Reserve Bank Governor Chris Stals talks to Max Gebhardt about the challenges he faces amid continued currency turmoil
COMPARED to last week’s freefall, the rand enjoyed something approaching a settled week. The currency’s downfall, while uppermost in the minds of the public, is one of several fundamental concerns over the economy.
Reserve Bank governor Chris Stals spent some time this week outlining his thoughts on these issues.
How has the rand’s fall influenced the inflation rate and interest rates?
The rand’s fall had an immediate direct effect on the prices of imported goods, as reflected by their month-to-month changes of between 0,8 and 1,8 percentage points in the three months April to June 1996. This probably also contributed indirectly to the rise in the prices of domestically produced goods since April 1996.
Part of the effect of the depreciation on imported goods’ prices was absorbed by foreign exporters as well as domestic producers.
Further increases in inflation should therefore still take place. This pressure has increased with the latest sharp depreciation of the rand.
This clearly demands a restrictive monetary policy and was an important reason for the increase in bank rate to very high real levels.
Future monetary policy will depend on developments in domestic economic conditions, such as the growth in domestic expenditure, money supply and bank credit extension.
Where will the rand settle?
Any person willing to predict the level at which the rand will stabilise under present circumstances would be very brave.
When does the bank plan further relaxation of exchange controls and what form will it take?
The minister of finance is responsible for changes to the exchange control. The bank can only advise the minister, but he takes the final decision. The government has indicated it intends to gradually reduce exchange controls as part of its macro- economic strategy.
Considerable progress has already been made in removing exchange controls. Non-residents are free to move funds in or out of the country. Current transactions are not subject to control, though qualitative limits are applied in a few cases to avoid a circumvention of the rulings applicable on capital transfers of residents.
Controls remain on outward capital investments of residents and the transfer of the capital assets of emigrants.
More lenient policies are followed in allowing direct investments abroad and concessions have been made on portfolio investments of domestic institutional investors in other countries.
Further steps would include more lenient rules on the foreign investments of institutional investors, which will broaden out to the relaxation of controls on the capital transfers of individuals. The free transfer of the capital assets of emigrants will probably only be implemented in the final stages of the abolition of exchange control.
Are you happy with the broad direction of the government’s fiscal and macro-economic policy?
The bank supports the government’s macro- economic strategy for Growth, Employment and Redistribution (Gear) and believes the package of measures proposed should lead to higher sustainable economic growth, employment creation and greater financial stability, and create opportunities for a more equitable distribution of income.
This plan also provides for structural adjustments in all the major macro-economic areas, which should alleviate the pressures on monetary policy to achieve and maintain price stability.
What role could or should the International Monetary Fund (IMF) play in policy formation?
A stand-by facility from the IMF will help in increasing the foreign reserves to a somewhat higher level.
In furnishing this financial aid, the fund also normally requires a country to fulfil certain conditions which could require even greater monetary and fiscal discipline and could increase the confidence of non- resident investors in the South African economy. An acceptable role for the fund in this regard is normally negotiated between the government of the country and the fund.
Minister of Finance Trevor Manuel is expecting a growth rate of 2,5% for 1997 (from an expected 3% this year). What is the bank’s prediction and what interest rate are you assuming in anticipation of the slow- down in the economy?
We agree with the minister’s projected growth rate. We cannot reveal our predictions on interest rates because of the direct influence that the bank has on the determination of short-term interest rates. These rates are also influenced by sudden changes in the underlying conditions, such as the recent large outflows of short-term capital from South Africa.
How does the bank plan to lower real interest rates as proposed in the government’s Gear document?
The level of real interest rates is dependent on the levels of nominal interest rates and the expected rate of inflation. The bank can influence nominal interest rates by changing bank rate. The inflation rate is the outcome of economic developments in South Africa and abroad as well as the broad macro-economic policy package pursued by the authorities.
The level of real interest rates in the Gear document is based on the implementation of the macro-economic strategy, assumptions about developments in the domestic economy, such as normal agricultural conditions, and assumptions of developments in the economies of South Africa’s major trading partners.
If all the proposals in the Gear document are implemented, real interest rates will decline.
How long will it be before the current account deficit on the balance of payments starts to narrow?
The trade statistics for the third quarter of 1996 indicate that the deficit on the current account narrowed sharply from the very high figure of the second quarter. Unfortunately, the latest depreciation of the rand could again produce leads and lags in imports and exports, which could delay the adjustment in this deficit. Normally with slower growth in production and expenditure the current account of the balance of payments adjusts relatively quickly. Under current conditions and taking the sharp depreciation of the rand into consideration, one could have expected a substantial and quick decrease in the current account deficit. This adjustment can, however, now be delayed if uncertainties continue to prevail in the foreign exchange market.
Conditions on the balance of payments are important in determining monetary and other macro-economic policies, because of the relatively low domestic savings of the country. If foreign reserves are also low, it places more pressure on monetary policy.
Why, if economic indicators are pointing to a slow-down in the economy, is private credit extension still so buoyant?
Credit extension continued to be boosted by strong consumer and investor confidence, reflected in relatively high growth in real consumption expenditure and real fixed investment. Demand for working capital from small and medium-sized enterprises has also increased sharply.
A switching from foreign to domestic financing of international transactions arising from the instability in the foreign exchange market this year also contributed to the steady credit demand.
On top of these shorter-term developments, important structural changes in the economy kept the demand for credit high.
Bank credit extension has continued to increase sharply as more and more younger people with a high propensity to consume are replacing workers in the age groups 50 to 65 years who are normally bigger savers.
The explosive increase in the turnover on financial markets in recent years probably also contributed to high demand for credit.
On the supply side, banks actively promoted the use of credit facilities, while a large number of retail outlets introduced in-house credit cards to encourage consumption expenditure.
Continued growth in credit extension is probably not a good indicator of the underlying strength of real economic activity.
The bank wants to withdraw from the forward cover market (one of the bank’s main weapons to defend the rand). How has the rand’s fall affected this policy?
Under present conditions the bank has no other choice than to remain an active participant in the forward currency market. The long-term objective is, however, to be involved in the forward market only on its own initiative when it deems it necessary to intervene in the market to prevent undue short-term fluctuations in the rand’s exchange rate. The withdrawal will only be possible under more calm and stable conditions than those that we are experiencing currently.