Anchoring inflation at 3% could be a turning point in cutting the country’s risk premium and lowering borrowing costs, Reserve Bank governor Lesetja Kganyago said on Tuesday.
According to Kganyago, the strategy aims to “de-risk” the economy and create space for sustainably lower interest rates, with improved investor confidence helping to strengthen the rand and ease inflation — a chain of effects he argues would support stronger, more sustainable growth.
“If we can reduce interest rates through permanently lower inflation, and by de-risking, we can finance debt at lower costs,” he said, adding that the shift towards a 3% target could trim the “neutral” policy interest rate from about 7.25% to closer to 5.25%.
“This is something we hope to deliver with our new preference for having inflation settle at the lower end of our 3% to 6% target range. This cannot be a promise, but it can be a serious aspiration,” he said at the National School of Government.
With inflation already near 3%, Kganyago described the move to a lower target as an “opportunistic” chance to lock in a lower target without major economic pain.
Country risk — the extra return investors demand to compensate for the possibility that SA’s economic or fiscal conditions could deteriorate — is the second-biggest driver of SA’s borrowing costs after inflation itself.
A lower-inflation strategy could shave as much as half a percentage point off that risk premium, Kganyago argued.
In July, the Reserve Bank went it alone in effectively shifting SA’s inflation target to 3%, the lower end of its target range, surprising market players who had expected the move to come only when the minister of finance announced it during October’s medium-term budget policy statement (MTBPS).
For the past four years, the Bank has called for the target to be lowered to make SA more competitive and ensure permanently lower inflation and interest rates.
It has stepped up that campaign in recent months as inflation has trended lower to 3% or less.
Finance minister Enoch Godongwana pushed back against the Bank’s statement that it now “preferred” the 3% target, accusing it of “unilateral announcements that pre-empt legitimate policy deliberation”.
The minister said he had no plans to announce a move to a 3% target during the MTBPS (as many in the market had expected), emphasising that policymaking in that area resided with the finance minister, working with the president and the cabinet, which set the inflation target in consultation with the Bank.
In his speech on Tuesday, Kganyago stressed that fiscal policy would need to complement monetary policy, with credible plans to stabilise debt further easing country risk.
Lower inflation and reduced country risk could work in a “virtuous circle”, where “lower interest rates improve fiscal dynamics, and better fiscal dynamics in turn lower rates”.
As rates fall, government debt service costs could ease significantly, freeing up resources for other priorities. A one percentage point cut in borrowing costs on a R5-trillion debt stock would save about R50bn annually, according to Kganyago’s estimates.
“It is not my role to set the issuance strategy. That is the work of National Treasury. But good monetary policy can help create opportunities for fiscal policy, which a nimble debt manager could seize,” he said.
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