Inflation affects South Africa like any other country in many ways. The South African Reserve Bank (SARB) uses interest rates as a lever to cool down borrowing in the economy and discourage consumer spending, which in turn acts as a measure to counter inflation. This increase in interest rates is an indication that the SARB projects inflation to increase over the medium term, which is important for the average South African. A higher inflation expectation triggers a rise in interest rates, which eats away the value of future returns on investments, while higher interest rates increase the cost of capital for companies.
For clarity, the repo rate is the interest rate at which the SARB lends to banks in South Africa. The repo rate increases are intended to discourage borrowing by making credit costlier. Existing credit financed by floating interest rates also gets costly to repay because banks pass on the increased interest rates costs to consumers.
The inflation target range set by the SARB is between 3-6%. This means that the SARB aims to maintain inflation within this range over the medium term. South Africa has experienced high inflation rates in recent years influenced by various factors such as government policies, supply and demand dynamics, exchange rates, and global economic conditions. To effectively manage this high inflation, the SARB hikes interest rates. Recent hikes have had minor improvements in the Consumer Price Index (CPI)- A yardstick index of inflation in South Africa.
Despite a recent slowdown in inflation, South Africa is still expected to hike interest rates as per the SARB’s forecasts. Also, Trading Economics forecasted the inflation rate in South Africa to be around 7.00% by the end of Q2 2023, and the long-term projection is around 4.80% in 2024 and 4.50% in 2025. Statistics South Africa reported that consumer inflation reached 7.8% in July 2022, which is a 13-year high. However, despite nine consecutive interest rate hikes since November 2021, South Africa’s inflation remained sticky, with April’s CPI standing easing at 6.8% from 7.1%, but CPI remains exceptionally high and outside the SARB’s target range of 3-6%. Therefore, the SARB’s aggressive tightening of the monetary policy by hiking interest rates proves ineffective in controlling inflation in South Africa
In the case of South Africa, factors that have contributed to the ineffectiveness of interest rates in controlling inflation are:
Inflation Expectations: The effectiveness of interest rate changes in controlling inflation depends on the credibility of the central bank and public expectations. If inflation expectations are already high and or if the public lacks confidence in the central bank’s ability to maintain price stability, interest rate adjustments may have limited impact. In South Africa, managing inflation expectations can be challenging due to historical inflationary experiences and uncertainties about the country’s economic outlook.
Inflation and the Wage-Price Spiral: South Africa has experienced a history of wage-price spirals, where wage increases in sectors with strong labour unions drive inflationary pressures. As noted by Netto Invest, “rising inflation expectations and tighter labour markets push workers to persistently demand wage increases to catch up to or exceed the recent rise in inflation.” Simply put, workers expect inflation to keep rising, so they demand and get higher salaries to keep up with rising prices. This aggravates the existing high inflationary environment.
Supply-Side Challenges: Inflation in South Africa is influenced by supply-side factors such as energy costs, transportation bottlenecks, etc. China’s Zero-Covid Policy has caused global supply chain disruptions and we have seen increasing commodity prices as a result. Also, the invasion of Ukraine by Russia then aggravated these effects, leading to higher energy and food prices. These factors have a substantial impact on the cost of production and overall price levels. Interest rate adjustments primarily target demand-side factors and may have limited effectiveness in addressing supply-side challenges that drive inflation.
Fiscal Policy and Government Spending: Ineffective fiscal policy measures or excessive government spending can contribute to inflationary pressures. If government spending exceeds revenue generation, it can put upward pressure on prices. According to Trading Economics, government Spending in South Africa decreased to 896 814 ZAR Million in the fourth quarter of 2022 from 903 134 ZAR Million in the third quarter of 2022. That is a marginal reduction in government spending. In such cases, interest rate adjustments may have limited effectiveness in controlling inflation.
External Factors: South Africa, being part of the global trade economy, is highly exposed to external factors, including fluctuations in global commodity prices, exchange rate movements, and capital flows. These external factors can significantly impact inflation dynamics in South Africa. Interest rate hikes alone may have a limited impact on inflation if it is primarily driven by external factors beyond the
control of the SARB’s monetary policy.
Some of the potential long-term solutions to address inflation in South Africa:
To manage inflation in South Africa effectively, policymakers need to consider an all-inclusive approach that combines monetary policy measures with structural reforms to address the underlying challenges, improve productivity, enhance competitiveness, and promote inclusive growth. This may involve implementing fiscal discipline, addressing structural inefficiencies, enhancing labour market flexibility, and promoting investment in productive sectors of the economy.
According to a working paper by the International Monetary Fund, monetary policy tightening aimed at maintaining low and stable inflation could reduce consumption inequality over a 12–18-month period. This suggests that the SARB could continue to implement monetary policy tightening to address inflation in the long term. Additionally, stabilizing fuel prices could help to reduce inflation, as fuel prices have been a major driver of inflation in South Africa. The SARB could also consider implementing policies to increase productivity and economic growth, which could help to reduce inflation in the long term.
Finally, the government could work to address structural issues in the economy, such as high unemployment and income inequality, which could help to reduce inflation by increasing economic stability and reducing demand for goods and services.
General steps individuals can pursue to mitigate the impact of inflation on their job and income:
According to Daily Investor: South Africa’s inflation is stickier than ever, with no sign of coming down soon. The SARB has been turning to interest rates to bring down the country’s high inflation for months. The effect of interest rate changes is usually only felt months after implementation. South Africa started its interest rate hiking cycle in November 2021, with a devastating effect on the country’s citizens.
