Falling Prices: Gift or Curse?

DEFLATION refers to a sustained fall in the general price levels in a country. Theory restricts the use of the term to when annual inflation falls below zero. The effect of deflation is to increase the real value of money meaning that for every dollar held, one can buy more.

Since late last year when we officially assumed the use of foreign currencies, prices of most commodities have been coming down. Official figures from the CSO show that prices fell by 2,8% in January and 3,1% in February. Indications are that the trend could be the same for March.

This comes as a relief to most locals who believe that this is a correction to fair value after initial exploitative pricing by business. Several valuation theories have been put up with price parity being the most popular. Using this measure, it appears we are gradually approaching regional levels.

The fall in prices, one may say, stems from several factors among them the improved supply of largely foreign goods. This is on the back of depressed incomes. The government –– which is the biggest employer –– and some sections in business are struggling to pay a living wage.

Most salaries below the poverty datum line. The process of dollarisation also contributed to this phenomenon. The ideal situation would have been that the central bank retires the local currency by replacing it with a specific currency. However, this did not happen because the bank does not have the foreign currency, leaving the economy with very little disposable incomes.

While prices have been falling, it appears efforts to raise money and subsequently incomes are hitting a wall. For local business, revenues remain low. Most companies are not producing optimally because of lack of working capital.

They are also facing cutthroat competition from foreign products. Government on the other hand is struggling to mobilise funding. This means that disposable incomes could remain constrained, which will affect consumer demand. To remain competitive, businesses have reviewed prices down.

Falling prices have potentially biting consequences that could prolong the recovery of the economy. In this light, the country potentially faces the danger of being caught in a disinflation spiral; a situation where after a certain level, a fall in prices acts as a disincentive for businesses to invest or produce. This inevitably forces them to reduce wages. This will have a knock–on effect on disposable incomes leading to a further fall in demand, exacerbating further the fall in prices.

In such a situation, falling prices become an indication of ailing economic activity, in particular, demand. If nothing is done to reverse this, there is an underlying risk that companies will go belly up.

Growth theorists suggest that an injection, aimed at increasing the level of spending or disposable income in the economy is needed to break this cycle. Ideally authorities should achieve this by adopting, measures in the form of expansionary monetary and fiscal policies.

However, the Treasury is dry and the Central Bank is at the moment out of the picture. If anything the country is heavily indebted to the tune of nearly US$3 billion. This leaves us with only one alternative; the international community but developments to date have not been encouraging.

If what Sadc approved is anything to go by, we don’t need a lot of money. The body endorsed an $8,3 billion package with $2 billion needed urgently to recapitalise companies and rehabilitate the economy.

Sadly South Africa, the biggest economy in Sadc, has only pledged $30 million over three months, hardly enough to cover our monthly cash budget of $100 million, while the other nations have said in one way or the other that they are incapacitated to help. This is despite them being the biggest underwriters of the GNU.

To put it into perspective, billionaire Warren Buffet spent US$5 billion in Goldman Sachs late last year while our neighbours Mozambique are reported to have raised a similar amount for 2010 tourism related expenditure. This figure is more than double our urgent needs and compared with some of the bailout spending we have witnessed, our requirements become almost negligible.

The recent G20 summit recommended that countries spend at least US$ 2 trillion in bailout money to avert the global recession. Evidently a partnership with one of the big eight countries can easily settle the bill. An example is the Mexicans who once got US$50 billion from the USA after their crisis in the 1990’s.

The biggest question then becomes why we have been failing to get this desperately needed funding.  Instead the IMF has adopted a rather harsh stance that the country will only access funds after settling its arrears. This is despite it being a given that before we can start paying we need to earn and that is the reason we need the assistance in the first place.

Certain conditionalities continue to crop up from all other possible investors and funders including private bodies.  There appears to be some pussyfooting around some of the harsh decisions that have to be made to meet these. These include issues to do with property rights, clearly defined exchange control laws and practices and an oversized civil service that needs to shed a bit of weight. 

Donors are particularly concerned about human rights, something that unfortunately as a nation we have earned a bad reputation.

We need help and we need it badly. While reforms have been made, there is a need to be more radical about removing the “risk image’’ on the country.

The bilateral agreement with the South African businesses is a step in the right direction. However, only a few companies of interest to them stand to get these credit lines.

Whatever concessions that they are trying to get from the bilateral agreement mirror the general concerns of every international investor or donor out there who may have interests in coming in.

There is an apparent need to create conditions that will make the whole economy a safe haven through changes in legislation using these concessions as a basis, and not selective cosmetic touches that favour one group and not the other.

This will in the long haul determine whether we sink or swim and whether incomes improve or fall.