Reserve Bank left toothless amid Eskom-induced stagflation

Reserve bank


With the cost of borrowing higher than it has been since the 2008 global financial crisis, some suspect interest rates are nearing their peak.

By ratcheting up interest rates even higher, the South African Reserve Bank (Sarb) risks over-tightening, imperilling the country’s already fragile economy. Meanwhile, prices have remained sticky and the risk of stagflation is rising — conditions which will further blunt the central bank’s main tool for taming inflation.

In the wake of the recent rand crash, a number of economists expect the Reserve Bank’s monetary policy committee (MPC) to lift the repo rate by another painful 50 basis points this Thursday.

The Reserve Bank has received consistent criticism since it began raising the repo rate in November 2021. 

Higher interest rates, its detractors have said, would throw cold water on the country’s already glacial economic growth. They also pointed out that hiking the cost of borrowing would probably not go far in the way of bringing down inflation, which is largely the result of supply-side blockages.

In March, the MPC unexpectedly raised the repo rate by 50 basis points, bringing it to 7.75%. This was despite the committee’s dire prognosis for the economy, which is expected to grow less than 1% in 2023, the result of the country’s deepening energy crisis.

‘Burning the house to roast the pig’

Although the Reserve Bank’s hiking cycle has brought the cost of borrowing to its highest level since 2008 — when economies around the world reeled in the wake of a rupturing global banking system — interest rates are still lower than they were then. In April 2008, then Sarb governor Tito Mboweni raised the repo rate 50 basis points to 11.5%.

But the country’s economy has also changed considerably since 2008, when the central bank arguably had greater scope to raise interest rates. In the decade prior to the global financial crisis, the country’s economic growth averaged 4% per year. Since 2008, the economy has more or less flatlined, growing just 1.7% each year.

South Africa’s economic decline is perhaps best expressed through the country’s unemployment rate, which — by its expanded definition — stands at 42.4%. In the first quarter of 2008, the unemployment rate was 30.9%.

As independent economist Duma Gqubule put it, bar 2020, “the economy has never been this bad”.

Raising interest rates even further is indefensible, given the country’s current economic conditions, according to Gqubule. “Rate increases cannot reduce supply-side inflation. They can’t reduce the price of bread. Using rate increases to reduce supply-side inflation is equivalent to … burning the house to roast the pig,” he said.

Eskom, Gqubule added, has done an effective job of reducing economic demand. “So, why should they be increasing interest rates again to further reduce demand, which has already been decimated by Eskom.”

The ailing power utility is now at the centre of the country’s inflation and interest rate dilemma. 

Severe load-shedding, according to the Reserve Bank, is expected to add

materially to headline inflation (0.5 percentage points in 2023). This is as the costs associated with back-up energy solutions, such as generators, are passed onto consumers. 

Meanwhile, the country’s energy crisis has played into the rand’s recent bout of weakness — a predicament which threatens to push up inflation and which the Reserve Bank has to respond to, given its mandate to protect price stability.

Danger ahead

But despite these inflationary pressures, which look like they will persist through the rest of 2023, some believe the Reserve Bank’s hiking cycle is near its peak.

“I think we are very close to the peak. I think the Reserve Bank has kind of acknowledged that there is not a lot of scope to raise rates significantly more,” Kevin Lings, the chief economist at Stanlib, said.

“The reason is that, at some point, you can go too far and it becomes significantly counter-productive … You can go too far. There is that danger and we are close to that.”

Investec economist Lara Hodes has also suggested this week’s MPC decision could mark the end of the hiking cycle, forecasting a cut to the repo rate, come November. According to the Reserve Bank’s monetary policy review, published last month, the March MPC decision prompted markets to price in a repo rate peak of around 8%.

The Reserve Bank will be faced with a dilemma if inflation persists, Lings added. “But I don’t know if you’re going to solve that through ever-higher interest rates. There will ultimately be negative consequences for inflation if you keep pushing up rates.”

On Monday, the Bureau for Economic Research (BER) similarly warned of the risk of over-tightening. According to the BER, it is now less clear whether this week’s repo rate decision will signal the end to the tightening cycle, especially given that the US Federal Reserve may not be done hiking.

More interest rate hikes by the Federal Reserve, the BER said, would add to the risk that the Reserve Bank also does more after this week. This would push the domestic policy “well into restrictive terrain, potentially overdoing the tightening”.

The BER also warned that the country’s load-shedding crisis is increasingly becoming a stagflationary shock, driving up prices while also bearing down on growth.

South Africa is already dealing with stagflation to some extent, according to Lings. “The economy is weak. We are very close to most people forecasting an outright recession … On the inflation front, there is no doubt that the ongoing load-shedding costs businesses and they are going to have to recoup some of that. Some of those costs will be passed onto consumers.”

Earlier this year, the International Monetary Fund slashed South Africa’s GDP forecast for 2023, from 1.2% to a dismal 0.1%, citing the effects of the country’s energy crisis. In a presentation to the ANC’s national executive committee last month, Electricity Minister Kgosientsho Ramokgopa noted that load-shedding could cost the economy as much as R375 billion.

Out of options

Stagflationary conditions stand to further dull the Reserve Bank’s main tool for taming prices — raising interest rates — which in any case is already considered less effective for taming supply-side inflation. 

“There is already an acceptance that interest rates are a blunt tool … In South Africa, it affects a lot of things simultaneously and it’s also not all that effective,” Lings said.

The question then becomes, why use the interest rate in the first place? 

“There are two answers. The one is, there’s not much else you’ve got … The second is, while they are not massively effective, they still have an effect. And any effect is better than no effect,” Lings said.

The Reserve Bank cannot create the impression that it has given up on taming inflation, because that stands to ratchet up inflation expectations. Higher price expectations over the longer term could prompt businesses to increase wages, which itself becomes a risk to inflation. 

“So, central banks are left with a difficult choice, but no real choice, no real option. They’ve got to follow through.”

Gqubule was less willing to let the Reserve Bank off the hook. “It’s time to be as angry with the Reserve Bank as we are with Eskom … Nothing short of replacing the Reserve Bank governor and the monetary policy committee will change things. We need to get people who can empathise with the pain of ordinary South Africans.”