Rumours of the demise of the financial rand system are greatly exaggerated, reports Duma Gqubule
A RESERVE BANK masterplan has caused currency speculators to burn their fingers and lose billions of rands betting against the rand over the past couple of months.
Governor Chris Stals this week laughed at speculators who had put wagers on the commercial rand continuing its headlong slide against the dollar as pressure mounted for the bank to scrap the financial rand dual currency system.
The finrand, as it is known, protects the reserves of the country by sterilising outflows of foreign capital. Non-residents who invest in South Africa use these special rands, a pool of which has been created by foreigners disinvesting. While non- residents should find the cheaper finrand attractive, it has many disadvantages, not the least of which is that inflows of money via this route do not build up the capital in the country, but only soak up the outflow of capital.
Stals also issued a warning to the speculators: “Nobody is going to force the bank to scrap the financial rand before the right conditions exist, especially now that our reserves are on the rise again and the market is flush with dollars.
“We are making profits in our dealings in foreign exchange markets at the moment while they are losing money. The financial rand exchange rate must first come towards that of the commercial rand and not the other way round. In that way there will be less room for speculators and the pain ordinary South Africans will have to bear when the finrand goes will be reduced.”
Stals said the bank had anticipated an outflow of short-term capital in the months leading up to the April election which would result in a sharp depreciation in the value of the rand against the dollar and other currencies.
These outflows would stabilise after the election, resulting in the rand gaining value against the dollar.
“We could have done nothing and allowed a sharp fall in the currency’s value which would be followed by a sharp appreciation after the election. Instead, we decided to supply the market with dollars before the election and buy them back after the election to smooth out expected volatile fluctuations in the rand’s value during the transition.
“Between end-August and May 10, the bank borrowed dollars worth R7,4-billion to prop up the rand, but the currency still depreciated sharply against the dollar. The fall would have been much sharper had the bank not intervened.
“We could have been wrong, but the plan worked out quite well because short-term capital outflows have receded and reserves are rising again.
“We are now net buyers of dollars and have repaid loans worth R4-billion. The currency has stabilised again — around R3,56 — R3,60 against the dollar – – over the past two months.
“Those who bought forward contracts at R3,70c have burnt their fingers. These people are the ones who are saying the bank must allow the currency to fall. But how can we do this if there are surplus dollars on the market?”
Stals said a repeat of the situation where international speculator George Soros broke the Bank of England’s back and pocketed Stg 1-billion was unlikely to happen in South Africa.
The difference was that in 1992, the Bank of England had decided to fix their currency against the European Exchange Rate Mechanism (ERM) and refused to budge even when all economic fundamentals said the pound could not be fixed at such a high level.
Speculative pressures built up and the bubble popped in September 1992.
“The Reserve Bank does not fix the price of the rand or have targets for it. We only lean against the wind smoothing out undue fluctuations in the currency’s value. If economic fundamentals are really against the rand we let it go.”
Stals hit back at economists who were calling for a sharp depreciation in the value of the rand to boost exports and prevent a balance of payments (BoP) crisis. Simplistically, the BoP shows how much in credit or debt the country is with the rest of the world.
“This will result in a short-term improvement in the BoP position as the value of exports increase faster than import prices are rising. But the gains for exporters will be wiped out very quickly by rising inflation.
“We estimate every 10 percent depreciation in the value of the rand will increase the inflation rate by 1,5 percent. Other knock-on effects in the domestic market, like higher wage demands, will result in a spiral of further rises in the inflation rate and inflationary expectations.”
On the possibility of an interest rate hike, Stals said many economic indicators (including the rate of inflation and the rate of growth of the money supply and credit extended by the banks) were moving in the wrong direction.
“The pressure is building up, but we have not yet reached the stage where bank rate will have to increase.” The bank rate, set by the Reserve Bank, is the key interest rate which determines all other short-term interest rates.
The bank was watching with interest developments in money and capital markets where rates were rising.
“So far the pressure in these markets is not enough to make us increase bank rate, even though some banks are complaining that an increase is needed to improve their interest margins.
“We will look at how much they are borrowing from us. At this stage it is only R2-billion to R3- billion a day. If our rate is too low they will borrow more and only if the figure rises to about R6-billion to R8-billion will we be forced to increase bank rate.”
Stals said there was no timeframe for scrapping the financial rand.
The country was moving in the right direction which would make it easier for the bank to recommend a removal of the dual currency system.
* The exchange rate had stabilised * Foreign exchange reserves were increasing * Arrangements were being made for South Africa to receive a credit rating and borrow overseas * Long-term interest rates had already discounted the ending of the finrand * Short-term capital outflows were improving * Soon long term outflows would follow suit and maybe, in 18 months, foreign direct investment would start arriving
“We are moving in the direction that the shocks to the economy (when the finrand was abolished) would be reduced.”
On the country’s growth prospects during the transition, Stals said he was optimistic.
“This year there will be not much more than two percent growth. Hopefully, we will be able to gradually solve the structural problems in the economy and raise our medium and long term growth potential. These structural adjustments will happen over time — some are already happening in the clothing and textiles industries — and not in one big bang package from the IMF.
“South Africa’s problems are not as great as those of countries like Argentina which had an inflation rate of 200 percent and a growth rate of -5 percent. These countries had no choice but to make their adjustments in one big bang.”