Deflation – sounds good …is it?

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Decoding the complexities of inflation

It may sound odd, but the world needs inflation. Here in South Africa we don’t have that problem, we’re always trying to keep ours under control, but we are largely at the mercy of the price of our imports, especially oil. The well-above-average Eskom increases in previous years didn’t help (what the hell did they do with that money?) Our inflation is currently at 5.2% – thanks to the oil price. You can bet that the government is going to use that as an excuse to bump up the fuel levy, yet again. That’s okay right? We all need better roads and they can always use it to replace the e-tolls. Not so fast – those funds aren’t ‘ring-fenced’ (a financial term where revenues can only be used for a specific purpose) but goes into that great big trough called National Treasury (the National Revenue Fund to be exact). You know, the pot they used to pay for Nkandla from. Sigh. So you thought the fuel levy was the only tax? Nope there’s Petroleum products levy , Pump rounding, An incremental inland transport recovery levy, Customs duty collection, Demand side management levy, The Road Accident Fund charge and Fuel Tax. Talk about a cash cow! Note that all these taxes are a fixed Rand/cents amount per Litre and not linked to the price.

Inflation in the West has been under control for a decade now, with the target being 2%. The major European economies are now below that and the PIGS are all in deflation (negative inflation). Japan spent a decade crawling back from deflation, and that is where the worry comes from. Japan is now slipping dangerously close to deflation again, and China is down at 2% (it’s target is 4%).

Why is it bad? If there is a belief that money made today will be worth less tomorrow , investment stops – stifling supply. Consumers also then believe that goods will be cheaper tomorrow – so they stop buying. The economy stalls, warehouses build up with stock that can’t be moved. Central banks can’t raise interest rates, and already there are countries in Europe with negative interest rates! Wages, incomes, and salaries stall. Debts become more expensive to service. Because companies find it difficult to cut wages, (it would be very difficult here) they are more likely to lay off staff.

Here in South Africa we’re running at 75% debt to disposable income. If wage increases slow it becomes more difficult to service that debt. It will be interesting to watch the ‘collective’ (unionised) wage increase demands this year, especially in the resource sector. The big mines cannot just switch them on and off at will, or downsize. It’s often all or nothing. Retrenchments in the sector are looking increasingly likely. Glencore has already signalled it will be closing mines.

The threat of deflation has (largely) been created by the massive drop in the oil price. The importers (like us) are celebrating, at the expense of the producers, but that joy may be short-lived if it pushes Europe into recession.

So what does it mean to the average South African? The lower oil price is putting more money in your pocket. Don’t fritter it away, pay down debt, starting with the most expensive – usually personal loans and credit cards. If you want a significant pay rise anytime soon, you’re not going to get it from a dramatically improved economy or inflation, only from significant up-skilling.

‘Bracket creep’ is when the government allows inflation to push you into a higher tax bracket without having to do anything. As inflation drops, and those salary increases drop, their revenue doesn’t keep up with their voracious appetite. It’s highly likely we are going to see ‘actual’ personal tax increases this year (for the first time since 2002, when it was dropped from 42%, During the 80’s it was at 50%), as SARS runs out of ‘efficiencies’ ( getting more tax out of us poor mugs) and the other government departments continue to spend out of control. The inclusion rate of CGT was increased from 25% to 33% in 2013, and this might be increased yet again. This is perceived as a ‘fat cat’ tax, so is unlikely to get much political flack.

Actions: Use your fuel price windfall to get rid of expensive debt once and for all. Structure your short and medium term investments to anticipate market volatility. Start that emergency fund if you haven’t already.

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Author Dawn Ridler 

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