The South African Reserve Bank (SARB) has been turning to interest rates to bring down the country’s high inflation for months. However, South Africa’s inflation is stickier than ever, with no sign of coming down soon.

Central banks worldwide have been stuck in an interest rate hiking cycle for months. 

The US Federal Reserve started its tightening cycle in March 2022 and has implemented ten consecutive interest rate increases. 

While there is potential for another rate hike at the Fed’s next meeting, its chair Jerome Powell has said they are “closer, or maybe even there” regarding the hiking cycle’s end-point. 

US inflation remains high but shows signs of slowing, having cooled to its lowest point in almost two years in March, when it reached 5% year-over-year. 

It should be noted that the effect of interest rate changes is usually only felt months after being implemented.

South Africa started its hiking cycle in November 2021 – three months before the Fed began its cycle. The SARB has implemented nine consecutive interest rate hikes since, to where the repo rate now stands at 7.75%.

However, South Africa’s inflation has increased, with March’s CPI standing at 7.1% and food inflation at a 14-year high of 14,0%.

Despite this high inflation, South Africa is also experiencing muted growth and could even face a recession.

The SARB’s strategy

The SARB employs a strategy called “inflation targeting”, whereby interest rate cuts and hikes are used to control inflation.

The Reserve Bank attempts to keep inflation within a target range of 3% to 6% using monetary policy tools like short-term interest rates.

According to the SARB, “The core idea of inflation targeting is that monetary policy has only temporary effects on growth, but permanent effects on prices.”

The SARB has been using this strategy since 2000 in favour of other methods such as exchange rate and money supply targeting. 

The Reserve Bank website says, “The inflation targeting approach has been more successful.”

SARB Governor Lesetja Kganyago has also spoken on the importance of inflation targeting.

“The best chance we have with monetary policy to get faster, more job-rich growth is to maintain our focus on price stability with flexible inflation targeting, a proven framework,” he said in November 2022.  

However, recently, the SARB’s strategy does not seem to be working, and some experts say both the problem itself and the tools used to target it are to blame.

The inflation problem

Efficient Group Chief Economist Dawie Roodt recently told Newzroom Africa that there are fundamental reasons for South Africa’s high inflation rates.

One of these reasons is the country’s current lack of a competitive environment due to high energy prices and crumbling infrastructure.

In particular, load-shedding has had and continues to have a significant inflationary effect on the economy. 

The Reserve Bank recently said load-shedding would raise inflation by 1.1% in 2023.

Another concern is the SARB’s tight monetary policy that works against the National Treasury’s expansionary fiscal policy.

While the SARB is trying to dampen demand through interest rates, the Treasury is trying to boost the economy at the wrong time. This macroeconomic policy clash prevents the economy from growing and keeps inflation high.

According to Roodt, there is an incentive for politicians to keep inflation high, as it erodes the value of the government’s debt, allowing it to spend more while not increasing debt in real terms.

Chief economist at Sanlam Investments Arthur Kamp told Daily Investor that the SARB did not cause South Africa’s growth problem.

Instead, the problem reflects failing infrastructure, too much government involvement in economic activity, policy uncertainty, and low business confidence.

However, the country’s sluggish growth and weak currency amidst high inflation places the SARB in a difficult position, as it needs to decide between curbing inflation or providing relief to an ailing economy.

Interest rates as a tool 

Inflation and inflation expectations are difficult to manage, and the instruments at the Reserve Bank’s disposal to do so – interest rates – are blunt, inexact and have a long lag, said Genera Capital investment specialist Professor Adrian Saville.

The effectiveness of interest rates as a tool to control inflation has also been questioned by financial author and historian Edward Chancellor, who spoke on the S&P Global podcast.

“There was this narrow tunnel vision that still prevails today in monetary policy circles, which is that interest is just a policy lever to control inflation,” he said. 

“But interest, as a control of inflation, is one of perhaps seven functions of interest [and] possibly the least important and definitely the least interesting. Possibly even one that isn’t as efficacious as people believe.”

He said the relationship between interest rates and inflation is not as simple as many people may believe – if the former goes up, the latter does not necessarily come down.

“The era of zero interest rates and quantitative easing didn’t actually produce the inflation that people expected.  Higher interest rates can be inflationary since interest is part of the cost of doing business for producers.”

In addition, high interest rates can have devastating effects on a country’s citizens – particularly in an economy like South Africa’s.

“If you exact a high rate of interest – compound interest – in a primitive agrarian economy, the impact can soon become too great,” said Chancellor. 

In economies with no continuous growth, the core concern is that interest could be exploitative.

The SARB’s plans

The SARB recently announced that it is considering changing its interest rate modelling tool.

It said the monetary policy committee (MPC) would “look through temporary price shocks and focus on potential second-round effects and the risks of de-anchoring inflation expectations”.

Bloomberg reported that changes to the SARB’s model would include the following:

• A mechanism to account for fiscal policy actions in a systematic manner.
• Distinguishing between private and public wages.
• Augmenting the Phillips curves for the various consumer price index components to include nominal unit labour cost growth, along with the current real unit labour-cost gap.
• Accounting for changes in fuel and electricity costs that often spill over into core and food price inflation.
• Reflecting the state of the real economy by using the output and growth gaps.

Kganyago has also recently called for structural reforms and key deregulations of transport and electricity, which he described as critical in South Africa.