Africa Weekly Review: Inflation and the targeting debate in South Africa.

South Africa: Monetary policy and the broader direction

Inflation accelerated to 13.0 percent in July, the highest since the introduction of the CPIX measure ten years ago and above the market consensus for the month of 12.9 per cent. Bond yields immediately narrowed in the belief that inflation is close to peaking and that monetary tightening has come to an end in the present cycle. This buying of bonds anticipates a series of rate cuts by the monetary policy committee (MPC).

One-off boost from the new index

The MPC left its policy (repo) rate unchanged at 12 per cent at its last meeting on August 14. The central forecast of the South African Reserve Bank (SARB) underpins the buying of bonds: it has been revised to show a new peak of around 13 per cent in the third quarter of 2008 before significant declines in the first quarter of 2009. The new forecast reflects the rise in Eskom’s electricity tariff approved by the regulator, and the likely impact of the reweighting and rebasing of the inflation index from January 2009. The new tariff has pushed up near-term inflation in the forecast, while the new index should bring a one-off reduction in the underlying rate of between one and two percentage points.

Drivers of South African inflation 2008 (per cent yoy)

Our chart shows the components of the headline index which have contributed most to the rise in inflation in the past eleven months. Three are global factors, and the fourth (fuel and power) is largely domestic. The retail petrol price is adjusted monthly according to a set formula. In July the price was increased by ZAR0.95 per litre, as shown clearly in the chart under vehicle running costs, and in August it was reduced by ZAR0.30 per litre. The global factors cannot be influenced by monetary policy, while Eskom is looking for additional annual tariff rises for 2009-11. Other African central banks (such as Nigeria’s) have put their rates on hold. For the MPC, the expectation is that the gradual easing of demand pressures would more than offset the inflationary impact of another spike in food and fuel prices.

While inflation is close to peaking, the debate on broader economic policy becomes livelier. Both Jacob Zuma, who is set to become the next president of the republic in 2009 provided that he overcomes his legal difficulties, and Gwede Mantashe, the secretary general of the African National Congress (ANC), are adamant that there will be no radical changes in economic direction (see our inaugural Weekly Review dated 18 July).

A new call to drop inflation targeting

Those who enabled Zuma to assume the leadership of the ANC feel that they should be rewarded. The latest call for marked changes has come from Zwelinzima Vavi, the leader of the trades union umbrella group Cosatu. Vavi maintains that he is alert to business sentiment and possible pressure on the rand, which is already vulnerable due to the large deficit on the current account. At the same time, he would like to dispense with both inflation targeting and the National Treasury’s fiscal surplus. He will not be the last to call for radical changes. Our view remains that the Zuma/Mantashe direction will prevail.

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With best regards,

Gregory Kronsten
Director, Africa Research
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