Warning about South African inflation change

The Reserve Bank should shift away from its current 3% to 6% inflation target range towards a lower target point as this promises significant benefits for the country. 

However, it must be done at the appropriate time to ensure macroeconomic stability and minimise the potential impact on economic growth and employment. 

This is feedback from the International Monetary Fund (IMF), which outlined why a lower inflation target could benefit South Africa. 

The IMF recently concluded its 2024 Article IV Consultation with members of the National Treasury and the Reserve Bank. 

This consultation culminated in a report from the IMF on South Africa’s progress on key policy reforms and fiscal consolidation. 

Despite the widespread positivity about South Africa, given the formation of the Government of National Unity (GNU) and load-shedding nearing a permanent end, the IMF remains cautious about the country’s future. 

It highlighted the potential impact of global uncertainty and local reforms taking longer than expected as two of the key reasons why it thinks risks remain tilted towards the downside. 

As a result, its forecast for South Africa’s economic growth is below consensus at 1.5% in 2025. 

Concerningly, the IMF does not believe that the current trajectory will result in a rapid uptick in economic growth, a reduction in unemployment, and a slowdown in the growth of government debt. 

Its baseline projection shows that economic growth will hover around 1.7% annually until 2030, with unemployment marginally declining to 31.3%.

However, the institution highlighted some low-hanging fruit that could significantly boost South Africa’s economic activity. 

One of these areas of focus is shifting the current inflation target range of 3% to 6% towards a lower target point that is more in line with its trading partners. 

International experience suggests that target zones are less effective in anchoring inflation expectations than point targets, the IMF said.  

Moreover, South Africa’s midpoint target leads to a differential with trading partners that puts pressure on the exchange rate. 

Moving toward a lower point target would support medium-term macroeconomic stability and confidence and reduce financing costs. However, such a change may impact output and employment negatively in the near term. 

Fiscal consolidation, while supporting the disinflation process, also entails near-term output costs. 

Thus, the IMF said that appropriate timing, careful design, and gradual implementation are key to minimise reform costs and secure buy-in.

The institution also urged careful coordination between the Treasury and the Reserve Bank alongside clear communication of policy plans to anchor expectations. 

Coronation economist Marie Antelme echoed the potential benefits of a lower inflation target in a recent research note. 

Antelme explained that economies work best when there is price stability, as this enables people and businesses to plan their savings, spending, and investment goals. 

It also helps avoid the inefficiency of prices not adapting to prevailing conditions and protects purchasing power and the value of savings. 

Over time, it lowers the cost of borrowing, which supports sustainably higher growth and employment.

The Reserve Bank adopted inflation targeting in 2000 after a period of relatively ‘informal’ monetary policy. 

Officially, the primary mandate of the SARB is to protect the currency’s value in the interest of balanced and sustainable economic growth.

It delivers on this mandate by targeting inflation, which sets a measurable benchmark against which it is accountable.

Antelme said extensive studies by the National Treasury and the Reserve Bank have shown that the three percentage point target range is too wide, making it an ineffective inflation anchor. 

The targeted midpoint, an improvement, is also not low enough for price stability and, as such, has reduced the potential benefits of the mandate.

Coronation’s own research shows that currently a real repo rate of between 2.75% and 3.15% is needed to reach the midpoint of the Reserve Bank’s target range. 

With a lower inflation target, the required real repo rate can be reduced by about 50 basis points to 2%-2.5%. Over time, this translates into a materially lower nominal neutral rate of about 6%.

However, Antelme wanted that this would come into conflict with the country’s poor financial health, as a lower inflation target would require higher interest rates in the short term. 

“Running in parallel with the very necessary and increasingly challenging fiscal consolidation currently underway, a lower target could create a combined headwind to growth that may be considerably greater than initial modelling suggests.”

The solution, Antelme explained, is to have a clearly defined timeline for introducing a lower inflation target with an extended implementation runway so the Reserve Bank can manage expectations lower over time.