We cannot afford to react to the market clamour by lifting exchange controls too quickly, writes Madeleine Wackernagel
WITH the recent strengthening of the rand, the issue of lifting exchange controls is once again on the table. Every time the market rumours gain volume, the Reserve Bank rapidly quashes them; this time was no different.
James Cross, the new deputy governor, denies that the bank has brought forward its timetable for relaxing controls. “The process,” he told the Mail & Guardian, “needs to be managed carefully. We need to get to a situation where all the elements are in place and the decision, in effect, is taken for us, as with the abolition of the financial rand. Then it becomes a fait accompli and the opportunity for destabilisation is minimised.”
We certainly haven’t reached that stage yet – neither the fundamentals nor sentiment is strong enough to deter massive capital flight. Which begs the question – why lift exchange controls at all, at least in the near future?
The overriding rationale seems to be political (as was the original motivation for implementing controls), a desire to integrate South Africa into the global economy, boosting foreign confidence in the country’s status as a fully functioning player on the world stage. In effect, abolishing controls would signal that South Africa has grown up, and firmly put its paranoid past behind it.
It would also set us apart from the rest of Africa, which doesn’t have the best reputation for liberal economic policy and, consequently, is not a favourite haven for foreign funds.
And, depending on one’s political viewpoint, another plus is less government control over the economy – as Britain discovered to its cost in 1992 when the pound was driven out of the European exchange-rate mechanism.
But numerous successful economies still maintain controls, despite these perceived advantages. Indeed, when Korea’s economy was taking off in the 1980s, controls were kept firmly in place. Recent moves to liberalise capital flows have resulted in a rapid de-industrialisation process, with investment flowing to the Philippines and Vietnam.
Says James Heintz of the National Labour and Economic Development Institute: “With capital controls, it becomes more costly for money to move out of a country in search of a quick return, so it is more efficient to re-invest inside that country. What’s happened in Korea is very destabilising for the society as a whole.”
Exchange controls, he says, are a very useful tool for intervention – in any economy. With complete freedom, capital tends to be drawn to speculative, capital-gains type of investment, rather than adding value through production.
Heintz believes South Africa has a long way to go before it is ready and able to relax controls. “All the pieces of the puzzle must be in place before we can do anything. Only once all aspects of the economic reforms being undertaken are up and running, such as job creation and housing delivery, and we can honestly give the country an A plus on its report card, should we consider changing the rules.”
He points to the market panic in December last year, which resulted in another hike in interest rates, as evidence. “Adjusting for inflation, South Africa’s interest rates are among the highest in the world right now – and that’s with exchange controls. What would happen if they were lifted? We’d see a massive devaluation in the rand as capital left the country and even higher interest rates as a result. Not to mention the knock-on effects in terms of prices.”
The government and the Reserve Bank have made their intentions clear. A “big bang” approach is out but gradualism is in.
Says Pieter Laubscher of the Bureau for Economic Research in Stellenbosch: “An exchange-control ‘big bang’ is not possible without a macro-economic policy ‘big bang’. As Chris Stals [governor of the Reserve Bank] said recently, the painful short-term adjustments that will have to accompany a ‘big-bang’ approach could prove to be too much, placing the other components of the process of macro-economic restructuring in jeopardy and possibly leading to the reintroduction of capital controls at a later stage.”
On the other hand, waiting too long also has its downside. The market will expect a sharp depreciation in the currency in the event of controls being abolished, and consequently, engineer it.
While that threat has dissipated for the moment, continued depreciation increases the probability of exchange controls being lifted, as they will be seen as the prime obstacle to the successful implementation of the government’s growth, employment and redistribution plan (Gear).
Markets have a habit of getting their own way, witness the Mexican debacle in 1994/95. But in the South African scenario, common sense will hopefully prevail, giving the economy the breathing space to get the fundamentals right.
Opinion is divided on how soon that might happen, but expectations are high that further relaxation will take effect this year. Says Laubscher: “The prospects for a more stable domestic financial environment this year have improved and we expect more announcements on exchange controls soon, possibly before next month’s Budget. While such moves could postpone the chance of a drop in interest rates, they shouldn’t have excessive effects on the economy and markets.
“As the experience since the abolition of the financial rand has shown us, financial volatility is a new reality in South Africa. It will be countered only to the extent that the authorities implement credible, stable, transparent and consistent macro-economic policies.”