Are South African interest rates unnecessarily high?

Are South African interest rates unnecessarily high as one economist claims? Other economists say the South African Reserve Bank is maybe sometimes over-enthusiastic when it comes to rates, but it also keeps consumers from taking up unnecessary debts and it definitely benefits people with savings.

Economist Dr. Roelof Botha this week repeated his views on Newzroom Afrika that South Africa’s interest rates do not need to be as high as they currently are. He added that the South African Reserve Bank (Sarb) ‘nonsense’ costs South Africans at least R4 000 per month, warning them that they are paying the cost of an unnecessarily harsh monetary policy.

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Prof. Bonke Dumisa, an independent economic analyst, says on the whole, he fully agrees with Botha that the Monetary Policy Committee (MPC) of the Sarb sometimes becomes over-enthusiastic in hiking the repo rate.

“The reason I agree with Dr Botha is because it is often but definitely not always true that the Sarb simply pushed up the repo rates reacting to imported inflation caused by the exaggerated skyrocketing international Brent crude oil prices which were mainly due to the Russian invasion of Ukraine.

“The invasion caused Brent crude oil prices to jump from below US$80 per barrel to very close to US$140 per barrel within three weeks after the Russian invasion of Ukraine. Increasing repo rate under these circumstances does not reduce inflation but instead pushes it up.”

Hiking interest rates effective to stop credit spending

However, he says, it is important to note that the repo rate hike “tool” is very effective in cases where people are increasingly resorting to credit spending as increasing debts is very inflationary. “Under those circumstances, when the repo rate is increased, it discourages inflationary spending which tames inflation.”

Unfortunately, with the mostly imported inflation we had in South Africa 🇿🇦 due to skyrocketing international Brent crude oil prices, some (not all) of the repo rate hikes we had only increased the plight of South Africa without necessarily reducing inflation because they did not reduce the fuel price increases but instead increased inflation, he says.

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Sanisha Packirisami, economist at Momentum Investments, points out that the Sarb takes a number of considerations into account when setting monetary policy.

“The MPC noted in the past that it tends to look through the first-round shocks of inflation and will act when second-round effects take hold on the economy, such as when food and fuel pressures broaden out to the remainder of the economy and labour and businesses adjust prices upwards in response to a rise in cost-of-living pressures.”

She argues that inflation expectations on a two- and five-year basis remain uncomfortably in the top half of the inflation target range which has guided the Sarb to maintain a cautious approach to monetary policy in case of second-round inflation pressures triggered by inflation expectations which are not firmly anchored to the midpoint of the target where the Sarb desires inflation to settle.

Services inflation also very high

“More recently the Sarb highlighted that services inflation has ticked higher to 5% and is now contributing more to headline inflation, a phenomenon common in developed market economies. The risk is that services inflation could, given its nature, remain sticky for longer, which could keep inflation expectations elevated.”

In addition, Packirisami says, monetary policy carries a heavier burden to quell inflationary pressures in an environment where fiscal policy is running too loose. As such, the Sarb may have to keep real interest rates higher to counter the threat of fiscal dominance.

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She points out that the Sarb governor noted that although a number of other emerging market central banks already started to cut interest rates, they were in a position to do so given that they hiked earlier and to a greater extent.

“As inflation softened, reacting to these higher interest rates, the positive gap in real rates widened. These central banks then had to start loosening policy earlier to reduce real rates to a level that was more accommodative for growth. South Africa hiked rates later than these economies and to a lesser extent arguing for a shallower and later interest rate cutting cycle in SA.”

Interest rates very high for affordability and economic growth

Jee-A Van Der Linde, senior economist at Oxford Economics Africa, says what Botha says might be true from an affordability and economic growth perspective. “However, if one considers South Africa’s real interest rate differential with the US, the Sarb’s current monetary policy stance is probably justified.”

He says consumers are facing increasing hardship, evidenced by weak domestic demand. “Even so, the Sarb has been quite tolerant of low economic growth and is not expected to try and boost economic growth (which it says is up to the government) and risk compromising price stability.”

Reza Ismail, head of bonds at Presceint, says part of the difficulty here lies in the interpretation of the communication from the Sarb. “For example, there were many years when, regarding monetary policy, they would effectively say, “Let us try and,” with the central bank’s job essentially being to foster price stability within predefined ranges and understand the source of inflation.”

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He says if the argument is made that the South African consumer cannot cope with higher rates as it affects mortgage rates and car repayments which are all linked to the prime interest rate, then what Botha says is a true statement.

“But by the Sarb not acting, they will entrench higher inflationary expectations, which then leads down a very rocky road. These higher expectations eventually find a way into wage agreements, leading to higher wage settlements and secondary and third-round inflation and downstream inflationary processes.”

He says nobody wants that to happen. “They are not acting simply in response to what is being observed in terms of current inflation. But remember, the conduct of monetary policy now hinges on the workings of the quarterly projection model, which also takes into account inflation expectations.

Sarb must use interest rates to keep inflation expectations in check

“It is critical that the Sarb keeps inflation expectations in check so that you do not have these second-round wage spirals taking place. It is not just about reacting to current inflation because households are under water, which might well be the case. The Sarb has to take forward-looking inflation into account and manage that downwards towards the midpoint of the range, around 4.5%.”

Prof. Jannie Rossouw, visiting professor at the Wits Business School, says it is important to remember that while consumers with debts pay higher interest rates, people with savings and investments are accumulating more interest as well. “If we focus on the people who save instead of those who have debts, it is good for the banks. The extra money consumers pay on interest does not just vanish, it pays interest for those who save.”