Reserve Bank can do little about growth without structural reform

Twice a year, the Reserve Bank holds a series of monetary policy forums designed to open its research and debates to a broader audience than the usual suspects in the media and the markets. This week’s forum in Pretoria happened to come just after a leaked SACP document made a new call for changes to the Bank’s mandate — urging that price stability come second to growth and employment priorities — and just before the ANC came out with its latest views on reforms to boost economic growth. That growth desperately needs boosting is not in question, especially given the Bank’s latest estimate of SA’s potential growth rate, which has now fallen to a shockingly low 1%. Technically speaking, the potential growth rate is the rate at which an economy can grow without running into inflation problems. In effect, it is the trend growth rate, or “speed limit”, the average rate the economy can sustain over a number of years through the economic cycle.

Electricity shortages and weak investment have eroded the economy’s capacity to grow, and it’s now far below the population growth rate of 1.6%. But what to do about it? And how much can be achieved with interest rates, which are the main tool monetary policymakers have. It’s a question which — contrary to what the SACP might think — does preoccupy the Bank’s monetary policy committee.

A key metric it would look at is whether actual economic growth is lower than potential growth — the so-called “output gap”. That’s clearly negative for now, with this year’s growth forecast at 0.6%. But if potential growth is only 1%, the most the Bank could do by cutting interest rates further would be to raise it to 1%-1.5%. That may be worth doing, but if it were so easy to work out whether the risks justified the return, and whether to worry more about the real economy than about financial markets, the committee wouldn’t have to spend so much time deliberating, even when it keeps rates on hold.

The current environment, global and local, is highly uncertain and highly risky. Though inflation seems like it’s been brought well under control for the first time in decades, it’s hard to tell what could happen to the rand exchange rate and inflation in coming months. Globally, recession looms and financial flows are not necessarily behaving as they used to when low interest rates in advanced countries sent money flowing into emerging markets such as SA. Locally, nobody knows how or when markets will react to a medium-term budget which will surely be dire and decisions on Eskom which may or may not happen.

Then there’s the equally thorny question of what’s to be gained by cutting interest rates, in particular whether this would stimulate the investment the economy so sorely needs. The Reserve Bank only directly affects short-term interest rates, but companies make investment decisions based on longerterm rates — typically the cost of borrowing five- to seven-year money, not one-year money. In theory, if inflation is expected to be well under control, longer-term rates should come down along with shortterm rates. The trouble is that they haven’t — because markets are worried about the Eskom and budget risks, as well as South African political uncertainty more generally. The cost of long-term money, measured by 10-year bond yields, at 9.1% is now far above the cost of short-term money, as the forum heard this week. Any sign of weakness at the Reserve Bank could make that worse.

The bottom line is even the loosest of monetary policymakers could do little to boost growth now. Hence the importance of the kinds of structural reforms set out in the ANC document, and the recent Treasury proposals. But the divergences between the two are as marked as the overlaps, and they are silent on how and when the proposals will be implemented. Lifting SA off that 1% is going to be tough.

Economy’s capacity to grow has been eroded over the years