Two-pot retirement system: withdrawals can lead to repo rate increase

Almost two months and more than R21 billion later, pension fund members are still opting to withdraw funds from the saving pots under the two-pot retirement system, but the Reserve Bank warns that it could be forced to suspend or reduce its repo rate cutting cycle if the withdrawals are higher than expected.

According to the latest Monetary Policy Review of the South African Reserve Bank (Sarb), consumers will spend more when they have more money, but increased spending will push up inflation, which will in turn force the Sarb’s Monetary Policy Committee to suspend or reduce its repo rate cutting cycle.

The two-pot retirement system is a retirement savings reform that allows employees to withdraw one-third of their pension savings without having to resign first since 1 September. All retirement fund contributions are split between three components or ‘pots’:

• The vested component or pot contains all your accumulated retirement fund contributions made until 31 August 2024
• The savings component or pot contains one-third of all your net annual retirement contributions made after the implementation date, including the once-off seed capital transfer from the vested component
• The retirement component or pot contains the remaining two-thirds of all your net annual retirement contributions made after the implementation date.

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Two-pot retirement system withdrawals could boost disposable income

In the short term, pension fund withdrawals are expected to boost households’ real disposable income and therefore their consumption, according to the Policy Review.

Two possible withdrawal scenarios are considered here:

• The high withdrawal scenario assumes an additional pre-tax R100 billion will be withdrawn in the fourth quarter of 2024, followed by withdrawals of R40 billion per year thereafter.
• In the moderate withdrawal scenario which the Sarb considers more likely, a pre-tax withdrawal of R40 billion in the fourth quarter of 2024 is assumed and R20 billion per year thereafter.

The overall economic impact of the new pension reform is sensitive to the size of the total withdrawal, the Sarb says.

“Under a high withdrawal scenario, consumption increases significantly, rising by 0.8 percentage points in 2024 and by 1.8 percentage points in 2025 before reverting to the baseline (before the two-pot retirement system impact).”

Spurred by stronger household spending, gross domestic product (GDP) growth would then edge higher by 0.3 percentage points in 2024 and by 0.7 percentage points in 2025, before returning to the baseline in 2026.

Unsurprisingly, the Sarb says, in an environment of constrained supply, the stronger demand lifts inflation, which increases by 0.2 percentage points in 2025 and by 0.3 percentage points in 2026 compared to the baseline.

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Sarb warns an increase in inflation can cause increase in repo rate

The Sarb warns in the Policy Review that the increase in inflation can then trigger a repo rate response, with the repo rate increasing by 0.6 percentage points in 2025 and by 0.9 percentage points in 2026 compared to the baseline to prevent the inflation impulse from becoming entrenched, affecting the cost of capital to firms and borrowing costs for households.

However, the Sarb expects a smaller increase in real household spending and GDP growth in the moderate withdrawal scenario, with GDP growth only gaining 0.1 percentage points in 2024 and 0.3 percentage points in 2025.

According to the Policy Review, this scenario has more muted inflationary effects, with headline inflation ticking up by about 0.1 percentage points in 2025 and 2026. Accordingly, the repo rate response will also be muted, at 0.2 percentage points in 2025 and 0.4 percentage points in 2026.

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Economic growth benefits are in any way temporary, inflation will linger

The Sarb also warns that in both scenarios the economic growth benefits are temporary, while the inflation effects appear to linger. While the two-pot retirement reform provides some short-term relief to distressed consumers, there are potential downsides:

• If the withdrawal rates turn out to be much higher, the increase in inflation would be substantial, potentially requiring a commensurate monetary policy response. Such an outcome would undermine household consumption as well as corporate investment in the near to medium term, weighing on economic activity.
• The higher the withdrawal rates, the less funds will be available at retirement age, implying lower household consumption in the longer run. The reduced total saving would, other things being equal, then also increase the cost of capital and depress investment and ultimately the economy’s productive capacity in the medium to long run.