24 March 2009
Introduction
The global economy has continued to weaken significantly in recent months as
a result of the turmoil in the financial markets. There is growing uncertainty
regarding the depth and duration of the economic slowdown. The South African
economy has not escaped the impact of these developments, and domestic
production has contracted as a result of weak domestic demand and a significant
decline in export demand. Against this backdrop of widening domestic and global
output gaps, the balance of risks to the inflation outlook has changed
somewhat.
Recent developments in inflation
Inflation as measured by the re-weighted and reconstituted consumer price
index (CPI) for all urban areas (which is the new target measure) measured 8,1
percent in January 2009. Food and non-alcoholic beverages prices, which
increased at year-on-year rates of 15,7 percent in January, contributed 2,4
percentage points to total inflation. The housing and utilities category
contributed 2,1 percentage points, and together with food accounted for more
than half of the measured inflation increase. The transport component had a
minimal impact on the overall CPI as a result of the 20,3 percent reduction in
petrol prices during January. Producer price inflation, which reached 19,1
percent in August 2008, continued its downward trend, measuring 9,2 percent in
January 2009. Despite the depreciation of the rand during 2008, producer prices
of imported goods declined at a year-on-year rate of five percent in
January.
The outlook for inflation
The most recent central forecast of the bank shows a near-term deterioration
in the inflation outlook but a more favourable trend is forecast for the medium
term, which is the relevant time frame for monetary policy. Consumer price
inflation is expected to average 8,1 percent in the first quarter of 2009 and
then to decline to below six percent in the third quarter of the year. As a
result of technical base effects, inflation is then expected to marginally
exceed the upper end of the inflation target range, before returning back to
within the range in the second quarter of 2010 and to remain there until the
end of the forecast period in the fourth quarter of 2010, when it is expected
to average 5,3 percent. The heightened levels of uncertainty and the rate of
change of global developments make these forecasts subject to higher risk than
is usually the case.
Expectations by analysts are similar to those of the bank, with the Reuters
consensus forecast showing a moderate upward revision of inflation in 2009 and
a relatively unchanged forecast in 2010, when inflation is expected to average
5,5 percent in the final quarter. Most forecasters expect inflation to have
increased moderately in February 2009 before resuming its downward trend.
Inflation expectations, as reflected in the yield differential between
inflation-linked bonds and conventional government bonds, have increased
slightly since the previous meeting of the MPC but remain within the inflation
target range.
The inflation outlook has been dominated by the continued weakening of the
global economy and financial markets, notwithstanding significant monetary and
fiscal measures introduced by central banks and governments. The decline in
global demand has resulted in a marked contraction in international trade. The
International Monetary Fund (IMF), which in January was forecasting global
growth to average 0,5 percent in 2009, now expects the global economy to
contract by up to one percent in 2009. Numerous industrialised and developing
countries are already experiencing negative growth. World inflation is being
restrained by declining demand and lower commodity prices which are expected to
remain subdued under these conditions of negative or low growth.
The weak global demand has been reflected in the export performance of the
South African economy. However, the decline in the value of exports in the
final quarter of 2008 was more than offset by a lower value of imports, mainly
due to declining international oil prices. Combined with a narrowing of the
deficit on the services, income and current transfer account of the balance of
payments, this resulted in a narrowing of the deficit on the current account
from 7,8 percent in the third quarter of 2008 to 5,8 percent in the final
quarter. However, the published January trade data, which showed a further
considerable decline in the value of merchandise exports, suggest that the
improvement in the trade deficit may not be sustained to the same extent seen
in the fourth quarter. The deficit on the current account of the balance of
payments measured 7,4 percent for the 2008 calendar year.
Domestic demand conditions have also deteriorated further. In the fourth
quarter of 2008, gross domestic expenditure and domestic final demand
contracted by 3,9 percent and 0,4 percent respectively. Final consumption
expenditure by households declined by 2,7 percent, mainly as a result of a 20
percent contraction in consumption of durable goods. The growth in gross fixed
capital formation moderated further, recording an annualised growth rate of
three percent. Motor vehicle sales, which have been under pressure for some
time, declined at a year-on-year rate of 35,6 percent in February. In January,
real retail sales increased at a year-on-year rate of 1,7 percent, the first
year-on-year increase in nine months, while wholesale trade sales declined by
4,5 percent over the same period.
Domestic demand conditions are expected to remain under pressure as a result
of declining disposable incomes, tighter credit conditions and negative wealth
effects. Credit extension to the private sector has continued its downward
trend, a result of lower demand and more stringent lending criteria being
applied by banks. In January 2009, growth in total loans and advances to the
private sector measured 11,4 percent. The slower rate of credit extension has
resulted in a further moderation of the ratio of household debt to disposable
income to 76,4 percent in the fourth quarter of 2008, compared with a peak of
78,2 percent in the first quarter of that year.
Domestic output has been impacted appreciably by these external and domestic
demand developments, resulting in a further widening of the domestic output
gap. In the final quarter of 2008, gross domestic product (GDP) contracted at
an annualised rate of 1,8 percent, mainly due to a 22 percent decline in
manufacturing sector output. The high frequency data indicate that these
adverse conditions may have persisted in the first quarter of 2009.
Manufacturing and mining output contracted at year-on-year rates of 11,1 cent
and 8,7 percent respectively in January, while the Investec/BER Purchasing
Managers Index reached a new low in February, reflecting continued strain on
the manufacturing sector. The latest Bureau for Economic Research manufacturing
survey indicates extreme and broad-based weakness in this sector in the first
quarter of 2009. The RMB/BER Business Confidence Index surveyed in the first
quarter of 2009 reached its lowest level since 1999, particularly in the
manufacturing, wholesale and construction sectors. The confidence of retailers
of non-durable goods increased somewhat.
On a trade-weighted basis, the rand has been relatively stable since the
beginning the year and has appreciated by about 2,5 percent since the previous
meeting. Movements in the rand exchange rate in recent weeks have been mainly
reflecting volatile international currency developments. After the previous
meeting of the MPC, the rand first depreciated to around R10,60 against the
United States (US) dollar, as the dollar strengthened against most currencies.
Since then the US dollar has weakened somewhat, and the rand is currently
trading at levels of around R9,45 per US dollar.
The upside risks to the inflation outlook emanate primarily from cost-push
pressures, particularly from administered prices. These include possible
higher-than-expected electricity tariff increases. The decline in inflation may
also be delayed by continued high rates of increases in food prices, despite
marked declines in producer price food inflation.
Monetary policy stance
Against the background of a slowing global and domestic economy and an
improved medium-term outlook for inflation, the Monetary Policy Committee has
decided to reduce the repurchase rate by 100 basis points to 9,5 percent per
annum with effect from 25 March 2009.
TT Mboweni
Governor
Contact:
Samantha Henkeman
Tel: 012 313 4669
E-mail: Sam.Henkeman@resbank.co.za
Issued by: South African Reserve Bank
24 March 2009
Source: South African Reserve Bank (http://www.reservebank.co.za)
