Africa-Press – South-Africa. The move to a lower inflation target is a double-edged sword for South Africa, with long-term benefits coming at the cost of some short-term pain.
A lower inflation target promises to enhance the competitiveness of South African exports, stimulate economic growth, and alleviate the government’s debt-servicing burden.
However, in the short term, it may negatively impact the country’s already weak economic growth and increase pressure on households with debt.
This is feedback from Old Mutual Investment Group (OMIG) portfolio manager Jason Swartz, who outlined the asset manager’s analysis of a lower inflation target at its most recent quarterly update.
Swartz said the decision to move to a lower inflation target is a double-edged sword, characterised as both a perfect opportunity and a leap of faith.
Currently, South Africa has an ideal opportunity to lower its inflation target, as inflation is hovering around the lower end of the Reserve Bank’s 3% to 6% range.
The Reserve Bank, in particular, has done extensive work on the impact of a lower inflation target to justify the potential benefits and explain why they outweigh the short-term pain.
Currently, its target range of 3% to 6% is too wide and far higher than its peers, leaving South Africa as an uncompetitive outlier.
“There is no magic number for this kind of thing, but the Reserve Bank appears to have settled on a 3% target rate. This will bring it in line with its peers and still give it room to adjust interest rates effectively,” Swartz said.
This lower target of 3% promises to yield immense benefits for South Africa over the long term, with the Reserve Bank estimating that it could reduce its steady-state repo rate by 1.5% to 5.5 percentage points from 7%.
As a result, it will significantly reduce the cost of capital in South Africa, thereby boosting economic growth and easing the government’s debt burden.
“So, we could have a long-term interest rate that is 1.5% lower, which has huge implications for what happens with bond yields, equity valuations, and economic growth,” Swartz said.
Perhaps the largest impact will be on the government’s debt-servicing costs, with a reduction in interest rates potentially easing these payments, which currently equate to over R1 billion a day.
This will potentially free up billions of rands for the government to address its significant debt burden, invest in infrastructure, and improve service delivery.
The Reserve Bank estimates that a lower inflation target could 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.
It also suggests that a lower target could reduce debt-servicing costs from 5.4% in 2025 to 5.1% in 2030 and 4.2% in 2035. This translates to savings of R130 billion in the first five years and R600 billion by 2035.
Short-term economic pain
While Swartz believes the long-term benefits are great for South Africa and that it should have a lower target, he explained that it could come with short-term economic pain that the country cannot afford.
South Africa’s economy is projected to grow by around 1% in 2025 and the coming few years, making it vulnerable to any shock.
Swartz said that if the move to a lower target rate does not come at a time when inflation is already low and expectations are moving downwards, there could be trouble.
“The Reserve Bank believes that it has quite a lot of credibility around managing inflation, which should help push down expectations,” he said.
“Inflation expectations should adjust, but the risk for us is that if they do not adjust, then the sacrifice in terms of growth that they have to give up to reach the lower target could be substantial.”
There are also a few other issues with moving to a lower inflation target at the current point in time, given the government’s relatively high fiscal rise and the expectation that inflation will tick upwards throughout 2025.
However, the largest potential threat is the administration of prices for goods and services, such as electricity, water, education, and medical aid.
Much of this is determined by the government and has significantly outstripped inflation in South Africa over the past few years.
Swartz said that these increases, which should be anchored to inflation, have appeared relatively unanchored in recent years, with price increases averaging around 7% per annum.
While these components make up only 15% of the total inflation basket, they put immense pressure on the private-sector segment to minimise price increases.
“If you do the math on it, it does mean that the private-sector inflation component needs to undershoot significantly to compensate for higher administered prices,” Swartz said.
“The math becomes a little bit intractable to get private sector inflation to 2.5% given that the lowest it has ever reached is 3% in South African history.”
As a result, administered price increases pose a significant threat to achieving a lower inflation target in South Africa, potentially necessitating a tighter monetary policy to reach the target.
The graph below shows the inflation expectations for South Africa in 2025, with all groups surveyed by the Bureau for Economic Research expecting inflation to be higher than the Reserve Bank’s potentially lower target of 3%.
The second graph shows the impact of a slower adjustment in inflation expectations on the GDP growth that will be lost through tighter monetary policy.
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