Interview: Lesetja Kganyago
To what extent are inflationary pressures driven by exogenous rather than domestic factors?
LESETJA KGANYAGO: A combination of external and internal factors impact inflation in South Africa, which influences monetary policy decisions. In 2015 the Monetary Policy Committee (MPC) meetings consistently highlighted that risks to the inflationary outlook would come from the exchange rate, which will largely be driven by the impending rise of US interest rates. We expect that when the takeoff occurs, there will be some capital outflows from South Africa, leading to a re-pricing of South African assets. As re-pricing entails a currency depreciation, it becomes a source of inflation to the extent that it could lead to second-round effects. Another significant source of inflation which we have identified is the price of food. Though food prices are declining globally, they are going up here because of drought conditions affecting feedstock such as maize.
A third factor is the rising electricity tariff. Eskom’s financial struggles and a sluggish domestic economy led to a tariff rise in 2014; however, that doesn’t look like a one-off event as another rise seems likely, going into a new multi-year price determination, which could lead to second-round effects. Fourth, wage settlements that are way above productivity gains ahead of the targeted inflation rate could become a source of inflationary pressure going forward.
Lastly, inflation expectations seem to be anchored around the upper end of our target band of 6%. It becomes interesting to look into who believes inflation will go up: analysts think it will stay within the target, while business and labour believe it will go above. The latter two are the price setters, so if they believe inflation will be above target, it becomes worrying as they end up setting wages and prices higher.
What could dampen inflationary pressures is the behaviour of the price of oil and thus of fuel. Oil and fuel prices came down in early 2015, which provided benefits. However, given our exchange rate, these were somewhat constrained for South Africa.
How sensitive is the rand to external pressures?
KGANYAGO: The rand is highly traded and considered an emerging market bellwether, and thus can be sensitive to exogenous factors. In 2015 South Africa’s external vulnerability improved in line with the trade balance, based on an import slowdown rather than export growth. The country also has a strong international investment position that mitigates against external vulnerability. Government borrowing is predominantly in the domestic market, with about 10% of outstanding debt denominated in foreign currency. That said, foreign investors hold about 40% of domestic bonds. This means that when the US interest rate lift-off takes place, there might be a sell-off domestically. South Africa has an advantage over other emerging markets in that we have a strong domestic investor base in insurers and pensions funds. About 70% of rand trading takes place offshore, and its volatility led the MPC to decide that we can’t determine its rate through policy. Nonetheless, South Africa faces a policy dilemma of rising inflation at a time when the economy is trapped in a low-growth environment.
What is the biggest risk facing South Africa’s banking sector at the moment?
KGANYAGO: As South Africa has complied with Basel III requirements, enhancing the resilience of the banking sector, credit and liquidity risks for the most part have been effectively dealt with. However, given structural issues in domestic funding markets the net stable funding ratio is proving to be challenging as banks need to better match up assets with liabilities, likely requiring extended maturities. One big risk is a slowdown in the domestic economy. Not only will there be an increase in defaults, but the retrenched will not borrow and banks will extend fewer loans.
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