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Does South Africa face the risk of stagflation?

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Dec. 18 2014, Updated 3:14 p.m. ET

Stagflation risk looms over South Africa

Stagflation is characterized by low economic growth and relatively high unemployment—a time of stagnation—accompanied by a rise in prices, or inflation. In this situation, the economy isn’t growing, but prices are.

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Trade-off between growth and inflation

The South African Reserve Bank is faced with a very difficult trade-off between growth and inflation. Interest rates in South Africa have been on the rise over the past year. The benchmark interest rate has risen from 5% in early 2013 to 5.75% in late 2014. Rising interest rates should contain inflation, but this move also entails the risk of throwing the economy into recession.

On the other hand, by cutting interest rates and stimulating the fragile South African consumer, the Reserve Bank might succeed in reviving the growth outlook. However, there is a greater risk of letting inflation spiral out of control.

The performance trends of ETFs such as the iShares MSCI South Africa ETF (EZA) are closely reflective of growth patterns within the economy. The economy of South Africa is also significantly down from its peaks in gold and diamond production.

South Africa’s widening current account deficit

The current account deficit in South Africa has been widening since 2010. From a shortfall accounting for 2% of GDP in 2010, it had widened to 5.8% in 2013. The main reasons for this include the prolonged wage strike at the platinum mines that hurt mining exports, as well as a weakening currency that raised local prices of imported goods, fueling inflation.

The AngloGold Ashanti Ltd. (AU), Gold Fields Ltd. (GFI), and the Harmony Gold Mining Company Limited (HMY) are some of the key players in the South African gold mining and exploration industry. The VanEck Vectors TR Gold Miners ETF (GDX) and the VanEck Vectors Junior Gold Miners ETF (GDXJ) invest in the equities of gold mining companies.

For South Africa, the key to economic revival lies in the narrowing of its current account deficit.

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