Gumata ndou bank credit extension and real economic activity in south africa; the impact of capital flow dynamics, bank regulation (2017)

Nombulelo Gumata and Eliphas Ndou The Impact of Capital Flow Dynamics, Bank Regulation and Selected Macro-prudential Tools Bank Credit Extension and Real Economic Activity in South Africa Nombulelo Gumata • Eliphas Ndou Bank Credit Extension and Real Economic Activity in South Africa The Impact of Capital Flow Dynamics, Bank Regulation and Selected Macro-prudential Tools Nombulelo Gumata Economist South African Reserve Bank, South Africa Eliphas Ndou Economist South African Reserve Bank, South Africa ISBN 978-3-319-43550-3    ISBN 978-3-319-43551-0 (eBook) DOI 10.1007/978-3-319-43551-0 Library of Congress Control Number: 2016958293 © The Editor(s) (if applicable) and The Author(s) 2017 This work is subject to copyright All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations Cover illustration: © Ben Oliver / Alamy Stock Phot Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Preface The four parts of this book examine a variety of issues Among them are establishing the strength of links between credit supply dynamics and the real economy and determining if they are responsible for fragile economic growth recovery We also assess the impacts of financial regulation uncertainty, regulator excesses and bank risk-taking channels in South Africa We use simple scatterplot analysis cross-correlation to examine the leadlag relationship and then apply advanced econometric analysis to show linkages that could not be shown using simple basic statistical techniques Unconventional Monetary Policies  Since the onset of the US subprime crisis, which translated into global financial crisis and recession followed by serious economic uncertainties, the South African economy has experienced a fragile recovery To deal with domestically weak economic growth recoveries in the USA, UK and the Eurozone, monetary policymakers embarked on quantitative easing, which injected liquidity using various instruments It is undeniable that prevailing low interest rates in these economies led to capital flows into emerging markets, including in South Africa Thus increased demand for assets in these economies may lead to high asset prices and a reversal of capital flows through disposing of these assets may lower their prices v vi Preface Recent Policy Changes  Currently, as policymakers are implementing prudential polices, we give new insights into what policymakers infer from the role of existing macro-prudential tools which were implemented by financial institutions themselves for the residential sector on economic activity These macro-prudential policies coincide with different monetary policy phases; hence we give new insights into the extent of the interaction between macro-prudential policies and monetary policy and show that prudential policies also spill over into price stability and inflation expectation In addition, inflationary pressures and expected inflation rates may lead to undesirablly tight prudential tools We fill these gaps by showing the strength of spill over linkage  art I: Global Liquidity, Capital Flows, Asset P Prices and Credit Dynamics in South Africa Subsequent to the 2007 global financial crisis, key central banks in advanced economies embarked on conventional and unconventional accommodative monetary policies The policy rates were lowered to very low levels and bank balance sheet expanded considerably While large amounts of global liquidity may be desirable, there are mixed views on the extent to which South Africa (SA) has benefited from abundant global liquidity during this period of low interest, made possible through increased capital inflows which impact the real economy Amidst this expectation, the debate is captured via the views of the “initiator countries vs the recipient countries” First, the tapering of asset purchases can be interpreted as an indication that the US economy is recovering, and this can be seen as good news for the South African economy to the extent that, with positive growth impulses from the USA, global growth and demand benefit South African exporters The thesis is that an improvement in world output (global demand) will lead to increased demand for South African exports Thus, spill-over to foreign economies could occur via exports growth amongst other key channels of transmission While income effects encompassed within the trade channel and tend to dominate the development, this is not the only channel that fully reflects  Preface  vii the spill-over effects of foreign demand The exchange rate appreciation linked to G3 central bank liquidity injection could lead to undesirable outcomes Global liquidity can operate via different channels, hence we investigate its effects through assessing different aspects Is there any evidence of the inverse transmission of global liquidity shocks into the domestic economy? We apply counterfactual analysis to see what would happen to selected variables in the absence of G3 liquidity Are there any differential effects on gross domestic product (GDP) growth between US and European Central Bank (ECB) liquidity? We extend the analysis and quantify the undesirable effects of capital flow uncertainty by providing a systematic analysis of how large capital inflows, capital inflow reversals and net portfolio flow volatility affect economic performance, and show there exists an understated sectoral reallocations transmission channel To give further insights, we perform a counterfactual analysis to assess how economic growth, changes in the Real Effective Exchange Rate (REER) and growth in credit extension would have evolved in the absence of the contributions of capital flows While credit market indicators may exhibit divergences, to overcome this and enable proper indication of prevailing conditions, we construct a credit conditions index (CCI) for South Africa This matters as we examine the extent to which tighter credit conditions impact real economic activity We use the constructed CCI to examine the extent to which the massive policy rate reduction since 2009 impacted credit conditions Are the repo rate contributions during