The Reserve Bank has made its strongest case yet for a sweeping monetary policy shift, saying a lower inflation target of 3% could yield nearly R900bn in debt-servicing savings costs over the next decade.
The estimates — contained in modelling by the Bank’s in-house economists — provide a serious incentive for the National Treasury to show tangible support to lower the target. If enacted, the proposal would mark the most substantial monetary policy rethink in 25 years.
Lesetja Kganyago, governor since 2014, has been advocating for a policy shift since the mid-2010s, arguing that SA’s inflation target range of 3%-6% is out of sync with its emerging market peers. He has urged policymakers to correct what he sees as a misstep made two decades ago when the Treasury abandoned plans to lower it.
But Kganyago’s advocacy has ratcheted up in recent years as his tenure nears its 2029 expiration and inflation itself falls below 3%, well below the midpoint — 4.5% — which serves as an informal guidepost for the monetary policy committee members to ensure inflation remains anchored within the target band.
In a working paper published on Friday, the Bank presented a clear fiscal incentive for the Treasury to act, estimating that a 3% inflation target would sharply reduce interest payments as a share of GDP.
“We estimate that over the course of a decade, a 3% inflation target in tandem with a borrowing strategy that emphasises short-term and inflation-linked borrowing could generate almost R870bn in nominal cumulative savings on debt-service costs, rapidly reducing interest payments as a share of government revenue and GDP,” the paper reads.
SA pays about R386bn a year in interest on its R5.7-trillion debt, totalling 5.2% of GDP in the 2024/25 fiscal year, more than a fifth of revenue and reinforcing concerns about public debt crowding out spending on essential services. The budget tabled in parliament last month showed debt-servicing costs will amount to more than R1.3-trillion over the next three years. This equates to R1.2bn a day in the 2025/26 financial year alone.
Still, the Bank said that with a lower inflation target the fiscal burden would ease over the next decade.
“Debt-service costs would decline to about 4.8% of GDP by 2029/30 and 3.8% of GDP by 2034/35, absorbing a diminishing share of government revenue,” reads the paper posted on the central bank’s website.
The paper analysed the evolution of debt-service costs and debt dynamics after the adoption of a lower inflation target, finding that almost 40% of historical government debt would benefit nearly instantaneously from lower inflation expectations.
Yield curve
The Bank’s paper warns that not moving sooner in reducing the inflation target “opens up the risk that the space that exists now to issue debt in the short end of the yield curve will disappear” as inflation stresses persist.
“We estimate that inflation at 3%, rather than 4.5%, would result in a debt stock that is R150bn smaller over ... 10 years, while a slower pace of exchange rate depreciation would reduce the debt stock by about R170bn in rand terms over a decade,” it said.
“A decline in real yields could help mitigate the discount that the government pays from repeatedly issuing bonds below their par value, which has added R320bn to the debt stock over the past five years (about 1% of GDP annually). The scale of improvements in debt and debt-service costs could be even larger if the cost to the economy resulting from policy-induced disinflation — known as the sacrifice ratio — is smaller.”
We will also consider scenarios with a 3% objective at future meetings.
— Monetary policy committee
The Bank estimates that the government’s overall borrowing requirement could average about R550bn per year over the next decade, “with a risk that funding pressures are even bigger if the government is unable to deliver sustained fiscal consolidation”.
The Bank’s monetary policy committee last week said it was of the view that the 3% scenario was more attractive than the 4.5% baseline.
“We will also consider scenarios with a 3% objective at future meetings,” the committee said after its meeting, which reduced the cost of borrowing by 25 basis points.
Stephen Hall, head of the department of economics at Leicester University in the UK, has also published a paper considering whether the inflation target of the Bank should be lowered to something closer to that of SA’s trading partners, which is almost 3%.
He found that the broad conclusion is that most of the arguments for a non-zero inflation target suggest a target of 2%-3%.
However, his paper said any change in the target rate should be carried out slowly with full transparency and without loss of credibility.
The Bank’s paper says that over the next decade about half of the government’s long-term domestic debt (R2.2-trillion) and foreign currency debt (R340bn) is set to mature. It says this will impose sustained funding pressure on the government and keep debt-service costs elevated.
“Lowering the inflation target presents an opportunity to relieve some of this pressure and realise significant fiscal savings as new debt issuance benefits from a stronger rand, reduced interest rates and lower inflation in the medium term.”
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