Do you know what your inflation is?

27 September 2011

By Ryan Adams, Investment Analyst, Glacier by Sanlam

The most recent inflation rate released by Statistics South Africa (Stats SA) indicated a rise in the Consumer Price Index (CPI) of 5.3% y/y for the period ending August 2011. Have you ever asked yourself the question, “Is that the price increase I experienced over the last year?”, or do you accept that your expenditures have risen commensurately with the published inflation rate? The inflation figure published on a monthly basis is a measure of the rate of change in prices for a pre-determined basket of goods and services.

The CPI basket of goods and services is constructed based on 12 broad categories. There are more sub-categories but for purposes of succinctness I’ll explore only the broader categories (as shown in the table below).

Reference CPI basket

Table 1: Consumer Price Index components and weights, All Items.

	CPI Components	Weights	Year -on - Year % change in prices	Contribution to annual change in CPI
	All Items	100.0%		5.3%
1	Food and Non Alcoholic Beverages	15.7%	7.3%	1.1%
2	Alcoholic Beverages	5.6%	6.1%	0.3%
3	Clothing and Footwear	4.1%	2.7%	0.1%
4	Housing and Utilities	22.6%	6.8%	1.5%
5	Household Contents, Equipment and Maintenance	5.9%	2.1%	0.1%
6	Health	1.5%	5.2%	0.1%
7	Transport	18.8%	5.9%	1.1%
8	Communication	3.2%	-1.9%	-0.1%
9	Recreation and Culture	4.2%	-0.4%	0.0%
10	Education	2.2%	8.6%	0.2%
11	Restaurants and Hotels	2.8%	5.7%	0.2%
12	Miscellaneous Goods and Service	13.6%	4.4%	0.6%

Source: Statistics South Africa, Statistical release P0141.5 (3 February 2009) & INET (y-o-y % change in price); rounding to one decimal point.

Table 1 is the output of the combined ‘All Items’ CPI basket to produce the inflation released monthly. It takes into account the component weights, the year-on-year price changes and the contribution (CPI component weight multiplied by the year-on-year % change in prices) each component has to CPI.

Over the last year the main contributors to CPI came from the Food and Non Alcoholic Beverages, Housing and Utilities and Transport components.

Over the year the rate of inflation for Education was 8.6%, the highest of all the 12 components. However it only contributed 0.2% towards inflation due to its paltry weight of 2.2% in the basket. This may well be different if you are responsible for paying school fees (whether it is for primary, secondary or tertiary studies) because your inflation basket could have a higher weighting to Education which may significantly affect your individual inflation rate.

Food inflation is currently a concern in the economy and expenditure groups with a higher weighting to this component are experiencing higher inflation rates. At the end of August 2011, the rate of inflation for food and non-alcoholic beverages component increased by 7.3% and the corresponding effect would be higher inflation experienced by groups whose expenditure had a higher weighting to this component (lower expenditure groups). Food and Non-Alcoholic Beverages contributed 1.1% towards inflation.

The Housing and Utilities category witnessed a rate of inflation of 6.8% and contributed 1.5% towards inflation for the year ending August 2011. This component saw significant price increases in the sub-categories of Water and other services¹ and Electricity and other fuels¹, rising by 9.2%² and 17.2%² respectively. Going forward electricity price hikes are likely to continue as Eskom have secured a multi-year price increase form NERSA of close to 25% per annum. Although not all households experience the full brunt of the hike, it does add fuel to the inflation fire.

I looked at these three categories to illustrate the importance of considering the weight or importance you place on certain items, as well as the corresponding price rise. The Education category experienced the fastest rise in prices but contributed the least out of the three examined above. Now that we have an understanding of what constitutes and propels inflation in our country currently it is important to understand how your inflation basket compares and the effect this could have on your inflation experience.

Table 2: Expenditure quintiles, weight and annual CPI

	Quintile	Expenditure Bands per annum	Weight	Annual CPI
1	Very Low Expenditure	R0 to R14 564	1.8%	6.4%
2	Low Expenditure	R14 565 to R23 278	3.9%	6.2%
3	Middle Expenditure	R23 278 to R36 755	7.2%	6.1%
4	High Expenditure	R36 756 to R79 152	15.6%	6.2%
5	Very High Expenditure	R79 153 and above	71.6%	5.0%
	Total		100.0%	5.3%

Source: Statistics South Africa, Statistical release P0141.5 & P0141 (3rd Feb 2009 & 21 September 2011); rounding to one decimal point

Table 2 divides households’ expenditure into five equal groups. The cut-off bands are obtained by ranking total annual expenditure of all households in South Africa and selecting households with the highest expenditure as the cut-off point for each quintile. Each quintile is assigned a weight based on the importance of it in the overall CPI basket and a corresponding inflation rate. The data is then combined to calculate the monthly inflation rate. i.e. the ‘very high expenditure’ quintile, where annual expenditure commences at R79 153 has a weighting of roughly 72% in the CPI basket, is much more influential compared to the ‘very low expenditure’ which has a weighting of 1.8%.

From the results we can see that the ‘Very Low Expenditure’ group experienced the fastest rate of inflation compared to the ‘Very High Expenditure’ group which experienced the slowest rate of inflation over the year. This is mainly due to the way their inflation baskets are constructed. The lower expenditure groups have a higher weighting to the food and non-alcoholic beverages³ component and over the year the inflation for this component escalated at a rate of 7.3%, compared to the higher expenditure groups whose weighting to the food and non-alcoholic beverages component was less but offset by higher weights in other components.

How does this impact you?
It is likely that the inflation rate you experience is different from the published data released by Stats SA due to the vagaries of your expenditure patterns compared to that of the published CPI basket. We know that inflation doesn’t only reduce your purchasing power; it reduces the total real return from your investments and savings too. Being cognisant of the fact that your inflation rate might be higher than the published rate can be useful when constructing your investment portfolios. It is important to understand the risk-reward trade off when constructing your portfolio in terms of which asset classes offer you the best prospects of earning inflation beating returns in the long run.

In conclusion I believe it is important for you and your adviser to understand your inflation basket and the main contributors to your inflation so that in the long term your investments are able to generate sufficient inflation beating returns to ensure your purchasing power is maintained.