meeting of shareholders
20 September 2007
Introduction
The primary goal of the South African Reserve Bank (the Bank) is the
achievement and maintenance of price stability. However, the role of the Bank
in the economy goes beyond a narrow monetary policy focus. Low and stable
inflation provides an important framework for economic growth, but regulation
and supervision of parts of the financial sector, as well as the oversight of
the payment system ensure that the wheels of the economy continue to turn
efficiently. In the past year we have had to execute our mandate in an
increasingly difficult and uncertain environment.
The South African financial markets have not been spared the effects of the
recent volatility in the financial markets and we have to be increasingly
vigilant of the risks posed to the domestic economic landscape. At the same
time we have to ensure good governance with respect to the internal workings of
the Bank. It is against the backdrop of this volatile economic environment that
I report to you today. Today we also release our Annual Economic Report which
covers developments in the domestic and international economy over the past
year. In particular, we highlight the main economic developments which have
affected our operations and policy implementation.
The focus of this address is on the main operational areas of the Bank
including monetary policy and its implementation, gold and foreign-exchange
reserves management, financial stability issues, the national payment system,
banking regulation and supervision, international co-operation and internal
administration.
Monetary policy
This past year has been a challenging one for monetary policy. As I reported
in August last year, from the middle of 2006 pressures on inflation emerged,
and have since intensified. By December 2006, year-on-year CPIX inflation
measured 5,0 percent compared to 3,7 percent in April of that year. Inflation
remained within the target range until April 2007 when it increased to 6,3
percent from 5,5 percent in the previous month.
Since then it has remained outside the target range. Initially the main
drivers of this adverse trend were food and petrol, but more recently there has
been evidence of a more generalised upward trend in inflation, including that
of services prices. The Monetary Policy Committee (MPC) responded to these
developments by raising the repurchase rate by 50 basis points in June 2006,
the first increase since 2002. This was followed by successive increases of 50
basis points at each of the subsequent three meetings of the MPC in 2006.
By December the repurchase rate had increased to 9,0 percent per
annum.
The pressures on inflation emanated from both international and domestic
sources. At the global level, the world economy continued its strong
performance which contributed to sustained upward pressure on oil and food
prices which, in turn, had a direct impact on domestic food and petrol prices.
These items were the major contributors to the upward inflation trends during
2006.
In August last year international oil prices peaked at levels just below
US$80 per barrel. Prices were influenced by strong global demand, supply
disruptions in a number of South African Reserve Bank countries and
geopolitical uncertainties. Food price pressures have also had a global
dimension.
Drought conditions in a number of countries as well as the increased
diversion of agricultural products, particularly wheat, maize and sugar, to
bio-fuels production have contributed to this trend. South Africa was not
immune to these developments which, in conjunction with the impact of drought
conditions in a number of regions, resulted in an acceleration of food price
inflation, in particular meat prices and to lesser extent maize prices. In
October and November 2006 meat prices increased at year-on-year rates of almost
20 percent, while grain product prices increased by around six percent.
Although world inflation remained under control, the pressures emanating from
these developments have dictated that monetary policy remains restrictive in
many countries. Domestically, the MPC had to contend with the combined threats
of high rates of growth of consumption expenditure and credit extension.
In the second half of 2006, domestic household consumption demand growth
also continued at a robust pace of around seven percent per annum, while the
various consumer confidence indices indicated sustained optimism on the part of
consumers despite the tightening stance of monetary policy. Towards the end of
the year, motor vehicle sales, particularly passenger vehicles, showed some
signs of moderation. Underpinning this consumer exuberance were strong rates of
growth of credit extension, despite an increase in securitisation
transactions.
Following the 15 percent depreciation of the effective exchange rate from May
to July 2006, the exchange rate of the rand had an impact on the inflation
outlook.
