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Presentation to the Parliament Committee on Finance The South African economy: recent developments and monetary policy Ben Smit BUREAU FOR ECONOMIC RESEARCH UNIVERSITY OF STELLENBOSCH 28 March 2007 Outline Overview of the March 2007 SARB Quarterly Bulletin The MPC statement of 15 February 2007 The performance of Monetary Policy Overview of the March 2007 SARB Quarterly Bulletin The SA economy continues to produce quite high and stable economic growth 8 5.2% 6 Ave 1995-04: 3.1% pa % change 4 Ave 1985-94: 0.8% pa 2 0 -2 -4 -6 1980 1985 1990 1995 2000 2005 Growth in the 4th quarter supported by all the main production sectors 2006 Q1 Q2 Q3 Q4 Year 1994 2006 -9½ -7¼ -4 1 -4½ 11,9 10,6 Agriculture -18¾ -30 -15 -8½ -13 4,6 2,7 Mining -5½ 3½ ¼ 4½ -¾ 7,3 7,9 4¾ 7¼ 5½ 8½ 5¾ 27,7 23,0 3¼ 6¼ 4¾ 8¼ 4¾ 20,9 18,2 7¼ 6¼ 4¾ 5¼ 6 60,4 66,4 5 5½ 4½ 5½ 5 100 100 Primary sector Secondary sector Manufacturing Tertiary sector Total Share of GDP While both household consumption expenditure and gross fixed investment contributed strongly to expenditure (constant 2000 prices) 15 % change 10 5 0 -5 -10 94 96 98 00 Household consumption exp 02 04 Gross fixed investm 06 Household consumption expenditure supported by real disposable income ….. 10.0% 8.0% Y.o.Y. % change 6.0% 4.0% 2.0% 0.0% - 2.0% - 4.0% 91 92 93 94 95 96 97 98 99 Rea l household consumption expenditure 00 01 02 03 04 05 06 Rea l disposa ble income …. and by credit extension Household debt as % of disposable income 75 70 65 60 55 50 45 40 35 30 80 82 84 86 88 90 92 94 96 98 00 02 04 06 … and by consumer confidence 30 20 2006Q4 1994 election WC soccer bid announcement index 10 0 - 10 - 20 - 30 - 40 M ar -82 ar-84 ar-86 ar-88 ar-90 ar-92 ar-94 ar-96 ar-98 ar-00 ar-02 ar-04 ar-06 M M M M M M M M M M M M FN B/ BER CCI 3m mov ave Gross fixed capital formation increased in all three institutional sectors, led by the public corporations (constant 2000 prices) 200 180 160 140 120 100 80 00 02 General Govt 04 Public corps 06 Priv enterprises The upbeat overall economic conditions is reflected in, and supported by, continued high business confidence …… RMB/BER Business Confidence Index 100 •To 81 in 07Q1 from 83 in 06Q4 80 •Manufacturing ( 78(75)) 60 •Building (90(90)) 40 •New vehicles ( 72(71)) 20 •Retail ( 87(91)) 0 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 •Wholesale ( 76(88)) Employment continues to recover (BER Surveys: net balances) Wholesale: Gowth in number of people employed Retail: Gowth in number of people employed 80 80 40 40 0 0 -40 -40 -80 00 01 02 03 04 05 06 07 -80 00 Manufacturing: Number of factory workers 01 02 03 04 05 06 07 Building Contractors: Growth in employment 80 80 40 40 0 0 -40 -40 -80 -80 00 01 02 03 04 05 06 07 01 02 03 04 05 06 00 CPIX inflation increases but remain in target range 21 January 2007 18 CPI = 6.0 15 CPIX = 5.3 PPI = 9.8 12 9 6 3-6% target range 3 0 J-80 J-85 J-90 CPIX actual J-95 36m mov ave J-00 J-05 … but production prices have increased substantially during 2006 20 15 YoY % change 10 5 0 -5 -10 -15 2000 2001 2002 2003 SA produced goods 2004 2005 Imported goods 2006 Total The deficit on the current account increased to very high levels ……. 8 6 4 % of GDP 2 0 -2 -4 -6 -8 -10 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Current account: Including / excluding oil 10 8 6 % of GDP 4 2 0 -2 -4 -6 -8 1980 1985 1990 Current account 1995 2000 Current acc ex oil 2005 The exchange rate has broadly stabilized 12 10 R/$ 8 6 4 2 0 75 77 79 81 83 85 R/$ 87 89 91 93 95 PPP (1970; PPI) 97 99 01 03 05 07 Monetary Policy Committee Decision 15 February 2007 The decision: “….the MPC is satisfied that the inflation outlook has improved somewhat and expects inflation to remain within the target range for the forecast period. As the mandate of the Bank is to keep inflation within the target range, the MPC has decided to leave the repo rate unchanged for now at 9 per cent per annum.” Statement of the Monetary Policy Committee 15 February 2007 p4 MPC Statement: June 06 – Feb 07 Causal factors / Motivation Decision Inflation outlook Breach target Strong demand Current account deficit Oil price Repo rate MPCA 8/06 Deteriorate Q107 Yes Concern Concern +0,5 MPCS 3/08 Deteriorate Q107.Q207 Yes Concern Less concern +0,5 MPCS 12/10 Upside risk Around 6% Q2-Q407 Yes Concern Less concern +0,5 Yes Deficit improve somewhat Concern +0,5 Yes Sharp deterioration (but oil) Less concern 0 MPCS 7/12 MPCS 15/02 Improved Improved Q207 No MPC statements on the BoP current account deficit 1. “In previous statements the MPC expressed concerns about the expanding deficit on the current account of the balance of