral here."

In Montalto's view, the market is underestimating the threat to the SA Reserve Bank (SARB) and its independence.

"It is easy to dismiss the current focus on SARB's mandate as simply part of the political noise in this succession year...The market view seems to be that the government sets the inflation target. In fact, legally it is the SARB that sets its own mandate for the MPC on inflation," explained Montalto.

In his view, the SA Constitution indicates that SARB has ultimate target-setting as well as operational independence - it has just never chosen to publicly test this.

The way Montalto sees is, the SARB has just never had to test it publicly, because up to now it has had "a strong cooperation and coordination with the National Treasury".

Now, with the SARB under attack, according to Montalto, the market is confused about the extent of the legal basis of the SARB’s independence.

"We do not believe a precedent exists for National Treasury to 'direct' the SARB. SARB is at risk of becoming a scapegoat for low growth into 2019," said Montalto.

"Changing the constitutional objective seems impossible in the short to medium run, but personnel changes after the 2019 elections are a key risk now."

Specific context

From Montalto's perspective, current events regarding SARB are happening within a very specific context.

"The Zuma faction within the ANC sees the SARB as a blockage to more radical transformation within the financial services sector, including allowing banks to maintain too tight a set of credit standards that is seen as restricting credit from black SMEs and black industrialists, as well as not applying enough pressure to banks on black ownership and black management criteria," said Montalto.

"The SARB is also, through its systematic imposition of a consistent rules-based system, seen as a blockage against bank ownership by politically connected parties and a frustration at its application of exchange controls in the same vein."

Public Protector

According to Montalto, the recent report by the Public Protector on the Bankorp bailout by the SARB - some 27 years ago and more specifically relating to ABSA some 20 years ago - has led to an idea being floated about changing the SARB’s constitutional objective. He adds that Nomura differentiates between the constitutional objective that governs the whole SARB and its MPC mandate which relates only to monetary policy.

"In our opinion, the problem for the SARB - and investors in the long run - is that markets are far too near-sighted here and too willing to dismiss the threat as being too far away or unlikely to happen because of still-overestimated expectations of a (Cyril) Ramaphosa camp win in December,"' said Montalto.

"Our point is that a lot of damage can be done in the short term to investors’ sentiment even if there are no changes to the SARB’s objective or mandate. However, just as the lack of a severely negative market reaction at the end of March between Pravin Gordhan’s recall from London and his firing a few days later did not prevent that event, so we believe that a lack of market reaction now will directly embolden the forces attacking the SARB."

Correctly pricing the risk

In Nomura's view, it will ultimately be up to ratings agencies to correctly price the risk – and if this path is maintained it could directly accelerate downgrades and eventual index events.

"We think markets and ratings agencies have overestimated the 'strong institutions narrative' of South Africa. Yes the free media, court system and SARB have been bedrocks, but we can see how quickly views of institutional quality can be eroded or called into question," said Montalto.

"We will then watch the government’s interactions on the financial sector charter review through the third quarter, which may again be used to highlight the SARB’s role in overseeing the financial sector and its progress on transformation. Bank ownership issues may come up here as well. We expect some suggestions that the Mining Charter could be repeated for the financial sector."

Montalto sees it as very difficult to shift things in the short term, "but the environment of tension around the SARB could grow further with more future policy change promised and a future SARB becoming clearer as a risk event on the horizon, which in turn would impact ratings most directly even if markets continue to discount".

He said Nomura thinks it would be premature to start thinking about the impact on monetary policy of a different mandate or objective. However, the increased risk to ratings reinforces the risk of higher funding costs, a steeper curve and weaker rand in the medium run.

"Our monetary policy call remains that, with a view to there being a relatively small output gap - given most of the low growth is from structural constraints including politics - so inflation will remain high and sticky in the medium run and hence the MPC will see no reason to cut rates through the end of the forecast horizon."