22 Nov Should SA be looking to the US to determine rates?
- Does it make sense in a post-Covid world to follow US interest rate movements particularly as their reasons for adjusting rates are different to South Africa’s?
- Local unemployment makes a case for linking interest rates to macro factors instead of rising inflation.
While South Africa follows the global trend of aligning rate changes with those of the US Federal Reserve (the Fed)to help curb local inflation concerns, does this mandate fit our current reality? The US bases their interest rates primarily on employment, not the outlook for GDP and pricing increases.
The MPC makes its moves based on the current inflation environment. It doesn’t factor in job creation or employment issues, which are among the biggest factors impacting South Africa’s economy (unemployment stood at 33.9% in the second quarter of 2022).
One could argue that in this post-Covid environment, which is only in its infancy as the virus has not entirely disappeared, adjusting rates simply to curb inflation may not be the right measure for our economy.
Under new pressure almost every quarter, households and businesses are battling to keep up. The Bankserv Africa Economic Transactions Index (BETI) is just one indicator of this, which sees a decline in economic activity – and October’s BETI saw the lowest activity this year so far. The MPC has raised interest rates by a total 275 basis points over the last year alone.
Rates: to fix or not to fix
One might consider fixing rates on current debt but it’s important to be aware of the risks. We have been here before – in a cycle of rising interest rates – which is some comfort. But it’s important for businesses to avoid overextending themselves any further, as rates could keep climbing.
When considering fixing your rate, it’s difficult to predict where to draw the line. One can buy hedges and caps against interest rate increases, but these are generally expensive, and you can make a mistake. It’s crucial to weigh up the cost of getting it wrong versus the certainty of managing to fix your rate successfully, should rates go much higher than expected.
The next question to ask is whether to borrow from a bank or a non-bank lender. While the interest rate you’re charged may be similar, you may find that as rates increase, so traditional banks start to lose their lending appetite and covenants may become increasingly onerous as their risk begins to increase. Non-bank lenders, on the other hand, will still consider a business and their funding requirements holistically. You might have a second income stream or additional collateral, for example, which non-bank lenders do recognise for credit purposes whereas banks generally discount such values. The partnership with the right non-bank lender could provide strong optionality and flexibility where the traditional banks may be limited. Many of your business’ risks may be better managed if you partner with a non-bank lender overall.
For businesses with sufficient headroom, it can be a good exercise to fix rates. Ultimately, you will achieve cashflow certainty and forward operations will be more manageable, as opposed to being entirely at risk. Some may have forgotten during 1998 – 1999 when the prime lending rate fluctuated between 15.50% and 25.50%; you can never know for sure what to expect, or when prime is at its best.
It’s best, however, not to ignore the possibility of fixing your rates and to consult your lender about the best option for your business. An extra 1%, as some economists are predicting for this week’s MPC decision, makes a big difference on a large balance sheet.
But whichever way the MPC goes, the question remains: Is enough being done to counter the impact of rising interest rates on South Africa’s economy?
Rising inflation assumes improved economic development and pricing, so anticipating economic output when inflation is on the up has been the modus operandi– or justification – for raising interest rates, along with following what international parties are doing to remain competitive. But is the MPC being a leader in handling SA’s unique circumstances or simply a follower of international movements?
Should our monetary policy be focused on solving local issues rather than trying to maintain global economic competitiveness or is price stability the key to an economically sustainable future?