South Africa in the global currency war

* RAZIA KHAN | Friday October 15, 2010 00:00

Until August 2010, there was little evidence of sustained foreign exchange accumulation by the South African Reserve Bank (SARB), despite increasing disquiet over the South African Rand(SAR) strength, and a growing clamour ahead of the ruling ANC's early September policy meeting for the SARB to intervene more actively in markets.

While a proposed tax on capital inflows came up for discussion at a closed-door session of the ANC meeting, there was little discussion of the ZAR in the press briefings that followed. Instead, mine nationalisation made the headlines. The SARB's absence from foreign exchange markets was attributed to its preference for sterilising any intervention.

The cost of sterilising traditional foreign exchange buying, a function of the interest-rate differential between South Africa and the major markets, was thought prohibitive.

Earlier episodes of more active foreign exchange reserve accumulation - in 2004-05 for instance - came at a time when the treasury was in a sufficiently comfortable fiscal position to be able to accommodate SARB losses as a result of foreign exchange-market intervention.

This time around, with an expanded deficit in response to the economic downturn, tougher choices were required. Nonetheless, in July, indications that the treasury might favour a more interventionist stance increased, with a rise in treasury foreign-currency deposits at the SARB.

In August, the SARB announced that it had resumed foreign exchange market intervention, using longer-term currency swaps in order to neutralise the impact of such 'intervention' on liquidity.

Ahead of the release of gold and foreign exchange reserves data for September, the key question will be how active the SARB has been over the last month.

The authorities may well be in a no-win situation. If evidence of foreign exchange buying emerges, ZAR appreciation in September might suggest that buying was ineffectual.

If - on the other hand - there is little sign of significant foreign exchange market activity (in contrast with other emerging-market central banks), this may be seen as an invitation to further inflows.

 Complicating matters, the nature of the foreign exchange market intervention may make the reserve data more difficult to interpret in the future. Market expectations are for a modest increase in net reserves to US$40.2bn, from US$39.2bn previously. Attention will turn next to the medium-term budget on 27 October, and expectations of further gradual liberalisation of existing exchange controls to relieve pressure on the currency.

The timing of the medium-term budget is key - falling just between the G20 Finance Minister's meeting on 21 October, and the November G20 summit; but in South Africa, there has never been much appetite for anything other than a gradualist stance on foreign exchange liberalisation. From the market's perspective, taking a global view of currency wars, South Africa's defence may appear the weakest. -

* Razia Khan is Head of Macro-economic Research, Regional Head of Research, AfricaStandard Chartered Bank, United Kingdom.