Is Namibia developing its own monetary policy?

THE recent decision by the Bank of Namibia to leave short-term interest rates unchanged for now has the potential to stimulate domestic demand and boost local economic growth, but capital flows could be negatively affected should perceptions persist that a diverging monetary policy stance is developing in the Common Monetary Area.

This is the view of Johannes !Gawaxab, Managing Director of Old Mutual’s African Operations, commenting on the latest decision by the Bank of Namibia to leave the current Bank rate unchanged at 10,5 per cent. The interest rate differential between Namibia and South Africa has now dropped from 125 basis points to 75 bps.The BoN decision is noteworthy because the South African Reserve Bank, which primarily sets the monetary policy, increased short-term rates on 6 December 2007.In South Africa the case for the latest interest rate hike was sealed: CPIX-inflation breached the target range of 3-6 per cent for the seventh consecutive month reaching 7,3 per cent in October, Production Price Inflation (PPI) remained high at 9,5 per cent in October and the short-term inflation outlook had deteriorated.According to the Bank of Namibia the local economy continued to perform satisfactorily, the rate of increase in private credit extension is slowing down, inflation has continued on a downward trend and on balance, the Bank has decided for its rate to deviate from the South African repo rate to some extent, hence the decision to leave rates unchanged for the time being.The arguments advanced by the two monetary authorities for their respective rate decisions would seem to be valid and sensible.Namibia’s decision in particular is a brave one, given present Common Monetary Area (CMA) realities and the move towards a single SADC currency.We could potentially see billions of Namibian dollars flowing out of the country, significant adjustments to our rate regime at a later stage and the erosion of the current attractiveness of our local financial system, unless monetary policy in the CMA region is closely co-ordinated, synchronised and arbitrage opportunities closed.INFLATION The South African Reserve Bank is targeting inflation – price stability – and has set itself a 3-6 per cent target band.Inflation is a process of continually increasing prices, which implies a continual reduction in the value of money.Inflation is an economic evil on a grand scale: it damages growth, harms investment, destroys jobs, increases the cost of capital and generally negatively impacts on prosperity.The poor in society are hardest hit by inflation, as they spend the bulk of their income on food, accommodation and transport.Inflation primarily originates from demand-pull or cost-push pressures.Demand-pull inflation originates as a result of strong economic growth and consumer spending demand.The way central banks manage this type of inflation is to raise interest rates – the cost of borrowing – to levels required to rein in economic activity.Consumers then have to pay more on their home loans and car instalments and therefore have less disposable income to spend in the broader economy.Cost-push inflationary pressure is the result of rising input costs that have a knock-on effect in the production of goods and services.Historically, this type of inflation was managed with higher interest rates which reduced disposable income and the demand for goods and services.If oil and food prices are primary drivers of this inflation, central banks are simply not equipped with the tools to manage this.DILEMMA Consumer inflation (CPIX) is currently outside the target band and exogenous factors – food and energy prices – are primarily responsible for this.By raising interest rates, monetary authorities merely address inflation expectations or secondary effects rather than stemming the increase in petrol or food prices.The populist concern that rising interest rates will curb economic growth and destroy jobs without doing much to subdue soaring inflation becomes relevant.Alternatives to consider * Price stability: The notion of stable prices is often contentious if not controversial.There will always be shocks to the system that push up price levels.If there is to be long-run price stability, there must be periods of rising and falling prices to offset each other.The regime that economists call price stability could thus be defined as price instability.Instead, shouldn’t we focus on a productivity regime, in which continually rising productivity would result in continually falling prices? Milton Friedman has recently argued that a regime of falling prices would be better than a regime of broadly stable prices * Target band: Should we not consider widening, deepening or increasing the range or perhaps even excluding petrol or food from goods in the basket altogether? The current band is too restrictive for an economy with a 36 per cent unemployment and subject to so many external shocks (price disruptions) * Should we not follow the example of Chile and keep rates on hold although inflation is outside the target band? (The country has a floating exchange rate and targets an inflation band of 2-4 per cent.CPI in Chile increased to 6,5 per cent and expected to remain high).When the Monetary Policy Committee of Namibia vote next to give an asymmetric directive – towards tightening/easing or even a neutral stance – it is of vital importance that unintended consequences of the latest decision be reviewed rigorously and that perceptions around a “temporary deviation of local rates from South Africa” be managed proactively.