South African Reserve Bank hints at revising inflation target amid economic pressures

The South African Reserve Bank (Sarb) is contemplating a recalibration of its inflation targeting framework, a debate that has sparked significant discussion among economists.

Sarb Governor Lesetja Kganyago hinted at potential shifts in the Monetary Policy Committee’s (MPC) approach during the opening of the SARB Biennial Research Conference in Cape Town on Thursday.

Kganyago suggested that while South Africa has traditionally aimed for a midpoint inflation target of 4.5%, there was an ongoing discussion around moving towards the lower end of the range, towards 3%.

He spoke of the effectiveness of inflation targeting, highlighting its historical role in guiding South Africa through fiscal challenges, pointing out the dramatic reduction in interest rates from over 20% in 1998 to the current rate of 7.5%.

Kganyago attributed this achievement to the inflation targeting framework that has effectively mitigated macroeconomic volatility during crises, including the 2008 financial meltdown and the disruptions caused by the COVID-19 pandemic.

Kganyago said the benefits of inflation targeting have established it as a widely adopted framework among central banks, and the framework has become a global monetary standard.

“However, inflation targeting continues to be challenged, with central banks facing various competing demands, including faster economic growth and greater responsibility for financial stability. These have once again come to the fore for both advanced economies,”Kganyago said.

“One particular issue that both advanced and emerging market economies grapple with is making sure that their targets are efficient and align with clear and practical definitions of ‘price stability’. Most advanced economies have settled on maintaining inflation targets at 2%, while emerging markets are closer to the 3% mark. 

“Early adopters of inflation targeting have updated their frameworks to better reflect changing realities on the ground, with Armenia being the latest central bank to also reduce its target to 3%.

“In this respect, the South African target is now rather dated, reducing our competitiveness and opportunity to generate faster and more sustainable growth. We will have the opportunity to discuss what a more optimal inflation target for South Africa may look like, especially in the context of structural rigidities.”

Investec chief economist, Annabel Bishop, said this has been going on for many years now that Kganyago has said this.

“A lower inflation target, if achieved sustainably, would then mean a lower neutral rate of interest and so lower interest rates, but higher interest rates may occur first in order to achieve the lower inflation target,” Bishop said.

“A more modest inflation rate would be helpful in reducing the pressure on the rand to depreciate, and improve the real spending power for households, as would a lower interest rate environment.”

Meanwhile, Kganyago said that open discussions like these were important for how the bank thinks about the trajectory for global macroeconomic policy over the medium term, and what that means for the path of inflation targeting within the South African context.

“In my many years in public service, I have come to think of inflation targeting much like Winston Churchill viewed democracy: it is the worst form of governance, except for all the others,” Kganyago said. 

“Research conferences like these should at least bring us closer to learning from our mistakes, and my hope is that we walk away with a few much-needed lessons for the future.”

Momentum investments chief economist, Sanisha Packirisamy, said South Africa’s inflation target of 3% to 6%, with a preference for the midpoint of 4.5%, kept interest rates elevated as the Sarb maintains a restrictive stance to anchor inflation expectations, currently around the midpoint of the target.

She said high real interest rates - among the world’s steepest - can stifle growth. 

“A lower target could align SA with its peers and trading partners, potentially reducing borrowing costs and boosting investment (lower financing rates). Governor Lesetja Kganyago has suggested this could be achieved with minimal economic disruption, citing past shifts like the 2017 focus on 4.5%, suggesting that the sacrifice ratio to achieving lower inflation was negligible on growth,” Packirisamy said. 

“However, risks include short-term rate hikes to hit the new target (particularly as administered prices are not affected by the interest rate transmission mechanism and account for 16% of the inflation basket) and medium-term inflation pressures from public debt or global shocks. As a result, a lower inflation target can help to achieve lower interest rates and faster growth in SA, if fiscal discipline and reforms support it.”

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