Distancing and dislocation – monetary policy in a pandemic

It’s often been said through the current pandemic that fiscal and monetary stimulus alone cannot solve what is ultimately a medical crisis. Nonetheless, the swift action of central banks and governments can go a long way towards mitigating the impact.

The South African Reserve Bank was one of the central banks that moved swiftly, while countries were locking down, to flatten the curve and prevent the spread of Covid-19. Firstly, it cut the repo rate by 200bps in two moves, adding to the 25bps move earlier in the year. The Bank then followed this up by introducing a bond purchase programme, something never previously seen in the local market.

Governor Lesetja Kganyago, guest on the seventh episode of Investec Wealth & Investment’s webcast series, “Markets and investing in a time of Covid-19”, explained the Bank’s actions.

“As we were going into our March Monetary Policy Committee (MPC) meeting, we realised that there was a dislocation in the market, that price discovery seemed to have been hindered,” said Kganyago.

“When we saw the dislocation in the market we were able to deploy our open market operation through our bond purchase programme. We also responded by adjusting the financial regulatory requirements, relaxing the liquidity cover ratio and we reduced the capital buffers so that the [banking] sector could dip into those capital buffers.”

Kganyago noted that all of this was possible because inflation remained within the target band and because of the capital and liquidity buffers that were in place within the banking sector.

Chief Investment Strategist at Investec Wealth & Investment, Chris Holdsworth, reiterated the point that we need to recognise the limitations of monetary policy.

“This [the crisis] is an issue that's linked to the Coronavirus,” he said. “For example, tourism is 2.5% or so of South African GDP, it doesn't matter what our interest rates are, we are not going to entice foreigners to come to South Africa while this problem is ongoing. It’s the same with restaurants and other industries.”

Nonetheless, one shouldn’t underestimate the importance of the Bank’s actions. “It ensures that there isn't the sort of dislocation that we may have seen in other markets around the world,” he said.

The Reserve Bank has opened up the possibility, in many commentators’ minds, of further unprecedented action, such as expanding the Bank’s balance sheet, buying corporate bonds, or even directly helping to fund government’s efforts to combat Covid-19.

“We shouldn't be imposing limits on ourselves for as long as we see dislocation in the market and we feel the correct thing to do is to continue to purchase the bonds. However, there are specific constraints that had to be taken into account, which have nothing to do with the balance sheet of the central bank.

“Bond purchases can do nothing where there is a concern about the sustainability of the debt of a country. You can go and buy all the bonds you like, you will not be able to move the dial because there would be concerns about the debt situation of the country,” he said.

“Secondly, unlike the advanced economies that have the benefit of having their currencies as reserve currencies, we are a small open economy so there is a limit to the bond purchases that you could make because you are actually creating rands that you are putting into the market .”

“Finally, you must also think of when the situation normalises or reverses. Can you unwind all of these measures?”

“We’ve not bought any corporate debt. We moved from the premise that the underlying market was the government bond market and if the government bond market is dysfunctional, then you have a problem because the corporate bond market is priced off the government bond market.

“Also, South African corporates have not really funded that much within the bond market, unlike in the US where you have a vibrant corporate bond market. Here, corporates that issue bonds are really limited and many of them have very strong balance sheets.”

On the question of the Reserve Bank being used to help fund government’s efforts to tackle the Coronavirus:

“Let me say firstly that we do not comment on fiscal policy. There is a debate going on amongst the central bank community about the extent of the bond purchases that the central banks are doing and the extent to which it could suck the central banks into making fiscal policy decisions – which could be problematic.

“Furthermore, our legislation provides a limit on how much government debt we can purchase in the primary market.  And as a member of the Southern African Development Community (SADC), we are bound by the limitation on central banks to not provide more than 10% of the funding to the government.”

Holdsworth said that the Bank’s actions and the outlook for inflation should be good for the bond market. This was partly because of the collapse in demand and partly because of much lower oil prices, which have offset the impact of the rand’s depreciation of some 25%.

“We don't see inflation as a threat in the short term or even in the medium term in South Africa.

“So we've got an environment where the 10-year bond yield in South Africa is above 10% but inflation is at 4% and may even land up being lower. For us that's very attractive.”

Looking beyond the role of fiscal and monetary policy, and doing some blue sky thinking, Holdsworth said South Africa needed to tackle the “binding constraint” on growth, in the form of Eskom. “Ironically, the current virus period may in fact accelerate our recovery because it's allowed Eskom to increase its amount of planned maintenance. So presumably this will accelerate a path back to a normal situation, though we're still far from that point,” he said.

Education could also benefit out of the current situation. “Ironically again, the current situation may speed up the growth of online learning. At some point, you may be able to sit in South Africa and receive the best education from anywhere in the world. So perhaps we get rescued by the world even if not through our own policies.”

Holdsworth added that the government could also act in other ways, such as making it easier to do business. “We rank very poorly relative to the rest of the world on ease of doing business measures, so there's lots of scope for improving that,” he said.

In a similar vein, Kganyago said there were opportunities to grow e-commerce. “I can tell you now that the battle at home now is not who has left their teacup out, the battle is 'get off the internet' because I need the broadband now,” he said.

“To take advantage of that, we are going to have to release spectrum because as we restart this economy, as we maintain social distancing, we are going to have to take advantage of what e-commerce offers.”

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