An address by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the University of Limpopo,
05 September 2023
Dealing with the high cost of living: South Africa's experience
Introduction
Ladies and gentlemen, it gives me great pleasure to be here in Limpopo and to
address you today. This province is home to the baobab tree - a symbol of growth
amid adversity, which bears a stark resemblance to the domestic economy's
resilience, despite its challenges. The province's contribution to commodity exports
has also helped South Africa withstand the headwinds to growth in recent years.
Over the past three years, the global economy has endured multiple large and
overlapping adverse supply shocks. This was at a time when the COVID-19-induced
expansionary fiscal and monetary policies were firmly in place. This confluence of
factors pushed global inflation to multi-decade highs, eroding real incomes and forcing
consumers to make some difficult choices.
Today, I want to talk about how the high cost of living has impacted households globally
and relate it more specifically to how the typical South African consumer has fared. In
doing so, I will discuss how the resilience of global demand has perpetuated high
inflation; how global inflation has propagated into the domestic economy; and how we,
as the South African Reserve Bank (SARB), have responded to this inflation scourge.
Global backdrop
To provide context, I will begin by providing the global backdrop.
Global inflation averaged 8.7% in 2022 - its highest level in four decades. The genesis
of this inflation was a confluence of factors, including supply chain pressures
occasioned by the COVID-19-induced lockdowns and higher international food and
energy prices brought about by Russia's war in Ukraine. Expansionary fiscal and
monetary policies meant to cushion economies from the ravages of the COVID-19
pandemic inadvertently became accelerants to inflation as demand recovered faster
amid constrained supply.
Early in the recovery, consumption shifted to the less contact-intensive goods as
mobility restrictions held back services consumption across the world. Goods
consumption benefitted from pent-up demand due to lockdowns as well as from the
savings accumulated during the pandemic. Unfortunately, constrained supply chains
could not cope with the sudden pick-up in demand, and shortages of goods became
the order of the day, which resulted in soaring goods prices globally. You may recall
the shortage of microchips in 2021 which impacted the production of vehicles in our
own economy.
Initially, inflation was thought to be transitory, but it soon became clear it was anything
but transitory. The sharply higher and more persistent inflation prompted global central
banks to begin normalising policy rates, with institutions such as the United States
(US) Federal Reserve at times hiking rates in successive steps of 75 basis points. With
a synchronised global hiking cycle, and monetary policy moving to restrictive territory,
expectations were for global growth to slow sharply in 2023, weighed down by high
interest rates. In fact, many forecasters assessed a high likelihood of a recession in
the major advanced economies this year. Ordinarily, sharply rising interest rates
squeeze household and corporate incomes and thus reduce demand and investment,
and hence quickly extinguish inflationary pressures. This is what many commentators,
policymakers and analysts had expected early in the hiking cycle.
Global growth, however, has proved resilient. Growth prospects have continued to
improve, leading to an overall upgrade in the 2023 growth forecasts. The global
economy is now forecast to expand by 3.0% this year, from 2.8% projected in April
2023.1 China's strong rebound at the start of the year, following the country's reversal
of its zero-COVID policy, together with the easing global supply chain disruptions,
provided a boost to global economic momentum. Demand, which had earlier shifted
to the less contact-intensive goods consumption at the height of the pandemic, has
rebalanced by rotating back to services as the COVID-19 pandemic has faded.
Consequently, services-intensive economies, such as the US, have shown strong
growth so far in 2023.
One unexpected challenge brought about by the resilience in household spending is
inflation persistence. The pass-through of high energy costs into broader prices in the
economy - the so-called second-round effects - have also added to inflation
persistence, particularly across Europe.2 Although global inflation peaked last year, its
pace of decline has been much slower than expected, especially given the rapid pace
of monetary policy normalisation by the major global central banks. Global headline
inflation has fallen from a peak of 9.4% in the third quarter of 2022 to 5.7% in the
second quarter of 2023.
Much of the decline in headline inflation has been due to lower international food and
oil prices, which have fallen considerably as the uncertainty occasioned by Russia's
war in Ukraine has abated, as well as the normalisation of supply chain pressures.
Headline inflation is projected to average 6.8% in 2023 from 8.7% in 2022. Measures
of underlying inflation have, however, remained persistently high in major advanced
economies, with core inflation3 declining more slowly. The rotation of demand from
goods back to services that I alluded to earlier has also seen goods inflation slow
markedly, while pushing services inflation higher, meaning that the stickiness in core
inflation is largely a services inflation story.4
Several factors, including still elevated excess savings and unusually tight labour
markets, especially in advanced economies, have also continued to support consumer
demand and have possibly delayed the impact of rate hikes on aggregate demand.
