The fallacy of interest rates being an economic panacea: SA Interest hike

Johannesburg - The South African Reserve Bank has erred by raising interest rates by 25 basis points taking the repo rate to 7%.
Even though the inflation rate has breached the upper ceiling to 6.2%. The critical issue is the source of this inflation and the current economic environment.

The central bank has steadfastly pursued an inflation targeting policy since February 2000 with a target of between 3 – 6%, because of interest rate volatility and ineffective management of inflation expectations, creating certainty in the market and an environment in which the economy could prosper.

However, of late the inflationary pressures have emanated from exogenous factors mainly, increased imports prices owing to the unstable rand which briefly touched lows of R17.99/US$1 in January owing to the events of 9/12 (Nenegate) the drought, the current political instability attributed to state capture and the impending downgrading of South African investment rating to junk status.

Economist Peter Montalto at the beginning of the year predicted a rate R19/US$1 by end of the year. However it seems quite likely that this rate will be breached in the event of a downgrade.  Imports have become dearer owing to the unstable rand and fed into the local price increases.

The focus should be on stability of the exchange rate, which is not so much at what level but to remain stable at any particular level, ensuring financial sector stability. This is not a call for the reserve bank to intervene on the exchange market.

The events in China at the beginning of the year showed the fallacy of this policy as authorities burned billions of US dollars in defence of the Yuan.

Economic fundamentals

South Africa is faced with stagnant growth with 2016 economic growth forecast revised downwards to 0.8%; the country could easily slide into recession in the event of a downgrade further exasperating untameable unemployment.

Drought

The drought has had a devastating effect on Southern African economies, greatly impacting on the food security situation in the region with the UNFP launching aid appeals to assist nations hardest hit such as Zimbabwe. The El Niño effect is not only on food production but also affects the power generation capacity in the region which is largely hydro-dependent.

The drought has fed the increases in the food prices and also increased the imports and the demand for foreign currency.

This element of inflation cannot be tamed by interest rate hikes.

State capture

The events of 9/12 and allegations of state capture circulating and some confirmed by ANC heavyweights such as Mcebisi Jonas (Deputy Finance Minister), Barbara Hogan (former Public Enterprises Minister) on 702 Radio about Jet Airways, Pravin Gordhan vs. Hawks and from the EFF raise serious concerns on the direction of the country.

With the rating agency Moody currently in the country, these reports and allegations are damaging on the country's reputation and do little to calm the markets affecting the rand and hastening our downgrade potential, further fuelling uncertainty.

The ANC needs to restore confidence in the nation and call for a judiciary enquiry to clear these allegations once and for all.

ANC Electioneering

With the Zuma administration on its last lap towards the finish line. Politicians are positioning themselves for the ANC leadership gravy train and the economy suffers as politics take centre stage.

It is time that politicians put the interests of the country first rather than their self-interests and their political parties.

The parties need to rally around efforts by the finance minister in resuscitating the economy and instilling prudence and fiscal discipline.

World outlook (Interest rates)

The US Fed in its recent monetary policy meeting left interest rates unchanged and cut forecasted rate hikes from 4 to 2 for the year.

The ECB had previously cut all its rates to 0% throwing all it has to reignite the European economy in the wake of a depressed economic outlook.

On the other hand Japan implemented negative interest rates in attempts to ignite consumption expenditure and boost demand.

In Brics, Brazil is facing a recession on the backdrop of the Zika virus and large corruption scandals that have seen millions protesting on the streets demanding the fall of President Dilma Rousseff and the police questioning predecessor Lula da Silva.

Conclusion:

The central bank should not have increased interest rates as the inflationary pressures are external. The bank should be cognisant of the delicate and depressed economic state in which growth is stagnant and the country could easily slide into a recession.

Interest rates should have been used at the moment of the downgrade when the country loses its investment status and capital flows out to other investment destinations.

In the interim inflation rate should be left to breach the target in the interests of economic growth and the stubborn unemployment. The pressure on the rand is self-inflicted by the government and the focus should be on addressing these first before tinkering with interest rates.