Interest rate nightmare for South Africa

As the VAT debate rages ahead of the new budget date, more economists are warning of the impact hiking the tax will have on consumers and the Reserve Bank’s position on interest rates.

As things currently stand, economists see more room for interest rate cuts in South Africa in 2025, though the timing remains iffy.

Given the turbulent global climate—particularly around US President Donald Trump’s looming trade and tariff war—experts don’t see rate cuts happening in the near term.

However, with inflation sustaining at lower levels, there is certainly room for around 50 basis points of cuts by the end of the year.

This could all be undone in a nightmare scenario, however.

If the National Treasury hikes VAT amid global tensions, inflation could spike, putting to bed the prospects of interest rate cuts.

According to the Bureau for Economic Research (BER), the pendulum could even swing in the opposite direction and lead to interest rate hikes if inflation is not managed.

Investec Chief Economist Annabel Bishop noted on Monday (3 March) that the proposed 2%pt VAT increase in the now-shelved 2025 Budget would have had a “heady” effect on CPI inflation of nearly a 1%pt increase.

Similar numbers were put forward by the BER, which said that a straightforward interest rate equation shows this would potentially put South Africa on the path to rate hikes.

Bishop said that the true impact of a 2%pt VAT would depend on various factors, many of which are not easily calculated.

The degree of zero-rating on consumables may have mitigated some of the impacts, but even with those measures, the VAT hike would impact the cost of living, she said.

Raising the cost of living, in turn, impacts real disposable incomes and, crucially, inflation.

Looking back at the last time VAT was raised, in April 2018, Bishop noted that the headline inflation rate rose by an estimated 0.6% y/y over a twelve-month period following the hike.

This was due to direct (0.5% y/y) and indirect (0.1% y/y) or spillover effects.

“Spillover effects include the impact on wages and other prices not covered by the VAT increase immediately, which are typically smaller or can be delayed,” she said.

This had a knock-on effect on GDP growth as demand weakened.

Bishop said that the 2018 experience of a 1%pt VAT hike from 14% to 15% has been estimated to have negatively impacted GDP growth by -0.2%pt between mid-2018 and mid-2019, as higher prices due to sales tax increase reduce household consumption.

“With CPI inflation expected to average 3.5% y/y this year, and 4.5% y/y next year, (a 2%pt VAT hike) would have meant the inflation rate would likely have moved significantly away from the midpoint target of 4.5% y/y and so reduced the likelihood of interest rate cuts,” she said.

One consolation is that the Government of National Unity (GNU) appears to have largely nixed a 2%pt hike to VAT—however, a compromise of a 0.75%pt hike may still be on the table.

The BER warned that even a 1%pt VAT hike could prompt the Reserve Bank to consider hiking interest rates again.

The inflation problem

Bishop said there may be another spanner in the works: inflation targeting.

Over the years, the Reserve Bank has indicated that it wants to set the inflation target even lower—perhaps as low as 2%—to match global trends.

The National Treasury sets the inflation target, and Finance Minister Enoch Godongwana has already quashed any official move to this target in the near term.

However, in 2024, Godongwana asked the National Treasury and the Reserve Bank to determine the full impact on consumers and the economy before making any adjustments.

The change is on the cards, and it may happen gradually, even though the Reserve Bank has said it is long overdue.

But Bishop said that even a small drop in the target range—like moving from 3%-6% to 2%-5%—would mount pressure on interest rates.

“A lift in CPI inflation to above 5.0% y/y, combined with a drop in the inflation target range to a mid-point of 4.0% y/y, provides a double whammy to targeting,” she said.

“Higher inflation and a lower target typically would spell an interest rate increase, adding to the burden for the consumer, who would also be facing a lower real income and lower real disposable income.”

Bishop said that the inflation targeting process is forward-looking, and the Reserve Bank will assess the likely inflation outcome over a six- to twelve-month period.

Interest rates are altered based on what inflation is expected to be in twelve to eighteen months. For now, the outlook remains optimistic but uncertain.