Certain changes on the cards

A shift in South Africa’s currency policy – long resisted by the South African Reserve Bank (SARB) and the Treasury – may be on the cards later this year. However, it is not likely to go as far as pegging the rand as has been called for by the left-wing allies of the ruling African National Congress (ANC), although they have some seemingly unlikely support for their stance.

The ANC’s allies, the South African Communist Party (SACP) and the Congress of South African Trade Unions (Cosatu) have long criticised the government and SARB’s inflation targeting policy and have called for direct government intervention to protect the value of the rand, saying these factors increased poverty and led to job losses.

But it is not only the Left that has expressed concerns over the volatility of the rand.

In the first quarter of this year, the rand climbed 1.6% against the dollar, following a 28% surge last year. This cut heavily into the earnings of exporters, particularly mining companies, while some sectors such as the clothing and textile industry were unable to compete with cheaper imports. This prompted a group of local manufacturers and South Africa’s three largest trade union federations to jointly express their concern that an over-valued and volatile rand was the greatest concern for the manufacturing industry.

Chinese influence

This formed part of the launch in Johannesburg on 10 May of a joint declaration toward the creation of jobs. Addressing the group, Cosatu secretary-general Zwelinzima Vavi said the rand was “far too strong” and that “the declaration calls for interventions to ensure an appropriately valued, competitive and stable currency” to allow South African manufacturers to compete on a more equal footing with other developing countries.

"The Chinese economy has grown because the Chinese actively intervene in their currency and they peg it at a particular level,” he said.

Calls for stronger government intervention have long been resisted by the government and SARB, which conducts monetary policy within an inflation-targeting framework and a floating exchange rate policy in which there are no exchange rate targets.

However, after growing pressure from various quarters, SARB governor Gill Marcus, in an address to the Bureau for Economic Research Annual Conference in Johannesburg in April, said: “There is little doubt that the rand exchange rate is one of the most volatile currencies, and is also currently assessed to be overvalued by many market participants and analysts, including the IMF [International Monetary Fund]. However, estimates of the degree of overvaluation differ markedly.”

Asking what can be done about it, Marcus said, “direct intervention is constrained by the costs of sterilisation; the jury is still out as to whether taxation of inflows, such as applied by Brazil, are effective; and while economic theory tells us that a narrowing of interest differentials should lead to a decline in inflows, this is not always the case, particularly if lower interest rates encourage growth-sensitive flows”.

She said the Bank has continued buying foreign exchange as part of its strategy to increase the level of foreign exchange reserves, but despite significant foreign currency purchases, the rand has remained at elevated levels on a trade-weighted basis.

However, said Marcus, the cost of sterilisation had been significant given the wide interest rate differential. One of the consequences, she said, would be that the SARB would report an after-tax loss of around R1bn for the 2009/10 financial year.

Answers not straightforward

Marcus said the central bank had continued building foreign reserves as necessary, which were sometimes obscured by valuation changes relating to the dollar, euro and sterling.

She further denied at the time that recent reductions of interest rates had been an attempt to weaken the rand, as experience had shown that the response of the rand to the lowering or raising of interest rates is unpredictable, this had not been a factor in the bank’s decision.

Marcus added: “While we do not target the exchange rate, we would want to see the rand at a stable and competitive level. Unfortunately, we have seen that achieving this is not straightforward.”

In May, the governor said the Bank’s “core responsibility” is to have a “sound macro-economic environment and to tackle inflation,” while she dismissed calls to peg the rand to boost exports as “unrealistic”. That seems to put paid to the demand of a fixed rand value.

However, Bloomberg recently reported that analysts of the Nomura Global Economics unit of the financial services group Nomura International were expecting a change in currency policy in the second half of 2010 after they had met with South African policy-makers – SARB’s Marcus, other SARB Monetary Policy Committee members, the Economic Development ministry, National Planning Commission, various departments from the National Treasury, local banks, politicians, economists, public sector institutions and political parties.

According to the report, one of the “strongest conclusions” that the group took from its meetings with policy-makers in Pretoria “was that a change in currency policy is increasingly likely in H2”. This also fits with the signals that have lately been coming from within sections of the ANC, Cosatu and the SACP as well as the Department of Economic Development headed by former trade unionist, Ebrahim Patel.

According to Nomura and other analysts, the government is likely to take a conservative approach to any change in currency policy. Such changes are likely to be discussed at the ANC’s policy-making National General Council to be held in September, after which Finance Minister Pravin Gordhan could announce it in his mid-term Budget Speech.