However, it then remained in a fairly tight trading range, despite the
continued widening of the deficit on the current account of the balance of
payments, which continued to be adequately financed by capital inflows. Not all
the determinants of the inflation rate posed a threat to the outlook. Nominal
unit labour costs were well contained, fiscal policy continued to be supportive
of monetary policy and although the economy was growing at a robust pace, it
was not deemed to be growing at a rate significantly above potential. Inflation
expectations were also anchored within the inflation target range.
In the first two months of 2007 international oil prices declined
significantly, with the price of North Sea Brent crude oil reaching a low of
US$51 per barrel in January. These developments contributed to a general
downward revision of oil price and inflation forecasts. At the same time, there
were tentative signs of some moderation in household consumption expenditure,
particularly with respect to passenger vehicle sales. The MPC was also mindful
of the fact that interest rate adjustments take time to impact fully on demand.
Although the inflation risks were still perceived to be on the upside, the
continued stability of the exchange rate, sustained fiscal restraint and the
improved inflation expectations resulted in the committee keeping interest
rates on hold at the February and April meetings of the MPC.
By the June 2007 meeting of the MPC, the outlook had deteriorated further.
Despite the previous adjustments to the monetary policy stance, available data
at the time suggested that real household consumption expenditure and credit
extension remained strong, growing at year-on-year rates of around seven
percent and 26 percent, respectively.
International oil prices resumed their upward trend, eventually peaking at
around US$78 per barrel in July. The overall impact of the adverse oil-price
trend on domestic inflation was moderated somewhat by the relative stability of
the rand exchange rate.
However, following the breach of the upper end of the inflation target,
there were some worrying signs of deterioration in inflation expectations.
Furthermore, partly in response to the higher inflation outcomes, nominal wage
settlements began to trend higher, posing a further risk to the inflation
outlook. In response to these pressures and the less favourable outlook, the
repurchase rate was increased at both the June and August 2007 meetings of the
MPC. At the time of the August meeting, the turmoil in the world financial
markets had begun. At that stage it was unclear to the MPC whether these
developments would be confined to the financial markets, or if they would
impact significantly on the growth prospects domestically and abroad.
The committee decided that it was appropriate to remain focused on the
inflation target and react to financial market developments insofar as they
affected the inflation outlook. The breach of the target can be seen as a
setback for monetary policy. Nevertheless, it should be noted that the main
cause of inflation exceeding the upper end of the inflation target range was
factors beyond the direct influence of monetary policy. We are mindful,
however, of the impact of these developments on inflation expectations and the
need to act against the emerging broader inflation pressures. The most recent
inflation forecasts of the Bank suggest that inflation may return to within the
inflation target range during the second half of next year and the MPC will
continue to act accordingly to ensure that this outcome is achieved.
Money-market operations
To ensure that the implementation of monetary policy was in line with the
stance determined by the MPC, the Bank managed the daily liquidity requirement
in the money market in a range roughly between R10 billion and R15 billion. The
Bank also broadened the list of securities that qualify as eligible collateral
in its refinancing operations. With effect from 23 May 2007, two categories of
collateral are now accepted.
Category 1: Securities comprise of Government bonds, Land Bank bills,
STRIPS, South African Reserve Bank (SARB) debentures and Treasury bills. The
new Category 2: Securities comprise all non-banks, non-government securities
that are included in the All Bond Index of the Bond Exchange of South Africa.
Borrowers using this category have to provide more collateral.
In co-operation with various market participants the Bank addressed
shortcomings that had been identified in the South African Overnight Interbank
Average (Saonia) rate. The Saonia rate was replaced by the South African
Benchmark Overnight Rate on deposits (Sabor), which is a more representative
and reliable pricing benchmark than its predecessor.
