The bottom two decile income groups in South Africa experience inflation of 9.4% – more than twice the rate of the top two decile income groups, which experience inflation of 4.3%, according to Statistics South Africa's latest reading.

"Any development strategy that does not promote price stability is by definition anti-poor because the poor feel the ravages of inflation more than other income groups," South African Reserve Bank (SARB) governor Lesetja Kganyago said during financial services company PSG's latest 'Think Big Series' webinar on October 5.

"High inflation reduces disposable income, as consumers are paying more for goods and services compared to a year ago. Inflation affects all of us, and even if a person is unemployed and therefore unable to secure loans affected by interest rates, she or he will feel the impact of inflation.

"Because inflation reduces disposable income, the central bank must step in to curb inflation, which requires deploying interest rate adjustments. As they are deployed, we feel the pain, but it is a bitter medicine we must swallow to curb the impact of inflation," he said.

No country can grow sustainably with high inflation. There are countries that are not growing much that have low inflation, but there are no countries that are growing sustainably that have high inflation.

"High inflation has not bought any countries growth. This is why the authors of the Constitution mandated the SARB to protect the value of the currency in the interest of balanced and sustainable growth. They understood that price stability is a necessary precondition for balanced and sustainable growth.

"However, while price stability is necessary, it is by no means a sufficient condition for growth," Kganyago emphasised.

The constraints in the South African economy are structural, which the SARB has indicated before.

"Post the [Covid-19] pandemic, when the world opened up and bulk commodity prices increased, South African mining houses were profitable but could not get the iron-ore or coal to markets.

"There are problems with the national logistics system, as seen by the number of trucks increasing the pressure on the roads.

"Similarly, without energy, we cannot fuel a modern economy, and electricity is a binding constraint on us," he emphasised.

Education outcomes are also a binding constraint on the economy.

"The biggest wealth of a modern economy is not its mineral wealth or the wealth found underneath the ground, but real wealth is that which is in the heads of its citizens. This is where we should be focusing, because it is by creating know-how that we will grow and compete," Kganyago said.

INFLATION RISKS
Further, the exchange rate, as well as the oil price and food prices, present risks to the inflation outlook, and the SARB worries about the currency to the extent that it feeds into inflation.

"A fair rand:dollar exchange rate is one set by the process of demand and supply with the foreign market," he added.

"Interest rates globally have gone up and there are indications that they will remain higher for longer worldwide. This means there has been a realignment of exchange rates, which has already affected multiple developed economy currencies, and the rand is no exception to the realignment," Kganyago said.

Further, global inflation dynamics have changed and pose a challenge.

"Even with the steps taken by central banks, inflation has not gone lower as we thought it would have. All central banks acknowledge this and this is why they are talking about interest rates being higher for longer," he said.

Further, when asked whether South Africa should increase its inflation target band from the current 3% to 6% band, Kganyago said that South Africa was a bit of an outlier compared to peer countries, firstly by having a higher inflation target band, with India targeting 3% to 5% and Brazil targeting 3%, but also that it had a wider inflation target band than its peers.

FINANCIAL STABILITY
Currently, there are no financial stability concerns in the South African financial sector.

"Capital and liquidity levels are adequate and the sector has very good buffers. It has used the profits from the past two years to build buffers.

"Interest rates have increased and nonperforming loans have also risen in South Africa, but there are adequate buffers in the system to absorb them so there are no financial stability concerns there.

"However, there can be no doubt that the household sector is feeling the pinch and people are struggling to meet their monthly needs, with some having to reduce expenses, but this does not pose financial stability concerns," he said.

However, globally, of concern in terms of financial stability is the fact that 60% of developing countries are either in or at risk of debt distress, he said.

"This is becoming a global financial stability issue if there are defaults. We have already seen Ghana and Zambia restructure their debts, while Mozambique is busy doing so," he said.

COUNTRY RISK PREMIUM
Central banks use a metric called neutral interest rates to assess whether interest rates are high or low. If interest rates are higher than the neutral mark, they are termed restrictive and, if lower, they are termed accommodative.

"Our fiscal health influences our country's risk premium. The risk premium is driven by fiscal policy and, if South Africa is to have a lower neutral interest rate, it needs effective fiscal policies to bring down the country risk premium," he said.

Administered prices have risen more than inflation, which are set by government departments, he pointed out.

"We can arrest inflation if the price setters in government set price increases that are consistent with inflation targeting," said Kganyago.

"In many cases, municipalities are making things more difficult. Some local governments play around with rates and taxes, including naughty measures such as re-evaluating the value of a property to be 10% to 20% higher, and therefore required to pay higher rates. The truth of these increases is not seen in the housing market," he noted, quipping that a 20% profit on a property could be sufficient to warrant a sale.

The SARB takes a forward-looking approach when assessing the inflation outlook. This is done to determine whether previous policy actions have started for filter through.

However, price setters, businesses and labour unions tend to focus on the most recent inflation figures when expressing their inflation expectations and therefore adopt a backward-looking approach.

"Financial analysts also take forward-looking views on inflation, and produce inflation expectations that are similar to the SARB's, but they do not set prices. What matters is what the price setters do and what they expect.

"Further, while inflation has been sticky, it has not been volatile, although it may remain higher for a longer period than we think. This is why central banks are cautious and some have not ruled out further rate increases," Kganyago noted.

However, the challenges facing the economy are not insurmountable.

"What has been driving investment in South Africa recently is embedded generation, and we are now grappling with insufficient transmission capacity. I am sure we will make a plan to overcome this as well," he said.

Meanwhile, as a political project, the decision to establish a common Brazil, Russia, India, China and South Africa (Brics) bloc currency should be taken by the relevant decision-makers. However, the main purpose of a central currency would be to facilitate trade.

The central banks of the Brics nations already facilitate trade by facilitating settlements between them, he noted.

"We are working with other Brics central banks and we have interconnected and interoperable national payments systems to make settlement easier, thereby fulfilling the purpose," he said.