Date: 01/03/2004
Source: South African Reserve Bank
Title: T Mboweni: Forward book & publication of official reserves
ANNOUNCEMENT BY MR TT MBOWENI, GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK, REGARDING THE SQUARING-OFF OF THE OVERSOLD FOREIGN EXCHANGE FORWARD BOOK AND THE INTRODUCTION OF A NEW PUBLICATION FORMAT FOR THE MONTHLY REPORT ON OFFICIAL GOLD AND FOREIGN EXCHANGE RESERVES 1 March 2004
Welcome ladies and gentlemen and thank you for accepting the invitation to this briefing session.
This briefing session is aimed at addressing two very important issues. Firstly, to give you an update on the progress made to date in eliminating the oversold forward book, and secondly, to introduce a new format, on the basis of which the South African Reserve Bank (SARB) will release its monthly publication of official gold and foreign exchange reserves. The SARB will release its reserves figures in the new format as from this month (March 2004).
FORWARD BOOK
I have indicated on previous occasions that, with the conversion of the negative net open foreign currency position (NOFP) in May 2003 into a positive position, which has been growing since, one of the SARB's key objectives going forward was to close out the oversold forward book. This historic milestone was achieved during February 2004. It may be helpful to provide some historic perspective to the forward book.
The build-up of the forward book took place after the announcement of the foreign debt standstill in September 1985, at which time the country's foreign debt amounted to some USD24 billion. At the time the SARB had an NOFP of some USD12 billion, implying that the country probably had an outstanding uncovered foreign exchange position totalling some USD10 billion (approximately USD2 billion represented debt of the government which was not covered forward). It is important to note that this was not a commitment of one institution, but many South Africans had foreign commitments at the time. It emerged after the debt standstill that there were government agencies and large corporations that had large foreign exchange exposures. The type of crisis that was experienced in 1997 and 1998 in Asia was in fact experienced by South Africa in the mid-eighties at the time of the debt standstill, albeit for different reasons, back.
As a result of the government's apartheid policies, the country had no access to the international capital markets at the time, including no access to borrowing from the IMF or other official agencies. With the Government unable to borrow foreign currency, the country could only use one mechanism to raise foreign capital: providing forward cover to the private sector to ensure their use of trade credits. Private sector and government corporations accessing trade credit abroad funded these needs. In addition, certain private sector and government corporations were able to raise trade credit for longer terms, e.g. for the purchase of items such as power generators or aircraft, but the Bank had to provide forward cover for those foreign currency exposures as well.
The large forward book and the NOFP thus became a surrogate for what would have been IMF or other international capital market borrowing. Without the above-mentioned limitations, the exchange rate risks that the Government was carrying through the forward book might have been carried in a different format, which would have been better understood by the markets.
It can thus be argued that the forward book, in a real way, was an intricate part of political developments in this country. In fact, it was a structural overhang from apartheid.
The dual exchange rate mechanism, which was re-introduced in 1985, was abolished in 1995 implying that purchases and sales by non-residents of any assets in South Africa had since then been channelled through the unitary exchange rate. Foreign exchange flows emanating from such transactions therefore became available to be purchased by the SARB, influencing the NOFP. A large inflow from the purchase of bonds or shares by non-residents would make a difference to the net reserves, implying that the Bank could start reducing its forward book and NOFP. After the dual exchange rate was abolished in March 1995, there was significant excitement and the SARB was able to make a significant reduction to the NOFP in a matter of 12 months. By March 1995 the NOFP was USD25,8 billion and by March 1996 it had been reduced to USD8,5 billion.
What actually happened was the risk position that Government had been carrying with the NOFP at USD25 billion, was reduced mainly by purchasing foreign exchange from the market. The proceeds of Government bond issues abroad were purchased, and the balance was purchased from the market. The result was that the market carried significantly more risk in March 1996 than it was carrying in March 1995. This significant transfer of risk to the market almost inevitably influenced the exchange rate of the rand and it depreciated sharply in 1996, owing partly to speculative activity.
