Two-pot system bad news for interest rates

Implementing the new two-pot retirement system will likely result in higher inflation in the coming years and, thus, elevated interest rates to ensure price stability. 

On 1 September, South Africa’s retirement system experienced its most dramatic overhaul since 1994, with individuals now able to withdraw a portion of their savings prematurely. 

In short, the two-pot system will result in all future contributions to retirement or pension funds being split in two –

Two-thirds of every contribution goes into a retirement component, and the assets in this component cannot be accessed before retirement. 

At maturity, these must be used to purchase a retirement income product, such as a living annuity or guaranteed life annuity.

One-third of every contribution goes into a savings component, from which provides one withdrawal (of R2,000 or more) per tax year before retirement can be made if necessary. 

Asset managers have repeatedly warned South Africans that any premature withdrawal, even under the two-pot system, will negatively impact their financial outcomes in retirement. 

The access to a portion of retirement savings is only intended to be used in the case of emergencies. 

Despite these warnings, South Africans have withdrawn billions from their retirement funds, and analysts expect these funds to be used for discretionary purchases. 

This is expected to boost consumer spending and economic growth while also providing additional tax income for the government and reducing its debt burden. 

However, it is not without negative consequences, as some economists have warned that the two-pot system will be a form of economic stimulus, likely to boost growth and inflation. 

“While some surveys suggest that up to 50% of the money withdrawn will go to paying down debt, we argue that a large portion will simply be used for general consumption,” Stanlib senior economist Ndivhuho Netshitenzhe said. 

Positively, this means that the additional disposable income will boost consumption towards the end of this year and in 2025. 

However, it is important to note that the increase in household consumption expenditure will likely be import-intensive, limiting the upside benefit to overall GDP. 

Stanlib expects GDP to increase by an additional 0.2 percentage points in 2024 and 0.2 percentage points in 2025.

Netshitenzhe said this boost will likely be short-term, with increased spending in the next year offset by declining savings and a smaller pool of capital to fund investments in South Africa. 

Chief economist at Momentum Investments, Sanisha Packirisamy, warned that while the two-pot system may benefit South Africa’s economy in the short-term, it will also result in higher inflation and interest rates. 

The retirement reform is not expected to have an inflationary impact in 2024 under both the moderate withdrawal and the high withdrawal scenarios but will drive inflation higher in 2025 and 2026. 

Using the Reserve Bank’s core model to forecast the impact on interest rates, this uptick would result in rates being 20 basis points higher in 2025 and 40 basis points higher in 2026. 

This is under the moderate withdrawal scenario. Under the higher interest rate increases of 60 basis points in 2025 and 90 basis points in 2026 are forecasted.

However, this impact is not clear-cut as improved economic growth may support the rand, decreasing the cost of imports and driving inflation down. 

Improved economic performance will also reduce the government’s risk premium, giving it cheaper access to capital and reducing its debt-servicing costs. 

These factors are not featured in the Reserve Bank’s core model and may offset any need for interest rate hikes to tame inflation. 

Packirisamy also said much will depend on how consumers use their funds once withdrawn. If more is allocated towards paying off debt, then the impact on inflation will be moderate. 

Despite the potential impact of the two-pot system on interest rates, Packirisamy maintained Momentum’s outlook of 100 basis points of cuts by mid-2025. 

This is provided the inflation target range remains unchanged at 3% to 6% and no significant external shock hits the South African economy. 

The anticipated impact of the two-pot retirement system on inflation, interest rates and the strength of the rand is shown below, courtesy of Momentum Investments.