THE Reserve Bank’s decision to cut interest rates by 0.5% last month reflects heightened concern about the growing weakness of SA’s economy. This concern is echoed in the recent World Bank report on SA and its lowered forecast of our gross domestic product (GDP) growth this year to just 2.5%. And that isn’t all. SA, the World Bank noted, is especially vulnerable if the economies of the European Union or China weaken more than expected. This is because Europe is SA’s largest export market, while weakness in China could trigger further falls in the prices of commodities that make up the bulk of our exports.
The World Bank ranks SAamong10 countries that would be most severely affected by a fall in global commodity prices. By its calculations, a 20% fall in non-oil commodity prices could cause our GDP growth to fall 1.7 percentage points. Against this backdrop of domestic weakness and a deteriorating global outlook, the cut in interest rates was probably prudent. Lower consumer price inflation provided an opportunity to cut rates without jeopardising the inflation target of 3%-6%.
The cut in interest rates will provide modest relief to heavily indebted households. Its effect on the pace of overall economic activity will, however, be slight. According to the Reserve Bank, household debt in SA is equal to 75% of after-tax income and the cost of servicing that debt equals 6.7% of after-tax income. This implies that the 0.5% cut in interest rates will increase household income available for consumption by only 0.4%. This calculation ignores the loss of interest income by households that are savers, so the overall effect will be even less than this. It is also not clear whether households will spend their interest savings. Household debt remains exceptionally high by historical standards, so some households may use the opportunity rather to reduce debt.
The other possible benefit of cutting interest rates is that it will encourage households to borrow more and firms to invest more. A 0.5% cut in rates is too small to have a substantial affect in either area. A 0.5% cut in interest rates reduces the monthly payment on a R100,000 car loan payable over 54 months by just R24 a month.
Monthly payments on small and medium homes with an average price of R800,000 fall by R256. It is unlikely that savings as small as this are sufficient to encourage either stronger creditbased consumption spending or home buying, or encourage firms to invest more.
The impotence of monetary policy at times of economic weakness and low consumer confidence was recognised long ago by John Maynard Keynes, who described cutting interest rates in such circumstances as “pushing on a string”. Households in SA are reluctant to borrow because they are concerned about their job security, given the weakness of the local economy. Weak house prices and fears that a renewed global financial crisis could further weaken the domestic economy add to these concerns.
Reserve Bank governor Gill Marcus has warned that further interest rate cuts are unlikely. The necessary stimulation for the South African economy to grow faster is therefore dependent either upon better than expected global economic performance or a local recovery in mining production and fixed investment spending.
The World Bank notes that manufacturing, mining and agriculture in SA are all operating at below 2008 levels, so there is capacity to absorb increased levels of demand should the global economy grow more strongly than is expected.
The exception is electricity, where capacity is strained even at current weak levels of economic activity. This constraint will not disappear until Eskom’s new generation capacity comes on stream or its demand management programmes translate into reductions in power usage. Paying existing large users to temporarily shut down is not the answer, as power savings are achieved only by also cutting domestic economic activity. A further weakness is that SA is running a current account deficit of nearly 5% of GDP. The World Bank warns that 20% of fixed investment in SA in the first quarter of this year was funded by foreign capital inflows. Such inflows could be curtailed if uncertainties in Europe precipitate another financial crisis. Foreign capital outflows would mean volatility in the value of the rand exchange rate, producing a double whammy to already weakening economic growth.
The World Bank report suggests SA’s growth potential is 3.5% a year — half the 7% a year long-term growth SA has targeted. While the Reserve Bank and the National Treasury provide steady hands on the tiller, we lack a clear vision from our politicians of how we can double growth.
As long as we lack such vision and a strategy to achieve it, we will remain at the mercy of uncertain global forces, hoping desperately for a recovery in global economic activity to lift us from our economic slump.
• Gavin Keeton is with the economics department at Rhodes University
This article appeared on Business Day website.