Why South Africa's food prices are going up‚ even as world costs are cheaper

Why are South Africans paying so much for food? Increasing prices of electricity and water as well as the weak rand are partly to blame‚ and there is little hope of an improvement anytime soon. Here is an analysis by Christie Viljoen‚ Manager in Financial Risk Manager at KPMG in South Africa.

Data from the Food and Agricultural Organisation (FAO) indicates that world food prices declined by 18.5% last year following marginal declines in the previous two years as well. In contrast‚ Statistics South Africa (StatsSA) measured a 5% increase in the cost of its benchmark food basket during 2015.

For this year‚ the South African Reserve Bank (SARB) said in late-January that local food price inflation is expected to rise to 11% y-o-y (year-on-year) in 2016-Q4 – the highest in five years – from 5.9% y-o-y recorded in December 2015. A significant upward revision in its forecast for food price inflation played a big role in the central bank deciding to raise its benchmark lending rate by 50 bps on January 28 to the highest level in five years.

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El Niño and drought pressure food prices

The SARB attributed a build-up in food price pressures to a depreciation in the value of the rand as well as the impact of El Niño on the local and regional agricultural sector. The South African Weather Service (SAWS) measured an average country-wide rainfall of 403 mm during 2015: at only two-thirds of the long-term average‚ this was the lowest calendar year rainfall reading since the organisation started keeping records more than a century ago.

This level of precipitation will‚ according to the South African government’s Crop Estimates Committee (CEC)‚ result in a near 25% decline in the country’s grain harvest during the 2015/16 agricultural season. Farmers’ organisation Grain SA expects the decline to be even larger due to the lateness of planting in some areas due to a moisture deficit.

Weak rand problematic in face of much-needed grain imports

Meanwhile‚ South Africa will have to import up to half of its grain needs this year‚ which is a big problem considering the recent record-low valuation of the rand. The South African currency has been on the back foot for most of the past three years. The rand closed 2015 almost 35% weaker against the strengthening US dollar as waning demand for the local unit gathered pace during the fourth quarter. Both domestic and international factors have contributed to this deterioration‚ including a weak local economy‚ a slump in international commodity prices‚ and a recent rise in US interest rates. Many economists are also far from positive about the rand’s prospects during 2016 even after the SARB lifted interest rates in January.

Other factors that caused accelerating cost pressures on food production during the second half of 2015:

Following annual adjustments to electricity tariffs in April last year‚ electricity was 13.2% y-o-y more expensive during 2015H2. This is part of a multi-year ramp-up in power tariffs to fund recurring and capital expenditure at Eskom that has seen electricity costs rise by an average of 11.4% p.a. over the past three years. Increases in the cost of piped water has not lagged far behind that of electricity. Commercial water tariffs were on average 8.4% higher during 2013-15. Amongst the highest inflation readings during this period was an 11.5% y-o-y rise during 2015Q4.

The issue of rising labour costs – not necessarily accompanied by productivity gains – is a longstanding challenge for local companies. Non-agricultural remuneration increased by 7% y-o-y during 2015H2 compared to 6.4% y-o-y during the first half of the year and 6.1% y-o-y in the preceding six-month period.

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From a farming perspective‚ the prices of some non-urea fertiliser variants recorded double-digit y-o-y cost increases during the latter part of 2015 as the cost of importing these commodities soared.

Rate of food price inflation might not slow down soon

It is clear that upward pressures on food production costs – and demand factors associated with the current drought – accelerated during the latter part of 2015. However‚ there has so far been only limited pass-through of these production cost pressures to the consumer.

The main reason for this is the weak state of the South African economy and the pressure being felt by households from rising interest rates‚ weak employment creation‚ and generally weak consumer confidence. The result has been that the massive increase in the cost of producing maize‚ wheat and sugar products‚ for example‚ has so far not been passed on to the consumer.

The SARB is clearly of the opinion that local manufacturers‚ wholesalers and retailers will be unable to continue stemming food price inflation‚ with the projected 11% y-o-y rise in food prices during the fourth quarter suggesting the fastest rate of food price inflation since 2011Q4.

- This article was published via Twitter by KPMG in South Africa