South Africa’s central bank governor has given warning about emerging market turbulence if volatility over the Chinese economy continues, but has ruled out any intervention to prop up a weak rand. The South African Reserve Bank (Sarb) surprised analysts on Monday when it released a statement on currency volatility, saying it “may consider becoming involved in foreign exchange markets to ensure orderly market conditions”.
But in an interview with the Financial Times, Lesetja Kganyago, the bank’s governor, said it was not looking to defend the currency, which hit all-time lows against the dollar this week. The central bank would get “involved” only if it felt the need to use its “power of persuasion” to ensure there was sufficient liquidity in the rand foreign exchange market.
“I’m ruling out intervention to try to defend a level of the currency,” said Mr Kganyago. “To the extent that the depreciation of the rand is driven by fundamentals, no amount of central bank involvement, or even intervention, will stem the depreciation of the currency.” He acknowledged, however, that he was “very” worried about South Africa’s economic outlook.
Data released on Tuesday revealed the economy contracted in the second quarter of this year, as the country was plagued by a crippling power shortage, the collapse in commodity prices, rising costs and weak consumer and investor confidence. “There are red lights flashing and I think that policy makers will be spurred into action,” he said, adding that the Sarb’s forecast of 2 per cent growth for the year was “definitely at risk”.
Even 2 per cent growth is far below the level needed by South Africa to tackle widespread unemployment and poverty. Mr Kganyago also expressed concern about the turbulence in emerging markets as worries about the health of China’s economy reverberate across the globe. “I’m not sure I would call it an emerging market crisis — yet,” he said. “It could be one . . . if the volatility is accompanied by a contraction in emerging market economies.”
He said nations that had accumulated significant foreign currency denominated debt and had seen their currencies fall sharply, increasing the cost of servicing the debt in local terms, could face challenges. “If you are an emerging market company and you borrowed in foreign currency and you happen not to have foreign currency-denominated earnings . . . then you are in trouble unless you have hedged.”
He said South Africa was fortunate that less than 10 per cent of government debt was in foreign currency. South Africa is one of the most liquid and traded emerging markets and the rand has fallen by 11 per cent against the dollar this year. It hit R14 to the dollar on Monday before recovering to around R13. It has also depreciated against sterling and the euro in recent weeks amid emerging market currency turmoil.
The country’s vulnerability to global turbulence is exacerbated by its wide current account deficit, which is higher than many of its peers. China, meanwhile, is a key market for its commodity exports. Still, Mr Kganyago described the rand’s floating exchange rate as a “shock absorber” for the economy. He is also mindful of the more than $20bn cost to the treasury when South Africa attempted to intervene to prop up the rand in the late 1990s.
“If there’s any central bank anywhere in the world that knows where its exchange rate should be and says it can keep it there, I want to meet it, because I would like to know how they do it,” said Mr Kganyago. “We won’t have a currency crisis — currency crises are created by central banks and this one is not about to create a currency crisis.” He added: “Philosophically, we have a problem with having to defend the level of the currency using interest rates.”
However, the weakness of the rand — identified by Sarb as the main inflation risk — complicates the bank’s policy dilemma as it grapples with the grim growth outlook, set against inflationary pressures. The central bank’s primary focus is keeping inflation within a band of 3-6 per cent, and it raised the repurchase rate by 25 basis points in July. But further interest rate rises could have a negative impact on the deteriorating growth outlook, while a US rate rise could put additional pressure on the rand.
Mr Kganyago said a US rate rise was “only priced in to a significant extent; not to a full extent”. He added that the Sarb would stick to its mandate — a position that has maintained the bank’s credibility — and said that South Africa’s economic challenges were structural and “not in the purview of just fiscal and monetary policy”.
They include the electricity constraints, transport bottlenecks, labour market issues and a poorly performing education system. “It is those structural issues that you have to deal with, and those unfortunately need time,” he said.
These constraints, coupled with weak global demand, have prevented South African manufacturers from taking advantage of the rand’s weakness, with the sector’s output shrinking by 6.3 per cent in the second quarter, The Financial Times reports.