The South African Reserve Bank has increased the repo rate since 2021 by 4.75% to the current repo rate of 8.25% and a prime rate of 11.75%. In its last meeting, the bank’s Monetary Policy Committee decided to increase the repo rate by 0.5% even though the latest inflation rate has shown a decrease to 6.8% for April.
The SA Reserve Bank seems hell-bent on returning the inflation rate to the mid-point of its inflation target of 4.5%. To get to this point, it seems nothing else but the inflation rate matters, not even economic growth.
The last GDP results released by Stats SA, quarter four of 2022, indicated a negative growth of minus 1.3%. The results of Q1 of 2023 are expected on 6 June 2023, and there is a major concern for a second negative quarter in a row. And we know what that means.
The South African economy is experiencing cost-push inflation and not demand-pull inflation, meaning the pressure on inflation is from the supply and not the demand side. Consumer demand growth has been low since 2019. The annual increase in consumer demand from Q4 2019 to Q4 2022 was only 0.59%. So there is no pressure on inflation from the demand side. The pressure is from the supply side.
Cost-push inflation occurs when the general price level increases primarily due to increases in private-sector production costs. Businesses primarily aim to make a profit; therefore, if production costs increase, they increase the prices of goods and services.
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Cost-push inflation is therefore driven up by production factors and input costs, including increases in energy costs, including fuel costs and electricity costs (load shedding is having a massive impact on production costs); government taxes and policy uncertainty; municipal costs relating to rates and taxes; supply chain processes and logistics; and an increase in wages as a result of the above factors. Cost-push inflation reduces the purchasing power of consumers.
In the cost-push inflation environment, the monetary policy, by increasing the repo rate, has limited positive impacts on inflation; it mainly results in the destruction of economic growth efforts.
Steps to take
Possible policy interventions include, first, specific price control – for example, keeping electricity prices stable, limiting municipal rates and tax increases and keeping fuel costs stable.
All these costs have been rising far above the inflation target and are still rising rapidly, driving inflation up. Electricity costs will again increase by more than 30% from 1 July. Fuel costs could be stabilised and reduced by removing the fuel levies.
Second, wage increases should be below the current inflation mid-point of 4.5%.
Third, supply chain processes and logistics should be urgently improved. Producers have considerable costs in transporting their goods to markets, and those exported products meet a bottleneck at the export ports.
Fourth, policy certainty is at a low point, preventing the business community from expanding and investing.
And last, load shedding significantly affects production costs and a secure electricity supply is urgently needed. The government must invest in infrastructure development on a broad front to help businesses to be more productive and competitive globally.
The SA Reserve Bank has been ruthlessly successful in keeping inflation within the target range of 3% to 6% over the past decade, except since the beginning of 2022 until today.
The start of the Russian war on Ukraine disrupted energy prices and the cost of other essential prices on a global scale, causing a cost-push inflation problem in South Africa. A decade of low inflation has resulted in a low-growth environment in the country.
We need much higher growth than what has been achieved in this low-inflation environment. We need at least 3% growth per annum, but is this achievable within the inflation targets of the SA Reserve Bank of 4.5% (mid-point)? The inflation target policy has yet to be successful from an economic growth point of view.
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In a recent research project, using an econometric methodology of inflation versus growth nexus, it was found that an inflation rate of 6% allows for an optimal “sweet-spot” growth environment. The question is therefore: is our inflation target policy as implemented by the SA Reserve Bank realistic for a developing country in Africa? Most developing countries have higher inflation targets with higher growth levels.
Last, rising interest rates cause a series of domino effects; it suppresses economic growth, reduces investment, destroys jobs and increases poverty and the risk of uprisings and instability.
We need urgent changes in the management of the economy. DM