KEY POINTS
- The South African rand dropped by over 0.5% on October 21, 2024, against major currencies, sparking investor concern.
- This decline comes as inflation data is expected, with inflation currently sitting above the South African Reserve Bank’s target range of 3-6%.
- Investors are bracing for potential interest rate hikes if inflation continues to rise, which would impact borrowing costs and foreign investment flows.
The recent decline in the South African rand against other currencies has investors waiting for the country’s inflation figures. As per the report published by Reuters, the rand declined by more than 0.5% to October 21, 2024, and the speculation of inflation may lead to an increase in the interest rates by SARB. This recent development could therefore be a major boost to South Africa, an economy that has for a long time been grappling with inflation and economic instability to mention but a few.
South Africa’s inflation history
For South Africa, inflation has always been high in the past, with factors such as currency devaluation, increasing global oil price, and political and economic turmoil in the country contributing to the general inflation rates. The inflation targeting policy of the South African Reserve Bank has set an inflation rate target of 3%- 6%.
However, sustaining this target has been difficult, particularly in the past few years because of global factors such as the COVID-19 pandemic, the war in Ukraine, and local factors such as power outages.
Inflation in South Africa has been above the SARB’s target range for the past few months due to some reasons. Higher fuel costs, the effect of the weaker rand on the price of imported goods, and the availability of energy from the troubled state utility Eskom have all contributed. South African consumers are already bearing the brunt of the high costs, and if inflation is to go higher then the citizens will suffer.
Impact on foreign investment
Inflation data is therefore important for foreign investors. High inflation reduces the prospect of returns on investment in South Africa especially when the rand the currency of the country is weak. Though higher interest rates can mobilize short-term funds for bonds and other instruments they are a sign of instability and therefore can deter FDI.
This recent drop in the rand shows that South Africa has a problem – attracting and maintaining foreign investment. Market participants will probably be more careful as inflation figures are published and the threat of a rise in interest rates arises. This can lead to higher inflation and interest rates which can have the effect of a higher cost of doing business in South Africa and hence a negative effect on the overall economic growth and investment.
Consequences for the broader economy
The South African economy has been struggling for several years with a high unemployment rate, high levels of inequality, and low economic growth rate. These are compounded by the increasing inflation and a declining currency value as a major challenge. Higher inflation erodes the purchasing power of consumers leading to a decrease in the demand for products and services while the cost of production increases especially for imported inputs.
Also, inflation is always a burden to the poor because they are the ones who spend most of their income on necessities such as food and fuel. This could further entrench inequity in inequality in South Africa which is one of the most unequal societies in the world.
If inflation persists in rising, the South African Reserve Bank is likely to act, probably by raising interest rates. But this has its drawbacks. Even though raising rates can curb inflation, it slows down economic activities since borrowing becomes costly for both the consumer and the business. This could slow down growth when South Africa needs it most since unemployment remains rampant and investment levels remain low.
Structural issues and economic reform
As much as inflation and a weak rand can be seen to be some of the problems affecting the South African economy, they are not the only problems. It has always relied on the exportation of raw materials, especially commodities thus is exposed to shifts in the global commodity market. Also, the shortages of energy especially the frequent power outages due to Eskom’s management inefficiencies have further slowed down the economic growth.
For these problems to be solved, South Africa requires structural changes. These are important steps: Firstly, the diversification of the economy beyond the export of commodities; secondly, the restructuring of the energy sector. Besides, the development of education, and infrastructure can contribute to creating a more stable environment for growth and further attract more sustainable types of foreign investments.
The recent decline in the value of the South African rand together with the rising inflation factor also shows the problems of the economy. To curb inflation, the SARB may have to increase interest rates, and this will negatively impact the economy’s growth rate and hinder consumers and businesses from accessing cheap credit facilities.
