Rampant inflation — driven by food and fuel prices — is hurting the poor the most, but anticipated interest rate hikes might not adequately deal with the problem, some economists argue.
Food prices, which are rising at more than 12% a year already, are expected to continue this trend for the next few months. Light sweet crude hit $89 a barrel on Wednesday, the Associated Press reported, with prices set to hover around the $90 mark, a $40 increase since the beginning of the year. Absa Capital predicts that consumer price inflation less mortgages (CPIX), now at 7,3%, will peak at just more than 8%. Since poor and working class consumers spend a disproportionate amount of their income on food and transport, increases in these areas will hit them the hardest.
Cosatu’s labour market policy coordinator, Rudi Dicks, has called for the Reserve Bank to abandon its targeted range. “There are too many developmental challenges, for which we need growth. What we want is for monetarists to accept that we are a developing economy and we want 6% growth. The trade off for that is higher inflation.”
There are questions around the statistics considered by the Reserve Bank, says Dicks. Manufacturers have colluded on bread prices, and possibly other products, giving rise to distortions. Administrative pricing accounts for between 45% and 50% of the cost of petrol at the pump, Dicks says. Although excessive inflation is unwelcome, there is scope for inflation to be higher than the targeted range without it adversely affecting the economy.
“The problem with the neoclassical approach is that it doesn’t take account of the social cost on the working poor and unemployed,” he says.
“Quick-fix solutions like price controls have been proved not to work,” says Simphiwe Ngqangweni of the National Agricultural Marketing Council, which advises the minister of agriculture. “In an open economy such as ours such interventions don’t work. They distort the market.” Ngqangweni says South Africa needs to increase its capacity to produce food, although increases in agricultural input costs also need to be considered.
While the Reserve Bank cannot control food and oil prices, it can control higher inflationary expectations, which would make it easier for businesses to raise prices and for labour to demand higher wages, says Metropolitan economist Rejane Woodroffe. But a stronger rand could have softened inflationary pressures. “A lot of the pain would have been alleviated if the rand had been allowed to strengthen,” she says. While one sector of the economy — exports — is hurt by a strong rand, consumers are helped.
“You could argue that growth doesn’t necessarily help poverty and inequality,” Woodroffe says, because of the lack of a trickle-down effect. She says it is not clear how employment numbers have risen as a result of growth, but the construction sector remains buoyant. While sales of light commercial and passenger vehicles are down, heavy construction vehicle sales are up. There is evidence of weaker demand, despite strong gross domestic product growth figures, but the effect of the present interest rate hikes will be felt until the beginning of 2009. “People don’t change their behaviour immediately. [It] changes after 12 months,” she says.
But she agrees that further rate hikes are likely to slow the economy. The economic literature is not clear on the effect of precise levels of inflation on growth. Inflation above 40% is bad, but the effect of inflation below 10% is not clear. Even the effect of inflation of between 10% and 20% is uncertain. “It could be argued that our targets are quite tight, given the research,” she says.
But because the Reserve Bank chose its targeted band of between 3% and 6%, it will be difficult to change the target. “Inflation could spiral out of control, with the Reserve Bank losing credibility,” she says.
The main drivers of inflation — food and fuel prices — are worldwide pressures that are largely out of the hands of central banks. Fossil fuels are running out and governments have responded by promoting biofuels, which in turn have caused demand for food crops to spike, Woodroffe says.
A government economist says there is a need to look at the factors behind inflation, such as credit extension and higher agricultural prices. “Government knows it should cut costs but doesn’t,” the economist says. On the food side, higher agricultural production could alleviate pressure on prices.
But inflation has become increasingly broad-based. Food and fuel inflation is driving headline inflation higher, but other economic costs are rising faster. Jeff Gable, head of research at Absa, says nearly three-quarters of the weighted basket of goods, used to calculate CPIX, is rising at more than 6% a year. “This is evidence that underlying inflation is rising. Prices that were falling at the beginning of the year are falling by less now. Many prices that were rising at the beginning of the year are rising by more,” he says.
Food prices are rising by more than 12% a year. Transport inflation is rising by more than 6% a year, with petrol prices touching a new high of R7,47 a litre this week in Gauteng, from R5,98 in January. Prices of tobacco, household operations (which include wages for domestic workers), fuel/power (including electricity and coal), education, alcoholic beverages, housing and personal care are all rising at 6% or more. Prices of non-alcoholic beverages, healthcare and books, while still within the target range, are rising about 5% a year. Recreation, clothing and footwear and furniture prices have dropped.
Increases in producer prices — now more than 9% — are feeding into higher consumer inflation, Gable says. And, because of sustained growth, the economy is beginning to run short of certain items, such as concrete, which has to be imported. Eskom has run out of capacity and has asked for tariff increases above inflation.
Despite the gloomy outlook, consumer confidence is at a near-record high, because of increased employment and wage settlements of 8% and 9% in nominal terms. “When you look at your pay cheque, you don’t subtract inflation,” Gable says. “More people have jobs than before. There’s a general sense that interest rate hikes must be coming to an end. Consumer spending power has gone down, but consumers are still pretty resilient.”
Gable says the central bank has no option but to raise rates as, according to its mandate, it is an inflation-targeting bank with interest rates its only tool.
Hard to swallow
Food price inflation has now topped 12%, according to the latest CPIX figures, and is expected to be even higher over the next few months. The cost of producing food has risen steeply and there has been a general worldwide increase in demand, according to the latest Quarterly Food Monitor published by the National Agricultural Marketing Council (NAMC). Simphiwe Ngqangweni, one of the authors of the report, says food prices are expected to continue rising over the next three months.
According to the August Quarterly Food Monitor, food inflation is also rising in the United States, Europe and Asia. The US Food Commodities Index, which tracks the prices of raw food ingredients, has risen by 21% this year. US food inflation has topped 6% so far this year from 2,1% last year. UK food price inflation has also reached 6%, ahead of overall inflation of 2,8%.
In China, food prices are rising twice as quickly as other prices, at 7,1% from a year earlier. Rising energy costs and increasing demand for biofuels are the culprits, while greater affluence in South East Asian countries has also driven up demand, says the report.
The November Quarterly Food Monitor shows that the cost of fresh vegetables has risen by 33,81%, wheat products have risen by 17,56%, maize by 24,96%, processed meat by 11,65% and fresh meat by 9,17% in urban areas from October last year to October this year. But producer price inflation has been much higher. From September last year to September this year, producer prices for grain rose 50,4%, for oil seeds 98,3%, for vegetables and dried beans 58,7% and 21,5% for milk and dairy.
According to the report, pressure on food consumption was likely, particularly in more expensive categories, because of high interest rates and consumer indebtedness. Increased non-food costs could also affect food prices, as food is supplied through extensive supply chains. There was an increase in the numbers of consumers, both as a result of increased spending power and immigration from countries like Zimbabwe, which meant that although consumers were financially constrained, demand was more broad-based than previously.
The NAMC’s report on input costs for maize shows that fertiliser, fuel, animal health and crop protection, maintenance and repairs and farm seed all rose significantly between 1990 and 2006. Altogether, the producer price index for maize rose 252,6%. Almost half of fertiliser products are imported, and demand for biofuels has influenced the international prices for fertiliser.