Effectively, the nominal repo rate is at its lowest level in 48 years in South Africa.
The last time South Africa had to lower interest rates to this level was during the Yom Kippur War and oil crisis of 1973.
Back then the policy rate stayed below 3.5% for less than 90 days before going to 3.78% and higher within a short space of time.
The last time the repo or policy rate stayed below 4% for over a year ended in June 1964. That’s nearly 57 years ago!
See chart below for the long-term history of the SA repo rate.
Moreover, the drop in the repo rate was quick.
The last time the repo rate halved in less than six months was at the back end of 1998 when SA recorded a central bank policy rate of nearly 22% during the emerging market crisis. The SA repo rate does not just halve, and it does not fall below 4% much either.
South African Reserve Bank (Sarb) rate action was decisive. Savers had a more challenging time, but they knew that lower rates would help the recovery.
But a low rate takes time to have an impact; it needs to stay low for a long time. Communication from the Sarb was vital, and the monetary policy made it clear that rates were to remain low for long. At times there were votes for even lower rates.
The interest rate impacts an economy only about nine to 12 months later.
On May 22, a repo rate of less than 4% will have been in effect in SA for a year.
I believe the rate will likely stay there for another few months. Sure, the rate will increase from the 3.5% level – but in small steps.
Other central banks are also starting to hint at small increases or long periods of zero rates and no further cuts.
At long last, the hoarding of cash declines
Business, or more correctly, the non-financial private sector, responded to the crisis by hoarding money out of fear.
Cash deposits by private firms went from 19% of GDP to 24% (partly due to hoarding and partly due to a decline in GDP). See chart below.
Cash deposits by businesses went from R874 billion in the first quarter to R993 billion in Q4. Fear drove company savings up by R120 billion. But since November, private sector cash deposits have declined R33 billion.
So a quarter of business hoarding has dissolved due to the repo staying low and the economy bouncing back.
The incentive to keep even more money in the bank was taken away as interest rates had more inferior returns than the return on assets the private sector made – mainly due to lower interest rates. Firms now want to employ their capital in their businesses again as economic activity returns (more on this aspect in the following section).
In March this year, consumers spent more on their credit cards for the first time in a year. Only just – but they did, and that would not have happened if rates did not decline for a long time.
As the pandemic and lockdown hit South Africa, consumers also got a fright which resulted in the fastest increase of deposits in at least a decade. Deposits by residents went from R3.97 trillion in January 2020 to R4.47 trillion a year later.
Yip, that is an extra R500 billion in deposits driven at least partly by fear and uncertainty.
But with a record low level of interest rates, consumers finally started spending those deposits in February and March. Remember, rates are not just there to encourage borrowing but also to promote some cash spending in times of economic distress.
In the first quarter of 2021, R30 billion left consumer deposits and was spent in the economy. Of course, more needs to be spent, but at least the excessive hoarding is over for now.
Again the level of the repo rate impacted on consumer behaviour, but only nine months or so later. The economic blow was softened over time. At least now, low rates on their own will impact stronger on economic growth. Consumer confidence is at least not as low as it was last year, and if no other lockdowns take place, the confidence could reduce the cash pile further. We are not talking credit here but actual money in bank accounts.
Combined, the consumer and private sector have just pumped back R70 billion into the economy – in about three months.
That I believe is faster than the government spent money on consumers and businesses last year.
The lower repo rate also helped firms and consumers who were highly indebted. Low rates gave consumers some breathing space, and gave companies a better chance of survival.
The repo rate will however have to remain low to increase credit extension again as the latest numbers there suggest the consumer is still scared of creating debt. Private sector credit declined at the fastest rate since May 1966!
Hoarding may be over, but private sector credit creation is still in decline. That is perhaps partly a function of government crowding out, but the low policy rates should positively impact credit creation. For this reason, I believe monetary policy will have to remain extremely loose. Yes, the rate will surely increase, but I expect that to be slower than usual as the shot in the arm needs time to work.
Private sector return on assets beat money market rate in Q4
Private business must decide where to deploy assets. Too many private sector assets in the banking system is not always a sign of economic health.
Business cash deposits at around 20% is a sign of low confidence and returns in an economy.
Company shareholders are probably more pleased as the return on assets for the private sector was higher than money market rates for the first time in six years in the fourth quarter of 2020.
As private sector companies have to make a return for their shareholders, one of the measures would be what can a shareholder get in interest in the bank. If bank interest is higher than the return on the assets deployed, it is onerous to make a case for more investments into the company rather than depositing money in the bank.
In the fourth quarter of 2020, for the first time since the first quarter of 2015 did the total non-financial private sector see returns on their assets that were higher than the bank rate.
On average, it makes sense for companies to invest in either human or fiscal capital again.
In the following chart, the three-month money market rate and the non-financial private sector return on assets are compared, and the decrease in interest rates is starting to have an impact as the rate of return improves while interest rates stay low.
The extended lowrate outlook should encourage more risk-taking by firms. This is the best news that low rates will have on the real economy.
SA also lowered its nominal rates far faster than the average emerging market.
The trend shows that the Sarb acted quicker than most, and dropped rates further. SA rates are also still lower than the average emerging market out there, which at present is a great thing.
While inflation will rise again due to big reserve-currency economies having very low rates, our Sarb can at least still leave rates low for a while – SA will not get punished for too-low rates in a low-rate world. There are very few places where inflation is lower than policy rates right now.
A good band-aid
In summary, low rates in an environment of economic turmoil are a good band-aid until confidence comes back and fear is diminished. Of course, it is not a permanent fix, and structural reforms are still needed in SA.
However, the central bank acted fast, far and long with its monetary policy, while the impact is only really being seen now. It is perhaps a bit early to raise rates again, but the medicine is working, and the hoarding of cash has stopped.
Also, inflation at least played along, as did the rand.
The economy also felt the positive impact of higher export prices.
And all the extra spending by the government and the Unemployment Insurance Fund (UIF) released well over a hundred billion of helicopter money into the economy.
But the more recent impacts are driven by lower rates rather than extra spending by government. This won’t last forever, but signs are that the economy needed that shot in the arm. It got it on time, and probably for long enough to make an emphatic difference.
The low rate saved much of the economy and will probably stay low for a long time to come, although maybe not as low as now.