Calls for intervention ignore cost to taxpayers
If there had been any major intervention by the Reserve Bank in the currency market the US dollar value would have increased
YET AGAIN we’ve had calls for a weaker rand – this time from labour, banding together with a number of manufacturers who claim they can’t be competitive with the rand at around US$1/ R7,50. But it’s not just those vested interests who have argued for a weak rand: there have been reports Trade & Industry Minister Rob Davies – speaking on the sidelines at the World Economic Forum’s meeting on Africa in Dar es Salaam – also indicated the rand is overvalued.
One can’t be sure how accurate those reports are. The official Government position has been articulated by Finance Minister Pravin Gordhan, who said in his Budget speech: “We have agreed with the Reserve Bank we’ll continue to take steps to counter the volatility of the exchange rate and to lean against the wind during periods of rapid capital inflows, including reserve accumulation and further exchange control reform.”
But reserve accumulation isn’t taking place. Reserve accumulation occurs when the Reserve Bank buys US dollars or euro in the market in exchange for rand. The transaction causes the rand to weaken due to the extra supply of rand. There’s been no evidence in the monthly reserve figures from the Reserve Bank that reserve accumulation has been taking place. But Reserve Bank Governor Gill Marcus explains that’s because the reserves are quoted in US dollars and fluctuations in international currency markets have resulted in the dollar value of the reserves remaining more or less the same, at around US$39bn. But if there had been any major intervention by the Bank in the currency market, the dollar value would have increased.
Marcus said in a speech the Bank’s reserve accumulation had resulted in a loss for the Bank in the 2009/2010 fiscal year of R1bn. That’s a crucial factor that could explain why the Bank hasn’t been active in the currency market. The reason may be that it’s too costly.
The cost arises from the fact that any buying of forex has to be followed by action to “sterilise” the inflow of rand into the money market. If no action is taken there’s an increase in money supply and downward pressure on interest rates and monetary policy won’t work. The Reserve Bank or Government has to take action to drain that liquidity from the money market.
In the past (2004 to 2006) Government issued bonds to draw the rand out of the market. The money invested in those bonds was deposited at the Reserve Bank, where it wasn’t defined as money supply. That worked well during periods when Government had extra revenue and could borrow comfortably. It allowed the Bank to at times buy $1bn/month of forex.
But now Government’s debt is a problem, Treasury is probably less keen to borrow to drain liquidity from the money market. In that case, the Reserve Bank can issue debentures, which is what happened over the past fiscal year. The loss made arises from the fact the interest paid on the debentures (say, around 7%) is so much lower than the interest earned on the reserves.
Interest rates on dollars and euro are close to zero. That loss doesn’t show up in the Bank’s books when Government is the one undertaking the sterilisation action. But when the Bank itself issues debentures instead of Government issuing bonds, a loss is incurred, as happened over the past fiscal year.
It’s understandable Government should be reluctant to issue bonds for sterilisation purposes at a time when there’s concern about Government debt. But a question arises: Why doesn’t Government spend the money it raised during past sterilisation exercises to meet its Budget requirements now, thus reducing its overall borrowing?
However, it seems the crucially important fact is that it’s expensive for the taxpayer to intervene in the currency market because of the interest incurred. That cost is often ignored by those making calls for Reserve Bank intervention in the currency market.