A protracted overvalued currency harms economy
October 6, 2009
By Raymond Parsons
The necessary debate on what to do about the stronger rand has gained momentum this year along with the unit. Although the collapse of the proposed MTN-Bharti Airtel deal knocked the rand last week, this year has seen the unit rise by about 40 percent against the dollar, pushed largely by capital inflows and global trends.
Overvaluation of a currency can become a serious problem in emerging economies. It not only makes imports artificially cheaper for consumers and exports relatively dearer for producers, but also reduces the external competitiveness of a country - thus causing losses of domestic production, employment and fiscal revenues.
International experience suggests there is no automatic mechanism to ensure an exchange rate will not become misaligned. The real exchange rate must therefore be seen as a relevant policy guideline, especially for an economy now in recession.
Overvaluation of a currency can have many faces: manufacturing exports become overpriced in world markets relative to the prices of competitors; traded goods are overly cheap for domestic consumers, and the costs of production become too high to compete effectively with imports.
The eventual net result is a larger import bill and smaller exports. Jobs are also lost. Risks exist for two main reasons:
Instead of output reductions, entire industries could disappear; and
The persistent trade deficit could widen further as the domestic economy starts to recover and import volumes increase.
This makes an economy more reliant on foreign capital inflows and vulnerable to a sudden reversal.
With the World Cup around the corner, if the local costs of a vacation rise, tourist inflows will be hit. Except perhaps for the dedicated soccer aficionados, tourists, like everybody else, go shopping for bargains.
Overvaluation may mean that hotels will do less well and other tourist-related industries suffer. So next year, we particularly want South Africa to be seen as a cheap country to visit after the soccer. It is not a year in which we should worry about an excessively strong rand.
This is a worst case scenario. The extent to which overvaluation actually harms an economy depends on factors such as the strength and duration of an overvaluation. A brief spell hardly means great trouble; indeed, it helps to contain inflation. But protracted overvaluation is a different story.
There are winners and losers, but what matters is where the national interest lies.
If a country like South Africa finds its exchange rate persistently rising because of the largesse of foreign capital, should the real rate be allowed to appreciate freely? The rand may yet stabilise or weaken, but on present evidence, given global trends, it could well firm over the next year.
The large capital inflows may be transitory, and even if extended, they will dry up. When that happens, it is essential there is still a traded goods sector able to earn foreign exchange to keep South Africa going.
That all said, given the flexibility and volatility of the rand, what can be done? Business would like more certainty and less volatility in the currency. Must a government or central bank stand aloof?
Governments do intervene in exchange markets from time to time in the hope of moving the exchange rate in the appropriate direction. Dirty floating is a fact of life. Yet the track record of successful currency interventions by authorities is patchy and country-specific.
What tools nonetheless exist for policymakers, especially in emerging markets?
The reality is that the various options available - lowering interest rates, strategic forex management, a Tobin tax on capital inflows and relaxing exchange control - all have their proponents and critics. The Tobin tax was proposed 40 years ago by US economist James Tobin, and despite being espoused by interests across the political spectrum, has never made much headway.
But that does not mean that South Africa should not sensibly look into the policy toolbox instead of simply proclaiming that nothing can be done. We need to craft an approach that can help us to lean against the wind when necessary.
Perhaps South Africa should think of creating a sovereign wealth fund, building up a pool of foreign exchange, as other countries have done for the proverbial rainy day when commodity prices fall or capital inflows are less plentiful. Whatever the ultimate judgement call, recent rand trends are flashing a warning signal to policymakers to create a framework for a more stable and competitive unit to facilitate economic recovery in South Africa.
Raymond Parsons is the deputy chief executive at Business Unity SA. These views are his own.
|
|
