Higher for longer rates could mean a better for longer SA
On the morning of the budget, I wrote an article that called for the Treasury to use the gold & foreign exchange contingency reserve account (GFECRA) to reduce SA’s debt burden.
This was premised on the idea that a reduction in debt would lead to lower interest payments and less need to raise government debt. This would in turn put us on a more sustainable fiscal path and unlock cash flow for spending on delivery of basic services and infrastructure investment.
It was clear from the finance minister’s speech that the state is committed to dealing with SA’s debt problem. There was also a clear commitment to reducing the sovereign risk premium placed on SA given our malignant structural issues. While the initiative was well received, the question now is: how realistic are the budget’s expenditure projections? And what is the outlook for continued primary surpluses and a lower budget deficit?
We have many issues confronting us that require fiscal support, not the least of which are the state-owned enterprises (SOEs). This is the reason ratings agency Fitch stated categorically that it was “cautiously optimistic” about the budget. But before we get too excited, perhaps we should be a bit more circumspect.
What is now grabbing headlines is the proposition by the Treasury that will allow the SA Reserve Bank to continue to explore lowering the inflation target range (now 3%-6%). It has had mixed reviews, but if one were to consider the overall objective of the Bank’s mandate and consider who bears the brunt of high inflation, perhaps we ought to be more considerate.
The objective of lowering the inflation target is to ensure greater price stability and protect consumer spending power (particularly lowerincome consumers, who are most exposed to the inflation basket).
About a year ago, Stats SA released a report that explored the relative levels of inflation among different income groups.
At that time inflation for the poorest South Africans was at an eye-watering level of 11%, while the figure for the richest South Africans was a “mere” 6.2%. In essence, prices for the poor were growing at double the rate of those for the rich. In such an environment there is a significant risk of social unrest in response to the extensive economic hardship.
Focusing on the most marginalised should be of paramount importance. My first proposition is that a lower inflation target can have the effect of lower inflation expectations and lower inflation outcomes in the long run. This will be based on how credibly the central bank implements policies that ultimately reduce inflation to the new, yet to be determined level.
Lower inflation is good for price-setters, wage-setters and for overall price stability in the economy. It ensures better financial planning and protects consumer spending power. The goal of any consumer is to have income growth, which at the very least maintains the same quality of life.
However, to get inflation to a lower level implies that interest rates should remain higher for longer. That is the only way inflation can be anchored within a lower target range. The real question is the source of inflation, and whether elevated interest rates will have the effect of lowering that inflation.
Inflation in SA has not been demand driven, and the argument that interest rates will remain higher for longer carries less weight in such an environment. The rand-dollar exchange rate and dollar price of Brent crude have been significant drivers of inflation, while demand remains subdued.
PROTECTION OF THE CURRENCY AND FOREIGN INFLOWS IS IMPORTANT TO THE RESERVE BANK AND SUPPORTS THE CASE FOR HIGH RATES
We should similarly keep in mind that protection of the currency and foreign inflows is important to the Reserve Bank and supports the case for high rates.
Protection of the currency and foreign flows is good for the currency and good for our sovereign risk premium — and both are good for inflation and inflation expectations. Therefore, lower inflation can offset temporarily high interest rates.
The idea that the Bank could keep interest rates high artificially when demand is perpetually under destruction requires greater inspection. I believe the Reserve Bank’s monetary policy committee understands the implicit goal of monetary policy is to enhance growth and employment outcomes.
The key point is that there are many moving parts when it comes to reducing the inflation target range. However, the underlying objective of price stability is sacrosanct, and perhaps even if the Bank has to keep interest rates higher for a little longer it will improve the prospect of better days in the long run.