the recession similar to those in other periods when the repo rate was lower before the tightening phase in 2007? Given that equity markets are impacted by capital flows dynamics, we identify episodes of real stock price busts and the associated economic costs, the behavior of selected macroeconomic variables and the possible existence of financial imbalances prior, during and after episodes of costly booms, especially before the unwinding of unconventional policy measures and the imminent normalization of monetary policy settings We demonstrate how eco- viii Preface nomic growth would have likely evolved in the absence of stock returns and volatility as well as their propagation Part II: Credit Supply Dynamics and Economy The second part of the book focuses on credit supply dynamics and real economic activity Theory suggests that credit and GDP growth are linked As shown in Fig 1, neither credit nor GDP levels have returned to pre-recession trends and have remained fairly subdued Some quarters use this to explain the fact that the economy has been plagued by two negative gaps in the credit markets and the real economy The close movement between GDP and credit could indicate that credit supply dynamics matter for the real economy such that the adverse credit supply shock may be responsible for weak economic growth recovery and elevated credit interest rate spreads Certain chapters in Part II of the book disentangle the adverse credit supply shock effects from those of tighter monetary policy and adverse credit demand shocks It is only the demand and supply side effect of credit that matters, so it is possible that regulatory changes which require banks to hold liquid government securities play a big role In this context, we determine the relationship between government credit supply contributions to growth in (i) Fig 1  Credit and GDP trends pre- and post-global financial crisis and recession (Source: South African Reserve Bank and authors’ calculations)  Preface  ix GDP and (ii) gross fixed capital formation and bond yields and credit risk Apart from influencing GDP growth, we show policymakers that credit market frictions introduce nonlinear effects with implications for the direction and magnitudes of the repo rate adjustment and inflation dynamics, paths and magnitudes of the policy rate adjustments in any way towards the primary mandate of curbing inflationary pressures We establish thresholds and show that nonlinearities in credit market dynamics are relevant for monetary policy and financial stability, and that this an under-researched area The nonlinearities may reveal if negative credit shocks lead to larger declines in output under a low credit regime relative to the high credit regime In addition, the nonlinearities may reveal whether positive economic growth shocks lead to higher credit growth in a lower credit relative to the higher credit regime  art III: Financial Regulatory Uncertainty P and Bank Risk-Taking The third part of the book focuses on financial regulation uncertainty, regulators excesses and interest rate spreads and the bank risk-taking channel In Fig the capital adequacy ratio (CAR) has exceeded the minimum required ratio over the long horizons The liquidity asset holdings of banks have exceeded the minimum required levels since 2009 In addition to regulatory amounts or quantities, the National Credit Act (NCA) was passed into legislation in 2005 and implemented in June 2007 Empirically, little is known about this macro-prudential tool’s effectiveness and how it interacts with monetary policy So to what extent did the NCA, holding excess Capital Adequacy Ratio (CAR) and Liquid Asset Holdings (LAH), impact credit dynamics? In view of the costs involved, did these excesses induce any frictions in credit markets by raising lending spreads? How the effects of these excesses differ from those associated with the NCA and Basel III shocks? We also show that the NCA does propagate the effects of monetary policy on credit and output, which may be indicative of an economic case for these tools to be coordinated Regulatory uncertainty may also be a significant player which impacts the interdependence between growth in credit and lending spreads before and after the financial x Preface Fig 2  Capital adequacy ratio and the holding of liquid assets (Source: South African Reserve Bank and authors’ calculations) crisis in August 2007, inflation and the repo rate shocks We apply the financial regulatory policy uncertainty as constructed by Nodari (2015) to show the extent that regulatory uncertainty could be responsible for anemic macroeconomic performance Part IV: Macro-prudential Tools and Monetary Policy Little is known about the effects of macro-prudential tools in South Africa, and Part IV of the book focuses on the effects of selected tools The macro-prudential policies for residential mortgage lending tools include the repayment-to-income (RTI) ratio shock and unexpected tightening in loan-to-value (LTV) ratio Credit provisions tend to move together with the repo rate; however, this has changed since 2010 This change in the relationship may have unintended policy consequences (Fig 3) We rely on the literature on the interaction of monetary and financial policy, which argues that some features of the housing market explain differences in the transmission of monetary policy and can amplify swings in the real economy and can be sources of financial instability The interaction of macro-prudential policies for residential mortgage lending and monetary policy can induce macroeconomic fluctuations, particularly if .. .Bank Credit Extension and Real Economic Activity in South Africa Nombulelo? ?Gumata? ??• Eliphas? ?Ndou Bank Credit Extension and Real Economic Activity in South Africa The Impact of Capital Flow Dynamics,. .. The four parts of this book examine a variety of issues Among them are establishing the strength of links between credit supply dynamics and the real economy and determining if they are responsible... undeniable that prevailing low interest rates in these economies led to capital flows into emerging markets, including in South Africa Thus increased demand for assets in these economies may lead