This year has been characterised by a significant build up in inflationary pressure in the South African production system.

For the past 53 years, the Steel and Engineering Industries Federation of South Africa (SEIFSA) has been tracking the price movement in over 250 different products on a monthly basis. The word “products” is used as a generic description of the different areas of costs covered, which include labour, steel prices (at producer and merchant level), metal prices, production price indices, various chemicals, commodities, exchange rates, mining equipment, electrical machinery, to name a few. Over this period, SEIFSA built a credible database with long time series on each of these cost areas. The significance of this database is that it provides us with a bird’s eye view of inflationary pressure at a macro level of the economy, while also allowing us to track inflation at product level to assist business in making informed decisions. 

It is for this reason that, through our various research initiatives, we have noted with grave concern the double-digit input cost inflation building up in the production system. The result of the higher cost has been the haemorrhaging of profit margins and, worse still, a threat to the sustainability of manufacturers in South Africa.

Year to date (August/September 2016) the following trends have emerged:

• Rand Exchange Rate – 20% (has a blanket inflationary effect on domestic price inflation)
• Fuel Prices – 18%
• Electricity and water – 11%
• Machinery and Equipment – 7%
• Rentals – 5%
• Wages increases – 8% to 10%
• Steel/metal prices – 26 %
• Production Inflation – 8.2%
• Consumer Inflation – 6.5%

These adverse trends have made operating in an already difficult environment much more challenging. The challenge is compounded by the magnitude, persistence and cumulative nature of the inflation.

Companies operating in South Africa, either manufacturing a product or supplying a service, have been most adversely affected by these inflationary trends. For these companies, the situation can be characterised by various impacts.

For example, in periods of strong economic growth, where the production of companies is increasing and the order book looks equally healthy, companies are able to off-set some of these price increases into higher volumes. These periods of economic growth are also characterised by the producing companies being able to pass on some of this inflation to their clients. The combination of these two aspects almost completely negates the effect of the price increases.

Unfortunately, the current economic environment in South Africa is one of a dire lack of economic growth (0% GDP forecast in 2016) and is also characterised by very weak markets. This means the companies supplying products have no means to off-set the price increases they experience and, therefore, have to contend fully with the inflation. The end result is one of diminishing of profit margins and the very sustainability of the companies.

The same inflationary trends also make project planning and execution an extremely difficult exercise for companies that buy the manufactured products for either consumption or use in large-scale capital expenditure projects such as those undertaken by State-owned entities, mines, municipalities and general government departments. These price increase trends are often the very reason for significant project cost overruns.

In our various interactions with many companies on both the supplying and buying sides, it is obvious that companies are not alive to the reality of inflation and the detrimental effect it can have on their sustainability. Most companies generally consider inflation to be a theoretical concept and, as a result, do not place enough emphasis on managing it as a risk. Conceptually, managing this inflationary risk can be considered as the equivalent of de-risking the inherent risk of operating in the current volatile economic environment.

At the beginning of 2016, SEIFSA created a composite cost index which measures the input cost inflation experienced by companies in the metals and engineering sector. This composite cost index includes the exchange rate (40%), labour (20%), administered prices (15%) and other/miscellaneous costs (25%). The structure of the index (costs and associated weights) is determined by the input cost structure of the industry derived from input-output models.

The idea of the composite input cost index is to provide companies with a yardstick of the inflationary pressure experienced in the sector. It will be an important indicator for companies to measure their company inflation relative to this index and a more important indicator for understanding the degree to which costs need to be contained, prices increased or volumes increased where they are falling short relative to the index.     

To date, we have been testing the index for its accuracy and building an historic trend. We expect to release this index publicly this monthly. Subsequently, we will start rolling out composite cost indices for the other sectors of the economy.