IMF Updated View on SA

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2010 Article IV consultation with South Africa, the IMF released a 58 page report on the SA economy. We will examine some their conclusions over the next couple of days. However, their comments on the exchange rate, seem particularly pertinent given the current ANC policy discussion in Durban.

The following is a summary of the some of the key points made by the IMF regarding the value of the Rand:

• The rebound in the Rand is one of the strongest among emerging markets, and has been largely driven by capital inflows.
   
• At its most recent valuation level, the IMF’s estimates suggest that the real exchange rate could be around 5% to 15% overvalued, although there is a large degree of uncertainty around these estimates.
   
• The currency appreciation is a source of legitimate concern, in that it could retard the economic recovery.
   
• South Africa’s floating exchange rate regime has been an important absorber of shocks, enabling the economy to adjust in the face of the global financial crisis. The flexible exchange rate regime had served South Africa well and should be retained.
   
• The floating exchange rate has discouraged private sector borrowing in foreign currency, preventing a build-up of foreign currency mismatches on household and corporate sector balance sheets, and ensuring that foreign investors share in the adjustment burden in the event of Rand depreciation.
   
• IMF argues that there is greater scope to use the opportunity provided by strong capital inflows to build reserves (SARB has been intervening more actively in the currency market during recent months/weeks).
   
• The scale and depth of South Africa’s foreign exchange markets - with a daily transaction volume of the order of $10-12 billion - means that the government’s ability to influence the level of the Rand is limited.

In terms of various policy options to deal with the Rand strength, the IMF made the following key points:

• The IMF supports the further removal of exchange controls, but argues that the gradual approach should not be accelerated given the heightened uncertainties.
   
• A small tax on inflows might help slow the volume of inflows or change its composition. However, the international experience is that these tools might be easily circumvented, with their effectiveness eroding overtime. Further, given South Africa’s reliance on foreign savings to finance investment the adoption of such an instrument would not be as straight forward.
   
• Interest rate decisions should remain fully embedded in monetary policy considerations. The IMF argues that rate cuts for the sole purpose of countering capital flows might well be counterproductive, as lower interest rates might elicit more inflows into equities, and strengthen the exchange rate.
   
• The IMF sees some merit in temporary targeted intervention to help the enterprises that are being most adversely affected by the strength of the Rand. For instance, increases in the investment tax allowance for small and medium sized companies engaged in labour intensive, non-traditional activities could be considered. By tying the benefit to investment, this could help elicit more investment in plant and machinery as well as creating more jobs. However, care would need to be taken to ensure that such measures are easily reversible.
   
• Other options included finding ways to make it less costly for affected companies to hedge exchange rate risk. Any such schemes would need to be carefully designed to focus their coverage and include some degree of automaticity, so that they expire when the degree of overvaluation diminishes.

All of the above seems sensible, logical, and workable. It also certainly argues against a radical change in policy to try and heavily impact the Rand. Instead the remarks take into account the practical realities of the Rand as well as the risks.