SIMON BROWN: Aiming at the targets

Last week the monetary policy committee of the Reserve Bank cut the prime lending rate by 0.25%, as expected. In the announcement, governor Lesetja Kganyago discussed many of the risks to inflation, most of which are beyond our control, such as the oil price, tariffs and deglobalisation. However, it was at the Q&A session where things got interesting.

Asked about reports that the National Treasury is considering a reduction in the inflation target, he gave an excellent history of South Africa’s inflation targets.

In February 2000 we introduced an inflation target range of 3%-6%, though the governor usually refers to the midpoint of 4.5%. In April last year I wrote about the global history of inflation targeting; South Africa was one of the early adopters. But our target is high and the range wide, which makes us an outlier.

The point is that the level at which a country sets its inflation target is hugely important, and a lower target has significant benefits for the country.

First, it sets inflation expectations, which is why the governor always refers to 4.5%. If the target is a wide band topping out at 6%, wage negotiations will always start north of that number before moderating lower, but likely still ending high. With an inflation target of 3%, negotiations will start and end at lower levels.

Now, sure, that means a lower pay increase, but it also means (if the targeting is working) that our spending will go up more slowly. This in itself helps stabilise an economy as bouts of very high inflation are less likely.

Second, most of our trading partners have lower inflation targets — generally 2% for developed market countries and about 3% for emerging markets. If we’re running a higher inflation target, and therefore a higher inflation rate, we start to become less competitive as the cost of our goods for export is increasing faster than the prices of our trading partners.

Third, it can also help the currency. Right now, with a higher inflation rate, investing here is riskier because inflation can eat away at the returns. But more than that, in a hypothetical world, our currency should weaken by the difference between our inflation and that of other countries. So if we’re running our inflation, say, 1% higher than the US, the rand would depreciate closer to only 1% a year. Of course there are other influences on the rand, but a lower inflation difference would be an excellent start.

Lastly, perhaps the biggest issue for consumers is potentially lower debt costs. In the Q&A session, Kganyago referred to a stable repo rate of about 6% in a lower inflation world. This would put prime at 9.5%, making debt a lot cheaper, with the result that we could spend the money we save on interest on consumption and so help grow the economy.

So here’s hoping we get a new, lower inflation target sooner rather than later.