Reserve Bank keeps repo rate unchanged, warns municipal dysfunction holds back economic growth

Governor Lesetja Kganyago noted households are suffering. The South African Reserve Bank’s Monetary Policy Committee (MPC) kept the repo rate unchanged at 7% on Thursday, while warning that growing dysfunction in municipalities is increasingly holding back the country’s economic growth. The central bank said failing local governments have become a major constraint on growth, as unreliable delivery of essential services such as electricity, water and infrastructure continues to weigh on businesses, investment and economic activity. Governor Lesetja Kganyago said four members preferred a hold, while two favoured an increase of 25 basis points. Many analysts had predicted a hold. This is despite inflation increasing to 5%, higher than the Reserve Bank’s inflation target of 3% Households continue to suffer Kganyago noted that first-quarter growth was stronger than expected, running close to 2% year-on-year. However, this was due to higher net exports rather than domestic demand. “We anticipate slower growth through the second and third quarters of this year,” he said. “Consumer confidence has fallen sharply, and business confidence has also weakened. Sectoral data show generally lower activity since the start of the war. Prices for our export commodities have also fallen, although terms of trade are better, given lower prices for imports.” The governor highlighted that households have suffered from higher fuel prices, while uncertainty has weighed on investment. Poorly run municipalities hurt SA’s growth Kganyago noted it is becoming increasingly clear that poorly run municipalities are hurting the country’s economic growth, as many businesses are moving to better-run municipalities. He said he cannot speak to why this is happening as he is not an institutional government analyst. “What we do know is that it [municipal dysfunction] is constraining business and economic activity. What the source is, it’s for the government to identify. Suffice for us to say… there’s dysfunction and that dysfunction is constraining. “You have heard of companies that relocate out of dysfunctional municipalities to try and find greener pastures elsewhere. We are just grateful that they are still [in the country], they can still find greener pastures in South Africa and they didn’t decide to seek those greener pastures elsewhere.” Economy expected to grow Kganyago added that the MPC believes the economy can get back to a rising growth trend as global conditions stabilise. “Our baseline forecast is that the economy starts to recover in the second half of this year, as the shock fades. But the outlook is uncertain.” He noted that inflation has been above target mainly because of higher fuel prices. Petrol and diesel prices eased this month, but global prices have now risen again. Kganyago said headline inflation is expected to stay above 4% until early 2027. “Aside from fuel, goods prices have been relatively contained. The exchange rate has been resilient, with the rand close to where it started the year against the dollar, and stronger against the euro. This has helped with import prices.” Food inflation Kganyago said food inflation has also slowed recently, which reflects good harvests, as well as fading effects from the outbreak of foot-and-mouth disease. El Niño may start affecting food supply next year, but this is still a risk factor, not part of the MPC baseline. However, services inflation remains a concern with most components now well above 3%, including insurance, transport and housing. “Our various measures of underlying inflation also indicate stronger inflation pressures,” he said. “According to the latest survey from the Bureau for Economic Research, inflation expectations have risen. The changes are bigger for the near term than the longer term. All survey groups anticipated higher inflation, with the biggest change coming from trade unions. “We see upside risks to inflation.” Future looks uncertain The MPC agreed that the outlook is uncertain, and with the rate increase at the previous meeting, the policy stance is appropriate for now, with rates somewhat restrictive. The forecast from the Reserve Bank’s quarterly projection model (QPM) shows the policy rate broadly stable through the remainder of the year. The model shows cuts later in the forecast, as inflation falls to 3% and rates adjust towards neutral levels. As before, this rate path remains a broad policy guide. “Our decisions will continue to be taken on a meeting-by-meeting basis, with careful attention to the outlook, data outcomes and the balance of risks to the forecast.” Pressure on salaries Kganyago said the committee looked at what could happen if expectations keep on rising throughout this year. “The scenario showed extra pressure on wages, which feeds through to core inflation. The model therefore sees tighter policy, with one more rate hike than the baseline forecast, and rates staying higher-for longer after that. “For fuel, the recent volatility in oil prices shows that we face both upside and downside risks, depending on how the Middle East conflict evolves. We therefore considered an adverse case, with oil at $100 a barrel for 2026, easing slowly to $80 by 2029. “That was paired with a positive scenario, where oil is $78 this year, falling to $60 by 2029.” Food prices to go up He added that the adverse scenario has inflation persistently above target, with the shock feeding through to food prices. This requires an extra hike this year and an extended period of restrictive policy. By contrast, the favourable scenario shows inflation returning to target more rapidly, implying that rates start easing in the current year. Kganyago noted that inflation is still too high, while growth is weak. “We are setting policy to achieve 3% inflation over time, ensuring the current supply shock does not de-anchor inflation expectations.” He highlighted that the country’s growth prospects will be driven mainly by domestic reforms. “This covers structural interventions, such as fixing local government, and improving productivity in the network sectors, like transport and energy. It also includes the macroeconomic goals of sustainable debt and permanently lower inflation. “Our main contribution is to stabilise inflation in line with our 3% target, over time, and the MPC will act as needed to achieve that.”