NOTICE | Can South Africa’s inflationary exceptionalism last?
South Africa is one of the few countries where inflation is in line with the official target, and the Reserve Bank deserves some of the credit, says Carmen DoI. But can it last?
South Africa is often seen as a high beta game, whether in terms of financial market risk aversion or political uncertainty and corruption. Yet we have shown remarkable exceptionalism over the past year, rarely appearing on the global political risk radar or suffering from capital flight. South Africa, however, stood out on the inflation front. Along with China, Indonesia and Vietnam, we are one of the few countries where inflation is in line with the official target.
Despite near record grain and oil prices, South Africa’s inflation rate has not (yet) exceeded the upper limit of 6%. While this is largely due to the fuel tax reprieve, which was recently extended, it is nonetheless exceptional in the context of high global inflation. Moreover, South Africa’s inflation rate is lower than that of the United States, the Eurozone and the United Kingdom, where inflation rates are above 8.0%. Even in more developed emerging markets, such as Czechia, Poland and Hungary, consumers are facing double-digit price increases. And spare a thought for Turkey, where prices have risen 70% over the past year.
Source: Bloomberg, Matrix fund managers
Consumer Price Index (CPI, %y/y)
What explains this exceptionalism?
The expenditure weight in South Africa’s Consumer Price Index (CPI) basket is similar to that of developed markets, with a relatively low share allocated to fuel and food, and a relatively high on services. This reduces direct sensitivity to global oil and food price dynamics, at least as measured by the CPI.
Structurally weaker economic growth since 2015 has reduced corporate pricing power, as weak job and wage growth has made consumers more price sensitive. It is important to note that limited credit growth, due to tighter banking sector regulations following the 2008/09 global financial crisis and the collapse of African Bank Investment Ltd (ABIL) in 2014, further dampened demand and therefore inflationary pressure. Similarly, attempts to consolidate the budget by cutting spending and raising taxes have put additional pressure on consumer demand.
While much of the disinflation from 2016 to 2020 reflected weak demand, we should extend credit to the South African Reserve Bank (SARB). Since 2015, under Governor Lesetja Kganyago, a prudent monetary policy geared towards inflation expectations has steadily lowered long-term inflation expectations towards the median target of 4.5%.
Since the onset of the Covid-19 pandemic lockdown in early 2020, South Africa’s inflation rate has been constrained by imported deflation and weak demand. Many national sectors are yet to return to pre-pandemic levels. This negative output gap – where economic activity is below its potential – has continued to dampen pricing power.
By contrast, many economies in the rest of the world have recovered to or surpassed pre-pandemic levels, thanks to extremely loose monetary and fiscal policies. These supportive policies have been maintained in the face of escalating supply disruptions, now exacerbated by the Russian-Ukrainian war. Excessively high money supply growth led to the traditional “too much money for too few goods” in many developed markets, while the SARB maintained tight control of the local printing press.
But what about the rand?
It is also disconcerting to note that inflation has been subdued despite a significant depreciation of the rand in March and April 2020. This may be explained by a weaker exchange rate pass-through due to increased competition, weaker demand, import price deflation and a rapid market recovery. rand. The rand has been trading sideways, albeit in a wide range, since 2015. In addition, the inclusion of owner’s equivalent rent in the CPI basket in 2009 and its relatively large weight in the index has increased the importance of services and therefore reduces the direct sensitivity to currency.
Can it last?
The scale of the global inflation shock, particularly following Russia’s invasion of Ukraine, will make it difficult for South Africa to continue to buck the trend of soaring inflation. However, the height of the inflation rate will depend on a few factors.
If the rand remains resilient, this will ease some pressure on import prices. If the SARB’s credibility remains intact, which we believe, longer-term inflation expectations will be capped, as will wage growth.
While the housing market showed signs of life after aggressive rate cuts in 2020, that was short-lived. The credit channel remains somewhat clogged and the SARB began its upward cycle in November last year. Moreover, there is a growing risk of even more aggressive policy tightening at the start of the period.
The dynamics of property prices have already slowed and rental growth remains subdued. Given the substantial weight of housing costs in the CPI basket, a weak housing market will offset some of the mounting pressures on food and fuel prices.
Change in the psyche of inflation
Large increases in the prices of basic commodities, such as food and transportation, act as tax hikes on consumers because they cannot easily consume less of these commodities. That means they have to cut elsewhere to make ends meet. This will dampen economic growth, especially for more discretionary goods and services.
The great global debate is whether we are seeing a regime shift as the inflation psyche shifts from low and stable inflation to higher and more volatile prices in the future.
In South Africa, the SARB is still leading the inflation battle on the expectations front. The warmongering of the MPC is to prevent us from returning to the high inflation psyche that prevailed before and during the early years of inflation targeting.
Difficult times are ahead as policy makers try to convince us that South Africa must remain exceptional. As the scales tip in their favour, we should expect continued warmongering rhetoric and potential action to ensure the message gets through.
Carmen Nel is an economist and macro strategist at Matrix Fund Managers. The opinions expressed are his own.