* This article expresses the opinion of Johannes !Gawaxab: CEO Old Mutual African OperationsThe interest rate differential between Namibia and South Africa has now dropped from 125 basis points to 75 bps.The BoN decision is noteworthy because the South African Reserve Bank, which primarily sets the monetary policy, increased short-term rates on 6 December 2007.In South Africa the case for the latest interest rate hike was sealed: CPIX-inflation breached the target range of 3-6 per cent for the seventh consecutive month reaching 7,3 per cent in October, Production Price Inflation (PPI) remained high at 9,5 per cent in October and the short-term inflation outlook had deteriorated.According to the Bank of Namibia the local economy continued to perform satisfactorily, the rate of increase in private credit extension is slowing down, inflation has continued on a downward trend and on balance, the Bank has decided for its rate to deviate from the South African repo rate to some extent, hence the decision to leave rates unchanged for the time being.The arguments advanced by the two monetary authorities for their respective rate decisions would seem to be valid and sensible.Namibia’s decision in particular is a brave one, given present Common Monetary Area (CMA) realities and the move towards a single SADC currency.We could potentially see billions of Namibian dollars flowing out of the country, significant adjustments to our rate regime at a later stage and the erosion of the current attractiveness of our local financial system, unless monetary policy in the CMA region is closely co-ordinated, synchronised and arbitrage opportunities closed.INFLATION The South African Reserve Bank is targeting inflation – price stability – and has set itself a 3-6 per cent target band.Inflation is a process of continually increasing prices, which implies a continual reduction in the value of money.Inflation is an economic evil on a grand scale: it damages growth, harms investment, destroys jobs, increases the cost of capital and generally negatively impacts on prosperity.The poor in society are hardest hit by inflation, as they spend the bulk of their income on food, accommodation and transport.Inflation primarily originates from demand-pull or cost-push pressures.Demand-pull inflation originates as a result of strong economic growth and consumer spending demand.The way central banks manage this type of inflation is to raise interest rates – the cost of borrowing – to levels required to rein in economic activity.Consumers then have
to pay more on their home loans and car instalments and therefore have less disposable income to spend in the broader economy.Cost-push inflationary pressure is the result of rising input costs that have a knock-on effect in the production of goods and services.Historically, this type of inflation was managed with higher interest rates which reduced disposable income and the demand for goods and services.If oil and food prices are primary drivers of this inflation, central banks are simply not equipped with the tools to manage this. DILEMMA Consumer inflation (CPIX) is currently outside the target band and exogenous factors – food and energy prices – are primarily responsible for this.By raising interest rates, monetary authorities merely address inflation expectations or secondary effects rather than stemming the increase in petrol or food prices.The populist concern that rising interest rates will curb economic growth and destroy jobs without doing much to subdue soaring inflation becomes relevant.Alternatives to consider * Price stability: The notion of stable prices is often contentious if not controversial.There will always be shocks to the system that push up price levels.If there is to be long-run price stability, there must be periods of rising and falling prices to offset each other.The regime that economists call price stability could thus be defined as price instability.Instead, shouldn’t we focus on a productivity regime, in which continually rising productivity would result in continually falling prices? Milton Friedman has recently argued that a regime of falling prices would be better than a regime of broadly stable prices * Target band: Should we not consider widening, deepening or increasing the range or perhaps even excluding petrol or food from goods in the basket altogether? The current band is too restrictive for an economy with a 36 per cent unemployment and subject to so many external shocks (price disruptions) * Should we not follow the example of Chile and keep rates on hold although inflation is outside the target band? (The country has a floating exchange rate and targets an inflation band of 2-4 per cent.CPI in Chile increased to 6,5 per cent and expected to remain high).When the Monetary Policy Committee of Namibia vote next to give an asymmetric directive – towards tightening/easing or even a neutral stance – it is of vital importance that unintended consequences of the latest decision be reviewed rigorously and that perceptions around a “temporary deviation of local rates from South Africa” be managed proactively. * This article expresses the opinion of Johannes !Gawaxab: CEO Old Mutual African Operations