Reserves accumulation and management
The Bank has continued to increase its level of official reserves. Gross
gold and foreign exchange reserves increased from US$23 billion at the end of
March 2006 to US$29,8 billion at the end of August 2007. The international
liquidity position, which was positively affected by the prepayment by the Bank
of the US$1 billion syndicated loan that was raised in 2004, increased from
US$19,5 billion to US$27,4 billion over the same period. The prepayment
resulted in some cost savings for the Bank and conveyed a positive signal to
counterparties of the Bank and the market. With the recent buy-back of foreign
currency-denominated debt by the National Treasury, the prepayment also
contributed to the effort to reduce the external vulnerability of the
country.
South African Reserve Bank
A key focus area remained the refinement of the reserves management
capabilities of the Bank. In this regard, the Bank worked closely with the
World Bank under the auspices of the latter's Reserves Asset Management
Programme for central banks. Capacity building is central to these efforts and
the Bank continued to invest in training and systems for staff involved in the
areas of reserves and risk management. In addition, the investment policy of
the Bank was reviewed and the governance structure was enhanced by the
establishment of a Reserves Management Committee.
The Bank and the National Treasury further strengthened their co-operation
in the areas of reserves accumulation and liquidity management. The National
Treasury assisted in draining a large portion of the liquidity created by the
foreign-exchange purchases of the Bank. At the end of July 2007, the special
deposit account of the National Treasury with the Bank, which was created for
this purpose, totalled R54,5 billion including accrued interest.
Agreement has been reached on the settlement of outstanding balances on
the
Gold and Foreign Exchange Contingency Reserve Account (GFECRA). The Bank and
the National Treasury have agreed that, in future, only realised profit or loss
positions that have an influence on money-market liquidity would be settled on
a regular basis. This arrangement should reduce the amount of funds flowing
between the Bank and the National Treasury and moderate the impact on
money-market liquidity. Under this new arrangement, the Bank transferred an
amount of R319,3 million (including interest) to the National Treasury for
settling the outstanding GFECRA balance as at 31 March 2006.
Currency distribution
Efforts are continuing to combat the counterfeiting of banknotes and to
ensure that only banknotes and coin of acceptable quality are in circulation.
Minimum standards for the reissue of banknotes have been prescribed. In
collaboration with the commercial banks the primary phase of the implementation
of the Integrated Cash Management System has been completed. This system has
the potential to improve the efficiency and effectiveness of the National Cash
Management System in the cash value chain, thereby reducing the cost of cash to
the public. The developmental phase of the interactive Cash Risk Identification
and Mitigation programme developed by the Bank and the South African Banking
Risk Information Centre with the participation of the commercial banks, the
cash-in-transit industry and the South African Police Service (SAPS) has been
completed.
This programme defines the minimum security standards for the cash
management industry to reduce incidents of cash-in-transit heists and banking
crimes and is now being consulted on with unions and employee representatives.
The minimum standards will also be promulgated into regulations by the Minister
of Safety and Security.
The national payment system
The value of total settlement in the South African Multiple Option
Settlement (SAMOS) system amounted to an all-time high of R5,6 trillion in July
2007, which is approximately R280 billion per day. This settlement figure also
includes transactions stemming from the equity and bond markets. In 2006 and
2007, approximately 90 percent of settlement through the SAMOS system was
affected on a real-time basis during the day. The remainder, which emanated
from the retail environment, was settled in the evening.
Directives for conduct in the payment system for system operators and
third-party service providers will become effective during 2007. In May 2007
the Bank also commenced with the detailed oversight of non-bank participants in
the national payment system. Specific focus is being placed on the operational
soundness of payment clearing house operators.
Following the promulgation of the National Credit Act, 2007, amendments were
made to the National Payment System Act, 1998. These amendments outlawed any
non-statutory preferential treatment of a payment instruction in any given
payment system and paved the way for the implementation of a specific payment
stream to process payment instructions randomly.
Financial stability
In support of its objective to achieve and maintain price stability, the
Bank also seeks to identify inherent weaknesses in the financial system and
monitor risks that may result in financial system disturbances. On the basis of
an analysis of various financial soundness indicators the financial system was
appraised as sound. - also assessed the financial regulatory system in South
Africa to be inherently robust in terms of the 12 key financial soundness
standards identified by the Financial Stability Forum of the Bank for
International Settlements (BIS).
