The rand debate

The strong rand clearly is doing damage. Economic Development Minister Ebrahim Patel has promised a thorough and open debate on the rand. Although we had the rand debate before, it is different now:

• SA has now built up fairly substantial foreign exchange reserves - of USD 40bn at last count - so that it has the wherewithal, at least in theory, to intervene in forex markets. Until about six years ago the reserve position was a net negative, a legacy of the huge losses the Reserve Bank sustained when it intervened in the market to try to prop up the rand in the late 1990s. Memories of that debacle loomed large in earlier years, making policy makers reluctant even to discuss intervention - and markets wary of any suggestion that SA might try to intervene again. 
•  The inflation-targeting regime is now well established, but in the early 2000s was still fairly new and its credibility not fully established. So it was seen as important to emphasise there was only one target for monetary policy - and that was inflation, not the exchange rate.

Today, the options for intervention, and the risks, haven’t changed that much. So even if there were agreement that the rand was overvalued, what would we do about it?

Much of the debate lately has focused on what might be called direct intervention - pegging the rand. Apart from the formidable risks involved, what would one target? Supporters of fixing tend to assume it would be the rand-dollar exchange rate, but in a world of volatility, where the dollar is moving rapidly against other currencies, pegging the rand-dollar might not have the effect expected.

More acceptable to markets, and possibly less risky, would be indirect interventions designed to influence the value of the rand, by buying dollars to build reserves or by influencing capital flows in or out of SA. The Bank has long had a policy of “creaming off” dollars in the market to add to foreign reserves

Economists have often called for the Bank to buy dollars more aggressively. But building reserves has a cost, because it has to print rands to buy the dollars, creating excess liquidity in the market that the Bank then has to “sterilise”, not only to prevent this liquidity from causing inflation, but also because the way the Bank conducts monetary policy depends on it keeping the market slightly short of rands. Sterilisation has a cost, as to remove those excess rands from the market the bank must issue bonds or debentures on which it pays interest.

One solution for this is the sovereign wealth fund idea, that instead of buying dollars or euros and holding them as low-yielding reserves, the authorities could make higher-yielding investments in foreign equities or properties or whatever it is a sovereign wealth fund should be invested in. However, there’s no guarantee stronger foreign reserves, in whatever form, will necessarily weaken the rand. Past experience suggests they could have precisely the opposite effect.

Much the same goes for other kinds of indirect intervention. In theory, encouraging money to flow out by loosening exchange controls should weaken the rand but in practice, the rand has strengthened since Finance Minister Pravin Gordhan announced further relaxation in his October budget.

One idea being floated is that the government employees pension fund - which, unlike private pension funds, is not allowed to invest up to 20% of its assets abroad - could be given the go-ahead to do so, potentially releasing more than R100bn to flow out of SA. But economists on the left increasingly are calling not for the government to encourage outflows but for it to discourage short-term inflows - by means such as the tax that countries such as Brazil have imposed on foreign investors. Given SA’s need for investment, and its inability to finance it from domestic sources, this hardly seems the moment to deter foreign investment.

Source: Business Day