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The gray areas of the interest rate environment

11 June 2007 Gareth Stokes

Statistics are full of surprises. Nowhere is this more evident than in the recent release of South African retail trade data for the first quarter of 2007.

Despite numerous adverse economic developments and expectations to the contrary, these numbers showed an improvement of 10.1% on the same period last year.

Local consumers endured two interest rate hikes at the end of 2006. The expectation was that these increases would have cooled inflation through direct pressure on consumer spending. But economics is not like physics And the demonstration of Newton's "for every action there is an equal and opposite reaction" law is not immediately obvious. The impact of rate hikes on consumers only trickles down to the economy six months later.

Six months on, it appears the first round of rate hikes have had little effect. The Reserve Bank's attempts to cool inflation were in vain and CPI breached the bank's 6% upper level in May this year. Reserve Bank governor Tito Mboweni had no choice but to raise rates by a half percent more.

Why interest rates will fail to crush consumer spending

We are surprised that so few of the economic analysts comment on the dominance of cash in the South African retail environment. Interest rate hikes will not impact heavily on domestic retail sales (particularly the non-durable goods category) for the simple reason that those most affected by interest rate hikes are not driving the current retail boom.

Heavily indebted South African families making hire purchase payments on two motor vehicles and mortgage payments on a million rand house have been replaced as the driving force in the domestic economy. The new stars are members of the emerging market. These economically liberated individuals do not suffer from the massive credit hangover associated with massive capital borrowing. And as millions of these previously disadvantaged negotiate the journey from being have-nots to haves, the retail sector will continue to flourish.

The emerging market now accounts for the majority of food and clothing sales. In much the same way, the market for cars, appliances, furniture and other durables is also driven by this non-traditional section of the economy. It can also be argued that the consumer market for durable goods is less sensitive to interest rate hikes due to the nature of the financial contracts concluded in their sale. Sales people in furniture shops and motor vehicle outlets can play with large interest rate margins when structuring sales agreements.

More than simple economics behind lower than expected car sales

Another indicator of local retail strength is new vehicle sales data. This number, according to the economic analysts, showed negative growth to May this year. What worries us is that no mention has been made of the impact of the eNatis traffic system on new vehicle registrations. Can we really place much reliance on numbers which could have been severely tainted by a countrywide system breakdown?

There could be hundreds of new vehicles sales which are not reflected in industry numbers due to Department of Transport incompetence. The truth is that commercial vehicles have hardly showed a hiccup since the first round of interest rate hikes. The National Association of Automobile Manufacturers in SA (NAAMSA) says that year on year growth in commercial vehicle sales is 15.2% to the end of May 2007. What this indicates is despite recent rate hikes, the local motor vehicle industry remains robust.

New vehicle sales are another traditional measure of the impact of interest rate hikes on the consumer; but as indicated here, care should be taken to ensure that changes in the number are not caused by non-interest events.

Food and fuel price inflation will bring the house down

Major inflation concerns stem from spiralling fuel and food prices. Unfortunately, the Reserve Bank has no control over either. Reducing consumer's disposable income is unlikely to put a dent in food and transport costs. Instead, higher food and transport costs will continue to hit the poor hard, and result in private sector wage demands in coming months that echo those of public workers', who are striking for 10%.

For the many reasons mentioned above, the consumer is less affected by tighter monetary conditions than previously thought. Perhaps it is time for the central bank to consider other inflation busting methods.

Early indications are that other inflationary pressures (such as rising employment and tax concessions) have dampened the impact of the first series of rate cuts. If the latest half percent hike fails, we can expect a more severe response from the bank in the next few Monetary Policy Committee meetings. And that's when the consumer is likely to feel the punch!

Editor's thoughts:
The most recent 50 basis point hike in interest rates came as no surprise. The reality is each rate hike means thousands of rand less in disposable cash for South African consumers. How many more rate hikes do you believe the local consumer can stomach? Send your comments to
gareth@fanews.co.za

 

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