There are growing calls for the South African Reserve Bank (SARB) to shun interest rate increases aimed at fighting inflation at its next monetary policy meeting in October. Economists interviewed by Emerging Markets claim that further monetary tightening would undermine economic growth, at a time when global financial markets are already volatile. Their warning follows data released on Wednesday that shows a surprising surge in CPIX inflation in July to 6.5%, outside the bank's 3%-6% target, leading to fears that interest rates will be raised further.
SARB governor Tito Mboweni has increased the policy rate by 300 basis points since June 2006 and on August 21 said that upside inflation risks can only be tamed by one medicine: interest rates."
But Colen Garrow, an economist at Brait Merchant Bank, argued that "the SARB's inflation-targeting strategy compromises economic growth and a more flexible monetary policy is needed." Garrow believes that Mboweni's aggressive inflation-targeting stance is not striking a sufficient balance between economic expansion on the one hand, and managing the monetary challenges of demand-side inflationary pressures and high credit growth on the other.
"Current growth of 4.5% is clearly inadequate, South Africa should be aiming for 6% GDP growth at least. One option is to move the upper inflation target band to 7% and change the definition of core inflation to exclude food and fuel so the SARB can more clearly react to underlying pressures in the economy," he argued.
Garrow even questioned whether a rate hike would help to fight inflation in any case, because it would not address the underlying reasons for rising prices in South Africa. "It has been caused by increases in food and fuel prices, which means that the pressures South Africa is facing are external. As a result rate, hikes won't have any meaningful effect," Garrow told Emerging Markets.
Given the current risk aversion towards emerging market assets, he argued that further tightening could end up weakening the rand by damaging sentiment towards South African equity markets, driving imported inflation still higher. The Johannesburg Stock Exchange (JSE) has fallen around 5.5% since July, dragging the rand 5% lower in the same period. Equity portfolio investments, at $15 billion in 2006, almost entirely funded the South African current account deficit, which reached the highest for more than three decades last year at $16.28 billion, 6.5% of GDP. Consequently, if rate hikes spark a further exodus from the JSE, this would put additional downward pressure on the exchange rate.
Magan Mistry, senior economist at Nedbank agreed, fearing that the SARB's hawkish obedience to its inflation-targeting mandate would undermine the economy at a crucial time. "There is a strong case for keeping rates on hold because of the financial market jitters. But given its obsession with inflation, I doubt they will show any flexibility," he told Emerging Markets.
By contrast, Nico Kelder, chief economist at Pretoria-based Efficient Group, was more supportive of the central bank, arguing that it should not be swayed by pleas from financial market players, and should stay focused on the real economy. "Inflation data should be the main consideration of the SARB rather than financial market woes. They need to aim for price stability while having confidence in the strong fundamentals of South Africa's economy," he told Emerging Markets.