JOHANNESBURG — South Africa needs to set policies that aim to reduce the volatility of the rand exchange rate as capital flows pose challenges to emerging market currencies, central bank deputy governor Lesetja Kganyago said in a speech posted on the bank’s website on Friday.
“The capital flows challenge needs fresh thinking. Over the medium term, to moderate the real exchange rate, we need fiscal and monetary policy settings that reflect that policy objective and seek to achieve it,” Kganyago said in the speech to an investor fund conference in Cape Town.
Emerging markets are sensitive to exchange rate volatility as near-zero interest rates of developed economies lead investors to seek yields in the riskier, but higher-yielding emerging market assets. “The impact on countries like South Africa is capital flows to our countries looking for better returns and this poses a challenge for us, to manage the capital flows so that they don’t lead to exchange rate misalignments,” Kganyago said in emailed comments.
The rand gained about 30% on the dollar between 2009 and 2010, but lost about the same amount between August and November last year when it tumbled to a two-year low, showing its sensitivity to global risk sentiment. It is up 7% so far this year.
Powerful labour unions, allies of the ANC-led government, have bemoaned the currency’s strength, putting pressure on government to limit its gains. The central bank has previously ignored pressure to take action such as taxing capital inflows like some emerging markets economies have done, saying they do not target a level on the rand.
Kganyago joined the policy setting committee of the Reserve Bank in May 2011 and was making the first governors’ speech for the year, which could signal the bank may be ready to rethink its policy on the rand exchange rate.
The European Central Bank on Wednesday announced a second long-term liquidity injection, money that analysts say will likely fund carry trades, where investors use lower-yielding currencies to buy emerging market assets.
Central banks globally are pumping money into their economies to support fragile economic recoveries and boost growth.
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The South African Reserve Bank has said it does not target a specific level on the rand and participates in the market to build up its foreign currency reserves.
The bank said it will continue to deal with financial shocks to the economy through its flexible inflation targeting policy, which allows for the rand to cushion the economy.
“The policy of the government is to maintain a stable and competitive real effective exchange rate. What this means is that we have to bring South Africa’s inflation in line with or lower than that of our trading partners,” Kganyago said.
The central bank targets inflation of between 3 and 6%. Headline consumer inflation quickened to 6,3% in January and has been outside the target since November. The bank expects inflation to return within the band only in the first quarter of 2013. — Reuters
