One thing stopping big interest rate cuts in South Africa 

The mismanagement of South Africa’s government finances over the past 15 years is preventing the Reserve Bank from cutting interest rates more aggressively to stimulate the local economy. 

Since 2007/08, when the government last ran a full budget surplus, state spending has skyrocketed without much benefit to economic growth, saddling it will a significant debt burden. 

As a result, the government’s credit ratings have deteriorated into sub-investment grade or junk status, prohibiting many global pension funds and investment schemes from investing in South African assets. 

This resulted in significant outflows from South African assets over the past few years, significantly weakening the rand and further limiting economic growth.

The state’s mismanagement has pushed the Reserve Bank to keep interest rates relatively elevated to attract capital to South Africa and prevent a disorderly weakening of the rand as the country’s financial standing deteriorated.

Efficient Group chief economist Dawie Roodt said this is preventing the Reserve Bank’s Monetary Policy Committee (MPC) from cutting interest rates by 50 basis points. 

Roodt explained that the MPC has room to cut interest rates by this much, but is hampered by its need to balance against the historic mismanagement of fiscal policy. 

“The fiscal accounts, which the politicians are responsible for, have been messed up big time. Not only the national accounts, state-owned enterprises, local authorities, the Road Accident Fund and all of that sort have been messed up,” Roodt told the State of the Nation podcast.

“But there is one thing that has worked very well in South Africa and that is the Reserve Bank, with Governor Lesetja Kganyago doing a fantastic job.” 

“The Reserve Bank is maintaining interest rates at relatively high levels. In fact, I think it has more than enough room to cut interest rates by 50 basis points.”

“But the reality is, these rates are necessary to act as a counterweight to the mismanagement of the economy on the fiscal side.”

Elevated interest rates limit South Africa’s economic growth by limiting the extension of credit to households and businesses. 

South Africa’s fiscal risk

Roodt is not the only one to point to South Africa’s poor financial health as a reason for the Reserve Bank being hesitant to cut interest rates more aggressively. 

Old Mutual Investment Group portfolio manager Jason Swartz pointed out at the asset manager’s most recent quarterly update that the country’s policy and fiscal risk is a major reason why the country’s interest rates remain relatively high. 

Swartz explained that the risk premium attached to investing in South Africa means that interest rates have to be more than 2% higher to compensate.

This gap has also widened in recent years, with the country’s risk premium growing as the government’s financial health deteriorates and its credit rating declines.

Swartz said the Reserve Bank has built up significant credibility since inflation targeting was first introduced in 2000, keeping price increases largely within its 3% to 6% target range. 

It plans to use this credibility to push inflation expectations lower amid talk of a lower inflation target of 3%. A slow adjustment in expectations is likely to result in economic pain for South Africa in the short term. 

Swartz explained that a lower inflation target could see the Reserve Bank’s steady state for the repo rate decline to 5.5% from 7%, significantly boosting the local economy. 

However, the bank has warned that South Africa’s elevated risk premium may make this more difficult, as it has complicated the management of inflation in recent years. 

Swartz said South Africa’s heightened risk premium is one of the major drivers behind the country’s relatively elevated interest rates. 

The Reserve Bank has to compensate for this risk premium to attract capital to the country and support the value of the rand. 

As the risk premium grows, interest rates have to compensate further by being relatively higher. This limits economic growth by keeping lending subdued.

The graph below shows the significant impact of the risk premium on interest rates in South Africa, with it growing from 1.5% in 2010 to nearly 2.5% in 2025.