You have to hand it to Reserve Bank governor Lesetja Kganyago. He loves to give colourful economic explanations, but yesterday he excelled, treating journalists at Thursday’s monetary policy committee briefing to an account of a series of complex financial markets concepts in nursery school terms.
Were you wondering what the markets folk mean when they talk about spreads? Or about country risk premiums? Think butter or jam. Foreign investors will eat the US government’s slice of bread just as it is, lending to the US government at US treasury bond yields that are viewed as the risk-free rate. But when it comes to a small open economy such as SA with fiscal challenges, investors will demand some form of incentive to eat the bread. “They won’t eat unless you put some spread on it. That spread is the country risk premium,” says the governor.
The country risk premium feeds into yields on long term government bonds, which as the committee pointed out are extremely high and priced at a wide spread to US treasuries. That’s in part because of SA’s fiscal outlook — a subject on which the governor and his deputy, Kuben Naidoo, both former senior Treasury officials, were careful not to discuss.
But the reason that stuff matters for monetary policy is that the country risk premium feeds into the so-called neutral real rate of interest, the rate that neither stimulates nor contracts the economy. That’s used to determine whether monetary policy is loose or restrictive. Now, with the benchmark repo rate kept at 8.25%, inflation falling to an average 5.3% in the year ahead and the neutral real rate estimated at 2.5%, policy is definitely restrictive. And the Bank is explicitly keeping it there, slowing the economy to tackle an inflation rate it believes is not slowing fast enough and inflation expectations that are still well above the midpoint of the inflation target range.
Take a step back though, and SA’s rather fierce monetary policy stance doesn’t seem to add up entirely. SA didn’t act quite as early as some of the Latin American countries to clobber inflation as it started to climb globally in 2021 — the Latin Americans really do know inflation when they see it, and they didn’t wait to see whether it was transitory or persistent, as the US and other advanced countries did. However, SA did start hiking rates quite early on, in November 2021, and Kganyago and his team can claim a reasonable degree of success. SA’s headline inflation rate never went higher than the 7.8% at which it peaked in July 2022 — higher than the top of the 3%-6% target range, but nothing like five times the target as in the US or UK.
And it has declined quite rapidly to the current 4.8%. The Reserve Bank now expects headline inflation to average just under 6% this year and to come down to the 4.5% midpoint by late 2025. That seems slow, but what’s more striking is the core inflation rate, which reflects the underlying price pressures in the economy excluding the volatile, externally-driven fuel and food prices. And in a very weak economy, with growth forecast at just 0.6% this year and 1% in 2024, there’s clearly very little underlying inflationary pressure.
Not for SA, sadly, the “overheating” economies of the advanced countries with their labour shortages and still strong pricing pressures. SA’s core inflation rate is forecast to average under 5% in 2023 and to stay well within the 4% range over the next two years. Economists such as Goldman Sachs’ Andrew Matheny think the disinflationary pressures will be even stronger than the Bank expects, with the economy performing well below its potential.
The trouble is the Bank doesn’t really have the headroom to decide interest rates on SA’s underlying price pressures alone, as the US Fed might, for at least a couple of reasons. One is self-imposed: Kganyago has made it clear the Bank wants to lower the inflation target towards a level (possibly 3%) closer to that of our major trading partners. Interest rate cuts, when they come, might be slower if the Bank is aiming to push inflation lower than 4.5%.
Other constraints are more external. Further shocks could lift fuel or food prices again. And crucially, no-one is too sure yet whether advanced economies have inflation under control, whether they will hike further, and how long interest rates will stay high even if they don’t. That global uncertainty and volatility is likely to be bad for the rand, and therefore for inflation. To that must be added the butter and jam of SA’s country risk premium, which feeds through into inflation and monetary policy via at least two channels — the rand and the neutral rate. In other words, SA’s fiscal policy is indirectly putting pressure on the Bank to keep interest rates higher than they might otherwise have been, though foreign policy and load-shedding have fed the risk premium too.
Investors would be demanding even more butter and jam if SA didn’t have an independent and somewhat hawkish central bank, standing firm against inflation and also, crucially, against any move to get it to help government out with its borrowing costs, as some commentators have suggested it should. In theory, the central bank could help with those high yields by intervening in the bond market in some form or imposing regulatory requirements on banks that compel them to buy even more bonds than they already have. In practice, nobody in the government has suggested any such thing, and Kganyago and his team would surely clobber anyone who tried.
They have the constitutional independence to do so. The question is whether their replacements will use it as fiercely and expertly, and indeed as colourfully, as they have done. And here’s the risk. Kganyago’s term ends in November 2024; the terms of two of the deputy governors end in August. They can be reappointed by the president, whoever he or she is after next year’s election. Hopefully they will be reappointed, or replaced by equally expert and independent-minded people.
A key protection is that a new governor must have served as a deputy governor: deputy Fundi Tshazibana is seen as a likely candidate and she is well regarded in the market. But she would need the support of good deputies too. Much depends on who will be making those appointments next year, and in 2025. Those spreads will tell the story as the time nears.
• Joffe is editor-at-large.
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