There are not many things we are able to control as South African individuals when it comes to economic decisions affecting the country. We may not be able to control these decisions, but it is worthwhile to understand them. In understanding some of the choices that are made which have a direct impact on how we live, it broadens our minds and aids us in changing some of the things that are in our control of.

 

Last week, the South African Reserve Bank (SARB) increased the repo rate by 25 basis points to 6% per annum resulting in the prime lending rate to increase to 9.5%. We know this is going to impact us in some way but do we understand why such an adjustment was made and does it matter?

 

Why the repo rate was increased

 An increase in the repo rate was not unexpected but rather anticipated, why?  

South Africa’s inflation target is between 3 and 6%. One of the ways of curbing inflation increase is to raise the interest rate. 

Gary Palmer, CEO of Paragon Lending Solutions, says; “An interest rate hike has been on the cards for a long time, especially with inflation increasing fuelled by petrol and food price hikes and the devaluing of the rand…” 

Firstly, it must be understood that inflation and interest rates have a direct impact on one another. Inflation is basically a rise in the price of goods or a reduction in the value of currency (i.e. R1 will buy less). 

The picture below depicts the relationship between interest and inflation: 

According to the SARB “Moderate interest rate hikes are likely to achieve price stability, the bank’s primary mandate, without unduly sacrificing growth,”

Price increases included (but not limited to):

• - Wage rate hikes

• - Increase in the average oil price resulting in rising fuel prices and in turn, rising food costs

• - Eskom tariff application to increase electricity prices

Some other factors also included:

- The impact of the Chinese stock market crash, which led to a reduction in demand of commodities (“All of a sudden China slowed and we did not get the inflow we had anymore”- Sizwe Nxedlana Chief Economist FNB), and the subsequent decline in commodity prices, namely iron ore.

- The vulnerability of the Rand against the US Dollar.

 

You may have also read that the possibility of increased interest rates in the US will have an impact on South Africa’s economic outlook. The SARB in an attempt to remain ahead of the US rate hike increased the repo rate to reduce the impact on the rand and to minimise the subsequent impact on inflation.

Since South Africa is currently facing a current account deficit, it is reliant on foreign investment to boost capital inflows into the country. If the US raised its interest rates, investment within the US becomes more attractive which means that less investment will take place in South Africa.

Another factor that must be considered is if the US raises its interest rates, debt financing becomes more expensive i.e. the state borrows money that may be denominated in US dollar, this borrowing is now more expensive as a result of the interest rate hike.

The table below illustrates countries vulnerable to rising US interest rates with South Africa likely to be the least affected from the countries presented:

Economies Viewed As Being Vulnerable to Rising US Interest Rates
US FED	Morgan Stanley	Société Générale	UBS	Moody’s
Brazil	Brazil	Brazil	Brazil	Brazil
India	Mexico	Mexico		Chile
Indonesia	Indonesia		Indonesia	Malaysia
Turkey	Turkey	Turkey	Turkey	Turkey
South Africa	South Africa	South Africa	South Africa	South Africa

Source: Federal Reserve, Estado, Moody’s

What the increase in the repo rate means for the economy

Many analysts have advised against a rate increase citing that an increase is going to worsen a very weak economy and there is no need to worry about the interest rate differential in July as the US is expecting to delay its rate hike until December 2015. Needless to say, the increase is upon us and it only makes sense that we revise our budgets accordingly.

Consumers are already under pressure given the rise in the cost of electricity, fuel and food prices (basically increase in the cost of living), the increase in the interest rate means that consumers will have even less disposable income since car, home loan, credit cards and any other form of cost related to borrowing will increase.

The effect on the increase is particularly painful for the lower income earners.

“An increase in interest rates makes the cost of money more expensive and may crowd out private demand, particularly when investments show a significant sensitivity to changes in interest rates. This could lead to a decrease in aggregate demand, both directly through investment and indirectly through a lower wealth effect in the private sector and subsequent lower consumption. However, higher interest rates could also lead to an increase in savings and could attract foreign inflows that could lead to a currency appreciation.”- JC Jordaan, independent researcher (Bureau of Market Research UNISA)

Given that July was marked as national savings month, it is alarming to come across statements like: “A clear indication of the dire state that consumers are finding themselves in is the fact that according to Standard Bank, South Africans are among the worst savers in the world.” The increase in repo rate does not bode well for savings.

In light of this, there is a likelihood that banks will once again tighten their lending policies.

The interest rate hike is also favourable for investors who will enjoy a better interest rate or return on their capital. However, the tax man must not be forgotten. Increase in interest income may push investors over the interest-free bracket of R21 000. It may therefore be necessary to revisit the tax structuring of investments. It also makes the tax-free saving accounts very attractive.

Natasha Bhowani Seeth- CA (SA)