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We all know about S&P's decision to downgrade SA's sovereign debt to "junk status" following President Jacob Zuma's Gupta inspired cabinet reshuffle which included the removal of Finance Minister Pravin Gordhan (the one man willing to stand up against the Zuma and his Gupta pals plundering of state resources). So a covered in our previous article the downgrade sets of a chain reaction and part of this chain reaction is a weaker exchange rate as weaker growth is expected in countries that are downgraded to "junk status". The question is how this will impact on our import prices? Will SA be "importing inflation", and if so what will the impact be on the local inflation rate, and therefore interest rates in South Africa.
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How significant is SA's import inflation currently?
Before discussing the possible impact a weaker exchange rate could possibly have on South Africa's import prices one has to answer the question as to what the current rate of inflation is of goods being imported into South Africa? The graphic below will take a look at overall import inflation as well as highlighting a few of the main import inflation categories. Note the graphics are based on SA's import and export Unit Values as published by Statistics South Africa.
The graphic above shows a line chart reflecting the year on year import prices of All Items, Crude Petroleum and General Purpose Machinery into South Africa. Crude Petroleum and General Purpose Machinery are two of the biggest categories of items being imported in South Africa while the All Items category is the general rate of inflation of all items being imported in South Africa.
As the graphic shows the overall level of imported inflation has been in negative territory for a few months now, largely thanks to the negative price growth experienced in Crude Petroleum and General Purpose Machinery. Large depreciations in SA's exchange rate (see dashed red line increases in 2015) against all currencies (and in particular the US Dollar) has not lead to massive increases in imported inflation during 2015 and early 2016. But this is in main due to massive declines in the price paid for crude oil imports, thanks to very low international crude oil prices. But in recent months crude oil prices has started increasing slightly.
As the graphic shows the overall level of imported inflation has been in negative territory for a few months now, largely thanks to the negative price growth experienced in Crude Petroleum and General Purpose Machinery. Large depreciations in SA's exchange rate (see dashed red line increases in 2015) against all currencies (and in particular the US Dollar) has not lead to massive increases in imported inflation during 2015 and early 2016. But this is in main due to massive declines in the price paid for crude oil imports, thanks to very low international crude oil prices. But in recent months crude oil prices has started increasing slightly.
The problem South Africa now faces is a continued weak exchange rate due to the ratings downgrade to "junk status". And should international crude oil prices start to increase, that combined with the weak exchange rate should see SA paying a lot more for it's crude oil imports and this will push fuel prices in SA up, which would push up transport costs (as well as the cost of farming, think all the machinery using petrol and diesel) and that will ultimately push up food prices for consumers.
The same holds true for machinery and vehicles imported into South Africa. Even if their prices in Dollars/Euro's remain exactly the same, a 10% depreciation in the exchange rate should see these items becoming 10% more expensive to import into South Africa. And higher costs of production will lead to higher retail costs (as producers look to offest higher costs onto consumers). In the end South African consumers will have to bear the brunt of increased import costs.
The same holds true for machinery and vehicles imported into South Africa. Even if their prices in Dollars/Euro's remain exactly the same, a 10% depreciation in the exchange rate should see these items becoming 10% more expensive to import into South Africa. And higher costs of production will lead to higher retail costs (as producers look to offest higher costs onto consumers). In the end South African consumers will have to bear the brunt of increased import costs.
Increased import costs, will lead to higher levels of inflation as producers and retailers try and pass on the cost of increased imports onto consumers. The Reserve Bank (SARB) who's mandate is to ensure inflation ranges between the 3% to 6% range will look to curb increased inflation by increasing interest rates (which will crub consumers spending and slow economic growth). Lower spending by consumers will mean goods move out of retail and wholesale stores slower. And retailers and wholesalers will then start decreasing prices in order to move their products fasters. But this has an impact on their profit margins, and investors and shareholders will put pressure on retailers and wholesalers to maintain their profit margins. And since increased import costs pushes up these companies operating costs, they will look to cut expenses elsewhere. And easiest way to do this is to retrench staff, since staff makes up a large portion of companies total expenditure.
The relationship between unemployment rate and inflation is often mapped/measured using the Phillips curve (see SA's Phillips Curve here).
From the above it is clear that increased import inflation does not only have an impact on producers inflation, but that this feeds through to consumers which in turn leads to reactions from SARB which impacts consumers again, and this in turn has a negative impact on producers and retailers and their reaction by cutting costs (including staff) has a negative impact on consumers again.
The ulitmate loser is the economy (as growth will slow due to lower spending and cost cutting by businesses) and it's people (as prices will be higher, interest rates will be higher and unemployment will be higher) while the economic growth will be slower.
The relationship between unemployment rate and inflation is often mapped/measured using the Phillips curve (see SA's Phillips Curve here).
From the above it is clear that increased import inflation does not only have an impact on producers inflation, but that this feeds through to consumers which in turn leads to reactions from SARB which impacts consumers again, and this in turn has a negative impact on producers and retailers and their reaction by cutting costs (including staff) has a negative impact on consumers again.
The ulitmate loser is the economy (as growth will slow due to lower spending and cost cutting by businesses) and it's people (as prices will be higher, interest rates will be higher and unemployment will be higher) while the economic growth will be slower.