The world’s markets are worrying about higher inflation. SA’s are worrying about a lower inflation target. More specifically, they are wondering what exactly Reserve Bank governor Lesetja Kganyago means when he says — as he did recently in interviews with Business Times and the Financial Times — that there is a compelling case to cut the target.
Other countries have cut their targets where SA has not, he said. If SA wants to remain competitive it has to cut its inflation rate to levels closer to those of its competitors.
A first question, though, is when? The governor told Business Times there wasn’t a conversation about this at the moment, and the Financial Times that lowering the target was a long-run plan.
But he and the Bank clearly are thinking about it, and will surely want to open that conversation with the Treasury. Even for those who support the idea, timelines would be a key issue.
Then there’s the bigger question of why.
Officially, the inflation target range is 3%-6%. But under Kganyago’s leadership the Bank has, since 2017, unofficially shifted the target to the 4.5% mid-point of the range.
Inflation targeting is really about psychology more than it is about economics. The idea is that if the firms that set prices and the employees who negotiate pay believe that the central bank is determined to keep inflation at a particular level, and will act to ensure it does so, they will adjust their expectations to that level and price accordingly. So, when price-setters in the economy believed a few years back that the Bank was really targeting 6%, that’s what they expected, and price increases and inflation tended to hover at or above that level.
Since 2017, however, inflation has come down, to a record low average of 3.3% last year, and inflation expectations are now anchored at that mid-point — which is one reason inflation is expected to stay around that level over the next three years, despite a variety of global and local pressures. Kganyago certainly credits the Bank’s clear messaging on 4.5% for getting inflation “structurally lower”, though he says lower food and fuel prices did a lot to make it possible to do that without much pain.
But he points to the fact that other emerging markets — “even inflation-loving India” — have cut their targets to levels below SA’s. Some in the market are wondering if he simply wants to lock in SA’s inflation-fighting gains by making 4.5% the new official target. But he appears to have something lower in mind.
And that raises the “what?” question. Some countries have a target range, as we do; most have a “point” target, with a tolerance range of 1% or so either way, and that might well be the Bank’s preference. Kganyago has long argued that our target range is too wide to work well anyway.
But if a point, what point? Most of our advanced-country trading partners target 2% (and for the first time in many years, they are worried about inflation heading too high, not too low).
But somewhere in the 3% range could be a lot more appropriate for an emerging market such as SA. Several Latin American markets are in that range — Brazil, for example, is stepping its target down towards 3% in phases over the next few years. It’s a level that would be close enough to that of trading partners and competitors to support competitiveness.
And there are good reasons for emerging markets not to go too low. As the experience of advanced countries since the global financial crisis has shown, too-low inflation and the too-low, “zero bound” interest rates that go with them become a real problem for monetary policy when the economy needs stimulating.
In practical terms, too, the rigidities in emerging-market economies and in SA’s in particular — reflected specifically in SA’s high inflation rates for administered, public sector-set prices such as electricity or municipal rates — make it difficult to get as low as 2% or even 3% without a lot of economic pain. It’s the pain question that is the issue — which is why the timing is so crucial. Even if the case for a lower target and lower inflation is compelling, the advantages must be weighed up against the economic sacrifice needed to get there. Now is hardly the time for such sacrifice. A lower target could force the Bank to raise rates to get there just as the economy is recovering.
It may well not be the right time for some years yet — which is why Kganyago talks of the long run, not the short run.
But what does he mean, exactly? Inflation-targeting policy is supposed to be transparent and predictable but Kganyago’s latest comments are far from it, causing confusion in the market about policymakers' intentions.
He has opened the conversation. Now he needs to bring some clarity to it.
• Joffe is contributing editor
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