Rand manipulation is deficient way to boost competitiveness
Forex Affairs
October 13, 2009
By Azar Jammine
The debate on the rand and its correct value is complex. For one thing, although the rand-dollar exchange rate appears to have appreciated dramatically of late, the local unit has not appreciated year on year or over two years to anywhere near the same extent against several other currencies.
This is because the dollar has depreciated considerably against so many other currencies over the past two years.
So the real trade-weighted appreciation, while substantial, has not been anywhere near as great as superficial examination of the rand-dollar exchange rate would suggest. Indeed, on a real trade-weighted basis, the rand is no stronger than it was in 2007.
Nonetheless, one senses that even in 2007 the currency was strong enough to wash out much of the competitiveness of the export sector. A level that would generate a more even balance between exports and imports would be R8.50 to the dollar and R12.50 to the euro.
The problem with the markets is that they are significantly influenced by capital flows in the short term rather than by issues relating to trade competitiveness. At present, the rand, together with a couple of other currencies such as the Antipodean currencies and the Brazilian real, are the flavour of the month because of the massive injections of liquidity aimed at preventing recession. This liquidity effect has driven up not only equity prices but also commodity prices and currencies of major commodity producers.
In a sense, therefore, the South African economy is not losing out too much in the short term on a macro level because the strength of the rand is doing no more than neutralising the benefit of higher dollar commodity prices. The problem is that producers of manufactured goods, whose prices are not determined on international commodity markets, are bound to be suffering a loss of competitiveness compared with seven months ago.
What has exacerbated the strength of the rand, of course, is the fact that it is a highly tradable currency and the paucity of reserves, compared with other currencies, makes it prone to exaggerated movements in both directions. The situation is exacerbated further by the fact that South Africa's economy is lacking in underlying competitiveness. We rely heavily on imports for much of our infrastructural development, let alone energy needs, and even consumer goods at times. We just cannot produce enough of what we need domestically.
Currency depreciation alone will not address this deficiency. One has to look far more deeply at factors that will increase productivity. These include improving levels of skill and education, as well as reducing the real cost of labour and other inputs in production processes.
It involves improving the competitive structure internally - moving the economy away from reliance on a relatively small number of large private sector enterprises and parastatal organisations, towards a far greater production by small businesses, which employ relatively more people at a lower cost. The concentrated structure of the local economy is a function of the strict exchange controls introduced during the apartheid era and the associated legacy of economic sanctions, as well as the increasing regulation of the economy, which is stifling small business activity and concentrating economic power in the hands of the so-called Golden Triangle, namely government, organised labour and big business.
Cost structures have been further increased relative to productivity by the imperatives imposed on the economy in the form of employment equity and empowerment. Even though they may be considered essential from a social perspective, these initiatives have eroded the competitiveness of the South African economy still further than would otherwise have been the case.
Changes in the structure of monetary and exchange rate policy on their own are unlikely to achieve the desired results. What should be done in the interim? There are a number of options.
Reduce interest rates further to dissuade hot money capital inflows from driving the currency up further. The risk of this is that it could create dislocations and inflation elsewhere in the longer term.
Introduce a tax on hot money inflows, such as occurred in Chile, with reasonable success. But this risks detracting from one of the major long-term attractions of drawing investment into South Africa, which is its relatively well-developed financial sector and associated markets.
Abolish all exchange controls. It is uncertain how much this may defuse upward rand pressure by urging local investors to diversify their funds to the rest of the world. Some argue that capital that would have left the country has already left and that the impact of a total relaxation of exchange controls would be minimal. But others believe that a total of abolition of exchange controls would indeed encourage some large investors to transfer funds abroad, in that way alleviating some upward pressure on the rand.
One suspects that the fear on the part of the authorities is that once such funds have left our shores they will never be repatriated. This irks some of those who believe that the accumulation of such funds domestically took place during the apartheid era and it would therefore be wrong to allow such capital accumulation to leave the country.
An alternative is increased intervention by the Reserve Bank to accumulate foreign exchange reserves. The bank was doing so more aggressively between 2004 and last year, yet now that the rand has strengthened so significantly, the bank appears to have slowed down its intervention.
Ironically, at the time that the Reserve Bank was intervening heavily to build up reserves a few years ago, I suggested this was boosting money supply growth as the bank was creating rands to sell into the market in exchange for forex, with inflationary implications. The bank suggested that it was "sterilising" the proceeds of such intervention, but this was by no means obvious. It now appears the bank is refraining from intervention because it recognises that such moves help boost money supply.
But surely, with money supply hardly growing, now is the time to intervene without fearing the boost to monetary growth? It makes sense to intervene heavily now to build up reserves. In the process, one would both limit the appreciation of the rand to benefit the export sector and build forex reserves to reduce potential volatility of the rand and its reputation as a speculator's paradise.
One is also told that the losses incurred in buying up forex because of the lower rate of interest payable on forex compared with that available on rands acts as a deterrent to accumulating forex reserves. Surely this is a minor consideration from a central bank's point of view?
The final alternative is simply to fix the rand's value against another currency at a lower rate than currently prevails. The problem with this is there could be unforeseen circumstances. If the unit was perceived cheaper than the market suggested, this might encourage even more hot money inflows into the currency, which would make it still more difficult to control in the longer term. The bank would be compelled to increase its creation of rands to purchase forex manifold. Even in an environment of low monetary growth, this could prove inflationary and extremely risky. One could also argue that currency inflexibility might destroy confidence in the conduct of macroeconomic policy.
In conclusion, improvement in the country's competitiveness is better achieved through means other than exchange rate manipulation.
Azar Jammine is the chief economist at Econometrix.
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