SARB’s plans for lowering inflation target is toothless without Treasury coming to the party
By Zain Wilson, Strategist at Old Mutual Investment Group
Since February 2000, inflation targeting has been the anchor of South Africa’s monetary policy framework.
The South African Reserve Bank (SARB) currently operates with a band of 3–6%, aiming for the midpoint of 4.5%.
While this target has been an unequivocal success – driving down both inflation and inflation volatility, the consensus among economists and within the SARB itself is that transitioning to a lower target can unlock further benefits for the economy.
Compared with our peers—where emerging markets typically aim for around 3% and developed markets for 2%—South Africa’s inflation band is both higher and wider, undermining competitiveness and borrowing costs.
Against this backdrop, the case for lowering the inflation target is gathering momentum.
The global evidence, our own research, and the unique juncture of South Africa’s economy all point to why now is the optimal time to act.
However, while it is widely acknowledged that moving to a lower target has some real benefits in potentially alleviating South Africa’s debt-servicing burden, helping to unblock some of the fiscal channels holding back growth and stifling domestic investment, a lower inflation target alone cannot move the economic dial without National Treasury’s support through reform, fiscal consolidation and meaningful GDP growth.
Greasing the wheels of the local economy
The theory behind inflation targeting is simple: modestly positive inflation helps “grease the wheels” of the economy, while excessive or volatile inflation acts like “sand in the wheels,” creating uncertainty, eroding purchasing power and constraining investment.
Lowering South Africa’s inflation target would offer several benefits:
- Debt sustainability: Lower inflation expectations would reduce risk premia on government borrowing, easing debt-servicing costs in a fiscally constrained environment.
- Currency stability: Aligning inflation with our trading partners would reduce depreciation pressures on the rand and enhance domestic competitiveness.
- Growth and investment: Lower funding costs and stronger competitiveness would attract investment, raise productivity, and lift real growth at the margin.
- Equity: Lower inflation disproportionately benefits poorer households, strengthening purchasing power and reducing inequality.
These benefits are not theoretical. A post-Global Financial Crisis wave of countries lowering their inflation targets demonstrably reduced bond yields in both absolute and relative terms, creating tailwinds for fiscal sustainability.
Globally, the IMF counts 43 countries as formal inflation targeters, and 37 of them have lowered their targets at least once since 1990.
Many of these adjustments came in the first years of adopting inflation targeting regimes, followed by further recalibration after the Global Financial Crisis and again in recent years.
A meta-study by Petrevski (2023) finds mixed evidence that inflation targeting improves growth, but clear evidence that credible regimes lower government borrowing costs and reinforce monetary transmission.
These fiscal benefits are particularly significant for emerging markets—like South Africa—where fiscal credibility is fragile.
Strike while the iron is hot
Critics often highlight the “sacrifice ratio”—the short-term growth cost of higher interest rates during the transition to a lower inflation target.
But in South Africa’s current environment, the evidence suggests these costs would be modest.
Private-sector survey data shows that businesses do not see high interest rates as their primary constraint; instead, weak growth and political uncertainty dominate.
Meanwhile, the Phillips curve tells us that with unemployment at elevated levels, demand driven inflationary pressures are already minimal.
In other words, tightening policy further to entrench lower inflation expectations would likely carry limited additional growth costs.
At the same time, South Africa’s fiscal position strengthens the argument. Interest costs have crowded out non-interest spending, acting as a drag on GDP of around 1% per year.
With roughly 85% of domestic debt stock linked to long-term and inflation-linked bonds, the fiscal channel is particularly sensitive to inflation premia.
A credible lower target, coupled with fiscal consolidation, would help unlock trapped fiscal space, support growth, and reduce the risk of a debt spiral.
Lower inflation targeting is not an economic panacea
However, South Africa faces its own transition challenges. Structural rigidities, such as administered prices (Eskom, Transnet, municipalities) and inflexible wage-setting, slow the pass-through of lower inflation expectations into actual outcomes.
This means the private sector would bear much of the adjustment burden in the short run, potentially weighing on employment and nominal profits.
Furthermore, vulnerability to supply-side shocks could complicate the SARB’s credibility during the transition.
Perhaps the biggest risk of lowering the target is institutional misalignment.
While the SARB has already signalled its intention to lean towards the lower end of the band, it is ultimately the National Treasury that sets the official target.
Without Treasury’s explicit support, the credibility of the shift could be undermined.
And with Treasury walking a delicate political tightrope on the issue, given the likely negative labour response to such a move, there is not yet any clear agreement between the two institutions when it comes to the inflation band.
The stakes are high: a lower target not backed by fiscal discipline would fail to anchor expectations, leaving real rates high, the yield curve steep, and growth hamstrung. Conversely, if Treasury and SARB act in concert—with credible fiscal consolidation and clear communication—the market could do much of the work, lowering yields and stabilising the currency with minimal transitional pain.
A necessary step in the right direction
Lowering South Africa’s inflation target is not a silver bullet.
On its own, it will not resolve the country’s fiscal crisis, nor will it eliminate structural bottlenecks in energy, logistics, or labour markets.
But as part of a coordinated policy mix—including credible fiscal consolidation and long-delayed growth reforms—it could unlock trapped potential.
The decision ultimately comes down to the SARB and Treasury moving together through a coordinated effort to address the country’s rising debt and low growth.
With markets convinced of their shared commitment, in such a scenario, South Africa could reap the full rewards of a lower inflation target.
Comments