By Radithebe Rammutle
L ately Large-Scale Assets Purchase, known as Quantitative Easing (QE), has attracted political attention, inevitably putting a spotlight on the South African Reserve Bank (SARB) and its balance sheet.
Adopting a monetarist and economics logic, the SARB leadership explained why QE was suitable monetary policy for developed countries but not for South Africa. ?The US Federal Reserve has taken further steps to expand its balance sheet and the European Central Bank (ECB) has made similar commitments. Emerging and developing economies generally have less policy space available and credit is more expensive? said Mr.Lesetja Kganyago, Governor SARB during the monetary policy announcement on the 21st of may.
Shortly after, SARB stance was contradicted by Mr. Ace Magashule, general secretary of the African National Congress (ANC), who announced on the 2nd of June that the party?s lekgotla decided to explore QE as a policy option to counter Covid-19 economic shocks.
QE is an attractive proposition for some not because it is an exotic monetary tool for exploration. In a monetary environment where there are extreme monetary supply (M1) shortages, QE can be a useful tool because it counters deflation. To achieve this QE relies on fractional reserve banking, a system that uses monetary base (also M0) to increase M1 in an economy.
Reserve authorities faced with the temporary M1 shortages regularly undertake limited open market purchase of assets in the secondary market. Since March 2020, SARB purchased bonds worth R20,9 billion in the secondary market as part of its measures to manage liquidity. The expected effect of this purchase is that prices of debt securities will increase whilst their yield declines. This is also expected to lessen interest payment burden on households and businesses.
However, these transactions are at the lower end of the open market purchase spectrum. On the upper end of this operation is QE which involves large scale purchases of bonds in the secondary market. QE programmes are justified by extraordinary deflationary pressures and the need to drive inflation up.
QE motivates credit transactions and multiplies deposits in the banking system. The amount of multiple deposits created in the banking system depends on the minimum reserve requirements set by the reserve authority and the behaviour of banks and individuals participating in the credit market. Economists use money multiplier model to estimate how actions of banks and depositors? impact M1. Based on the reserve requirement set at 2.5%, and SARB balance sheet data it was estimated that SA money multiplier is R19,86. In other words R1 of M0 supports R19,86 of M1. This meant that the current M0 that supports the R5 642 trillion M1 in the banking system is equal to R285 billion at the end of the financial year 2019/2020.
In his 18 June lecture speech at Wits University, Mr. Kganyago said proposals for increasing M0 through open bond buying have not been modest, referencing the suggestion from institutions such as Trade and Industrial Policy Strategies (TIPS), a policy think tank Non-Governmental Organisation (NGO) based in SA. In May 2020, TIPS proposed that SA needs asset purchase worth R1 trillion as part of the QE programme to support government fiscal deficit. A R1 trillion increase to the current R285 billion M0 is equivalent to 71,5% (R1 285 trillion). If assets purchase under QE are not sterilized , the money multiplier effect of R19,86 would increase the current bank deposits by R19 102 trillion to R24 744 trillion in total and R634,45 billion will be held as reserves.
Monetary authorities warned that such an increase in M1 (equivalent to 77%) could drive inflation up given a history of persistent inflation driven by other factors other than monetary policy. Despite inflation targeting policies, inflation grew out of the 3% and 6% range significantly in the second half of the last decade, moderating closer to 6% in the first half of the current decade (see graph 1).
Forces outside the control of the monetary authority, particularly the economic history of SA, have been identified as drivers of inflation. Expansionary fiscal policy and labour laws are often credited as drivers of inflation.
Considering the compounding effect that M1 brings about ??SARB cannot take responsibility for solving a fiscal sustainability problem, nor can it jeopardise the value of the currency by agreeing to inflationary money printing? said Mr. Kganyago. For him even the alternative of sterilising these purchases are not viable since they also carry costs that SARB cannot afford.
Countries that sterilise large-scale assets purchases do so because their reserve authorities have the financial resources that they can mobilise. The United State Federal Reserve (Fed henceforth) implemented this type of QE design in 2008. The asset purchases were worth $4,605 trillion between 2008 and 2013. Despite such an expansionary monetary policy, its effect on M1 was unnoticeable mainly due to sterilisation (see Graph 1 and Graph 2). M0 increased by more than 200% yet M1 rose by 25%. This was a consequence of banks increasing their reserve thanks to the Fed?s decision to sterilise asset purchases.
While the Fed can absorb sterilisation costs through interest rate payment on excess reserves this could prove to be an uphill for SA. The suggested TIPS R1 trillion asset purchase bearing sterilisation features at the current 3.5 repo rate means that the reserve bank would have to pay R35 billion in interest. This amount is equivalent to 165% of the SARB R23 billion capital and reserve. Mr. Kganyago said that this could bankrupt the reserve bank in a year forcing it to seek bailouts from government just like other failed state-owned enterprises (SOEs).
Cautious of QE inflationary and reserves bank solvency risks – if sterilisation mechanism is included in the proposed QE programme ? Mr. Kganyago, alongside Mr. Titus Mboweni, the SA?s finance minister, resisted pressure to shift the burden of Covid-19 economic recovery to weigh more on monetary policy. Instead of the QE the Reserve Bank used conventional monetary policies to address Covid-19 economic shocks.
In addition to the R20,9 billion highlighted earlier, the Reserve Bank embarked on an extended program of lowering the interest rate. At the time of going to print, the rate stood at 3.75%. It decreased from 6.5% in January.
SARB attitude towards QE is that SA has not met necessary conditions to pursue this policy option. Accordingly, interest rates need to hit the 0% lower bound before QE could be pursued. On the contrary Professor Cristopher Malikane in the School of Economics and Finance at Wits University said SA?s current 2.2 inflation levels and 3.5% interest rate are suitable conditions to pursue QE. At these levels emerging markets such as SA could pursue QE because their interest rates match sovereign risk premium of developed countries, and its inflation is also not at a 0% lower bound. Prof. Malikane assessed that, pursuing QE at these levels would not produce inflation and currency depreciation as is
According to Prof. Malikane, emerging markets do not have the luxury enjoyed by developed countries who can wait until their inflation hit the 0% lower bound before they implement QE. ?To expect the emerging-market inflation rate to be on the verge of 0% before embarking on QE is to allow the unemployment rate to soar to high levels because demand would have to fall significantly to pull inflation down to zero, before aggressive measures to counter the downturn are implemented? said Prof. Malikane.
Tussle over the inclusion of QE as part of the response to Covid-19 could further fuel tensions in SA and ANC. The governance policies of SARB will however shield it from those seeking its reform in the short term. The downside is that some stakeholders may perceive SARB dismissal of QE as an attempt to maintain status quo, increase the power and prestige of that institution. These is considered undemocratic to have a monetary policy ? so important to the public ? controlled by an elite that is not accountable to the public. How this tussle further deepens polarisation, it remains to be seen.