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CIARAN RYAN: Should the Reserve Bank be hiking interest rates? That’s the topic we are discussing today with Adriaan Pask, chief investment officer at PSG Wealth.
Adriaan, we’ve seen one of the largest fuel price increases in history in the past month, and it’s going to ripple through the economy. But these are external shocks caused by the war in the Middle East and supply-chain disruptions.
I guess if you add the weak economic growth, you can see the Reserve Bank is in a tough spot: should it increase interest rates to fight inflation and, in the process, kill any prospect of economic recovery?
Maybe give us some context here, Adriaan. We have inflation building because of these rising fuel prices, yet we have weak growth. How does the Reserve Bank manage this?
ADRIAAN PASK: Yes, it’s a real challenge. Obviously, what we have seen recently is inflation coming down a bit. Looking at the medium- to longer-term picture, the Reserve Bank has signalled a clear shift toward lower inflation targets.
It is no longer working within the 3-6% range with a mid-point of around 4.5%. Instead, it has set a much more stringent target, effectively saying, “We want to average around 3%, nothing higher than that.”
We’ve more or less maintained that inflation level – it moved from 3% to 3.1%. That doesn’t look too material in terms of risks, but obviously this is all looking backward; these are historical numbers.
Given what’s happened with the US, Iran and oil prices, that will inevitably filter through to the broader economy. We’ve already started to see inflation ticking higher, and I think we need to be cautious about what to expect from the next inflation print on 20 May.
CIARAN RYAN: All right. So we are really here talking about supply-driven inflation. These pressures aren’t coming from inside South Africa; they’re coming from outside. Now why is it important to make that distinction?
ADRIAAN PASK: I think it’s really important for people to understand how the traditional theory around interest rates and inflation works, because it is quite a simple exercise in theory.
If you see higher inflation, it suggests the economy is doing really well and you can afford to increase interest rates to curb consumer demand.
That essentially takes money out of consumers’ pockets through higher interest rates, meaning they pay higher debt-servicing costs on their homes and other obligations, etc. In doing so, you slow the economy down to a point where you can manage inflation. But that is all theory.
In practice, the economy is not even growing by 1%. The consumer is driving economic growth. If you look at our economy, roughly two-thirds or more of GDP comes from consumer spending. If the consumer is not doing well, the economy is not doing well.
So you have to be very careful before putting further pressure on consumers who are already under significant strain. That’s the predicament we face, with many now arguing that the economy is not in a strong position.
We are increasing interest rates because the Monetary Policy Committee (MPC) cannot allow inflation to get out of control. It has only one tool – interest rates – to cool demand. But this mainly reduces inflation on the consumer-spending side and does not address supply-side pressures.
Much of the inflation pressure we’ve seen over the medium term is related to input costs, so supply-side factors. Think about the impact of Eskom tariffs and how that has fed into inflation, and now oil prices as well.
So you are really addressing the symptom – yes, we may get lower inflation – but the consumer is under real pressure, and you cannot afford to ignore that because, in the longer term, it can do harm to the economy.
That said, it is the mandate of the Reserve Bank, and the MPC needs to respond when inflation is high. If it does not, we run into other problems.
CIARAN RYAN: All right, Adriaan, let’s put you on the spot. If you were the Reserve Bank at the moment, what would you be doing? Would you be hiking interest rates – and is that the right response?
ADRIAAN PASK: I think the things that would factor into my mind are that, yes, the consumer is already struggling, and yes, if you increase rates, you can make it worse – in fact, you will make it worse.
But in terms of the MPC’s mandate, the committee cannot ignore inflation risks. If there is an expectation that the Reserve Bank will not respond to higher inflation, there are meaningful risks there.
Think about wage negotiations. Higher wages have been a real problem for inflation for a long time, because unions push for higher increases. We can’t really afford that, because it feeds into inflation.
We’ve seen unions agree to more moderate increases, but that has largely been on the back of inflation being under control.
If inflation is not under control, expect unions to come back and say, “You promised us low inflation. That’s not what we’re seeing. We’re going to push for higher wages.” At the same time, foreign investors lose faith, which weakens the currency and leads to further inflation.
So if you don’t respond to inflation early, you risk entrenching medium- to longer-term inflation expectations, which is a bigger risk.
If I were in the MPC’s shoes, I would look at the April inflation print, which is likely to come in around 4% or higher according to some forecasts, and conclude that if it settles at that level, the MPC will have no choice but to respond with interest rate hikes at its 28 May meeting.
