Flawed Monetary Policy behind Eskom crisis

By Buddy Wells

Eskom recently applied to NERSA to increase electricity tariffs by a whopping 15% per year over the next 3 years (59% compounded).  Eskom’s major expense driving its need to increase tariffs is the high interest payments on its massive debt of R419 billion.

This massive increase in electricity tariffs is a classic example of cost-push inflation:  The price of electricity increases due to production costs, and these tariff increases in turn push the price of other goods and services up as producers and service providers must make up for the extra costs they incur.

It is important to understand that this kind of cost-push inflation is very different from demand-pull inflation, which occurs when an economy is growing too fast and consumers drive prices up because they have more money to spend.

SA’s inflation currently is mostly cost push, not demand pull, and it is being exacerbated by SA’s shortsighted monetary policy which is based on outdated and limited economic dogma pushed by institutions who do not have our best interests at heart.

As a sovereign country, with its own reserve bank and currency, SA has the ability to prevent cost-push inflation by using the SA Reserve Bank to cheaply fund the supply of energy, goods and services.  The only limit to the SARB’s power to fund increased supply is that increasing the money supply (pumping money into the economy) might increase demand-pull inflation, and we cannot afford to let demand-pull inflation become too high.

However, our inflation currently is historically mild at around 5% and it is mostly cost push (driven by increased costs of electricity, fuel etc), our unemployment is extreme and our economic growth is around 0%, so there is a strong case to be made for increasing SARB investment in supply of energy, goods and services to limit our cost push inflation up to the point when we see demand driven inflation start to increase due to economic growth, higher employment etc.  At this point (when our economy is growing too fast and we experience demand pull inflation) then the SARB and Government can put the brakes on using interest rate hikes, higher bank reserve requirements and tax hikes.

Instead, due to the SARB’s unconstitutional monetary policy framework, the SARB is stupidly trying to limit cost-push inflation caused by inputs like Eskom tariff hikes with rate hikes (an instrument meant only for demand-pull inflation).

Rate hikes do not reduce cost-push inflation, but actually increase it by increasing the cost of borrowing for producers.  Eskom debt is a case in point!

Raising interest rates increases production costs, so producers must raise costs further to break even (more inflation).

Rate hikes simultaneously reduce consumer demand for goods produced.  All of this negatively affects investment appetite.  So we are on a self-inflicted path to lower investment in productive sectors, recession, higher unemployment, ratings downgrades, etc.

The SARB governor recently labeled calls for SARB investment in the productive sector “populist”.  Ironically, his unquestioning commitment to the SARB’s growth killing policies actually strengthens the appeal of populist leaders:

FDR once said, “People who are hungry, people who are out of a job are the stuff of which dictatorships are made”.

The SARB is constitutionally bound and legally empowered by the SARB Act to reduce cost-push inflation like the Eskom tariff hikes by buying out Eskom’s debt up to the point when demand driven inflation becomes an issue.

But because the SARB is committed to stupidly trying to control cost push inflation only with rate hikes, it will instead respond to the Eskom tariff increases by raising interest rates, which reduces demand and economic growth, and increases unemployment and cost push inflation, which in turn will reduce incentive for investment and increase political uncertainties and social turmoil.  All of the above will likely lead to further ratings downgrades, so Government and SOEs will pay more on their debt, which in turn will lead to yet higher cost push inflation as the State and SOE’s raise taxes, electricity tariffs etc to pay off those higher debt costs.  Then because cost push inflation has increased again, the SARB will again keep interest rates unnecessarily high.  Thus the cycle will continue, leading to less and less local production, and an ever-increasing reliance on imports, weakening the Rand further.

All this in the name of “protecting the value of the currency in the interest of balanced and sustainable growth” (the SARB constitutional mandate).

And before you say privatization is the answer.  Privatization of Eskom must lead to Rand depreciation over the long-term as foreign investors will take more profit out than they invest, so the SARB and government should be doing everything in its power to keep electricity production (and profit) in local hands.

The SARB can do this by either buying Government or Eskom bonds or by providing 0% loans to local private energy producers.  Again, demand driven inflation is the only limitation in this regard and we have quite a bit of slack on that rope.

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