Well known Investec economist Brian Kantor reflects on yesterday’s events at Parliament. He says amid all the pandemonium, the one thing that went totally unnoticed was that inflation has flat-lined for the past 3 months. His conclusions from this are economically depressing. He says it is the weak state of final demands from both South African households and firms that is holding inflation down as well as anaemic GDP growth. The only way out, more public and private austerity. – Stuart Lowman
By Brian Kantor*
Amid the pandemonium in and around Parliament yesterday, something may have been missed. What probably escaped notice was that for a third month the CPI was unchanged. It reached a value of 116.1 in July, remained 116.1 in August and prices maintained that level of 116.1 in September. In other words, average prices in SA since July 2015 have remained unchanged and so the inflation rate in Q3 2015 remained a round zero. Headline inflation, the percentage increase in the CPI over 12 months was 4.6%, also unchanged from August 2015.
The upward pressure on the CPI from rising utility bills and house rentals, including the rentals owner occupiers are assumed to pay themselves, that added 0.9% to the CPI in September, was offset by lower petrol and transport costs that took 1.6% off the index. The prices of food and non-alcoholic beverages rose by a mere 0.1% in the month.
These outcomes in Q3 must have come as a surprise to the Reserve Bank, which believes inflation is driven largely by inflationary expectations. Hence its tendency to impose higher interest rates on the economy, regardless of where the pressure on prices may be coming from, less supplied or more demanded, for fear that inflationary expectations are self-fulfilling.
These inflationary expectations, with a much weaker rand in the quarter, might have been expected to have been elevated in Q3.
Judged by the gap between the yield on conventional and inflation-protected RSA bonds, reflecting compensation for bearing inflation risk, as good a measure of inflation expectations as any, have changed little, and remained very stable about the 6% level, in line with the upper band to the inflation targets, as it has done for many years.
It is clearly not expected inflation that stabilised the CPI at 116.1 (2012=100). It was the weakness of final demands for goods and services that has so limited the pricing power of firms supplying households and firms not only in SA but almost everywhere else too. This lack of demand has put pressure on the dollar prices of goods imported into SA, including that of oil and grains. The so-called pass through effect on prices of a weaker rand is running at about a fifth of the impact predicted by the Reserve Bank’s inflation forecasting model.
The Reserve Bank needs a better theory of how prices are formed in SA than are determined (mostly) by inflationary expectations. This will help it avoid imposing unwelcome extra burdens on the economy in the form of higher interest rates when too little, rather than too much, spending is part of the problem, as it has been doing ever since early 2014 when short term rates were first increased.
Read also: SARB puts a smile on bleak inflation outlook
Yes, higher taxes on energy or higher charges for electricity or water or roads or imports may put upward pressure on prices charged (as may the budgets of firms with pricing power) that presume prices can be increased in line with inflation expected. But as is now highly apparent, prices charged and recognised in the CPI are not crudely equivalent to costs, including employment costs, plus some profit margin. They are much better explained as profit-maximising or perhaps loss-minimising prices – what the market will bear prices, which reveal highly variable operating profit margins.
The update from Shoprite, SA’s leading food retailer released on the morning of the CPI update, told the same story of pressure on food prices and operating margins. And the declining employment numbers tell of the pressure of higher wage demands on numbers employed rather than on prices charged.
It is the weak state of final demands from both SA households and firms that is holding down the CPI as well as the GDP that is barely growing. Higher taxes imposed by the national government and the higher charges for electricity etc. levied by municipalities and yes also the fees charged by educational and medical service providers that have monopoly type pricing power and also, most avoidably, higher interest rates set by the Reserve Bank, have all taken their toll on household budgets and spending power and so the pricing power of the firms supplying them.
This lack of demand for goods and services and labour is being exacerbated by the inability of the SA government to sensibly limit and manage its own spending on employment benefits for government workers, the largest item by far in its Budget. This outcome, understandable in the circumstances, and given conservative objectives for government debt ratios, means discouraging still higher taxes on the productive economic agents of the economy and less spending by government on other items, including on useful infrastructure.
The Budget statement to Parliament was eloquent in its admission that unexpectedly large employment benefit concessions to public sector employees greatly disturbed the Treasury’s Medium term expenditure and revenue plans. This disruption to sound fiscal policy was explained in the Budget Statement as somehow beyond the control of the government itself. The bargaining arrangements with public sector unions that led to such exorbitant outcomes post the main Budget in February 2015, may well have been out of the control of the Treasury and its fiscal constraints. As such it represents just another government failure.
It is the failure of the government to recognise that the path to faster growth in SA is not only through more effective government spending, but less of it, combined with less interference in the economy that so engages the well paid but now shrinking government workforce. It is less government and so lower taxes and much more reliance on business for solutions to poverty and growth that should be the way forward for SA. Resisting this direction, as it is being resisted in Budget after Budget, leads to higher taxes and charges and less rather than more spending and slower rather than faster growth. In other words more public and private austerity of the kind we are experiencing.
*Brian Kantor is the Chief Strategist and Economist at Investec Wealth and Investment in South Africa.