The National Treasury anticipates a turbulent economic journey following the implementation of Minister of Finance Enoch Godongwana’s decision to reduce the inflation target to 3%.
Godongwana confirmed the change in the 2025 medium-term budget policy statement (MTBPS) delivered in parliament on Wednesday, a move that has previously attracted criticism from experts.
The change comes after the inflation target band has been between 3% and 6% for over 25 years.
“The lowering of the inflation target to 3% has important, multi-stage implications for the public finances,” reads the MTBPS.
“In the short to medium term, targeting lower inflation will result in lower nominal GDP [gross domestic product], which in turn results in reduced revenue projections and a less favourable debt-to-GDP ratio.”
Long-term benefits
Beside these projected economic risks, the National Treasury made a case for the amendment, stating that the benefits would in the long run outweigh these shorter-term concerns.
“Lower inflation will support higher levels of real economic growth. South Africa’s inflation target will be more in line with its trading partners and peer economies, making the economy more competitive.
“Household spending and private investment will rise mainly due to higher real disposable income and lower borrowing costs,” said the department.
The Treasury stated that the negative impact of the fall in revenues on the budget balance is counteracted by the reduction in debt-service costs.
“The net result is that the fiscal balance continues to improve steadily over the forecast period,” it said, adding that the cost of servicing government debt is lower due to improved sentiment as the fiscal position improves.
The National Treasury further argued that South Africa’s average inflation rate is higher than its trading partners and emerging market peers, which erodes the country’s competitiveness and causes the rand exchange rate to depreciate.
“Higher inflation also increases the cost of living to the detriment of households—particularly the poorest and most vulnerable,” said the department.
Move will reduce cost of living
Godongwana said the inflation target reduction to 3% will have a tolerance band of 1 percentage point on either side to accommodate normal economic fluctuations.
“The revised target will benefit all South Africans, especially poorer households. Although the impact on government finances will be mixed in the short term, this change is expected to reduce the costs of living and borrowing while boosting economic growth and revenues in the years ahead,” he said.
Godongwana, in the statement, explained the thinking behind the transition. “There are clear signs that consistent fiscal discipline is paying off in improved investor confidence.
“This has been aided by sound monetary policy, which has reduced inflation and inflation expectations, enabling lower interest rates.
“To reinforce these positive outcomes, I have decided after careful consideration to reduce South Africa’s inflation target to 3%,” he said.
The move comes after Reserve Bank governor Lesetja Kganyago proposed the change to inflation targeting in July.
While announcing a monetary policy committee interest rate decision in July, Kganyago said the central bank’s model shows that by targeting 3%, core inflation would remain steady, expectations would shift to a new low-inflation environment by 2027, and the exchange rate would likely strengthen.
Both Kganyago and Godongwana, on one hand, argue that the new target is aimed at anchoring inflation at permanently lower levels and reducing the cost of living and borrowing costs for households, businesses and government, supporting higher long-term economic growth and job creation.
Decreased inflation expectations
Critics, on the other hand, argue that a lower inflation target will result in interest rates remaining high for longer periods.
The critics’ argument is based on data showing that inflation has spent longer periods hovering above 3%.
Godongwana, however, stood his ground. “In the short term, reducing the inflation target to 3% will result in more cuts in interest rates than would be the case under a 4.5% target.
“Over time, a lower target will decrease inflation and inflation expectations, creating the space for permanently lower interest rates, which will support household spending and investment—boosting economic growth and job creation.
“A lower target aligns the country with international best practice and makes the cost of borrowing cheaper by reducing the inflation risk premium that investors demand to lend to South Africa,” he said.