Complicating the disinflation efforts is that labour markets in advanced economies
have remained unusually tight, which is likely to strengthen workers' bargaining power
and drive real wage growth above productivity gains.5
Although longer-term inflation expectations have remained anchored, headline
inflation is expected to remain above the 2.0% target beyond 2024 in most advanced
economies. Inflation also remains elevated in most emerging market economies,
including here at home, and is expected to decline only gradually towards central
banks' targets by 2025.
Despite the recent moderation in headline inflation, risks to global inflation are
assessed to be on the upside. Geopolitical tensions show no signs of abating, which
will likely keep global food and energy markets tight, while the probability of El Niño
weather conditions this year has risen sharply. Monetary policy is likely to remain
focused on ensuring that inflation continues to retreat, implying that global policy rates
could remain higher for longer.
Now, let me turn my attention to developments in the domestic economy.
How has the domestic economy fared?
Like the rest of the world, South Africa has been grappling with persistently high
inflation. South Africa has experienced a sustained inflation target breach, with
headline inflation having remained above the midpoint of the target range for
27 consecutive months since May 2021. High inflation erodes the purchasing power
of the rand and thus makes South Africans poorer. Over the past 18 months, South
Africans, alongside their global counterparts, have endured a rise in the cost of living.
This came at a time when South Africans had become accustomed to low and stable
inflation.
After hovering in the upper half of the target range for a year, South Africa's inflation
breached the upper limit of the SARB's 3-6% inflation target range in May 2022, and
reaching a high of 7.8% in July 2022 before beginning its retreat. The trajectory of
domestic headline inflation has been shaped primarily by fuel, food and electricity
prices. The first two have largely reflected global developments, beginning with the
sharp rebound in the demand for goods amid supply bottlenecks, and later
exacerbated by the Russia-Ukraine war, which further strained global energy and food
markets.
Sharply rising food and fuel prices raise fundamental concerns from a distributional
standpoint. To provide some perspective, fuel inflation in South Africa soared to 56.2%
in July 2022, and pushed pump prices well above R25 per litre, with immediate knock-
on effects on transport and production costs for goods and services.6 Meanwhile, high
electricity tariffs have further raised the cost of living for many South Africans.
Food and transport inflation impact the poor the most, as their consumption baskets
are weighted heavily by these items. Recent inflation data by Statistics South Africa
shows inflation for the lowest income deciles (deciles 1 and 2) averaging 9.0% in July
2023, while that for income deciles 9 and 10 averaged at 4.3%.7 Low-income earners
and the poor more generally are less able to protect their incomes from being eroded
by inflation, and this contributes to rising inequality in our society. The authors of our
Constitution understood the need to protect those who cannot protect themselves. The
Constitution tasks the SARB with protecting the purchasing power of the rand, and we
are committed to executing on this mandate.
In light of the deteriorating domestic inflation environment, the SARB's Monetary
Policy Committee (MPC) raised the repurchase (repo) rate by a cumulative 475 basis
points since the hiking cycle began in November 2021. At the current level of 8.25%,
monetary policy in South Africa is now considered restrictive. While the MPC paused
the hiking cycle in July, the committee will continue to assess inflation developments,
and will act appropriately to steer inflation to the midpoint of the 3-6% target band
(4.5%) to create an environment conducive to balanced and sustainable economic
growth in the interest of all South Africans.
Inflation outlook
As food and fuel inflation have eased, mostly reflecting base effects, so has headline
inflation, which recorded a low of 4.7% in July 2023. Going forward, we expect to see
further moderation in headline inflation on the back of further declines in fuel and food
inflation as well as the cumulative effects of the repo rate increases to date. This
should help ease the burden of high costs for both consumers and businesses.
However, core inflation has exhibited signs of stickiness, much like we have seen at
the global level. Core inflation was initially pushed up by markedly higher global goods
inflation and exacerbated by the depreciation of the rand. Inflationary pressures have,
however, broadened within the core basket, in part reflecting spillover and second-
round effects from the high fuel and food price increases over the past year.
Within the core basket, inflation has been driven mostly by core goods, and to a lesser
extent, services.8 Housing - the largest services component - has experienced
subdued inflation since the pandemic. This has helped to keep services inflation more
muted and slowed the rise in core inflation. Core inflation is expected to average 4.9%
this year.
