Impact of GDP and Inflation in South Africa

1. Introduction
It should by now be well-known that the mission of the South African Reserve
Bank is to achieve and maintain stable financial conditions in our country. This
objective is spelled out in both the Constitution of the Republic and in the South
African Reserve Bank Act. In these acts it is recognized that only by protecting the
value of the currency can balanced and sustainable economic growth be achieved.
It is believed in the Bank, and indeed in most countries of the world, that the
potential for economic growth and creating job opportunities can only be fulfilled
under stable financial conditions.
By achieving this primary objective the Reserve Bank will make its contribution to
sustainable higher economic growth in South Africa.
Some economists and other commentators on monetary policy in South Africa
seem to think that the Reserve Bank is applying an over-zealous monetary policy
stance to achieve its primary objective of price stability. They argue that the Bank
is obsessed with inflation at the expense of economic growth and job creation. At
the current level of the inflation rate, this implies that an inflation rate of 8% is too
low to be treated as a serious concern. The Bank should therefore provide more
liquidity to the money market, allow the interest rate on repurchase transactions to
fall and in this way encourage the economy to grow more rapidly. In the Bank we
believe that it would be a big mistake to shift the goal of monetary policy away
from controlling inflation to promoting economic growth.
2. The determinants of economic growth
Economic growth is basically determined by three factors, namely:
(i) The quantity of capital and labor available in a country;
(ii) The quality of capital and labor; and
(iii) The ingenuity of people in combining the available production resources in the
creation of goods and services.
Output will rise if more production resources are put to work, or where a given
supply of labor and capital is utilized more productively. Nowhere does the
aggregate stock of money or the aggregate price level form part of the determinants
of any production model for sustained long-term economic growth.
Government policies, including monetary policy, affect the growth of domestic
output to the extent that they affect the quantity and productivity of capital and
labor. For example, government policies that restrict commercial activities for fear
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that these activities may cause undue environmental or ecological damage raise the
cost of doing business and make firms less productive. Obviously there may be
good reasons to have such policies, but they can harm productive activity and
economic growth.
Monetary policy is only one element of overall macroeconomic policy, and can
only affect the production process through its impact on interest rates. There are
two main channels of monetary policy. One is through the effect that interest rate
changes have on the exchange rate of a currency, and the other is through the effect
that interest rate changes have on demand. Therefore monetary policy has an
impact on economic activity and growth through the workings of foreign and
domestic markets for goods and services.
Economic growth involves the allocation of production factors to productive use
and this allocation of resources takes place in markets. In a modern economic
system, markets for goods and services, and for production factors, function more
efficiently because of the existence of money as a medium of exchange. Without
such a medium of exchange, barter trade would take place and most modern
market arrangements would simply cease to exist. Money allows markets to
allocate economic resources to sectors of economic activity in a highly efficient
and cost-effective way.
In a market economy, exchange values are expressed in terms of money prices
which are determined by the forces of supply and demand. When a good or service
is in short supply, or when demand increases relative to the supply of a good or
service, the price will rise. This signals to suppliers that they must shift resources
in response to the change in relative prices, or to buyers that they must economies
on their purchases. The productive allocation of resources needs clear signals about
relative price changes.
This is where monetary policy really comes into the picture. Sound monetary
policy makes price signals clearer. In an environment of overall price stability, it is
much easier to detect changes in relative prices. Bad monetary policy clouds the
picture. When prices are always in a state of flux, it is hard to make out whether a
particular price change is signaling a change in relative scarcity or whether it is
simply part of an inflationary process where all prices keep on rising.
The uncertainties that inflation creates make the problem worse. The mere
possibility of inflation creates uncertainty about the true meaning of changes in the
prices of individual goods and services.
This uncertainty could lead to the misallocation of resources, which would reduce
economic growth.
This problem is nowhere more serious than in the capital market. Inflation
uncertainty raises the risk premium that investors require and increases the cost of
capital, thus lowering fixed capital formation.
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Lower investment means lower future growth and less future income.
If producers and consumers feel confident that the average price level will remain
stable, they can be more certain that price changes indicate true shifts in demand
and supply. Obviously a monetary policy that maintains price stability can improve
the efficient functioning of markets. This promotes the full and productive
employment of resources. As Alan Greenspan once stated, a monetary policy that
prevents inflation from being a factor in the decision making of businesses and
consumers, is a monetary policy that best promotes economic growth.
Empirical evidence shows that high inflation has a negative correlation with
economic growth. In countries where inflation is high, economic growth is
normally low. Many economists are therefore convinced that inflation is
undesirable and should be avoided at all costs. Recent economic research has cast
some doubt on this argument. In principle, there is likely to be a reversal
somewhere in the inverse relationship between inflation and growth as there are no
grounds for believing that continuously declining prices, i.e. deflation, are good for
growth.
Stanley Fischer of the International Monetary Fund (IMF) found that the inverse
relationship would hold, even at low rates of inflation. Another study by Barro
confirmed this inverse relationship, but found that it was relatively weak.
Increasing inflation by 1% led to only a small reduction of less than 0.03% in
growth, according to Barro. A range of other studies found no effects from
inflation on growth. Sarel, a researcher at the IMF, came to the conclusion that:
When inflation is low, it has no significant negative effect on economic growth:
the effect may even be positive. But when inflation is high, it has a powerful
negative effect on growth. The structural break is estimated to occur where the
average annual rate of inflation is 8%.
Despite this uncertainty about the negative correlation between inflation and
growth at inflation rates below 8%, there is still no evidence of a positive
correlation between inflation and growth over any long period of time. In any case,
if the inflation rate is close to 8%, it still seems wise to follow a policy countering
a general increase in prices, because it could easily move to levels above 8% and
accelerate further
In South Africa the 1970s were a decade of high inflation compared with the
1960s. Inflation had averaged 2.6% per year between 1960 and 1970. In 1974
inflation moved to higher than 10% and averaged 10.2% per year from 1970 to
1980. If inflation was good for growth, one would have expected faster growth in
the 1970s than in the 1960s. This did not happen. Quite the contrary happened.
Economic growth slowed down from 5.7% per year in the 1960s to 3.4% in the
1970s.
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There were broadly similar slowdowns in growth and accelerations in inflation in

