Relative and real – the price of goods, services and the rand

30 Jul 2020

Professor Brian Kantor

Investec Wealth & Investment

In goods and services as well as in currencies, it’s the relative price that matters.

When it comes to prices, what matters is whether a good or service has become relatively more or less expensive, rather than the absolute price. Relative prices can change a great deal even as prices in general rise consistently or remain largely unchanged.
 
For example, the prices of food and non-alcoholic beverages in SA have risen much faster than the price of clothing. Since 1980, the prices of the goods and services bought by consumers have risen on average (weighted by their importance to household budget) by 31 times. Clothing and footwear prices are up a mere 8 times over the same 40 years. And food prices have increased 43 times since 1980, making food about 5.4 times more expensive than clothes.
Consumption of goods and services
LHS: Deflators for different categories (1980 = 100)
RHS: Multiple increases (1980 – 2019)

Consumption of goods and services graph
Source: SA Reserve Bank Quarterly Bulletin, Investec Wealth & Investment
Inflation rates:  All consumption goods and services, food and beverages, clothing and footwear (2010 – 2019)
 
Inflation rates:  All consumption goods and services, food and beverages, clothing and footwear (2010 – 2019)
Source: SA Reserve Bank Quarterly Bulletin, Investec Wealth & Investment
Other relative price movements are worth noting.  Over the 10 years 2010 to 2019, furnishings and household equipment became 20% cheaper in a relative sense, while education has become 25% more expensive. Utilities consumed by households (water, electricity) have increased by only 6% more than the average consumer good.  Health services (surprisingly perhaps) have only become 3% more costly in a relative sense. More powerful pharmaceuticals and less invasive surgical procedures may well have compensated for these above average charges. Communication services have become about 37% cheaper in a relative sense, helped of course by the price of many a phone call falling to zero.
Relative prices (individual price deflators / consumption goods deflator) (2010 = 1)
 
Relative prices (individual price deflators / consumption goods deflator)
Source: SA Reserve Bank Quarterly Bulletin, Investec Wealth & Investment
Businesses that serve consumers (retailers and service providers) are likely to flourish when passing on declining real prices. Producers are likely to suffer declining profitability as the prices they are able to charge decline, relative to the costs they incur.
 
It will be the changing supply side forces that will dominate real price trends. Temporary surges of demand in response to changes in tastes that force real prices higher will tend to be competed away. Constantly improving intellectual property or technology can give producers the opportunity to consistently offer competitive real prices, yet sustain profit margins and returns on capital to fund their growth.
 
The dominance of China in manufacturing has been an important supply side force acting on real prices, for example on the real prices of clothing, household furnishings, equipment and communication hardware. Having to compete with lower real prices has decimated established manufacturers everywhere, including in SA though often to the benefit of consumers.
 
Predictably low inflation makes for more easily detected real price signals that consumers and producers should respond to. Unpredictable inflation rates make it harder for businesses to separate the real forces acting on prices from what is merely more inflation, common to all buyers and sellers.
 
There is however one important real price that shows no sign of stabilising. That is real value of the rand, in other words the rand after it has been adjusted for differences in SA inflation and inflation of our trading partners. The real, trade-weighted rand is now about 30% below its purchasing power parity level. SA producers exporting or competing with imports must hope that it stays as competitive, but there would be no reason to expect it to stay so. It is an important real price given that imports and exports are equivalent to 60% of SA GDP.
 
The real value of the rand moves in almost perfect synch with the market rates of exchange, which tend to be highly variable. The real and the nominal rand exchange rates have been almost equally variable. The average three month move in the real exchange rate calculated each month since 2010 has been 2.03% with a wide standard deviation of 19.8%.
 
For an economy open to foreign trade, this real exchange rate volatility adds great uncertainty to business decisions. It disturbs the price signals to which businesses must react. Until SA gets a higher degree of exchange rate stability, the price signals will remain highly disturbed, regardless of the inflation rate.
Quarterly percentage movements in the nominal and real traded-weighted rand exchange rate
 
Quarterly percentage movements in the nominal and real traded-weighted rand exchange rate chart
Source: SA Reserve Bank and Investec Wealth & Investment

About the author

Brian Kantor headshot

Prof. Brian Kantor

Economist

Brian Kantor is a member of Investec's Global Investment Strategy Group. He was Head of Strategy at Investec Securities SA 2001-2008 and until recently, Head of Investment Strategy at Investec Wealth & Investment South Africa. Brian is Professor Emeritus of Economics at the University of Cape Town. He holds a B.Com and a B.A. (Hons), both from UCT.

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