Take economic effect of capital flows with a pinch of salt

inflows of foreign savings at the rate of 5 percent of gross domestic product (GDP). The difference between low savings (14 percent of GDP) and higher rates of capital expenditure (about 19 percent of GDP) is equal to the deficit on the current account of the balance of payments.

South Africans, to maintain their standard of living, must hope that, on balance, capital continues to flow here – for which we have to give up an increasing net flow of interest and dividend payments abroad.

As a result of capital attracted over the years, these payments now account for over half of the current account deficit.

It needs to be appreciated that for every foreign seller or buyer of a listed security (unlike a new issue) there will be an equal and opposite domestic investor, attracted (or repelled) by lower (higher) prices and higher (lower) yields led by these foreign flows into the equity and bond markets.

These variable prices and yields act as one of the absorbers of the shocks that result in foreign capital flowing in or out of the rand. The other important shock absorber is the variability of the exchange value of the rand.

Clearly these capital flows have a statistically significant impact on the value of the rand, although there are other forces acting on the currency market over any 30day period. Ideally, capital flows to and from here would be more predictable and the rand less volatile. It would appear, however, that not all sale proceeds from the selloff were transferred abroad.

The Reserve Bank has published its latest Financial Stability Report. Among its understandable concerns is the economy’s dependence on flows of portfolio capital into and out of equity and bond markets.

The report states that “non-resident investors in South Africa were net sellers of R69 billion worth of domestic bonds and equities between October 2013 and March 2014… It would appear, however, that not all sale proceeds from the selloff were transferred abroad.”

This statement that indicates that not all the flow into and out of the rand from abroad can be accounted for by the statisticians and the banks that supply the record of foreign trade and financial transactions. The balance of payments accounts, which should sum to zero theoretically, are in reality balanced by what is often a very large item, known as unrecorded transactions.

This line item was particularly large in the fourth quarter of last year at R30.6 billion, compared with recorded capital flows of R5.3bn.

The reality is that the balance of payments is somewhat mysterious and so conclusions about the role of capital flows in the economy must be treated with some caution. The capital flows themselves may be under- or overestimated, as may exports or imports or even interest and dividend payments.

What is fully known and recorded is what happens to the rand and the prices of securities.

The important conclusion to draw is to let the markets act as the shock absorber, and for the monetary policy authorities to set their interest rates with the state of the domestic economy in mind.

The influence of unpredictable exchange rates, led by unpredictable capital flows, on the rand and on inflation is best ignored because there is nothing much to be done about them.