The welcome indication from the SA Reserve Bank (Sarb) last week that there is a possibility of a cut in interest rates was overshadowed by the news of attacks on two oil tankers off the coast of Iran, which saw the oil price jump, as well as the continued weakness of the rand.
The interest rate on the one side, and oil prices and the exchange rate on the other, are forever important for SA consumers. While a reduction in interest rates will put a bit of extra money in our pockets, the possibility of yet another fuel price increase will take it out again.
Just more than 10 years ago, when oil prices surged to above $100 per barrel, an American stockbroker published an interesting report that compared the effects of increases in the fuel price and interest rates on the US economy.
The study concluded that an increase of $1 in the price of a gallon of fuel would have the same effect as a certain increase in interest rates. In other words, an increase in fuel prices could be viewed very much as contractionary monetary policy.
Locally, Thebe Securities repeated the exercise and booked flights to present their findings to asset managers in Cape Town. Their conclusion was that certain consumer shares would be affected by fuel prices as much as by interest rates.
The calculations are quite simple and an update of the figures still yields interesting results.
The effect of a change in interest rates on the economy can be calculated using figures published by the Sarb. The latest summary of banking sector statistics (as at the end of April 2019) shows that banks’ total outstanding loans amounted to R4 251 billion. This includes R1 002 billion in home loans, R983 billion in term loans, R426 billion in lease and instalment loans and R362 billion in overdrafts and credit cards, among other loan types.
Interest rates down, disposable income up
A decrease of 50 basis points in interest rates would reduce the annual interest to be paid on the aggregate debt by just less than R21.3 billion, or nearly R1.8 billion per month. This translates to an increase of R1.8 billion in disposable income every month – money that consumers can spend on pizza, beer, shoes and clothes.
If the Sarb cuts the repo rate by 25 points at the next meeting of its Monetary Policy Committee – reversing the hike of November 2018 to take the prime rate back to 10% from the current 10.25% – it would stimulate the economy to the tune of around R900 million per month.
This translates to an extra R10 billion that could potentially flow through the economy over the next year to bolster demand for products, which creates opportunities for businesses to increase production and employ more people. Economists will be quick to point out that the effect would be much larger than the nominal R10 billion through the multiplier effect as each transaction in the economy leads to another.
Neutralising effect
Unfortunately, increasing petrol prices neutralises the positive effect of lower interest rates by far. According to the SA Petroleum Industry Association (Sapia) motorists use around 11.2 billion litres of petrol and 12.1 million litres of diesel per annum. Every R1 increase in fuel prices increases the monthly spend on fuel by more than R1.9 billion.
In a nutshell: an increase of 38c per litre in the price of fuel has the same effect on citizens’ aggregate disposable income as a change of 25 points in interest rates.
The monthly petrol price increases in SA since the beginning of the year amount to a moderate R1.57 per litre, largely due to the big decrease in the petrol price at the beginning of January after prices spiked at the end of 2018. Similarly, the cumulative increase in the diesel price in the year to date is only 54c per litre, limited by the decrease of R1.55 per litre in January.
Nevertheless, the moderate increase in the fuel price has claimed an additional R12 billion of spending in the economy in the first six months of the year, or R2 billion per month. This would equate to an increase in interest rates of just more than 50 basis points.
Applying the same methodology on an individual household would show the same trend, although the figures would differ in line with how much people drive and how much debt the household has.
According to two different home loan originators, the average mortgage bond is just less than R1 million. Wesbank says the average loan for a new car is R300 000 and for a used car around R180 000.
Add some credit cards or a personal loan, and it’s possible that a middle class family has debt of around R1.4 million. At current interest rates for home loans, instalment finance agreements and personal debt, the annual interest charges can amount to nearly R157 000, or R13 000 per month. The monthly repayments are obviously much higher when including capital repayments.
A decrease in the prime lending rate from 10.25% to 9.75% would reduce interest charges on this debt to R149 750 per year or R12 480 per month.
Swings and roundabouts
The saving of R520 in interest every month if interest rates fall by 50 basis points would be very welcome, but would bring little relief if fuel prices keep on increasing.
This calls for more assumptions, such as the distance people drive every year and their vehicles’ fuel economy. The South African Revenue Service (Sars) works on an average of 30 000 kilometres per annum for personal travel for tax purposes, and the second-hand car industry uses a similar figure to determine the value of used cars.
A family with two vehicles can use around 365 litres of fuel per month (assuming 30 000km per annum on one vehicle and 15 000km on the other at 10 litres per 100km). The change in the petrol price since January would have increased the household’s fuel cost by R570 a month – more than the benefit of a relatively big fall of 50 basis points in the interest rate.
The economists at the Sarb would be quick to point out that they make provision for fuel price increases in their models – and that monetary authorities have control over interest rates, but not over the oil price or exchange rate.
We therefore need to hope that the tanker incidents in the Middle East do not escalate into a new war and that the oil price resumes its downward trend of the last few months. More importantly, we need to hope that the rand reverses its trend of the last few months and strengthens from the current R14.81 per dollar. And that the Sarb does cut the repo rate.
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