Publication Details

Honoured guests

Ladies and gentlemen

1.   Introduction

It is perhaps not all that well known that I am an honorary member of the Rotary organisation. I was introduced to the Pinelands Rotary Club by Mike Osche, a colleague who retired from the Bank some years ago.  I have reason to believe that Mike is in our audience tonight and thank him again for introducing me to the world of Rotary.

The motto of Rotary, Service above self, is a notion that central bankers can easily associate with.  Central bankers have to make and implement policy decisions without any cognisance being taken whatsoever of their personal interests.  It should be remembered that my colleagues and I at the Bank are also subject to the effects of our monetary policy decisions.  We thus also subscribe to the motto of service above self.  I cannot but think of a previous Commissioner for Inland Revenue who apparently once remarked that he was cross with the tax man whenever he had to complete his own tax return.  Central bankers also take policy decisions that may not always be in their own personal best interest.

In my comments to you tonight I will reflect on some of the issues that came out of the Monetary Policy Committee meeting that ended yesterday where it was decided that the repo rate would be increased by a further 50 basis points. The full statement of the MPC is available on our website, so I do not want to repeat it here. In my remarks tonight I will touch on the issues of savings and growth and their relationship to monetary policy.

2.  Rotary and monetary policy- what is the connection?

For its 2006/07 year Rotary has chosen Lead the way as its guiding principle.  This holds true for both the organisation and the Bank, as the Bank leads the way in monetary policy in South Africa.  I know from personal experience that leading the way is not always the popular way.  I often think about the Rotary 4-way test, which I should repeat for the sake of the non-members in our audience tonight:

Of the things we think, say and do: Is it the truth? Is it fair to all concerned? Will it build goodwill and better friendships? Will it be beneficial to all concerned?

In its activities, the Bank can relate to this test.  Central bankers have to stick to the truth at all times, as this is an important way to gain monetary policy credibility.  The conduct of monetary policy addresses the issue of fairness, in the sense that it is directed at ensuring the achievement of our inflation target. In containing inflation, the Bank ensures that monetary policy implementation is beneficial to all South Africans.

While the Bank guards and values its autonomy, we have also paid particular attention to building ‘goodwill and better friendships’. My presence here this evening is one such endeavour in this regard. However, the implementation of monetary policy, particularly at times of changing interest rates, does not necessarily build goodwill, nor foster better friendships.  At times of changing interest rates, there are always reactions from two groups of people.  Savers and people living from the interest earned on their savings are pleased by interest rate increases.  Borrowers, however, often feel aggrieved during periods of rising interest rates, because of higher interest payments.  Whenever interest rates change we get an avalanche of mail from both sides, either congratulating us or berating us for not considering the plight of particular groups. I should add that it is not a coincidence that as interest rates rise, I tend to become more popular with the older generations. Unfortunately, farmers are usually perennially in debt, so I will have to try and keep out of the way of the farmers of Worcester tonight!

On a more serious note, Worcester is in an agricultural heartland.  As a community with its foundations firmly in the agricultural industry, it naturally follows that you will be interested in the impact of policy decisions on agricultural production, in your case particularly the production and export of deciduous fruit and wine.  I am also aware that the exchange rate of the rand against the US dollar, the euro and the pound, as the currencies of your major exporting destinations, is of particular importance. I should emphasise, however, that the Bank does not set or target the exchange rate. Our monetary policy actions may impact on the exchange rate, and we have to take cognisance of how expected exchange rate changes impact on the inflation outlook. The exchange rate is set in the market, and we do not attempt to implement monetary policy, or influence the exchange rate in the interest of any particular group or sector of the economy.

