Uncertainty will keep doves quiet

South African consumers and companies started 2017 on a positive note. The political situation was stable, the rand was much stronger than it had been 12 months before and there were forecasts for improved economic growth.

The optimism was shortlived. In the space of a week in March, Pravin Gordhan — viewed as a safe pair of hands by business and foreign investors — was fired as finance minister and the country’s sovereign credit rating was promptly downgraded.

Economic growth forecasts were downgraded soon after, while concerns mounted that President Jacob Zuma’s extensive cabinet reshuffle would threaten SA’s fiscal and institutional framework.

With growth barely expected to reach 1% in 2017 and inflation falling, questions are being raised about whether the Reserve Bank should cut interest rates to stimulate consumer and business spending.

Retail credit growth among banks is at its lowest level in 20 years, suggesting that an interest rate cut by the Reserve Bank could encourage consumers to borrow and spend more, says Andrew Vintcent, portfolio manager at ClucasGray Asset Management.

This would lend some support to economic growth, he says. “The growth in the banking industry’s retail assets is lower than it was following the financial crisis.

“Corporate credit growth is running ahead of inflation, but overall credit growth remains negative in real terms.”

Figures from the National Credit Regulator for the quarter to December 2016 indicate weak growth in credit applications among consumers.

Credit applications increased 4.4% to 10.52-million over the period, which is seasonally a peak time for credit extension. This followed four successive quarters of declines and only a marginal increase for the three months to September 2016.

The rejection rate for credit applications was 52.39%, suggesting banks are lending cautiously as economic growth falters, unemployment swells and the possibility of further credit downgrades looms.

“A lower interest rate environment would lend some support to consumer confidence and lift consumer spending,” says Investec economist Kamilla Kaplan.

“However, the extent of such a boost would likely be limited as in the present environment existing levels of consumer indebtedness are high; credit criteria applied by both bank and nonbank lenders are relatively strict and unemployment is rising.

“Historical data show that in 2013, when interest rates were at historic lows, consumer confidence was still mostly depressed.”

Still, low spending by consumers will have a considerable effect on economic growth, because it contributes about 60% to GDP. With demand-side inflation so low, supply-side inflation is also moderating.

At its March monetary policy committee meeting, the Bank said it expected consumer price index inflation to average 5.9% in 2017 — down from a previous forecast of 6.2% — moderating to 5.4% in 2018. The forecast may decline further, given that consumer inflation slowed to 5.3% year on year in April, from 6.1% in March.

The reasons for lower inflation are largely supply side: lower food price inflation as crop production recovers, more moderate electricity price increases and a stable rand.

But Momentum economist Sanisha Packirisamy says upside risks to the currency remain. These include a fasterthan-expected pace of interest rate increases by the US Federal Reserve, a lower commodity price environment and the risk of further sovereign credit downgrades.

At the March monetary policy committee meeting — hours before the cabinet reshuffle — Reserve Bank governor Lesetja Kganyago said the exchange rate had “reemerged as an upside risk to the inflation outlook”, following domestic political uncertainty.

“Should the rand weaken considerably, we could see inflation expectations picking up again,” says Packirisamy.

This is largely because SA imports a large amount of raw materials and other goods and services, which immediately become more expensive when the rand is weak.

“We don’t believe that there is room for the [Bank] to cut interest rates,” says Kaplan.

“Although the rand has been relatively resilient, there is still a risk of a substantial and sustained depreciation if our local currency sovereign credit ratings get downgraded. This risk is likely to see the [Bank] retain a cautious policy stance.”

Unclear economic policy direction has a far greater effect on consumer and business sentiment and, in turn, economic growth than an interest rate cut could have, adds Packirisamy.

For example, 76% of manufacturers cite the general political climate as a constraint to fixed investment, while only 49% say short-term interest rates are a constraint.

Kganyago has previously said that the growth constraints to the economy were of a structural nature and could not be solved by monetary policy.

“Structural constraints include low skill levels, infrastructure constraints and labour legislation,” says Kaplan, who forecasts steady rates for the remainder of 2017.

“Ratings agencies have reiterated the need for structural reforms and policy certainty to boost confidence.”