South Africa’s inflation rate remains stubbornly high, but another interest rate increase may not make any difference.
The South African Reserve Bank’s (SARB’s) Monetary Policy Committee (MPC) meets on Thursday to decide whether to hike interest rates.
South Africa’s interest rate is already at its highest in a decade, but the latest inflation data showed CPI standing at 7.1% and food inflation at a 14-year high of 14.0%.
Inflation is far above the SARB’s 3% to 6% target range and shows no signs of easing in the short term.
The problem for the Reserve Bank is that inflation is not caused by strong consumer demand but by poor government policy and increased load-shedding.
Food retailers and producers, for example, rely on diesel generators to keep the lights on during load-shedding. As load-shedding increases, so do their diesel costs.
These increased operational costs are passed on to consumers, which shows in the high food inflation.
Another problem is that the Treasury is trying to bolster the economy, which is further driving inflation.
Efficient Group chief economist Dawie Roodt said he feels very sorry for the SARB, which is trying to reduce inflation while government policy is accelerating it.
The SARB is putting its foot on the brakes to reduce demand and slow the economy down. The Treasury, in turn, is stepping on the gas.
“Treasury is trying to boost the economy at the wrong time, with inflation remaining elevated,” Roodt said.
This macroeconomic clash between the SARB and the government will result in low economic growth with high inflation.
The government’s commitment to expansionary fiscal policy undermines the Reserve Bank’s attempts to bring inflation down.
Roodt explained politicians like inflation because it erodes the value of the government’s debt, allowing it to spend more while not increasing debt in real terms.
Two inflation types
To understand the South African Reserve Bank’s challenge, especially when it comes to factors like load-shedding, it is important to look at what causes inflation.
Broadly speaking, there are two main types of inflation.
- Demand-pull inflation – caused by the demand for products rising faster than the products can be supplied. It typically happens in a strong economy.
- Cost-push inflation – caused by increases in the prices of production inputs. These increased production costs are passed on to the consumer and cause inflation.
Demand-pull inflation is responsive to monetary policy and higher interest rates. When interest rates increase, demand will fade away.
Cost-push inflation is not caused by a booming economy but rather by the cost of production inputs rising.
The most common example is the price of oil which affects shipping and travelling costs affecting the price of goods and services.
Load-shedding is another example. It significantly increases the operating cost of businesses, which, in turn, results in rising product prices.
Cost-push inflation is less responsive to interest rate increases as they do not address the underlying cause of the high inflation.
Cost-push inflation is the biggest cause of stagflation, where unemployment and inflation are high, and GDP growth is low or negative.
Increasing interest rates in such an environment can push the economy into a deep recession without lowering inflation.