other parts of the world during the 1970s. In the 1980s inflation in South Africa
accelerated to 14.6% per year, and growth fell back further to 1.5%. By contrast,
most of the advanced countries brought inflation under control and their economic
performance generally started to improve. A striking example is the United
States, which now seems to be cruising along a path of strong and sustained
economic growth with low inflation. In South Africa inflation slowed down to
about 7% between 1993 and 1999. Although there were many other factors
conducive to higher economic growth over this period, it seems to be more than
pure coincidence that the growth in domestic production averaged 2% per year.
3. Other major disadvantages of inflation
Apart from the negative impact that inflation has on growth and wealth creation,
inflation also affects income distribution and worsens inequality in a number of
ways. Inflation can have a direct impact on income distribution where wage
increases are below the inflation rate or where marginal tax rates are not adjusted
to take account of nominal adjustments in wages. Inflation can indirectly also
affect income distribution by slowing output growth and hence job opportunities.
What is more, the rich can invest their surplus income in assets such as real estate
and tradable securities, and in many instances benefit from non-taxed inflationinduced capital gains. The poor are usually not able to do this and may see their
saving at banks being whittled away by high inflation.
A perhaps even more important argument against an artificial stimulation of the
economy through the creation of money, lower interest rates and higher inflation,
is that in a globalised economic environment this may lead to the withdrawal of
foreign capital. If non-residents start expecting depreciation in a countrys
currency, they will probably immediately react by withdrawing the funds that they
have invested in such a country. Foreign investors can do this easily now that
world financial markets are better integrated. If large amounts of capital are
withdrawn this could even lead to an exchange rate crisis with a sharp rise in
inflation.
Inflation has many other disadvantages which, all in all, can only lead to the
conclusion that the central bank must always carefully monitor economic
developments to maintain price and financial stability. No country can afford to
move out of line with the inflation rates in the rest of the world.
Economic co-operation, regional integration and trade
South Africa is a member of various regional and sub-regional groupings including
the Common Monetary Area, Southern African Customs Union, Southern African
Development Community (SADC), and the African Union. South Africa
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dominates the region economically, accounting for 41% of all SADC trade and
about 63% of its combined GDP. It is also a member of BRICS (Brazil, Russia,
India, China and South Africa), an association of five fast-growing and emerging
economics, which accounts for 25% of global GDP and 40% of global population.
In the first 11 months of 2013, exports rose to the value of ZAR 846 billion over
ZAR 817 billion in 2012 boosted by the rands deterioration (of 15.2% in the 18
months to September 2013), while imports increased to ZAR 921 billion up from
ZAR 852 billion. As a result the trade deficit almost doubled, going from ZAR 40
billion in 2012 to over ZAR 74 billion in 2013. The current account deficit is
estimated to reach 6.5% in 2013, compared to 5.2% in 2012. For the first 11
months of 2013 the top four export commodities were gold, iron ores and
concentrates, coal, and platinum. The primary imports were petroleum, original
equipment components, electrical machinery, equipment, vehicles and accessories.
Emerging markets and the Euro area economies are the key drivers in the demand
for commodities. Foreign direct investment (FDI) revenues increased from ZAR
37.5 billion in 2012 to ZAR 47.4 billion in the third quarter of 2013. The key
recipient sectors included mining, pharmaceuticals, automotive equipment,
financial services and, most recently, renewable energy. Investments originated
from BRICS (China and India in particular), as well as Europe and the United
States. Despite South Africas poor economic performance in recent years, shortterm capital flows also remained strong, reaching ZAR 95 billion in 2012. Aid
remains insignificant, amounting to less than 0.8% of South Africas budget.
Impact of GDP in South Africa
The economy of South Africa is the second largest in Africa, behind Nigeria, it
accounts for 24% of its gross domestic product in terms of purchasing power
parity, and is ranked as an upper-middle income economy by the World Bank; this
makes the country one of only four countries in Africa in this category (the others
being Botswana, Gabon and Mauritius). Since 1996, at the end of over twelve
years of international sanctions, South Africa's Gross Domestic Product has almost
tripled to $400 billion, and foreign exchange reserves have increased from $3
billion to nearly $50 billion; creating a growing and sizable African middle class,
within two decades of establishing democracy and ending apartheid.
According to official estimates, a quarter of the population is
unemployed, According to a 2013 Goldman Sachs report, that number increases to
35% when including people who have given up looking for work. A quarter of
South Africans live on less than US $1.25 a day.
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South Africa has a comparative advantage in the production