That said, there are still important conversations to be had with Treasury around wage expectations and what constitutes reasonable increases. But fundamentally, what we need – and this has been said repeatedly – is structural reform.
There is significant scope to address supply-side inflation pressures by lowering energy costs, reducing logistics costs, and tackling other input costs. That requires lowering regulation, improving the ease of doing business, maintaining competitiveness to drive prices down, and investing in logistics to reduce costs for businesses and consumers.
But those are medium- to longer-term measures. In their absence, we remain in this cycle where the consumer bears the burden of supply-side inflation.
Reluctantly, I am not in the camp that says we should cut rates to stimulate the economy.
The risks on inflation are simply too large. I would like to support the consumer – but not at the cost of more significant risks. Ultimately, the key is reforms, deregulation, and investment to reduce supply-side cost pressures.
CIARAN RYAN: And do you think the regulators are listening to that message? We have administered prices. You’ve mentioned fuel levies; you’ve mentioned Eskom tariff increases. Are there other options that the policymakers have, other than raising interest rates?
ADRIAAN PASK: Well, I think we’ve seen glimpses of cognisance that we’re dealing with supply-side inflation – things like the reduction in the fuel levy in April and May.
That’s a good tactic to say: “Listen, we understand the consumer can’t deal with it; we need to bring prices down. This is something we can do on the supply side.” So the quick fix is there, yes.
If we think back over the past few years in terms of what has been happening with Eskom and the independent power producers, that has been a very positive move because it introduces more supply, a more stable supply, and helps bring energy costs down.
Some of the things we’ve seen at Transnet, such as outsourcing parts of operations at the Durban port, are also positive developments. It does seem like there is awareness of these issues.
A lot of infrastructure spend is also taking place, and those budgets are quite significant. There also seems to be a better relationship with unions. So a lot of this is happening, but it takes time and there is still much work to be done.
Overall, if we compare where we are now versus six or seven years ago, there has been a clear shift.
Previously, there seemed to be little recognition that reforms were needed in logistics, transport, energy, and the broader energy mix. These are now largely accepted priorities.
However, we still need to see the benefits of these reforms materialise over the coming years. For now, it does look like the right plans are in place, but the key is ensuring continuity behind them.
We also know the political landscape has shifted quite a bit in recent years, so the focus needs to be on maintaining policy continuity and ensuring these priorities remain in place going forward.
CIARAN RYAN: All right. Finally, let’s just cycle this back to investors. How should they position themselves at a time like this in terms of their portfolios?
ADRIAAN PASK: Maybe we can briefly touch on spending as well. I think, unfortunately, we’re going into a period where interest rates are going to be higher.
I would be cautious to take on additional debt at this point, especially at prevailing interest rates. Avoid debt if you can.
If you do have to go in that direction, factor in higher costs in the coming months.
From a portfolio-diversification point of view, I think a lot of what we are talking about is positive for the rand, because an MPC that is focused on doing what it needs to achieve signals that it is following its mandate and taking inflation seriously – and that is largely what offshore investors want to see.
Those things are largely positive for the country. That being said, we need to see what the full impact is going to be if you pinch the consumer further, and how that’s going to affect corporate profits.
So, in all likelihood, we will see retail spending come down. Retail is already under pressure, and we have seen many local retailers come under significant strain. So those are areas to be particularly careful of.
We’ve had a strong couple of years from bonds, supported by lower interest rates, which came down by 1% last year. I think it’s likely that much of that will be reversed as inflation comes through higher.
In that environment, bond performance may come under pressure, but you do get higher cash rates coming through.
Money markets are probably going to be more attractive in a higher interest rate environment. Bonds are still offering decent yields, but higher rates could create some pressure there.
In equity markets, it’s about being selective – avoiding highly interest-rate-sensitive sectors and rather focusing on businesses with more earnings persistence and some buffering, that are less sensitive to interest rate moves.
At the end of the day, these are largely tactical shifts. The key fundamentals remain diversification across regions, sectors, and asset classes. Over time, that approach should hold up.
This is all economic noise and, to a certain extent, political noise, but if you stay invested in a well-diversified portfolio across asset classes, you should do fine over time.
CIARAN RYAN: All right. That was Adriaan Pask, chief investment officer at PSG Wealth. We’re going to leave it there. Thanks for your time, Adriaan.
ADRIAAN PASK: Thanks, Ciaran. And thanks to everybody listening. I appreciate it.
Brought to you by PSG Wealth.
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