ALREADY MORE THAN R100bn: that’s the direct cost attributable to the SA Reserve Bank and the Treasury for their combined efforts over the past 18 months in taking preventive measures so the exchange rate of South Africa’s rand doesn’t rise too much. Ultimately, that cost comes out of taxpayers’ pockets. Luckily, a great deal of that expenditure is either not of a cash flow nature or is past profit on foreign exchange reserves currently evaporating. Taxpayers will therefore not to have to pay for this directly – as often happened between 1980 and 1998, when the Reserve Bank and the Treasury chalked up huge losses by trying to keep the value of the rand artificially high.
Billions, especially hundreds of them, are still large figures in the context of SA’s economy. It’s no wonder the Monetary Policy Committee (MPC), now headed by Gill Marcus, in its latest report on 22 July warned about the efforts to stabilise the rand’s value. It stated: “We’re ready to continue to play our part in a considered manner and discussions with the National Treasury about the various options available to address these issues, as well as the availability of resources to do so, are ongoing.”
It’s no secret the Bank’s balance sheet has for a long time been nowhere large or strong enough to absorb the surplus US dollars that keep flowing into SA. Currently, the Treasury is helping. But that puts pressure on their (Bank and Treasury) combined resources, as the latest MPC report explains.
To calculate/estimate the direct cost for the Bank and the Treasury in stabilising the rand, we have to consider the accounts in their books:
The Foreign Exchange Contingency Reserve Account.
The major part of the expenditure of more than R100bn is the loss or valuation adjustment of R58bn the Bank had to make to its Gold and Foreign Exchange Contingency Reserve Account for the year to 31 March this year. The particular items in that account will only become clear next week, when the Bank issues its annual report for the year to 31 March 2010. The Bank’s latest Quarterly Bulletin (issued in June) contains the figure in a summarised format.
The accumulated profit on the bank’s foreign exchange account for the 12 months to 31 March 2010 fell from R101bn to R43bn. That’s a valuation adjustment that can be attributed directly to the poor performance of the US dollar, the euro and sterling, the currencies in which our reserves are held. If you don’t like the valuation approach from that side, look at it from the other side. The value of our foreign exchange reserves fell by R58bn over that period because the value of the rand increased.
On the graph of the nominal exchange rate of the rand, we’ve indicated the annual valuation adjustment – and it’s easy to see the extent of the profit or loss in each of the past three fiscal years (the year to 31 March) on each account. The balances of the unrealised profit on the foreign exchange account – which is an asset of the Treasury – are almost incredible for us old-timers who had to live through the losses of 1980 to 1995. The balances and value adjustments on the Reserve Bank’s account are as follows:
Let me confess: I doubt if many economists – especially those who are becoming slightly grey around the temples and can still recall the balance on this foreign exchange account, which was always seriously in the red between 1980 and 1995 – realise it turned around to a profit or asset of R101bn at the end-March 2009 fiscal year. Though the Bank and the Treasury don’t like pointing out that profit or asset, if it’s added back into SA’s brilliant fiscal achievements for the year to March 2009 it explains very well why the rand was so exceptionally strong over the past 12 to 18 months.
The Reserve Bank and the Treasury’s combined holdings of foreign exchange reserves and the interest loss on it.
Yes, unlike the custom of the past 75 or more years, the name of the Treasury must be added to that of the Bank when the monthly statement of SA’s holdings of gold and forex reserves is published. The Bank’s balance sheet is just too small to handle them alone. In fact, currently it’s the Treasury that’s absorbing the major portion of the surplus net inflow of forex.
Third, the latest summary statement of gold and foreign exchange reserves on 31 July is shown in table below:
It costs money to keep that amount of reserves. The forex reserves consist chiefly of US dollars, euro and sterling. The current interest rates on deposits of those currencies are extremely low. US 90-day Treasury bills currently offer investors, such as our Reserve Bank, an interest rate of only 0,13%/year. On gold and SDRs no interest is earned. Remember that for every gold or forex asset the Bank or Treasury holds, there’s a corresponding liability in SA rand. The cheapest corresponding money available to the Bank and Treasury is local 91-day Treasury bills, on which the interest rate is currently 6,46%.
In short, the difference between the return on those forex assets and the cost of financing them is around 6%/year. On the total current combined holdings of $43 159m, the interest difference can be as much as $2 590m/year. That’s a direct expense for Treasury – and therefore SA’s taxpayers – of R19bn/year. A potential annual loss or expense such as that is difficult to stomach, especially now when people are striking for much smaller amounts.
Bearing that potential cost in mind, it’s easier to interpret Marcus and the MPC’s latest statement about supporting the exchange rate “and discussions with the National Treasury about various options available to address this issue as well as the availability of resources to do so, are ongoing”. It costs money just to buy up surplus US dollars every month – and someone is starting to find it a bit much.
The sterilised money of the Treasury at the Reserve Bank
When both the Treasury and the Reserve Bank buy surplus foreign exchange on the local market it also pumps rand into the money market. This could be too much money, which in turn creates the danger of pushing up South Africa’s inflation. Sometimes, with large transactions – as was the case with Barclays plc’s partial takeover of Absa and could now happen with HSBC’s potential offer for 70% of Nedbank – it could be the case that just too much money is flowing into the country.
