The latest inflation figures are higher than expected and breach the Reserve Bank’s target range of 3% to 6% for the second consecutive month. The main culprits of this inflationary pressure are oil and food prices, both of which are influenced directly by the rand- dollar exchange rate.
A stronger rand means lower petrol prices, lower food prices and lower inflation. At the beginning of last year, the Reserve Bank and the government, through Asgisa, South Africa’s growth initiative, wanted a weaker rand. At the time the rand was trading at about R6 to the dollar.
After expressing a negative view on the rand and on raising interest rates, the authorities effected a 30% devaluation in the currency by October last year. This exacerbated the inflationary pressures from imported fuel prices and food prices (which have to trade at the same price as on international markets) already under pressure from adverse weather conditions for agricultural products at the time.
A central bank simply cannot target inflation and the currency — and control interest rates at the same time. If the bank uses interest rates to constrain inflation, foreign inflows attracted by the higher interest rates earned on cash balances will force the currency stronger. This inflow of capital will increase money supply and inflation. The central bank will have to hike rates again — and so the cycle goes.
The only thing the Reserve Bank can do to prevent this is to sterilise the foreign inflows by selling government bonds into the market. By selling, the government borrows money from the market and reduces the prevailing money supply. Because of South Africa’s national budget surplus, the last thing it needs to do is borrow money, especially at the current market rate of 8,5% or R85-million for every R1-billion.
The cost of these borrowings is a direct cost to the taxpayer and effectively a subsidy for exporters, which is the only sector of the economy that benefits from a weaker rand. A stronger rand benefits consumers and keeps inflation under control. While the case can be made to support exporters, doing so through a weaker currency is a costly and risky exercise. Although currency strength has had some impact on the development of the export sector, negative consequences arise from a decline in profitability and our trade policies.
Interventions in competition policy and trade policy could have a powerful impact on the export sector, rather than weakening the currency and paying the high price it demands.
Furthermore, the government’s R300-billion infrastructure plans and preparations for 2010 need a stronger currency as gross fixed investment has a 50% larger import component than the manufacture of consumer goods.
In 2006, when the rand was trading at R6 to the dollar, South Africa was experiencing relatively strong and stable levels of growth, inflation and currency levels. To get back to this positive path, the currency should be allowed to find its own level.
Rejane Woodroffe is chief economist for Metropolitan Asset Managers