|To set sound economic policy, Central Banks need to differentiate between supply side and demand side shocks on inflation. Higher energy prices are a supply side shock that cannot be remedied by a demand side measure such as raising interest rates.|
This is the view of Brian Kantor, a professor of economics at UCT (on leave of absence) and investment strategist at Investec Securities.
At the recent Rode Conferences on property in Johannesburg and Cape Town, Kantor said South Africa should take a leaf out of Australia’s book on rates. He agrees that the rand has lost its moorings, but says it isn't good economic policy to try and defend it by pushing up interest rates.
“When there was volatility in developing markets during 1998, the Australians did not up their interest rates and their economy did very well. In South Africa, on the other hand, our governor of the Reserve Bank at the time, Chris Stals, kept increasing interest rates and killed our economy.”
Kantor said the exchange rate should be allowed to take its course and interest rates should not be raised to defend it.
“If it goes, so be it - it will stabilise again. We cannot stop it by raising interest rates when inflation is fuelled by the increases in oil prices. If we don't get it right this time, we'll damage our economy once more.”
Kantor also lamented the over-cautious approach of local investors. He said investors made two kinds of mistakes; they invest too much, or they invest too little – the latter being much more difficult to spot.
“The risk appetite of South African investors has been deficient for a long time. They set required returns far too high”, says Kantor.
If investors want to hedge the rand, it's going to cost them 3,5% per annum, he advised, being the difference between SA long bond yields and their US counterparts.
On the local front, Kantor emphasised that increasing interest rates would be a mistake as it is likely to slow economic growth, and, as growth slows, the risks to policy settings rise, and vice versa. Other factors that he cited in support of his stance against an interest rate increase, are that although household debt ratios are up, debt service is well contained; output growth is much slower than spending growth and the focus should be on incentives to stimulate it; plus the rand is deeply undervalued again. Kantor also highlighted the reversal of SA risk premium since 2002 to a level of 3,46, having been as low as 2,46 in April 2006.
From an international perspective he saw it as a helpful sign that US inflation was edging back, that US corporate spreads are remaining risk tolerant, and that the default risk in the US is still very comfortable.