South Africa’s inflation battle

South Africa’s Reserve Bank may find it difficult to achieve and sustain an inflation rate of 4.5% over the next few years as infrastructure backlogs and fiscal constraints push up the prices of key essential services.

Inflation has topped 4.5%, the midpoint of the target range at which the South African Reserve Bank prefers to anchor price-growth expectations for more than three years.

Despite this, the monetary policy committee has discussed lowering the goal, with Governor Lesetja Kganyago previously saying a single-point target of 3% would be in line with the country’s peers and allow for lower interest rates. 

“Bringing the inflation rate fully under control — 4.5% or lower — has to be focused on controlling the cost increases of key essential services,” Kevin Lings, Stanlib’s chief economist, said in a research note. 

Extensive infrastructure backlogs and severe fiscal constraints in the public sector suggest the prices consumers will have to pay for key goods, including water, electricity and health care, “will continue to escalate at a relatively rapid pace for many years, adding upward pressure to inflation,” he said. 

The cost of key services such as electricity and water have exceeded inflation for several years, partly to allow state-owned companies to supplement declining revenues and fund infrastructure projects after years of mismanagement and underinvestment.

On average, electricity costs were 15.2% higher in the first five months of this year than a year earlier, while water was 7.9% more expensive, according to Lings. 

Kganyago has frequently bemoaned the costs set by state companies or regulated by government institutions to keep price growth and interest rates elevated. 

“We remain concerned about administered prices,” he said last week after the MPC decided to leave the key rate at a 15-year high of 8.25%.

“We have had to mark up electricity inflation for this forecast round, even as other categories shifted lower.” 

An anticipated increase in economic activity will probably drive-up price growth for rental housing, new clothing, appliances and further impact the central bank’s ability to achieve and sustain a lower inflation rate, Lings said. 

A local currency that tends to weaken against the dollar on an annual basis and labour unions that command wage increases at or above the top of the target will add to the Reserve Bank’s challenges, he said. 

South Africa’s inflation target is set by the finance minister in consultation with the central bank. In February, National Treasury said there’s a case to be made for the goal to be reviewed to improve competitiveness and offset the adverse impact price growth has on the poor.