Kganyago reveals forgotten factor keeping interest rates high

One of the biggest drivers of elevated interest rates in South Africa is the country’s heightened risk premium, which has been created by over a decade of mismanagement of the state’s finances. 

The Reserve Bank’s Monetary Policy Committee (MPC) must compensate for this risk by protecting the value of the rand and ensuring price stability in South Africa. 

It is estimated that this compensation translates into interest rates having to be around 2% higher than neutral levels. 

Worryingly, the gap has only widened in recent years as South Africa’s economy stagnated and the state’s financial health deteriorated. 

Much of South Africa’s country risk comes from the government consistently forecasting debt stabilisation without it ever happening, Reserve Bank Governor Lesetja Kganyago said. 

Speaking to the National School of Government, Kganyago outlined the two major drivers of elevated interest rates in South Africa – inflation and the country’s risk premium. 

While inflation’s impact on interest rates is clear and well-documented, the effects of South Africa’s elevated risk premium are often forgotten. 

“I hope you will also have noticed that the second-biggest driver of interest rates is country risk, because doing something about that brings me to the other key topic of this speech – macroeconomic policy,” Kganyago told attendees. 

He explained that South Africa’s country risk is driven mainly by the strong growth of the state’s debt burden over the past 17 years and the failure to stabilise and reduce this debt load. 

Relative to the country’s GDP, debt has grown every single year since 2008, when the state last ran a full budget surplus. 

This has resulted in one of the fastest debt increases of any country in recent history. Compared to its peer group, South Africa also has one of the highest debt levels on record. 

Kganyago explained that this risk makes the country’s assets relatively less attractive to investors than those in other countries, weakening the currency and potentially driving inflation higher. 

To compensate for this, the Reserve Bank’s MPC keeps interest rates elevated to make local assets more attractive to investors by increasing the returns on offer. This attracts capital to South Africa and bolsters the rand, limiting imported inflation. 

“If there were widespread confidence that debt levels were heading lower, this would create space for monetary policy to support growth through lower interest rates,” Kganyago said. 

“All the drivers point in the same direction: credible fiscal consolidation would lower country risk. Improved investor confidence would also help the rand, which eases inflation.”

Balancing fiscal mismanagement

Economists and analysts have bemoaned the impact South Africa’s elevated risk premium has had on the country’s interest rates, with tighter monetary policy constraining economic growth. 

Efficient Group chief economist Dawie Roodt said the Reserve Bank is a highly respected institution and has built up immense credibility through inflation targeting since 2000. 

He explained that the Reserve Bank’s job of managing inflation is complicated by the government’s mismanagement of the country’s fiscal accounts. 

While the Reserve Bank has space to cut interest rates more significantly and aggressively than it has, the MPC has been limited by the state’s deteriorating financial health. 

“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. Governor Lesetja Kganyago is 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.”

Old Mutual Investment Group portfolio manager Jason 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.

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 will likely result in short-term economic pain for South Africa.

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 rand’s value. 

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, growing from 1.5% in 2010 to nearly 2.5% in 2025.