In an effort to counter such speculative activity, the SARB in 1996 intervened in the foreign exchange market by increasing the forward book to USD22 billion, in other words it sold about USD14 billion into the market. In taking such action, it temporarily put some brake to the depreciation of the currency, although the rand declined from R3,50 = USD1, to R4,80 = USD1, before appreciating to about R4,50 = USD1, after the Bank completed this intervention. That meant that a large amount of risk, amounting to some USD14 billion, had been taken on again by the SARB on behalf of the Government. However, this only contained the depreciation from R3,50 = USD1 to R4,50 = USD1 as indicated above.
Then in 1997, after this episode, the SARB was again successful in reducing the NOFP by almost USD10 billion. This came from portfolio inflows and the purchase of shares and bonds by non-residents. However, in 1998 the emerging markets crisis occurred, and South Africa appeared to be used as a surrogate hedge for investors and speculators who had exposures to other emerging market countries with less liquid financial markets. Although little factual information is available, the impression indeed was that South Africa had been used as a surrogate hedge by market participants. They sold the rand in order to try and recover some of the money lost in other emerging markets.
Again the SARB intervened, this time in two ways. Firstly, the SARB sold slightly more than what it had bought, to the tune of about an extra USD1 billion. Secondly, interest rates were increased by 7% in real terms. However, these actions only resulted in containing the depreciation from a level of around R5,00 = USD1, to a peak of some R6,84 =USD1, before it returned to a level of around R5,80 = USD1. This implied returning the NOFP to exactly the situation ten years before, almost to the last billion dollars.
Subsequent to this episode, there was a shift in the SARB's policy. A decisive decision was taken to reduce the NOFP to zero. The NOFP was reduced by around USD9 billion in 1999, from USD22 billion in December 1998 to USD13 billion in December 1999. Significantly, during that year the exchange rate of the rand actually appreciated by 0,6 percent on a trade-weighted basis. With no change in the exchange rate, the market accepted the risk back from the Bank.
However, despite regional instability, the SARB continued reducing the NOFP, from USD13 billion in December 1999 to USD9,5 billion at the end of 2000. That was a small reduction compared to the year before, but because of regional events the markets were jittery and unwilling to accept more risk at a reasonable price. The rand depreciated on a trade-weighted basis by 12,4% during the year 2000.
In the first quarter of 2001 there was hardly any reduction in the NOFP. The reduction came towards the end of the first half of the year (in the second quarter), mainly from the proceeds of the Anglo American Corporation/De Beers Mining Company restructuring.
Viewing the risks that were being transferred from the market to the SARB, the Government and the taxpayer and back to the market and comparing them with the real flows in our economy, the real flows in the economy pale into insignificance. South Africa's financial account had a surplus of R9 billion in 2000, while it had a current account deficit of around R3,7 billion. Capital inflows amounted to R7 billion in 2001, while the country had a current account deficit of round R1,7 billion. This implies that a net amount of around R6 billion flowed into South Africa in both those years. The Anglo American Corporation/De Beers Mining Company restructuring transaction amounted to approximately R24 billion and this amount represented approximately 10% of the forward book exposure at its peak of USD28 billion in March 1995.
In using intervention, "your bark has to be as good as your bite". If foreign currency is being sold and it does not achieve immediately the intended objectives, the policy should be continued. The markets have to believe the policy if the central bank gets involved in selling foreign currency either from reserves or through the forward book in an effort to influence the exchange rate. In South Africa's case the market knew unequivocally that the IMF had highlighted the NOFP as vulnerability on numerous occasions and expressed the opinion that the position be bought back. Moreover, the stated policy was to close out the NOFP as and when circumstances permitted. So the simple answer was that whatever the SARB sold, would have to be bought back. The perception, in these circumstances, was that the rand was effectively a one-way downward bet. Therefore, intervention in this context would have been a completely blunt instrument. This is why the Bank did not choose intervention as a policy option during 2001.
