Understanding the "Real Increase": Forecasting Salary Hikes Beyond Inflation.

“Sharon, please could you give Finance the forecast salary increase percentage for 2025 and the projected increase in our salary cost.”

This request normally sparks a sense of foreboding as it is a clear indication that the annual salary increase process is imminent- with all the associated angst, issues, problems, heated negotiations and hard work that is required.
The forecast is not difficult, and we have long advocated that clients adopt a scientific approach to the preliminary salary increase forecast and then use the unfolding economic data over the next few months to update the original forecast. Finally, to incorporate other factors into the decision and to then formulate an equitable final salary increase for 2025.

INFLATION

Our departure point in the forecast process is to determine the expected inflation rate for 2025. Salary increases are implicitly linked to inflation; where inflation is one of the most important determinants when deciding on the quantum of the salary increase. Employees want to retain the same purchasing power with their remuneration from one year to the next.
Consistent with the Axiomatic methodology, a “forward looking” approach must be adopted where inflation is forecasted for 2025, and the proposed salary increase is based on this result. We remain firm advocates of this methodology as it calculates the amount of the salary increase which will be “forfeited” to inflation. The alternative approach, namely the “backward looking” methodology, uses the previous year’s inflation rate which is “sunk” and thus does not exert an influence on the additional purchasing power given to the employee by granting him or her an increase.

Axiomatic’s inflation forecast for the remainder of 2024 and 2025 is detailed in the table below:

Our forecast for 2025 is closely aligned with the MPC Committee’s forecast of 4.4% which they predicted at the 18 July 2024 meeting. Importantly, 4.5% represents the mid-point of the MPC’s 3.0% to 6.0% target range and the target percentage they want to anchor in terms of market expectations.

SA Reserve Bank Governor Lesetja Kganyago recently said, “What matters for the future is what the outlook for inflation is. Our forecast is that we will be 4.5% in this coming quarter. Some of the months we might even be below 4.5%. But what matters is the next three quarters in the New Year. And at the moment it looks like we will be 2025 averaging the 4.5% that we are targeting.”

Normally we state that the risks to the forecast are to the upside- where the risk is greater that inflation could be higher than our forecast. This year, barring any exogenous shocks, we think the risk is to the downside because of the strengthening of the rand and lower fuel and food prices.

REAL SALARY INCREASE

The next step in the scientific process is to establish the possible quantum of the “real increase”. A real increase is defined as the increase after inflation has been considered. As an example, if the salary increase is 6.0% and inflation is 4.0%, then a 2.0% real increase has been granted.

The historic methodology adopted in South Africa, when determining an equitable salary increase in the past, was to add a 2.0% real increase to the forecasted inflation figure. However, there has been a discernible trend over the last few years of lower real salary increases being granted. This assertion is corroborated by the 5-year moving average in the graph above, which has been steadily declining in recent years. One must recognise that 2022 and 2023 were an anomaly, as inflation increased to higher levels than those envisioned when increases were determined at the beginning of the year, reducing the 5-year average.

The conclusion of the analysis is that a 1.0% real salary increase is the “new normal”.

FORECAST OF 2025 SALARY INCREASE

The scientific and qualitative approach would conclude that an equitable salary increase would therefore be:

The current forecast salary increase for 2025 is thus 5.50%.

The above forecast obviously ignores quantitative factors such as economic growth, union demands, trends in compensation and benefits and of course, the unique financial position of the company. These however should be considered closer to salary increase time.
Over the coming months Axiomatic will continue to update our 2025 recommended salary increase in response to new data, include some quantitative considerations and discuss some emerging trends we are observing in the market.

Stay ahead of the salary increase curve with our strategic guide, contact us to access our latest insights and ensure your business stays on top!

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