The South African Reserve Bank (SARB) spent R53-billion, or 2% of gross domestic product (GDP), during 2010 on foreign exchange reserve accumulation in a bid to moderate the effect of capital flows on the rand, which appreciated strongly last year, Finance Minister Pravin Gordhan confirmed in his 2011 Budget.

Reserve accumulation was deployed as the main measure to weaken the South African currency which surged in line with net inflows of R92-billion of liquid capital during the year. In fact, the local unit appreciated by 12% against a trade-weighted basket of currencies during the period, which precipitated calls from the manufacturing sector, as well as from some labour movements, for greater intervention by the monetary authorities and policymakers to weaken the rand so as to protect productive sectors and jobs.

Between December 2009 and the end of January 2011, South Africa’s gross foreign exchange reserves rose by $5,8-billion to $45,5-billion, and between August 2010 and January 2011, the SARB also entered into long-term currency swaps worth $4,3-billion to sterilise foreign currency flows related to large inward investments.

Gordhan claimed that the policy measures announced in October, which lent support to further reserve accumulation, as well as further liberalisation of foreign exchange controls, had, together with shifts in investor sentiment, supported the rand’s depreciation from December 2010 to mid-February 2011. Over the period, the rand depreciated by about 10% against the US dollar, the euro and sterling.

He, thus, refrained from announcing any additional measures to manage capital flows and reduce exchange rate appreciation. By contrast, a number of other emerging markets, from Brazil and Chile, through to Indonesia, Israel and Thailand, had already instituted additional measures such as taxes, limits on foreign holdings of local bonds, the institution of minimum holding periods for bond ownership, or increasing limits on foreign investments by pension funds.

“We have examined these options and their impact, and will continue to monitor the adjustments made in other countries, while recognising that circumstances vary from country to country. The National Treasury is cognisant of the risk that financial instability and currency volatility can arise from large capital movements. If necessary, appropriate steps to moderate these effects will be taken, together with the Reserve Bank,” Gordhan said, adding that government would continue to assist the SARB to accumulate foreign-exchange reserves.

Since the fourth quarter of 2010, South Africa began experiencing capital outflows, which contributed to the recent weakening of the rand.

Gordhan warned that shifts in the volume and direction of capital flows might be significant over the year ahead, and that any overly rapid currency depreciation would carry risks to macroeconomic stability.

“So we expect the Governor of the Reserve Bank [Gill Marcus] to be vigilant in monitoring inflationary pressures and ensuring that monetary policy is effective in meeting our inflation targets.” South Africa has an official policy of maintaining inflation within a 3% to 6% band.

“Changes in the volume and direction of capital flows may be significant over the year ahead, and are largely beyond our control or influence. We will allow the actions announced in the Medium-Term Budget Policy Statement to have their full effect and continue to monitor capital flows,” Gordhan said.

He added that the credibility of monetary policy in achieving the target inflation range, combined with the commitment to fiscal discipline, were important foundations for moderating exchange rate volatility.

“Fiscal and monetary policy will continue to work in partnership. Monetary policy, operated by the Reserve Bank, will continue to be focused on controlling inflation, and we will continue to ensure that fiscal policy is countercyclical within a sustainable long-term framework."

Gordhan warned that increases in oil and food prices were posing new risks to the inflation outlook. “Inflation is forecast to remain within the target range of 3% to 6%, edging towards the upper end of the range in 2013, as the economy strengthens.”

Statistics South Africa estimates that the domestic economy grew by 2,8% in 2010 and over the medium term, the National Treasury expects real GDP growth to reach 3,4% in 2011, 4,1% in 2012 and 4,4% in 2013.