As indicated earlier, the SARB continuously reviewed its strategy to close out the forward book and withdraw from the forward market by way of transferring this activity to the private sector. Having made considerable progress in this regard, the use of the forward book for foreign exchange intervention purposes in 1998 represented the last major setback, which resulted in the forward book increasing from US$11,9 billion in February 1996 to US$25,3 billion in September 1998. Given that the losses incurred on the forward book were for the account of the government, the forward book was a huge structural burden on the fiscus and resulted in enormous costs to the fiscus over the years.
Since October 1998, the Bank has not used the forward book to finance intervention to support the exchange rate of the rand. This policy change was partly necessitated by the costs of pursuing such a policy and partly by the ineffectiveness of such intervention strategies on their own. Moreover, the Government introduced a formal inflation targeting monetary policy framework in February 2000. The SARB has, however, used opportunities that presented themselves to purchase foreign exchange from the market to reduce the forward book, which represented an important source of external vulnerability, which had drawn negative comments from the IMF, rating agencies and financial market participants, and which, amongst others, affected South Africa's borrowing costs and rating prospects. That is, foreign exchange purchased in the spot market was swapped out, i.e. sold spot and bought forward, thereby reducing the oversold balance on the forward book. In the most recent period, not only has the Bank purchased foreign exchange proceeds emanating from foreign currency denominated privatisation proceeds and Government offshore borrowing, it has also used a "creaming-off" strategy to purchase foreign exchange to achieve its goal of reducing the oversold forward book and ultimately to increase its level of foreign exchange reserves.
At the end of the SARB's last financial year, March 2003, the oversold forward book amounted to US$6,6bn. During the most recent period the main factors contributing to the reduction of the oversold forward book and its eventual elimination were foreign exchange purchases from the market and proceeds of government's external borrowing programme, which resulted in the Bank being able to purchase proceeds of a Eurobond issue of Euro1,25bn in May 2003 (dealing in the process also with the negative NOFP).
I am truly delighted to announce to you today that the oversold forward book was closed out during February 2004. Squaring-off the forward book indeed represents a significant milestone and has allowed us to finally successfully deal with one of the sad consequences of an unfortunate part of this country's history. Purchases of foreign exchange going forward will now generally be reflected in increasing gross reserves. An old chapter has closed. A new chapter of building our reserves as a country has started.
NEW FORMAT FOR MONTHLY PUBLICATION OF OFFICIAL RESERVES
I will now turn to the second item of this briefing, being the introduction of a new format for the monthly publication of official gold and foreign exchange reserves.
In order to improve the level of transparency with regard to the gold and foreign exchange reserves and also to provide information to the public in a more timely manner, Deputy Governor Plenderleith and Mr Mminele, Head of Financial Markets, will be informing you about the proposed new format of the information notice which will be released every month on the day on which the SARB's Statement of Assets and Liabilities is released, being the 5th business day after month end.
We have identified that the current process of reporting reserves is somewhat fragmented. Currently, at the beginning of each month, with the release of the SARB's Statement of Assets and Liabilities, we report for the previous month the rand value of the gold and foreign exchange reserves. Towards the end of the month, via the SDDS template and the Bank's "Release of Selected Monthly Data", we publish data pertaining to the reserves and foreign liabilities as well as the net open foreign currency position. The new format will ensure that, within a few days of the end of every month, reserves data pertaining to that month will be made public in a comprehensive manner. The new information notice, we are convinced, will enhance transparency and we hope that you will find the information useful.
In the process we would also like to harmonise our use of terminology to conform to international format. As a result we will no longer use the term net open foreign currency position (which is quite technical and possibly not understood by many people), and in future refer to the term "International liquidity position (net reserves)".
I would now like to hand over to my colleagues to take you through the new format, following which we would like to offer you an opportunity to ask questions relating to the two topics which are the subject of today's briefing. A copy of my remarks of today has been made available to you, together with the new template for our monthly publication of reserves.
Thank you.
