Transcript The exchange rate of the rand

Presentation by the South
African Reserve Bank to the
Portfolio Committee on Trade
and Industry
Parliament, Cape Town
6 April 2010
Outline

Observations on the exchange rate of the rand

Observations on the cost of capital in South Africa

Conclusion
The exchange rate of the rand
In thirty years the cost of one US dollar has on balance risen from
less than R1 to more than R7
Nominal exchange rate: Rand per US dollar, monthly averages
Does the movement in the cost of one US dollar from less than
R1 to more than R7 mean a sevenfold-plus increase in the
international competitiveness of South African goods?
 Unfortunately not
 Inflation also comes into the competitiveness picture,
along with many other factors
 If prices in the US stay unchanged but prices in SA rise
sevenfold, the rand price of one US dollar should go up
roughly sevenfold, all other things equal
 To see if competitiveness has really changed,
economists calculate the real exchange rate between two
currencies. It is also called the inflation-adjusted
exchange rate
 Real rand-dollar exchange rate:
$
R
X
Price index in SA in rand
Price index in US in dollar
Although more competitive than in the early 1980s, the real exchange rate of
the rand against the dollar is currently close to its 30-year average
Real exchange rate, US dollar per rand
Stronger rand=up
Formula:
$
R
Price index in SA in rand
X
Price index in US in dollar
Not just against the US dollar but also against a basket of currencies,
the rand has depreciated considerably in the 1980s and 1990s
Nominal effective exchange rate of the rand
Stronger rand=up
“Effective” = against a basket
It is helpful to study the recent movements in the exchange
rate more closely
Nominal effective exchange rate
Stronger rand=up
Lehman
Brothers
failure
For long-run analysis of competitiveness, the real effective
exchange rate is a useful tool
Real effective exchange rate of the rand
Stronger rand=up
“Real” = adjusted for inflation
“Effective” = against a basket of currencies
Numerous forces and events have an effect on the exchange
rate, of which those indicated below are but a few
Real effective exchange rate of the rand
Stronger rand=up
Gold price
boom
Financial
sanctions and
debt standstill
Financial rand
abolished
Southeast
Asian
crisis
Rumours
regarding
President’s
health
Severe
speculation
against rand
Lehman
failure and
“flight to
familiarity”
Drivers of the exchange rate of the rand include export
commodity prices, which are currently strong
Real effective exchange rate of the rand and the gold price
US$ per fine ounce
Stronger rand=up
Drivers of the exchange rate of the rand include export
commodity prices, which are currently strong
Commodity prices
Changes in non-resident investor interest in South
Africa also influence the exchange rate
Annual cumulative monthly net purchases of shares and bonds by non-residents
Lehman
failure and
“flight to
familiarity”
Renewed interest
Recent movements in the exchange value of the rand
traced the movement of other commodity currencies…
Exchange rates - Commodity currencies
Stronger rand=up
Crisis
…and of Brazil, Russia and India, with China being an
exception
Exchange rates - BRICs and South Africa
Stronger rand=up
Crisis
While a lower level of the real effective rand should boost manufacturing
production, other factors seem to have been more important
Real effective exchange rate and share of manufacturing in GDP
Stronger rand=up
Strategic industries, isolation,
high protection
Normalisation, re-integration, reduced protection
Real GDP growth in manufacturing seems more sensitive to local and
international income and expenditure than to the exchange rate
Real effective exchange rate and annual growth rate of real GDP of manufacturing
Stronger rand=up
Real growth – GDP of manufacturing
Capital expenditure in manufacturing is partly on imported capital goods.
Capital spending is often lower when the exchange rate is weak.
Real effective exchange rate and real fixed capital formation in manufacturing
Stronger rand=up
Confidence, income are important
determinants of capital expenditure
The fall in manufacturing production and exports in 2008 and 2009
was driven by the global economic crisis, not by the exchange rate
Global and South African industrial production
Percentage change over twelve months
15
10
5
0
-5
-10
-15
-20
-25
2007
2008
2009
2010
World industrial production
South Africa: Physical volume of manufacturing production
Maintaining a stable and competitive level of the
exchange rate of the rand
• Both the stability and level of the exchange rate are important
for sound resource allocation and sustainable growth
• Stability: The problem is not with frequent smaller fluctuations
but with big “order of magnitude” changes in exchange rates
– Impossible to have a constant exchange rate against multiple
currencies in a world of floating/constantly adjusting exchange
rates
– There are instruments such as forward foreign exchange
contracts available to hedge against exchange rate volatility
• South Africa has made progress with reinforcing the
robustness of its financial system, strengthening its
international financial ties and raising its foreign exchange
reserves
• This contributes to reduced volatility
• Real effective exchange rate volatility:
standard deviation calculated on monthly data
– 1994-1999:
– 2000-2004:
– 2005-Jan 2010:
8,8
11,0
8,4
There has been a reduction in the volatility of the real
effective exchange rate
Real effective exchange rate of the rand
Stronger rand=up
Maintaining a stable and competitive level of the
