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Email This Article  Printer Friendly Version Was Out Front In Explaining The Fall Of South Africa's Rand

Many of our viewers will remember a special two-part series, back in January, written by Cedric Muhammad and Matt Sekerke, on why the rand, South Africa's currency had fallen so dramatically, in the latter part of the year 2001. While the enemies and friends of South African leader Thabo Mbeki's administration made a rush to judgement on the matter, in order to support their political and economic interests and ideologies, we undertook a careful analysis of the matter and made a reasoned argument as to why the rand embarked on a virtual free fall.

Now, over three months after our writings were published the commission established by the South African government is hearing evidence that begins to approach our conclusion as to why the rand lost so much of its value. Others in the African press and the international financial media are echoing various aspects of the argument that we made public.

Part of our intention in publishing the two-part series was to move the discussion above short-term and narrow political arguments and tired, superficial debates over capitalism vs. communism. African economies are not going to thrive economically, in our opinion, until critical analysis becomes married to discussions regarding the most important economic matters on the continent. We believe that we are making progress.

Here is one of the more recent articles from Business Day, published in South Africa, that bears witness to some of what concluded regarding the weakening of the rand. We follow that article with Part 1 of what we wrote in late January.

Foreigners not to blame for rand's fall'

Financial Services Editor

FORENSIC investigators for the rand commission put paid to any notion that foreign players were responsible for the rand's collapse late last year, finding that their activities in November and December supported the rand's value rather than undermining it.

Nonresident banks were net buyers of rands for 28 of the 42 business days in November and December, according to KPMG, which conducted a forensic investigation into last year's Reserve Bank data.

This would have supported the rand, said KPMG financial services partner Allison Beck.

KPMG's evidence added to the list of deals and flows that the commission has heard might have been negative for the rand last year, but could not have caused the currency to crash during November and December.

On Friday Beck took up the controversial issue of dividend outflows to SA companies (Billiton, Anglo, Old Mutual and SA Breweries) with primary London listings, saying that although the outflows were high during the year, at R6,6bn, their effect in the last quarter was fairly minimal.

Dividends to the London-listed companies made up only a small percentage 9,5% of total dividend flows to foreigners for the year.

But the KPMG study, which scrutinised cross-border currency flows from April to the end of December, identified several sets of transactions that could have contributed to the rand's sharp fall. Beck emphasised there was no suggestion any were illegal or unethical or earned improper profits, with one exception. Equity Diamond Cutting Works did trades in December that appeared to be speculative, and these were reported to the exchange control authorities.

Some of the deals identified by KPMG were quite small but, in December's thin market, would have caused the rand to decline. Most significant was a change in exchange control policy, announced in November, permitting a new class of fund managers to invest money offshore until the end of December.
This led to R1,9bn of outflows that could have contributed to the rand's sharp fall, Beck said.

In a separate survey of exchange control administration, KPMG found the system a hindrance to efficiency and both foreign investors and businessmen saw it negatively.

Beck said that the gradual abolition of exchange controls opened greater opportunities to circumvent it.

May 06 2002 12:00:00:000AM Hilary Joffe Business Day 1st Edition

Here is what we wrote at back in January:

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)

Wednesday, May 8, 2002

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