(See http://www.reservebank.co.za for information notice)
Issued by: South African Reserve Bank
1 March 2004
Source: South African Reserve Bank (http://www.reservebank.co.za)
Source: South African Reserve Bank
Title: T Mboweni: Forward book & publication of official reserves
ANNOUNCEMENT BY MR TT MBOWENI, GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK, REGARDING THE SQUARING-OFF OF THE OVERSOLD FOREIGN EXCHANGE FORWARD BOOK AND THE INTRODUCTION OF A NEW PUBLICATION FORMAT FOR THE MONTHLY REPORT ON OFFICIAL GOLD AND FOREIGN EXCHANGE RESERVES 1 March 2004
Welcome ladies and gentlemen and thank you for accepting the invitation to this briefing session.
This briefing session is aimed at addressing two very important issues. Firstly, to give you an update on the progress made to date in eliminating the oversold forward book, and secondly, to introduce a new format, on the basis of which the South African Reserve Bank (SARB) will release its monthly publication of official gold and foreign exchange reserves. The SARB will release its reserves figures in the new format as from this month (March 2004).
FORWARD BOOK
I have indicated on previous occasions that, with the conversion of the negative net open foreign currency position (NOFP) in May 2003 into a positive position, which has been growing since, one of the SARB's key objectives going forward was to close out the oversold forward book. This historic milestone was achieved during February 2004. It may be helpful to provide some historic perspective to the forward book.
The build-up of the forward book took place after the announcement of the foreign debt standstill in September 1985, at which time the country's foreign debt amounted to some USD24 billion. At the time the SARB had an NOFP of some USD12 billion, implying that the country probably had an outstanding uncovered foreign exchange position totalling some USD10 billion (approximately USD2 billion represented debt of the government which was not covered forward). It is important to note that this was not a commitment of one institution, but many South Africans had foreign commitments at the time. It emerged after the debt standstill that there were government agencies and large corporations that had large foreign exchange exposures. The type of crisis that was experienced in 1997 and 1998 in Asia was in fact experienced by South Africa in the mid-eighties at the time of the debt standstill, albeit for different reasons, back.
As a result of the government's apartheid policies, the country had no access to the international capital markets at the time, including no access to borrowing from the IMF or other official agencies. With the Government unable to borrow foreign currency, the country could only use one mechanism to raise foreign capital: providing forward cover to the private sector to ensure their use of trade credits. Private sector and government corporations accessing trade credit abroad funded these needs. In addition, certain private sector and government corporations were able to raise trade credit for longer terms, e.g. for the purchase of items such as power generators or aircraft, but the Bank had to provide forward cover for those foreign currency exposures as well.
The large forward book and the NOFP thus became a surrogate for what would have been IMF or other international capital market borrowing. Without the above-mentioned limitations, the exchange rate risks that the Government was carrying through the forward book might have been carried in a different format, which would have been better understood by the markets.
It can thus be argued that the forward book, in a real way, was an intricate part of political developments in this country. In fact, it was a structural overhang from apartheid.
The dual exchange rate mechanism, which was re-introduced in 1985, was abolished in 1995 implying that purchases and sales by non-residents of any assets in South Africa had since then been channelled through the unitary exchange rate. Foreign exchange flows emanating from such transactions therefore became available to be purchased by the SARB, influencing the NOFP. A large inflow from the purchase of bonds or shares by non-residents would make a difference to the net reserves, implying that the Bank could start reducing its forward book and NOFP. After the dual exchange rate was abolished in March 1995, there was significant excitement and the SARB was able to make a significant reduction to the NOFP in a matter of 12 months. By March 1995 the NOFP was USD25,8 billion and by March 1996 it had been reduced to USD8,5 billion.
What actually happened was the risk position that Government had been carrying with the NOFP at USD25 billion, was reduced mainly by purchasing foreign exchange from the market. The proceeds of Government bond issues abroad were purchased, and the balance was purchased from the market. The result was that the market carried significantly more risk in March 1996 than it was carrying in March 1995. This significant transfer of risk to the market almost inevitably influenced the exchange rate of the rand and it depreciated sharply in 1996, owing partly to speculative activity.
