Money Talk

We hear about interest rates and inflation, the gold price and a trade deficits but, should we care? Oh yes, says Jac Laubscher. He makes tricky economic concepts sound like child¹s play.

What is the REPO rate?

The repo rate is the interest rate at which the Reserve Bank is prepared to provide funding to the banking system and as such it is an important benchmark for both deposit and lending rates. The banks¹ prime overdraft rate is set at 3,5 per cent above the repo rate and it fluctuates automatically with the repo rate.

How does the repo rate impact on me?

The Reserve Bank adjusts the repo rate from time to time to influence the cost of borrowing and therefore of total demand (or spending) in the economy. For example, if the Reserve Bank believes that demand in the economy is too buoyant, resulting in prices rising more rapidly (higher inflation), it will increase the repo rate to make it more expensive for consumers and businesses to borrow and spend money. Since December 2008, the Reserve Bank has reduced its repo rate by five per cent. Interest rates are relatively low at the moment to encourage a turn-around in the economy. It's expected that they¹ll remain low for a while still.

How important is gold in the economy?

Gold played a major role in the development of South Africa¹s economy, but this has been in long-term decline since the 1980s as gold production has dwindled. Some 30 years ago gold mines accounted for approximately 25 per cent of government revenue, now their contribution is negligible. Gold¹s most significant contribution today is that it remains an important export commodity, second only after platinum. Gold mines also continue to employ large numbers of workers from both South Africa and neighbouring countries. The recent global financial crisis has once again demonstrated the role of gold as a hedge in times of uncertainty, but unfortunately South Africa¹s gold production will continue to decline as it becomes more and more expensive to mine.

Should inflation be high or low?

Inflation should preferably be low (in single digits) and stable and it should be more or less in line with the inflation in our major trading partners. High and volatile inflation introduces uncertainty into economic decisions. It impacts on business expansion, resulting in lower economic growth. High inflation also means that the purchasing power of household income declines more rapidly and workers may seek to be compensated for this through higher wages and salaries, creating new inflation pressures in the process. If inflation is higher than in other countries, it will cause exports to become less competitive, putting downward pressure on the exchange rate of the rand.

What is the trade balance?

The trade balance is the difference between exports and imports. If exports exceed imports it is referred to as a trade surplus, and if exports are less than imports the result is a trade deficit. The trade balance is a major part of the current account of the balance of payments. In recent years, a large part of South Africa¹s current account deficit was accounted for by the trade deficit. The trade balance influences the exchange rate of the rand, and therefore inflation and interest rates. For example, a trade deficit means that South Africa will receive less foreign exchange from its exports than it requires to pay for the goods being imported, thus exerting downward pressure on the value of the rand.

What factors influence foreign investment?

Foreign direct investment depends on a long list of factors, such as a country¹s competitiveness, its geographic position, political stability, security situation, legal system, etc. Competitiveness in turn includes a range of factors such as the quality of the labour force, labour laws, the quality of infrastructure, the exchange rate, the size of the domestic market and its rate of growth. The benefits of foreign direct investment are mainly that it is accompanied by a transfer of technological know-how and managerial skills, it provides access to global distribution networks, and it is a relatively stable form of foreign finance for the balance of payments. Unfortunately South Africa receives very little foreign direct investment, and foreign investors have generally expressed a preference for buying an interest in an existing business rather than setting up new greenfields operations.

JAC LAUBSCHER is Sanlam¹s Group Economist. In 1994 he was one of the first South Africans to obtain the internationally recognized Chartered Financial Analyst qualification from the CFA Institute in the United States. He received the Sake Award as Economist of the Year for 2002 for his economic forecasts. Jac is professor extraordinaire in the Department of Economics at the University of Stellenbosch. He serves on the Management Committee of the Bureau for Economic Research at the same university, as well as on a number of economic advisory committees. He is well known in the financial media for his analysis of and commentary on the South African economy and financial markets, and is the author of numerous publications on these topics.

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