Investment in the public sector should be used as an anti-inflationary tool

The announcements in the Medium Term Budget Policy Statement (MTBPS) about a lower inflation target and cuts to public expenditure in real terms will exacerbate material insecurity and worsen developmental outcomes.

The decision by the South African Reserve Bank (SARB) to drop the repo rate by 25 basis points comes just eight days after the National Treasury announced in the MTBPS the narrowing of the inflation target to 3%. 

The idea that a lower target will increase opportunities for more frequent rate cuts by the central bank is misleading.

It gives the perception to the public that the narrow target is driving interest rates down. It is the current inflation rate and relatively low inflation environment, not the target, that is partly responsible for the rate cut.

The pattern by the SARB has been to mirror the actions of the United States Federal Reserve Bank, which in September of this year also implemented a rate cut of 25 basis points.

Treasury itself admits that the narrowing of the inflation target will lead to reductions in nominal GDP and revenue.

This means a worsened fiscal position and increased probability of heightened household indebtedness in the future. A rate cut would still be possible under a higher inflation target without the negative risks. 

The inflation target is used by the central bank to indicate the direction of monetary policy and whether the interest rate should go up or down.

The SARB claims to use the interest rate to keep prices low and steady within a defined target and range, but this is self-defeating given the nature of inflation in South Africa.

When prices rise too quickly beyond the inflation target, the SARB, under its mandate, would need to respond by hiking interest rates.

There is a misconception that a narrower inflation target directly translates to lower inflation and that lower inflation means greater household disposable income.

What is actually happening is that the goalpost is becoming harder to reach, and when inflation rises above the bounds of the target (for example, through a fuel hike), the SARB would argue for increases in interest rates.

We are in a relatively low inflation environment, which explains the rate cut, but this would have also been possible under the previous wider inflation target. 

The SARB’s mechanistic approach to inflation targeting ignores the fundamental structure of South African inflation, which is driven predominantly by supply-side shocks and administered prices - such as the cost of electricity - that are simply unresponsive to interest rates.

By attempting to curb inflation through suppressing domestic demand, the central bank is applying a remedy that is not only ineffective against the disease but which actively worsens the patient’s condition.

Under the scenario of rising supply-side inflation, the response by the central bank to curb domestic demand through maintaining high interest rates is the wrong policy measure to deal with the cost-of-living crisis.

At the same time, persistently high interest rates will mean continued high costs of borrowing for both government and households. Under these dynamics and a narrower inflation target, the cost-of-living crisis is worsened. 

According to Jason Hickel, there is no conclusive evidence that a low inflation target leads to greater economic growth, and no evidence for its inverse – that higher inflation (below 20%) is harmful to growth.

Furthermore, high interest rates discourage investments in the productive economy and encourage speculative financial investments, which is part of the reason why the financial sector has been reacting so positively to this announcement. It also benefits creditors at the expense of indebted households.

The profound lack of consultation on the decision to narrow the inflation target reflects an economic orthodoxy within the Government of National Unity (GNU) that capitulates to the market irrespective of the consequences for household welfare, fiscal sustainability, economic growth and unemployment.

The announcement now by the central bank manufactures public approval for the narrower target through a misleading and temporary outcome.

The question remains, why would a dwindling ANC government support such a move that puts a gamble on economic growth, disposable household income and debt costs? In the shadow of declining power and the spectre of coalition governments, hard rules are being hastily erected to bind future fiscal and monetary policy.

The narrowing of the inflation target together with budget cuts form two parts of a whole that lock in austerity for years to come. Austerity has been shown to be self-defeating, which the Finance Minister himself admits.

Yet, Treasury is doubling down on spending cuts and encouraging tighter monetary policy. Together, the new parameters will increase the possibility of growing debt-servicing costs, resulting in a downward spiral that suppresses public spending in the long term.

On top of this, the size and role of the state are shrinking. Main budget non-interest expenditure moves from 25.1% in 2022/23 to a projected 23.3% in 2028/29. Combined with structural reforms under Operation Vulindlela, the GNU is paving the way for deepening privatisation.

Rights-based citizens will turn into clientele, and the decay of public services will calcify. 

Despite an exponentially growing primary budget surplus, non-interest main budget expenditure declines by an average of 0.4% in real terms over the next three years.

Debt-servicing costs as a percentage of main budget expenditure also rises, meaning that more spending space is not being made for health, education and social protection even with a large primary budget surplus.

Stagnating public expenditure will put further strain on dwindling headcounts in the public service.

A more direct response to addressing public debt is to have more frequent reductions in the interest rate, which becomes harder under a more restrictive inflation target.

Investment in the public sector should be used as an anti-inflationary tool. Strategic public spending in public transport, free basic services, housing, healthcare and education allows for increases in non-disposable income.

This acts as a massive real-income boost for the poor and middle class, protecting against wage-inflation spirals, and effectively increasing disposable income far more effectively than any marginal and uncertain reduction in CPI.

As international economists argue, a strict inflation targeting regime is inappropriate for a country that has  mass unemployment, intractable inequality and financial instability emanating from international and domestic factors.

Aliya Chikte is an Economic Justice Project Officer at the Alternative Information and Development Centre.

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