ECON­OMY WATCH

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South African in­ter­est rates look set to rise even fur­ther in fu­ture after in­creas­ing by a cu­mu­la­tive 75 ba­sis points this year. Rate in­creases will be wel­come news to savers but not to the over-in­debted.

The rate in­creases will, how­ever, be mod­er­ate and could even be de­layed if the cur­rent be­nign in­fla­tion out­look con­tin­ues for longer and in­ter­est rates in the US do not go up sig­nif­i­cantly when they fi­nally do start ris­ing.

The ef­fects of the in­creases are un­likely to be as se­vere as in 2014, given that at least in 2015 eco­nomic growth should im­prove and more jobs could be cre­ated, which will support spend­ing in the lo­cal econ­omy.

The Re­serve Bank’s mon­e­tary pol­icy com­mit­tee be­gan the in­ter­est rate-in­creas­ing cy­cle in Jan­uary 2014 amid ris­ing in­fla­tion and a sell­off in emerg­ing mar­kets as­sets that saw the rand weaken con­sid­er­ably.

The in­fla­tion threat has come down quite sig­nif­i­cantly since, although risks re­main that it could in­crease again.

Th­ese risks in­clude a weak rand, steep wage in­creases and high ad­min­is­tered costs such as elec­tric­ity tar­iffs.

Lo­cal real in­ter­est rates have to rise back into pos­i­tive ter­ri­tory to keep in­vestors in­ter­ested in lo­cal as­sets by the time US rates start go­ing up. Most an­a­lysts ex­pect US rates to in­crease in the sec­ond half of next year.

Re­serve Bank gov­er­nor Le­setja Kganyago an­nounced at the most re­cent mon­e­tary pol­icy com­mit­tee meet­ing that an im­prove­ment in the in­fla­tion out­look cou­pled with slug­gish do­mes­tic eco­nomic growth had led the com­mit­tee to leave the bench­mark re­pur­chase (repo) rate un­changed at 5.75%.

He stated, how­ever, that the rate-hik­ing cy­cle con­tin­ued and would de­pend on a num­ber of

Do­mes­tic in­fla­tion has been helped by much lower oil prices

fac­tors, in­clud­ing how in­fla­tion per­formed over the next year or two, and on eco­nomic growth. He also con­firmed that US in­ter­est rate in­creases would play a role.

The Re­serve Bank said the rand ex­change rate had been rel­a­tively volatile since Septem­ber in re­sponse to mat­ters such as ex­pec­ta­tions around the tim­ing of in­ter­est rate in­creases in the US and Moody’s down­grade of SA’s sov­er­eign credit rat­ing. The mon­e­tary pol­icy com­mit­tee ex­pects in­fla­tion to av­er­age 6.1% this year from an ear­lier pro­jec­tion of 6.2%, 5.3% next year from 5.7%, and 5.5% in 2016 from 5.8% be­fore. In­fla­tion is fore­cast to reach a low of 5.1% in the sec­ond quar­ter of 2015.

Do­mes­tic in­fla­tion has been helped by much lower oil prices. Brent crude oil prices have dropped from about $112/bar­rel in June to four-year lows of around $78/bar­rel. This has helped lower lo­cal fuel prices and eases the pres­sure on in­fla­tion. Lower global food prices have in re­cent months also of­fered support and helped ease do­mes­tic in­fla­tion. But in­di­ca­tions are that this could change, and cou­pled with rand weak­ness could spell dis­as­ter for in­fla­tion in 2015.

The Oc­to­ber UN Food and Agri­cul­ture Or­gan­i­sa­tion’s food price in­dex av­er­aged 192.3 points, which was 0.2% be­low Septem­ber’s fig­ure.

What raises con­cern, how­ever, is that the ce­real price in­dex showed that in­ter­na­tional prices of wheat and coarse grains firmed slightly in Oc­to­ber after five months of steep falls, owing mainly to maize har­vest de­lays in the US and de­te­ri­o­rat­ing wheat prospects in Aus­tralia.

The in­dex mea­sur­ing meat prices fell 2.3 points to av­er­age 208.9 points in Oc­to­ber, although more data showed that quotes for most types of meat were still at his­toric highs.

Rates need to rise to keep in­vestors in­ter­ested in SA’s yield ad­van­tage when US in­ter­est rates start to in­crease — some­thing that is ex­pected to hap­pen in the sec­ond half of 2015, if not ear­lier.

SA re­mains be­hind the curve com­pared with its peers re­gard­ing its in­ter­est rates, which are slightly higher in coun­tries like Brazil and Turkey.

This puts SA at risk of los­ing out on in­vest­ments, be­cause in­vestors are in the business of

chas­ing yield. If the rate of re­turn on in­vest­ment is higher in Brazil than in SA, that is where in­vestors will invest.

