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Inflation downtrend points to structural and cyclical decline in economy


Nazmeera Moola is Head of SA Investments at Ninety One.

In 21 out of the last 34 months, economists have overestimated the inflation rate for the previous month. This suggests there has been a structural decline in the economy. Essentially, the weak demand environment has eroded pricing power.

If anyone were in any doubt, the latest company reporting season has made it abundantly clear that there is virtually no pricing power in the bulk of the South African economy. The Foschini Group reported price deflation of 0.4% in the last year. Truworths had 0.4% inflation. Dischem fared better, recording inflation of 2.3%. Food retailers Pick n Pay and Shoprite reported inflation rates of 2.8% and 3% respectively.

This low pricing power environment is confirmed by the official consumer price inflation (CPI) rate, which measured 3.7% in October 2019. This is the lowest since February 2011. While South Africa has achieved lower inflation rates in late 2010, 2004 and late 1999, each of those instances was fairly short-lived. For example, the dip in inflation in late 2010/early 2011 was driven by the combination of a strong rand and low food inflation.

In contrast, the current inflation downtrend is quite different. First, it has been long-lived. With some temporary upticks, since the beginning of 2017, South Africa’s inflation rate has persistently moved lower, from 6.6% in January 2017 to 3.7% in October 2019. Each of the previous instances saw inflation dip for nine to 15 months before heading back to previous levels.

Second, this downtrend has been broad-based. Each of the previous instances were driven by a strong rand coupled with either (or both) falling food or oil prices. The SA Reserve Bank’s November Monetary Policy Committee (MPC) statement noted that “recent monthly inflation has been lower than the mid-point of the inflation target range, as owners’ equivalent rent, food and services inflation remain subdued”. This encompasses the vast majority of the inflation basket.

In October, goods price inflation was 3.1%. Within that, food and non-alcoholic beverage price inflation was 3.6%. Services inflation was 4.2%, despite higher increases in municipal rates, medical aid and electricity. The other components of services inflation recorded sufficiently lower increases (or deflation) to offset these problem categories.

This broad-based nature of the decline in inflation has meant that all forecasters have consistently over-estimated inflation. This is particularly true on a longer-term view. In early 2017, the SA Reserve Bank forecast CPI to average 6.2% in 2017, 5.5% in 2018 and 5.5% in 2019. With the data in hand, we see that inflation has realised about one percentage point lower in each of those years. It averaged 5.3% in 2017, 4.6% in 2018 and 4.2% in 2019.

Not only have forecasts been too high in the longer term, but forecasters have struggled to get the forecast correct historically. Statistics SA publishes the CPI number for a given month on the third Tuesday of the following month. Therefore, economists are dealing with a historical datapoint when they release a forecast a few days before the CPI data point is released.

In the 34 months since the beginning of 2017, inflation has been in line with the forecast on seven occasions; it has been higher than the forecast on six occasions and lower than forecast on 21 occasions.

Therefore, in 21 out of the last 34 months, economists have overestimated the inflation rate for the previous month.

This suggests there has been a structural decline in the economy. Essentially, the weak demand environment has eroded pricing power. This means that despite inflation expectations hanging around 5%, the translation of inflation expectations into prices is lowered in a variety of ways:

  • Companies have put increasing pressure on their suppliers. The starkest example of this is Tiger Brands, where margins appear to have shifted structurally lower. Tiger’s ability to pass through inflation has been eroded by a more price-sensitive consumer who is willing to try alternatives. In a recent meeting, one retailer noted that they viewed a 5% increase in food inflation as a hard upper limit for consumers.
  • Companies are controlling their wage bill. While the public sector has been unable to contain the growth in their wage bill, the private sector has dealt with this either by cutting jobs to offset higher wage increases or by providing much smaller wage increases than we see in the public sector – after all it is patently absurd for the loss-making SAA to settle on a 5.9% wage increase when inflation printed 3.7% in October.
  • Companies are negotiating lower rentals. Relatively high rental escalations have been offset by much lower reversions when leases are renewed, including several months of rental holidays to facilitate fit-outs. Not surprisingly, rental reversions have been negative – and this trend has escalated in 2019.

In the November MPC statement, the SARB assesses the risks to the inflation outlook to be balanced. While there is no doubt a risk that fiscal uncertainty could translate into rand weakness, that situation has yet to occur. In the meantime, demand is having a profound impact on inflation. However, while inflation has realised around 100 basis points lower, the SA repo rate is down only 50 basis points since the beginning of 2017. Why is the SARB so reluctant to cut interest rates further?

Ideally, monetary policy should be countercyclical. If this is the case, the SARB should look to cut interest rates by 50 basis points in the next six months – preferably starting in January.

It is certainly true that that the SARB cannot resolve the structural impediments to South Africa’s growth. However, growth does appear to also be cyclically weak. Therefore, the SARB has a role to play. BM


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