The unchecked rise in government-administered prices and the diversion of resources to the public sector are threatening the country’s growth, and is calling on the SA Reserve Bank not to raise interest rates in response to these price pressures.
While just about all sell-side analysts and economists expect rate hikes either by the end of 2011 or early 2012 at the latest, we believe it would be a mistake to raise rates into an economy that clearly does not suffer from excess demand.
Sessions points out that in past years, administered price inflation – as determined by government rather than regular market forces - has run well ahead of the average inflation rate, echoing comments reportedly made by Reserve Bank governor Gill Marcus in March, when she said that administered prices remained a concern and one of the challenges for the New Growth Path to address.
Data from StatsSA show a significant difference in increases between prices set by government for services - such as for water, sanitation, electricity, vehicle licensing and registration, education fees and communications tariffs - and those determined by market forces. Between January 2002 and the end of March 2011, the measured price level rose from R100 to R150, whereas that of administered prices rose from R100 to R205, which represents an annual average inflation rate of 8.2%.
This means that consumers are spending more on goods and services supplied by the public sector, and less on goods and services produced by the private sector.
The continued upward trajectory of prices charged by the public sector means that an increasing share of the private sector wallet is being diverted to less efficient and unproductive sectors of the economy, and that such price increases should not be viewed as inflation, but rather as “the increased taxation of productive resources”.
To us, this reveals an increasing ineffectiveness on the part of government to deliver on its promise to reduce the cost of doing business in South Africa. The continued taxation of the economy in this way reduces the return to capital invested. This, in turn, undermines the ability of the economy to grow.
To raise interest rates to curb administered price inflation would be a mistake.
The Reserve Bank can only affect domestic demand and, consequently, prices that are subject to domestic market forces. Higher interest rates will do little to curb inflation, but it will slow recovery.
The view of BoE Private Clients on the mooted rates hikes was increasingly becoming a minority opinion: However we stand by our assessment that raising rates would be a mistake.
Without significant currency weakness, we remain more optimistic than the market about the likely inflation trajectory, and therefore do not expect rates hikes for 2011.