Africa-Press – South-Africa. The decision to implement inflation targeting in 2000 has yielded tremendous benefits for South Africa, with increased price stability and competitiveness supporting the local economy.
Inflation targeting also helped the Reserve Bank minimise its losses on foreign exchange interventions to support the rand.
More crucially, stable inflation at a lower rate enabled the bank’s Monetary Policy Committee to lower interest rates, boosting economic activity.
However, the largest benefit from inflation targeting and a credible Reserve Bank comes from what South Africa avoided with regard to elevated inflation, a disorderly weakening of the rand, and potential social instability as a result.
The Reserve Bank is banking on repeating these benefits as it pushes for a lower inflation target of 3% to bring South Africa in line with its peers and more developed economies.
Governor Lesetja Kganyago sang the praises of inflation targeting in a speech to the National School of Government on 12 August.
Kganyago explained that South Africa implemented inflation targeting in 2000 after other approaches to ensure price stability and support the rand failed.
“Like many other countries, once we started inflation targeting, we found it worked better than previous frameworks,” Kganyago said.
“We stopped losing money on foreign exchange interventions, inflation moved lower, and interest rates also shifted down.”
Prior to the implementation of targeting in 2000, South Africa’s inflation rate whipsawed significantly due to a relatively limited ability to manage economic and financial crises.
However, since then, inflation has been relatively well contained within the 3% to 6% target range set by the National Treasury for the Reserve Bank, despite a sharp uptick during the Great Financial Crisis (GFC).
This is despite a significant weakening of the rand over the past 15 years, which would typically translate into elevated inflation as the cost of importing rises.
The currency went from trading at just over R5 to the US dollar in 2006 to crossing R16/USD a decade later, after the country was downgraded to junk investment status.
As the state’s finances continued to deteriorate, spending ramped up, and economic growth slowed, the rand continued to weaken.
The currency has flirted with R20 to the US dollar several times since 2020, being saved by a commodity boom and renewed optimism following the formation of the Government of National Unity in 2024.
Despite this, the Reserve Bank has kept inflation relatively well contained within its 3% to 6% target range, greatly minimising the impact of a significantly weaker currency on South Africans and the economy.
This can be seen in the graph below, courtesy of Old Mutual chief economist Johann Els.
South Africa’s saving grace
A weakening rand and the deterioration of the state’s financial health have made the past decade immensely difficult for the Reserve Bank in terms of managing inflation and interest rates.
Initially, the bank targeted an inflation rate of 5.99% as the country’s stagnant economy required looser monetary policy.
“As the decade wore on, however, it became clear that growth was not improving. The problem was larger than weak demand, and inflation pressures were intensifying,” Kganyago said.
South Africa became classified as a highly fragile economy, vulnerable to tightening global financial conditions. This prompted the Reserve Bank to change course.
“With inflation higher at around 6% and weak economic growth, the bank changed course. Between 2014 and 2016, interest rates rose from 5.5% to 7%.”
“We stopped treating the top of our 3% to 6% range as the implicit target and, in 2017, communicated our preference to target the 4.5% midpoint as our objective.”
This has resulted in interest rates being relatively higher than expected, with the bank having to offset some of the state’s fiscal mismanagement through monetary policy.
Kganyago explained that a lower inflation rate would enable policy to ease and support the economy despite the various factors dragging growth down. It would also allow policy to be more flexible, even if inflationary shocks materialised.
“Improving the credibility of monetary policy could strategically offset the deteriorating fiscal position, slowing growth and the effects of weakened institutions,” Kganyago said.
As a result of the bank’s ability to effectively target inflation despite a weakening currency and the deteriorating financial health of the state, it has become increasingly credible in the eyes of investors.
If it were financial institutions, particularly the Reserve Bank, that had lost credibility in the eyes of investors, the country’s situation could have been worse.
Credit ratings agencies have praised the Reserve Bank for its dedication to maintaining its independence, prudent monetary policy, and tight regulation of South Africa’s financial sector.
South Africa remains unique among emerging markets in its ability to issue debt in its local currency and thus avoid the dangers of foreign exchange fluctuations threatening a government’s financial standing.
This is almost entirely down to the Reserve Bank and its protection of the value of the rand through prudent monetary policy and its fierce independence.
Source: dailyinvestor
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