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Cape Town - South Africa would not be making "inappropriate short-term" responses to deliberately weaken the currency as this would pose longer-term problems to economic growth, Finance Minister Pravin Gordhan said on Wednesday.
Delivering his medium-term budget to parliament, Gordhan outlined some strategies on how the country could dampen the effect of high levels of capital inflows.
"As many emerging economies, South African producers are currently under pressure because the strength of the real exchange rate reduces competitiveness of manufactured exports and lowers the cost of imports," Gordhan said.
"We appreciate that sustained exchange rate over-valuation creates difficulties for many businesses and threatens jobs in some sectors. It can lead to unbalanced growth, widening of the current account deficit and increase vulnerability to economic shocks."
While the mini budget outlined a strategy to relax exchange controls as part of what it called a plan to tighten fiscal and loosen monetary policy, Gordhan and South African Reserve Bank (Sarb) governor Gill Marcus agreed that South Africa cannot fully offset the impact of massive global currency inflows.
While National Treasury and the South African Revenue Service also plan to continue purchasing foreign exchange reserves (gross foreign exchange reserves stood at $44bn in September 2010), Gordhan said that capital inflows to emerging markets also had a positive effect on the domestic economy that had to be harnessed.
"It's enabled the governor (Marcus) to be Mother Christmas early. It has enabled agencies like Eskom and Transnet to bring in capital goods. It's kept inflation down," said Gordhan.
Gordhan stressed, however, that while emerging markets try to figure out ways to protect domestic interests, the leaders of the 20 most developed nations (G20) needed to come up with a "coordinated international agreement on currency realignment".
According to the Institute for International Finance, net private capital flows to emerging economies will reach $825bn in 2010, up from $581bn in 2009. JP Morgan estimated that inflows into emerging market fixed-income investments will rise to a record $70bn to $75bn in 2010.
Net capital inflows to South Africa have risen strongly over the past two years, reaching 5.5% of GDP in the first half of 2010 compared with 4.7% in 2009 as a whole.
"The investment pattern over the past decade suggests that a structural change is under way in global savings allocations," Gordhan stated in his speech.
"This shift may result in a long-term rise in levels of fixed and portfolio investments held in well-managed developing countries, providing an important source of funding for private sector growth and infrastructure development.
"At the same time, low interest rates in advanced economies are supporting a short-term investment wave motivated by the prospect of quick gains," he said.
"The policy challenge is how to benefit from these capital inflows while minimising the attendant risks."
The rand has appreciated by 7.5% against the dollar since December 2009, and by 6.1% against a trade-weighted basket of currencies. Since South Africa has higher inflation than its major trading partners, the real effective rand exchange rate - which reflects losses or gains in competitiveness - is now about 12% above its average level for the past decade.
"Fiscal and monetary policy have adjusted to take account of these circumstances. As a small open economy with low domestic savings and relatively high financing needs, South Africa cannot fully offset the impact of massive global capital flows, barring a much sharper tightening of fiscal policy that diverts resources towards substantially larger reserve purchases," stated the speech.
- Fin24
Delivering his medium-term budget to parliament, Gordhan outlined some strategies on how the country could dampen the effect of high levels of capital inflows.
"As many emerging economies, South African producers are currently under pressure because the strength of the real exchange rate reduces competitiveness of manufactured exports and lowers the cost of imports," Gordhan said.
"We appreciate that sustained exchange rate over-valuation creates difficulties for many businesses and threatens jobs in some sectors. It can lead to unbalanced growth, widening of the current account deficit and increase vulnerability to economic shocks."
While the mini budget outlined a strategy to relax exchange controls as part of what it called a plan to tighten fiscal and loosen monetary policy, Gordhan and South African Reserve Bank (Sarb) governor Gill Marcus agreed that South Africa cannot fully offset the impact of massive global currency inflows.
While National Treasury and the South African Revenue Service also plan to continue purchasing foreign exchange reserves (gross foreign exchange reserves stood at $44bn in September 2010), Gordhan said that capital inflows to emerging markets also had a positive effect on the domestic economy that had to be harnessed.
"It's enabled the governor (Marcus) to be Mother Christmas early. It has enabled agencies like Eskom and Transnet to bring in capital goods. It's kept inflation down," said Gordhan.
Gordhan stressed, however, that while emerging markets try to figure out ways to protect domestic interests, the leaders of the 20 most developed nations (G20) needed to come up with a "coordinated international agreement on currency realignment".
According to the Institute for International Finance, net private capital flows to emerging economies will reach $825bn in 2010, up from $581bn in 2009. JP Morgan estimated that inflows into emerging market fixed-income investments will rise to a record $70bn to $75bn in 2010.
Net capital inflows to South Africa have risen strongly over the past two years, reaching 5.5% of GDP in the first half of 2010 compared with 4.7% in 2009 as a whole.
"The investment pattern over the past decade suggests that a structural change is under way in global savings allocations," Gordhan stated in his speech.
"This shift may result in a long-term rise in levels of fixed and portfolio investments held in well-managed developing countries, providing an important source of funding for private sector growth and infrastructure development.
"At the same time, low interest rates in advanced economies are supporting a short-term investment wave motivated by the prospect of quick gains," he said.
"The policy challenge is how to benefit from these capital inflows while minimising the attendant risks."
The rand has appreciated by 7.5% against the dollar since December 2009, and by 6.1% against a trade-weighted basket of currencies. Since South Africa has higher inflation than its major trading partners, the real effective rand exchange rate - which reflects losses or gains in competitiveness - is now about 12% above its average level for the past decade.
"Fiscal and monetary policy have adjusted to take account of these circumstances. As a small open economy with low domestic savings and relatively high financing needs, South Africa cannot fully offset the impact of massive global capital flows, barring a much sharper tightening of fiscal policy that diverts resources towards substantially larger reserve purchases," stated the speech.
- Fin24
