Deflation, as opposed to inflation, exposes the world economy to great risk, says Christo Luüs, chief economist of banking group Absa. However, Luus believes that it is unlikely that deflation will occur in South Africa in the foreseeable future.
Luus told delegates at an agricultural seminar at Wolmaransstad that Japan has already experienced deflation for some time. Germany is on the verge of deflation and there is great concern that it may even hit America.
But should South Africa’s economy grow at a slower tempo or move into a recession because of deflation, its exports and economic growth will also suffer setbacks, he said.
Debt levels in South Africa, however, are insignificant compared with those in Japan (and even Germany and America). Moreover, South Africa does not experience asset-price bubbles that can be pricked and surplus capacity here is not a problem.
Additionally, South Africa’s nominal interest rates are still reasonably high, which offers ample room for the Reserve Bank to crack down on deflation, should this become necessary,” he added.
Luüs added that inflation in South Africa should decline in the next few months to between 3% and 4%, which should make it possible for the Reserve Bank to reduce interest rates by at least three percentage points. He expected the prime rate to level at 12,5% by the end of the first quarter of 2004.
Luus said that on the face of it deflation did not appear to be such a bad thing.
Indeed somewhere it had been defined as a continuous decline in the general price level, which was exactly the opposite to inflation.
Yet, deflation could produce disruptive results, from which grip it could be far more difficult to escape than from inflation.
Where debt levels in a country were high (as in Japan where domestic and corporate debt together amounted to about 25% of GNP) it could mean that deflation was continuously increasing the financial obligations of borrowers, while prices, wages and income were gradually decreasing.
This inevitably gave rise to a reduction in jobs, which intensified unemployment, and in turn activated a spiral of shrinking economic production (and thus negative economic growth). – I-Net Bridge