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Investors are pushing for South Africa’s government to endorse a plan by its central bank to cut its inflation target for the first time this century, in the hopes it will permanently lower the borrowing costs of Africa’s most industrialised nation.
Portfolio managers said a rally in South African bonds and the rand in recent weeks has partly reflected bets that the country’s treasury will sign off by early next year on lowering the South African Reserve Bank’s official inflation target to 3 per cent from 3 to 6 per cent currently.
Asset managers, hedge funds and others have been preparing for missives and meetings with the National Treasury to back the change, with some advising that it will need a careful transition, said people familiar with the matter.
At stake is one of the most important levers for managing South Africa’s economy and potentially lifting it out of years of stagnation.
South African inflation remained below 3 per cent in May, even as interest rates are currently 7.25 per cent.
The base rate means the prime lending rate used to price South African bank loans and mortgages is close to 11 per cent. It also feeds into yields on government bonds, which are about 10 per cent for 10-year debt.
The upper end of South Africa’s target is relatively high by the standards of big developing nations, such as Brazil, which since 2018 has reduced its inflation target from 4.5 per cent to 3 per cent, with a ‘tolerance range’ of 1.5 per cent on either side.
Supporters of a lower target in South Africa say its central bank’s strong record in keeping inflation low in recent years has made it the right time to align the country with other emerging markets that have used lower targets to help anchor investment.
Lower interest rates would help reduce debt costs for South Africa as it grapples with the long-term threat a weak economy poses to public finances.
“If you want to do it, there is hardly a better time than now,” said an investor who recently attended meetings on the subject with officials, citing low inflation, a buoyant rand, and strong trade such as a revival in prices for gold and platinum — two key exports for South Africa.
But transitioning to a lower target could also be a political minefield for President Cyril Ramaphosa’s fragile coalition government, which needed three attempts to pass a budget this year because of divisions among parties on economic policy.
Expectations for price and wage increases would have to be carefully managed in South Africa’s deeply unequal post-apartheid society.
The central bank used a monetary policy decision in May to model how it would potentially have acted had the lower inflation target been in place.
“Inflation targeting has been in South Africa for 25 years. This is our best chance in 25 years,” Lesetja Kganyago, governor of the South African Reserve Bank told the Financial Times.
He compared doubts about South Africa’s ability to fight inflation to the so-called fear of floating in central banking, when policymakers hesitate to abandon long-held fixed exchange rates.
“You have got a central bank that can swim, so it can keep this inflation down . . . nobody will drown,” he said.
The bank estimates that the ‘sacrifice ratio’ of a change, or how much growth might be sacrificed through different monetary policy to hit the target, is almost zero as a share of GDP, though some analysts contest this.
“The high and wide inflation target keeps long-term inflation risks higher than they need to be, depressing economic growth and deepening inequality,” a paper by the bank’s economists said in May.
The Reserve Bank has already de facto targeted 4.5 per cent inflation, or the midpoint of the current target, since 2017. Kganyago became governor in 2014.
One key challenge of introducing a lower target would be for Ramaphosa’s African National Congress, the biggest party in the coalition, to restrain wage increases for civil servants and price hikes by state companies and municipalities.
“You have to get ducks in a row, this is not a simple change — there is a huge amount of political socialisation work to do that the market doesn’t consider,” said Peter Attard Montalto, managing director at South African consultancy Krutham.
South Africa’s public sector workforce is dominated by trade unions that often negotiate wages based on recent inflation numbers. This could make it hard to bed in a new target, said Daan Steenkamp, head of Codera Analytics, an economic research firm.
About a third of South Africa’s basket of consumer prices is also influenced by government, such as utilities, public transport, and education, he added.
‘Administered’ prices, set by government bodies or regulators, still often outpace overall inflation. “That means government buy-in is important if we are to have a lower inflation target,” Steenkamp said.
The National Treasury did not respond to a request for comment.
