WILL Finance Minister Pravin Gordhan announce significant changes to the South African Reserve Bank's (Sarb's) inflation targeting framework, or even its abolition in the budget next week? That question is on the mind of anyone watching interest rates in SA.
People have started speculating about change because Gordhan made certain vague comments about the issue in a recent radio interview. He said: "We are talking, working, thinking, reflecting, interacting with the key stakeholders from within the government and listening to the voices from outside, and will inform SA where we intend to go on February 17."
The other hot potato - the call by the left to extend the bank's mandate beyond inflation targeting to encompass economic growth and employment - was also referred to in passing. Gordhan reiterated that the independence and mandate of the central bank remain enshrined in the constitution. This suggests there's likely to be no change to Sarb's mandate.
But will the bank fight inflation under a new system, with the 3% to 6% target we have become so used to a thing of the past?
Absa thinks Gordhan will simply give a report-back on talks, with no change to the status quo. Other economists have begun speculating on what they call "regime change" and its implications. One such economist is Standard Chartered's Razia Khan, who says it's likely the authorities will use the budget as an opportunity to announce meaningful change.
"There could be a modification to the inflation target itself to, say, a 4% to 7% range, which would allow the Reserve Bank the flexiblity it may require in the setting of monetary policy, especially in the context of the steep electricity tariff increases expected over the coming years."
Fight inflation first, says Marcus
Khan goes on to speculate that this may not be enough to appease the left, and that the bank's mandate might also be changed, paving the way for another interest rate cut in March.
However, I disagree with Khan on that; Gordhan's radio comments - admittedly vague - seem to suggest that the status quo in the constitution is enough.
The constitution defines the bank's job as protecting the value of the currency in the interests of balanced and sustainable growth. So, growth is already included, but the emphasis is on inflation - or "protecting the value of the currency".
New bank governor Gill Marcus has repeatedly stated that the bank's task, first and foremost, is to fight inflation - so a change to include targets for employment and growth wouldn't make sense.
The Reserve Bank's contribution to economic growth and employment is to make sure it's sustainable - that inflation doesn't create a boom-bust scenario.
But keeping the mandate unchanged doesn't mean the target won't change. I don't think it will be abolished, because inflation targeting provides a useful point of departure for guessing the Reserve Bank's next move.
Still, I think that the targeting framework will change - and it should. Otherwise massive increases in electricity tariffs will upset the inflation apple cart.
The Reserve Bank's latest inflation forecasts assume an electricity tariff increase of 25%, though Eskom has asked regulator Nersa for 35% a year for three years. Even with the assumption of a lower electricity price hike, inflation will - in terms of the bank's forecasts - remain uncomfortably close to the upper limit of the 6% target.
This is hardly a perfect situation. Ideally, the bank has to strive for inflation of 4.5% - the midpoint of the 3% to 6% range.
Three choices
But this range has effectively been discarded in favour of a point target of 6%. Now, it seems a job well done if inflation is below 6%. Change to the inflation targeting framework has already taken place.
If Eskom gets a 35% tariff increase, inflation will once again be above the 6% target. Since inflation targeting began, the inflation rate has spent long periods outside the target. That's bad for the Reserve Bank's credibility, and the whole targeting exercise. It shows a naïveté about inflation in SA.
What needs to happen is one of three things: SA should target inflation excluding electricity; discard the 3% to 6% range in favour of a point at 7%; or bring in a new range, say 4% to 7%.
In the past, the treasury and the central bank have shied away from targeting inflation, excluding certain items (such as food and fuel) despite the fact that the US Federal Reserve looks at a core inflation measure excluding these items.
In SA, the authorities believe that the message of inflation targeting can be conveyed more effectively if everything is included.
On that basis, targeting inflation excluding electricity won't happen. One could expect either a new range or point target.
I think a range doesn't work, because the implication is that the midpoint is the actual target, with the bottom and top ends representing "tolerance levels". So 4% to 7% would really be 5.5% - but in practice, everyone would see 7% as the target.
So instead of that, just make 7% the target, which would also solve the question of electricity tariffs pushing inflation above 6%.
Change is needed to the inflation targeting framework, and it can be implemented without upsetting the markets.
- Fin24.com