In the case of the Absa transaction, the Treasury intervened directly and bought the offered US dollars for rand. After that, Treasury bonds were issued to slurp up the rand again and deposit them back at the Bank. That’s called sterilisation and on those deposits Treasury earns no interest but has to pay interest on the instruments it issued to keep the rand away from the public. That’s a direct expense for taxpayers.
The Bank’s latest assets and liabilities statement shows the Treasury currently holds two types of deposit at the Bank on which no interest is earned. They total just more than R100bn. The annual interest loss on this would be around R6bn.
Now for a quick calculation: the valuation loss on our forex reserves for the 12 months to 31 March this year was already R58bn. Meanwhile, the value of the rand strengthened further and the balance on the account, which was still R101bn 18 months ago, has presumably fallen to hardly more than R30bn. That’s a loss of R70bn.
The interest loss on our steadily growing balance of forex reserves is still increasing and was at least R25bn over the past 18 months. The Treasury’s interest loss on its sterilised deposits was close to R10bn over the past 18 months. In total, that’s a cost of just more than R100bn – just because the rand isn’t weakening, even with all the mess-ups made by SA’s politicians.
Fiscal discipline and the rand exchange rate
Daniel Mminele, one of the new Deputy Governors at the SA Reserve Bank, speaking at the 13th Southern African Internal Audit Conference, made a very accurate forecast about the exchange rate of the rand over the next three years. It’s potentially very strong.
In order to interpret Mminele’s remarks correctly, we first need to look at the earlier (1997/1998) conditions for admission to the single currency, the euro, contained in the Maastricht Treaty. The two cornerstones for membership of the euro were that a country’s fiscal deficit – that is, the difference between the state’s income and expenditure – should not be more than 3% of gross domestic product, while the state’s total debt shouldn’t exceed 60% of GDP.
During the conference, Mminele said the following about the 2008 financial crisis, which some think appears to be a warning: “The combined effect of slower growth and higher spending (by governments) was an increase in budget deficits in many advanced economies to levels in excess of 10% of GDP. The International Monetary Fund projects that, as a consequence, public debt ratios will most likely increase from around 70% of GDP to average approximately 110% of GDP in 2014. We have to remind ourselves that not too long ago a debt:GDP ratio in excess of 60% was viewed to be bordering on fiscal irresponsibility.”
Unfortunately, he didn’t say what the position in SA is. However, the Bank’s Quarterly Bulletin of June this year reported SA’s net fiscal deficit for the financial year to 31 March 2010 had increased from 0,7% in the previous fiscal year to 5,4% of GDP. It also reported our State debt increased from 26,6% to 32,4% of GDP over the two years.
If Mminele looked at Maastricht, the IMF predictions and our low level of State debt, it would have been difficult to forecast anything else than that the rand exchange rate could still strengthen considerably against the “advanced economies” he referred to.
It looks as if the debate on who will have to keep the rand in check and how much it will cost will continue for a long time. Hopefully, it’s not one of the topics that will be censored. For those of you who still remember, two decades ago we weren’t allowed to know how many reserves the country really held. The Bank’s net deficit position in futures US dollars was a state secret. For those who have forgotten, our net forex reserves were a massive negative of just more than $25bn in 1998. In 1993/1994 SA’s fiscal deficit was just over 10% of GDP and the rand exchange rate was constantly under pressure.
Buy SA retail bondsInternational interest rates still too lowIF THE International Monetary Fund’s predictions are correct – that state debt of the older economies, such as in Europe and even the United States are going to rise to more than 100% of GDP over the next three years – interest rates in those countries will have to stay low for a long time. Take Japan for instance. Its state debt as a percentage of GDP has been more than 200% for a long time. However, Japan’s surviving because its interest rates are so low. What would happen in Japan if interest rates were to increase to 10%/year and the interest on state debt alone became 20% of GDP? Answer: Immediate bankruptcy.
This concept of forced low interest rates in many countries must still reach South Africa. Our interest rates are still too high, which is one of the reasons why the rand remains so strong. Domestic interest rates must fall further – and that’s why everyone, especially older people, must make maximum use of the attractive interest rates still available on retail bonds.
The interest rate is 8,5% for an investment over two years, 8,75% for three years and 9% for five years. Remember: these interest rates, as well as the capital, are guaranteed by the State, which makes it SA’s safest investment. Buy now, because those interest rates can’t be held at those levels for much longer.
Good news for exportersIT LOOKS as if the rand’s real effective exchange rate (REER) is turning or at least stabilising at the level of about 110. That’s good news for the country’s exporters. REER is an index calculated by adjusting the country’s ordinary nominal exchange rate, weighted for the importance of our trading partners, by the difference between our inflation rate and that of our trading partner. The theory says that if the inflation rate of a country, like in SA at the moment, is higher than that of its trading partners, its currency should continually weaken by the difference. The opposite is the case if a country’s inflation rate is lower than that of its trading partners.
In a perfect world, the value of REER would always equal 100. It could therefore be argued that our current REER of 110 is saying that the value of the rand is at least 10% too high. Exporters of course dream of a REER of less than 100, even better the 90 and less of 2008. But, unfortunately, foreign investors also notice when a currency is undervalued, and that’s when they can’t get enough of buying our assets, especially if our interest rate is also too high.