South Africa Takes Short-Term Pain to Stay One Step Ahead of Fed

Updated on
  • Economy is in a stagflationary bind, Citadel's Herman says
  • Rate increase may help to underpin the rand before Fed meeting

South African Reserve Bank Governor Lesetja Kganyago took the tough decision to inflict short-term pain on the economy by staying ahead of the U.S. Federal Reserve and avoiding a potential rout in the currency.

The Monetary Policy Committee raised the benchmark interest rate by 25 basis points to 6.25 percent on Thursday in a move that had divided economists, traders and even policy makers. While the MPC lowered its inflation and growth forecasts for this year, it warned of the risk of price pressures spreading because of a weakening rand.

“The SARB is now one step ahead of the Fed, which means they can sit back and see what the Fed does,” George Herman, head of South African investments at Citadel Investment Services, said by phone from Cape Town. “The problem is that we are now transposing the American economic situation on South Africa. We follow blindly what they are going to do and our economy is not as strong as theirs. We are sitting in a dramatic stagflation bind and it’s only getting worse.”

The rand fell to a record low of 14.4410 against the dollar this week and has lost almost a fifth of its value this year, threatening the bank’s 3 percent to 6 percent inflation target. More currency turmoil may follow the Fed’s December meeting as speculation mounts the U.S. will tighten monetary policy for the first time in almost a decade, reducing the appeal of riskier, emerging-market assets.

“The MPC had to decide whether to act now or later,” Kganyago told reporters in Pretoria, the capital, after predicting the Fed will probably raise its rate next month. “Delaying the adjustment further could lead to second-round effects and require an even stronger monetary policy response in the future, with more severe consequences for short-term growth.”

While inflation accelerated to 4.7 percent in October, it remains inside the bank’s target range, and is only forecast to breach that band temporarily in 2016. At the same time, the economy is struggling in the face of falling metal prices, a power shortage and drought, with gross domestic product contracting an annualized 1.3 percent in the second quarter. The Reserve Bank lowered this year’s growth forecast to 1.4 percent and estimates expansion of 1.5 percent in 2016.

“South Africa does not have an inflation problem,” Elize Kruger, an economist at KADD Capital in Johannesburg, said in an e-mailed note to clients. “But we have a very real growth problem, which is likely to be impacted negatively by today’s decision, even if marginally, and will definitely dent consumer confidence and resultant festive season spending.”

Brian Kahn, an MPC member and adviser to Kganyago, told reporters that a quarter-point increase in the repurchase rate is projected to reduce the annual GDP growth rate by 0.1 percentage point.

The rate increase may help to underpin the rand before the Fed meeting, said Peter Kent, a portfolio manager at Investec Asset Management in Cape Town. The currency gained 1.1 percent to 14.0110 against the dollar as of 5:45 p.m. in Johannesburg on Thursday. Yields on the government bond due December 2026 fell 5 basis point to 8.46 percent.

“From a monetary policy perspective, we are in the most defensive setting in the event that you do get emerging-market weakness and dollar strength,” Kent said by phone. “It certainly gives us the best chance of putting a floor under” the rand, he said.

African central banks from Zambia to Uganda have been raising interest rates this year as sliding commodity prices and speculation of Fed tightening pushed currencies to record lows. Ghana and Mozambique raised borrowing costs on Nov. 16, while Kenya left its key rate unchanged a day later after 300 basis points of increases earlier this year. Before Thursday, the South African Reserve Bank had raised the repurchase rate by 1 percentage point since January last year.

The latest increase was favored by four of the six MPC members, while two called for the rate to stay unchanged. Kganyago reiterated that the central bank was still in a tightening monetary policy cycle.

“The hawkish tone of the SARB leaves no room for doubt that it intends hiking interest rates at the expense of economic growth,” Mohammed Nalla, head of strategic research at Nedbank Group Ltd., said by phone from Johannesburg. “The decision was a little counter intuitive. I just don’t understand the rationale for hiking at this particular meeting.”