As Reserve Bank governor Lesetja Kganyago often reminds us, no-one likes a high cost of living and inflation is a tax on the poor. The Bank is now conducting an active campaign to cut SA’s inflation target to 3%. But it may find it easier to win the hearts and minds of the public than the support of the Treasury, which is still mulling the mixed impact on public finances.
On the one hand, a lower inflation target could significantly cut government’s high cost of debt, particularly over the longer term. On the other hand, it would worsen the fiscal ratios and shrink tax revenues in the next few years. To get the full benefit the Treasury would also have to shift its borrowing strategy significantly at a tough time.
All of which means if Kganyago wants to get finance minister Enoch Godongwana’s sign-off on a lower target — and avoid the Bank having to go it alone — there is work to be done to convince the Treasury that longer-term economic growth and fiscal gains will outweigh short-term fiscal pain, and that the market will accommodate that pain.
At last month’s monetary policy committee meeting the Bank launched a 3% scenario, as well as an academic paper by its researchers that estimates government could save R870bn on its debt costs over the next decade in that scenario. That is tempting for a government that is spending a fifth of tax revenue on interest costs. However, the Bank’s estimates assume government more than doubles its annual borrowing in the short-term treasury bill and inflation-linked bond markets, to about half of total borrowing.
The Treasury has a conservative debt management strategy, keeping risks low by keeping much of its debt local and long dated. The average maturity of government debt, at almost 11 years, is one of the longest in emerging markets. But investors demand a far higher interest rate (or yield) on SA’s long bonds than they do on short-dated debt, so going shorter would be cheaper. With a stronger exchange rate making foreign debt cheaper to service, and an assumed lower risk premium, that should lower the cost of debt over time.
But one concern for the Treasury is that it must repay or refinance more than R300bn of debt in two years, triple last year’s level. That will make it more wary of issuing masses more short-term debt for now, even assuming the market were willing.
One classic way overindebted governments deal with their debt is precisely to let inflation eat away its value, so by the time they have to repay it is worth a lot less.
More concerning is that while debt costs are lower in a 3% scenario, government’s debt ratio is higher for longer, as are other fiscal ratios such as the deficit. Lower inflation cuts the size of the economy in nominal, money terms — and the fiscal ratios are ratios of nominal GDP. The Bank’s own paper shows government debt doesn’t stabilise at 77% this year before declining, as the Treasury projects. It takes until 2035 to come down to the Treasury baseline.
Tax revenues are a function of nominal GDP too, and lower revenues could mean a higher deficit in the short term. In the long term, growth and revenue would lift, making the public finances more sustainable. But in the short term government would appear not to deliver on fiscal consolidation, with the risk the bond market could respond with higher, not lower, debt costs.
The real question is whether the market would see through all this. It might well. One classic way overindebted governments deal with their debt is precisely to let inflation eat away its value, so by the time they have to repay it is worth a lot less. One reason bond market players are so enthusiastic about a lower inflation target is precisely because it prevents government ever trying to do that. Risk would be lower so they would demand lower returns, cutting the cost of borrowing across the economy and raising investment and growth.
The Bank is selling the prospect of that virtuous cycle hard, but the Treasury is doing its own modelling. We will see if it is persuaded that the permanent benefits of a lower target offset the temporary cost soon enough to lock in current low inflation rates.
• Joffe is editor-at-large.
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