South Africa’s window of opportunity for a lower inflation target is closing

South Africa has a limited window in which it can implement a lower inflation target without negatively harming the country’s economic growth. 

A lower inflation target promises to create immense benefits for South Africa, including faster economic growth, lower debt-servicing costs, and ease cost-of-living pressures. 

However, implementing it could result in interest rates remaining elevated for a longer period to ‘lock in’ lower inflation and maintain the Reserve Bank’s credibility. 

This could be minimised if South Africa takes the opportunity to lower its target from a 3% to 6% range to a 3% target point while inflation is not rising, Standard Bank chief economist Goolam Ballim told Daily Investor. 

The bank expects inflation to average 3.4% in 2025, with prices rising slightly quicker throughout the second half of the year. 

“We think inflation will stay comfortably within the lower half of the Reserve Bank’s 3% to 6% target zone,” Ballim said. 

This should give the Reserve Bank space to cut interest rates at least once more in 2025 and provide a golden opportunity to lower the inflation target. 

“We appreciate that there is much debate surrounding the lowering of the inflation target, with much discussion about the timing of the reduction,” Ballim said. 

“The politics of the moment may dictate that, when growth is weak, lowering the inflation target and the tighter monetary policy that comes with it, is not something that South Africa can afford.” 

There is a concern that if the inflation target is lowered, the Reserve Bank may need to keep interest rates elevated, potentially stifling economic growth in order to achieve the lower target. 

“However, I would be inclined to argue that we have a window of opportunity that is going to close soon for lowering the inflation target without much negative impact,” Ballim said. 

The window of opportunity has been created by inflation being below 3% year-on-year, meaning that it is already at the lower target point. 

“If the target was lowered now, the impact of the shift of expectations towards the new target would be very, very small because of the low level of inflation,” Ballim said. 

With South Africa’s low inflation and declining expectations, very little has to change in terms of monetary policy to achieve the new target and maintain credibility. 

“If the target is calibrated to a 3% point, for instance, right now, the inflation expectations adjustment would be bearable.”

“If inflation expectations adjust quickly, it means the Reserve Bank will not need to employ a tighter monetary policy than otherwise to reach the target, thus minimising the impact on growth.” 

Ballim said he expects the inflation target to be lowered before the end of 2025, with the window of opportunity closing throughout the second half of the year. 

“If all parties, the National Treasury and Reserve Bank, are in sync, then the only question is timing. I would argue that, tactically, there is a window of opportunity while inflation is low to minimise the impact on growth.” 

Benefits of lower inflation 

A lower inflation target promises to bring significant benefits to South Africa, including faster economic growth, reduced debt-servicing costs for the government, and a generally lower cost of capital. 

Ballim explained that lower inflation is already having a positive impact on the local economy, with real wages growing faster than they have in years. 

This has helped to boost consumer spending, which is one of the largest drivers of economic growth in South Africa. 

Lower inflation has also translated into lower interest rates, easing the financial pressure on households and freeing up more disposable income. 

Ballim also said that even the indication of South Africa moving to a lower inflation target has pushed yields down to some extent, easing the government’s debt-servicing costs. 

The Reserve Bank’s economic research department has extensively analysed the impact of a lower inflation target on South Africa’s economy. 

Its latest white paper on a lower target showed that a lower inflation rate will increase the competitiveness of South African exports globally by reducing the local cost of production. 

In turn, a lower inflation target should also bolster the rand, making imports relatively cheaper and keeping prices stable.

Reserve Bank researchers estimate that a lower inflation target of 3% can result in additional GDP growth of over 0.25% per year within five years and 0.4% within a decade due to improved economic competitiveness.

The greatest beneficiary of a lower inflation target is likely to be the government, which could potentially result in hundreds of billions of rands in savings from reduced debt-servicing costs. 

South Africa’s government has accumulated a substantial debt load over the past fifteen years, totalling over R5 trillion and accounting for more than 75% of the country’s GDP. 

Over the coming decade, approximately half of the government’s long-term domestic debt and foreign currency debt is expected to mature, totalling around R2.5 trillion. 

“With the marginal borrowing costs higher, this is set to impose sustained funding pressure on the government and keep debt-servicing costs elevated,” the researchers said. 

Lowering the inflation target presents an opportunity to alleviate some of this pressure and will result in significant fiscal savings, as new debt will benefit from a stronger rand, lower interest rates, and reduced inflation. 

These savings will initially be relatively small, but will gather momentum over time and grow significantly to reduce debt-servicing costs by billions of rands and bring down the government’s debt load. 

In the researchers’ baseline scenario, debt-servicing costs as a percentage of GDP are projected to decline from 5.4% in 2025 to 5.3% in 2030 and 4.8% in 2035. 

This compares to debt-service costs that fall to 5.1% of GDP in 2029/30 and 4.2% of GDP in 2034/35 as the move to a lower inflation target reduces inflation, lowers short-term interest rates, strengthens the currency and supports a decline in real yields.