Following the South African Reserve Bank’s (SARB) aggressive near-two-year interest rate hiking cycle, headline inflation in South Africa seems to be getting under control and moving closer towards the inflation target. Does this suggest interest rate cuts could be on the cards? During a recent Allan Gray event, SARB deputy governor, Kuben Naidoo, provided insight into the short- to medium-term risks to and drivers of local economic growth. Thandi Skade, investment writer, summarises Naidoo’s key points.
As central banks around the world continue to battle stubbornly high levels of inflation, particularly among advanced economies, the SARB’s Monetary Policy Committee (MPC) is cautiously optimistic that it is winning the battle to contain inflation. Since the MPC began raising interest rates aggressively in November 2021, headline inflation, which peaked at 9.7% in the third quarter of 2022, has fallen back in line with the target range, slowing to 4.8% year-on-year in August this year.
Naidoo says raising interest rates earlier than most advanced and emerging markets spared South Africans from facing an even larger inflation problem, with data indicating that the country’s inflation rate is lower than 60% of global economies and slightly lower than the emerging market median.
While the battle to tame inflation is far from over, with the last quarter of the year expected to bring more pain, Naidoo says the outlook for 2024 is more positive. Household consumption forecasts for the next three years indicate positive growth in real terms, albeit slightly muted compared to 2022.
Household and business investments in renewable energy solutions have risen steadily over the past two years, accelerating rapidly in the first half of 2023. In fact, Naidoo says energy investments have more than doubled over the past 12 months, exceeding the total number of renewable energy solutions that had been installed in the country up to that point. Over the last 18 months alone, households have spent around R54bn investing in rooftop solar systems. These investments will bring much-needed relief to the electricity grid, providing around four gigawatts of power that translates into two stages of loadshedding if one adjusts for intermittency, or the fact that the sun doesn’t shine at night.
Economic growth to remain subdued
The energy crisis continues to be a major constraint to South Africa’s economic growth prospects. Over the past eight years, the economy has been “running hard but standing still”, growing at around 1% per year. Current projections anticipate weak economic growth of 0.4-0.7% in 2023, driven by several factors, including the rand, which has depreciated by more than most emerging market currencies, a burgeoning budget deficit and food inflation. While the economy is becoming more resilient to the energy crisis, loadshedding remains the biggest obstacle to economic growth. According to SARB estimates, the economy would have grown by around 2.5% this year in real (i.e. inflation-adjusted) terms, if it were not for loadshedding.
Weak property sector growth in China has contributed significantly to the country’s slowing economic growth, which has traditionally driven commodity prices, and is another contributor to SA’s economic stagnation.
From a global perspective, the growth outlook remains muted amid higher and persistent inflation rates.
The inflationary risks
South Africa faces two major inflationary risks over the medium term: climate phenomena and loadshedding.
Weather forecasts for spring project higher-than-normal rainfall, heightening the risk of flash flooding, while forecasts for the summer season project below-average rainfall from October, driven by the El Nino weather phenomenon, which is associated with warmer and drier conditions.
This poses a major risk to food inflation, which has been on the decline in recent months, but is expected to rise again. “Whenever we experience El Nino, food inflation tends to go up by around 10% and we’re expecting food prices to rise again, but not immediately, likely in the next 12-18 months,” Naidoo says.
Inflation is expected to return to the midpoint of the target range (4.5%) by 2025, at which point the MPC may start considering interest rate cuts.