Inflation and debt are our biggest headaches

By Adam Jacobs

In this month’s economic review, I will focus on two important economic or financial aspects.

First is inflation: International as well as local, as it will determine what can happen to interest rates.

The second aspect is: The progress of the state finances so far this year, in the light of information obtained from the medium-term budget statement on 1 November this year.

Inflation

Inflation, or the reduction in the value/purchasing power of money, is a persistent economic issue that countries have had to contend with in the past two years in particular. The definition I prefer is: “Inflation is the ongoing increase in prices of goods and services over a wide front.”

Accordingly, I would not consider inflation as, for example, only the prices of old country products rising due to a one-off factor such as drought. Of course, it will have to be thrown ashore that this does not result in other prices also rising. However, under normal conditions, this will not be continuous in nature.

However, should something happen that causes prices to rise across a broad front, such as for example excessive growth in the money supply, then this could be a typical case of excess demand, relative to production. There may of course also be other factors such as insufficient production due to war conditions, resulting in imbalances, which may increase the inflation rate. It must then be kept in mind that depending on the source that feeds inflation, those instrument(s) must be chosen that can best fight it. Left it there and simply as background.

Where do we stand now?

There has been some progress in the rate increase over the past number of months. In first world countries in general, the target is an inflation rate of 2%. As previously explained, it is estimated that quality improvements of products and services increase by 2% per year. So 2% inflation, so calculated, is actually 0% inflation.

Seen this way, policymakers have not yet reached this goal. I show what the rates were for a number of countries in September and August.

(Simply from an interesting point of view it can be mentioned that the latest inflation rate in Argentina amounts to 138% and in Venezuela 318%. In the Seychelles there is deflation observable of 2.47%. It can also present problems as people may decide to spend less with a view to spending later if goods and services are cheaper. We know from experience that this can hurt the growth rate.)

In September this year, the inflation rate locally accelerated slightly from 4.8% in August to 5.4%. A closer look at the figures shows that food prices are still one of the main drivers of inflation, as they rose by 8.1% in September. Excluding food prices, the CPI rises by 4.7%. If we look at what is happening with prices as measured at the “farm gate”, it amounted to 8.3% in September, which was an acceleration from the 6.3% in August.

On the positive side, however, I must point out that the increase in September last year amounted to 16.0% and in May last year was as high as 18.9%. The war between Russia and Ukraine also plays a role here, as especially grain prices in US dollar terms have accelerated significantly. Currently, sugar prices are rising sharply due to restrictions on its export from India.

As far as prices measured on the production side are concerned, the purchase price index for manufactured products shows an increase of 5.1% in September. This is unfortunately an acceleration in the rate of increase of 2.7% in July but lower than the 16.3% rate of increase a year before. Prices of intermediate manufactured goods were 2.9% in September lower than a year before. Prices of intermediate manufactured products have already been falling for the past three months.

Looking at the overall inflation picture, it does not look like it will reach the 2% rate in the US and the Eurozone before the middle of next year. This could lead to interest rate cuts. This may help that rates can also be lowered locally, provided that our own rate increase also tends to be lower.

The state’s budget

When I assess the state’s budget, there are a number of factors that are considered with a view to consequences for the economy and the financial markets:

• The government’s total expenditure relative to nominal GDP.
• The division of expenditure between current and capital expenditure.
• Taxes advanced relative to nominal GDP.
• The deficit before loans in relation to nominal GDP.
• The basic balance, ie the deficit excluding interest payments.
• Financing the total deficit.
• The government’s savings relative to nominal GDP.
• The extent and growth of the state’s debt.

The medium-term budget statement is exactly what the name says. These are preliminary indications of what can be expected in the next two to three years. The actual budget is annually in February. Then we will get an indication of what will apply to us for the following year.

The information presented by the minister was quite disturbing. The tax receipts for the current year will be at least R50 billion less than what was envisaged in February this year. The reasons for this are weaker dollar commodity prices and weaker production volumes in mining in particular. Then there are also weaker growth conditions which obviously lead to lower profits and therefore lower taxes paid.

Add to this power outages that interrupt production and the costs that must be incurred to generate power. Added to this is Transnet’s inability to transport cargo and the problems at our ports. It is therefore understandable that tax receipts do not meet expectations.

Along with this, government expenditure is also higher than anticipated. The combination of the two factors has the result that the state’s deficit before loans will amount to around 4.9% of GDP compared to the 4% that was foreseen in the budget. This means that the state will have to take out more loans on the capital markets than was previously foreseen. So the interest burden increases which further increases expenses. Also, capital market interest rates may rise further.

Along with this, it must be realized that the state’s debt, which is high in rand value and also relative to GDP, will continue to rise. Another matter to keep in mind is that the state’s dissaving, that is money that is borrowed to help finance current expenses, will continue to rise. This in its own right lowers the country’s growth potential. A further matter of importance is how the international credit rating agencies will assess the state’s creditworthiness. It is already at a non-credit worthiness level and a further downgrade means that it becomes more difficult to obtain loans and if so, it is done at higher interest rates.

What awaits in 2024/-25?

The minister has already indicated that tax(s) will have to be increased. An increase in the VAT seems the most possible with further exemptions from it in respect of certain basic products. He also indicated that expenses will have to be curtailed. In this respect, it does not seem that he gets the support of the cabinet; not now and not with an election imminent. If he wants to do that, it will probably be further curtailment of capital expenditure projects that should not be done.

In summary, it is clear that the country is in a very problematic situation. It comes over many years that have gradually built up to a point where, figuratively speaking, the wheels are now coming off.

For the current year, this is exacerbated by the poor performance of the mining sector in particular, which is largely outside the control of the mines. It is important to realize that the mining sector is a very big asset for the country, but is very unstable, especially due to foreign events. Strict discipline will have to be applied in times of prosperity for the sector that generates large tax receipts.

In such a situation, the windfalls will have to be used to support capital works, which in many cases are one-off expenses, and to pay off debts. In short. It should not be built into the country’s current spending pattern, such as, for example, giving rise to higher salaries.

• Adam Jacobs is an independent economic analyst.