of agriculture, mining and manufacturing products relating to these sectors. South
Africa has shifted from a primary and secondary economy in the mid-twentieth
century to an economy driven primarily by the tertiary sector in the present day
which accounts for an estimated 65% of GDP or $230 billion in nominal GDP
terms. The country's economy is reasonably diversified with key economic sectors
including mining, agriculture and fisheries, vehicle manufacturing and assembly,
food processing, clothing and textiles, telecommunication, energy, financial and
business services, real estate, tourism, transportation, and wholesale and retail
trade.
The unemployment rate is very high, at more than 25%, and the poor have limited
access to economic opportunities and basic services. Poverty also remains a major
problem. In 2002, according to one estimate, 62% of Black Africans, 29% of
Coloreds, 11% of Asians, and 4% of Whites lived in poverty.
The high levels of unemployment and inequality are considered by the government
and most South Africans to be the most salient economic problems facing the
country. These issues, and others linked to them such as crime, have in turn hurt
investment and growth, consequently having a negative feedback effect on
employment. Crime is considered a major or very severe constraint on investment
by 30% of enterprises in South Africa, putting crime among the four most
frequently mentioned constraints.
South Africa, unlike other emerging markets, has struggled through the late 2000s
recession, and the recovery has been largely led by private and public consumption
growth, while export volumes and private investment have yet to fully
recover. The long-term potential growth rate of South Africa under the current
policy environment has been estimated at 3.5%.Per capita GDP growth has proved
mediocre, though improving, growing by 1.6% a year from 1994 to 2009, and by
2.2% over the 200009 decade, compared to world growth of 3.1% over the same
period.
Impact of Inflation on South African economy
When we talk about the rate of inflation in South Africa, this often refers to the rate
of inflation based on the consumer price index, or CPI for short. The South African
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CPI shows the change in prices of a standard package of goods and services which
South African households purchase for consumption. In order to measure inflation,
an assessment is made of how much the CPI has risen in percentage terms over a
given period compared to the CPI in a preceding period. If prices have fallen this is
called deflation (negative inflation).
IF, as many consumers have long suspected, general price inflation is running at
closer to 8, 5% than the official consumer price index (CPI) rate of 5, 8%, it
changes our assumptions about everything.
And what if this has been going on for 13 years and is likely to continue as we
head into 2014?
New research from ETM Analytics in Johannesburg suggests that is exactly what
is happening. Chris Becker, an economist with the firm, says the understatement of
consumer inflation has serious implications for all South Africans.
"Worst affected are the poor because they have less capacity to absorb price
increases. It also means CPI-linked wage increases are leaving people worse off
with each passing year because these increases do not measure the actual cost-ofliving increases for the poor," he says.
"Our research suggests that high inflation as a result of monetary expansion by the
banking system increases social tension. It is interesting to note that prior to the
2012 Marikina massacre, when dozens of striking miners were shot dead, inflation
had spiked. The same is true of the xenophobic attacks five years ago - just prior to
this, inflation jumped sharply. Unless the Reserve Bank starts to rein in its loose
monetary policy, we can predict more social tension going into 2014."
Research does suggest South Africans have been losing purchasing power far
faster than they imagined. This will also come as a shock to investors seeking
above-inflation returns. In order to keep ahead of inflation, they need to be making
at least 8, 3%/year on their investments. Perhaps more alarming, it means we may
be overstating our already meager economic growth rate.

