Asymmetric effect of Oil Prices on Inflation in South Africa: An Econometric Approach

Abstract

The surge in oil price levels remains a world-wide concern, more specifically to oil-importing countries such as South Africa. The dependence on crude oil from these net exporters makes the country vulnerable to external shocks, such as geopolitics. These effects have a pass-through effect to domestic headline inflation, induced by imported inflation. The general objective of the study is to investigate the asymmetric effect that the price of oil has on inflation in South Africa. To achieve these objectives, the study applied the Nonlinear Autoregressive Distributed Lags (NARDL), Error Correction Model (ECM), Pairwise Granger Causality, Impulse Response Function and Variance Decomposition. The bounds test of cointegration revealed that cointegration exists between the observed variables of the study. After estimating the error correction model, the study found that in the short-run, the relationship between a positive change in oil price and inflation is negative and significant. However, the relationship between a negative change in oil price and inflation in the short-run is now positive and significant. Therefore, the correction of disequilibrium will take place in the long run by means of short-run adjustments, with the speed of 1.71%. Pairwise Granger Causality test revealed that a unidirectional relationship occurs from oil prices to inflation. The Variance Decomposition results show that a shock to oil price accounts for a greater percentage of fluctuation in inflation. The Impulse Response Function reveals that within a 10-year period there is a positive response of inflation to oil prices, specifically from year three to year five. The study recommends the South African oil import diversification policy to source oil from multiple exporting countries to ensure steady supply and reduce dependence on any single source. This strategy improves security and reduces vulnerability to oil price shocks and supply disruptions caused by various factors.