Markets See South Africa Cutting Rates To Boost Growth: Reuters

Article
Markets see South Africa

cutting rates to boost growth by
Reuters JUNE 7, 2017
Photo: Shutterstock.
Mfuneko Toyana | JOHANNESBURG
South African bonds priced in a higher likelihood of a 50 basis point rate cut by the central bank
sooner than anticipated after the economy unexpectedly slipped into recession and raised the
risk of further credit downgrades.
Forward rate markets on Wednesday were pricing in a nearly 30 percent chance of a 50 basis
point interest rate cut at the next policy meeting in July, up from a 9 percent probability seen
before the May policy meeting.
The South African Reserve Bank (SARB) has treaded a cautious policy path in the last 18
months; keeping benchmark rates on hold at 7 percent while signaling it had reached the end of
a tightening cycle that began in early 2014.
The bank may however be pushed to act to save the economy by cutting lending rates sooner
than planned to make money cheaper in a bid to boost consumer spending, analysts said.
Data on Tuesday showed the economy contracted by 0.7 percent in the first quarter of 2017
after shrinking 0.3 percent in the fourth quarter of last year.
At its policy meeting in May, Reserve Bank Governor Lesetja Kganyago played down the
prospects of cheaper borrowing costs, citing risks to inflation posed by currency volatility in light
of domestic political uncertainty and credit ratings downgrades.
Economists also said risks to inflation and the currency, posed by large capital and trade deficits,
had faded.
“For a whole host of reasons the prospect of a rate cut has definitely increased. The bank
could very well prioritize growth, putting it higher than has been case where inflation has
been front and centre,” said director ETM Analytics George Glynos.”
“These traditional drags on the rand are no longer there and as a result they will probably feel a
lot more comfortable in reducing interest rates.”
The country’s trade balance swung to a 11.4 billion rand surplus in March and has remained in
the black since then, while the current account narrowed to a six-year low in the first quarter.
“Cutting next year would be too late and that will have driven the economy into a permanent
recession,” said senior economist at Old Mutual Johann Els.
“Cutting rates now would potentially boost confidence and the growth outlook and that would be
positive for rating expectations because the agencies have said they’re looking for growth
possibilities that will aid fiscal sustainability.”
(Reporting by Mfuneko Toyana; editing by Mark Heinrich)

Commentary
In the article Markets see South Africa cutting rates to boost growth, Reuters' journalist
Mfuneko Toyana touches on the high possibility of the South African Reserve Bank
(SARB) to sanction an interest rate cut, an intervention in response to the prospective
recession, which is an economic contraction, where there is falling real GDP and
increasing unemployment of resources. Interest rate is defined as “the percentage of the
amount of the loan to be paid each year” (Tragakes 331). Adjusting the rate of interest is
the responsibility of the central bank and is referred to as monetary policy.
In the diagram above, there has been a leftward shift of the aggregate demand curve
from AD1 to AD2 , resulting in a 0.7 % contraction of South African economy in the first
quarter of 2017. The shift has resulted in a fall in price from PL 1 to PL2 and GDP
From Y 1 to Y 2, creating a recessionary gap in the short-run. A variety of factors must
have hindered the four components of the aggregate demand, including consumption,
investment, government spending and net export. In fact, it is asserted in the article that
“trade balance swung to a 11.4 billion rand surplus”, which means that the ability to
consume imported goods has decreased, and the government intervention has been
focusing on export to save the economy from further recession.
According to director ETM Analytics George Glynos, “the prospect of a rate cut has
definitely increased”. Given such case, a target rate will be decided upon and the SARB
will be incrementally adjusting the interest rate. In the diagram, the money supply curve
shifts rightwards, resulting in an approximately a 50 basis point (0.5 per cent) rate cut,
from 9.0% to 8.5%. This intervention means lower cost of borrowing, incentivizing
consumption and investment. The ultimate effect is to increase aggregate demand, and
thus to trigger the outward shift of the real GDP level of South Africa, clearly showing the
Government intervention is an economic tool to achieve its economic objectives.

