Government to blame for high interest rates in South Africa

Interest rates in South Africa are structurally elevated due to the government’s poor creditworthiness, increasing borrowing costs, and above-inflation price hikes for administered services such as electricity and water. 

Old Mutual Wealth investment strategist Izak Odendaal said that, apart from various infrastructure and policy challenges, higher interest rates are a contributing factor to South Africa’s slow economic growth over the past 15 years. 

Interest rates rose quickly to their highest level in over a decade in 2022 and 2023 to combat surging inflation. The Reserve Bank raised rates by a cumulative 475 basis points since November 2021. 

More recently, the bank has begun its cutting cycle, with the Monetary Policy Committee (MPC) having reduced the repo rate by a cumulative 75 basis points since September 2024. 

After last week’s rate reduction, homeowners will pay R1,000 a month less on a R2 million bond at the prime rate – money that can be spent elsewhere and boost economic growth.

Lower inflation does not just allow for lower interest rates but also increases the purchasing power of South Africans. 

Income growth for employees now generally exceeds the inflation rate, and this can be seen in the retail sales numbers. 

This is an important cyclical boost and contributes to a better growth outlook over the medium term. The Reserve Bank expects the economy to expand by 1.8% this year and next, rising to 2% by 2027. 

This is slow compared to many other emerging markets, but it is a meaningful improvement over the 0.5% average growth rate over the past decade, Odendaal said.

The interest rate relief is due to lower inflation and an improved outlook for price increases to slow in South Africa. 

In December, annual headline consumer inflation was only 3%, and ‘core’ inflation, excluding food and fuel, was only 3.6%. 

Despite the recent declines in inflation and interest rates, Odendaal warned that they remain structurally elevated. 

As a result, these declines are expected to be temporary, and structural drivers will push inflation and interest rates higher in the future. 

This can be seen in the Reserve Bank’s forecast for inflation, which expects headline inflation to average 3.9% this year and 4.6% next year.

These forecasts might be too high since energy regulator NERSA subsequently announced lower-than-expected electricity tariff increases. 

In the coming financial year, Eskom will be allowed to raise its tariff by 12.7%. This is much less than it asked for and what the utility was expected to get, with the Reserve Bank forecasting a 15% increase.

However, Odendaal said these increases are still three times higher than the midpoint of the Reserve Bank’s 3% to 6% inflation target range. 

These above-inflation increases, which also occur in other sectors, such as water, are a major driver of inflation in South Africa. Ultimately, they force the Reserve Bank to keep interest rates elevated to manage inflation. 

To lower the long-term trajectory around which rates will fluctuate, a similarly lower inflation trend is required.

Odendaal said the government’s perceived lack of creditworthiness is the other source of structural upward pressure on interest rates. 

Its creditors – bond investors – demand a risk premium that also applies to private sector borrowers, directly or indirectly. 

This risk premium will only decline when economic growth has accelerated meaningfully and structurally, and the government’s finances are in better shape. 

Growth will boost tax revenues, thereby lowering the government’s borrowing requirement, but discipline on the spending side is also necessary. 

This is not easy, but the Budget Speech later this month will probably show the Treasury sticking to the script of fiscal consolidation and maintaining a rising primary surplus. 

Success on this front should see eventual credit rating upgrades and lower borrowing costs.

The MPC’s latest statement noted that a scenario where deeper structural reforms are implemented would allow growth to rise to 3% by 2027 while resulting in lower inflation and interest rates. 

Stronger growth usually puts upward pressure on inflation and interest rates as the economy eventually runs too hot. However, in South Africa’s case, the supply-side reforms that boost growth will also lower costs. 

For instance, improved electricity supply means firms can produce more but also don’t have to pass on the cost of running diesel generators to consumers.