DANGEROUS GAMES

The Reserve Bank is the latest institution to come under attack in the battle to capture the state — but it cannot be allowed to fall

No-one could envy Reserve Bank governor Lesetja Kganyago right now. Falling inflation and collapsing growth make a compelling case for an interest rate cut, but growing political instability is raising the risks to the rand.

To complicate matters, the Bank is the object of a new front that has opened up in the battle to capture state institutions.

The first salvo was fired by public protector Busisiwe Mkhwebane when she ordered parliament to amend the constitution to replace the Bank’s inflation-targeting mandate with one that puts growth and transformation front and centre.

The second salvo was more serious, coming from deputy finance minister Sfiso Buthelezi. He said last week that inflation targeting is bad for emerging economies such as SA and should be up for debate, adding: “The role of the Reserve Bank is a contested space.”

Buthelezi’s curve ball in particular has set the financial community’s teeth on edge, given that it adds to the extreme political and policy contestation that have destroyed confidence and put the economy into recession.

In April, SA’S foreign currency rating was junked following President Jacob Zuma’s axing of former finance minister Pravin Gordhan and his deputy, Mcebisi Jonas. The one beacon of stability has been the steadfastness of the Reserve Bank. To contest the Bank’s monetary policy foundations now is to invite further rating downgrades, weaker growth and rising debt in a downward spiral.

Can Kganyago really be expected to answer challenges to the Bank’s mandate as if this were a normal technical debate aimed at benefiting the economy? No country can afford the types of games the Zuma faction is playing.

One interpretation of the political shots being fired at the Bank is that the Zuma faction wants to pressure it into cutting rates to stimulate growth, or to make it the scapegoat for keeping policy too tight and growth too low. A more sinister interpretation is that it is about destabilising the Bank and the economy to benefit those who would pick up relinquished assets at bargain basement prices.

If the monetary policy committee (MPC) draws these conclusions, it could be reluctant to cut rates at its July meeting for fear of creating the impression it has bowed to political pressure — something that would irreparably harm its credibility as an inflation fighter.

Investec Asset Management’s Nazmeera Moola and Clyde Rossouw think it would be a mistake for the Bank to react in this way. “Inflation is falling, growth is collapsing. It is time to cut interest rates,” they argue.

Though fixing SA’S long-term growth problems is beyond the Bank, it can influence short-term growth, even if only cyclically and at the margin.

“Given the weakness of growth, this is an important consideration to escape the negative spiral,” Moola and Rossouw say. “Keeping the SA economy out of stall speed is [also] vital to prevent the threat of further populism down the line.”

Normally if inflation surprised consistently on the downside when the economy was in recession, the Bank would cut rates to ease pressure on households and firms. However, it has to balance this against the fact that lower interest rates would reduce the yield attraction of the rand and so increase SA’S vulnerability to foreign flight.

Economists estimate that up to R120bn could flow out of SA if its local currency rating is junked by S&P and Moody’s — something the attack on the Bank has made increasingly likely.

At the May MPC meeting, Kganyago said that for rate cuts to occur, inflation would have to continue to surprise on the downside and the Bank’s forecast would have to be for inflation to remain within the target range until the end of 2019.

Citi Bank economist Gina Schoeman believes SA’S inflation momentum is softening dramatically. She notes that there are fewer items rising in the consumer price index basket now than in all the years since 2010. In fact, the last time core inflation was as low as 4.8% and on a downward trajectory was in April 2010, in the immediate aftermath of the global financial crisis.

Even so, Schoeman notes that the risk to the rand is “immense”, so though inflation may be falling, this may not be sustained for long. She believes that while the Bank will eventually cut rates, the cutting cycle will be shallow (about 75 basis points in total) and will start only in January.

Old Mutual Investment Group senior economist Johann Els agrees that inflation is heading substantially lower, driven by the weakness of the economy, falling food inflation and lower petrol prices.

He feels the Bank would be making a “serious policy error” should it not cut 25-50 basis points before the end 2017.

Investec also expects one to two rate cuts before December.

What it means: Recent statements about the Reserve Bank’s function have added to political instability