How Much Will SARB Cut This Time?
Given the unprecedented easing around the world, virtually all analysts agree that the SARB will cut rates at their meeting on Thursday.
Despite reporting relatively few cases, South Africa has not been exempt from the market reaction to coronavirus.
One would expect that the flight to safety and demand for liquidity would pull assets from emerging markets. But South Africa has additional troubles. And their financial system was already in critical condition long before we even heard of COVID-19.
South Africa already had a liquidity problem. Many companies were failing to find funding to maintain operations. This includes the national airline which is also being significantly impacted by the current events as people drastically scale back travel.
With a plethora of major industries already needing financial support, the SARB will be under increased pressure to do something to help the economy.
What We Are Looking For
The consensus among economists is that the Reserve Bank will cut the rate by 25 basis points at the meeting on Thursday.
That’s a far cry from the 100 points of the Fed, and the 75 points by the RBNZ. The effect on the economy is likely to not be as much as would be hoped.
The reality is that the SARB likely wants to cut rates quite a bit more. However, the inflation rate means they can’t. And the latest package of measures announced by President Ramaphosa isn’t likely to help in that scenario.
Increased government spending might help the economy in the short term, but inflation might get further out of hand.
The Rate Isn’t So High
With the Fed setting rates near zero, it seems like there is a pretty large interest spread between the ZAR and USD.
That would normally be seen as supportive of the emerging currency. But there are some factors to consider in terms of capital investment flows.
The latest report showed inflation at 4.5% annualized. In fact, it has been above 4% for quite some time with only a brief excursion below that late last year.
Add on top of that the South Africa credit default swaps have moved up to 184bps, the cost of investment comes out to 6.34%.
The cost of doing business on a financial risk profile erases the benefit of the interest rate. This effectively puts the current policy on par with the US.
In Other Words, SARB Doesn’t Have Much Easing Room
Central banks around the world are mostly fighting low inflation rates, allowing them to cut rates to record lows in an effort to stimulate the economy.
But with inflation rates so high already, if the SARB wants to help boost the economy, they are going to have to make a similar move as Japan – but in the opposite direction.
The BOJ recently gave up on its commitment to raising inflation in order to support the economy. The SARB might be in the unenviable position of having to forgo currency stability in order to support the economy.
With several state-run institutions desperate for a cash injection, the SARB might not have much choice in the matter.