South Africa lowers inflation target for first time this century

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South Africa’s government has cut its inflation target for the first time this century to 3 per cent, bolstering a rally in the country’s currency, even as it warned that GDP growth might be lower than it initially hoped this year. 

Africa’s most industrialised economy has been struggling to lift growth after a decade in which GDP expansion has remained below 1 per cent during a jobs crisis that has left nearly one in three people unemployed. To revive growth over the longer term, South African Reserve Bank governor Lesetja Kganyago has been advocating a lower inflation target. 

Speaking in parliament while presenting the country’s half-year budget update on Wednesday, finance minister Enoch Godongwana said the country would lower the inflation target to 3 per cent from 4.5 per cent, which was the midpoint of the range from 3 per cent to 6 per cent.

“Over time, the lower target will decrease inflation expectations and inflation, creating room for lower interest rates. This supports household spending and business investment, boosting economic growth and job creation,” he said.

This helped the rand to strengthen 0.7 per cent against the dollar on the day to R17.05, while the country’s stock exchange gained about 1.5 per cent. The change had largely been anticipated by portfolio managers, after Kganyago had described recent benign inflation numbers as the “best chance in 25 years” to lower the target.

The central bank said the “sacrifice” for the economy in the short term would be almost zero.

Daan Steenkamp, head of economic research firm Codera Analytics, welcomed the lower target but warned it would not be easy. “The South African Reserve Bank has its work cut out for it to achieve a 3 per cent midpoint over the next year, as we expect underlying inflation pressure to keep increasing from its cyclical lows,” he said. 

Godongwana conceded it would be challenging. “The short-term fiscal costs of a lower target, which include lower nominal GDP and revenue growth, will make achieving fiscal targets more challenging. Yet the long-term benefits of taking this step far outweigh these costs,” he said.

The Reserve Bank’s campaign to change the target this year has powered large gains for South Africa’s bonds and currency, during a strong year for other emerging markets and a rally in gold and platinum prices, both key South African exports.

The South African rand has gained a tenth against the US dollar this year on a spot basis, or more than 17 per cent when accounting for the interest-rate differential between the two currencies, while the yield on South Africa’s 10-year rand government debt has fallen from 11 per cent in April to about 8.7 per cent.

The upper end of South Africa’s previous inflation target had become an outlier compared with other large developing nations such as Brazil, which has over time reduced its target to 3 per cent with a tolerance band.

Peter Attard Montalto, managing director at South African consultancy Krutham, described this as a “macro-policy reform big bang”, since most investors had only expected the target to be shifted in next year’s budget. 

“The impact on the yield curve is important and significant for the whole economy with interest rates able to be structurally lower in nominal terms first, and then also in real terms of time that will particularly support investment,” he said.

While Godongwana presented a picture of an improving economy, he lowered the country’s expected GDP growth for this year to 1.2 per cent, from 1.4 per cent in May. Equally, he said South Africa’s debt-to-GDP ratio would peak at 77.9 per cent this year, marginally higher than earlier estimates.

This improved picture may set the stage for South Africa to receive another boost, should rating agency S&P Global Ratings lift the country’s sovereign rating on Friday by one notch. At the moment, the long-term foreign debt rating is BB-, three notches below investment grade.

Additional reporting by Joseph Cotterill in London