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Trapped between ‘sticky prices’ and a flat-lining economy

28 May 2009 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

You’ve heard the expression “stuck between a rock and a hard place.” This twist of phrase is usually reserved for someone making a difficult choice between two unsatisfactory options. We expect it applies to the interest rate decision the Monetary Policy Committee will take later this afternoon. Should they continue with their slow-and-steady interventions by administering another 50 to 100 basis point interest rate cut to South Africa’s flat-lining economy? Or should they throw caution to the wind and shock the patient with 200 basis points?

After looking at the Q1 2009 GDP growth statistics we suspect neither option will have much impact. Reserve Bank governor, Tito Mboweni, knows he cannot turn the recession with interest rates. His best approach is to continue administering the cuts as frequently and consistently as possible. He can’t afford to use all the medicine in one hit so he’ll announce another 100 basis points at most.

Something in reserve to fight a long illness

His detractors aren’t going to be happy. They’ll argue that a dramatic cut is the only solution given the latest statistical data. The economy contracted 6.4% in Q1 2009 – hot on the heels of the 1.8% decline in the final quarter of last year – signalling the start of the country’s technical recession. “The fall-off in Q1 2009 GDP was extremely broad-based with almost all the key economic sectors in decline including manufacturing, finance, retail, and mining,” said StanLib economist Kevin Lings. The only sectors to achieve meaningful growth over the quarter were construction and government.

A closer look at these numbers could give an indication of the severity and duration of the recession. Let’s begin with the construction sector. It’s been suggested that the country’s massive infrastructure expenditure will prop up this sector, thereby averting a serious economic slowdown. The reality is construction only comprises 3.9% of the country’s economy. Despite growing 9.4% q/q, construction only added 0.4% to the GDP number over the latest quarter. The news is equally gloomy if we look at the government sector. Activity in this sector has to be funded. As tax revenue declines the government will have to increase its budget deficit to maintain current levels of spending. But they can’t afford to let the deficit slip too far. Spending your way out of recession is great in theory, but funding the plan usually proves problematic.

Lings’ next paragraph rings like the last nail in a coffin: “It is now very clear SA exports are under enormous pressure due to the global recession (hence the reduction in mining and manufacturing output), that the decline in economic activity has broadened significantly during the past few months (now includes retail, finance, transport etc) and that the monetary and fiscal policy stimulus that has been enacted over the past six months has had little impact on the economy to-date.” Economists expect 2009 GDP to come in at -2.2% after years of positive growth.

Forget the conventional inflation argument

The main argument against a massive interest rate cut is inflation. Lowering rates too quickly is inflationary – as consumers tend to spend more when there’s more money doing the rounds. But this argument doesn’t hold in current economic conditions. It seems the average citizen has got the message – it’s time to start saving.

If only inflation would play the game. Statistics SA reported a disappointing 0.5% month-on-month decline in headline CPI inflation yesterday. This means year-on-year CPI inflation to April 2009 is 8.4% (against March’s 8.5%) and still well outside the 3% to 6% inflation target that the Reserve Bank set all those years ago. Believe it or not, there are still a few die-hard economists who want to chase inflation back into that band, recession or not. “This is the 24th consecutive month that CPIX inflation has been above the target range,” said Lings. The usual suspects contribute to this higher than expected number. Petrol increased by 31c per litre in April and petrol price inflation now stands at 17.5%.

Food is also problematic with year-on-year inflation in the food and beverage category coming in at 13.6% Lings notes that “while SA food inflation is moderating the rate of decline is extremely slow and disappointing considering the agricultural food inflation is currently -8.1%, while producer food inflation has eased to 9.4%.” Economists still hope that inflation will move back into the target range before the end of this year. They say the stronger rand, excess production capacity and economic recession should put the brakes on prices. If this happens, Mboweni will be able to drop rates consistently – say by half a percent each month – until Christmas.

Editor’s thoughts:
Since the MPC started meeting on a monthly basis we’ve had about as much ‘interest rate debate’ as we can stomach. We sympathise with the Reserve Bank governor – he knows he can make everyone happy with a big rate cut – but must act prudently in the interest of long-term financial stability. Would you prefer one massive rate cut today – or a phased approach of smaller cuts on a monthly or bi-monthly basis? Add your comments below, or send them to


Added by gregz, 28 May 2009
I dont think that a percentage or two or even three would make a lot of difference...the interest rate spread by the retail banks would minimise the positive effect...Is is possible to have a very low repo rate, banks lending well above prime and high inflation in the midst of low consumption/low production...certainly possible...? Until the underlying causal factors to the recession are dealt with I am not sure whether uncertainty which embodies risk and therefore heightened hurdle rates on capital usage/provision will be reduced...Capitalism and a free market system at least from a self regulating financial system in the US will never be the same...and shouldn't be because of those ivy league prigs who became very short term and greedy in their perspectives, and indeed the systems and processes that supported that orientation...Even here bankers stare at the technicalities of the recession and not at themselves in terms of their attitude towards social responsibility and long-term wealth creation for their shareholders...
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