Reserve Bank governor warns inflation is spreading

South African Reserve Bank (SARB) governor Lesetja Kganyago has warned that inflation is becoming broad-based and may raise the cost base of the entire economy, resulting in detrimental “second-round effects”.

Kganyago issued this warning in response to questions from Parliament’s finance committee on Tuesday following a briefing from the SARB on its Financial Stability Review. 

“Inflation is spreading from those factors we consider temporary, such as food prices and fuel, to core inflation,” the governor said. 

Broad-based inflation may result in the entire cost base of the economy increasing.

This will result in “second-round effects”, such as wage spirals, potentially disastrously affecting the economy. 

“As a result, you have to act because people will soon adjust their inflation expectations to a higher level,” resulting in further price increases and demands for higher wages. 

Thus, a negative feedback loop could be created where inflation spirals out of control. 

Kganyago was also asked whether inflation can effectively be reduced by raising the repo rate, as inflation is also driven by factors such as load-shedding and a weak currency. 

The Reserve Bank has no control over these factors and thus cannot mitigate their effects on inflation and price stability. 

The government keeps inflation high

Kganyago has previously bemoaned the government’s role in keeping inflation elevated through a lack of financial discipline and inability to tackle structural issues such as load-shedding. 

Idiosyncratic factors such as load-shedding and the country’s greylisting keep inflation elevated in South Africa while it is declining globally, Kganyago said last month. 

In particular, the ongoing energy supply challenges are fuelling inflation by raising operating costs for businesses which are passed on to consumers.

The Reserve Bank estimates that load-shedding adds 0.5% to inflation in 2023, and this is something it can do nothing about.

Food inflation provides a good example of the idiosyncratic nature of South African inflation. It is increasing in South Africa while agricultural commodity prices are decreasing globally.

The Reserve Bank has to fight inflation “in a context where many of the drivers of both inflation and growth are outside of its control”, according to Kganyago.

Furthermore, “fighting inflation is much harder when the economy is already underperforming” due to structural constraints.

The Reserve Bank is not able to solve these structural issues nor influence long-term growth – this requires sound economic policy from the government.

Dawie Roodt, the Efficient Group’s chief economist, agrees with Kganyago. 

Roodt said the Reserve Bank is doing the right thing in trying to bring inflation down by raising interest rates while calling on South Africans to support its efforts.

However, the SARB is limited in what it can do. It cannot address structural economic problems keeping inflation elevated, such as electricity prices and deteriorating infrastructure.

He is most concerned about the clash between the SARB’s monetary and the National Treasury’s fiscal policy.

This macroeconomic clash between the SARB and the government will result in low economic growth and high inflation.

The government’s commitment to expansionary fiscal policy undermines the Reserve Bank’s attempts to bring inflation down.

Roodt said 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.

Thus, he suspects that “politicians will put more pressure on the Reserve Bank to relax monetary policy” in the future.

Such calls are heard already, with politicians in the government and the opposition calling for the nationalisation of the SARB and changing its mandate.