The Minister of Finance, Enoch Godongwana (pictured), yesterday changed the country’s inflation target to 3% with a tolerance band of 1 percentage point.
The new target immediately replaces the previous target range of between 3% and 6% and will be implemented over the next two years. This is the first adjustment to the inflation target in 25 years.
“This decision follows agreement between the Governor of the South African Reserve Bank and my consultations with the President and Cabinet,” Godongwana said in a speech when he tabled the Medium-Term Budget Policy Statement (MTBPS).
The 1-percentage point tolerance band on either side of the target will provide flexibility to accommodate any unexpected inflationary shocks, he said.
Over time, the lower target will decrease inflation expectations and inflation, creating room for lower interest rates. The short-term fiscal costs of a lower target will make achieving fiscal targets more challenging. But the long-term benefits of taking this step far outweigh these costs, Godongwana said.
National Treasury said in a statement that the SARB will pursue the target on a continuous basis and clearly communicate any deviations from the target.
“National Treasury and the SARB will continue working closely to ensure effective policy co-ordination as the economy navigates global uncertainty and domestic structural challenges,” the statement said.
In explaining the reasons for lowering the target, the MTBPS said that in 2022 Treasury published a review of South Africa’s monetary policy by two international experts. Their study, which informed Treasury’s 2024 Macroeconomic Review, recommended that the inflation target of 3% to 6% be reviewed.
Over the past year, the Treasury and the SARB conducted joint research on the impact of a lower inflation target on the economy and the fiscal framework. They also reviewed the wider literature on optimal inflation targeting in emerging markets. South Africa’s average inflation rate is higher than those of its trading partners and emerging market peers, which erodes the country’s competitiveness and causes the rand exchange rate to depreciate. Higher inflation also increases the cost of living to the detriment of households – particularly the poorest and most vulnerable, the MTBPS said.
“In the short term, reducing the inflation target to 3% will result in more cuts in interest rates than would be the case under a 4.5% target. Over time, a lower target will decrease inflation and inflation expectations, creating the space for permanently lower interest rates, which will support household spending and investment – boosting economic growth and job creation.
“A lower target aligns the country with international best practice and makes the cost of borrowing cheaper by reducing the inflation risk premium that investors demand to lend to South Africa.
“However, lower inflation will also initially slow nominal GDP growth and revenue growth, given that tax receipts are linked to nominal GDP. This will reduce fiscal space, while the real value of public debt will decline more slowly.”
The MTBPS said the government has concluded that the benefits of a lower inflation target outweigh the costs.
“Furthermore, policies to restore the health of the public finances and implement growth reforms will mitigate short-term adjustment risks. Given the year-to-date revenues collected and the measures already implemented to stabilise the public finances, the National Treasury has concluded that the target change can be managed without jeopardising government’s fiscal objectives.”
