KYLE WALES: MPC’s growth-barring inflation policy bucks global trend

The SA Reserve Bank’s mandate focuses on protecting the value of the currency in the interest of balanced and sustainable economic growth, and maintaining financial stability. This has been interpreted to mean keeping inflation within a 3%-6% band.

This relatively narrow mandate places it at odds with other central banks worldwide. Most notable among these is the US Federal Reserve, which has a dual mandate of maintaining price stability (keeping inflation low) and keeping the economy at full employment.

The Reserve Bank’s narrow mandate is more orthodox than many of its peers. While this has earned it credibility among inflation hawks, it has come with unpalatable growth trade-offs, given the country’s slow growth trajectory.

There are the following types of inflation:

• Cost-push inflation, in which aggregate demand remains the same but aggregate supply decreases due to external factors that cause a rise in price levels.
• Demand-pull inflation, in which aggregate demand becomes greater than aggregate supply.  

Clearly the world has recently seen much inflation due to cost-push factors. Supply chain constraints due to the world emerging from the pandemic have driven prices higher. Disruptions caused to global commodities markets by the Russia-Ukraine crisis are further worsening the problem.

The oil price has jumped to $110 per barrel. This not only pushes up the cost of transport for SA consumers but has an impact on other items in the consumer price index (CPI) basket as well. The increase in the wheat price has also played a role, as Ukraine and Russia account for 30% of global wheat exports between them.

Predictably, due to these and other factors, SA’s consumer inflation stood at 5.7% year on year when it was last reported (just below its 6% upper bound), and the monetary policy committee raised the repo rate by 25 basis points on March 24.

Excess capacity

However, unlike the US, where we are seeing visible signs of overheating, SA sits atop a number of deflationary forces, which makes the risk of demand-pull inflation almost zero. Using monetary policy tools to tame cost-push inflation is unlikely to succeed without inflicting harm to SA’s economy.

The first of these deflationary forces is SA’s negative output gap. Many economies are larger than they were before Covid-19. The US’ economy, for example, surpassed its prepandemic size in 2021. The same cannot be said for SA. According to the IMF, at the end of 2021 our economy was still 2% smaller than it was at end-2019. The SA economy thus sits with excess capacity, which is deflationary because economic actors typically try to reduce prices as a mechanism to clear this excess.

The second deflationary force is the increase in the prices of the cost-push factors such as oil and wheat themselves. Similar to an increase in interest rates, they serve to withdraw liquidity from the economy. Interest rates withdraw liquidity from the economy by raising the cost of servicing debt. This in turn reduces aggregate demand.

Increasing the price of items such as oil and wheat also withdraws liquidity from the economy but does so by increasing the price of the typical South African’s consumption basket, leaving them with less money to spend on other discretionary items. Why is it necessary for the MPC to withdraw additional liquidity from the economy in addition to this?

Short-sighted

If the problem is viewed from a cost-push perspective, we are also left scratching our heads. It is impossible for an economy that accounts for a mere 0.6% of global GDP to bring the oil and wheat markets to balance globally. Only a resolution of the Ukraine crisis will be able to do this, and the role SA can play to hasten this will be minimal.

Perhaps the MPC is hoping that an increase in interest rates supports the rand, but this too is short-sighted. Current high commodity prices should provide their own support to the rand and, should they fall, much inflationary pressure will be removed.

While the MPC may be doing the things its narrow mandate requires it to do, it is coming at a substantial cost to the economy in terms of economic growth. If the MPC continues to approach monetary policy as it now does, it will only add a further obstacle to SA’s economy exiting its low-growth paradigm, and further impair the country’s attractiveness as an investment destination.

The discussion about monetary policy has to evolve from “high inflation, therefore higher rates” to conceding that monetary policy is a multivariable problem in which inflation is only one of the factors that should be considered.  

• Wales is global portfolio manager at Flagship Asset Management.