On the 25th of March, the South African Reserve Bank announced its Monetary Policy decision to keep the policy rate unchanged at 3.5%. This unanimous decision was expected by most economists, financial market experts, and participants as policymakers globally continue to employ tools to assist the economies re-establish their paths to recovery.
Since the announcement, the rand has slightly appreciated against the dollar from R15.02/$ on 25 Mar to R14.77/$ on 31 Mar, with some variance in between. This appreciation of the rand against the dollar may signal a positive reception of the decision by both domestic and foreign investors. This is because an appreciation of a currency is associated with an increase in its demand, all else constant. However, other economic factors can result in an appreciation of a currency.
While the appreciation of the Rand against the US Dollar informs us about how the global economy has reacted to South Africa's Q1 Monetary Policy stance thus far, South Africa remains a small open economy. That is, our economy is relatively more sensitive to policy announcements that occur in other global economies than those economies are to our policy announcements. Such economies include the US and the Euro area. Therefore, global developments play a critical role in the SARB’s decision on the policy rate. What factors informed the latest SARB MPC decision?
Global Growth Forecasts
According to the International Monetary Fund, Global GDP growth is expected to grow by 5.8% in 2021. Comparing this positive growth rate with the contraction of -3% that was predicted for the year 2020 shows the resilience of global economies in the face of the persistent Covid-19 pandemic.
Positive global GPD growth boosts the confidence of investors to participate in financial markets, including financial markets in emerging market economies such as South Africa. According to the SARB, December and January saw an increase in capital flows to emerging markets, including South Africa. All else constant, this would create room for the central banks in emerging market economies to increase policy rates. However, the delayed progress in vaccination programs evident in many economies, including our own, will result in slow and uneven global economic recovery, thus hindering the central banks from raising interest rates.
Keeping our imports basket constant, increases in oil prices increase the cost of imports. One of the largest items in our economy’s import basket is capital goods (i.e Machinery used for production). Also, increases in global oil prices lead to higher domestic petrol prices. For 2021, South Africa’s petrol price inflation expectation sits at 12.7%. Thus, the forecasted increase in oil prices is expected to weigh down domestic production, and hence growth. This steals away the room the SARB may have had to increase its policy rate.
The R/$ Exchange Rate
Before the announcement of the policy rate, the rand was already on an appreciation trajectory against the US dollar. This nominal depreciation of the dollar may be a result of the persistent near-zero interest rate Monetary Policy stance announced by the US Federal Reserve on 17 May 2021. This appreciation of the Rand makes imported goods relatively less expensive, thus reducing upward inflationary pressure. A rapid upward inflationary pressure would have prompted the SARB to increase its policy rate to rein in inflation.
However, the subdued inflationary pressure has created a safe economic environment for the SARB to keep the rate unchanged.
While global economic conditions have a significant influence on domestic Monetary Policy decisions, domestic factors also have an equally significant role.
In the words of the SARB governor Lesetja Kganyakgo "Important macroeconomic gains would be realized by achieving a stable public debt level, increasing the supply of energy, moderating administered price inflation and keeping inflation low into the recovery. Such steps will enhance the effectiveness of monetary policy and its transmission to the broader economy."
Which other prevailing global factors do you think have influenced the current Monetary Policy stance by the SARB? Let us know in the comments or write to us at firstname.lastname@example.org.
Yours in Thoughtful learning,