Evolving SARB policy

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By Cees Bruggemans, Chief Economist FNB

With an imminent change in SARB Governors, one has reason to wonder whether the monetary policy emphasis may change, and if so, with what kind of implications for the two most important prices in the economy (interest rates and the Rand).

The two terms of Governor Mboweni since 1999 stand out clearly for what they achieved.

The SARB can claim successful regulatory bank oversight, an important explanation why South Africa got through the recent global financial crisis without any major bank problems.

Governor Mboweni’s era began with inflation targeting, a new approach strategically imposed by government. This was a major break with the past as the SARB started to conduct a new monetary policy (philosophy).

There was a distinct break with Governor Mboweni’s predecessors, where Governor Stals’s policy could be described as exchange rate anchoring and his predecessor, Governor De Kock, as money supply anchoring.

Under Governor Mboweni interest rates were treated as a stability anchor for the economy, kept mostly appropriately positive in real terms, with the primary aim of containing inflation expectations and achieving over time a CPIX or CPI inflation reality within a stated target of 3%-6% as decreed by government.

External shocks at times deflected inflation from its intended target range, but their passing and vigilant policy application succeeded mostly in returning CPI to its target range over time.

As regards the currency, a totally different approach prevailed under Governor Mboweni, best described as ‘hands-off’ after the disaster of the late 1990s when the limits of managing the exchange rate were driven home rather painfully at the time of the Asian Contagion Crisis.

Though the SARB did buy surplus foreign exchange on a large scale during 1999-2009, working off the oversold forward book of $25bn and eventually building up a net foreign reserve of $35bn, such purchases were mostly not actively intended to target the Rand.

Still, net purchases tended to occur when the Rand was firming under the influence of surplus capital inflows and the pace of reserve accumulation tended to slow down during periods of Rand sell-offs.

Such judicious interventions and the favourable external conditions prevailing during most of this decade allowed the external reserve position to be fundamentally transformed from being chronically Dollar-short at the end of the Apartheid era to the comfortable external financial position the country enjoys today.

Things did not always work out, though.

Especially the 2001 currency episode, like its 1998 predecessor, can be partly attributed to SARB action choices. One thinks of continuing foreign reserve accumulation and interest rate easing after the international tide in foreign currency markets had turned against the Rand, as well as the verbal interventions of the period, apparently contributing to some big international players for a while refusing to make a market in Rand, greatly worsening the currency’s instability.

One can also point to cyclical turning points where monetary policy wasn’t always equally fast in changing direction. For instance continuing too long with rate easing in 2001, continuing too long with rate tightening in 2002, probably easing rates too far in 2003-2004, starting too late with rate easing in 2008 (and probably not vigorous enough right away).

However, it must be admitted that hindsight is a perfect science, and that at all these turning points it wasn’t always equally easy to discern what was the appropriate policy stance in a rapidly changing world. Under the circumstances, these possible policy over- and undershoots were mostly mild and rapidly corrected through subsequent actions.

Always deeply difficult was the necessity to explain and sell the government policy of believing in a low inflation environment and the unpopular policies it may require from time to time of achieving this.

What did stand out about Governor Mboweni’s era were the impressions he returned with from overseas visits, probably most of all his BIS meetings. On the international central bank circuit he must have been privy to many conversations and debates that did influence his views and coloured his domestic messages.

Indeed, under Governor Mboweni the SARB really tried to implement a monetary policy formulated according to Best International Practice.

Everything so far suggests this will continue in the new era under Governor Marcus. In this respect the transition to Governor Marcus will probably be far less dramatic compared to the change from Governor Stals to Governor Mboweni. History will probably assess the Mboweni era as highly positive.

Governor Marcus, like President Zuma in terms of the country, is privileged to take over the SARB stewardship at a time when a great global crisis has probably run its course, creating hopefully a new stable base from which another long-run cycle may be possible.

This does not mean the coming years will be without major challenges, but it does mean a favourable opportunity.

The central challenge will presumably remain one of successfully marketing the government policy of preferring low inflation to an not always willing public, portions of which too often prefer the road of least resistance, with potentially catastrophic consequences if it were to lead to accelerating inflation, especially for the many unprotected poor.

To this end, interest rates will need to remain appropriately positive in real terms, especially in times when the economy performs well. At the same time one would expect monetary policy to be sensitive during periods of economic underperformance, especially if accompanied by an undershooting inflation rate.

Still, interest rates are probably the ultimate domestic stability anchor in a world dominated by free capital flows and an exchange rate determined by mostly free flowing market forces. For this reason one would hope for less rather than more interest rate variability.

Even so, at times of crisis, as we have most recently seen in 2008, 2001 and 1998, one would hope the SARB to show fleet-footedness and determination in the way it responds to fast changing financial markets and economic circumstances, at all times trying to preserve domestic stability as far as possible.

Like the Fed, besides showing a strong determination to contain inflation at low levels as prescribed by government this may well be accompanied by something best described as output gap targeting.

This would of course not be the same as targeting the growth rate, but rather the level of GDP, given a certain amount of resource slack.

Following recessions, this suggests a period of low interest rates even as growth starts to recover, as there will be for quite some while much resource slack dampening inflation while policy would presumably like to achieve a fuller use of economic resources over the full business cycle.

In all this, monetary policy can ultimately contribute optimally to creating the best conditions in which our market economy can thrive and South Africa can achieve the fastest growth possible in its institutional circumstances.

On this score, one may wonder whether there will be small course corrections to monetary policy as prevailed during much of the Mboweni era. Perhaps a somewhat less hands-off policy towards the Rand exchange rate, opportunistically participating more actively in currency markets when conditions tend to become unruly or at least less orderly, aiming to prevent excessive Rand overshoots damaging to especially exporters.

Also one might hope for a somewhat faster reaction response at cyclical turning points or crisis moments, provided such events are correctly and early assessed and decisive actions decided upon.

Finally, we may hope that the population at large will come to recognize and accept to a greater degree that low inflation is to all our advantage in the long term, and that the SARB needs the freedom of action at all times to act decisively, even if this isn’t always popular.

We have every reason to express confidence in the leadership of the SARB, as much when Governor Stals made way for Governor Mboweni and as he now in his turn is preparing to make way for Governor Marcus.

Ultimately, it is the stable continuity projected by these smooth generational changes of leadership at the SARB that are most promising, as much for our economic performance as our international reputation.

Source: Cees Bruggemans, FNB, August 25, 2009.

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