More rate hikes are not going to fix South Africa’s problems: economist

Various international institutions found that weak economic fundamentals, political instability, commodity dependence, exchange rate volatility and the US dollar surge are major contributors to high levels of inflation in emerging countries like South Africa, says Francois Stofberg, the managing director of private clients at Efficient Wealth.

As a result, the interest rate increases in the country may not effectively combat inflation, he said.

On 30 March, the South African Reserve Bank (SARB) hiked interest rates by a surprise 50 basis points, marking the ninth hike since November 2021 and a cumulative adjustment of 425 basis points since the start of the rate cycle.

Stofberg said even though the SARB is sturdy and precise in its policy, the country’s poorly-managed state and lack of fiscal discipline negate many of the benefits that a strong central bank may provide.

He added that, as a commodity-dependent country, South Africa is susceptible to inflationary pressures when global demand for scarce resources increases. Furthermore, with a volatile currency and a reliance on imports, the country is vulnerable to import inflation.

Typically, exchange rate disparities are driven by inflation differentials between countries and a ‘sentiment’ factor, representing ‘consumers’, businesses, and investors’ perceptions of a country.

“In South Africa, inflation differentials have accounted for nearly 73% of the difference in the USD/ZAR exchange rate since 1980, with sentiment contributing to the remaining 27%.

“However, sentiment can be volatile in the short term, resulting in exchange rate fluctuations,” he said.

For example, long-term negative sentiment towards emerging markets, particularly South Africa, most likely caused the rand to depreciate by 7.75% and 16.42% in 2021 and 2022, respectively, despite having lower inflation rates than the US.

In contrast to emerging countries, developed and competitive regions, such as Germany or Japan, typically have strong exchange rates owing to lower inflation rates and supportive sentiment – attracting short-term capital for investment.

Countries that are competitive but not developed, such as China or Mexico, have strong exchange rates in the short-term but weaker rates in the long term due to inflation.

“These countries often attract long-term capital in periods of positive sentiment where the return on investment can more than make up for an underperforming currency in the long term,” said Stofberg.

As it stands, the SARB’s attempts to attract either short or long-term capital growth and support the exchange rate is rather futile, he said.

“Higher real interest rates in South Africa have been largely ineffective in supporting the rand. Since 2008, while the SARB persistently kept real interest rates higher than those in the US, the rand depreciated more than 125% from R8/$1 to more than R18/$1 in 2023.”

“It even depreciated more than the 96% average depreciation of counterparts such as Brazil, Russia, India, China, Indonesia, and Malaysia, among others. The only ones who have benefitted from higher positive rates in SA are the handful of households with more assets than liabilities,” said Stofberg.

The economist said that the US dollar surcharge had taken its toll on South Africa’s currency; when the US Federal Reserve increases rates, the dollar appreciates significantly – exerting inflationary pressure on emerging countries owing to their declining buying power.

It is for this reason that Stofberg cautions against the rate and size of the SARB’s interest rate increases.

“In the past, this blunt tool might have been sufficient to address inflation. But today, where broader economic factors contribute to relatively higher inflation, it is more likely to be ineffective and places an unnecessary burden on a country that is already under severe strain.”

“We agree that price stability is important for a healthy, growing economy, but we believe that the SARB has lost touch with the citizens they serve. Slightly higher inflation with lower interest rates would be easier for most families to stomach,” he said.

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