To understand why more interest rate increases in South Africa (SA) may not effectively combat inflation, one must first understand the broader economic factors that contribute to higher inflation rates in emerging countries when compared with developed nations. According to research conducted by various institutions, including the International Monetary Fund (2018), the World Bank (2021), Alhassan and Biekpe (2020), and our own studies, weak economic fundamentals, political instability, commodity dependence, exchange rate volatility, and the United States (US) dollar surcharge, are major contributors to relatively higher levels of inflation in these countries.

Despite the South African Reserve Bank’s (SARB’s) status as an independent and healthy institution, the country’s poorly-managed state and lack of fiscal discipline negate many of the benefits that a strong central bank may provide. Political instability further exacerbates the issue. Also, as a commodity-dependent country, SA is susceptible to inflationary pressures when global demand for scarce resources increases. Furthermore, with a volatile currency and a reliance on imports, SA is vulnerable to import inflation.

Typically, exchange rate disparities are driven by inflation differentials between countries and a ‘sentiment’ factor, which represents consumers’, businesses’, and investors’ perceptions of a country. In SA, inflation differentials have accounted for nearly 73% of the difference in the USD/ZAR exchange rate since 1980, with sentiment contributing to the remaining 27%. However, sentiment can be volatile in the short term, resulting in exchange rate fluctuations. For example, negative long-term sentiment towards emerging markets, particularly SA, most likely caused the rand to depreciate by 7.75% and 16.42% in 2021 and 2022, respectively, despite having lower inflation rates than the US.

Developed and competitive countries, such as the US, Japan, German, and Switzerland, typically have strong exchange rates owing to lower inflation rates and supportive sentiment, which attract short-term capital for investment in their financial markets. In contrast, countries that are competitive but not developed, such as China, India, Malaysia, and Mexico, may have strong exchange rates in the short term owing to supportive sentiment but weaker rates in the long term owing to higher inflation rates. These countries often attract long-term capital in periods of positive sentiment where the return on investment can more than make up for an underperforming currency in the long term. The SARB’s attempt to attract either short- or long-term capital and support the exchange rate, and thereby inflation, is, therefore, rather futile. Higher real interest rates in SA have been largely ineffective in supporting the rand. Since 2008, while the SARB persistently kept real interest rates higher than those in the US, the rand depreciated more than 125% from R8/$1 to more than R18/$1 in 2023. It even depreciated more than the 96% average depreciation of counterparts such as Brazil, Russia, India, China, Indonesia, and Malaysia, among others. The only ones who have benefitted from higher positive rates in SA are the handful of households with more assets than liabilities.

Finally, there is the US dollar surcharge, whereby the US uses their reserve currency status and their ability to generate excessive demand for globally-traded goods and commodities by using tools such as record-low interest rates, quantitative easing, and large stimulus checks to drive up prices. When inflation eventually occurs in the US, the Federal Reserve will increase interest rates, causing the dollar to appreciate significantly, thus exerting inflationary pressure on emerging countries owing to their declining buying power.

For these reasons, we have consistently cautioned against the rate and the size of the SARB’s interest rate increases. In the past, this blunt tool might have been sufficient to address inflation. But today, where broader economic factors contribute to relatively higher inflation, it is more likely to be ineffective and places an unnecessary burden on a country that is already under severe strain. We agree that price stability is important for a healthy, growing economy, but we believe that the SARB has lost touch with the citizens they serve. Slightly higher inflation with lower interest rates would be easier for most families to stomach.

South Africa (SA) is in a peculiar place. For the first time, in a long time, the ruling party might not remain in power. Since the African National Congress came into power in 1994 many South Africans have started to question the party and their policies. Very few, if any, of the promises that were made almost three decades ago, have come to fruition. Weak, unaccountable leaders have left millions of South Africans wanting and there is simply no more room for excuses. Unfortunately, the prevailing economic policies that have taken root in our politics are insufficient. Although these policies were necessary for social upliftment, they have proven to be insufficient for economic upliftment, that is for long-term sustainable economic growth and job creation.

