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Currency volatility and overvaluation in the spotlight

30th July 2010

By: Terence Creamer
Creamer Media Editor


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Greater policy effort to avoid currency overvaluation in South Africa “is warranted”, a newly released Organisation for Economic Cooperation and Development (OECD) report has argued.

In fact, the inaugural OECD Economic Survey of South Africa, released in Pretoria last week, stated that, despite the potential pitfalls associated with a more activist approach to currency management, there could be “net benefits from a range of actions designed to ease upward pressure on the real exchange rate”.

Using the Fundamental Equilibrium Exchange Rate approach, the survey quoted an estimate suggesting that the rand was about 15% overvalued in real effective terms in March 2010. It noted, too, that there had been further appreciation since that date.


Secretary-general Angel Gurria argued that South Africa’s weak export volume growth could be partly attributed to the strong rand. “Stronger [export] trend growth may thus require greater efforts to avoid, or reduce, overvaluation. Several measures are worth considering in this regard,” he said, adding that no single policy intervention could be pursued to deal with the problem.

The OECD specifically outlined the following possible interventions:

  • setting aside commodity-related windfalls to provide a buffer against private capital inflows, which tend to surge when commodity prices rise;
  • a more active accumulation of foreign exchange reserves by the South African Reserve Bank (SARB) when net inflows are strong and allowing depreciation when these flows weaken;
  • backing up such intervention with increased communication to send stronger signals to the market about where the SARB sees the exchange rate in relation to its own ‘equilibrium level’;
  • iberalising capital outflows by removing exchange controls and replacing them with ‘prudential rules’ could also provide one-off support for rand depreciation and;
  • raising saving levels, owing to the negative relationship between savings and over- valuation.

The OECD said that the two major challenges facing South Africa were to increase employment and improve export performance. Gurria even argued that an improved export performance would be key to increasing employment, as had been the case in a number of other developing countries.

South Africa has one of the highest unemploy- ment rates in the world, having increased to above 25% following the 2009 recession, when nearly one-million jobs were shed.

Finance Minister Pravin Gordhan welcomed the report, saying it would feed into government’s thinking on how to forge a “new growth path” and meeting a growth target of “7% a year, for 20 years”.

Gordhan also reiterated government’s stance that a more competitive and stable currency was required, and indicated that the SARB had been given greater authority to buy reserves in a bid to support that aim.

The Finance Minister also noted that the SARB’s mandate had already been broadened beyond inflation targeting to include con- siderations relating to growth, employment and the threat of asset bubbles when it set interest rates.

The call for a more active management of the rand also gelled with a recent joint decla- ration by South Africa’s Manufacturing Circle and three of the country’s largest trade unions, which called on government to intervene to weaken the buoyant South Africa currency, which rose 30% against the US dollar in 2009.

The strength of the rand, which, together with Brazil’s real and Australia’s dollar, was among the world’s top-performing currencies last year, was held up by the signatories to the declaration as a barrier to industrial development and job creation in manufactur- ing.

The Congress of South African Trade Unions, the Federation of Unions of South Africa and the National Council of Trade Unions indicated that a rand:dollar exchange rate of between R9 and R10,50 would go a long way to helping to revive the embattled domestic manufacturing sector.

Toyota South Africa Motors, which manu-facturers and exports from South Africa, said last week that South Africa’s global competitiveness could not be based solely on the value of its currency. But president and CEO Dr Johan van Zyl added: “It can give some support.

“A strong rand has a big impact on our export ability,” Van Zyl said, adding that costs associated with the appreciation of the rand were “huge”.

He said the company did not necessarily want to see a weak currency, “just a stable one”, and one that reflected “the economic ability of the country”. He added: “Short-term flows through the stock exchange have too much influence.”

The contribution of manufacturing to the South African economy had fallen from around 22% of gross domestic product in the early 1990s to around 16% currently.

However, those closest to the country’s exchange-rate policy setting processes are, naturally, concerned about the unintended consequences of aggressive intervention, particularly the possible inflationary impacts.

The OECD stressed that the more active foreign-exchange interventions should be deployed within the constraints of the inflation-targeting regime.

But it also acknowledged that South Africa’s nominal exchange rate volatility was among the highest of all commodity exporters and emerging markets and that, in time of “excessive volatility”, currency movements did not act as a shock absorber reflecting changes in relative prices, but as a “source of vulnerability”.


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