The Reserve Bank decision that could cost South Africa dearly

The Reserve Bank’s recent decision to anchor inflation expectations around 3%, alongside the National Treasury’s recently released inflation guidelines, presents a significant risk to the country’s financial stability.

This is because the central bank’s inflation target is now lower than the Treasury’s objective, creating a misalignment that could increase the risk of budget overruns due to overspending and underestimated revenues.

S&P Global Market Intelligence recently warned of this threat, explaining that it risks undermining the credibility of fiscal policy efficiency and the goal of achieving debt sustainability.

In addition, it could un-anchor market expectations of inflation, thereby complicating the effectiveness of monetary policy.

This warning comes after Reserve Bank Governor Lesetja Kganyago recently announced that the bank will now aim for inflation expectations to settle at the bottom of its target range, 3%.

This came as the central bank and the National Treasury are still in talks to officially shift the current target range of 3% to 6% to a lower, narrower target.

The National Treasury sets the inflation target that the Reserve Bank must achieve. Since 2000, this target has been a range of 3% to 6%.

Before Kganyago’s announcement, the bank preferred for inflation to be anchored around the mid-point of its target range, 4.5%. Now, the Reserve Bank will aim for 3%.

When asked if the Reserve Bank’s decision is an official adoption of a lower target, Kganyago explained that this is merely the committee’s preference.

Finance Minister Enoch Godongwana was also quick to set the record straight in a press statement released the following day.

He clarified that policy-making responsibility in this area resides with the Minister of Finance.

“As a result of this announcement, an expectation has been created that the Minister of Finance will make an announcement at the Medium-Term Budget Policy Statement confirming this move to a 3% target,” he said.

“Minister Godongwana has no plans to do this,” the statement said.

Reserve Bank vs National Treasury

While the Reserve Bank and Godongwana have been clear that the bank’s decision is not an official change, S&P explained that there are still risks.

This is because the bank’s inflation target now conflicts with the medium-term spending guidelines that anchor inflation projections at 4.5% over the medium term. 

Therefore, there is a misalignment between South Africa’s fiscal and monetary policy objectives.

The National Treasury’s inflation guidelines are what the government uses to plan its spending and revenue projections.

Therefore, if these guidelines are set at a higher rate than inflation, departments could plan for more spending in real terms or overestimate revenue, thereby increasing the risk of overspending.

This is something the country’s Budget cannot afford, as the Treasury is already under immense pressure to increase revenue and rein in spending to run a primary budget surplus.

Achieving this surplus is crucial to the Treasury’s plan to stabilise South Africa’s immense debt burden, which currently sees the government spend around R1.2 billion a day servicing its debt.

S&P warned that the National Treasury’s primary unofficial anchor for achieving debt sustainability may become more difficult for the authorities to achieve due to the misaligned inflation objectives.

“Government revenue and spending objectives will be aligned with an inflation projection of 4.5% rather than 3%, increasing the risk of budget overruns owing to potential overspending and underestimated revenues,” the organisation said.

“This situation risks undermining the credibility of fiscal policy efficiency and the goal of achieving debt sustainability while also potentially unanchoring market expectations of inflation, thereby complicating the effectiveness of monetary policy.”

“Aligned policy objectives by the monetary and fiscal authorities are preferable, and, if implemented consistently, could ensure lower interest rates, lower debt servicing costs and some fiscal space in the medium term.”