Risks to the domestic inflation outlook are on the upside. Although some food price
components have eased over the past few months, domestic food price inflation is still
elevated (10% in July 2023), while the risk of drier weather conditions in coming
months has increased. Domestic food prices also remain at risk from exchange rate
volatility as well as the impact of geopolitical developments, particularly following
Russia's decision to withdraw from the Black Sea Grain Initiative agreement. Similarly,
global oil markets remain tight and sensitive to geopolitical tensions. Risks also
emanate from the still elevated inflation expectations, which could feed into prices and
wages, providing impetus to core inflation.
Before I conclude, let me briefly touch on the recent performance of the South African
economy.
GDP performance
Much like the global economy, the resilience of the domestic economy has surprised
policymakers. After contracting by 6.0% in 2020, the domestic economy rebounded
sharply, growing by 4.7% in 2021 and 1.9% in 2022. These growth rates were much
stronger than we had expected and meant that the recovery to the pre-pandemic
output level was achieved sooner than we had forecast.
South Africa experienced large terms of trade gains as the global economy re-opened
following the COVID-19 lockdowns, underpinned by buoyant global commodities
demand while imports remained subdued. The strong domestic recovery also reflected
a very supportive domestic macroeconomic environment, with massive fiscal support
and multi-decade low interest rates.9
With output now back to its pre-pandemic level, South Africa's medium-term economic
outlook has weakened sharply again, this time on the back of extensive load-shedding.
Expectations were broadly for the domestic economy to experience no growth in 2023
and only modest growth (1.0%) over the medium term. The domestic economy,
however, is again likely to surprise to the upside this year with projected positive, albeit
subdued, growth of 0.4%, following a better-than-expected growth outturn in the first
quarter of 2023.
Load-shedding continues to place increasing pressure on economic activity and will
remain a drag on domestic growth in the near term. The SARB estimates that load-
shedding will shave up to 2 percentage points off real gross domestic product (GDP)
growth in 2023. This means our economy could have grown by at least 2.4% this year.
Let me put the challenges of load-shedding into perspective. We have seen more load-
shedding in the first six months of 2023 than for the whole of 2022.10 Load-shedding
is having broader effects on the cost of doing business and ultimately the cost of living
for all South Africans.11
Encouragingly, we are beginning to see some traction on reforms, particularly in the
energy sector. While some strides have been made in removing structural barriers to
entry for independent energy producers, the full benefits of these interventions will
mostly materialise in the medium to long term. The SARB sees both potential growth
and output growth slightly higher over the medium term.12 Meanwhile, private sector
investment in alternative energy is providing a welcome boost to fixed capital formation
and is supporting domestic economic activity, particularly in the construction industry.
Investments in back-up energy solutions have cushioned business operations from
the impacts of load-shedding and partly explain the resilience we see in the economy.
Despite high inflation eroding real incomes, household spending has grown over the
past year, although its contribution to overall economic growth has been declining.
High inflation and rising interest rates, alongside slower employment recovery and
declining real disposable income, continue to weigh on consumer confidence, raising
14
the prospect of further slowdowns in household consumption growth.13,
Slower domestic growth ultimately reflects in weaker fiscal numbers, especially so
given the reversal in revenue windfalls. The current trajectory of the fiscus is
characterised by elevated budget deficits and rising public debt levels. This has
contributed to a higher risk premium, driving up the cost of borrowing, and depreciating
the rand exchange rate, thereby raising exchange rate pass-through inflation. Fiscal
consolidation can significantly lower fiscal risk, and this should support
macroeconomic stability and ultimately economic growth.
Conclusion
Finally, let me conclude by recommitting the SARB to the challenge posed by our
Constitution. Our job is to contain inflation in the interests of balanced and sustainable
growth. The SARB will continue to exercise its mandate to guide inflation and inflation
expectations closer to the midpoint of the target band which, in turn, keeps demand
and supply in the economy in balance. By so doing, we play our part in creating an
environment conducive to inclusive and sustainable economic growth for the benefit
of our people. It is important, however, to realise that economic growth and
development really is a team sport, and as such, needs all the players to pull together
and do their jobs well. So, while we work hard to lower inflation and interest rates to
support a healthy balance of saving and investment, it is critical that the broader public
sector identifies constraints to growth and job creation and focuses on relieving them.
Thank you.