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Sunday, February 1, 2004
Time for stability

Is the current trend in falling rates sustainable over the longer term? Would it be fair to say we are entering a new economic era; and can we really look forward to pre-1974 rates on a sustained basis? Or, are we ‘jumping the gun’?

The last time the prime bank lending rate was below 12% per annum was April 1981 — over 20 years ago (and a lifetime for many). Indeed 1981 seemed to mark the beginning of a new era for South Africa, both economically and politically. It had shared the fallout from the 1973 oil crisis with the rest of the world. But after that came the 1976 Soweto riots, and the country was headed off on its own course into sanctions and the isolation of the 1980s.
The latest rate has been settled at 11,5% for some two months. With many homeowners receiving a discount on this of as much as two, even 2,25 percentage points, they are now borrowing at single-digit figures, the first time since the oil crisis.
So, why have interest rates fallen so far? And, more to the point, are we entering a new era of sustainable single-digit interest rates? It’s a crucial question for South Africa. Lower interest rates mean tangible, as well as psychological benefits for the country:
• Tangible benefits include:
o Lower financing costs for home ownership. More homes means more stability;
o Lower fixed investment costs encourages businesses to invest for the future through capital expenditure. This increases in productive efficiency;
o Reduced burden on financing Government Debt, releasing more funds into social spending;
o Improved outlook for equities, boosting the JSE, and creating a more stable investment environment; and,
o Increased employment through more stable long-term business strategies.
• Psychological benefits include:
o Narrowing the interest gap with our trading partners means we no longer stick out like a sore thumb;
o A more stable currency boosts confidence of overseas investors;
o A more stable monetary and fiscal policy will be possible;
o Domestically, businesses and consumers will start making longer-term decisions; confident they won’t be caught wrong-footed by a sudden change of monetary or fiscal policy.

Behind all these nice things there are certain structural problems — but we’ll list those later.
First, let’s try and put the current interest environment in perspective by reviewing some history. Based on data supplied by Econometrix, the prime bank lending rate since 1949 rose post-war right through to the mid-Eighties; then remained volatile from 1985 to 1998; and then, in what seems to be a third phase, entered a downward trend. Indeed, never before has there been such a sustainable fall — from 25% in August 1998, down to 11,5% currently.
The last time prime rate was below 10% on a sustained basis was pre-June 1974. It briefly flirted with 9,5% in August of 1979, but other than that the rate has remained in double-digit territory ever since. Economists are presently predicting rates will rise back to 12%, maybe a bit more by the end of 2004. But their reasons are no more cogent than an argument that rates will actually fall further. Incidentally, in over four months’ of research we could find no economist in the country who was able to answer the following questions:
• Why did interest rates fall (there were six periods since the late Seventies when they did)?
• Why did rates enter a severe ‘correction’ phase each time, rising again afterwards?
• What does this tell us about prospects concerning the current period of falling interest rates?
• What were the differences between the various economic conditions of each period, and are the present differences of sufficient quality to herald a new era of sustainable low rates of interest?

If they can’t answer these questions, then I don’t see how they know enough to reason that rates are about to rise again. Be that as it may, let’s try and figure out what’s been happening.
Probably the key to understanding South Africa is to consider its stability — or lack of it. Indeed, since the oil crisis it’s been unstable. Whatever variable you take, it would tell of an economy living on a knife-edge, able to plunge into a crisis at the slightest provocation. The legacy of this is that everyone thinks long-term means a maximum of three years — reason that 10 years after our first democratic elections, despite the incredible progress we have made, people are still clinging to well-worn habits of short-termism.
  Over the years instability got progressively worse. The prime rate changed 25 times in the first 25 years (1949 to 1974); then did the same again but in only 10 years, 1974 to 1983; it worsened still, changing 25 times in only four years up to February 1987, indicating the growing volatility of interest rates, exacerbating uncertainty in the economy. The rate of change was back to 25 times over the next ten-year period (1987-1996), but there was nothing to suggest an overall improving economic environment when you consider the rate changed 27 times again in a shorter period of seven years to the present. In all, out of 28 years rates remained unchanged for only 28 months.
Since 1976 there have basically been six periods (totalling less than 11 years) when interest rates rose; and six periods (totalling almost 15 years) when interest rates fell. In other words, prime increased faster over a shorter period, while falling rates were more gradual. There were basically only two periods when rates remained on a fairly even keel: briefly in 1984 and then for a two-year period during 1996/98.
A comparison of the previous periods of falling interest rates reveals the following:
Period 1 — 1976-1979 rates fell 3 percentage points over 38 months: 12,5% to 9.5%
Period 2 — 1982-1983 rates fell 6 percentage points over one year: 20% to 14%.
Period 3 — 1985-1986 rates fell 13 percentage points over 23 months, the biggest drop in SA history: 25% to 12%
Period 4 — 1989-1993 rates fell 5,75 percentage points over four years, the longest period of falling rates ever: 21% to 15,25%
Period 5 — 1998-2001 rates fell 12,5 percentage points over three years: 25,5% to 13%.
Period 6 — 2002 to present, rates have fallen from 17% to 11,5%, or 5,5 percentage points.

