TAXtalk provides comment from Brett Scott of The Perfect Portfolio on the state of the South African economy.

Background

One of the worst gifts you can give a child must be a noisy toy, particularly one of those dolls or fluffy toys that speaks when you prod it in the midriff. The first hundred times the cowboy doll utters the words "Reach for the Sky" may be vaguely cute, but thereafter the headache sets in. After a while the batteries (thankfully) start to fade and the toys start speaking of their own accord although the words progressively become less and less understandable.

Tito Mboweni is currently acting like one of those toys that you would like to send back to the manufacturer to have the volume switched lower (or off), and the content of his speech altered. Granted, being Governor of the Reserve Bank is not an easy role. When inflation is under control and you are cutting rates everybody loves and admires you, but when the cycle turns you become public enemy number one. And yet this is a role that requires both discipline and independent thinking.

Foot-in-Mouth Disease

Unfortunately, the current Governor seems to revel in the attention and appears not averse to shoot-from-the-hip throwaway comments that are not well considered. Last week`s remark that he was considering pushing for a 200 basis point rate hike at this week`s MPC meeting was just such an occasion, and the danger of uttering such remarks was borne out by the subsequent surge in bond yields and sharp decline in banking stocks on Thursday morning.

Nobody can argue with the Reserve Bank talking tough on inflation in this environment but, as always, comments on directions in monetary policy should be measured. Take the US Fed`s lead: They spend hours discussing the inclusion or omission of just one word in their policy statement and the incumbent Chairman is ever-mindful of living in an environment where the world`s financial press are waiting to dissect each utterance with surgical precision. Can the same be said for our Governor? We think not.

But Worse Still

Still, the Governor`s "open mouth operations" are not the most worrying aspect of monetary policy at present. By far the more disturbing issue is the failure of the Reserve Bank to distinguish between inflationary pressures that are beyond their control from those that they can influence.

Inflation targeting is a good thing. But the point of departure should be an understanding that a tool such as interest rates can only be used to suppress inflationary pressures that are demand driven. When inflation originates on the supply side the only way to suppress rising prices is to increase supply; interest rates can do nothing to deal with the source of the problem. This is why the Reserve Bank has an escape clause - to give them the option of sitting on their hands when inflationary pressures emanate from external forces. Why they are not invoking this escape clause at present is beyond us.

South Africans with debt are bleeding. They have seen their debt servicing costs rise by around 43% in two years and more rate hikes appear likely. Pressure on retail sales, car and house repossessions and mounting bad debts are very clear indicators that the 4.5% hike to date is biting hard and current restrictive monetary policy is starting to significantly curtail demand. Sure, levels of inflation, with CPIX currently running at 10.4% year on year, are worryingly high, but the underlying causes of much of the inflationary pressures are very much supply driven, with food and energy the largest culprits.

Hammer and Peg

As we all know, spiralling food and energy costs are very much a function of global supply problems. If you choose to try to counter supply-side inflation that emanates from global sources - and is as rampant as global inflation is at present - by trying to suppress domestic demand you are going to need to pulverise domestic demand into submission. This approach is a little like trying to hammer a square peg into a round hole - you can do it if you hit hard enough! However, the impact of this approach on an economy that desperately needs growth can be catastrophic.

Welcome to the land of boom and bust

Many Central Banks around the world are failing to recognise that the increase in oil, metal and agricultural commodity prices is largely structural in nature. The urbanisation and move up the income ladder by hundreds of millions of people in China and other developing nations has created a massive new pool of demand for raw materials. Supply has been unable to keep up so far and prices have thus soared.

It is difficult to see prices returning to the levels they were at five years ago. Policy makers should recognise the pressure that these one-off moves upwards in prices have had on inflation.

Response to Criticism

The Reserve Bank`s response to criticism of its current approach has been that inflation expectations are running too high and need to be dealt with swiftly. Of course inflation expectations are running high, the average South African has seen an explosion in their cost of living! Again, these inflation expectations are largely being driven by factors that are beyond the Reserve Bank`s control.

Higher fuel and food costs are already acting as a punitive tax on expenditure and we feel that to raise the interest rate excessively in addition is not necessary and certainly doesn`t promote long-term economic stability.

Brace Yourself

And yet it looks like another rate hike is a definite this week, with recent rhetoric nudging the market towards the possibility of 100 basis points. It is our belief that we are starting to tread a dangerous path in the madness of our current interpretation of inflation targeting and monetary policy.

We strongly feel that the escape clause should be invoked. We would not rule out the appointment of a commission of enquiry into our monetary policy within a year, but by then the damage will have been done. The Reserve Bank is keen to preserve their "credibility" in the war against inflation. SA interest rates went too low in 2005. In the interests of preserving their "credibility" they are in grave danger of going way too high in 2008.
 
The above article was produced by Brett Scott, Group Sales Executive of The Perfect Portfolio  South Africa, and is reproduced with the kind permission of TAXtalk, South Africa's leading tax publication (www.taxtalk.co.za).

Article Added Friday, 13 June 2008 | 1056 Hits

Your attention is drawn to the disclaimer on this site, which applies to the content in this section.