24 October 2006

South Africa: Rates 'Must Be Lower for Economy to Grow'

Johannesburg — SA NEEDS lower interest rates if plans to halve unemployment and grow the economy at 6% and above are to be realised, says a new study.

The study, released yesterday, titled "An employment-targeted economic programme for SA," says the country's interest rates are too high. The report says this is a deterrent to investment and higher and more sustainable economic growth.

The study was commissioned by the United Nations Development Programme and conducted by the University of Massachusetts-Amherst economics professors. It warns, however, that more expansive fiscal policy, which is crucial to higher economic growth, may be viewed by potential investors as negative, and could lead to a sell-off in the rand.

"Many policy makers will object strenuously to this proposal on the grounds that it will encourage inflation," said co-author of the study Robert Pollin, who is economics professor at the University of Massachusetts. He said the costs of letting inflation rise and the currency depreciate slightly were "negligible".

A shift in investor perceptions, causing a sell-off in the rand, regardless of whether the fundamental indicators of economic stability changed by relatively modest amounts, was not likely to occur, although the possibility existed, the authors noted.

The study says that the Reserve Bank's current inflation target of 3%- 6% could be moved higher, although still within single digits.

Using the vector autoregression framework, the study showed that if the prime rate was lowered from 11% to 7% over five years, gross domestic product growth increased from 3% to 3,6%, while CPIX (consumer price index less mortgage costs), the Reserve Bank's targeted measure of inflation, would rise to 6% from 5%, while the rand would weaken to R7,10 against the dollar, from R6,32.

"Keeping interest rates high means stifling the growth of new business and jobs. Moreover, the effects on inflation of pushing the prime lending rate down to about 7% should be relatively modest."

This was especially true if government also pursued complementary methods of controlling inflation, Pollin said, including preventing exorbitant price mark-ups by monopolistic firms such as Mittal Steel.

Massachusetts economics professor Léonce Ndikumana, also a co-author of the study, commended SA for having achieved macroeconomic stability. "Macroeconomic stability should not be an end in itself, but should rather be seen as a means to achieving higher economic growth."

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