Aligning the stars: why South Africa needs a fiscal anchor

South Africa’s macroeconomic debate has recently focused on the appropriate inflation target and monetary policy stance given current fiscal conditions. But a lower inflation environment also sharpens an older problem: debt sustainability becomes harder when real borrowing costs remain high and growth remains weak. Our research argues that this tension can be understood through the idea of a fiscal neutral rate , or fiscal r-star . Fiscal r-star is the real interest rate consistent with a stable debt-to-GDP ratio for a given primary balance, growth rate, and debt stock. It is the fiscal equivalent of the monetary policy concept of the neutral rate, or monetary r-star, which is the real interest rate consistent with inflation at target and output at potential. When the monetary-neutral rate is above the fiscal-neutral rate, the two arms of macroeconomic policy are no longer pulling in the same direction. Monetary policy may need relatively high real rates to stabilise prices, while fiscal sustainability requires lower financing costs or stronger fiscal adjustment. That is the central policy tension we study. Using an estimated DSGE model for South Africa, we find that this tension has been persistent. First, monetary r-star has tended to exceed fiscal r-star, implying a structural misalignment between the interest rate consistent with price stability and the interest rate consistent with debt stability. Second, market interest rates have also exceeded fiscal r-star, which means that actual borrowing costs have remained above the level that would stabilise debt under prevailing fiscal conditions. In practice, that gap shows up as rising debt-service costs, reduced fiscal space, and more pressure on the rest of the budget. The source of the problem is not simply the level of the policy rate. A key result from the paper is that the risk premium on South African borrowing has played a major role in widening the monetary-fiscal gap. In the model, the spread between the