Reserve Bank in battle with Treasury over inflation

The Reserve Bank and National Treasury appear to be at odds regarding fighting inflation. The central bank says the government’s above-inflation price increases for administered services and its spending are making it hard to cut interest rates as they keep inflation elevated. 

Since November 2021, the Reserve Bank has hiked interest rates by 475 basis points to a 15-year high to combat inflation. 

The initial drivers of inflation were global supply shocks, which greatly increased the price of fuel and other commodities – driving their prices higher. 

However, these supply shocks were relatively quickly resolved, and the supply of goods, particularly fuel, soon rebalanced with demand. 

Oil supply has picked up to the extent that the Organisation of Petroleum Exporting Countries (OPEC) has implemented supply caps to artificially drive up prices. 

These supply shocks were compounded by structural economic issues within South Africa, such as load-shedding and logistical inefficiencies. 

The Reserve Bank was clear at the time that resolving these issues, which would bring inflation down, was the government’s responsibility, and it could do very little to mitigate these structural issues. 

At the same time, the government began implementing above-inflation price increases for these services, compounding their impact on inflation. 

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. 

Electricity and water tariffs have surged, and despite no increases in the past two budgets, taxes levied on fuel purchases have risen significantly over the past five years. 

“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,” the bank said. 

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

“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.”

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. 

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

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

Another point of contention between the Reserve Bank and the National Treasury is the government’s excessive spending over the past decade, which has added fuel to the inflation fire. 

The portfolio manager of Allan Gray’s money market fund, Thalia Petousis, explained that because government spending continues to grow faster than tax revenue, inflation will be stickier in South Africa. 

She said the Reserve Bank carries an outsized burden with regard to stabilising South Africa’s economy and fighting inflation. 

In this regard, the Reserve Bank has repeatedly called for the government to share the burden via prudent fiscal policy and, particularly, reduced spending. 

Excessive government spending over the past decade, without any meaningful economic growth, has significantly increased the country’s risk premium as it has been forced to borrow money to fund its operations. 

This manifests itself in increased borrowing costs for the government and companies, raising the cost of debt and the cost of doing business in the country. 

Petousis said this also contributed to a weaker rand and thus keeps the price of fuel imports elevated among other things. 

Thus, the Reserve Bank has repeatedly urged the state to reduce its debt burden as this will create a virtuous cycle, bringing down inflation and borrowing costs.