What’s happening with the investors:
So not a lot has changed since last week. And the indicators:
You’ll notice that the Repo Rate went up by 25 basis points? That came into effect last Friday.
I find that very few people actually understand rate hikes, or why they happen, or how on earth they’re meant to make a difference. So I thought that I might spend the rest of this post explaining it.
How The SARB thinks
So the South African Reserve Bank has a single mandate: “keep the inflation rate between 3% and 6%”. But it also has some other (minor) considerations, namely: “But, you know, we need to keep in mind that destroying the economy in the pursuit of that mandate would be a tad foolish.”
In all of this, the SARB has one tool with which to play: the repo rate.
Here’s what the SARB thinks/knows/believes will happen if they lower the repo rate:
- Lowering the Repo rate means that it’s cheaper for the commercial banks to borrow money from the SARB (and, correspondingly, it’s more expensive for them to keep money at the SARB).
- So the banks, because they’re competitive, pass on some of that to cheapness to their customers.
- People with mortgages and hire-puchase agreements (on cars, etc) suddenly find that they’ve got a little more spare money each month, because their monthly repayments have come down. So maybe they’ll spend more.
- Businesses with mortgages and hire-purchase agreements suddenly find that they’ve also got a little more spare money each month, so they can perhaps afford to hire more people, or do more expansion, or whatever.
- In addition, it just became a bit cheaper to borrow money – so perhaps people/businesses that hadn’t made some big purchase decisions beforehand might choose to make those purchases now.
- Meaning that demand is stimulated – which would cause some inflation. But acceptable inflation when the economy is slowing down.
- Lower interest rates mean that foreign investors might start to earn lower returns on their investments (at least, that’s the theory).
- And in particular, there will be lower forward rates in the foreign exchange market (which is driven by interest rates).
- So foreign capital might start to leave South Africa in the search for higher returns.
- Which would cause the Rand to depreciate.
- Which would make imports quite expensive.
- Which would hurt any industries that are reliant on imported goods.
And the opposite is true when the SARB raises the repo rate:
- Raising the Repo rate means that it’s more expensive for the commercial banks to borrow money from the SARB (and, correspondingly, it’s more lucrative for them to keep money at the SARB).
- So the banks, because they’re businesses, pass on the higher costs to their customers.
- People with mortgages and hire-puchase agreements (on cars, etc) suddenly find that they’ve got less spare money each month, because their monthly repayments have gone up. So they’ll spend less.
- Businesses with mortgages and hire-purchase agreements suddenly find that they’ve also got less spare money each month, so they might need to cut back and/or attempt to sell off assets in order to maintain their solvency..
- In addition, it just became more expensive to borrow money – so perhaps people/businesses that were about to make some big purchase decisions might choose to delay those purchases.
- So demand is suppressed.
- Oh, and higher interest rates would cause the exchange rate to appreciate (normally).
- Making South African exports quite expensive.
- Which would hurt any industries that produce goods for export.
I would also point out on this whole exchange rate story that foreign capital is flighty. It almost only ever negatively impacts. And I say that because:
- People doing long term investments into South Africa don’t make impulse decisions to get into and/or out of SA on the back of a 25 basis point rate movement. They’re concerned with things like “long-term sustainability” and “profit margins”. Of course exchange rates matter – but they’re a risk that can be managed.
- The foreign capital that wreaks havoc on the exchange rate is speculator flows, which move into and out of bond and equity markets.
- So the SARB needs to consider that whatever it does, the exchange rate will be affected opportunistically.
The Current Situation
The SARB has found itself awkwardly placed. On the one hand, inflation is up to 6.6% – which has them concerned because now they’re outside their mandate. But on the other hand, there is an economy that’s looking pretty stagnant with all the strikes and the depreciated Rand. Here’s ETMAnalytics‘ graph of the SARB’s GDP forecasts over the last year:
So the SARB might want to raise interest rates to stop the inflation, but raising interest rates also suppresses demand, which would prolong all this poor growth.
Either way, the SARB has elected to do something: they’ve raised the repo rate by 25 basis points. Which is really quite conservative.
And now we’ll wait to see what difference it makes.