Gill MArcus

The unfolding debt crisis in Europe could have “unthinkable consequences”, Reserve Bank governor Gill Marcus said yesterday.

Marcus, who has repeatedly warned that Europe’s unresolved problems pose great dangers to the rest of the world, was speaking to the Swiss Chamber of Southern Africa in Johannesburg yesterday.

Despite the looming dangers, Marcus said “a meltdown in the euro zone” was not built into the assumptions of the bank’s monetary policy committee (MPC). Instead she raised the spectre of stagflation in South Africa.

“The combination of rising inflation and sluggish domestic growth holds the risk of a stagflationary environment,” she said. The concept of stagflation – rising prices and slow growth – was coined in the US in the 1970s.

The bank’s dilemma is that low interest rates are considered a tonic for slow growth while high interest rates are needed to curb rising prices.

Marcus said the “interconnected risks” of the global outlook and the impact of the exchange rate (on inflation) featured strongly in the MPC deliberations last week, when it kept the repo rate on hold at 5.5 percent. The currency has lost 20 percent of its value, since late July, moving in a range of between R6.65 and R8.50 against the dollar. The rand yesterday fell throughout the day and was bid at R8.1108 by 5pm.

Referring to the “dramatic leadership changes over the past week in both Greece and Italy”, she said: “We are getting closer to the end game at what seems to be increasing speed, but we do not know when that will happen and what form it will take. This makes policy-making extremely complicated, as it is difficult, if not impossible, to meaningfully quantify the risks, and build them into policy decisions.”

If the worst case materialises, the MPC “is prepared to take appropriate action”, she said. In other words, the MPC would cut the bank’s key repo rate, which has been at a 30-year low for 12 months.

Europe’s debt crisis has been dragging on since early last year, when problems emerged in heavily indebted Greece. That country’s problems have yet to be resolved.

Now Italy, a core euro zone country, has moved into dangerous territory. Italy sold e3 billion (R33bn) worth of five-year bonds at 6.29 percent on Monday, according to Reuters. The news agency said the rate was “a euro-era record, fuelling worries the high borrowing costs would derail the country’s efforts to slash its e1.9 trillion worth of debt”.

Dennis Dykes, the group chief economist at Nedbank, said Marcus had not referred to stagflation in any of the MPC statements, since she took over the helm at the bank at the end of 2009. However, he said her essential message was the same: that the bank would monitor the risks and move on rates when necessary. Depending on which risk – low growth or rising inflation – appears more threatening, monetary policy will respond.

Marcus again said monetary policy “cannot on its own generate the higher rates of growth that this economy requires for employment creation”.

“Part of the solution will need to come from improving much needed infrastructure, such as energy, rail and ports, which will strengthen the country’s export capacity. There is also the need for sustained efforts to enhance South Africa’s ties with its traditional trading partners such as Switzerland and also to develop new trading relations outside the euro zone.” - Business Report