Politics is killing the rand

In December 2015, President Jacob Zuma fired then finance minister Nhlanhla Nene and replaced him with the almost parodically inexperienced David “Des” van Rooyen. The rand immediately suffered a sharp depreciation against foreign currencies.

Although Zuma’s decision was reversed a few days later, when he relieved Van Rooyen of his short-lived duties and rehired former finance minister Pravin Gordhan, the rand continued to depreciate into January 2016, before staging a partial recovery.

Then, in August 2016, Gordhan’s job came under threat for seemingly political reasons related to his former position as commissioner of the SA Revenue Service (Sars). Again, the rand depreciated sharply.

On Tuesday, October 11 2016, the National Prosecuting Authority issued a formal summons to Gordhan on charges of fraud. The rand immediately reacted, depreciating by about 3% against the dollar.

When the government is so heavily involved in the economy, state credibility and the standards of governance tend to matter a lot for the broader economy, and hence the currency.

While this is easy to grasp, it does not help us understand why certain political events matter more than others for the exchange rate.

For years the Zuma administration has been making poor decisions, undermining governance standards and placing favoured, unqualified party cadres in positions of power and influence without eliciting such dramatic currency depreciation as that experienced in December 2015, August 2016 and October 2016.

What was different about these political events? The fundamental difference was that influential parties undermined governance standards by targeting a critical node of currency credibility – the Treasury.

Given that the Treasury plays such an overbearing role in our economy – taking in taxes and allocating spending on a massive scale – investors fret when it is at risk of being captured for narrow political ends.

To put it bluntly, when market participants believe that Treasury will be used by politicians to loot the country, it places tremendous strain on currency confidence – because financial market participants fret that the national debt will become unsustainably high and geographic productivity will decline as the state levies higher taxes in the future.

The other thing investors worry about regarding the “capture” of Treasury for corrupt political ends is that this could quickly lead to the usurpation and corruption of the most critical node of currency credibility – the central bank.

Currency markets are extremely liquid, being extensively and efficiently traded, and try to discount future events. So, the rising threat of Treasury’s capture – as is allegedly the case in Nene’s sacking and legal threats directed at Gordhan – translates into an increasing threat of the capture of Sars.

This risk, in turn, means currency speculators price in a weaker exchange rate in anticipation of less responsible management of the currency supply in the future. Even though the prospect of central bank capture in South Africa is probably not imminent, a rising risk of capture is quickly discounted in the exchange rate.

Although the reaction of the rand to these events may seem extreme, we should bear in mind that currency speculators are basing their actions on how past experiences of deteriorating governance standards and central bank capture have affected currency exchange rates.

The world is littered with examples of dramatic currency depreciation once central banks became a state tool to fund government expenditure directly by printing money, and once the institutional decay of these banks led to the corruption of commercial banking.

Zimbabwe – from the mid-1990s to 2009 – stands as a dramatic example of the calamity that can befall a currency once the central bank is grabbed for nefarious political ends.

Corruption of the fiscal and monetary agencies has far-reaching effects on our economy and the currency since these are critical institutions for financial and exchange rate stability in our current monetary system.

As long as a dark cloud hangs over the tax collection agency and Treasury, the rand is likely to remain vulnerable and prone to erratic and sharp depreciation.

South Africa’s general governance structures have deteriorated markedly with regard to the state’s fiscal arm, given leadership changes at Sars and political meddling at Treasury.

On the other hand, the central bank remains reasonably free of such meddling and is far from operating in ways that could dramatically undermine currency credibility – at least, not compared to other central banks around the world.

The rand is currently caught between this strange mix of conflicting forces. This partly explains its extreme volatility in recent months.

Going forward, Treasury and, in particular, the central bank are essential to maintaining the country’s currency credibility.

If Sars is usurped for narrow political ends, not only will it spell doom for the rand but this could imperil South Africa’s entire social order in unthinkable ways.

* Nqabeni is the author of sci-fi novel The Girl From Space. He writes under the pen name Michael Kush.