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The Fall Of The South African Rand: Placing Blame Where It Belongs (Part 1) By Matthew Sekerke and Cedric Muhammad

Thanks to a sharp depreciation in the final quarter of last year, the South African rand secured the dishonor of being last year's worst emerging market currency, losing 37.3% of its value against the dollar. Having dipped as low as R 13.91 against the dollar on December 21, South Africans are now, more than ever, worrying about the future of their currency.

Consequently, on January 4, the South African Chamber of Business (Sacob) called for an official probe into the rand's dismal performance, blaming the "dubious financial methods and instruments" of "certain institutions." South African President Thabo Mbeki concurred, saying the rand's fall "had nothing whatsoever to do with our national economy".

The recent comments from Mbeki and Sacob amount to a thinly-veiled attack on currency speculators and hedge funds who have profited from the rand's tumble. Indeed, they sound very similar to the attacks leveled on currency traders during the Southeast Asian currency crisis of 1997. Nearly 5 years ago, then-President Suharto of Indonesia asserted that "there are parties trying to engineer the fall of the rupiah to the 20,000-level against the dollar." Not to be outdone, President Mahathir bin Mohamed of Malaysia took aim at financier George Soros in particular, saying Soros "benefited handsomely by whipping the currencies and markets of poorer countries." Oddly, it was Malaysia's central bank, Bank Negara Malaysia, that alternately made and lost hundreds of millions speculating on European currencies in the early 1990s.

Were currency speculators and hedge funds responsible for initiating the currency crises in Indonesia and Malaysia? Evidence suggests that they were not. In fact, IMF research following the Southeast Asian crisis found that many hedge funds actually took long positions in the Indonesian rupiah, and only a few hedge funds took minor short positions in the Malaysian ringgit.

The source of the troubles in Indonesia and Malaysia, rather, was a fatally flawed exchange rate regime. Both countries employed pegged exchange rate regimes, where the central bank has both a monetary policy and an exchange-rate policy. In the event of a large capital outflow, like that experienced by all Southeast Asian nations during the 1997-98 crisis, the exchange-rate policy and monetary policy conflict with one another, and a balance of payments crisis ensues. In an attempt to relieve the distress in their balance of payments crises, each country pursued different policy avenues. Indonesia, after being talked out of moving toward a currency board (a fixed-rate regime) by the IMF, made its exit toward a floating exchange rate regime, and immediately saw its currency, the rupiah, sink substantially. Malaysia, on the other hand, instituted capital controls on foreign currency and re-pegged the ringgit to the U.S. dollar. Neither Indonesia nor Malaysia in their different policy responses have solved their vulnerability to currency depreciation and inflation. Just last week President Mahathir told Malaysia's national news agency, "If neighboring countries decreased or increased their currencies by 20% and (they) remain at that level, then we will consider changing the value of our currency." In Indonesia, in the same time frame, rupiah were being sold for dollars over further inflation fears due to the country's decision to institute IMF-mandated fuel price hikes.

Like Indonesia and Malaysia in the late 1990s, South Africa today owes its currency troubles to its choice of an exchange rate regime. True, South Africa's choice of a floating exchange rate precludes a balance of payments crisis. However, its combination of floating and "inflation targeting" imposes high costs on the South African economy and stifles growth, which has averaged 2% over the last 5 years, an anemic rate for any emerging market country.

The basic ingredients of inflation-targeting include the announcement by the monetary authority of a target for future inflation at some lower level or range; subsequent monitoring of the expected rate of inflation; and the use of various monetary policy instruments in order to keep the inflation rate estimates in line with the inflation target which the government has publicly announced. Hitting the target requires accurately forecasting the demand for money with the aid of complex econometric models. Despite the sophisticated techniques employed in such models, they often produce forecasts that are disconnected from reality. Those flawed forecasts can then lead to questionable policy responses; indeed, in the fourth quarter of last year, the South African Reserve Bank (SARB) increased the supply of high-powered base money by 18% in the face of falling domestic and international demand for the rand.

Without confident estimates of the demand for money in South Africa and abroad, the SARB must use a two-pronged strategy of exchange controls and high interest rates to maintain the external value of the rand and limit inflation. Exchange controls have the negative effect of constraining liquidity in domestic financial markets. The combination of a prime lending rate of 14% and the looming institution of a capital gains tax makes capital very expensive in South Africa. The result is choked investment, reduced enterprise development, and rising unemployment, as the capital to labor ratio adjusts. Rather than casting innuendo at currency speculators the Mbeki administration should be rewarding and encouraging capital formation and risk taking, especially among the country's Black population. With a strong currency and the maintenance of a zero capital gains tax environment, total investment - domestic and foreign - would grow in South Africa and demand for the rand would increase. Instead, the administration's current mixture of fiscal and monetary policy has caused financial capital to flee from otherwise viable investment opportunities.

(End Of Part 1)

Matthew Sekerke is a Woodrow Wilson Undergraduate Research Fellow at the Johns Hopkins University. He can be contacted at

Cedric Muhammad is President of Black Electorate Communications and can be reached at

Matthew Sekerke and Cedric Muhammad

Tuesday, January 22, 2002

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