I know from first-hand experience that farming is never easy, and I have sympathy with the many challenges that you face.  I have been told that farmers in this region can lose up to as much as 10 per cent of their annual fruit or grape harvests as a result of unexpected heat waves over Christmas and New Year. You may not be aware of the fact that I am also a farmer, albeit only on a very part-time basis.  I have a small plot in Magoebaskloof in the northern part of our country.  The full tale of my farming woes will keep us occupied all evening, but suffice to say that I shall be very interested to receive advice from anybody in the audience who may have tried before to grow avocado trees.  Currently I must confess that despite all the challenges, I find monetary policy-making easier than farming!3. The monetary policy stance and domestic savings

As I noted earlier, a further increase in the repo rate was announced yesterday after the meeting of the Monetary Policy Committee. Our mandate is to keep CPIX inflation within the inflation target range of 3-to-6 per cent. Inflation has been within this range since September 2003, and we want it to remain within the range for most of the next three years, the forecast period. There are a number of risks to the inflation outlook, which led to our decision. These risk factors relate to the strength of domestic demand, exchange rate developments, food prices increases, as well as the potential threat from international oil price developments.

I often get asked by people on the street why I keep warning about consumer demand. In the second quarter of this year, household consumption expenditure increased by 8 per cent on an annualised basis. This is the highest rate of growth in 10 years.  Vehicle sales have reached record highs during the year, and consumer confidence has been at an all-time high. Consumer demand has been fuelled by a number of factors including lower nominal interest rates, lower taxes, higher real incomes and higher asset values.

There are a number of reasons for being concerned about these developments. In terms of our overriding inflation objective, if demand expands excessively, pressure on prices is logically likely to emerge. So from a narrow monetary policy perspective, we need to keep the growth of consumer demand in check. That does not imply that we want to see no growth in demand, but rather we would like to see demand growing at more sustainable levels. The higher interest rates are meant to restrain demand by making credit more expensive, which should make consumers think twice before making the next purchase.

Apart from the inflationary consequences, there are other reasons why we should be concerned about excessive consumption. It is generally the case that during a consumer boom, people tend to get themselves into more and more debt. Currently, credit extension by the banks to the private sector is growing by over 25 per cent per annum. This is high by any standards. The resulting increased indebtedness is showing up very clearly in household debt which, as a percentage of household disposable income, has risen to about 70 per cent. This is fun while the party lasts, but what happens when the party is over and we have to deal with the hangover? It will take more than a few headache pills to overcome this. The personal and social consequences can be significant.

South Africans are not only spending too much, we are borrowing too much. In other words, we are not saving enough. There is simply not a culture of saving in South Africa, and people tend to live as if there is no tomorrow. I have noted with concern when many of the young people resign from the Bank to move on to what they believe to be greener pastures, that instead of transferring their pension funds to preservation funds, they tend to cash in their pensions, pay a significant portion of this in tax, and spend the rest. However, there is a tomorrow and the burden of adequate pensions for all cannot be shifted on to the state.

South Africans are not alone in this profligacy. Bill White of the Bank for International Settlements (BIS) has pointed out that it appears to be a feature of Anglo-Saxon economies. South Africa has a savings ratio of just over 12 per cent of GDP, compared to around 25 per cent in the early 1980s. In the United States and the United Kingdom, savings ratios are approximately 13 per cent and 14 per cent respectively. In the Asian economies, by contrast, there is a strong savings culture. In China, for example, the savings ratio is above 40 per cent. This could be due to the fact that there is very little by way of social old-age pensions and people know they have to save for retirement as no-one else will do it for them. But even in advanced Asian economies such as Japan we see a very strong culture of saving, where the savings rate is approximately 27 per cent. In fact, part of the difficulty of getting the Japanese economy out of its prolonged downturn was the inability to get Japanese consumers to consume more.

This is illustrated by a story related to me by a Japanese central banker, about twin brothers who reached the ripe old age of 100. As this was quite a rare achievement, the Japanese government decided to honour the brothers at a highly publicised ceremony, where a gift of a substantial amount of cash was presented to them. When asked what they were going to do with it, they replied that they were going to put it away in case they needed it for a rainy day!

At the macroeconomic level, the lack of saving is also reflected in the deficit on the current account of the balance of payments. Or put another away, it reflects the excess of consumption over production. To finance this, we need to borrow from abroad, or attract investment from abroad, but there are limits to how much we can borrow.

