Gordhan warns on currency devaluation, trade protectionism

2010-10-27 14:38

Finance minister Pravin Gordhan today again warned against currency devaluation and trade protectionism as a response to the strong rand.

Tabling his 2010 medium-term budget policy strategy in Parliament, he said South Africa would follow the established course of mitigating the negative impacts of the local currency’s gains by boosting foreign currency reserves and easing restrictions on capital outflows.

Gordhan cautioned that South Africa, as a small economy, could not fully offset the ravages of massive global capital movement, and needed greater productivity and competitiveness to cope with the rise of the rand.

“Inappropriate short-term responses to global currency adjustments, such as competitive devaluations or increased trade protectionism, will entail longer-term costs to economic growth.

“A co-ordinated international agreement on currency alignment would help to minimise the negative effects of this rebalancing, especially for developing countries.”

The minister’s remarks echo his warning last week that devaluations by separate nations could spark a trade war, which appeared at odds with a call by Reserve Bank governor Gill Marcus for “extraordinary measures” to mitigate rand strength.

Today, however, Marcus sat next to the minister as he briefed the media on the medium-term budget policy strategy and agreed that trying to depreciate the currency could prove dangerous and a fleeting benefit.

She said it was vital for the treasury and the central bank to work together on measures that “mutually reinforce each other. For us it really is about what is appropriate and what is the likely outcome that you would achieve.

“Japanese debt-to-GDP ratio has now risen to 226%.

If you look at one or two days where they intervened with trillions of yen and the currency might have weakened for a day or two and then just strenghtened again, ” she said.

“The first question we need to face is not about depreciating the currency, but whether there are ways in which we could stop it appreciating further.”

Gordhan noted that the real effective exchange rate had risen to 12% above its average level for the past decade, posing a threat to stable growth.

“Sustained exchange rate overvaluation will lead to unbalanced growth, widening the current account deficit and increasing the economy’s vulnerability to shocks.

“Fiscal consolidation and lower interest rates are the macroeconomic prerequisites for a more competitive real exchange rate.

“The combination of tighter fiscal policy and looser monetary policy will support demand while moderating the build-up of imbalances arising from strong capital inflows.

“Short-term exchange rate risks can also be mitigated more directly through stepped-up purchases of foreign exchange reserves and reduced restrictions on capital outflows to encourage an increase in foreign assets.”

Gordhan said South Africa must strive to take advantage of the surge of capital flows to emerging markets, while minimising the risks that go along with such volatile investments.

Net capital flows continued to rise, reaching 5.5% of GDP in the first half of this year compared with 4.7% in 2009.

“The investment pattern over the past decade suggests that a structural change is under way in global savings allocations.

“This shift may result in a long-term rise in levels of fixed and portfolio investments held in well-managed developing countries, providing an important source of funding for private sector growth and infrastructure development.

“At the same time, low interest rates in advanced economies are supporting a short-term investment wave motivated by the prospect of quick gains.

“Such short-term investments are inherently volatile. The policy challenge is how to benefit from these capital inflows while minimising the attendant risks.”

Gordhan warned again that South Africa could not afford to embark on an aggressive forex buying spree.

“The rand has appreciated by 7.5%against the US dollar since December 2009, and by 6.1% against a trade-weighted basket of currencies.

“Because South Africa has higher inflation than its major trading partners, the real effective rand exchange rate, which reflects losses or gains in competitiveness, is now about 12% above its average level for the past decade.

“Fiscal and monetary policy have adjusted to take account of these circumstances.

“As a small, open economy with low domestic savings and relatively high financing needs, South Africa cannot fully offset the impact of massive global capital flows, barring a much sharper tightening of fiscal policy that diverts resources towards substantially larger reserve purchases.

“Complementary policies to support sustainable gains in productivity and international competitiveness are also necessary,” he said.

Marcus declined to say how much foreign currency the Reserve Bank would buy to bolster its reserves, which stood at $44.1 billion in September.

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