The post-Covid, well semi-post-Covid period, has started with a series of interest rate hikes by the SA Reserve Bank (Sarb), in terms of their monetary policy. At the peak of the Covid restrictions in 2020, the repo rate went down to a historic low of 3.5% and a prime rate of 7.0%.

Last week’s increase of the repo rate to 4.0% was expected by most analysts, primarily due to the spike in the inflation rate in December 2021 of 5.9%. The Sarb pushed the interest rate “panic button”, following their track record of conservative decision making within the inflation band of 3% to 6%.

The MPC statement on 27 January 2022 indicated an expected average inflation rate of 4.9% for 2022, after the inflation rate in 2021 averaged at 4.5%.

The decision to increase the repo rate was mostly based on the reality that the inflation rate has approached and reached the top of the inflation targeting band. The differential between the inflation and repo rates has reached substantial levels at 1.9%.

I predict that the January 2022 inflation rate (year-on-year) would be between 5.8% to 6.3%, close to, or above the top of the inflation targeting band, meaning that the MPC will raise the repo rate again by 0.25% in March 2022.

With rising oil and fuel prices and electricity costs, it is anticipated that the inflation rate will only move below the 5% level towards the second half of the year. At least one, but possibly three additional repo rate increases could be expected during 2022, taking the repo rate to 5% and the prime rate to 8.5%. This would mean a repo rate of 5% and an inflation rate closer to 4.5% by the end of 2022.

The use of interest rates as a monetary tool to curb rising inflation is limited in our inflation environment, known as “cost-push inflation”. The economy’s supply-side causes inflation in South Africa and not consumer demand. Rising fuel prices, electricity prices, and municipal rates-and-taxes accounts result in increased production costs, driving inflation. Increasing the repo rate by looking at the inflation rate will negatively affect the already weak and vulnerable economy.

From a theoretical perspective, interest rates and inflation have an inverse relationship. Increasing interest rates as part of monetary policy will slow growth and lower inflation increases.

But there is a positive relationship between the interest rate and exchange rate: raising interest rates will lead to an inflow of foreign capital, leading to an appreciating currency. This means that the local currency could benefit from the interest rate increase. However, if the trade partners also raise interest rates, which is expected to happen during March, the equilibrium will be restored, leading to possible currency volatility over the rest of 2022. Rising interest rates also could promote increased savings and increased investment. 

Other internal and external factors impacting the South African economy and the monetary policy process are:

1. Eskom: warnings have already been issued for more load shedding in the first half of 2022. The economic “growth-limiter” in the shape of Eskom is still looming large over any rapid economic growth prospects. In addition, many of the SOEs are still circling like parasites for a bail-out from central government;
2. Covid-19: It seems that the pandemic is under control in SA, but the virus is still causing massive disruption in the developed world. More Covid-19 variants and waves could not be excluded from any scenario planning. The pandemic will still have a substantial impact on local and global economic recovery in 2022;
3. Government: the current presidency is characterised by ongoing indecisive decision-making and implementation of action plans, large-scale policy uncertainty, and a lack of strategic economic planning allowing for a vacuum in the post-Covid economic recovery. As the sphere of government closest to the people, local government has generally failed, with most municipalities delivering poor basic services. All of these aspects mean that the investment strike by the private sector is set to continue;
4. Politics: the internal factional war within the ANC will intensify during 2022 with the next ANC elective conference on the agenda, this will negatively affect any economic implementation plans for 2022 and 2023;
5. Deteriorating law and order: we have seen an increase in organised unrest especially during July 2021 and these type of focused activities, which test the capacity of the SAPS, could be expected to continue;
6. Unemployment: levels of unemployment are expected to increase during 2022 due to the projected low growth rates of only 1.7% as predicted by the Sarb. The tax base of South Africa has also shrunk drastically from 5.8 million tax assessments in 2015/2016 to only 4.9 million in 2019/2020 (SARS); and
7. The current Russia-Ukraine conflict is already affecting the global political and economic environment and global oil prices have increased drastically over the last few weeks. In addition, most of the major economic global powers are planning interest rate increases due to high levels of inflation.

With SA’s economic growth rate still below the levels of pre-Covid, an urgent need exists for rapid economic growth. Rising interest rates will not contribute to this objective, especially without a clear strategic plan. Raising interest rates based only on the inflation rate does not make much sense and does not support the growth objective.

The target band used to contain inflation in SA also needs a relook. A target of between 3% to 6% may not be the most suitable and realistic for a developing country with substantial developmental needs.

Structural changes in the economy are also urgently required related to the role of government in the economy, the role of SOEs, the way policies are not finalised and implemented, the lack of committed service delivery by local government and lastly, we require a national focus on skills development and employment opportunities for the youth of this country. The private sector should be allowed to implement initiatives for youth development. DM

Professor Daniel Meyer is a lecturer in the College of Business and Economics, University of Johannesburg.