South African Reserve Bank governor Lesetja Kganyago. Photo: Waldo Swiegers/Bloomberg/Getty Images
There is still a very strong case for a lower inflation target, according to South African Reserve Bank governor Lesetja Kganyago.
Lowering the target would give monetary policymakers more room to respond to future economic shocks, Kganyago said in an interview with the Mail & Guardian.
A 4.5% target has been on the cards for some time now. The Reserve Bank’s current target range — between 3% and 6% — has been in place for 21 years.
“The reason the major economies could respond far more aggressively than emerging markets is they had more space than we did,” Kganyago said, adding that the treasury is still reviewing the benefits of a lower target.
The last time the M&G spoke to Kganyago about a lower inflation target, in July 2021, the treasury had said that its research was due to be completed in early 2022, by which time it would be able to make a decision.
But, during the second half of 2021, South Africa’s inflation started to become unanchored — reaching an annual rate of 7.8% in July 2022. The inflation rate only fell back within the 3% to 6% target range in June this year, when it dropped from 6.3% year-on-year to 5.4%.
Prior to the Covid-19 pandemic, the Reserve Bank under Kganyago had managed, for the most part, to keep inflation within the target range. The governor said the lower level of inflation allowed the bank to cut the interest rates significantly during the pandemic in an effort to buoy the economy.
The idea to lower South Africa’s inflation target is not a new one. In 2001, then-finance minister Trevor Manuel and Tito Mboweni, who was the Reserve Bank governor at the time, considered lowering the target range to between 3% and 5%. But between 2001 and 2002 the rand weakened significantly and the rate of inflation breached the upper band of 6%.
Kganyago said lowering the inflation target to 4.5% would bring it closer in line with emerging market economies, while advanced economies target a much lower 2% rate.
A Reserve Bank working paper, published last August, noted that South Africa’s inflation target remains well above the emerging market average, adding: “This is an unambiguous cost to the economy over time.”
“The benefits of lowering the inflation target to the emerging market average include better predictability of investment and savings returns and clearer relative price signals that support economic growth,” the paper said.
The argument against lowering the inflation target is that it would inflict unnecessary pain on an already hamstrung economy if borrowers are forced to endure higher interest rates for a period.
South Africa’s economy already faces this fate, with a number of economists predicting that the Reserve Bank will elect to hold interest rates at their current lofty levels. In May, the Reserve Bank’s monetary policy committee (MPC) raised the cost of borrowing by 50 basis points to 8.25% — the highest level since 2009.
Despite inflation coming down more quickly than expected, reaching 4.7% year-on-year in July, economists still believe that South Africa is only due for an interest rate cut sometime next year. This is as a number of central banks seem to be favouring a “higher for longer” interest rate regime in an effort to bring inflation sustainably lower.
Speaking on the prospect of higher for longer interest rates and its effect on the economy, Kganyago noted South Africa’s still anaemic growth — and the country’s somewhat different inflation dynamics.
“Higher for longer in advanced economies means that the cost of global finance will remain high. We must know that South Africa is priced at a premium to the advanced economies,” he said.
“And because we are priced at a premium to the advanced economies, with their interest rates higher for longer, that basically means that our rates are going to be higher for longer.”
That said, inflation has dropped far quicker in recent months, with both headline and core inflation falling, Kganyago pointed out. And with South Africa’s inflation problem proving to be more structural than cyclical, much of the solution remains out of the Reserve Bank’s purview.
Kganyago expressed his continued hawkishness during the Reserve Bank biennial conference last Friday. Noting the recent drop in the inflation rate, the governor said: “Seeing one swallow arrive doesn’t mean that spring is here.”
The MPC is set to meet later this month.