Can we trust the stats?

Inflation targeting isn’t working, say some economists. Others say it’s the only medicine the Reserve Bank has. But are the inflation numbers accurate? An article in the latest Pam Golding Properties Intellectual Property magazine examines the views of some highly prominent economists.

The hot debate raging among analysts, economists, bankers, homeowners and supermarket checkout ladies is whether the SA Reserve Bank will continue its interest rate hikes when the monetary policy committee meets again next month.

The debate between the professionals who favour a further increase and those who believe that enough is enough has become heated. So much so that retired Reserve Bank governor Chris Stals is quoted in the press insisting that economists who argue that the bank should not raise interest rates because inflation is mainly a product of externally determined food and oil prices “are barely fit to be called economists.”

Strong stuff.

Some economists are arguing that the Bank’s inflation targeting regime simply isn’t working and that continuing to increase interest rates is pushing the country towards recession. Inflation as measured by CPIX (minus mortgages) has been outside the target range of 3%-6% for almost a year. The February figure of 9,4% shocked the markets.

One question as yet unanswered is whether the current weighting components of CPIX are reflecting the true inflation picture, making it higher than it should be. From January next year Stats SA will use a new index, one in which the weight attached to food is lower and that attached to transport higher. Dynamic Wealth chief economist Prof Chris Harmse has found that the reweighted CPIX by Stats SA’s methodology is 1%-1,5% lower all the way back to January 2007. Harmse says February’s 9,4% would have been only 8,9% using the new methodology.

This reweighting exercise takes place every five years in order to reflect changes in consumer patterns. At least 10% of household expenditure must be spent on a product for it to be included (that’s why the new basket will have taxi fares and funeral costs). The new basket will throw out a number of items that don’t make the grade and thus reduce numbers to 386.

One problem is that the weight of water, housing, electricity, gas and other fuels will fall to around 12% compared with the 15,8% at present. Yet the most serious risk to inflation going forward is probably Eskom’s request for huge tariff increases.

Economists are again questioning the credibility of Stats SA’s data – this time the big jump in producer price inflation (PPI) for March. Since producer inflation tends to lead consumer inflation, the March figure (up 2% from February) shocked analysts.

Ben Smit of the Bureau for Economic Research says there is a need for a solution to the inflation targeting dilemma that would enable the Bank to invoke the statutory explanation clause, which it can do if inflation rises due to an external price shock. The expected electricity price rise is one – as is the oil price.

The economists lobbying against the current policy argue that hiking rates again won’t make any difference to rising inflation. Others counter that the Bank will lose credibility if it invokes the explanation clause – especially if it has to repeat the step.

Investec’s Brian Kantor, who has been a steady critic of inflation targeting, believes the Bank should target a definition of CPIX that excludes energy prices. He feels that inflation targeting was not designed for an economy like South Africa’s that experiences huge exchange rate volatility. “To work well, inflation targeting requires exchange rate stability,” he argues.

Iraj Abedian, former chief economist at Standard Bank and now CEO of Pan African Holdings, also feels that inflation targeting is inappropriate. He favours an approach similar to the US Fed, one which targets prices, a certain level of GDP growth (which South Africa is not achieving) as well as productivity. Abedian warns that if the Reserve Bank sticks to its policy, growth will suffer further, killing off industries and evoking a labour backlash.

There is some consensus that current monetary policy is too inflexible and the unions want to see job creation as part of the Bank’s mandate. Cosatu has described inflation targeting as disastrous and responsible for falling economic output.

Nevertheless, it is highly likely that the hawks will persist. The Bank’s governor, Tito Mboweni, says he does not believe that April’s interest rate hike represents an “overdose” that might kill off economic activity. He says the Bank still sees growth returning to close to 4,5% by the end of next year. He has intimated that beating off inflation is crucial in order to pave the way subsequently for interest rate cuts.

There have been calls for another interest rate hike next month, with some analysts even suggesting that the Bank should stop pussyfooting around with 50 basis points increases, as it has done since June 2006, and whack on a full 100 points. But talking after the April monetary policy committee announcement, Mboweni explained that the possibility of a full 1% rate hike was not even considered by the committee and that discussions centred mainly around whether to increase by 0,25% or 0,5%. He also said that the possibility of leaving rates unchanged was not even contemplated.

There are other economic issues that the Bank has to take into consideration. The rand’s average depreciation of 14% against the dollar will limit a deceleration in the rate of price increases, keeping inflation at stubbornly high levels. A further source of inflationary risk is the next round of wage negotiations. According to the Andrew Levy Wage Settlement Survey the average level of wage settlements in 2007 was 7,3%, but in the first quarter of this year the average level rose to 7,8%. However, Standard Bank economist Danelee van Dyk points out that unit labour costs data (the labour cost per unit of output adjusted for changes in productivity) provide crucial insight into inflation.

This eased last year. Van Dyk comments: “Thus, wage-driven inflation last year was not at concerning levels, owing largely to productivity gains.”

Another concern for the Reserve Bank is the deficit on the current account of the balance of payments. This widening deficit has been comfortably financed by capital inflows. But these are mainly short term and can flow out again just as quickly as they come in. The continuous widening of the deficit leaves South Africa vulnerable to more external shocks.

However, a recent survey by Dynamic Wealth shows that capital inflows from foreigners’ purchases of South African assets were not enough to finance the deficit during the first quarter of this year. Harmse says that a large part of these inflows was made up of foreign asset reduction – domestic banks bringing back foreign currency held abroad to meet the South African demand for it.

The challenge facing the Reserve Bank is complicated and fraught with pitfalls.

The Financial Mail asked in a recent cover story whether Mboweni had “lost the plot”? It’s not a matter of losing the plot, but rather of finding a screenplay with a happy ending.
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