Some financial regulatory challenges remain. These include the implications
of the recently introduced National Credit Act, the possible introduction of an
explicit deposit insurance scheme, the review of South Africa's membership of
the Financial Action Task Force, initiatives to bring the hedge fund industry
within the scope of current regulation, and the implementation of a new capital
framework (Basel II) for banks on 1 January 2008.
In co-operation with other stakeholders in financial stability, the Bank
furthered its efforts to prepare and maintain suitable contingency plans and
crisis management strategies to respond to systemic distress. In the year under
review, a programme of financial sector continuity testing was initiated to
help hone the responses of financial sector authorities to systemic threats.
The Bank also participated in the Coordinated Compilation Exercise of the
International Monetary Fund (IMF), aimed at developing capacities of countries
to compile financial soundness indicators for the surveillance of financial
systems.
Banking regulation and supervision
The Bank has the responsibility to ensure that the domestic banking regulatory
environment stays abreast of international best practice. A key focus area
remains the preparation for the implementation of Basel II. The implementation
programme aims to effect the requisite amendments to the legal framework and
ensures the successful implementation of Basel II on 1 January 2008. The
migration to Basel II has necessitated intensified interaction with the
Banks.
Interaction has included on-site visits by staff of the Bank, requests for
and the processing of specific information to assess the impact of Basel II on
the capital adequacy of banks, as well as readiness assessment meetings with
banks.
In accordance with the latest industry requirements and market developments,
and with the prescriptions of Basel II in mind, a finalised draft Banks
Amendment Bill was approved by the Standing Committee for the Revision of the
Banks Act in November 2006.
Parliamentary hearings on the draft Bill were held in mid-June 2007. The
Bill is expected to be promulgated later this year, with implementation
effective from 1 January 2008. The regulations relating to banks have been
reviewed in totality to comply with the prescriptions of Basel II and to
provide banks in South Africa with all the options and approaches offered under
Basel II. A compliance assessment with the revised 25 Core Principles for
Effective Banking Supervision of the Basel Committee on Banking Supervision was
completed in October
2006. Based on this assessment, a gap analysis was completed and supervisors
are implementing plans to improve the supervisory process with immediate effect
where possible.
Where necessary, amendments will be made to the Banks Act, 1990 and
Regulations to ensure effective supervision. During the review period the level
of compliance of the Banking industry with the application of anti-money
laundering and the combating of terrorist-financing legislation remained a
focus area. About 40 suspect business or investment schemes, which gave the
impression of being engaged in banking activity, are under investigation.
International co-operation
South Africa assumed the chair of the G-20 for 2007 and the Bank and the
National Treasury have been jointly co-ordinating activities. The G-20
comprises systemically important developed and emerging-market economies. Two
G-20 Deputies meetings, one in Pretoria and the other in Durban and two African
Policy Seminars, which were held on the fringes of the G-20 Deputies meetings,
were hosted.
Our term as host will culminate in the G-20 Summit of Finance Ministers and
Central Bank Governors, which will be held in the Western Cape on 17 and 18
November 2007. Policy topics that will be considered include the reform of the
Bretton Woods Institutions, commodity cycles and financial stability and fiscal
elements of growth and development. These topics were also the focus of G-20
seminars hosted in Brazil, the United States and Turkey earlier this year.
The international relations of the Bank remain focused on strengthening
co-operation with central banks and multilateral organisations. Special
attention has been given to the African continent and the Southern African
Development Community (SADC) region in particular, where efforts are geared
towards the achievement of regional integration. The Bank continues to take a
strong leadership role in the Committee of Central Bank Governors (CCBG) in
SADC.
In its role as leader of the SADC Payment System Project and under the auspices
of the CCBG, the Bank has continued to facilitate the modernisation and
harmonisation of the SADC regional payment clearing and settlement systems.