SA in 2014: Economic outlook & CPI

The CPI measures 70000 prices on a monthly basis and is currently running at an
annualized rate of increase of 6, 3%. The authors of the research say this is closer
to what the wealthiest 20% of the country experience in terms of price increases,
but is less reflective of the rate of inflation being experienced by the poor.
To get a better grasp of actual inflation experienced by ordinary South Africans,
the authors devised an index that measures not just consumer prices but asset
prices, raw commodities, producer inflation and foreign currency exchange rates.
The alternative price index (API), as it is called, shows inflation running at an
annualized 8, 3% since 2000. If this provides a more accurate measure of the rate
of inflation experienced by most South Africans, it means we have lost more than a
quarter more purchasing power in the past 13 years than is suggested by the CPI
measure.
This starts to make sense when you consider that SA has been expanding its M3
money supply at rates in excess of 15% for the past five years, while the narrower
M2 money supply figure is expanding at close to 10%. Where is all this extra
money going? It is not showing up in the official CPI figures.
Newly created money filters unevenly into the economy, something that is known
as the Canutillo effect. The first recipients of the newly created money are
government and wealthy individuals, who get to spend it before the inflationary
effects filter down to the ordinary consumer.
This is the basis of the claim that inflation is a disguised tax. It explains why the
stock market has risen so strongly over the past 18 months. Much of this new
money tends to float around in search of higher-yielding assets, and has been
blamed for causing a string of bubbles, from real estate to the stock market. Once
these bubble assets have been sold, the money enters the consumer economy,
causing consumer prices to rise.
The authors of the research argue that the CPI understates the actual rate of
consumer inflation for two reasons:

It does not measure "stealth-flatiron", whereby consumers are paying the same
prices for lower-quality products. Producers will reduce the quality of inputs to
maintain margins, which is a disguised form of inflation; and
Consumers stop buying products because they have become more expensive than
others, something the CPI does not measure. These items are given a lower
weighting in the basket of goods measured for inflationary purposes, but there is an
argument that they are still important to the consumer and shouldn't be downweighted.
Stats SA uses the inflation methodology outlined by the International Labour
Organization, even though this methodology has been criticised for being
inappropriate for lower- to middle-income countries with high wealth disparities.
The authors say the difference between CPI and API is significant for several
reasons.
It means the intuition many feel about CPI being a misleading indicator of price
increases is correct. It does not reflect the impact of asset prices, raw material costs
and the exchange rate on the cost of travelling to other countries - something many
people would like to, or aspire to do. It also means producers are facing "margin
compression" as a consequence of low business confidence, which is, in turn,
bearish for job creation.
"This exposes another point: the possibility that the gross domestic product
deflator has been underestimated, and therefore real economic growth has
been overestimated," says ETM.
Seen in this light, Reserve Bank monetary policy has been far too loose over the
past 13 years, and remains so now.
For investors and fund managers, the research makes sobering reading. "If the loss
of purchasing power has been on average 250 basis points higher than commonly
thought since 2000, have fixed money returns been sufficient to protect investors
against real monetary debasement?" ask the authors.
The underreporting of consumer inflation since 2000 indicates we may be
measuring the wrong thing entirely, says ETM Analytics. "There has been a lot
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more price inflation in the SA economy this century than official CPI stats have led
one to believe."
Graph CPI South Africa last year

