The South African Reserve Bank (SARB) has once again hiked interest rates, although only slightly, confirming that we are on a definite upward trend. This, even though the economy is weak and seems to get weaker still. The main reason was that inflation seems to be creeping higher, albeit slowly. It is widely accepted that higher interest rates (lending rates) will curb inflation, but at the same time slow the economy. This puts the SARB in a very difficult position. I am not sure that they have made the right decision. This is once again a situation where I think Reserve Bank governors want to do too much, and politicians do too little.

Some of the reasons given by the Reserve Bank were that the weakening Rand leads to imports being a lot more expensive, and that food costs are going up. I don’t think that a hike in the rates would achieve any of the desired effects. When it comes to food costs, South Africa is in a very unique position, different than America, Europe and Asia. Theoretically we produce largely enough for our own consumption, however if we fail to do that we need to rely on imports to make up for the shortfall. But in contrast to let say Germany, we can’t rely on our neighboring countries to supply our shortfall. Firstly, they are not big producers of crops themselves, and often have to import to make up for their own shortfall. Secondly, if our crop harvest is down by 10% it is the equivalent of the consumption of the whole of Namibia and Botswana combined. So if we do have a shortfall, we will have to import, and given the geographical position of South Africa, the transport costs will be high. This means that as soon as South Africa doesn’t produce enough crop, we will experience inflation as all crops are then sold at import parity pricing.

So would a rate hike curb food inflation in SA? As long as the inflation is supply driven, I doubt it. In fact it might even make it worse. There are many ways to increase the yield of crops, thus making sure that South Africa has the required food security. But these rely on economies of scale, and using modern technology to optimize the planting and harvesting process. These require big capital outlays which are often partly financed by banks. Increasing interest rates make such investments less feasible. The Governments latest comments about farm ownership (see previous article) also deters any such investments.

One of the other reasons given was the weak Rand, which would cause imports to be more expensive. Unfortunately the Rand was too strong after the world financial crisis, as investors around the world were searching for yield, since they got nothing at home. Thus a big demand for Rand came from investors, not from sustainable trade requirements. At that point, the SARB should have lowered the interest rate substantially to make the short term investments in South Africa less attractive.

In the subsequent years, consumption was one of the main drivers of the economy, as imports became cheaper and South Africans splashed out on new cloths, TV’s, cars, etc. Without any support of the producing side of the economy, the growth was only driven by the stronger Rand (which had nothing to do with the underlying economic factors) and thus unsustainable. Basically we helped countries like South Korea, Vietnam, Mexico, Thailand but also Spain and Italy among others achieve sustainable growth by buying all the products they produced.

Yet again, the government could do a lot more to foster growth. One of our natural big economic advantages are resources. We have a wealth of natural resources and in theory that should be one of the main drivers of economic growth and thus prosperity. Added to that we had just experienced the biggest commodities bull market since the sixties, but South Africa has not been able to increase production and thus benefit from these extraordinary times. In fact, due to the fast rising labor costs, poor electricity supply and a lack of infrastructure many of the small mines had to close down. Many of the big mines had to turn to their parent company or their shareholders for additional cash injections, just to survive.

A hike in interest rate will not make South Africa suddenly more attractive to international investors. A change in politics will though. Thus I am not sure that we are on the right course, however only history will determine the correct outcome.