Africa-Press – South-Africa. South Africa’s era of pain from elevated interest rates is over, with the country now on track to have structurally lower inflation and interest rates.
This will boost economic growth, reduce the government’s debt-servicing costs, and make South Africa more competitive in global markets.
These benefits are the result of an extended period of economic pain, whereby the Reserve Bank kept interest rates elevated to bring inflation down towards 3%, which is its new official target.
Efficient Group chief economist Dawie Roodt explained why this era of pain was necessary for South Africa to enable its economy to grow faster in real terms.
“You pay a price for low inflation, and we have been paying quite a dear price in getting inflation lower in South Africa,” Roodt told BizNews.
Elevated interest rates limit economic growth by reducing demand in the economy, as capital becomes more expensive for businesses and households.
“What the Reserve Bank has been doing in the last couple of years was necessary, but it is not good for economic growth,” Roodt explained.
“We need people to buy stuff in the economy, but it was more important to bring inflation down. In effect, the Reserve Bank postponed economic growth in favour of lower inflation.”
Roodt explained that in a high inflation environment, it is almost impossible to get the economy to grow in real terms and ensure individuals get richer to improve their quality of life.
“Low inflation does not guarantee economic growth, but high inflation almost guarantees no economic growth,” Roodt said.
“The Reserve Bank increased interest rates to slow inflation down, and they have succeeded in that aim, but we had to postpone economic growth.”
“Now, with low inflation and a lower target, we are in a position where we can start getting the benefits of low inflation.”
One of the major benefits of this is lower nominal interest rates, which boost demand in the economy and reduce the government’s debt-servicing costs.
“The Reserve Bank has cut interest rates consistently over the past year or so. Now, we can start spending more money and boost the economy by increasing demand,” Roodt said.
“Unfortunately, the process of getting inflation lower is quite painful, but the worst is behind us now, and I think we are in a position where the economy can grow much faster.”
South Africa heading for a miracle
Dawie Roodt
A lower inflation target promises to have significant benefits for South Africa, with it likely to translate into faster economic growth and substantially lower debt-servicing costs for the government.
This is reliant upon the Reserve Bank ensuring inflation is maintained around the new target of 3%, with its credibility pointing to that almost being a guarantee.
If inflation, and particularly inflation expectations, come down to 3% structurally, then South Africa could experience a significant change in fortunes.
Researchers at the Reserve Bank studied the potential impact of a lower inflation target of 3% on the South African economy and the government’s debt burden.
They estimated that this lower target can result in additional GDP growth of over 0.25% per year within five years and 0.4% within a decade, due to improved economic competitiveness.
“Ultimately, better control of inflation should achieve stronger macroeconomic outcomes for South Africa,” the researchers said.
“Inflation remains well above that of trading partners and the inflation premium in short-term and long-run interest rates is far too high, undermining investment.”
South Africa’s price level, and thus the cost of production, rises faster than that of the country’s trading partners. This makes its exports relatively more expensive and less competitive.
Regarding the government’s debt burden, the researchers’ baseline scenario has debt-servicing costs as a share of GDP declining from 5.4% in 2025 to 5.3% in 2030 and 4.8% in 2035.
With a lower inflation target, this decline will be much sharper, with debt-servicing costs falling to 5.1% of GDP in 2030 and 4.2% of GDP in 2035.
The researchers estimate that about R130 billion of nominal fiscal savings would be realised in the first five years, rising to R600 billion by the end of the decade.
One of the hidden benefits of a lower inflation target is a stronger and more stable rand, which will make it cheaper for South Africa to import goods and resources.
Crucially, a more stable rand will boost South Africa’s credibility with international investors, positioning it to attract greater flows of capital.
For South Africans, the benefits of sustained inflation at 3% will also be significant, with a far slower rise in the cost of living.
After just 10 years, a country with 4.5% annual inflation will have a price level 20% higher than one with 3% inflation. After 20 years, the gap is 60%.
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