Graph CPI South Africa long-term

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CPI ZA recent months

Period

Inflation

october 2014

5.910 %

september 2014

5.922 %

august 2014

6.430 %

july 2014

6.551 %

june 2014

6.809 %

may 2014

6.836 %

april 2014

6.232 %

march 2014

6.055 %

february 2014

5.929 %

january 2014

5.783 %

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CPI ZA recent years

Period

Inflation

october 2014

5.910 %

october 2013

5.533 %

october 2012

5.520 %

october 2011

6.201 %

october 2010

3.380 %

october 2009

5.665 %

october 2008

10.599 %

october 2007

6.898 %

october 2006

4.485 %

october 2005

2.394 %

South Africa Inflation Steady at 5.9%

South African annual inflation rate was unchanged at 5.9 percent in October,
staying in the central banks 3 percent to 6 percent target range for a second month
as a slowdown in food prices was enough to offset higher transport cost. On a
monthly basis, consumer prices increased 0.2 percent after being flat in the
previous month. The food and non-alcoholic beverages index increased by 0.2
percent between September 2014 and October 2014. The annual rate decreased to
7.8 percent in October 2014 from 8.5 percent in September. The following
components in the food and non-alcoholic beverages index increased: fruit (1.9
percent), other food (1.5 percent), meat (0.9 percent) and cold beverages (0.7
percent). The following components decreased: oils and fats (-1.1 percent), hot
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beverages (-1.0 percent), vegetables (-0.8 percent), fish (-0.5 percent), bread and
cereals (-0.3 percent), sugar, sweets and desserts (-0.2 percent) and milk, eggs and
cheese (-0.1 percent).
The alcoholic beverages index increased by 1.9 percent between September 2014
and October 2014. The annual rate increased to 6.3 percent in October from 5.3
percent in September 2014. The transport index increased by 0.3 percent on a
monthly basis. The annual rate increased to 4.8 percent in October from 4.2
percent in the previous month.
Northern Cape (5.8 percent), Gauteng (5.8 percent), Eastern Cape (5.7 percent),
Mpumalanga (5.6 percent) and Free State (5.5 percent) recorded lower inflation
rates. The provinces with an annual inflation rate higher than headline inflation
were Limpopo (6.3 percent), KwaZulu-Natal (6.2 percent), North West (6.1
percent) and Western Cape (6.0 percent). The core inflation rate, which excludes
food, non-alcoholic beverages, gasoline and electricity costs, rose to 5.7 percent in
October from 5.6 percent in the previous month.
South Africa Inflation Rate Edges Up to 6.4%
South African annual inflation rate accelerated slightly to 6.4 percent in August
from 6.3 percent in the previous month, driven by higher food prices.
On a monthly basis, consumer prices increased 0.4 percent in August, following a
0.8 percent rise in July. The food and non-alcoholic beverages index increased by
0.8 percent between July and August 2014. The annual rate increased to 9.4
percent in August 2014 from 8.8 percent in July 2014. The following components
in the food and non-alcoholic beverages index increased: hot beverages (2.1
percent), other food (1.7 percent), milk, eggs and cheese (1.5 percent), sugar,
sweets and desserts (1.1 percent), meat (1.0 percent), vegetables (0.7 percent), cold
beverages (0.5 percent), bread and cereals (0.2 percent) and fruit (0.2 percent). The
following component decreased: fish (-0.4 percent). The transport index increased
by 0.4 percent between July 2014 and August 2014. The annual rate decreased to
6.1 percent in August 2014 from 6.9 percent in July 2014.
The provinces with an annual inflation rate lower than or equal to headline
inflation were Western Cape (6.4 percent), Gauteng (6.4 percent), Northern Cape
(6.3 percent) and Free State (6.3 percent). The provinces with an annual inflation
rate higher than headline inflation were North West (6.9 percent), Limpopo (6.9
percent), Eastern Cape (6.7 percent), KwaZulu-Natal (6.7 percent) and
Mpumalanga (6.5 percent).

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