21 Aug 2018
CPI outlook: tax increases to boost inflation in an environment of structurally high inflation
With economy sluggish despite previous fiscal stimulus
South Africa has seen inflation moderate substantially over the past year, dropping by 2.6% y/y, and leading to some expectations of an interest rate cut this year. Specifically, CPI inflation exceeded the 3-6% target in 2016 in every month, save one, reaching 7.0% y/y and averaging 6.3% y/y as the rand saw substantial depreciation, and the widespread drought pushed up food price inflation to 12.0% y/y. Rand recovery in 2017 and an improvement in weather conditions in many areas, saw CPI inflation drop down to 4.4% y/y by January 2018, below the midpoint of the inflation target band of 3-6% y/y. Specially, CPI inflation peaked in the recent cycle at 6.7% y/y in December 2016, when food price inflation reached 12.0% y/y, then dropped to below 4.5% y/y as food price inflation moderated to 4.6% y/y (see figures 1, 4, 8 and 9). Indeed, the drop in inflation in January proved greater than anticipated, leading to a reduction in inflation expectations for the year, of a figure close to 4.5% y/y. However, a 1% VAT i crease, to take place from 1st April 2018, was announced the same day, which will add about 0.5% y/y to the CPI inflation rate for the rest of 2018, bringing it back to around 5.0% y/y. Indeed, besides the 1% VAT increase, other increases were announced for ad valorem tax, fuel levies, alcohol and tobacco, while a sugar tax will be instituted. Again, coming in from 1st April, these tax increases will impact inflation for twelve months, from Q2.18 to end of Q1.19, and so elevate the CPI outcome. With CPI inflation likely around 5.0% y/y this year as a consequence, and around 5.5% for next year and over the longer-term, the SARB is unlikely to cut interest rates on this basis. This is particularly due to the SARB basing its interest rate changes on what CPI inflation is likely to be six to twenty four months out, not what it has come out recently at.