DEFINING MOMENTS: What comes next after 25 years? Inflation targeting at turning point

As part of Business Day’s 40th anniversary reflections, we continue our deep-dive series into the policy pivots that reshaped South Africa — from inflation targeting and the rollout of a national HIV/AIDS programme, to landmark M&A deals and high-profile corporate collapses

Not long after Business Day’s launch in 1985, SA’s inflation rate hit a high of almost 21%. The rand had crashed in the wake of then prime minister PW Botha’s Rubicon speech and prices had spiralled.

South Africans are only just growing used to the pleasures of an inflation rate that has been in the 2% range for some months. Few remember a time when it was almost always in the double digits — as it was in the 1980s. Even fewer will remember a time when there was no inflation target and no monetary policy committee. When the Reserve Bank governor changed interest rates for whatever reason, he usually didn’t even make a public announcement — nor offer an explanation.

When SA introduced inflation targeting in 2000 it was a huge change. And it took quite a few years and a few bumps along the road before it really succeeded in getting down to within the target range on a sustainable basis. But succeed it did. And now we are looking to a tighter target than the 3%-6% range set 25 years ago, one which could bring SA much closer to genuine price stability.

During the 1990s monetary policy followed an “eclectic” approach, which was as likely to target the exchange rate and the money supply as the inflation rate itself. By the time inflation targeting was introduced to anchor monetary policy the inflation rate had already moderated, to high single-digit levels for much of the late 1990s. But the Bank’s processes were neither predictable nor transparent. Inflation and interest rates remained volatile, as did the rand exchange rate.

Inflation targeting was part of a broader push by the new ANC government towards macroeconomic policies that would provide a platform for rapid economic growth. Other countries were also starting to go the targeting route.

Announcing the new policy in his February 2000 budget speech, finance minister Trevor Manuel pointed out that price stability was one of the objectives of economic policy: “Simply put, our aim is to counter the erosion of people’s incomes and living standards that comes with rising prices, and to remove the fear of future inflation that undermines investment and savings decisions.”

Inflation targeting would increase the transparency and accountability of monetary policy and provide stability in the value of money, which in turn would enhance growth prospects, said Manuel, who announced that he and the Bank’s new governor, Tito Mboweni, had agreed on a target band of 3%-6%. Budget documents explained the aim was to reduce the inflation expectations of consumers, producers, employers and workers, stabilising and reducing inflation and interest rates.

It was then up to the Bank to implement the policy and Mboweni forged ahead. He established the monetary policy committee with its regular meetings followed by press statements and media briefings — at which in his day only the governor appeared.

The Bank introduced monetary policy forums open to all and the governor was given to “open mouth operations” when he thought the market had it wrong, summoning Business Day’s journalists to interview him on at least one occasion.

It took time for markets, the public and the Bank itself to get into the targeting groove. The road was often rocky. And the critics were often loud.

Inflation hit a low of 3.1% in February 2005 amid rand strength and strong economic growth; it hit a high of 13.7% in August 2008 in an overheated economy on the eve of the global financial crisis.

But it largely stabilised within the 3%-6% target range as the Bank gained credibility and everyone started to take it seriously, adjusting their expectations and their pricing and wage-setting behaviour accordingly. Interest rates became less volatile. Borrowing costs declined across the economy, benefiting the public finances as well as private investment.

But the average inflation rate remained stuck at just below the 6% top of the target range, above the average for SA’s main trading partners. Which is why in 2017 governor Lesetja Kganyago and his team began to target the 4.5% midpoint, instead of the whole range.

A strengthening rand helped but from 2017 inflation fell to an average 4.5%, without much negative impact on the economy, according to the Bank. Inflation went even lower during the Covid-19 pandemic; even when inflation spiked globally in the wake of the pandemic and Russia’s invasion of the Ukraine, SA’s inflation rate peaked at just below 8% in mid-2022.

It’s declined sharply since then, hovering below 3% in recent for months. Though it’s expected to climb again, the Bank’s forecasts don’t see it breaching 4.5% in the next two years. But as Kganyago frequently points out, inflation is bad, people don’t like inflation and 4.5% is not “price stability”, nor is it a level that keeps SA economy competitive or its exchange rate stable.

Most other inflation-targeting countries have reduced targets over time and the original intention of SA’s policymakers was to do the same. SA’s inflation rate has been above the median for 149 emerging market and developing economies since 2012, and its target range is looser than many others.

The Bank has pushed since 2021 to reduce the target further, ideally to a point of 3%. Treasury has been reviewing this. Outside experts such as the International Monetary Fund support it. Many in the market believe the Bank is already quietly targeting 3%.  

Kganyago has denied this, saying there would be no point in a secret target. Nor would it make sense for the Bank to “go it alone” without government’s buy-in. Still, the prospect of a lower target has buoyed markets in recent months.

The Bank stepped up its campaign at the May monetary policy committee meeting when it started publishing a 3% scenario showing the decisions it would have taken.

It also published research showing it could achieve the lower target with little short-term economic cost and much longer- term benefit, including big savings on government’s debt costs.

Some economists are more sceptical about how easy it would be to get to 3%. The Treasury is doing its own research. Finance minister Enoch Godongwana recently emphasised his agreement would be required and said he would not be rushed. But there are hopes in the market that the minister will make an announcement at his October medium-term budget, or earlier. 

A quarter of a century on, SA’s inflation-targeting policy has evolved and changed and it’s as yet unclear what’s next. But there’s no question we are much better off now than we were in 1985.