A blow to exchange control

Undoubtedly one of the budget’s highlights was the removal of exchange controls for institutional investors, all but dealing a death blow to exchange control.

Under the new provisions, foreign investment will be guided by prudential investment guidelines rather than the laager mentality that has driven exchange-control legislation.

Based on globally accepted prudential investment guidelines, long-term insurers and pension funds will be able to invest 20% of their assets offshore, up from the current 15%.

Investment managers of collective investment schemes and market-linked long-term insurance products will be allowed to invest 30% of assets under management offshore, up from the current 25%.

There will be an additional allowance for portfolio investment in Africa equal to 5% of total retail assets. Institutional investors will no longer be required to obtain approval from the South African Reserve Bank, but all their offshore investments will fall under the newly formed financial surveillance department, which will replace the Reserve Bank’s exchange-control division. Institutional investors will be required to report to the authorities on their investments to ensure that prudential investment guidelines are being adhered to.

Kevin Lings, an economist at Stanlib, says this step has sent a very positive message to investors. “What government is saying is that we are ready for it,” says Lings, who highlights the fact that foreign-exchange reserves have improved and the Reserve Bank is in a far stronger position. The country has very low levels of foreign debt and our credit rating is above investment grade, with a positive outlook. South Africa is therefore much less vulnerable than in the past and the government believes there is no longer a need to protect our currency and our reserves.

“When you take exchange controls away, you say there is no need for protection, so it sends a positive message and you gain credibility,” says Lings.

In the short term, he says, the rand may weaken as asset managers take advantage of the changes, but in the longer term this is not a high price to pay.

But while the move may be seen in a positive light, the government will have to back it up with action to ensure foreign investors that the country will be managed properly. For the asset-management industry, this is a major step forward. Lings says it will provide investors with far more flexibility.

Because of the cumbersome process of receiving permission to invest abroad, fund managers would not often actively manage their offshore exposure but would maintain a set offshore holding. Now they can take an active view on the rand or relative valuations and can reduce or increase exposure accordingly.

“It is not just about taking money out, but [also] bringing it back in. This creates a two-way flow,” says Lings, who adds that as a result new products will develop.

But in the shorter term there is likely to be more money going offshore as fund managers increase their offshore exposure in response to a weaker rand and a weaker local economy. Lings says that although some form of regulation will always remain, few countries have no form of control, but should not impede the day-to-day activities of business strategy and expansion.

In this regard, the budget reduced red tape for this by no longer making approval for a foreign direct investment of up to R50-million a year a prerequisite, although companies will have to report on their ongoing activities.

Banks will be allowed to invest 40% of their liabilities offshore. Trusts, companies and banks will be able to participate in the rand futures market on the JSE. Although the R2-million foreign-investment allowance was not increased, a discretionary allowance for travel, gifts and donations of up to R500 000 a year will be allowed.