Inflation in African countries is notoriously difficult to predict for the salient reason that it is extremely sensitive to two important drivers of inflation namely, the local currency and food prices.
The foreign exchange markets in African countries are illiquid and thus any depreciation in the currency tends to be over exaggerated and a black market develops which exacerbates the fall. The consequence is imported inflation. Further, food prices are constantly influenced by bad harvests and adverse weather conditions.
In most local markets, consumers have little bargaining power and because of imperfect market forces, costs push inflation from higher food prices and/or imported inflation resultant from any currency depreciation, is immediately passed onto the consumer in the form of higher prices. This frequently results in general market prices for all goods being increased – the consequence is often a vicious spike in inflation over the course of a few months.
The graph below illustrates how violent the change in inflation can be. The inflation rate in Mozambique has increased from 2.30% a year ago to 20.70%; an increase of 807%. Tanzania on the other hand has decreased from 6.40% to 5.10% over a one-year period; a decrease of 20%. This highlights the difficulty associated with inflation forecasting on the African continent.
Salary increases in Africa always present companies with difficulties. One must acknowledge that many of the large global surveys do not include African countries in the countries surveyed and despite this, even if the countries are included, by the time the survey is published, the results are often outdated. The starting point at which to set salary increases for many countries is thus guesswork.
In addition, most countries do not follow the same “rule of thumb” as South Africa where salary increases are calculated as one to two percent above the expected inflation rate i.e. a real increase of one or two percent. Nevertheless, the current and future inflation rate will be the determinant of an equitable salary increase.
The graph below illustrates the divergence of the current inflation rate in selected African countries:
So the question is how can a company decide what an appropriate salary increase would be for a specific country; one which is equitable to all stakeholders?
The departure point is for the company to decide whether it will adopt a backward looking or forward looking approach.
A backward looking approach would consider the current inflation rate which measures the rise in prices over the last year and then decide to grant a salary increase based on this figure. The forward looking approach is a little more difficult given that the inflation rate for the next year must be estimated.
We are firm advocates of the forward looking methodology as it calculates the amount of the salary increase which will be “forfeited” to inflation in the coming year. 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 when granting him or her an increase.
The company should formulate a forecast for inflation for the coming financial year (the forward looking methodology), decide the quantum of the real increase to be added and this becomes an equitable and scientifically formulated salary increase which is defendable to any scrutiny.
The problem then arises is what happens if inflation, for whatever reason, spikes as occurred in Mozambique. The forecast inflation is incorrect and concomitantly, so is the salary increases granted to staff.
We strongly recommend that companies have a contingency plan for an unexpected spike in inflation. The ideal vehicle to use is an Inflation Adjustment (“IA”). The company policy should state that in the event that the current inflation rate increases to more than double the salary increase granted for that year, the IA would immediately commence. The IA would be calculated and paid monthly where the objective is to compensate employees for the high inflation.
Obviously, there are several IA mechanisms however what is imperative, is that the mechanism is decided upon, entrenched in the company policy and immediately becomes effective once the “trigger” is breached.