In an effort to counter such speculative activity, the SARB in 1996 intervened in the foreign exchange market by increasing the forward book to USD22 billion, in other words it sold about USD14 billion into the market. In taking such action, it temporarily put some brake to the depreciation of the currency, although the rand declined from R3,50 = USD1, to R4,80 = USD1, before appreciating to about R4,50 = USD1, after the Bank completed this intervention. That meant that a large amount of risk, amounting to some USD14 billion, had been taken on again by the SARB on behalf of the Government. However, this only contained the depreciation from R3,50 = USD1 to R4,50 = USD1 as indicated above.
Then in 1997, after this episode, the SARB was again successful in reducing the NOFP by almost USD10 billion. This came from portfolio inflows and the purchase of shares and bonds by non-residents. However, in 1998 the emerging markets crisis occurred, and South Africa appeared to be used as a surrogate hedge for investors and speculators who had exposures to other emerging market countries with less liquid financial markets. Although little factual information is available, the impression indeed was that South Africa had been used as a surrogate hedge by market participants. They sold the rand in order to try and recover some of the money lost in other emerging markets.
Again the SARB intervened, this time in two ways. Firstly, the SARB sold slightly more than what it had bought, to the tune of about an extra USD1 billion. Secondly, interest rates were increased by 7% in real terms. However, these actions only resulted in containing the depreciation from a level of around R5,00 = USD1, to a peak of some R6,84 =USD1, before it returned to a level of around R5,80 = USD1. This implied returning the NOFP to exactly the situation ten years before, almost to the last billion dollars.
Subsequent to this episode, there was a shift in the SARB's policy. A decisive decision was taken to reduce the NOFP to zero. The NOFP was reduced by around USD9 billion in 1999, from USD22 billion in December 1998 to USD13 billion in December 1999. Significantly, during that year the exchange rate of the rand actually appreciated by 0,6 percent on a trade-weighted basis. With no change in the exchange rate, the market accepted the risk back from the Bank.
However, despite regional instability, the SARB continued reducing the NOFP, from USD13 billion in December 1999 to USD9,5 billion at the end of 2000. That was a small reduction compared to the year before, but because of regional events the markets were jittery and unwilling to accept more risk at a reasonable price. The rand depreciated on a trade-weighted basis by 12,4% during the year 2000.
In the first quarter of 2001 there was hardly any reduction in the NOFP. The reduction came towards the end of the first half of the year (in the second quarter), mainly from the proceeds of the Anglo American Corporation/De Beers Mining Company restructuring.
Viewing the risks that were being transferred from the market to the SARB, the Government and the taxpayer and back to the market and comparing them with the real flows in our economy, the real flows in the economy pale into insignificance. South Africa's financial account had a surplus of R9 billion in 2000, while it had a current account deficit of around R3,7 billion. Capital inflows amounted to R7 billion in 2001, while the country had a current account deficit of round R1,7 billion. This implies that a net amount of around R6 billion flowed into South Africa in both those years. The Anglo American Corporation/De Beers Mining Company restructuring transaction amounted to approximately R24 billion and this amount represented approximately 10% of the forward book exposure at its peak of USD28 billion in March 1995.
In using intervention, "your bark has to be as good as your bite". If foreign currency is being sold and it does not achieve immediately the intended objectives, the policy should be continued. The markets have to believe the policy if the central bank gets involved in selling foreign currency either from reserves or through the forward book in an effort to influence the exchange rate. In South Africa's case the market knew unequivocally that the IMF had highlighted the NOFP as vulnerability on numerous occasions and expressed the opinion that the position be bought back. Moreover, the stated policy was to close out the NOFP as and when circumstances permitted. So the simple answer was that whatever the SARB sold, would have to be bought back. The perception, in these circumstances, was that the rand was effectively a one-way downward bet. Therefore, intervention in this context would have been a completely blunt instrument. This is why the Bank did not choose intervention as a policy option during 2001.
