Treasury and Reserve Bank set new 3% inflation target

In the biggest monetary policy reform in 25 years, the inflation target that the Reserve Bank will aim for has been set at 3%, with significant consequences for fiscal metrics such as tax revenue, nominal GDP and government expenditure over the next three years.

Finance minister Enoch Godongwana announced the 3% target — with a one percentage point tolerance band on either side to accommodate nominal economic fluctuations — in the medium-term budget policy statement (MTBPS) tabled in parliament on Wednesday.

The MTBPS highlighted improved public finances compared to the 2025 budget. The new 3% target — strongly fought for by Reserve Bank governor Lesetja Kganyago — is the lower end of the previous 3%-6% range, which was set in February 2000. The bank has aimed at the midpoint of 4.5% since 2017.

The Reserve Bank is expected to guide inflation and inflation expectations gradually towards the 3% target over the next two years.

Fiscal strategy on course

Commenting on the decision to set the target at 3% — which he stressed was a joint one between himself and Godongwana — Kganyago said at a media briefing that there was only one winner in the decision: “South Africans, who are now going to enjoy a low inflation economy, which would mean that the consideration about inflation would be taken out of the decision-making process of investors and out of the purchasing decisions of our price-setters.

“There is no such thing as a costless policy. Every policy has trade-offs, and what is important is that the benefits outweigh the costs,” the governor said, adding that the previous inflation target band was too wide and too high. The 3% target was closer to that of SA’s peers.

The MTBPS highlighted improvements in the government’s fiscal position, though the lower inflation target would affect revenue and expenditure forecasts. It showed that the government remained on track to achieve its fiscal consolidation and debt stabilisation policies. Debt is due to stabilise this year.

“The fiscal strategy remains on course even in the current low-growth economic environment. There are clear signs that consistent fiscal discipline is paying off in improved investor confidence,” the Treasury noted, highlighting the positive effects of the economic reforms under way.

The debt-to-GDP ratio will stabilise in 2025/26 at 77.9%, falling progressively to reach 77% in 2028/29, and the consolidated budget deficit is forecast to fall from 4.7% (4.8% in the May budget) to 2.9% in 2028/29. The primary budget surplus — when revenue exceeds non-interest expenditure — is forecast to improve from 0.5% of GDP in 2023/24 to 2.5% of GDP (R224bn) in 2028/29, which would support a decline in debt and debt service costs, which will consume 21c of every rand in revenue this year.

Debt service costs have declined this year due to lower government borrowing rates. The Treasury has lowered its economic growth forecast for 2025 to 1.2% from 1.4% in the May budget and to 1.5% (1.6%) in 2026, but it is forecast to pick up to 1.8% in 2027 and reach 2% in 2028. However, the Treasury warned that risks to the economic outlook “are tilted to the downside”.

Contributing to the improved fiscal outlook has been higher tax collections with the gross tax revenue estimate for 2025/26 being revised upwards by R19,7bn due to higher net VAT collections and corporate income tax. In the first six months of the 2025/26 year tax revenue was R17,5bn over 2025 budget estimates.The revenue overrun narrows the main budget deficit by R8,2bn and provides the funding for spending priorities and capital investments.

However, gross revenue collection is expected to be lower than the 2025 budget by R15,7bn in 2026/27 and 2027/28 due to lower inflation expectations.The MTBPS never includes tax announcements but Treasury reiterated that it would “continue to monitor Sars’s revenue performance to determine whether the R20bn in additional tax increases for the 2026 budget proposed in the 2025 budget may be withdrawn.

A decision will be announced in the 2026 budget.”The higher revenue projection and lower than expected borrowing costs allow for a R15,8bn increase to 2025/26 non-interest expenditure estimates mainly targeted at infrastructure projects and the 2026 local government elections. Part of the revenue overrun will expand the contingency reserve from R5bn to R13,5bn which will be used for these purposes.

Real non-interest spending is expected to grow on average by 0,2% over the medium term. The public service wage bill will increase by a nominal annual average of 4,1% while capital payments mainly for infrastructure projects will grow by 7,3%.

Treasury pointed out that the 3% inflation target will result in the short to medium term in lower nominal GDP and therefore lower revenue projections and a less favourable debt-to-GDP ratio but added that this would be counteracted by the reduction in debt service costs. It will translate into a R6,2bn reduction in non-interest expenditure in 2026/27 and R14,2bn in 2027/28.Debt service costs in 2025/26 will be R4,8bn lower than the 2025 budget estimate supported by lower interest rates, lower inflation and a stronger rand. Medium term savings of R6,7bn have been pencilled in due to government efforts under the Targeted and Responsible Savings initiative to identify and remove low-priority or underperforming programmes which will be phased out over the next three years.

Consolidated government expenditure is forecast to increase from R2.59-trillion in 2025/26 to R2.88-trillion in 2028/29, growing by an average annual rate of 3.6%. Net additional non-interest expenditure of R15.8bn for 2025/26 compared to the 2025 budget is proposed to fund urgent priorities, additions to the contingency reserve, rollovers of R5.2bn from the previous year, unavoidable expenditure of R1.6bn mostly for disaster relief and funding for the Madlanga commission of inquiry, and R5.4bn expenditure announced in the 2025 budget.

It also includes spending announced at the time of the 2025 budget for the national dialogue, Stats SA and the Office of the Chief Justice, and confirms provisional allocations for health and education, including early childhood development.

An amount of R131.3m is allocated to various departments to cover the cost of SA’s hosting of the Group of 20 (G20) summit. However, the Treasury noted that over the next two years non-interest expenditure would decrease by a net R20.4bn compared to the 2025 budget.

That includes a downward adjustment of R19.1bn from lower-than-expected CPI inflation. Godongwana said in the MTBPS that the government was preparing a minimum R15bn infrastructure bond issuance for the Budget Facility for Infrastructure special window projects.