The government keeping inflation and interest rates high

The above-inflation price increases for government services, such as hikes in electricity and water tariffs, are making it difficult for the Reserve Bank to cut interest rates, as they keep inflation elevated. 

In recent years, the government has significantly increased the prices of administered services to compensate for revenue shortfalls caused by poor economic growth and mismanagement. 

Administered services range from electricity tariffs to municipal charges and significantly impact inflation as many of these services are universal inputs in the economy. Thus, when the price for these services rises, the entire cost base of the economy rises, too. 

In particular, electricity and water tariffs have surged, and taxes levied on fuel purchases have risen significantly. 

It also negatively impacts economic growth as it raises the cost of doing business, which is ultimately passed on to the consumer as companies cannot absorb such large increases. 

The Reserve Bank, in its latest Quarterly Bulletin, noted that administered price inflation has accelerated sharply since the beginning of 2023, reaching 8.9% in May 2024. 

It said this is primarily due to higher fuel price inflation. However, even when excluding fuel price increases, administered price inflation still rose from 7.5% in July 2023 to 8.6% in May 2024. 

This is largely due to the year-on-year increases of 8.4% in municipal assessment rates and a 6.3% increase in education services. 

When excluding electricity prices, administered price inflation has increased moderately – from 4.2% in July 2023 to 5.5% in May 2024. 

Old Mutual Wealth investment strategist Izak Odendaal said it is ironic that the government sets the Reserve Bank’s inflation target while it is the biggest culprit in driving inflation. 

He said the above-inflation increases in administered prices and the generous salary increases given to public sector workers over the past decade have driven inflation. 

This is compounded by government inefficiency, which raises the cost of business and thus the price the consumer pays for goods and services. 

“A renewed commitment across government entities to adhere to its own inflation target will go a long way to achieving it,” Odendaal said. 

The above inflation increases in administered prices can be seen in the graph below. 

The Reserve Bank has repeatedly warned that government spending and increases to administered prices have made it difficult to bring down inflation and, thus, allow it to cut interest rates. 

“As inflation risks emerge and materialise, and services prices normalise, the path back to the target midpoint is expected to take time,” it said in its Monetary Policy Review. 

“The repurchase (repo) rate at 8.25%, unchanged since May 2023, remains broadly consistent with persistent inflation, the uncertain domestic and global outlook, and getting back to the 4.5% midpoint over the forecast timeframe.”

In the review, the bank focused on the significant hikes in prices charged for government-administered services. 

“These regulated, public sector-controlled prices impede efforts to bring inflation down and maintain it at the midpoint of the target band; consequently, they also erode competitiveness,” it explained.

“Electricity and water prices, in particular, have for several years inflated at rates well above the 4.5% midpoint of the inflation target band.”

Last year, it was estimated that Eskom had increased the price of electricity by 446% since load-shedding began in 2008, driving inflation in South Africa and significantly increasing the cost of doing business. 

This number is likely far higher now in light of April’s electricity price increase. 

“Efficiency gains in these sectors would be important to ensuring that long-run, cost-reflective prices are achieved soon,” the SARB said.

“Other administered prices, such as education and assessment rates, are influenced by headline inflation outcomes and should be more closely aligned to the target midpoint itself.”

“Reducing headline inflation would bring down administered price inflation, creating a virtuous cycle.”