Two-pot withdrawals threaten interest rate hike

If withdrawals under the new two-pot retirement system are higher than expected, the Reserve Bank may be forced to increase interest rates or at least halt its cutting cycle. 

These withdrawals will result in increased household spending and thus may push inflation higher, requiring a response from the bank. 

The Reserve Bank revealed this in its latest Monetary Policy Review, which outlined the expected impact of the two-pot system on the economy and inflation. 

South Africa’s two-pot retirement savings reform allows employees to withdraw a portion (one-third) of their pension savings without having to resign first. 

From 1 September 2024, all retirement fund contributions are split between three ‘pots’, namely – 

• The vested component contains all accumulated retirement fund contributions made until 31 August 2024. 
• The savings component contains one-third of all net annual retirement contributions made after the implementation date, including the once-off seed capital transfer from the vested component. Individuals are allowed one withdrawal from this pot every tax year. 
• The retirement component contains the remaining two-thirds of all net annual retirement contributions made after the implementation date.

In the short term, the Reserve Bank expects withdrawals from the two-pot system to boost disposable income and consumption. 

This should result in higher economic growth as household spending makes up a large proportion of South Africa’s GDP. 

The bank considered two possible withdrawal scenarios. The high-withdrawal scenario assumes R100 billion will be taken out of retirement funds in the fourth quarter of 2024. 

It also assumes withdrawals of around R40 billion per year thereafter. 

In the moderate withdrawal scenario, only R40 billion is taken out of retirement funds in the fourth quarter of 2024 and R20 billion every following year. 

The impact of the withdrawals on the economy and inflation is dependent on the size of the withdrawals. 

Under the high-withdrawal scenario, household consumption picks up significantly by 0.8% in 2024 and 1.8% in 2025 before reverting to the baseline. 

This will have a positive economic impact, boosting GDP by 0.3% in 2024 and 0.7% in 2025. In turn, the government’s financial pressure will be eased through increased tax collection and a larger economy, reducing its debt-to-GDP ratio. 

The potential economic impact of the two scenarios is shown in the graph below. 

However, the two-pot system’s effects on the economy and households are not all good, and the Reserve Bank expects it to lift inflation. 

“Unsurprisingly, in an environment of constrained supply, the stronger demand lifts inflation, which rises by 0.2% and 0.3% in 2025 and 2026, respectively,” the bank said. 

“The rise in inflation triggers a repo rate response, with the repo rate increasing by 0.6% and 0.9% in 2025 and 2026, respectively.”

This would be to prevent the inflation created by two-pot withdrawals and spending from becoming entrenched in the economy and increasing the cost of capital for companies and households. 

Even in the moderate withdrawal scenario, the repo rate is expected to rise by 0.2% and 0.4% in the coming two years. 

“In both scenarios, the growth benefits are temporary, while the inflation impacts appear to linger.” 

“While the two-pot retirement reform provides some short-term relief to consumers, there are potential downsides,” the Reserve Bank warned. 

Should the withdrawal rates turn out to be higher than expected in these two scenarios, the rise in inflation would be substantial, potentially requiring a response from the bank. 

If the Reserve Bank hikes interest rates again, this would undermine household consumption and corporate investment in the near to medium term, limiting economic growth. 

Also, the higher the withdrawal rates are at present, the fewer funds will be available for retirement, limiting household consumption in the long run. 

The reduced total savings would, other things being equal, raise the cost of capital and depress investment and, ultimately the economy’s productive capacity in the medium to long run.