With the Medium-Term Budget Policy Statement due to be presented next week by Minister of Finance Enoch Godongwana, it is worth unpacking how possible such a move is.
The recent view expressed by Minister of Energy and Petroleum Resources Gwede Mantashe on what should be the correct price for fuel in South Africa would come as a welcome reprieve for consumers. He was quoted as suggesting that fuel prices should be 30% lower than the current price.
The view is even more encouraging when considering that our country’s lowest earners tend to spend between 30% and 40% of their income on transportation costs alone (even more when considering indirect transport costs). In this article I contextualise this, given how much is spent on travel relative to the national minimum wage of between R4,500 and R5,000 per month and the relative comparison to receiving a social grant.
With the Medium-Term Budget Policy Statement due to be presented next week by Minister of Finance Enoch Godongwana, it is perhaps worth unpacking how possible such a move is.
At some stage during the post-Covid-19 economic recovery and Eastern European conflict, the world experienced a significant rise in the price of Brent crude. This was a key driver of the subsequent inflation bubble, the full effects of which have only recently abated. For the context of this article, I ignore other inflationary pressures that were a result of supply chain issues and post pandemic pent-up demand.
Contextualised inflationary effects of rising transport costs (i.e. from fuel)
The price for Brent crude averaged $100 per barrel in 2022, up from a $70 per barrel average price the year before. The year-on-year rise peaked at nearly 80% in May 2022. During the six months of peak Brent crude pricing, the average year-on-year rise was about 55%.
The significance of this is the overall impact on producers and consumers alike in the form of input costs for the former, and consumption costs for the latter. The cost pressures pass through in food prices, the second largest cost item for lower Living Standard Measure consumers.
To put this into perspective, a 55% rise in the price of fuel would add about 220 basis points to headline inflation given that fuel makes up about 4% of the inflation basket. For example, core inflation, which excludes food and fuel, of 6% would translate into 8.2% headline inflation including fuel and excluding food. A similar scenario would be true for the food inflationary impact from higher Brent crude pricing as petrol in an important input cost.
This is among the reasons why there has been societal backlash on food pricing given that the currency has been stronger and petrol prices lower of late, questioning the existing pass-through mechanisms, but that is a discussion for another day to properly assess the intricate dynamics at play.
Mitigating inflationary impulse of rising Brent crude prices
For illustration purposes, there was a specific non-oil producing country that mitigated relatively well against the full effects of higher Brent crude pricing on fuel, which was the US (there may have been others). The US had sufficient internal fuel capacity (from oil reserves and fracking) to offset global fuel supply dynamics and mitigate against the full effect of rising fuel prices. This occurred at a time when the dollar was relatively strong, which would have been another cushioning effect.
In 2022, South Africa experienced elevated Brent crude pricing given higher oil prices compounded by a weak currency – Brent crude was at an average price of R1,648/barrel that year. Currency dynamics are among the reasons many argue that improved South Africa-specific sentiment, which is positive for the rand-dollar exchange rate, at the very least mitigates against higher Brent crude pricing.
For example, with the price of Brent crude currently at $80 and the currency at R17.40 against the dollar, the price of Brent crude in rand is R1,372. Had the rand been weaker, for example at R19 against the dollar, then the price of Brent crude in rand would be 10% higher at R1,520.
This is why we continue to argue that a strong rand is good for the cost of living in South Africa. The government should remain cognisant of this in respect of the drivers of sentiment. Although this article is primarily concerned with the direct costs of transport, it may be worth contextualising the indirect costs.
The situation is much more concerning when considering the indirect costs of transport (i.e. long commutes and the cost of “distance” and “time”) which, according to a 2022 working paper published by K Shah and F Sturzenegger of Harvard University, found that transport costs can make up 85% of after-tax income for low LSM households in South Africa.
Comparisons can be drawn from an article that appeared in The Wall Street Journal which investigates both the individual and societal implications of these indirect costs of transport, primarily from a lost productivity perspective.
Inflationary impacts on incomes and willingness to work
With a minimum wage of between R4,500 and R5,000 a month, and an estimation that up to 40% of income is spent on transportation, this means that the lowest earners in South Africa could be spending between R180 and R200 more per month (4% to 4.5% of income) on fuel if transport costs were 10% higher, as per the example above. This would erode the expenditure basket for other necessities such as food.
