Limits to growth sacrifice

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By Cees Bruggemans

The SARB is currently focused on containing inflation expectations. All must believe inflation will return to the 3%-6% target, no matter what disruption intervenes. Whatever pushes inflation higher will pass, with us showing through our actions that we believe inflation will return to target.

This beggars belief when numberless external inflation shocks ambush us, especially oil, food and rand driven by global markets and Eskom seeking tariff relief.

Yet the SARB is realistic on all these scores. It cannot control global inflation sources. It accepts that any first-round shocks from oil, food and the rand entering our universe change relative prices and increase inflation.

But as these higher prices eventually bed down, the year-on-year inflation rate should subside. As the high commodity prices are compared to high commodity prices a year earlier, they will no longer boost inflation.

It is when commodity prices explode higher, like today, that for a while we are comparing a rising price with a much lower price a year ago. That abrupt change gets absorbed into high inflation, creating a temporary bulge.

As this happens, we find simpatico central banks turning into severe disciplinarians. For how will we respond to the rising inflation? Make it worse or let it pass?

What foreigners, and Eskom, are doing to us is simple. They are impoverishing us. In essence the same as when your taxes are raised.

Income is taken away from us and given to others to enjoy as they please. Something we have to accept.

But tax increases are one thing, rising prices something quite different. We all believe in fair play, learned in kindergarten. You take something away from me against my will and I will retaliate, hissing, screaming and using nails if necessary. Give it back!

In adult life this is called restitution, if you will compensation. The SARB uses an arcane term, second-round demands, in response to first-round shocks.

In essence, the SARB wants us to turn the cheek, accept the impoverishment being dished out by external forces.

But we aren’t very good at turning the other cheek when getting slapped by whatever. We want restitution, compensation. Strong companies operate on cost plus. Pass whatever cost increases to customers while protecting high profit margins. Labour similarly wants to keep its real income, no matter what foreigners and Eskom do to them, demanding wage and salary compensation for any income losses.

No way, Jose.

On the principle of old Henry Ford that you could have any T-Ford you wanted as long as it was black, our macro policymakers are prepared to allow you any wage increase you want as long as it is less than 7% (keeping unit labour cost gains after productivity within 3%-6%).

Many of us don’t get this message.

Because the country engages through impersonal markets rather than cutting sensible deals between exhausted contestants in smoke-filled rooms, the SARB is incurring growth sacrifice by raising rates, with the Minister running a budget surplus. By accepting GDP growth below 4.5% potential, this increases resource slack.

Businesses encounter more competition. Labour may lose jobs. This should cool the compensation culture. Don’t demand more, inflation will return to target, rates will be lowered again, all will be well.

The indebted are the chosen vehicle through their spending to gain leverage over the economy’s supply side, maintaining pricing discipline.

But how much growth sacrifice is enough? There remain strong growth supports in booming infrastructure construction, mining and agriculture. But the remaining 85% of the economy is having an increasingly hard time, rapidly cooling off, already in deep recession in 15% of its sectors, with more joining this parade daily.

In a SARB speech last week, growth is already seen below 4.5% potential. Some such growth sacrifice is expected in containing inflation expectations. But the economy is not seen derailing.

So far this may be true. But growth sacrifice is deepening, with growth projections adjusted lower daily.

National Treasury earlier this year predicted 4% GDP growth. Private estimates currently suggest 3.6%. This would still be relatively robust, given the context.

But things aren’t standing still. Instead, they are sliding. NERSA estimates the cost to the economy of Eskom power outages during November-January at R50bn, 90% of it during January. That should make for an interesting GDP growth estimate for 1Q2008 this week.

At what point would growth sacrifice through purchasing power loss, higher interest rates and a firm rand become too high a price to pay to guide second-round inflation behaviour? And where is the current xenophobia leading?

The coming months will show. CPIX could peak above 12% in 2H2008, depending on oil, food, the rand and Eskom.

Wage demands could be 10%-15%, translating into 9%-10% wage bill increases, with some job losses.

Prime interest rate could peak at 16%-16.5%.

Non-agricultural GDP growth could halve to below 3% this year, and be nearer 1%-2% next year as many keep delaying replacement, cutting spending and inventories, increasing risk aversion, watching the passing show and most of all SARB’s blunt instrument. And xenophobia.

Source: Cees Bruggemans, FNB, May 26, 2008


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