In the short run, the expansionary monetary policy will ‘boost confidence and the growth
outlook’, resulting in a short-term growth, rescuing South Africa from ‘a permanent
recession.’ The short-term recession experienced by South Africa only represents a
temporary state of the economy, which occurred due to changes in determinants of the
aggregate demand. However, over a longer period of time, without any improved
conditions or intervention of the government, the economy might slip into a permanent
recession in which, due to insufficient funding, there are degradation of technology,
reduction in efficiency and inappropriate institutional changes. These factors will
ultimately lead to a leftward shift of the LRAS curve, signifying an economic shrinkage
over the long term.

In addition, the monetary policy will show several advantages in ‘fine-tuning’ the economy
towards sustainability. In the short term, monetary policy, compared to fiscal policy, has
quicker implementation, which will be beneficial in the case of South Africa when a
solution is urgently needed. Secondly, in the long term, since its enactment does not
impinge on the government’s budget, this intervention will ensure the ‘fiscal
sustainability’ of the government, which entails the ability of the government to sustain
current spending and other fiscal policies without posing a threat to its solvency (Krejdl
2).
Nevertheless, the increase in money supply is not without disadvantages. This is the
reason why the SARB took a prudent approach. Reserve Bank Governor Lesetja
Kganyago pointed out that the government’s pursuit of the intervention policy may not
necessarily lead to cheaper borrowing due ‘risks of inflation’ induced by ‘currency volatility’
and previous ‘credit ratings downgrades’, which had put South Africa in a less creditworthy
position and would potentially push up the interest rate. Therefore, the bank has been
maintaining the benchmark rates of 7 % despite the end of the tightening monetary period.
Furthermore, the policy does not guarantee its effectiveness in recession. Given the
poor economic performance and volatile currency of the country, consumers and firms
might hold back their borrowing and even spending or investment. At the other end, banks
might not be willing to increase lending either.
The concept of intervention is extremely important here as it is aimed to be the chosen
method to save the economy. Admittedly, the interventionist expansionary monetary

policy increases the money supply in the economy but also the several weaknesses of the
policy implementation may not necessarily bring about the desired effect of improving
economic growth. Nevertheless, this kind of government intervention will be the way
forward for South Africa to boost growth.

Works cited
Krejdl, AleŠ. “Fiscal Sustainability – Definition, Indicators and Assessment of Czech Public
Finance Sustainability.” Working Paper Series, by Krejdl, Czech National Bank, 2006.
CNB Working Paper Series 3.
Bibliography
https://qz.com/887811/south-africans-are-the-biggest-borrowers-in-the-world-says-the-world-ba
nk/
https://www.weforum.org/agenda/2015/12/what-is-a-credit-rating-downgrade/
Tragakes, Ellie. Economics for the IB Diploma. Second ed., Cambridge UP, 2015.

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Article

Markets see South Africa

Mfuneko Toyana | JOHANNESBURG

(Reporting by Mfuneko Toyana; editing by Mark Heinrich)

(SARB) to sanction an interest rate cut, an intervention in response to the prospective

increasing unemployment of resources. Interest rate is defined as “the percentage of the

the responsibility of the central bank and is referred to as monetary policy.

From Y 1 to Y 2, creating a recessionary gap in the short-run. A variety of factors must

focusing on export to save the economy from further recession.

Government intervention is an economic tool to achieve its economic objectives.

outlook’, resulting in a short-term growth, rescuing South Africa from ‘a permanent

recession.’ The short-term recession experienced by South Africa only represents a

recession in which, due to insufficient funding, there are degradation of technology,

reduction in efficiency and inappropriate institutional changes. These factors will

over the long term.

might not be willing to increase lending either.

The concept of intervention is extremely important here as it is aimed to be the chosen

method to save the economy. Admittedly, the interventionist expansionary monetary

forward for South Africa to boost growth.

CNB Working Paper Series 3.

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