In this insightful Rational Radio interview, heavyweight economist Roelof Botha unpacks why South African interest rates are 200 basis point too high. The economist to the Optimum Group, whose son is the managing partner of Silicon Valley’s top venture capital investor, explains why he believes something went seriously wrong at SA’s Monetary Policy Committee after former SARB governor Gill Marcus handed over the reins. – Alec Hogg
One of the great economists of South Africa joins us now – Roelof Botha – with a pedigree from here to next year. Roelof, I’m correct in assuming that you’ve been economist of the year and all kinds of other rewards, but you’re probably best known amongst the BizNews audience as being the father of your name sake, your son who’s the senior partner at Sequoia in Silicon Valley, do you talk to him much?
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Yes, fairly regularly. I taught him how to play tennis and chess.
And did you teach him how to invest, I guess that’s the most important part?
No, no, no, he knows more, I taught him how to play chess, but when he was in Grade 8 he started beating me, so I didn’t play against him again.
Oh goodness, all right, he’s certainly flying the flag high in Silicon Valley but you’re looking at another flag (the South African flag in particular). You’ve been doing some work on and been quite outspoken about it, on where interest rates should be in South Africa – the true level of interest rates. Just take us through your thinking.
Yes, I must tell you quite frankly it is mind boggling what is going on, at Reserve Bank’s monetary policy committee, because I’ve looked at it from every conceivable angle, if you look at the spread between our real repo rate and the average real Central Bank rate in Europe, its 450 basis points…
Which means what…4.5%?
We are 4.5% more expensive but it’s as clear as daylight that when Gill Marcus retired, during her term of office she maintained a real prime rate, prime minus CPI of 3%. It was virtually on the nose, exactly 3% on average during her term without hardly any volatility and our GDP grew at 2.6% per annum on average in real terms, and the minute she retired you can see the spike in interest rates and now the real prime rate is double. The new MPC increased the cost of capital in this country by 100%, so the cost of buying a tractor, the cost of buying equipment for your factory, or the cost of buying a car has increased by a 100%. It’s absolutely crazy, when virtually every one of our major trading partners was following accommodating monetary policy because of weak economic growth and weak demand. We went exactly the opposite route for no particular reason.
Now, Roelof, we’ve heard from Ace Magashule who is not the most popular man in the business community for other reasons but he’s been coming out and saying it’s about time that interest rates in South Africa get properly addressed, that the mandate of the South Africa Reserve Bank changes to also include growth and employment, sounds like you’re on the same hymm sheet.
Ha, ha, please don’t do that to me?
Ha, ha, well Ace needs some friends.
Ok, let’s be quite honest for the first time ever I actually agree with Ace but I, between the 2 of us I really don’t think he understands the bottom line because what they are missing is that the mandate of the Reserve Bank does not need to change. The mandate of the Reserve Bank as far as policy is concerned is very clear, they must try to keep inflation low and in the same sentence Alec it says, but also try to sustain economic growth and employment creation, and it’s as if the monetary policy committee have just torn out that half of their mission statement. There’s nothing wrong with the mandate, it’s about the discretionary powers of the monetary policy committee. I can guarantee you that if Lumkile Mondi was a governor of the Reserve Bank and he made me the deputy governor, and one or 2 other renowned economists of South Africa where to be the other 2 members of MPC, South Africa’s repo rate would be 200 basis points lower today Alec, at least. It’s a question of understanding the balance between combating inflation and making sure the economy does not go into a dip and I just need to add this quickly, if you look at the capacity utilisation in manufacturing in South Africa, that is going down and if you ask those industries why you are not producing at full capacity, the main reason is a lack of demand. Now how the hell are you going to stimulate demand if you don’t lower interest rates?
So, if interest rates were lower, would that not have a knock on effect on the Rand?
Well, it’s very interesting, I’m not 100% sure of my timing but about 18 months ago Moody’s admonished the Reserve Bank for its excessively strict monetary policy, and their argument was exactly the same as mine that if they were to lower rates and through that obviously stimulate demand, not only consumption demand but also capital formation, which is the key, it’s a lack of capital formation, that’s why the economy is doing so poorly, then obviously your returns of private companies and JSE listed companies would be better and it would attract, it would obviously have a knock on effect on dividends and that would attract equity inflows on a financial account. So, I must be quite honest with you, I get the impression that some of the MPC members don’t really understand economics.
Ok, there must be a thousand estate agents listening to this saying: “my goodness, you go Roelof, we are tired of seeing the property market under pressure as well”, and I guess lower interest rates wouldn’t hurt there either?
Exactly, I mean as we all know in real terms the property market, obviously it consists of various segments. Strangely enough in the agricultural sector over the last decade they’ve actually done quite well but residential properties, doesn’t matter in which income bracket, which price bracket it falls, in real terms it’s declined, but more importantly if you go and look, you take household credit, which is a whopping number, this economy has in the last 40 years never been able to grow in real terms unless there is at least modest or marginal growth in household credit, inflation adjusted in real terms, now that little indicator has been dropping like a stone ever since Gill Marcus retired, something is wrong at the MPC.
We have a very good economist who likes to keep his anonymity, so he goes under the name of John Maynard, I suppose in tribute to John Maynard Keynes and he wrote a piece on BizNews talking about Taylor’s rule. Do you agree with Taylor’s rule, do you think it has much sense and if so can you just unpack it for us?
Run that by me again quickly?
Taylor’s rule, it’s a rule on the level of interest rates around the world, and they take a guy called Taylor invented it, it took various components like economic growth and credit extension etcetera, put them together and said that translates into what interest rates should be and interestingly enough John Maynard says that the repo rate which is currently at 6.75%, according to Taylor’s rule should be 4.5%, so very close to where I guess you think rates should be?
Well, in fact my analysis if I were to, you know get somebody to assist me just with the weightings with regard to the different relative strengths of the arguments that I’ve got and I were to construct a composite index of what interest rates would be, it would be more or less on the nose of the figure you’ve just mentioned.
4.5%
And it’s so glaringly obvious, it’s so glaringly obvious that the Reserve Bank doesn’t, MPC doesn’t have a clue, they don’t have a clue.
Alright, so let’s just say that somebody’s listening to this, Cyril Ramaphosa is listening to this and he says for a change Ace is right, let’s do something about it, what A, can be done and secondly if interest rates were to be brought down by 2% percentage points or 2.5% percentage points, what would the short term impact be on the economy?
Well, I think the obvious thing that they should do is to identify perhaps one or a couple of economists, in South Africa, they could be vested in Universities, the private guys may, you know want to charge something, I’m not a 100% sure, but to get a reputable econometric model, I know UJ, Prof Ilse Botha has got one, she’s on her way to Thessaloniki to deliver a keynote paper at the world econometrics society and to let the model tell us, more or less, you know on the lines of the Taylor rule, but a little bit more sophisticated econometrics as to what rates should be in South Africa. I think the bottom line is that the MPC should be constituted of experienced, very well qualified economists that know about the importance of striking a balance between low inflation and sustaining economic growth and that is not currently the case.
Roelof what would happen if interest rates were to drop or the repo rate where to drop from 6.75% where it is right now to 4.5%, where you believe it should be. What would happen in the short term?
If it drops to where it’s supposed to be then, and everybody with credit from businesses to individuals, if they all decide to opt for the lower instalment on their debt instead of a shorter repayment period that would unleash into the economy roughly R70bn of demand, split more or less 80/20 between consumption expenditure and capital formation and that would take us out of the dire-straights within a couple of months.