To date, the project has focused on the implementation of Real Time Gross
Settlement systems, automated clearing and payment system oversight.
Significant progress has been achieved in this regard and the current focus of
the project is on areas such as remittances, retail payment system risk
reduction, the securities settlement project and capacity building for payment
system oversight.
Further assistance will be provided to the Democratic Republic of the Congo
and Madagascar in terms of the planning of their payment system development.
The Bank continues to be an active participant in the activities of the Bank
for International Settlements (BIS). The participation of the Bank in and its
contribution to the Foreign Exchange Settlement Risk Subgroup of the BIS
Committee on Payment and Settlement Systems ensured that the Bank keeps abreast
of international developments in this area and promotes best practice. Closer
bilateral relations with other central banks have resulted in the signing of
Memoranda of Understanding (MoU) with the central banks of China and Peru in
the past year.
In addition, the Bank has received numerous visits from other central banks
which have allowed for more exchange of information. The Bank has maintained
close relations with multilateral organisations. Our collaboration with the IMF
and the World Bank has resulted in a number of joint seminars and courses being
presented by the South African Reserve Bank College in 2007. These are open to
participants from central banks and finance ministries from the African
continent.
Internal administration
The Annual Report of the Bank was distributed to shareholders before this
meeting. The total balance sheet of the Bank shows an increase from R168
billion at the end of March 2006 to R220 billion at the end of March 2007. The
increase was mainly the result of the accumulation of official gold and
foreign-exchange reserves and was financed in the main by an increase in
government deposits, an increase in currency in circulation and the effect of
valuation adjustments to the net reserves as a result of exchange rate
movements.
These adjustments are reflected in the increase in the Foreign Exchange
Contingency Reserve Account (GFECRA). The profit before taxation of the Bank
increased from R1 038 million for the previous financial year to R2 907 million
for the financial year ending 31 March 2007. Budgeted expenditure of the Bank
for the current financial year amounts to R1 879 million, compared to actual
expenditure of R1 658 million in the financial year to 31 March 2007.
This represents an increase of 13,3 percent in budgeted expenditure compared
to actual expenditure for the previous financial year. This increase is largely
a result of the increased volume and cost of producing new currency. The four
subsidiary companies of the Bank achieved their objectives during the financial
year. After a review of reports by their Boards of Directors and internal and
external auditors, the Bank is satisfied that these companies are managed in
accordance with their objectives and best corporate governance practice.
The results of the subsidiaries are reported on a consolidated basis with
those of the Bank in the financial statements. The Bank continued to operate an
over-the-counter market for the trading of its shares. During the financial
year ending 31 March 2007, 24 transactions in respect of 94 700 shares of the
Bank were concluded at an average price of R1,60 per share. On 31 March 2007,
the Bank had 612 registered shareholders and by 31 August this number had
increased to 630.
The Bank views risk management as an essential element of good corporate
governance and has therefore established a Risk Management Committee (RMC) to
oversee the risk management process in the Bank. The RMC is chaired by a
Deputy
Governor and the four executive general managers of the Bank also serve as
members. Business continuity planning for the Bank has been completed and
extensive adequacy testing is currently being conducted. A consolidated
Information and Communication Technology (ICT) disaster recovery facility was
established to enable the successful recovery and continuation of critical
business processes in the event of a disaster or serious disruption at the Head
Office building.
The sourcing of an enterprise resource planning solution for the Bank was
approved and a suitable solution selected. This system will replace many of the
old and ageing central services software systems in the Bank and also integrate
data from disparate information systems into one unified system. The Bank
continues to maintain and improve existing buildings and additions not only to
enhance the value of its properties, but also to preserve the cultural heritage
of the country and support country-wide inner-city development initiatives
where possible.
