Excessive government spending prevents interest rate cuts 

Finance Minister Enoch Godongwana

High government spending, coupled with price increases for administered services such as electricity and water, keep inflation elevated, preventing the Reserve Bank from cutting interest rates. 

This is feedback from the portfolio manager of Allan Gray’s money market fund, Thalia Petousis, who outlined why a more restrictive rate is more necessary than in the past. 

Petousis singled out government spending, which continues to grow faster than tax revenue, as a factor that would make inflation stickier in South Africa. 

This is alongside other factors, such as the impact of load-shedding and logistics bottlenecks, coupled with global forces such as geopolitical tension and conflict in the Middle East. 

Petousis noted that several members of the Reserve Bank have said that high interest rates are not ideal but are necessary.

This is because the central bank carries an outsized burden when it comes to stabilising South Africa’s economy and inflation.

In this regard, the Reserve Bank has repeatedly called for the government to share the burden via prudent fiscal policy and, particularly, reduced spending. 

The SARB’s preference would be for lower interest rates and lower inflation. However, it has not been able to achieve this while the government continues to run a growing deficit. 

This growing deficit, which has to be funded by borrowing money, raises the country’s risk premium as it will increase the government’s already substantial debt burden. 

The elevated country risk premium entrenches itself in borrowing costs as foreign investors demand a higher interest rate to invest in the growing supply of South African government debt and to refinance the debt of ailing state-owned entities. 

Furthermore, it contributes to a weaker rand exchange rate and, consequently, higher imported price inflation. 

Beyond reducing its debt pile, the SARB also recommends to the government that it lowers inflation by increasing the energy supply and reducing government wage growth to match the weak economic productivity gains.

In addition to fueling inflation through excessive spending, the government compounds this impact by raising administered prices. 

South Africans have seen the price of electricity, water, and rates and taxes rise at double digits and faster than the country’s targeted price inflation, said Petousis. 

Such pricing pressures necessitate that the SARB keeps rates higher than it would prefer as a necessary evil that serves to lower consumer borrowing appetite and crush household demand. 

In theory, such action is meant to prevent any second-round price increases from taking hold.

Having said this, the market expects the Reserve Bank to begin cutting interest rates in mid-2024 in line with its quarterly projection model. 

This model pencils in a short and shallow cutting cycle with the repo rate dropping from 8.25% to 7.25% by end-2025 – which is still 100 basis points higher than its pre-Covid level.  

Given the SARB’s mandate to maintain price stability in the economy and expectations for higher and stickier global inflation, a restrictive rate is seen as far more necessary than in the past.


Top JSE indices