A growing cacophony of economists — including those commissioned by government — are saying that Reserve Bank Governor Tito Mboweni has significant wiggle room to maintain the rand at competitive levels, which will boost export and manufacturing growth.
The critical chorus says a more competitive currency can be achieved through market-friendly interventions, such as more aggressively building the country’s foreign exchange earnings, excluding extraneous factors such as oil when determining the targeted inflation rate and removing the final foreign exchange controls.
The view is that the authorities should be more focused on building the growth of manufacturing industry rather than focusing only on inflation.
President Thabo Mbeki weighed in last month on the currency debate, stating that a competitive and stable rand was desirable. His comments reflect the premise of government policies, to grow the economy and create jobs, that a competitive currency is necessary.
The Accelerated and Shared Growth Initiative (Asgisa) and the industrial policy draft both cite the rand as an important factor in stimulating jobs growth through building non-commodity exports.
But Mbeki added that while a desire existed for a competitive currency, “quite how we translate that desire into something practical is somewhat in the hands of the gods”. Perhaps sharing his pious view, the South African Reserve Bank sees the object of monetary policy to keep inflation safely within a 3% to 6% target.
Economists argue, however, that the bank could play a more interventionist role in preventing the rand from overvaluing. These interventions would align monetary policy with the objectives of policies seeking to grow job-creating sectors of the economy, such as manufacturing.
In a paper commissioned by the Treasury, Jeffrey Frankel has argued that the bank could intervene to dampen appreciation without having to peg the exchange rate.
The authors cite a study showing that countries that intervene in exchange rates have higher growth rates in one to three years after the intervention. The study also shows that export growth is stimulated by intervention in the previous four years.
Foreign reserves
One way for the bank to intervene is to build foreign exchange reserves. Frankel acknowledges that South Africa has significantly increased foreign reserves compared with “disastrously low levels” in 1997 but the ratio of reserves to imports is less than two months’ worth.
Oil prices
The authors also recommend that the bank should exclude oil prices from the targeted inflation indicator. The danger is that when the dollar price of oil rises, the bank will appreciate the currency when it tightens interest rates. This would mean targeting core inflation (consumer prices less oil prices) rather than CPI (consumer inflation) or CPIX (consumer inflation less mortgage prices).
Capital controls
Capital controls can consist of direct controls prohibiting cross-border capital transactions or an approval procedure for such transactions. Indirect controls attempt to discourage certain capital movements by increasing the costs of the transaction, for example, by taxing the capital flows of imposing multiple exchange rate systems.
Frankel considers capital controls as a way to control exchange rates but argues that this is probably not feasible or desirable for South Africa. He says removing capital controls on residents “could marginally help to weaken the rand”.
In contrast, Wits economist Seeraj Mohamed has written that South Africa should impose capital controls to stabilise the exchange rate and protect itself from speculation.
He points out that most countries around the world used capital controls until the end of the Bretton Woods arrangement in the 1970s. Late industrialising countries, such as India, have successfully used capital controls.
Economic opinion in general, though, favours the abolition of remaining foreign exchange controls as a measure that could release the upward pressure on the rand.
Pieter Laubscher, the chief economist at the Bureau for Economic Research, said that Mboweni appears to have decided not to intervene in the foreign exchange market. This follows the bank’s experience in 1998 when it recorded a deficit on the open account because it sold dollars to avert depreciation.
He also said there were costs associated with building reserves. When a bank takes foreign exchange out of the market, it has to issue bonds to guard against the inflationary impact of selling rands into the market. This “sterilisation” process has monetary costs that have to be balanced by the macroÂeconomic costs of allowing the rand to overvalue.
Laubscher agreed that with hindsight, the bank could have more aggressively built up reserves of foreign exchange to halt the strength of the currency when it dipped below R6 to the dollar.
“People who talk about the costs [of building reserves] maybe look at it a little too narrowly,” said Nedbank’s chief economist Dennis Dykes, pointing out that South East Asian countries lost money in keeping massive reserves, but saw it as part of their strategy to support manufacturing.
Dykes noted that the bank had not always appreciated the rand when the dollar price of oil rose and was only recently citing this as a reason to increase interest rates.
In another paper commissioned by the Treasury, Harvard economist Dani Rodrik argues that the bank will have to develop views about the real exchange rate relating to satisfactory output and employment outcomes and steer exchange rates accordingly. This is necessary to stimulate the non-mineral tradeables sector, which he says is critical to economic and job growth.
Rodrik says that tradeables use low-skilled labour more intensely than sectors that have seen more growth recently, such as services.
Economic modelling by Stewart Ngandu at the Human Sciences Research Council shows that an appreciation of the rand caused by a commodity boom results in increased employment in sectors such as mining and services, but a decline in manufacturing jobs. The net effect is an increase in employment. All sectors experience greater import penetration and lower export levels, except mining.