Efficient Group chief economist Dawie Roodt said the South African Reserve Bank (SARB) would unlikely win the inflation battle despite its best efforts.
In May, the SARB’s Monetary Policy Committee (MPC) voted in favour of an aggressive 50 basis points interest rate increase.
The decision was met with mixed reactions. Some economists welcomed the move, while others called it unnecessary and damaging to the economy.
Roodt was one of the economists who backed the Reserve Bank’s decision, pointing to the pain caused by inflation.
“Inflation reduces our buying power, erodes our savings, and creates social tensions between groups,” he said.
This is not where it ends. Inflation also causes tremendous damage to economic growth.
He explained that the common definition of inflation is the “continuous increase in prices”. However, it can also be defined as “money losing its value”.
This distinction is important because certain price increases are often seen as the “reason” for inflation, which it usually is not.
For instance, the increase in the price of fuel is not inflation, provided that the price of brandy falls within the same margin.
A fuel price increase only becomes inflation when it sets a process in motion where other prices increase in reaction to the increase in the price of fuel.
It is this process that the SARB wants to prevent, which is the reason why the SARB often refers to “secondary inflation”, “second round inflation”, or “core inflation”.
By increasing interest rates, it attempts to force the economy to accommodate the pain of higher fuel prices by forcing brandy prices lower before inflation becomes a process.
When inflation becomes entrenched, the real damage is done to the economy.
The SARB must, therefore, continue to maintain high interest rates to prevent inflation from getting out of hand.
The result can only be weak economic growth until something gives. And that something is likely going to be even more inflation.
However, South Africa’s inflation is not only demand-driven, which is the area which the Reserve Bank is targeting with higher inflation rates.
Load-shedding, poor governance, water shortages, failing rail infrastructure, and the weak rand all contribute to inflation through supply-side cost increases.
The government is also increasing spending, which puts more money into the system and increases inflation.
“The Minister of Finance might want to reduce state spending, but he cannot. He must continue to increase spending or face rebellion and fewer votes, which will continue to fuel inflation,” Roodt said.
Roodt expects inflation to slow down for a few months. “However, as long as we have a corrupt and incompetent government, inflation will remain high and may even morph into hyperinflation,” he said.
“The SARB is doing a splendid job in trying to combat inflation, but a marginally restrictive monetary policy is no match for a hugely expansionary fiscal policy. The SARB is simply overwhelmed.”
If Lesetja Kganyago is Governor and the ANC remains in power, expect highish inflation and interest rates and weak or no economic growth.
“Replace Kganyago with a dove, and high inflation could become hyperinflation with even lower economic growth,” Roodt said.