Chief Investment Officer Nick Balkin

The campaign to adjust the South African Reserve Bank’s (SARB’s) inflation target at the bottom end of the 3 – 6% band is gathering political momentum. The SARB has circulated estimates of almost R1 trillion in interest savings over a decade if the target is lowered. The thesis is that better price discipline will pull down borrowing rates, shrink Treasury’s debt‑service bill and release scarce funds for social priorities. The arithmetic appears neat but doesn’t take into consideration one of the main reasons putting upward pressure on borrowing costs: the deteriorating credibility of government.

I have spent two decades investing in South African debt and equity markets. During that time, the SARB has generally delivered on its mandate to keep prices stable within the target range. However, real economic growth has barely averaged one per cent a year since 2014. Stabilising prices has not unlocked capital expenditure or boosted economic growth. If anything, it was the weaker growth that helped keep inflation in check.

Lower inflation does not automatically mean lower borrowing costs for the South African government. Firstly, South Africa’s bonds have much higher average maturities than for many other emerging markets. So even if yields fell meaningfully tomorrow, the interest line in the national budget would decline only gradually as outstanding bonds mature and are refinanced at lower borrowing rates over time.

Secondly, lower inflation would result in lower nominal economic growth (nominal growth is equal to real economic growth plus inflation). As a result, South Africa’s troubling debt‑to‑GDP ratio - which is measured against nominal GDP - would continue to deteriorate, with the denominator lower than it would otherwise be. Without meaningful, structural state inventions to address the root causes of constrained economic growth, the debt burden may even worsen.  

Thirdly, South Africa’s risk premium - the yield above US Treasury yields demanded by bond investors - is another binding constraint. Strip inflation out of current bond yields and investors still demand a real return of roughly five per cent - double that of comparable emerging economies. The risk premium compensates investors for weak governance, unreliable energy supply and unresolved fiscal risks - not for an inflation target that is set too high. Unless these underlying fundamentals improve, global capital will continue demanding a high spread over US Treasuries, regardless of the official inflation target.

National Treasury also has other options to reduce borrowing costs. These include shifting debt issuance away from long‑dated, fixed‑rate bonds towards Treasury bills, floating‑rate notes and inflation‑linked securities - assets that already carry lower yields.  

The SARB’s stewardship of price stability is one of democratic South Africa’s macroeconomic successes. Central banks earn credibility by meeting the targets they set. A lower target that proves hard to attain - for myriad reasons - would force the SARB either to tighten policy sharply or tolerate repeated misses. Neither outcome would enhance the SARB’s standing.  

Finance Minister Enoch Godongwana was correct when he told Parliament in July that the process ‘should not be rushed.’ The priority should be the correct sequencing of reforms. Otherwise, the country risks the worst of both worlds: a lower inflation number (which worsens our debt burden) alongside persistently high real yields (which keep borrowing costs too high).

Lowering the inflation target may promise a quick political win but offers only a faint hope of materially lower funding costs. South Africa’s fiscal arithmetic improves meaningfully only when two conditions hold: when the economy grows at a faster pace than outstanding debt, and the country risk premium narrows. Achieving both depends on structural reform, fiscal consistency and reliable service delivery - not on fine tuning the inflation target.