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What does a 25 basis points drop in the Repo rate mean for the South African Economy?

23 July 2019 David Crossley, Business Manager at BDO Wealth Advisors

Before we unpack the drop in the Repo rate, it is good to remind ourselves of the main reason that the South African Reserve Bank (SARB) exists.

“The South African Reserve Bank is the central bank of the Republic of South Africa. The primary purpose of the Bank is to achieve and maintain price stability in the interest of balanced and sustainable economic growth in South Africa. Together with other institutions, it also plays a pivotal role in ensuring financial stability.”

Being to all intents and purposes independent of the politics of the State, the SARB can pursue this goal, theoretically without government interference.

The reality is slightly different, but this is not in the scope of this explanatory article.

The South African economy has been struggling for some time now with low growth, job losses and a general lack of business confidence, despite some reassuring moves by the President to appoint capable people to key positions.

However, the cost of borrowing money is key to economic growth and if this cost is softened, then business can extend their borrowing and thereby grow their capital expenditure. This stimulates growth and in turn should lead to better turnover and greater employment opportunities.

For the individual man in the street, a reduction in the Repo rate has a direct effect on commercial interest rates, which will drop in sympathy with the drop in the Repo rate.

Individual loans become less expensive and existing loan repayment amounts for bonds, vehicles and the like will reduce marginally, giving the borrower some cash flow relief.

However, the SARB has as its Mandate the control and management, as far as it is possible of the rate of inflation, which they keep within certain parameters. The softening of interest rates can have a negative effect on inflation if the demand for consumer goods increases too much.

This is based on the time economic principles of supply and demand. If demand for consumer goods increases, then unless supply follows this up, the price of goods can increase and jeopardise this inflation balance.

In addition to this, very low rates on interest can have a negative effect on money invested in South Africa, as foreign companies perceive that the advantage of higher returns here diminish.

You only have to look at Venezuela and Zimbabwe as examples of countries that are experiencing hyper levels of inflation to see what happens when a central bank gets it wrong!

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