Burgeoning services sector may add to SA's inflation woes

There is a need for SA's monetary policy regime to accommodate the burgeoning domestic services sector and address the possible underestimated price changes coming from this industry, says Ridle Markus, Absa Group senior economist.

"Services inflation has been running ahead of goods inflation for a few months already and there is also a possibility that it is being underestimated given the strong growth in the sector."

Since 1980, goods inflation has on average risen by 10,6 % per annum, while services inflation averaged 9,6% per annum. In the past six years since 2000, the trend continued, with goods inflation and services inflation averaging 4,2% per annum and 3, 8% respectively.

However, in October 2006, services inflation rose above goods inflation when it increased by 5,8% year-on year compared with 5% for goods inflation. The latter trend has continued with services inflation at  7,6% year-on-year in May 2007, compared to the 6,6% rise in goods inflation in the same period.

Markus attributes the change in this trend on factors including:

* Rise in household income levels.

* Changes in households' lifestyles, tastes and preferences.

* The 'untradability' of services.

The local services industry is the fastest growing sector in the economy, accounting for more than 66% of Gross Domestic Product (GDP) in 2006.

Markus points out that the domestic economy is shifting from a reliance on commodity production and industrialisation to a more service-oriented economy.

"The rapid development of information technology, the increased level of sophistication of consumers, rising per capita incomes and the increased demand for services have been driving this shift."

This sector has become an important employer and attracts large amounts of foreign direct investment.

Markus predicts that the trend of services inflation exceeding goods inflation is likely to continue unabated in the foreseeable future.

"As interest rates increase, the pressure on services inflation will increase as well. As a result, service inflation will run ahead of goods inflation over the next few quarters. Moreover, goods inflation will continue to be driven by higher petrol prices, although base effects will see a drop - off in inflation in the third, and early in the fourth quarter of 2007." 

Markus proposes policy changes in order to enable the domestic economy to reap the benefits of the burgeoning services sector. 

"Policy changes could help strengthen the capacity of the country to adjust to and embrace globalisation in services, which will aid the creation of jobs, improve productivity and lead to higher incomes.

"In a recent report, the Organisation for Economic Co-operation and Development (OECD) stated that a more productive services sector also underpins the better performance of other sectors, notably the manufacturing sector, because this is increasingly relying on support and inputs from efficient and cost-effective producer services."