VZCZCXRO2822
RR RUEHDU RUEHJO RUEHMR
DE RUEHSA #1956/01 1321343
ZNR UUUUU ZZH
R 121343Z MAY 06
FM AMEMBASSY PRETORIA
TO RUEHC/SECSTATE WASHDC 3374
RUCPCIM/CIMS NTDB WASHDC
INFO RUCNSAD/SOUTHERN AFRICAN DEVELOPMENT COMMUNITY
RUEHBU/AMEMBASSY BUENOS AIRES 0239
RUCPDC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 PRETORIA 001956 
 
SIPDIS 
 
SIPDIS 
 
DEPT FOR AF/S/MTABLER-STONE; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/JDIEMOND 
TREASURY FOR OAISA/JRALYEA/BCUSHMAN 
USTR FOR PCOLEMAN 
 
E.O. 12958: N/A 
TAGS: ECON EINV EFIN ETRD BEXP KTDB PGOV SF
SUBJECT: SOUTH AFRICAN MONETARY AUTHORITIES EXPECT INFLATION 
WITHIN TARGET RANGE ALTHOUGH RISKS REMAIN 
 
¶1.  Summary.  At the May 11th semiannual Monetary Policy 
Forum meeting, officials from the South African Reserve Bank 
(SARB) briefed members of the economic community on the 
justification of leaving interest rates unchanged so far in 
¶2006.  Citing lowered inflation expectations since November 
2005 and inflation having been within the 3%-6% target range 
for the past 31 consecutive months, the SARB expects 
inflation to remain within its target range over the next 
several years.  However, risks to inflation remain the same. 
Increasing current account deficits, rising oil prices, 
strong consumer demand and increasing household debt levels 
still worry the SARB as potential harbingers of accelerating 
inflation.  Recent statements by the SARB Governor Mboweni 
and Finance Minister Manuel suggest that future SARB action 
may lean towards interest rate increases to curb 
inflationary risks.  The SARB also presented research that 
suggested South Africa's current growth potential (non- 
inflationary growth) was slower than what would occur if 
government's economic targets were met or if South Africa 
attained the average competitive performance of emerging 
markets.  End Summary. 
 
So far, Inflation Under Control 
------------------------------- 
 
¶2.  Targeted inflation, i.e., consumer prices without 
mortgage costs, has remained within the 3%-6% range for the 
past 31 consecutive months.  Since the last Monetary Policy 
Forum in November, inflationary expectations have steadily 
declined, and thus the SARB has steadily lowered its 
forecasted peak inflation rate over the next two years.  In 
October 2005, SARB thought inflation would peak at 5.8%; its 
current inflation peak is 4.9% occurring in the first 
quarter 2007, and then receding to just over 4.5% throughout 
¶2008. 
 
South Africa Faces Same Inflationary Risks Over Past Year 
--------------------------------------------- ------------ 
 
¶3.  The inflationary risks facing South Africa have not 
changed over the past year.  High and volatile oil prices, 
widening current account deficits, strong consumer demand 
and increasing household debt levels have provided SARB with 
enough reasons to be cautionary about rising inflation in 
the future.  So far, none of these risks have translated 
into substantially higher inflation. 
 
¶4.  The relative strength of the rand has tamed the impact 
of rising oil prices denominated into dollars.  Little 
evidence exists to suggest rising oil prices are causing 
increased secondary inflation.  The strong rand did 
encourage cheaper imports, with imports increasing by 10.1% 
in 2005 compared with export growth of 6.7%.  However, 
cheaper imports provide more competition to domestically 
produced goods and limit possible price increases. 
 
¶5.  Rising disposable income along with relatively low 
interest rates mean that increased debt is still relatively 
affordable.  Even though household debt reached 65.5% of 
disposable income during the last quarter 2005, debt service 
costs are 7% of disposable income, less than half the 1998 
level. 
 
Jawboning Attempts to Reduce Inflationary Risks 
--------------------------------------------- -- 
 
¶6.  Recent statements by both SARB Governor Mboweni and 
Finance Minister Manuel on the dangers of incurring 
additional debt in the face of possible interest rate hikes 
underscore the importance of moral suasion in trying to cool 
strong credit and consumer demand.  Over the past two years, 
household consumption growth supported strong growth in GDP, 
with strong growth in household spending on durable and semi- 
durable goods. 
 
¶7.  SARB's most recent Financial Stability Review (March 
2006) warned about recent changes signaling that borrowers 
might be facing repayment problems.  Mortgage loans overdue 
(those that are more than 180 days overdue and either 
inadequately secured or uncollectible) increased by 5.5% in 
the year to February 2006, while the ratio of overdue 
 
PRETORIA 00001956  002 OF 002 
 
 
mortgage loans to total mortgage advances increased from 1% 
in the third quarter 2005 to 1.2% in the fourth quarter. 
Both Mboweni and Manuel have warned about possible impacts 
of increasing interest rates on consumers, saying what goes 
down must come up. 
 
Interesting Asides 
------------------ 
 
¶8.  For every Monetary Policy Review, the SARB publishes 
separate sidebars that highlight recent topics of research. 
This issue featured three topics, one of which generated 
great discussion and had implications for government 
policies.  The May issue of the MPR featured bank research 
on household indebtedness, comparing affordability indices 
across countries; a discussion on global trade imbalances 
and summary of research on measuring South African potential 
output.  Given the South African government's emphasis on 
achieving accelerated growth, discussion on potential output 
raised questions. 
 
¶9.  Potential output is the maximum sustainable level of 
output consistent with stable inflation.  It can never be 
observed, but most econometrically estimated macroeconomic 
models estimate potential output by using production 
functions that use total factor productivity, desired 
capital stock and a natural rate of unemployment (frictional 
not structural unemployment). 
 
¶10.  SARB's research posits four scenarios: status quo, 
utopia, government targets, and international benchmarks. 
SARB's discussion does not make it precisely clear which 
value of the natural unemployment rate each scenario uses. 
The status quo uses some positive value (not specified). 
Utopia scenario uses 0, which assumes there is neither 
structural nor frictional unemployment.  Government targets 
scenario assumes unemployment is halved in 10 years, savings 
to GDP ratio reaches 22% and the foreign direct 
investment/GDP ratio reaches 1.3%.  International benchmark 
scenario assumes that South Africa achieves the average 
performance of emerging markets, where the unemployment rate 
is 12%, FDI to GDP is 4% and the savings to GDP ratio is 
25%. 
 
¶11.  The results are illuminating.  The status quo scenario 
yields 4.1% growth in potential output, utopia shows 6.9% 
growth, the government target scenario's growth of potential 
output is at 5.1%, and the international benchmark scenario 
reaches 6.5%. 
 
¶12.  Comment.  Only the results were presented at the 
presentation without explanation of the assumptions behind 
each scenario.  Several questions arose concerning the 
relatively low growth of potential output in both the status 
quo and government target scenarios.  SARB representatives 
stressed that the analysis was intended as contributions to 
current research and not serve as the SARB's opinion of 
South Africa's current growth potential, or what would occur 
if the government's economic targets were met.  End comment. 
 
TEITELBAUM