Reserve Bank on a tightrope

The South African Reserve Bank is caught in a delicate balancing act between taming inflation, boosting growth, and aiding the National Treasury’s precarious financial position.

On Tuesday, 30 July, Reserve Bank Governor Lesetja Kganyago addressed the 104th annual Ordinary General Meeting of SARB shareholders, providing a comprehensive overview of the global and South African economic conditions as of mid-2024. 

He said the global economy continues to recover from the COVID-19 pandemic, with inflation decreasing from 8.7% in 2022 to 6.8% in 2023 and economic growth at 3.3% in 2023. 

However, challenges such as high public debt, technological risks, and climate change persist. 

In South Africa, economic growth slowed to 0.7% in 2023 due to load-shedding and logistical issues, while employment has rebounded, recovering 2.2 million jobs lost during the pandemic.

Despite this, South Africa’s unemployment remains high at 32.9% in the first quarter of 2024. 

Domestic inflation has moderated but remains volatile, with frequent fluctuations driven by fuel, food, and services prices. 

The latest June inflation print came in at 5.1% CPI, a slight moderation from the 5.2% recorded in April and May. However, this is still far higher than the SARB’s ideal target of 4.5%—the midpoint of its 3% to 6% target range. 

However, core inflation has recently eased, and the SARB expects it to continue declining. Headline inflation is projected to reach the midpoint of the target band in 2025 and 2026. 

The moderation in inflation has led many to hope for interest rate cuts at the Monetary Policy Committee’s (MPC) next meeting in September.

This hope has also been fueled by the US Federal Reserve’s indication that a September interest rate cut could be ‘on the table’. 

In addition, at the last MPC meeting, the vote to keep rates unchanged was split, with two members preferring a cut and the other three preferring rates to be left unchanged.

The MPC members who voted to keep rates unchanged were concerned that inflation expectations were still above the target point. 

However, Old Mutual Wealth investment strategist Izak Odendaal said expectations tend to follow actual inflation and have already declined meaningfully. 

Currently, South Africa’s interest rates are at 15-year highs, with the repo rate at 8.25% and the prime lending rate at 11.75%. This is despite the bank’s forecasting that inflation will hit its 4.5% objective next year. 

Odendaal said if the MPC “skates to where the puck is going”, they can start cutting already.

There is a concern that a divergence in interest rates between South Africa and other major economies, notably the US, can result in rand weakness as capital tends to flow to where risk-adjusted returns are highest. 

Rand weakness can place upward pressure on inflation as it will increase the cost of importing goods into South Africa, particularly oil. 

However, backward-looking inflation data continues to improve, although Odendaal cautioned that this doesn’t mean prices are falling. It just means that they are rising at a slower rate. 

This, along with other indicators, suggests that the SARB will be able to cut rates in September and November – the last two meetings for the year – and a few times next year. 

This turning point will ease pressure on consumers and indebted businesses, but rates are unlikely to decline significantly in South Africa.

In other words, the SARB will need to balance cutting rates, providing much-needed relief to struggling South Africans, and boosting the economy while ensuring inflation remains tamed and the rand does not weaken against other currencies.

Stanlib chief economist Kevin Lings has also said the Reserve Bank may begin cutting rates soon, but the cutting cycle will likely be short and shallow. 

Lings identified rising prices for administered services, such as electricity tariffs, as being a driver of inflation that is unlikely to come down in the next 12 months. 

He said that interest rates are likely to only come down by a cumulative 100 basis points in the next year, providing little relief for consumers.

This view has been echoed by Kganyago, who has repeatedly warned that interest rates may stay higher for longer due to inflation remaining sticky in South Africa.

In addition to balancing interest rate cuts and low inflation, the SARB is now required to aid the state coffers by tapping into its Gold and Foreign Exchange Contingency Reserve Account (GFECRA).

Finance Minister Enoch Godongwana announced in the February Budget that the National Treasury would restructure reserves held at the central bank to free up R150 billion over three years to reduce debt issuance.

Bloomberg reported that the country’s GFECRA showed paper profits of R507.3 billion as of January – a massive increase from the R1.8 billion recorded in 2006, which reflects the rand’s slump in value against the dollar.

The account has been reorganised to release the payout to the Treasury. R250 billion remains in the account to shield the country from losses should the rand gain in value, and R100 billion is allocated to the central bank to protect its balance sheet from loss.

This will go a long way in reducing the government’s debt burden, although many economists have warned that it is not a silver bullet.

In its 2024/25 Budget, the government claimed that the GFECRA would allow it to reduce debt without any increased costs or risks. 

However, Professor Stan du Plessis of the Bureau of Economic Research (BER) said this is not true.

If the R150 billion the government wants from the account is raised by selling forex reserves, confidence in South Africa will be undermined as these reserves are a vital buffer against external shocks. 

This will also negatively impact the country’s sovereign credit rating, but the government’s improved financial health following the debt reduction may negate this effect.