As many of you will know from personal experience, when you go to your bank manager for a small loan because you lack sufficient savings, you are greeted with a big smile, and sometimes asked why you are borrowing so little. When you go the next time, the smile is not so wide. Eventually, after a few more visits, when you are told by the bank manager’s secretary that he is unavailable indefinitely, then you know you have a problem.

The size of the bank manager’s smile is also a function of the purpose of your borrowing. If you want to borrow to finance an ostentatious wedding party for one of your children, the response may be different to the case where you want to borrow to expand your business. In the latter case, you are financing investment. If you have a good business plan, you will be generating future income to enable you to repay the loan, unlike in the case of throwing a party for the town. (Of course if your child is marrying into a wealthy family, this may be seen as a good investment!).

The same is true for countries. As I noted earlier, countries with low savings rates have to finance their current account deficits by borrowing from abroad or by attracting inward investment which is driven by growth perceptions and macroeconomic policy considerations. The ability to borrow is a function of how financial markets perceive the deficit - is it driven by excessive consumption or is it driven by productive investment expenditure that will raise the growth potential of an economy? In South Africa, the deficit on the current account of the balance of payments has grown to historically high levels of over 6 per cent of GDP. Until recently, non-residents have been smiling at us, and we have been able to comfortably finance the deficit through capital inflows. In other words, the deficit at levels of 3-4 per cent of GDP was seen to be sustainable. More recently, driven in part by rising consumer demand, the deficit has expanded, and the sustainability issue has come into question for some. This has contributed in part to the depreciation of the rand that we have seen in recent months with potential consequences for future inflation.

The bottom line is, if we want to grow, we need investment. Investment in turn requires sufficient savings. The less we save (i.e. the more we consume), the more we are reliant on capital inflows. These flows in turn are dependent in part on perceptions of the economy and possible future economic policies.

4. Monetary policy and growth

This brings me to the final point of my remarks to you tonight, and that relates to monetary policy and growth. The positive part of the story above is that, despite the increase in consumption, there has also been a significant increase in investment. Gross fixed capital formation as a percentage of GDP grew at an annualised rate of over 18 per cent in the second quarter of this year. This bodes well for future growth.

After a number of years of subdued growth, the South African economy has recently experienced an improved growth performance. In the past two years, growth rates measured 4,5 per cent and 4,9 per cent, respectively, and growth this year is expected to again exceed 4 per cent. In the second quarter of this year, the economy grew at an annualised rate of 4,9 per cent. Most sectors of the economy performed well, with the exception of agriculture which contracted, as you are all no doubt well aware. In fact, if we exclude the agriculture sector, economic growth in the second quarter was 5,8 per cent.

Whenever we adjust the repo rate, we are accused by some of being insensitive to growth. However our mandate is to achieve and maintain low inflation. In line with conventional wisdom, the view of the Bank  is that monetary policy cannot determine long-run growth, and the contribution we can make to growth is to provide a favourable low-inflation macroeconomic environment.

Although the monetary policy stance can at times have some short-term negative consequence for output, we do not think that our monetary policy actions will significantly undermine the current growth prospects. In fact, a low inflation environment over a longer planning period enables rather than impedes growth. Interest rate adjustments are a feature of the economic policy landscape, and it is not unusual for interest rates to be raised during periods of strong growth, when inflationary pressures build up. Furthermore, the exchange rate adjustment that we have experienced recently might also help to stimulate the export sector, which could see the growth impetus coming from the export sector rather than from consumption. Finally, the proposed infrastructure expenditure by government should also help sustain the underlying trend and also help increase the productive capacity of the economy. That is what we so desperately need.

5. Conclusion

By definition, different provinces and regions within the economy will contribute to growth in different ways. Worcester, in conjunction with the whole Breedekloof region, has identified its development potential as a tourism destination to complement agriculture.  Given your proximity to Cape Town and the excellent road infrastructure leading us to the Breedekloof region, this initiative can develop to the benefit of the whole community.  Tourism is an important export product of South Africa, and the development of the tourism potential in the Breedekloof will naturally contribute to further investment and employment creation. I wish you well in these endeavours and, as always, I look forward to returning to this beautiful region in the future to celebrate with you your moto, service before self.

I thank you for your attention and have a good evening.