Those eligible for social grants may be less willing or less incentivised to work when 34% and 30-40% of income is spent on food and transport, respectively. Spending on transport for a minimum wage of R4,500 equates to R1,800. This implies that it may be relatively more affordable to stay at home for a certain level of grant, which can lead to a more limited “incentive to work”.
Those who are not eligible for social grants would have a relatively higher “incentive to work” and a willingness to work despite comparably lower wages. Lower fuel prices, as experienced of late, may go some way in incentivising work.
The idea introduced is the concept of the reservation wage, which is the lowest wage at which a worker is willing to accept a job, which would be linked to the level of the national minimum wage and the level of social grants.
How fuel price reductions may potentially work
The Medium-Term Budget Policy Statement does not typically include changes to South Africa’s tax framework, but other information presented can give some indication on how possible a 30% reduction in fuel prices is.
There are two main mechanisms that can be used to reduce the fuel price that are within the control of the government. These include the Road Accident Fund (RAF) levy and the general fuel price levy.
Changes to these imply that the government would have to find alternative sources of revenue. At this point, one alternative source of revenue, which isn’t a direct alternative, is the National Treasury being in a position to adjust revenue projections upwards as a function of improving economic fundamentals and better growth outcomes due to the improvement in energy security and logistics.
Increased economic growth should lead to higher tax revenue collection, which could offset the reductions in the RAF and general fuel price levy. The other effect of reducing the RAF and general fuel price levy would be the increase of disposable income to enable spending on other goods and services (some portions of the RAF and general fuel price levy could find their way back to the fiscus through VAT and other consumption taxes).
The recent performance of our bonds suggests that the government may have lower interest expenditure as a percentage of government revenue, which could equally fund RAF and general fuel price levy shortfalls.
The effect of sentiment on the currency
The fundamentals of most currencies are driven by dynamics such as, among others, investor sentiment and capital flows, business confidence and consumer confidence, all underpinned by stability, economic and foreign policy and economic policy certainty and property rights.
Sentiment around the Government of National Unity (GNU) has largely explained movements in the rand (and our bond yields) as a function of reduced political risk and improving energy security and logistics. According to our estimates, if the rand trades closer to R17.50, that suggests that South Africa-specific risks have largely dissipated (the rand is trading around fair value), and further currency strength will be driven by increasing structural recovery momentum, a cyclical recovery and higher GDP growth.
Until we see the actual performance of the GNU, this remains to a certain extent an intangible speculative bet on South Africa. But the general optimism is clear evidence that most are on the side of its success. Success will be defined by the delivery of services and performance of the government.
A trend reversal in the rand-dollar exchange rate would be problematic for most economic forecasts, hence the importance of translating sentiment, confidence as well as economic and foreign policy into tangible results.
The ultimate driver of improved sentiment
The government (and the South African Reserve Bank) should remain cognisant that while current currency dynamics are a reprieve, underlying demand is an issue in South Africa. Since 2010 (excluding 2020 and 2021), growth in real household demand has averaged about 2% in comparison with 4.5% growth in real household demand between 1994 and 2008 (pre-global financial crisis).
Though the 30% reduction is applaudable, public transport systems such as trains are well understood to be more efficient and affordable. This would go some way in solving demand as incomes are less eroded by transport costs. This should also improve people’s willingness to work as the net benefit is higher.
But without economic growth and higher household spending, the view expressed by Mantashe can only be funded through reductions in expenditure in other line items.
In conclusion, the best cushion for protection against volatile Brent crude price movement remains building our internal capacity and putting South Africa on a firmer economic path through major reforms (some of which are already under way).
The government should keep track of Brent crude price movements and replenish our strategic oil reserves when prices are sufficiently low. This would be like the US, which replenished stocks when the price was sufficiently low and affordable.
The Africa Continental Free Trade Agreement should equally enable South Africa to access Brent crude at more favourable pricing from the likes of Nigeria.
In addition to these more permanent interventions, the funding should be covered by better growth outcomes and the implied increased consumption expenditure due to low taxes at the petrol pump.
One other suggestion is solving for the spatial disparities in South Africa that keep many far from economic opportunities, which has a direct and indirect cost on transportation, and ultimately productivity and the willingness to work. DM