“It is often precisely because of the tough environment that businesses invest more,” says an analyst

By David Dludla   

Inflation has quickened to multi-decades highs in both developed and emerging economies this year on the back of rising fuel and food prices following the invasion of Ukraine by Russia. The war in Eastern Europe upended global trade routes, cutting off exports to the rest of the world from three key Ukrainian ports. As the war rages on since February, shipping costs and the price of commodities such as steel, coal, fuel and petroleum products, as well as grains like barley, corn and wheat have skyrocketed. 

This is why fuel inflation in South Africa increased by much as 45% at the height of the war, with the price of petrol breaching the R25 mark per litre for the first time in history. Rising consumer inflation which peaked at 7.8% in July has forced the South African Reserve Bank (SARB) to frontload its monetary policy decisions. The central bank has been hiking interest rates more than expected to slow down demand for goods in a bid to tame rising prices. As a result, interest rates in South Africa have increased by a cumulative 275 basis points to 6.25% over the past 12 months. As some economists are forecasting global inflation to rise to 7.2% this year up from 3.4% in 2021, the domestic hiking cycle may be far from over.

The rising cost of living means that consumers have become frugal about their spending habits, prioritising only essential goods and services. But these spending patterns have translated into the corporate world also feeling the pinch of subdued demand amidst the elevated cost of borrowing. Multinational companies with significant largesse have managed to continue ramping up their capital expenditure, but the rising costs have called for revised business strategies and an investment freeze on smaller businesses.

According to the recently released Q2 2022 SME Confidence Index conducted by specialist SME financier, Business Partners Limited, SA small and medium-sized enterprises (SMEs) confidence levels took a dip at the height of the war. At least 88% of SMEs surveyed were affected by the interest rate hikes during the first half of the year, with 59% noting that their businesses were negatively impacted by consumers spending less as they cut back on non-essentials. Record high petrol prices saw 89% of SMEs surveyed feeling the crunch, confirming that the hikes directly affected their businesses. 

The upward trend of inflation has also affected housing prices tremendously. House prices in South Africa have been growing every month, with house price growth averaging 2.5% in 2020 before rising by 4.2% in 2021, the biggest increase in five years. Much of this was due to rising fuel prices, and food inflation as a result of supply line disruption. All this has made investment decisions a complicated mission in light of slowing economic growth, with a global recession now forecast in the first half of 2023. However, the impact of rising inflation is not uniform. 

While consumer spending is likely to remain under some pressure, the SARB forecasts a substantial increase in total fixed investment spending as, among other things, private electricity projects ramp up. Nedbank’s tracker of new CAPEX projects shows announcements to the value of R267 billion (annualised) in the first half of the year, up from R214 billion in 2021 and the pre-Covid R138 billion in 2019. Most of these projects are private, including one of the world’s largest green ammonia plants under construction in Coega in the Eastern Cape at an estimated cost of R78 billion. The plant will include its own 3 200MW wind and solar power generating capacity.

One of South Africa’s largest supermarkets, The Pick n Pay Group, has not been discouraged by the economic downturn. In an investor call on 18 October, Pick n Pay chairman Gareth Ackerman said the group will be spending about R4 billion in capital expenditure this financial year alone. “Much of this will be in expanding our infrastructure, with a large investment in our distribution centre. R10bn over four years is a serious commitment to the future of South Africa and our business,” Ackerman said.
 
Izak Odendaal, an investment strategist at Old Mutual Wealth, said there were clearly businesses making big investments in the future even in this tough environment. “Indeed, it is often precisely because of the tough environment that businesses invest more, for instance in more efficient processes. Witness the massive spending on new generation warehouses and distribution centres, for instance,” Odendaal said.

However, there are still other key bottlenecks to be resolved in the South African economy, especially infrastructure. Even with elevated commodity prices, export volumes of mineral products have declined due to inefficiencies in Transnet’s rail and port operations. The Minerals Council of SA recently noted that fixing logistical bottlenecks could raise mining revenues by R150 billion, contributing an additional R27 billion to the fiscus and creating tens of thousands of jobs.  So, inflation and interest rates may somewhat put off business from capital expenditure projects, but the ultimate risk factor lies with the government that does not invest in the ease of doing business.