Tito marshals us to higher interest rates

It is rare for private-sector economists and Cosatu to agree on anything. But, they have jointly criticised the decision of the South African Reserve Bank to increase the interest rate last week. The basic argument is that the monetary policy committee has gone too far by increasing the interest rate to 10,5%. Or, as they say — and you have to say it this way to sound intelligent — by 50 basis points. The SARB will argue that its main objective is to keep inflation in the 3%-to-6% range. That is inflation (CPI) minus mortgages (that is, CPIX). There are, however, important implications in this decision.

First, we must ask if there is an alignment between monetary policy and the government’s targets of increasing economic growth to 6%. There is a growing argument that there is little alignment. In his 2007 State of the Nation address, President Thabo Mbeki hinted at a shift to a more flexible approach that is supportive of economic growth. In turn, the Budget Review 2007 indicated that South Africa would have a “more flexible inflation-targeting environment”. This comes on advice from the “Harvard group of economists” advising the government to adopt a counter-cyclical economic strategy.

The government is planning significant infrastructure investments that by their nature might push up prices in the short term. However, the investments are aimed at lowering the costs of doing business (that is, reducing prices for transport, energy, and other logistical costs). In the long run these investments might have a bigger impact on reducing prices (provided that savings are passed on to consumers). The passing-on of savings to consumers is not certain, as even government departments are likely to attempt to recoup costs through higher tariffs or user charges.

The underlying intention is to keep have a cycle of low interest rates, and low inflation rates. This is supposedly a win-win situation, where low interest rates would stimulate and encourage fixed investment. In turn, this means higher economic growth and, ultimately, increased levels of employment. Or so the theory goes.

The Reserve Bank is having none of this, arguing that it is not a “strict inflation targeter”. It also argues that increasing the interest rate would damper very exuberant consumer spending. In addition, it is better to act sooner to raise interest rates so that in times of an economic downturn, the possibility of reducing interest rates might be possible. In other words, to use interest rates to stimulate economic growth.

This is a serious debate, and one that highlights the challenges of creating a “developmental state” in a globalised world. We will, however, be mostly excluded from this debate, even if we are card-carrying conference delegates to the ANC national conference. There are strong arguments for greater transparency.

Second, so far inflation targeting has not benefited the poor. While overall inflation has remained within the range, food price inflation has increased much quicker. Part of the increase might be due to droughts or other exceptional circumstances. However, it has meant that poorer people, who pay a greater percentage of the income on food, have not been protected from rising inflation prices.

In addition, inflationary pressures that are largely outside the control of the SARB have a major effect on household budgets in South Africa. The two most important “wild cards” are the exchange rate and price of petrol.

The price of petrol is determined in international markets, and is volatile to geo-political developments, as well as rampant economic growth in India and China. Similarly, changes in exchange rates affect on prices, especially food. There is thus a complex weighing-up process in assessing how the petrol price and the currency will affect prices, yet the SARB has, at best, limited control over these factors.

In a sense, the poor have a double whammy of higher interest rates, and the SARB not being able to control prices in areas where the poor spend most of their money. Part of the reason might be that the basket of goods used to determine the inflation rate is not reflective on what we spend money. Statistics South Africa is reviewing the basket of goods, and it’s about time. Whether it will do it right is another matter.

On balance, we need to stimulate economic growth during this period when commodity prices are high, when fiscal policy is trying to ramp up fixed investment, and because we have probably the highest unemployment rate in the world. The SARB should not have increased interest rates.

NB: I am a political scientist or political economist or public policy analyst — I can never decide. That’s a way of saying that my training in economics, was not in any economics department. As a Muslim, I avoid any dealing using interest — as it is forbidden — but the SARB decisions still affect all of us.