The SA Reserve Bank should lower the inflation target, and do it now.
The Bank’s constitutional objective is to “protect the value of the currency in the interest of balanced and sustainable economic growth”. To this end, the SA Reserve Bank Act says the Bank “shall pursue as its primary objectives monetary stability and balanced economic growth”. These mandates are supported by a lower inflation target.
To the constituency that argues the Bank should support government expenditure, investment or whatever else, the law is clear that the focus must be the rand. Bank officials cannot legally prioritise anything else unless two thirds of parliamentarians vote to change the constitution.
The Bank adopted the inflation targeting framework to guide execution of its mandate in 2000, and the 3%-6% inflation target was adopted for 2003. In 2001 a narrower band target of 3%-5% was announced for 2004. However, a tumble in the rand in 2001 pushed the targeted inflation measure above 10% in 2002. The target was missed, and the ambition to move it lower was abandoned temporarily. However, the Bank’s monetary policy committee subsequently took advantage of a decline in inflation in 2017 and, in effect, moved the target from 6% to 4.5%.
A target designed to “protect the value of the currency” should closely align with the inflation of trading partners. SA’s top five trading partners are, in order of importance, China (inflation target: 3%), the US (2%), Germany (2%), the UK (2%), Japan (2%) and India (4%). These countries make up 80% of SA’s trade. If the Reserve Bank continues to pursue the effective 4.5% target, the value of the rand will erode, and the Bank will fail to meet its constitutional mandate. A 1.5-point inflation differential implies a 16% erosion in the rand’s purchasing power over 10 years. This is why Reserve Bank governor Lesetja Kganyago seems fixated on 3%.
It can be difficult to change an inflation target, but the Bank now has an opening to do so since the move will be supported by the deceleration in inflation and acceleration in growth that are under way. Falling inflation allows the Bank to lower rates, giving some stimulus to the economy, but to retain the tight bias necessary to anchor inflation lower.
The Standard Bank research team expects inflation to trend below 4.5% by the end of 2024 and into the third quarter of 2025. If the rand trends stronger, which I suspect it will, inflation could fall to 3.5%. The Bank could lock the consumer price index (CPI) lower by cutting more slowly, which will be more palatable to economic actors.
The political economy will also cope better with the growth costs associated with moving the target lower now, as GDP growth is accelerating. The sacrifice ratio of lowering inflation from 4.5% to 3% is estimated to be about 0.3 of a percentage point in real growth.
Growth is expected to accelerate in the short to medium term, buoyed by the positive effects of structural reforms, the cyclical effects of global monetary policy easing and the near-term effects of the two pot retirement reforms. The ability of the economy to absorb the sacrifice from the adjustment to the inflation target will therefore be better in 2025 than it was in 2017, when the Bank made a similar adjustment to the inflation target.
The purported constraints to lowering the target include inflationary fiscal policy and high administered prices. Better fiscal policy management in the past few years makes this less of a concern. The main administered price culprits are electricity costs and municipal rates and services. The high tariffs here are reflective of gross inefficiencies and exact high costs on the economy, but the way to deal with these is not to bail them out by debasing the currency, but by improving their management.
Failure to change the target in the next few months could mean the next available opportunity will be in five or more years, when inflation decelerates again. I hope the Treasury gives the Bank the green light.
• Lijane is global markets strategist at Standard Bank CIB.
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