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Thoughts on disinflation

James Cumming

With all the attention on Namibia’s 25th independence celebrations and new parliament over, consumers now have to return back to the reality of February’s interest rate hike and years of debt accumulation.

One may argue that lower fuel prices and recent fall in consumer inflation should help rescue them, but we suspect something sinister is rising out of this low inflation, that of a higher real interest rate burden.
Over the last nine months or so, prices of crude oil and most other commodities have fallen significantly. Brent crude traded at US$110 per barrel in June last year, currently it is trading at around US$55 – a drop of 50%. In Namibian dollar terms, Brent crude prices have fallen 43% – muted by the weakening currency. Obviously, lower commodity prices, especially oil and its derivatives, impact input prices on a wide variety of consumer products that lead to a significant fall in inflation.
Namibia is not alone in experiencing this phenomenon, in fact most other countries are experiencing dis-inflation too – a recent report estimates that inflation is below 0.5% in over 70% of the world’s developed markets. And since Namibia is a net importer of consumer goods it will be importing this dis-inflation too.
Furthermore, global interest rates are being held low by central bankers with the hope of stimulating economic activity in order to raise inflation rates and to avoid deflation – which is a central banker’s worst nightmare. In contrast to this, Bank of Namibia’s interest rate decisions are somewhat detached from economic reality – they don’t particularly target inflation like other central banks do. Their main focus is to maintain sufficient foreign reserves to preserve the Rand/Namibian Dollar peg.
This is primarily done through the interest rate mechanism – if foreign reserves are running low (as it has been recently), interest rates are raised to retain more capital within Namibia, rather than having it flow out to South Africa. The 25 basis points rate increase during February was an attempt to stem this outflow of capital from Namibia – so despite the lower inflation, Namibia’s interest rate has risen, contrary to everywhere else in the world. Who gains, and who loses in this situation? We suspect that the net savers or the lenders are now the ultimate winners – lower inflation and rising interest rates means that their real interest earned is now positive (interest earned on money market funds of about 6% less inflation rate of 3.6% gives a positive real interest rate of 2.4%). Six months ago this would have been negative. Banks tend to do better in a rising interest rate environment too.
Using the argument above, you can guess that the borrower is now in an adverse position. The real interest rate on debt has risen (I.e. 10% currently paid on debt less inflation of 3.6% gives 6.4% real interest payments, vs 9.75% interest and 6.1% inflation giving 3.65% real interest rates six months ago). To make matters worse, if the low inflation environment persists – which it seems likely to do – then low inflationary expectations are reinforced which will affect annual salary adjustments, so instead of the usual 9% salary increase, employees will get significantly lower increases. Meaning less real money to service real interest payments.
To conclude, this may be a perfect storm for a highly indebted consumer. Lower annual salary increases coupled with higher real interest rates means that the monthly salary won’t go as far as it used to, and that there will be even less now available for discretionary spending – a bad omen for retailers indeed.

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