For much of the period, the Central Bank set itself the task of protecting both the balance of payments and the rand exchange rate. It tried to achieve this through various ‘market instruments’. During the Eighties it developed measures of, and responses to the changes in monetary aggregates. So-called ‘Money Supply’ reflected the ability of the banking system to create credit, and thus the amount of money in the economy.
Its main tool was the manipulation of the Bank Repurchase rate, the rate at which the Reserve Bank discounted bills to cover overnight shortfalls in the banking system.
Thus the Reserve Bank controlled consumer demand through controlling the rates charged on consumer credit, and used money supply aggregates to gauge the effectiveness of this policy. If money supply was growing too fast then interest rates were increased. The worst example of this was in 1984 when rates were increased from 20% to 21% then 22% and finally a whopping 300 basis points in one fell swoop in August to 25%. It was a let down for the authorities that had determined that 20% was the ‘politically acceptable maximum’. By controlling consumer demand, and therefore to some extent controlling the demand for imports, the Central Bank sought to protect the Balance of Payments (BoP) current account.
It was like trying to keep a balloon in shape by squeezing it. The reintroduction of the financial rand and the debt standstill in 1985 only put more hurdles in the way of growth; not helped by a continuing deterioration of the savings ratio, and the imposition of higher personal taxes. Then there was government overspending. Its debt, for example, rose from R30 billion in 1984 to R96 billion by the end of the decade (or almost 39% of total GDP). It reached R309,5 billion by 1997, swallowing up almost a quarter of the government’s resources just to service.
The BoP was forever under severe pressure for several reasons. Sanctions made alternative imports expensive; it also made it more difficult to find export markets. Up to the 90s South Africa had always been a commodity based economy. Its fortunes were very much determined by global demand for gold, diamonds, coal, iron and steel; and also raw materials such as platinum, manganese, cobalt, chromium, vanadium and asbestos. Commentators of the day belaboured South Africa’s lack of ‘beneficiation’, whereby raw materials should rather be processed into manufactured goods and components for higher value export.
The foreign debt standstill also closed off the country’s access to capital and imposed heavy repayment schedules. Failure to ensure a trade surplus on current account to provide for the capital outflow would mean South Africa reneging on her debt, and something the authorities had to avoid at all costs. The whole chain of events essentially meant they had to squeeze the consumer whenever this trade surplus was threatened.
Thus, monetary policy presided over two decades of boom/bust cycles. Indeed, during this period there was a distinct correlation between interest rates and economic activity: prime rate would rise with an economic upswing; and fall with an economic downswing. Consumers were penalised through high interest rates because they spent too much, and then berated for not spending enough when interest rates were brought down.
For example, from the start of the upward phase in April 1983 prime rose from a low of 14% to 22% in July 1984, which marked the end of that particular economic upswing. Rates still had to rise further, to 25% to cool the economy enough. Rates then fell during the downswing, reaching a trough of 12% prime in December 1986; the falling rates encouraged an upswing phase that had started April 1986. During the up phase rates were once again raised, reaching 19% in February 1989, and marking the start of another downswing. And once again, the lagged effect of rising interest rates meant they rose further, peaking at 21% in October 1989 as the downswing took hold. Rates had to fall to 16,25% before the economy started to pick up in June 1993. Into yet another upswing and we saw prime rising to a peak of 20,5% in May 1996, to bring the upswing to an end that November. Not until rates had been brought down to 15,5% in September 1999 did the next upswing emerge.
To be fair the authorities were facing increasing constraints from several exogenous factors. The oil crisis of the Seventies, faced by all world economies, was a piece of cake compared to what was to face South Africa alone: trade and financial sanctions. By the mid-Eighties a dozen or so countries had imposed a raft of sanctions, the severest of which came from the US, not only preventing South Africa from borrowing, but forcing it to repay an estimated US$23 billion in foreign debt. The last thing an emerging economy needs is to become a capital exporting country. But that became South Africa’s lot. For example, the second half of 1985 saw a net capital outflow of R7 billion, and a further R2,6 billion the following six months. This scenario was to plague the country for another ten years at a time when a rapidly depreciating rand was pushing up the costs of dollar repayments even more. The strict domestic interest rate policies were a tool to control demand, and therefore discourage imports. This in turn allowed the export side to create current account surpluses that were then used to meet foreign debt repayment obligations.
