The following article by Prof. Chris Harmse (Republished with the kind permission of Dynamic Wealth), makes interesting reading.

From January 2009, South Africa will enter another new era in the measurement of inflation, and this era is likely to have a dramatic impact on South Africa’s inflation rate. This change stems from the proposed reweighting of the goods and services in South Africa’s inflation basket. 

The reweighting exercise happens approximately every five years. The main source of information to perform the reweighting stems from STATSSA’s Income and Expenditure Survey (IES) 2005/06. The aim is to collect information on the spending patterns of South African consumers and then to reflect these changes in the CPI-basket. Although the IES is the main source of information, it is not confined thereto as STATSSA also uses other sources to reweight the CPI basket. 


On the economic growth front, the light at the end of the tunnel is fading quickly. Yes, Eskom has quite a lot to do with it. But so does the economic driving force of the past three years: the middle class. This income group is facing severe financial strain. In addition, world economic growth is slowing. At the same time, the two domestic imbalances in the economy, namely the ever increasing inflation rate and the deficit on the current account may impose a serious threat on financial markets for the rest of the year.   

 Inflation dilemma 

Both CPIX and PPI increased substantially in January and February. CPIX increased sharply to 8.8% in January and again to 9.4% in February. PPI reached 11.1% in February. However, though high increases were expected, both numbers underwent technical adjustments, causing the increase to be sharper than anticipated by the market.

Mr. Tito Mboweni, governor of the South African Reserve Bank, warned the markets on two occasions before the MPC meeting last Thursday that another increase in interest rates in April is inevitable. The reason being his statement at the end of March that if second-round effects are seen to be pushing the CPIX higher, an increase in interest rates will have to be seriously considered. The release of February’s inflation numbers show that this is indeed happening.

Closer investigation into the nature of the inflation pattern over the last two years, however, shows that the MPC made quite a few judgment errors in its interest rate decisions.

The first was by not starting the rate increasing process at their meeting in April 2006 – this is despite indications that CPIX will breach the target band. An even bigger blunder occurred when they failed to increase rates in February and April 2007. Moreover, CPIX already exceeded the 6% level. And inflation expectations also suggested that CPIX will increase continuously for a protracted period.

The nature of the current inflation rate

Interest rate sensitive prices (CPIX minus food and administered prices) which depicts second-round inflation in the clearest possible way increased by 5.7% in February, exactly the same as in January. Though this number did not increase, which is encouraging, it also did not decrease. It however was still within the target band. And as petrol prices for March and April (a year-on-year increase of 37.7%) is likely to push non-interest inflation even higher than the current 13.3%, it will most certainly have an impact on interest rate sensitive prices.

In addition, the proposed electricity tariff increases, will also add its weight to increase the fuel and power category from its current increase of 9% to way above 10%. These changes might see March’s CPIX to increase by around 10%. However, even though Mboweni & co. might be keen to raise interest rates again during the course of the year to stem second-round effects and salary increases, it might be the wrong policy decision, especially as the major proportion of inflation is caused by factors on which interest rates have little if any control.

The demand side of the economy is already cooling at a fast rate. Retail sales grew by 0.2% in January, car sales are still in a shrinking trend, while consumption expenditure on durable goods grew by a mere 2.5% in the fourth quarter. Credit extension to the private sector also started to decrease noticeably from 23% in January to 20.79% in February, while the M3 money supply also subsided strongly from 25.2% in January to 21.07 % in February. Under these conditions, it might be appropriate for Mr. Mboweni to stay put and ride out the current wave of high inflation.

Changing Landscape:  The new basket          

Adding to the debate is the new inflation basket that will be introduced from January 2009. According to STASSA, not only will the number of items in the basket decrease considerably (from 1 124 to 386 excluding health), the weighting of the various categories will be adjusted to reflect the patterns of the IES2005/06. The new weights, which reflect the average proportion of average household income spent on a particular item, will differ substantially from the current weights (based on the IES 2000).

The new weights show significant changes for food and non-alcoholic beverages – down from 27.4% (according to the IES 2000) to only 16.6% in the new basket (IES2005). The second main adjustment is in the weight for transport. It increases from 15.3% to 22.9% and includes the impact of the increases in the petrol price as well as the role of taxi fares not previously included in the basket.

Another large adjustment is in the Medical category. It will now only reflect changes in medicine prices and the cost increases in outpatient treatment. The weight will thus drop from almost 8% to 1.9%. Medical aid contributions, by far the part that has the largest impact on the medical category, will now be classified as insurance, together with housing and vehicle insurance. This is due to lessen transparency on health care increases, especially as insurance will be classified as part of the Miscellaneous category – with a huge combined weighting of 16.5%.

Calculating the impact of the changes

A new CPIX index was constructed to reflect the weights of the IES 2005/06 spending patterns. It must, stated at the outset, that the findings are indicative of trends only as the real weighting to be introduced next year will somewhat differ from the IES 2005/06 weights.

However, a rough calculation based on the IES 2005/06 shows that the CPIX would have been lower than currently reflected – 8.9% vs. 9.4% in February. This shows that the impact of the lower weighting in food prices is bound to be larger than the impact of the larger weight in transport costs.

A further interesting development is the decrease in the weight of housing, water, electricity, gas and other fuels category. According to the IES 2005/06, the weighting of this item will be substantially lower (12.6% vs. 15.85% currently). However, the proposed increases in property taxes which started last year in Cape Town and to be introduced in many other metropolitan areas this year, as well as the impact of higher electricity prices will not be reflected in the new weighting structure. Unless STATSSA makes special provision for these changes, the impact of the huge price increases in these two items on the CPI will thus be smaller than experienced by households.

Impact on interest rates

As the reweighting exercise will probably contribute to a different inflation rate (no matter whether it is higher or lower) than currently measured, the impact thereof should be taken into account by the Reserve Bank’s Monetary Policy Committee. It is uncertain whether the MPC is indeed taking this into account in its decisions as no mention was made thereof in the latest MPC statement.

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