To create a growth environment where income rises rapidly, and unemployment falls at a similar pace, centralising power can help, although too much of it can lead to more corruption and state capture. But centralising power can only work if it is paired with right-leaning economic policies that create wealth. These policies include effective spending on infrastructure, education, and healthcare, and making it as easy as possible to do business in a country. Ease of doing business includes allowing citizens to contract freely with one another without hindrance or interference, making it easy to hire and fire employees, but also making it easy to start, finance, and sustain businesses. China, and possibly even Saudi Arabia, proved this. But when centralising power is paired with left-leaning social policies that focus more on wealth redistribution, governments fall short. SA has proven this time and again. What we have been left with is a country where citizens are socially free but economically imprisoned. We can vote, but half the population lives in poverty.

It is, however, important to understand that redistributive policies are not necessarily less effective, their outcomes are just vastly different from wealth-creative policies. Right-leaning, wealth-creative economic policies lead to economic freedom (high income and low unemployment), whereas left-leaning, redistributive policies lead to social freedom. Wealth-creative economic policies are the only policies that have been proven to generate a return on investment that is greater than their cost because their rate of return is higher. A good example is effective spending on primary and secondary education. What this does is that it rapidly increases the productivity in a country, this not only fills the skills shortage and makes employees more employable, but also gives citizens the basic tools they need to start their own businesses. Redistributive social policies can help to bring social equality, but because they often do not allocate resources effectively, their rate of return is too low to cover their cost, which ends up reducing the potential and relative size of an economy. This is one of the main reasons why we have record-high levels of unemployment. A simple example: Black economic empowerment (BEE) was effective in allowing more social development and inclusion. But because BEE allowed many candidates to receive jobs they might not have been the best, most productive fit for, inefficiencies entered and reduced the overall potential and size of the economy in the long term. BEE should have been a short-term solution that would later have been substituted with effective government spending, support, and the execution of education.

The answer, however, is not in either/or, but in both/and, because focussing too much on either wealth-creative or redistributive policies cannot lead to a sustainable outcome. Similarly, the answer is not in government, but in public-private relationships. No political party has the proven track record of most corporations in SA, therefore, it is a shame that government has been unwilling to learn more from them. United we stand, divided we fall.

Research by the world’s largest financial institutions seems to support our view that the monetary policy tightening cycle in the United States (US) is approaching its third stage, an economic downturn. We have been expecting this for quite some time and have made the necessary changes to our investment strategies. Usually, when the US sneezes, the rest of the world catches a cold but, in today’s context, an economic downturn in the US will provide the necessary relief to many emerging markets and their currencies. Investors can, therefore, expect a persistently strong equity market in South Africa (SA) and a much stronger rand over the next 12 to 18 months.

The first stage of the monetary policy tightening cycle in the US occurred when markets recognised that the helicopter money provided by the US government produced a spending and inflation overshoot. Markets, consequently, started to price in the upcoming tightening cycle and central banks followed suit with rapid interest rate increases. The second stage occurred as tightening progressed, inflation peaked, and soon started to decline whilst the US economy avoided a more substantial economic contraction. Markets started to price in a soft landing, inflation would be back at 2% within months, and the US Federal Reserve would be able to start cutting interest rates. But, given the current conditions and cause-and-effect relationships, we will, most likely, not see the soft landing that markets have priced in, but an economic downturn; let us not scare everyone and call it what it is, a contraction or a recession.