As indicated earlier, the SARB continuously reviewed its strategy to close out the forward book and withdraw from the forward market by way of transferring this activity to the private sector. Having made considerable progress in this regard, the use of the forward book for foreign exchange intervention purposes in 1998 represented the last major setback, which resulted in the forward book increasing from US$11,9 billion in February 1996 to US$25,3 billion in September 1998. Given that the losses incurred on the forward book were for the account of the government, the forward book was a huge structural burden on the fiscus and resulted in enormous costs to the fiscus over the years.
Since October 1998, the Bank has not used the forward book to finance intervention to support the exchange rate of the rand. This policy change was partly necessitated by the costs of pursuing such a policy and partly by the ineffectiveness of such intervention strategies on their own. Moreover, the Government introduced a formal inflation targeting monetary policy framework in February 2000. The SARB has, however, used opportunities that presented themselves to purchase foreign exchange from the market to reduce the forward book, which represented an important source of external vulnerability, which had drawn negative comments from the IMF, rating agencies and financial market participants, and which, amongst others, affected South Africa's borrowing costs and rating prospects. That is, foreign exchange purchased in the spot market was swapped out, i.e. sold spot and bought forward, thereby reducing the oversold balance on the forward book. In the most recent period, not only has the Bank purchased foreign exchange proceeds emanating from foreign currency denominated privatisation proceeds and Government offshore borrowing, it has also used a "creaming-off" strategy to purchase foreign exchange to achieve its goal of reducing the oversold forward book and ultimately to increase its level of foreign exchange reserves.
At the end of the SARB's last financial year, March 2003, the oversold forward book amounted to US$6,6bn. During the most recent period the main factors contributing to the reduction of the oversold forward book and its eventual elimination were foreign exchange purchases from the market and proceeds of government's external borrowing programme, which resulted in the Bank being able to purchase proceeds of a Eurobond issue of Euro1,25bn in May 2003 (dealing in the process also with the negative NOFP).
I am truly delighted to announce to you today that the oversold forward book was closed out during February 2004. Squaring-off the forward book indeed represents a significant milestone and has allowed us to finally successfully deal with one of the sad consequences of an unfortunate part of this country's history. Purchases of foreign exchange going forward will now generally be reflected in increasing gross reserves. An old chapter has closed. A new chapter of building our reserves as a country has started.
NEW FORMAT FOR MONTHLY PUBLICATION OF OFFICIAL RESERVES
I will now turn to the second item of this briefing, being the introduction of a new format for the monthly publication of official gold and foreign exchange reserves.
In order to improve the level of transparency with regard to the gold and foreign exchange reserves and also to provide information to the public in a more timely manner, Deputy Governor Plenderleith and Mr Mminele, Head of Financial Markets, will be informing you about the proposed new format of the information notice which will be released every month on the day on which the SARB's Statement of Assets and Liabilities is released, being the 5th business day after month end.
We have identified that the current process of reporting reserves is somewhat fragmented. Currently, at the beginning of each month, with the release of the SARB's Statement of Assets and Liabilities, we report for the previous month the rand value of the gold and foreign exchange reserves. Towards the end of the month, via the SDDS template and the Bank's "Release of Selected Monthly Data", we publish data pertaining to the reserves and foreign liabilities as well as the net open foreign currency position. The new format will ensure that, within a few days of the end of every month, reserves data pertaining to that month will be made public in a comprehensive manner. The new information notice, we are convinced, will enhance transparency and we hope that you will find the information useful.
In the process we would also like to harmonise our use of terminology to conform to international format. As a result we will no longer use the term net open foreign currency position (which is quite technical and possibly not understood by many people), and in future refer to the term "International liquidity position (net reserves)".
I would now like to hand over to my colleagues to take you through the new format, following which we would like to offer you an opportunity to ask questions relating to the two topics which are the subject of today's briefing. A copy of my remarks of today has been made available to you, together with the new template for our monthly publication of reserves.
Thank you.
(See http://www.reservebank.co.za for information notice)
Issued by: South African Reserve Bank
1 March 2004
Source: South African Reserve Bank (http://www.reservebank.co.za)
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