With high-interest rates and more hikes anticipated to come, this comes with high-interest rate payments on your short-term and long-term debt obligations- credit cards, vehicle finance, mortgage bond, etc. Disposable income shrinks with every interest rate hike and below are some of the practical ways individuals can pursue:
One way is to negotiate for higher wages or salaries to keep up with rising prices. This is especially important for low-income individuals who are more vulnerable to the effects of inflation. Consideration needs to be taken on the employer’s financial standing as well.
If you have outstanding loans, such as a mortgage or a personal loan, consider refinancing them to lock in a lower interest rate before rates rise further.
Always shop around for competitive interest rates. Before taking on new debt or refinancing existing loans, compare offers from different banks to ensure you are getting the most competitive interest rates available in the market.
Another way is to reduce expenses by cutting back on non-essential spending and finding ways to save money on essential items such as groceries and utilities.
Individuals can also consider investing in assets that are likely to appreciate, to protect their wealth from the effects of inflation. Consulting with a broker or a financial consultant would be ideal. Consider diversifying your portfolio to spread risk and potentially minimize the impact of rising interest rates.
Lastly, individuals can stay informed about economic conditions and government policies that may affect inflation and take steps to prepare for potential changes in the job market or the economy.
Sources: biznews Bloomberg dailyinvestor iadb IMF mckinsey NPR statssa statssa statists tradingeconomics
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Good day Benjamin, what an informative and well rounded article. Super proud of you!! Onward and upwards. You make me want to get back into Economics and research on that industry. I have a few questions. Why does the interest rate keep increasing if it has a limited effectiveness on Inflation control, how does it benefit the government/SARB from their POV? You did mention that it’s a way to counterbalance inflation and decrease, if not optimally control the borrowing ability of consumers, but wages/salaries have already proven to not be sufficient in the new market for consumer spending abilities which in turn makes them run to creditors. In essence, why are we suffering (😂), how is that making things better for us/consumers? I would like to also commend you for the solutions placed, not only is it informative of the market, inflation and interest rates and it’s toll on consumers you brilliantly spared some solutions and tips/tricks. In a non sustainable environment/home where even basics/essentials are hard to obtain, where do we draw the line on cutting down spending when there’s already less to spare or even spend around?
Hi Mpho, Thank you for the positive remarks! With Life and Figures as your go-to economic blog, surely this shall be your home for well-researched economics topics.
It is worth mentioning that the effectiveness of interest rate adjustments in controlling inflation can vary depending on the specific economic conditions, structural factors, and the broader policy framework in place. Interest rates are one of the key tools used by central banks to manage and control inflation. The key benefit of using interest rates as a mechanism to control inflation is that higher interest rates can attract foreign investors seeking better returns, leading to an increase in demand for ZAR currency. This increased demand can strengthen the rand’s exchange rate and reduce the cost of imported goods and materials
Going back to my point mentioned in the article, staying informed about economic conditions and government policies that may affect inflation, one can take steps to prepare for potential changes in the job market or the economy. This is a way of being forewarned so that you can be forearmed and, informed decisions where matters of credit are involved in your life can be taken with greater detail.
Great artile. With hike today, the prediction was that the Reserve bank will rase by 75 basis points. Instead they raised by 50 basis points. So why did the Rand become even more weaker as a result of this. Was this not supposed to be the other way around?
Good question 😉 In economics, there is a phenomenon called Rational Expectations. Market participants have formed rational expectations of interest rate increases. However, based on the availability and interpretation of economic data, there is hardly ever a consensus on what the hike rate will be. Hence, you will find different views on whether interest increases will go up by 25,50, and/or 75 basis points.
When these rational expectations of interest rate increases are not met, it can have implications for the exchange rate. It seems like Market participants had priced in interest rate increases and those expectations were not met, resulting in a depreciation of the rand. Another consideration is that the hike was steep, signalling a disappointment in the SARB’s decision or forming a perception that economic conditions are weaker than expected. This could have led to a decrease in demand for the rand, causing its value to decline after the announcement.
Further to the above, unmet expectations regarding interest rate increases introduced uncertainty and volatility into the currency market.
Thank you for shedding some light on this stressful topic. As consumers we are feeling the pinch of hiked interest rates almost on a monthly basis. When will it get better?
As per the forecasts, the general consensus is that towards the end of 2023 and early stages of 2024, we would expect inflation to stabilize. However, we must be mindful of future uncertainties that can skew this view by being well-informed about economic conditions and government policies that may affect inflation.
There was a study instituted in America , that went as far as ~1950, and they found that hiking interest rates had a significant impact on the unemployment rate. increasing the interest rate , increased the unemployment rate by a certain margin albeit achieving their disinflation targets.
In a South African context , what do you think the impact of hiking the repo rate is on unemployment rate ? and if there is a direct link , surely the reserve bank’s disinflation mandate cannot continue to be achieved at the expense of putting people out of work..
Valid observations. Interest rate hikes can worsen our unemployment situation in South Africa. To measure the extent of this, a sacrifice ratio needs to be observed. A sacrifice ratio is an economic ratio that measures the effect of rising and falling inflation on a country’s total production and output. This is a note, for future research topics where our Economists will cover in detail the costs of this rising and falling inflation on our macro indicators.