Not surprisingly, it was politics, not economics that was seen as SA’s key to recovery. But that wasn’t going so well either. The 1976 Soweto riots are always seen as the nadir of political unrest, and yet ‘only’ 285 people were killed (though the official figure had risen to 550 by year end). In August 1990 over 500 died in rioting (143 in one day in Tokoza). The year ended at double the previous year’s total of 1 400 deaths. There were over a thousand acts of violence 1976-1988; in 1985 a State of Emergency had been declared. And from 1987 to 1990 over 4 000 people were killed in Natal. From 1991 to 1994 (in the run up to the country’s first democratic elections) an estimated total 14 474 people were killed country-wide in politically-motivated violence.
With such instability one could hardly blame monetary authorities for the boom/bust interest rate roller-coaster. Even attempts to control the rand exchange rate, contrary to the more acceptable free market policies, was understandable, given this scenario.
What added to the structural imbalances was political change. Transformation toward a democracy, good and vital though it was, was paved with fear, uncertainty and lack of inertia as various groups threatened violence. From a psychological point of view the world was anticipating the worst. The country was already awash with AK47s from the fading wars in the north. Increasing numbers of limpet mines, hand grenades and RPG-7 Rocket launchers and rockets were being confiscated. Now as SA embarked on the transformation process it became awash with TV networks relishing the prospect of a really good show of civil war and general mayhem. The international markets and foreign investors reflected the mood.
So what made the late 90s different? And does it mean we can expect interest rates will remain at sustainable low levels even though we continue to experience an economic upswing?
For the first time in living memory interest rates have been falling during an upswing. The pattern since the 1973 oil crisis has been broken. An important factor is that the Central Bank has changed tack. It now targets inflation, not money supply. It also no longer directly protects the rand, leaving it to find its own level.
In the present upswing phase rates have continued to fall — down to 13%. They rose to 17% during 2002, then resumed the falling trend to the current prime rate of 11,5% — all during an upswing.
Surely this must be the new look South Africa? At last after ten years of democratic rule it looks like the sceptics both at home and abroad are seeing the country as having a more stable economy, reliable politics and sustainable growth prospects.
Government must never threaten consumers with high interest rates again, else it will undo all its hard work. The scenario is now ripe for turning South Africans into net savers with longer-term views of prosperity and stability.
  South Africa has never before had such an opportunity to control its own destiny. On the global front the US now has to live with its horrendous twin deficits and the costs of peacekeeping in Iraq. It no longer has the time, money nor the will to control events in southern Africa. Our foreign debt position is well managed; the Reserve Bank has closed the vulnerable net open foreign currency position, while increasing numbers of local companies are adopting beneficiation to create exportable manufactured goods.
As noted earlier there are structural problems to contend with, however:
• Administered prices, especially through Telkom, Local Municipalities and the Post Office;
• Inflexible and prohibitively expensive communication networks (our slow Internet service is incredibly unproductive);
• An unreliable workforce, strikes, above inflation wage settlements, and the onerous labour laws;
• ‘Affirmative’ action, and its links with our skills shortage and the brain drain;
• Fundamental high unemployment rate, and rapid increase in population;
• Huge influx of illegal immigrants;
• Bulging prison population;
• Our dysfunctional educational and healthcare sectors; and, finally,

But what people are beginning to realise is that the South African economy is on such a sound footing that it is well capable of absorbing the effects of inefficiencies and imbalances in government’s social restructuring. It has successfully differentiated itself from the basket of emerging markets; has managed to keep its head above water; and, its prudent economic policies have remained in tact. Barring any external shocks, or further terrorist activity, it is therefore fairly likely the country will meet its inflation targets over the long term, and be in a position to enter a new era of sustainable low interest rates. By Nigel Benetton

Copyright © Insurance Times and Investments® Vol:17.1 1st February, 2004
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