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SA consumers brace for a lengthy battle with rising prices and interest rate hikes

06 May 2022 Gareth Stokes

It did not take long for South African consumers to join the US and other Western economies in the consumer price inflation doldrums, with the latest forecast from ratings agency Moody’s predicting that local inflation will hit 8% in 2022. This is the latest hint that inflation could move far outside the South African Reserve Bank (SARB) 3-6% target range, though many of our readers would argue that typical goods and services purchased by mid-income households are already inflating at a higher rate than reported.

The corrosive effect of inflation

This writer turned to Google for a quick refresher on the layperson’s definition of inflation and was quite pleased with the Wikipedia.org entry, which reads: “In economics, inflation is a general increase in prices of goods and services in an economy; when the general price level rises, each unit of currency buys fewer goods and services, [with the result that] inflation corresponds to a reduction in the purchasing power of money”. Effectively, in an 8% inflation environment, the loaf of bread that cost you R10.00 in May 2021 will cost you R10.80 a year later, in May 2022. 

This worsening in the domestic inflation outlook coincides with various global developments that are outside of the SARB’s control. Moody’s mentions the rather obvious Russia-Ukraine conflict alongside rising interest rates in the United States (US) as primary drivers of the upward trend, but one cannot ignore the myriad supply side constraints that remain under the pandemic context. Remember, while much of the West is ‘business as usual’ insofar post-pandemic operations, much of China remains in strict lockdown as that country adheres steadfastly to its zero Covid-19 infections pipedream. Incidentally, US inflation accelerated to 8.5% in March this year, the highest on record since December of 1981. South Africa, you are not alone! 

Eskom gets another (sic) accolade

According to Moody’s “inflation is set to be higher than the SARB 3-6% target range [for much of] this year, before falling in 2023 and 2024. And that means the central bank will have to stay in a monetary policy tightening frame of mind, repeatedly firing its weapon of choice: interest rate hikes. South Africans have already seen three quarter-percent hikes following Monetary Policy Committee decisions in November 2021 and January and March of this year. 

The ratings agency singled out Eskom as a major drag on the domestic economy, observing that “the electricity sector poses the greatest risks to economic growth prospects, with generation capacity already insufficient to cover the economy’s needs”. Multi-year above-inflation price hikes pushed through by the state-owned electricity producer combined with its inability to provide a consistent electricity supply are weighing heavily on businesses and consumers alike. 

In fact, Eskom is undoubtedly contributing to South Africa’s surging producers price index (PPI). In a recent economic update, Alexander Forbes said PPI rose to 11.9% year-on-year March 2022. “This is the highest producers inflation since comparable records began in 2013,” the wrote. The reason, dear reader, and brace yourself for this, is that rising commodity and energy prices are pushing a range of product classes through the roof. 

Price rises across the board

Rising input costs are putting upward pressure on the prices of coal-, petroleum-, chemical-, rubber- and plastic- based products; food, beverages and tobacco products; and metals, machinery, equipment and computing equipment to name a few. “Inflation risks remain on the upside, including the new Covid-19 infections in China which will further disrupt already existing supply bottlenecks, while the ongoing war in Ukraine continues to keep commodity prices high,” noted Alexander Forbes, as it reflected on the 11th consecutive monthly rise in PPI. 

Kudos to the financial services giant for getting through nine pages of economic insight without mentioning Eskom. Perhaps they now accept Eskom as part of the new normal business environment? That said, there is little doubt that the promised 35 days of managed (sic) power cuts this winter will add cost pressures to every South African business and household. As interest rates go up, and the price of goods and service creep ever higher, Jane and Joe Average will have to adjust their budgets for shrinking disposable income. Each household will end up spending more of its monthly take-home income on essentials rather than nice-to-haves. 

Can advisers and asset managers navigate this mess?

Inflation impacts individual investors, savers and salary earners differently depending on where in the financial planning lifecycle they sit. Salary earners will probably find it tough going through the first part of a rising inflation cycle because they usually have to wait a year before their employers considers adjusting salaries. Investors, and to some degree savers who are still years away from retirement, are less affected because they can rely on asset and fund managers to make strategic changes to the asset allocations in their portfolios to ensure the best possible return through the inflation cycle. 

Writing in an article titled ‘Which asset classes perform better when inflation is high?’ published on US-based RussellInvestments.com, Amneet Singh observed that inflation is not good for financial assets: full stop. “While skilled investors can achieve reasonable returns in such environments, in almost all instances, strong real returns are off the table,” he wrote, adding that certain asset classes do tend to perform better than others on a relative basis. 

Getting your asset allocation right will depend on the growth outlook in the financial market you invest in. Many local asset managers are moving from growth to value shares at the moment, but the reality is that South Africa’s low growth / high inflation environment will make it tough to generate stellar returns from local equities… That said investors may find some solace in commodity shares; goods manufacturers, retailers and other service providers that can push inflation-linked increases on to their consumers; and selected value plays. The high growth / high inflation scenario in the US and United Kingdom (UK) is more enabling for equity returns and could play into the hands of local investors with higher offshore exposures. 

High inflation is bad for bonds

As for the other asset classes, cash and bonds are not great for riding out the inflation storm, per this useful explainer lifted from a years-old Schroders blog: “High inflation is bad for bonds. As prices rise, the spending power of the bond owner’s income reduces, affecting the bond’s. Higher inflation is normally accompanied with higher central bank rates, which leads to increased rates on newly issued bonds”. Local investors have a bit of an edge over investors in the US and UK because they can still eke out real yields from cash and bonds even with inflation nearing 8%; for those in the West, real yields will move deep into the red. 

Of greater concern in the South African context is what happens when rising prices are mixed in with the country’s complex socioeconomic challenges. “At present, escalating joblessness is combining with elevated consumer price inflation to heighten social stability risks,” said PwC in its SA Economic Outlook April 2022. “Both unemployment and inflation are higher at present compared to the levels seen during the July 2021 unrest”. This is one of many reports that has recently hinted that our beautiful country could see a repeat of the widespread looting and rioting that caused an estimated R50 million in economic losses last year. 

The riot nobody wants

This is a scenario that our state-owned special risks insurer has already said it would struggle to respond to. Towards end-April 2022 various newsfeeds reported the insurer as saying it would be unable to cover business losses following a riot of similar scale to the 2021 event. Sasria SOC Limited is reportedly struggling to place its risk exposures on the insurance market and is facing up to 1000-fold increases in premiums following a record R37 billion in claims paid to affected businesses in areas of KwaZulu-Natal and Gauteng. We will hold thumbs such event does not repeat because it will be devastating to businesses and individuals across South Africa.

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