To get US inflation back down to 2%, wage growth rates need to be cut in half, from their current levels of around 5% to 2.5%. But, for this to happen, household spending must be cut in half, from its persistent levels of around 7% to 3.5%. For this to happen, unemployment needs to be increased by at least 2%. But, to increase unemployment, nominal gross domestic product growth needs to be driven materially below wage growth rates and profit margins need to be compressed enough to produce a 20% decline in earnings. For now, however, the strong labour market is keeping nominal spending too high to slow wages down, which is keeping household incomes too high, which, in turn, is keeping earnings too high. For this reason, a third stage in the tightening cycle, where interest rates remain high or even higher, is more likely. Persistently higher interest rates can then continue to cut into spending and earnings. The funding that companies receive from profits and credit has already started to turn negative, which will eventually cause them to stop hiring. This is an initial indication that we are close to the suggested downturn.

Another favourite indicator used to signal an economic downturn in the US is the diffusion index. This index tracks the divergence of spending on goods versus spending on services. Since 1960, in each of the six prior cases where the diffusion index was negative, there was a contraction in economic growth. Currently, nominal spending on services has grown at a rapid annualised rate of about 6%, whereas real and nominal demand for goods has been on a gradual decline. As a result, the diffusion index has turned negative for the seventh time since 1960. Because spending on services puts upward pressure on employment and wages, inflation will finally be tamed once the contraction does occur and spending is reduced sufficiently.

It is undeniable that South Africa’s (SA’s) economy is in a poor state. But evidence suggests that the rate of deterioration has slowed down considerably. In fact, a strong case can be made to show that the rate of improvement is greater than the rate of deterioration. And, if that is the case, the long-term trajectory is towards a flourishing rather than towards a withering economy, an economy where employment income and life expectancies increase rather than decrease. It is, however, important to understand that a cancerous economy does not get healthy overnight: Monetary and credit cycles, as well as internal cycles of conflict, take many decades to play out. Unfortunately, while many things are looking dire, too many South Africans fixate on the immediate and miss the important structural shifts that have changed our long-term trajectory.

When Jacob Zuma took office, it took him more than a full term to consolidate power and to sow the seeds of corruption, which eventually accumulated into, among others, state capture. But when Cyril Ramaphosa took over in 2019, another shift occurred. Not only did we now have a leader who understood wealth creation, rather than merely living off of the rents of others, but also one with fewer skeletons in his closet. Please bear in mind that perfect “hero leaders” only exist in fairy tales. When we refer to “President Ramaphosa”, we are using this as a collective term for everyone who supports him and his policies.

The next big shift was to build on the work done by the Public Protector who helped us to get rid of Zuma. Ramaphosa (the collective term) cleverly used different independent inquiries to stop the rapid rate of spreading corruption. It started with exposing the Guptas and all those involved with state capture. Later, many heads rolled: Gigaba, Nene, and even Magashule. Afterwards, Zuma ended up in prison. Even if it was only for a few days, no one really believed that it would ever happen.

Another important structural shift occurred in government finances. The state privatised a poorly run state-owned enterprise (SOE) and reduced its wastage on the rest. To this end, South African Airways was privatised, just like alternative energy sources are now also being privatised. Privatisation, smaller wage increases, and the recent announcement that certain SOEs will not need to procure from black economic empowerment (BEE) suppliers indicate a potential and very important shift away from social upliftment (redistribution policies) towards economic upliftment (wealth-creation policies).

An important underlying social shift also occurred: South Africans have grown tired of social injustice and a poorly performing government. South Africans have not only started to vote accordingly but they have also started to band together across different races. When riots hit the heart of Pretoria, and while the devastating riots in KwaZulu-Natal were underway, it was not merely the police that jumped in but South Africans from all races. Although racism is still a very real problem, doing something about a poorly run government and widespread corruption, that is costing lives and livelihoods, has become a point of agreement and co-operation among South Africans.

Of course, much more work is still needed. Leaders in the public and private spheres must be held accountable. Destructive redistributive policies, like BEE, and the protection of employees at the cost of employers, must be better aligned with economic development goals. Government spending on education and healthcare must be improved, and spending on economic upliftment must be increased. But what is clear is that a growing remnant remains in SA that has helped to shift the economy onto the correct trajectory.