Manuel suggests inflation target review

South African Finance Minister Trevor Manuel said on Thursday he was concerned about the use of higher interest rates as the only tool to fight soaring prices, and suggested that domestic inflation targets could be reviewed.

“I am concerned about interest rates…If the only thing we do is to use a blunt instrument like interest rate hikes then I think we are going to run into difficulties,” Manuel said in an interview with the South African Broadcasting Corporation.

The Reserve Bank has raised interest rates by four percentage points this year in response to spiralling inflation ignited mainly by the rand’s historic plunge in 2001, and its knock-on-effect on dollar-denominated food prices.

There are widespread fears that this trend will curb sedate economic growth, without bringing prices down.

Those concerns mounted this week on news that the targeted CPIX index—which excludes the impact of home loans—rose by a record 10,8% in August, shooting outside its official three to six percent target for the 10th consecutive month.

This has sparked a heated debate on the wisdom of inflation targets for an emerging market like South Africa—or at least of using the CPIX index itself, rather than a core measure which strips out more volatile elements like food and fuel prices.

Poor people who spend the bulk of their income on food have hardest hit by rocketing prices for basic staples like maize, and the cabinet said on Wednesday it had decided that “urgent steps” were needed to curb the impact of this trend.

Manuel suggested that Statistics South Africa, the central bank and the Treasury collectively have a closer look at whether the targeted inflation index was doing its job.

“If we can sharpen the instrument a bit through an examination like this—the CPIX is not a sacred cow, we should be taking a look at it—then we will be taking steps in the right direction,” he said.

South Africa’s volatile rand firmed nine cents to 10,53 against the dollar in early trade before pulling back to 10,56.

Traders said the move was partly in response to Manuel’s comments, as the prospect of higher interest rates and slower growth makes South African assets less attractive.

Economists welcomed Manuel’s views, saying the broader policy framework to fight inflation—including pricing policies by state enterprises—had to be looked at.

In the last few months, administrative prices set by state-run utilities and hospitals have added to price pressures, along with steep pay rises in the public and private sectors.

Increases in global oil prices are also a problem, as they have sharply pushed up prices for domestic fuel.

“I agree with him. We are trying to use inflation targeting to change people’s inflation expectations when these are a function of where inflation is at the moment,” said Jac Laubscher, chief economist at Sanlam Investment Management.

“The problem with the CPIX basket is that roughly 55 percent of it—food, energy and administrative prices—is not interest rate sensitive,” he said.

Manuel said inflation was being fanned by a combination of rand depreciation and external factors, including higher international prices for maize, an important local food staple.

He also suggested that the central bank could look at other factors when setting monetary policy to meet the inflation target, such as credit demand and money supply.

“What I am suggesting is that with the Reserve Bank and Stats SA, we examine the detail of what’s measured and how it is utilised so that we can improve on the quality of the life of all South Africans,” Manuel said.

South Africa introduced inflation targeting in 2000 in an attempt to shore up its financial credentials—setting a three to six percent target for 2002 and 2003.

Analysts believe the target will be missed both this year and next, and worries are mounting that the target for 2004—which narrows to three to five percent—is also in jeopardy.

“It’s a good step in the right direction that they will at least look at the targets, but they have to do it very carefully or they will lose credibility. Excluding food and energy may not be correct,” PSG economist Noelani King said.
- Reuters

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