South Africa’s big inflation debate

The South African Reserve Bank (SARB) is pushing to lower the country’s inflation target, leading to debates about what this process would look like and whether the benefits would outweigh the risks.

Supporters argue that lowering the target will help lower inflation in South Africa, easing the cost of living burden.

However, critics have pointed out that a lower target could mean higher interest rates for longer, which may be more painful for South African consumers.

Investec chief economist Annabel Bishop pointed out that, in recent years, South Africa has unofficially “changed” its inflation target by specifically targeting the midpoint of its target range.

In 2017, the Reserve Bank changed its preferred inflation target to 4.5%, the midpoint of the official target range, which is 3% to 6%. It has since sought to lower the target further to 3.0%.

The SARB has also noted that this decision effectively reduced the inflation target from 6% to 4.5%, which has allowed a reduction in prices and inflation expectations without negative effects on real output and employment. 

Reserve Bank Governor Lesetja Kganyago has been vocal in his support for a lower target, especially over the past few months.

“We have an opportunity to achieve permanently lower inflation and therefore permanently lower interest rates,” Kganyago recently told an audience at Stellenboshc University.

“Executed effectively, a lower target could be achieved at little cost – just as we moved to 4.5% at little cost.”

However, Finance Minister Godongwana has warned that “you don’t get there in a manner which is painless” and has asked the National Treasury and the Reserve Bank to determine the full impact on consumers and the economy.

The National Treasury sets the official target, while the Reserve Bank is tasked with enforcing it. 

Godongwana has also previously agreed that South Africa’s inflation target is “out of sync”. “What is clear is that if we revise the target, the target can only be revised lower,” he said.

The minister said it may well be that lowering the target makes sense economically if it benefits the economy as a whole. 

“But to get there is tough. The question then is: what needs to be done? If you want a lower target, to transition to that is not going to be a painless exercise. What is the pain that we are going to suffer, and how are we going to cushion the blow?”

The head of personal investments at Coronation, Pieter Koekemoer, has warned that lowering the Reserve Bank’s inflation target will have significant implications for interest rates, which will most likely be kept higher for longer. 

This will have significant implications for the local economy, with higher interest rates constraining spending and, thus, growth. 

Furthermore, if the new target is not consistently met, which will be more difficult than the current range of 3% to 6%, then the Reserve Bank’s credibility may be diminished, as may South Africa’s attractiveness as an investment destination. 

South Africans have felt the pain of high interest rates for the past few years, as the SARB embarked on a hiking cycle in November 2021 that saw interest rates rise by a cumulative 475 basis points.

However, the SARB’s announcement in 2017 to move the target to 4.5% coincided with the start of a downward trend in surveyed inflation expectations and in market-implied expectations derived from break-even rates.

“The latter emerged against the backdrop of reduced actual inflation in South Africa and globally, and de-anchoring of some inflation drivers from the upper band of the inflation target level domestically,” the Reserve Bank said.

Bishop said inflation expectations tend to follow the target, which the SARB has also pointed out.

“The results confirm that a credible reduction in the target has no negative real effects because the credible commitment to the new target is rapidly absorbed by private sector expectations,” the SARB said.

Bishop explained that there is a consequent positive effect on asset prices and credit to the private sector. 

In addition, lowering the inflation target would bring South Africa more in line with its key trading partners, which have inflation targets of around 2.0%.

“We have a relatively high inflation rate. We often speak as if this is a structural, inevitable thing and not a policy choice,” Kganyago said. 

“But the fact is, we could have a lower inflation target, like almost all our peers, and with it, lower inflation.”

Globally, central banks tend to converge around an inflation target of 2% to 3% for developed countries and 3% to 6% for emerging markets.

Below is an overview of the inflation targets of some of South Africa’s key trading partners, and other economies around the world, according to Central Bank News.