Has South Africa Acted Wisely?

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By Wezi Tjaronda WINDHOEK Bank Windhoek says South Africa’s central bank may have acted prematurely by increasing its bank or repurchase rate with 50 basis points. It says the next three to six months will tell whether the hike was warranted or not. In an economic review published in its quarterly newsletter, Agenda, the bank says: “It appears that the SARB may have acted prematurely and gambled that South African consumers will reassess their finances and scale down their spending and thus credit demand without causing too much of a halt in the economy’s growth momentum,” the bank says. The South African Reserve Bank’s Monetary Policy Committee announced a 0.50 percent hike in the bank’s repo rate on June 8 to 7.5 percent due to prevailing economic conditions such as high oil prices, high credit growth and negative trade balance. The Bank of Namibia followed suit, by increasing its repo rate to ensure that interest rates in the country are consistent with those prevailing in other CMA countries, which if not followed could lead to large capital outflows or inflows and may destabilise the Namibian economy. While the South African prime rate increased from 10.50 to 11.00 percent, the Namibian one has been increased from 11.75 to 12.25 percent. Analysts say despite the rise in oil prices, inflationary pressures were gentle, fears that the economy might be growing beyond its potential improved and while the rand had weakened in the preceding weeks, it was not viewed as the most vulnerable among currencies of emerging markets. But, Bank Windhoek (BW) wonders whether this interest rate hike was warranted. It says although the SARB based its decision on the change in oil price assumption used in its adjusted inflation model, “the outcome of the change is a deteriorated prediction that inflation will rise to just over the upper limit of their 3-6 percent inflation target range in the first quarter of 2007 and then moderate to 5.2 later in 2007”. BW also said the forecast was based on continuous high oil prices and a weak currency and is much higher than that predicted by the market. “The SARB’s argument that money supply growth, consumer demand and private credit extension are too strong, is valid, but does not represent a change in condition prevailing ahead of previous MPC meetings,” it said. The leading conditions, adds that bank, have eased recently and there are still no signs of it being inflationary. Among others, it noted that high household debt levels – compared to its disposable income reached a high of 68 percent in the first quarter of 2006 that flared up fears of consumer spending – show signs of moderation. However, with an economic growth of 4 percent, the publication says the SARB could argue that the outlook appears favourable for higher economic growth later this year and the economy would be able to stomach an interest rate increase. At the same time, it mentions that the indicators show that the South African economy is losing some steam judging by motor car sales which decreased in May, credit growth, which has started to ease and the rate of increases in property prices that has fallen sharply. And against the backdrop of the rate hike, these trends are likely to continue while spending is expected to be reduced sharply due to many consumers being quite heavily indebted and will thus spend less due to fear of future hikes. And while the risks argued by the South African bank are real and high, Bank Windhoek feels the reserve bank would not have hiked the rates because of the domestic inflation outlook alone had there not been interest rate hikes in the US and Europe. Suppose the difference in interest rates differ between the first word and South Africa, there may be fears of a significant sell-off in emerging markets, which would help destabilize sentiments towards emerging markets. At the same time, this may be true for interest rate sensitive money and capital markets and not for South African equity markets, which has in recent times performed well. “Higher interest rates may spoil the SA economy partly and may spell bad times for their equity market,” the bank said.