Three things the Reserve Bank got wrong

Economist Roelof Botha said the South African Reserve Bank’s (SARB) restrictive monetary policy has severely damaged the economy and identified three fundamental flaws in the bank’s approach.

Botha said the Monetary Policy Committee’s (MPC) decision to follow a restrictive monetary policy stance since November 2021 has resulted in a relentless increase in the official repo rate.

The significant increase in the repo rate automatically fed into South African banks’ prime overdraft lending rate.

He said South Africa’s prime rate was 7% at the end of 2021 but jumped to 11.75% in May 2023, where it stayed for 16 consecutive months, representing an unheard-of increase in the cost of credit of 68%. 

“The unwarranted increases in lending rates have a stifling effect on demand in the economy, especially household consumption expenditure and new investment in productive capacity by the private sector,” he said.

Botha said at least three fundamental flaws can be identified in the MPC’s overly restrictive monetary policy approach over the past two years. 

The first flaw is inconsistency. Botha explained that, during the tenure of the previous Reserve Bank Governor, Gill Marcus, the average real prime rate was just above 3% and real GDP growth averaged 2.5% over five years. 

Within one year of her retirement, the new MPC raised the real prime rate by 57% to 4.9%, and four years later, it stood at 6% – a 94% increase in the cost of capital and credit. 

“It remains a mystery why the MPC decided to lift the prime overdraft rate to a level of 11.75% in the aftermath of the Covid pandemic when it was 10% just prior to the Covid pandemic and also considered too high then by the standards set by the MPC under Gill Marcus,” he said.

The second flaw is a lack of understanding of the causes of higher inflation immediately after the worst of the lockdowns imposed by the outbreak of the Covid pandemic. 

Botha explained that the spike in the consumer price index (CPI) was mainly the result of three supply-side shocks:

• The increase of 720% in global shipping freight charges between the third quarter of 2019 and the third quarter of 2021.
• The 430% increase in the price of Brent crude oil between April 2020 and the beginning of 2022.
• Lower levels of capacity utilisation in South Africa’s manufacturing sector, which increased fixed overhead costs per unit of production. 

“Excess demand had nothing to do with the temporary rise in the CPI,” Botha said. 

“By raising interest rates to record high levels, the MPC’s policy approach only served to reduce aggregate demand and restrict the ability of the economy to recover from the effects of the Covid pandemic.”

The third flaw is the undue importance given to inflation expectations. 

Botha explained that, apart from the fact that significant variations permanently occur between the results of quarterly surveys on anticipated future inflation and observed inflation, the samples for these surveys are minute and devoid of meaningful academic substance. 

He pointed to extensive research by Reid that revealed how a relatively large number of respondents either declare that they have no knowledge of the subject or answer with ridiculously large numbers. 

“The crux of the problem with using inflation expectations as a basis for conducting monetary policy has been succinctly stated by Reid with the following conclusion: ‘Expectations matter, but they are unobservable’,” he said.

Botha explained that the costs of overly restrictive monetary policy have been huge. 

If the debt servicing ratio had stayed at 6.7%, household disposable income would have been R172 billion higher, boosting demand and generating R42.9 billion in additional tax revenue.

This would have been enough to build 370,000 low-cost houses and create 244,000 jobs.

High interest rates have severely negatively impacted the economy, with declines in the Afrimat Construction Index, Drive.co.za Motor Index, and per capita GDP growth.

The property market has also suffered, with the BetterBond Index down 31%. Unemployment has also worsened, with 2.6 million more jobless people since 2018, threatening social stability and government funding for grants.

Botha said it is high time to weigh the combating of relatively benign inflation against the negative effects that high interest rates inflict on job creation and economic growth.

“Furthermore, it should be of huge concern to the government’s economic policymakers to witness the recent increase in the country’s unemployment rate,” he said. 

“It is alarming that the number of unemployed persons, including discouraged job-seekers, has increased by 2.6 million over this period – threatening the ability of National Treasury to continue paying the so-called Covid grant whilst also acting as a potential source of social unrest.”