Brazil’s cen­tral bank raised the Selic bench­mark in­ter­est rate to 11.25% in Oc­to­ber from 11% to “en­sure, at a lower cost, the preva­lence of a more be­nign out­look for in­fla­tion in 2015 and 2016”. This 25 ba­sis points rate in­crease was the fourth in 2014 and was fo­cused on ad­dress­ing high in­fla­tion. In­fla­tion in twelve months reached 6.75% in Septem­ber, com­pared with 5.86% in Septem­ber 2013. The cen­tral bank of Turkey left its bench­mark one-week repo rate steady at 8.25% in Novem­ber de­spite high in­fla­tion and a weak lira.

Citibank econ­o­mists said that de­spite the chal­leng­ing ex­ter­nal and do­mes­tic back­drop in Turkey, that coun­try’s cen­tral bank was likely to main­tain “its op­por­tunis­tic ap­proach” in the con­duct of mon­e­tary pol­icy. This, they said, boiled down to the cen­tral bank tight­en­ing its stance and lan­guage when the lira came un­der pres­sure and mar­kets be­came “skit­tish”, and re­lax­ing the stance through ei­ther pro­vid­ing more liq­uid­ity or cut­ting rates when the lira and global con­di­tions per­mit­ted.

In­di­ca­tions are that SA will not be the only coun­try that will con­tinue rais­ing in­ter­est rates, even though this will hap­pen in an en­vi­ron­ment where eco­nomic growth is fore­cast to be much bet­ter than it was in 2014.

The South African econ­omy is ex­pected to start grow­ing faster in 2015 although by rates that are still far be­low those needed to ad­dress the coun­try’s chal­lenges of high un­em­ploy­ment and poverty. The Trea­sury ex­pects the econ­omy to grow by 2,5% in 2015, the same fore­cast as the Re­serve Bank’s.

The forecasts are slightly more op­ti­mistic when com­pared with the In­ter­na­tional Mon­e­tary Fund’s 2.3%.

Th­ese growth rates are lower than the more than 5% per year iden­ti­fied in SA’s vi­sion 2030 pol­icy frame­work, the Na­tional De­vel­op­ment Plan.

One of the fac­tors that will lift growth next year is higher global eco­nomic growth, which will boost de­mand for lo­cal ex­ports. An in­crease in ex­port vol­umes, cou­pled with a slow­down in im­port growth given weak do­mes­tic de­mand, would also help nar­row the deficit on the cur­rent ac­count and cause the rand to firm slightly.

Lo­cal de­mand is, how­ever, un­likely to shoot the lights out given that con­di­tions for house­holds — whose spend­ing ac­counts for over 60% of lo­cal ex­pen­di­ture — will re­main tough.

In­ter­est rates will con­tinue ris­ing and so will ad­min­is­tered prices, such as wa­ter and elec­tric­ity.

Elec­tric­ity tar­iffs will no longer go up by the 8% the en­ergy reg­u­la­tor ini­tially granted power util­ity Eskom, but by 12.7%. This in­crease is just for those whose elec­tric­ity is sup­plied by Eskom. Mu­nic­i­pal­i­ties are likely to charge more.

Eskom’s abil­ity to bring a unit at the Medupi power plant, which is un­der con­struc­tion, into op­er­a­tion, will also have an ef­fect.

Power sup­ply con­straints have weighed on business con­fi­dence and have been high­lighted by rat­ing agen­cies as a de­ter­rent to eco­nomic growth.

In­ter­est rates will con­tinue ris­ing and so will ad­min­is­tered prices such as wa­ter and elec­tric­ity

Eskom said re­cently it was “work­ing around the clock” to de­liver Medupi’s unit 6 by the end of this year.

If Eskom in­deed de­liv­ers on time, this will pave the way for com­pa­nies to pro­duce, em­ploy more peo­ple and con­trib­ute to higher eco­nomic growth.

Po­ten­tially more growth-dam­ag­ing are strikes, which cost the econ­omy bil­lions of rand in lost rev­enue and sub­dued out­put.

Rea­sons for the grow­ing im­pa­tience among work­ers and their de­mands for steep wage in­creases in­clude the ris­ing costs of liv­ing and un­der-pres­sure dis­pos­able in­comes.

Unions rep­re­sent­ing pub­lic sec­tor work­ers are go­ing back to the ne­go­ti­at­ing ta­ble as their cur­rent wage agree­ment will ex­pire in March next year.

Some unions have al­ready in­di­cated they in­tend to start ne­go­ti­a­tions at 15%, while the gov­ern­ment has hinted at sin­gle-digit wage in­creases, prefer­ably in line with in­fla­tion or 1% above it.

Gov­ern­ment fi­nances are un­der pres­sure and the state is al­ready try­ing to cut costs, which is an in­di­ca­tion that dou­ble-digit in­creases are un­likely.

The Re­serve Bank has al­ready warned that wage in­creases well in ex­cess of in­fla­tion would be un­de­sir­able as they pose a risk to in­fla­tion.

A strike by pub­lic ser­vants, even one last­ing a month, will be eco­nom­i­cally dam­ag­ing. It will re­quire a lot of un­der­stand­ing on the part of pub­lic ser­vants to put SA Inc first.

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