Exchange Rate Policy

Table of contents Pages 1. Introduction2 2. Exchange control and its uses2 2. 1. Disadvantages of tightly managed exchange control 2. 2. Advantages of flexible exchange controls 2. 3. Disadvantages of flexible exchange controls 3. Emerging markets and exchange control3 4. South Africa and exchange controls3 5. Conclusion5 6. References6 List of figure: Figure 1: Exchange rate forecast4 Figure 2: Price of Brent crude oil4 Figure 3: SA inflation: history and forecasts5 ? Introduction South Africa and the countries of the world have seen tremendous shifts in exchange control and exchange regimes since the mid 1990’s.

Evolving from stringent do-or-die fixed measures of tightly managed floats and soft pegs to more flexible floats and open capital accounts. Developed countries have succeeded in abolishing exchange controls and have set a standard for emerging countries to follow. This study evaluates the relaxation of exchange controls in the South African context. Exchange control and its uses Exchange controls are restrictive measures used to control the in- and outflow of foreign and domestic currencies in order to prevent uncontrollable large scale movements of capital. SARB (b)) The exchange rate is the rate at which a domestic currency is traded for a foreign currency and is determined by the demand and supply of money in a managed flexible exchange regime. (SARB (b)) Disadvantages of tightly managed exchange control •Exchange control restricts South African organisations from expanding their operations abroad, thus hampering their growth and competitiveness. (SARB (b)) •Exchange controls restrict the much needed inflow of foreign investment. (SARB (b)) •Exchange control administration and maintenance is costly and complicated. ( Cobbett 2005)

Advantages of flexible exchange controls •Greater inflow of foreign investment that leads to economic growth. (Mafu 2006) •The SARB can improve their balance sheets. •The improvement of South Africa’s credit rating abroad. (Mondi 2005) Disadvantages of flexible exchange controls •Less control over the movement of capital out of the country in times of crises. . Emerging markets and exchange control Most emerging markets in the world still use exchange controls with limited flexibility, as they lack the “so called” preconditions required to effectively manage and sustain a stable open capital account. Eichengreen & Razo-Garcia 2006: 410) These preconditions include among others, a strong and well developed financial sector, transparent and strong monetary and fiscal policies and well developed banking systems. (Eichengreen & Razo-Garcia 2006: 416) South Africa and exchange control South Africa boasts with a very well developed financial sector, far superior to that of most developing countries. It has a sound and well governed banking sector and transparent and consistent economic policies. As far as these preconditions are concerned, South Africa is a prime candidate for the eradication of exchange controls.

South Africa however opted for a flexible exchange regime with economic policy “anchored” to an inflation target. The inflation target is the primary concern of the SARB, with the interest rate as an operational target and the exchange rate as intermediate target. (Ingham 2004: 191)The interest rate affects the demand and supply of money in the market which in turn determines the exchange rate that ultimately affects the inflation. (Ingham 2004: 191) In concept the more flexible the exchange regime, the more volatile the market for the supply and demand of money and the higher the risk of unwanted capital flight.

In figure 1 below, the forecast depicts a steady increase in the exchange rate of the Rand against major currencies throughout 2007 to 2013. This indicates the depreciation of the Rand, although the value of the Dollar, Euro and Yen do not vary much throughout the forecast. ? Fig 1: Exchange rate forecast Source: Investec (a) The international upward trend of crude oil seen in figure 2 below, has led to much higher interest rates and higher inflation, inhibiting economic growth. In figure 3 below, inflation exceeds the maximum 6% inflation target, but is expected to fall once the consumer basket of the CPIX is revised in 2009.

The depreciation of the Rand, the higher interest rates and higher inflation has made the South African economy and money markets unpredictable. These developments have made investors wary of future prospects, increasing the risks of capital flight due to exchange control relaxation. Fig 2: Price of Brent crude oil Source: South African Reserve Bank (a) Fig 3: SA inflation: history and forecasts Source: Investec (b) Conclusion The South African exchange regime has undergone significant shifts towards exchange control liberalisation.

The current account has been improved, the limits on the amount of capital flows have been increased and portfolio investment has risen. The gradual relaxation of exchange controls have been managed effectively and have proven to be the best current policy to follow. Developed countries have shown that the eradication of exchange controls are inevitable and the way to economic prosperity and liberty. The current global economic environment however does not paint the same picture as the markets have become more volatile and investors more cautious in investing in South Africa.

South Africa should not be over eager to follow in the footsteps of the greats if they cannot fill their shoes. (721)? References 1. COBBETT, J. , 10 November 2005. Exchange controls useless-Tito. Citizen. [Online]. Available: http://www. samedia. uovs. ac. za. ez. sun. ac. za/cgi-bin/getpdf? year=2005&refno=17810&topic=8 : Retrieved 11 August 2008 2. EICHENGREEN, B. , RAZO-GARCIA, R. , 2006. Economic policy. #47. London: Blackwell Publishing Limited. : 410, 416 3. INGHAM, B. , 2004. International Economics. A European Focus. Harlow: Pearson Education Limited. : 191 4. INVESTEC (a) 2008. rd Quarter preliminary Macro-economic forecasts. [Online]. Available: http://www. investec. com/NR/rdonlyres/0485B809-FF67-4ABF-8578-AB9BBFFA0ADC/11894/Forecasttable_Q308. pdf : Retrieved 12 August 2008 5. INVESTEC (b) 2008. Houseview SA: Group economics interest rate outlook. [Online]. Available:http://www. investec. com/NR/rdonlyres/CD6B4D6E-87D9-4DD9-A662-C9EED3B62C49/12040/Houseview_InterestRate_Aug. pdf 6. MAFU, T. , 01 September 2006. Exchange controls still deter foreign investors. Star. [Online]. Available: http://www. samedia. uovs. ac. za. ez. sun. ac. za/cgi-bin/getpdf? ear=2006&refno=13416&topic=8 : Retrieved 11 August 2008 7. MONDI, L. , 19 November 2005. SA should retain exchange controls. City Press. [Online]. Available: http://www. samedia. uovs. ac. za. ez. sun. ac. za/cgi-bin/getpdf? year=2005&refno=18507&topic=8 : Retrieved 11 August 2008. 8. SOUTH AFRICAN RESERVE BANK (a). 2008. Monetary Policy Review May 2008. 9. SOUTH AFRICAN RESERVE BANK (b). 2008. Factsheet 4. [Online]. Available: http://www. reservebank. co. za/internet/Publication. nsf/LADV/67C1699E98E8A8C54225733700450AF4/$File/Fact+sheet+4. pdf Retrieved: 11 August 2008

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