Lower inflation target a possibility

SA could look to lock in lower inflation rates for the long term as price pressures appear likely to remain muted, making it possible to set lower targets without economic pain.

Though economists don't think the lowering of inflation targets is imminent, Reserve Bank governor Lesetja Kganyago said this week it is a possibility.

"There is a very strong case to lower SA's inflation target," he told Business Times.

"It's just that that conversation is not quite taking place at the moment. There is nothing virtuous about high inflation, and having lower inflation enhances our competitiveness and helps us absorb any shocks that might hit us."

Kganyago said SA's 3%-6% target range was still higher than that of its peers, many of which have lowered their inflation targets in recent years.

His comments, in an interview to mark the Bank's centenary this month, come after SA's average inflation rate sank to a record low of 3.3% last year, with the Bank forecasting that inflation will likely average less than the 4.5% midpoint of the target range for the next three years.

Economists say that would make it easier for the Bank to start communicating that it would like to see inflation head even lower over time, towards the 2% targeted by major trading partners, and start talking to the government about a lower target.

Kganyago revealed this week that when inflation targeting was introduced in 2000, the then finance minister and Bank governor agreed to step the target range down to 2%-4%, in line with SA's trading partners, to support the economy's competitiveness.

The government announced plans to reduce the range to 3%-5%, but after the rand crashed in 2001 policymakers opted to keep the range at its initial 3%-6% - a decision Kganyago now says was a mistake, though one he was part of as head of economic policy at National Treasury at the time.

"If you were to ask me what was the biggest monetary policy or inflation policy mistake we made, that was it," he said.

Under Kganyago's tenure the Bank has since 2017 made it clear it is targeting 4.5%. Its clear messaging that it would act if necessary to keep it there is credited with helping to set lower expectations for future inflation, thereby encouraging businesses to keep their prices in check and trade unions to moderate their wage demands.

The sustained decline in inflation since 2017 has also been helped by lower oil and food prices and by a very weak economy, especially during the Covid crisis.

"Indeed, inflation is structurally lower;

indeed, inflation expectations are now anchored lower and closer to the midpoint," Kganyago said.

"They used to be around the upper end of the target range and the price-setters believed the Reserve Bank was actually targeting 6%. What we did in 2017 was to decisively communicate that we would like to see it around 4.5%."

He said SA had been able to bring down inflation without the cost or "sacrifice ratio", as economists call it, of giving up output.

Kganyago, who has often emphasised that if SA wants lower interest rates it has to have lower inflation, also pointed to the benefits for public finances created by the lower inflation and interest rates of recent years.

"The Treasury was able to save on its debt service costs over the previous fiscal year precisely because inflation was low. Given what bond yields had done, if inflation was not lower the Treasury would have paid through the nose on debt service costs."

Standard Chartered economist Razia Khan noted that the easy way to set a lower target would be to do so once SA started to achieve inflation rates of 3%-4.5%.

The Bank would ideally start communicating it was targeting the lower half of the current target range, to make it possible to reduce the target at some point in the future.

Intellidex's Peter Attard Montalto said the target was not about to change, but "in the long term SA's inflation is going to be the same as the rest of the world - with a 2% target, otherwise your currency will always depreciate. The question is how to get there, and with how many steps."

Attard Montalto believes the target could be changed after the 2024 elections, or if and when President Cyril Ramaphosa is elected to a second term as ANC president next year.

Kganyago also warned against a "dangerous narrative" that ratings downgrades do not matter and the rand's strength means last year's downgrade to junk status had no impact.

He said the strength of the rand was due to better terms of trade - with SA's commodity export prices rising faster than import costs - as well as the current account surplus and better than expected fiscal deficit.

"The capital inflows this year are no cause for complacency. We are now attracting volatile inflows which are fickle and subject to sentiment."