Finance Minister Pravin Gordhan used the Medium-Term Budget Policy Statement (MTBPS), released last Wednesday, to outline some of the fiscal and monetary measures that will be deployed by the South African authorities to deal with the resurgent rand.
But Gordhan stopped well short of making a specific announcement regarding a new tax on inflows, which had been anticipated by some economic commentators, save to say that these were still being assessed.
“In several countries, tax measures have been introduced to counter currency appreciation. The effectiveness of these measures is being carefully monitored,” Gordhan said in his address to lawmakers, adding that further steps to moderate the impact of the capital flows would be con-sidered.
Instead, he announced that short-term exchange-rate risks would be mitigated by stepped-up purchases of foreign exchange reserves and reduced restrictions on capital outflows to encourage an increase in foreign assets.
In fact, further relaxation of foreign exchange controls were announced by Gordhan.
These include allowing international headquartered companies to “raise and deploy capital offshore” without exchange-control approval from January 1, 2011, removing controls on emigrant-blocked assets, by eliminating the 10% exit levy on remittances above R8-million, and increasing the limit on South Africa citizens from the prevailing R4-million lifetime limit to R4-million a year.
Nevertheless, government has signalled that a more activist policy to weaken the rand is being pursued, which is aligned to the New Growth Path, released the day before the MTBPS.
Besides other things, the document indicates that the country will pursue active monetary policy interventions to achieve growth through a “more competitive exchange rate”.
Since the start of 2010, the National Treasury and the South African Reserve Bank (SARB) have conducted foreign exchange purchases and swap interventions amounting to R43-billion, raising South Africa’s gross foreign exchange reserves to $44,1-billion by September.
The purchases of foreign currency, he said, would be funded by revenue overruns in 2010/11 and the issuance of government bonds and debentures, while the SARB would “sterilise inflows associated with foreign direct investment” by using foreign exchange swaps.
Gordhan also said that fiscal consolidation and lower interest rates were “macroeconomic prerequisites” for a more competitive real exchange rate and reported that the National Treasury and the SARB would continue to buy foreign exchange reserves.
Some sections and business, as well as the labour movement, believe that the rand, which has strengthened by some 30% against the US dollar since the start of 2009, is undermining South Africa’s still fragile economic recovery and have called on the authorities to actively pursue weakening efforts.
A range of interventions have been suggested and concerns have been raised about the prospects of “currency wars”, with a number of developed and developing economies having already taken active steps to weaken their currencies.
The MTBPS notes that the rand has appreciated by 7,5% against the US dollar since December 2009, and by 6,1% against a trade-weighted basket of currencies. “Because South Africa has higher inflation than its major trading partners, the real effective rand exchange rate, which reflects losses or gains in competitiveness, is now about 12% above its average level for the past decade.”
The MTBPS also acknowledges that the current scale of capital inflows, which is placing upward pressure on the rand, is reducing the competitiveness of manufactured exports and encouraging imports. It adds that sustained exchange rate overvaluation could lead to “unbalanced growth, widening the current account deficit and increasing the economy’s vulnerability to shocks”.
South Africa is not alone in facing this threat, with the Institute for International Finance projecting that net private capital flows to emerging economies will reach $825-billion in 2010, up from $581 billion in 2009. JP Morgan estimates that inflows into emerging-market fixed-income investments will rise to a record $70-billion to 75-billion in 2010.
Net capital inflows to South Africa have risen strongly over the past two years, reaching 5,5% of gross domestic product (GDP) in the first half of 2010, compared with 4,7% in 2009 as a whole.
But, as a “small open economy with low domestic savings and relatively high financing needs, South Africa cannot fully offset the impact of massive global capital flows, barring a much sharper tightening of fiscal policy that diverts resources towards substantially larger reserve purchases”.
It argues, too, that the combination of tighter fiscal policy and looser monetary policy will support demand while moderating the build-up of imbalances arising from strong capital inflows.
But government still maintains that, to prevent any resurgence in inflation that could put further upward pressure on the real exchange rate, monetary policy needs to remain focused on anchoring inflation expectations and supporting financial stability to promote growth and employment.
Overall, Gordhan emphasised South Africa’s countercyclical policy stance, which saw government increase fiscal spending during the 2009 recession, when GDP fell by 1,8%. Growth is expected to recover to 3% in 2010/11 and rise to 4,4% by the 2013/14 fiscal period.
As a consequence of fiscal loosening, the projected fiscal deficit for 2010/11 will be 5,3% of GDP, which is expected to narrow to 3,2% by 2013/14, as revenue recovered and growth in government spending moderates.
By contrast, the MTBPS argues that subdued headline inflation “should allow monetary policy to remain supportive of growth over the medium term”.
South Africa’s interest rates have declined further this year, with the SARB having reduced interest rates by one percentage point between March and August, lowering the repo rate to 6%, the lowest level since it was introduced in 1998.
But Gordhan stressed that higher rates of growth were required to ensure that South Africa began to reduce unemployment and poverty.
“For South Africa to grow at 7% a year, jobs, investment and productivity all need to grow more quickly.