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The Fall Of The South African Rand: Placing Blame Where It Belongs (Part 2) By Matthew Sekerke and Cedric Muhammad

As we discussed yesterday in part one of this series, the shortcomings of South Africa's inflation-targeting monetary regime have spilled over into the macroeconomy.

The hallmarks of this economic distress are high interest rates and systemic illiquidity, resulting in a high cost of capital.

Today we present a more detailed analysis of the effects of inflation targeting, and other policy moves by the South African Reserve Bank (SARB) which have led to the recent weakness in the rand.

South African companies have been driven by the high cost of capital to list their shares overseas. Twenty-five companies have listings on the London Stock Exchange, with share capital of 16 billion ($23 billion). And 82 companies issue American Depositary Receipts in New York with a combined market capitalization of $50 billion. In total, the overseas listings represent roughly half of the Johannesburg Stock Exchange's $155 billion combined market capitalization. However, the South African government has begun to drag its feet on further approvals for overseas listings, hoping to keep capital flowing into South Africa rather than overseas financial centers. The matter has degenerated into a classic 'which came first?' scenario as South Africa's inability to attract portfolio inflows, largely due to rand weakness, is now a major factor aggravating rand weakness.

Another factor contributing to the currency's weakness is a low net foreign reserve position. This will come as a surprise to some, since a cursory inspection of the SARB's balance sheet will show that its gold and foreign asset holdings are more than adequate to cover about 7 months of imports. However, since 1994 the SARB has held a large negative net open forward position (NOFP), the result of its attempts to boost the external value of the rand. The NOFP is a set of contracts to sell foreign reserves at a future date to buy rand. The fulfillment of those contracts implies a future drain of foreign reserves which must be deducted from total foreign reserves. At the end of 2001, these expected future drains were so large that they represented 110% of the SARB's pure foreign currency reserves - revealing that the SARB actually has negative net foreign reserves, strictly speaking.

Other factors putting downward pressure on the rand are political in nature. The disastrous implementation of land redistribution in Zimbabwe has led to concerns that the ANC's own redistribution program will lead to similar results. Foreign and domestic observers also worry about the state of property rights in South Africa, not only reflecting over President Mbeki's battle to override drug patents last year but also the ongoing debate in South Africa over whether sub-surface mineral rights should rest in the hands of the state, the apartheid-era elite, or the nation's citizens. Many analysts also note the historical stance of the Congress of South African Trade Unions (Cosatu), an ANC coalition partner, against private property. And finally, the privatization of state enterprise has barely moved forward, despite relatively ambitious plans. These political uncertainties will continue to keep portfolio flows weak and markets thin, exacerbating the current situation.

But much of the monetary problems in the nation-high interest rates, illiquidity, and poor foreign exchange cover-are institutional in nature, stemming directly from the policies of the SARB. Consequently, they can be solved through institutional reform led by the embrace of sound monetary policies. Pursuing a fixed exchange rate regime vis--vis the dollar would eliminate the need for exchange controls (enhancing liquidity), cause interest rates to converge with the dollar (the more perfect the link is to the dollar), and ensure the adequacy of foreign exchange cover. Specifically, a currency board regime would be the optimal system for South Africa.

When Advocate John Myburgh's commission of inquiry into the depreciation of the rand submits its report, it should note the domestic sources of the rand's weakness. The commission should also find that falling exchange rates, anemic economic growth and excruciating illiquidity will continue as long as the South African Reserve Bank continues to operate according to its floating exchange rate/inflation-targeting paradigm. In raising interest rates to stratospheric levels, supposedly to fight domestic inflation and foster demand for the rand, the SARB is not only following questionable economic theory but it is also grinding risk-taking and economic growth in the country to a halt. And no speculator was dictating policy when South Africa's Finance Ministry announced its inflation target for the year 2002.

South Africa's business establishment and its policy makers should stop looking for phantom currency predators and scrap the SARB's failed monetary policy in favor of a fixed exchange rate regime. A currency board would do just fine.

End Of Part 2

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

Wednesday, January 23, 2002

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