Major renovations and refurbishment are being undertaken at Head Office and
the branches in Pretoria North, Johannesburg and Cape Town. A new branch is
being planned for Bloemfontein and plans are under way to renovate the branches
in East London and Port Elizabeth, while preserving the historical character of
these buildings. Corporate art collections play a critical role in nurturing
artistic talent. In the more than 53 years that the Bank's art collection has
existed, it has supported a wide range of emerging and established artists. A
book depicting a selection of the more than 600 works of art, dispersed
throughout Head Office, the seven branches and the College was published
earlier this month and it is believed that this book will make a valuable
contribution to the appreciation of art.
The Bank continues to pay close attention to its human resources. The staff
complement decreased to 1 934 at the end of March 2007, compared to 1 956 a
year earlier. The overall staff turnover for the period was 6,8 percent. The
profile of new appointees was 84 percent black, with 77 percent of the
management appointees black and 45 percent female. The profile of new
appointees since 1 April 2007 until the end of July 2007 is 88 percent black
and 40 percent female, with 80 percent of the management appointee's black and
60 percent female.
The modernisation process pertaining to the revised Staff Policies was
concluded and the policies implemented. The outstanding policies pertaining to
outside occupations and directorships, as well as to ethics are being consulted
with staff. An emphasis on wellness management continues, with the focus on
physical and mental health. Disability management and HIV and AIDS prevention
continue to receive attention. Other measures taken include the provision of
medical and psychological wellness services.
The Bank continues to place an emphasis on developing its staff. In addition
to students who have recently completed their degrees, the Cadet Graduate
Programme will be expanded to also cater for staff members of the Bank. This
will double the number of cadets to twenty in 2008. In an effort to guarantee
future accreditation for its learnerships, the College has completed a process
to ensure that all its learning programmes adhere to the principles of
outcomes-based education.
To stimulate research in the Bank, a research fellows programme has been
introduced in terms of which senior researchers from other central banks and
academia are invited to spend time at the Bank and engage in collaborative
research. Three research fellows, two of whom are from abroad, have already
spent time at the Bank in 2007, and a fourth is expected later in the year.
Applications have been invited for the 2008 programme. To contribute further
to the economic research effort in the country, a conference on macroeconomic
policy challenges for South Africa was organised by the College in 2006. It
included papers presented by leading academics from local and international
universities, as well as other local economists.
Conclusion
From a monetary policy perspective this past year has been particularly
challenging for the Bank. The international environment has been uncertain and
the recent turmoil in international markets means that further challenges and
uncertainties lie ahead. Nevertheless, the Bank will continue to focus on
achieving its mandate and will strive to bring inflation to within the target
range. Low and stable inflation remains the best contribution the Bank can make
to economic growth and development in South Africa.
The Bank will continue to make a contribution to financial stability in the
country. Apart from oversight and regulation of the national payment system,
future challenges are likely to come from the introduction of Basel II at the
beginning of next year, the possible implications of the National Credit Act,
and the impact of higher interest rates on a highly indebted population.
We will not lose sight of the need to give attention to the internal
management of the Bank. The Bank remains committed to the training and
development of staff in the broader context of its Employment Equity Plan.
Acknowledgements
I want to thank the Presidency, the Government and Parliament for their
continued support. Through the system of bilateral committees, the Bank has
maintained a good working relationship with the National Treasury. I wish to
thank the Minister and Deputy Minister of Finance and the Director-General of
the National Treasury and his staff for their ongoing support and
co-operation.
I also wish to express my thanks to the members of the Board for their
commitment to the Bank. Their efforts are important in ensuring effective
corporate governance and strategic direction for the Bank. Last but by no means
least; I wish to thank the deputy governors, management and staff of the Bank
for their support and contributions to the successful running of the Bank. An
organisation such as ours is only as good as the quality and commitment of its
personnel. We are indeed fortunate to be able to attract an excellent group of
employees.
Issued by: South African Reserve Bank
20 September 2007
Source: South African Reserve Bank (http://www.reservebank.co.za)