payments. Current account deficits are a reflection of higher domestic expenditure and in themselves inflationary. There is however a possible risk to the exchange rate if the deficits are perceived to be unsustainable, particularly if the deficits are reflecting higher consumption expenditure.” MPCS 3/08/07 2. “We have explained on a number of occasions that the MPC does not have a target for the current account, nor does the MPC view deficits on the current account to be inflationary in themselves. The mandate to the Bank is to maintain inflation within the target range of 3 to 6 per cent. The risk to inflation arises if the market perceives a particular level of the current account to be unsustainable, which could have implications for the exchange rate and, consequently for the inflation rate. To date the current account deficit ….. Has been adequately financed. Current developments appear to indicate that the current account deficit will continue to be adequately financed given the coherent macroeconomic policy framework of the country and positive growth prospects.” MPCS 15/02/07 Current account vulnerability Balance of payments as % of GDP 8 6 4 % of GDP 2 0 -2 -4 -6 -8 -10 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Current account balance as % of GDP – 2005 relative to EM countries NIGERIA CHINA PHILIPPINES EGYPT BRAZIL ARGENTINA PERU INDONESIA MOROCCO AVERAGE CHILE MEXICO ECUADOR DOMINICAN REPUBLIC TUNISIA COLUMBIA THAILAND URUGUAY PAKISTAN EL SALVADOR SOUTH AFRICA 2006 X (-6,4) PANAMA TURKEY -8 -6 -4 -2 0 2 4 6 8 10 12 14 Whose the culprit? Trade balance & services and income balance as % of GDP 12 10 8 % of GDP 6 4 2 0 -2 -4 -6 -8 1960 1965 1970 1975 Trade blance 1980 1985 1990 Services balance 1995 2000 2005 (Disappointing) export and (booming) import volume indices and the Terms of Trade 175 165 2000 -2006 155 145 Exports: 100 121.4 135 Imports: 100 171.3 125 ToT: 115 105 95 00 01 02 Exports 03 Imports 04 05 Terms of Trade 06 100 113.6 Saving and investment as % of GDP 21 20 2000 -2006 % of GDP 19 18 Saving % GDP: 15.8 13.9 17 16 Investment % GDP: 15.9 20.3 15 14 13 2000 2001 2002 2003 Savings 2004 Investment 2005 2006 Does the current account matter? Empirical evidence Size of deficits (Edwards (2004,2005)) – 157 countries, 1970 – 2001 – >50% of countries, deficits >3,1% of GDP – >75% of deficits (3rd quartile) ≤ 7,2% of GDP – 26 of 157 countries experienced high deficits for 5 years or longer once Reversals – Edwards (2005) Incidence 9,2% (11,8%) – Milesi-Ferretti and Razin (1997) 116 reversals in 60 countries (1974 – 1990) – Output cost of reversals SA’s resilience to sudden stop/reversals Floating currency Borrowing small part of inflows Rand denominated foreign debt (“original sin”) Forex reserves improve MPC – The right decision? Trade-off between improved inflation outlook and continued strong domestic demand and the associated balance of payments deficit. Choice determined by judgment of risk of deficit becoming unsustainable and associated exchange rate, inflation and output consequences and of strong demand fuelling inflation. Performance of Monetary Policy Inflation record 12 11 10 9 8 7 6 5 4 3 2 1 00 01 02 03 04 CPIX 05 06 07 Anchoring inflation expectations 11.0 10.0 9.0 8.0 7.0 2006Q4 6.0 5.0 4.0 3.0 2.0 2003Q1 2004Q1 Average 2005Q1 Analysts Business 2006Q1 Labour Handling of supply shocks “The response of monetary policy to supply shocks appears to be countercyclical, i.e. dispelling somewhat the idea that monetary policy may have been overly procyclical in response to supply shocks.” Frankel, Smit & Sturzenegger (March 2007): Macroeconomic challenges after a decade of success, p68 Policy transparency “Central bank transparency in South Africa has improved greatly under inflation targeting, from a score of 5 in 1994, to 9 in 2004 (out of a possible 15)” Aaron and Muellbauer (March 2007): Transparency, Credibility and Predictability of Monetary Policy in South Africa, Mimeo, p5 Forecast accuracy “… no other forecasting agency consistently produced more accurate inflation forecasts than the Bank in the period May 2003 to December 2005.” SA Reserve Bank (Nov 2006): Monetary Policy Review, p31 Other issues Contribution to output and price stability Room for the “pursuit” of other goals such as exchange rates/Bop, growth Overly conservative / too high interest rates Bureau for Economic Research Economic information that works for you Website: www.ber.sun.ac.za E-mail: Tel No: [email protected] 021-887 2810 xxxxx xxxxxxxxxxxxx xxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxx xxxxxx xxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxx xxxxx xxxxxxxxxxx xxxxxxxxxxxxxx xxxxxxxxxxxxxxx