The recent medium-term budget policy statement (MTBPS) was full of good news for our economy, as witnessed by a ratings upgrade from S&P Global Ratings (even though we’re still junk).
Perhaps the bigger story was the reduction in our inflation target to 3% with a 2%-4% range.
The previous 3%-6% inflation range had been in place since 2000, when then finance minister Trevor Manuel and the Reserve Bank agreed to it, with the plan that the Bank would have two years to get into the range. Initially the focus was on core inflation, but that was changed to headline inflation in 2009.
The plan was also to adjust the range downwards and target the mid- or lower points of the band. That effectively happened when the Bank started targeting 4.5% in 2017 and then 3% in the July meeting this year. But the range never adjusted as was planned back in 2000.
The lower target is good news for South African citizens, companies and the state as prices will rise more slowly. More importantly, the cost of debt will be lower.
The reality is that this will take time. The new target is in place, but keeping inflation at that level and anchoring consumers’ and salary increase expectations at the new levels will take longer.
Business is already benefiting from lower rates, and we’re starting to see this in locally listed real estate investment trusts, with other sectors likely to follow as loans are rolled over or restructured.
Anybody who’s ever looked at the rand/dollar exchange rate knows that there’s theory and then there’s the rand
But aside from lower inflation and debt costs, there are other important points to consider. One is exports and currency volatility.
If, for example, we’re running inflation at 5% and are exporting to Europe with inflation of 2%, then every year our exported goods become 3% more expensive. Now, the exporter can absorb some of this increase, but with shrinking margins. Further, the exchange rate could negate or increase any price changes as it bounces around.
But with most emerging markets at an inflation target of about 3% and developed markets at 2%, it will help keep our exports competitive, which is good for the economy.
Then there is the fact that the theoretical weakness in our currency should be the difference between our inflation and the other country’s inflation. So, again, if we’re at 5% and the US is at 2%, then the rand should weaken by about 3% every year. But anybody who’s ever looked at the rand/dollar exchange rate knows that there’s theory and then there’s the rand. But it should help reduce rand volatility over time.
While much of the MTBPS’s focus was on the primary budget surplus and debt not expected to exceed 80% of GDP (all good news), the change to the inflation target is perhaps one of the biggest economic shifts we’ve seen in decades and will be of significant benefit in the years and decades ahead.
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