exchange rate of the rand
• Level: Again, the problem is with major overshooting or
undershooting of the exchange rate
• The equilibrium level of the exchange rate is a moving target
which constantly adjusts to changes in the economic
environment, such as:
– Changes in the terms of trade
– Changes in foreign appetite for acquiring assets in SA
• Recognising misalignment is difficult
• The authorities can contemplate various courses of action if
misalignment of the exchange rate is suspected, including:
–
–
–
–
–
Dissemination of factual economic data/information
Official pronouncements, guidance, warnings
Exchange control relaxation or tightening
Purchases or sales of foreign currency
Policy interest rate changes
Options if misalignment of exchange rate is
suspected
• Dissemination of factual economic data/information
– This is done anyway – SA subscribes to the Special Data
Dissemination Standard
• Official pronouncements, guidance, warnings
– Can help to inform, but can also trigger speculation as market
participants push to see if authorities will put their money where
their mouths are
• Exchange control relaxation or tightening
– Difficult to forecast uptake and lags associated with relaxation,
and business repulsion associated with tightening
– South Africa needs foreign saving due to a domestic saving
shortfall
• Policy interest rate changes
– Impact uncertain: A lower policy interest rate may reduce foreign
depository and bond investment, but bolster foreign share
investment into the country
• Purchases or sales of foreign currency
– Constrained by availability (if selling forex) and cost
considerations (if buying forex)
SARB purchases have increased the country’s gross reserves
from $8 billion to almost $40 billion since early 2004.
South Africa’s official foreign reserves
If the SARB purchases foreign currency, it has moneymarket effects which have to be countered
• The SARB purchases US$100 from a bank and pays for it
with R750
• Rand in circulation has increased by R750
• To counter this and prevent an explosion of rand liquidity, the
SARB has to sterilise the rand that has been created
• It does so inter alia by selling SARB debentures to banks and
the public. These are certificates of indebtedness which pay
interest to the holder.
• Government can also help by placing more money on deposit
with the SARB instead of with private-sector banks.
Sterilising the money-market effect of foreign currency purchases has been costly,
with lower interest rates on international reserves than on sterilisation instruments
International reserve accumulation and related sterilisation
Attempts to influence the exchange rate through official purchases
or sales of forex should be mindful of the size of the forex market
Daily turnover in the foreign exchange market
The relationship running from the exchange rate to
inflation is also important
Exchange rate and targeted inflation
Stronger rand=up
The cost of capital in South Africa
• There are various instruments through which
capital can be raised:
– Loans, debentures, share capital, retained earnings,
hybrid instruments etc
• Focusing on loans and debentures:
– It is helpful if interest rates do not fluctuate excessively
– From a cash flow point of view it is also helpful if nominal
interest rates are lower rather than higher
– Sustainability is important: a very low interest rate
environment which cannot be sustained and makes room
for a high interest rate environment is extremely
damaging
The nominal rate on long-term bond financing has been
high from the mid-1970s to around 2000…
Nominal bond yields
…but much of this was due to high inflation.
Nominal bond yields and the inflation rate
Real (or inflation-adjusted) bond yields have not been very high in
recent years, despite rising capital expenditure in South Africa
Real Eskom bond yield
Short-term nominal lending rates were very volatile and often
very high in the 1980s and 1990s
Nominal prime overdraft rate
The real (or inflation-adjusted) prime overdraft rate has also been
less volatile and well below previous highs in recent years
Real prime overdraft rate
Real central bank interest rates depend on country circumstances
Average real central bank interest rates in selected countries, 2000 - 2009
Conclusion
• A stable and competitive exchange rate of the rand is an important
component of an appropriate industrial strategy for South Africa
– Building financial robustness and foreign-currency reserves when the supply of
foreign currency is strong, reduces volatility and moderates undue appreciation
of the rand.
– That is what the SARB is currently doing, mindful of the importance of the
exchange rate.
– Such intervention or “leaning against the wind” is not the same as targeting a
specific level of the exchange rate. The latter is not advisable, given the size of
the relevant market, the cost and risk attached to such a policy, and international
and domestic experience with such attempts.
– Supply-side measures and programmes to build industry should simultaneously
be vigorously pursued; the exchange rate is no substitute for that.
• The cost of capital should not be unduly volatile or high
– An environment of financial stability and low inflation reduces the uncertainty and
inflation premia built into interest rates
– It also counters volatility and brings down the level of nominal interest rates
• Bottom line: The SARB is committed to promoting financial stability
and maintaining low inflation, in conformity with its mandate. Its
prime contribution is therefore to create a stable platform for
sustainable growth and development.