South Africa’s rand has had an exceptionally volatile year, almost reaching R20 to the dollar in May before strengthening to about R17.27 in late July and then weakening again to trade between R18 and about R19.30 to date.  Most notable about the domestic currency’s weakness is that it has been weak on a relative basis compared with some of the other emerging market currencies and not just against the US dollar, which suggests that there are other forces at work.

Over the past two years, South Africa has not only weakened against the dollar, but it has come up against an unexpected contender: Mexico. The Mexican peso has performed much better than the SA rand against the dollar since mid-2022, when the peso decoupled from our exchange rate after closely tracking it for years. The chart below, which compares the performance of the two currencies relative to the dollar, shows the peso has strengthened over the period while the rand has weakened.

South African rand vs. Mexican peso: normalised returns:

So where has the rand’s weakness stemmed from? The emerging markets, of which South Africa is one, are often viewed as a collective by foreign investors. Though diverse, these countries are generally considered to offer the prospective of relatively higher returns based on their faster economic growth rates and more favourable demographics than advanced economies that are aging fast.

Thus, investors willing to take on the higher risks associated with emerging markets stand to benefit from the opportunities they offer. Their fixed interest yields ordinarily compensate investors for their risk by trading at a premium to developed market yields, particularly to US Treasuries, which are viewed as safe havens. Stock markets, like South Africa’s JSE currently trades at a discount, with the US stock market currently trading above its long-term average after an extended bull market.

Emerging market financial markets and foreign exchange rates usually benefit during periods when investors have an increased appetite for risk, resulting in a weaker dollar when money flows out of the US and into emerging market assets, and lose ground when investors become risk averse and money flows back into the US, buoying the dollar.

Notwithstanding these opportunities, the US Federal Reserve’s proactive stance on interest rates, outpacing counterparts like the Bank of England and the European Central Bank, saw the US dollar gain significant ground over the past two years, fortifying its position as the strongest currency globally. It has also confounded expectations that it will weaken this year in anticipation of the US’s long-awaited recession. High interest rates have been expected to take their toll on the world’s largest economy, but the economy has proved much more robust then envisaged.

Emerging market currencies, like the rand, typically face headwinds in the wake of a robust dollar. Yet exceptions to this trend exist. Notably, the Mexican peso has been remarkably and unusually resilient against the dollar. South Africans can glean invaluable insights from Mexico’s experience, which can be attributed to the country’s favorable economic conditions and inflation dynamics, but most importantly prudent central bank policies.

The peso has benefited from the Bank of Mexico raising rates in line with rising inflation. While the South African Reserve Bank (SARB) responded swiftly to the threat of inflation too, its approach has been more measured and this nuanced distinction has played a pivotal role in the divergence in the performance of the rand relative to the peso against the USD.

South African CPI vs. 3m swap:

 Mexican CPI vs 3m swap:

It is crucial to recognize that currencies are inherently relative, reflecting disparities in economic fundamentals, inflation projections, central bank strategies, and interest rates between the countries against which they are measured. Exchange rates thus serve as the barometer of a nation’s relative economic vitality on the global stage.

Real interest rates matter most in foreign exchange markets and explain why the Mexican peso parted ways with the SA rand last year. In 2022, the Bank of Mexico swiftly returned to positive real rates while the South African Reserve Bank allowed our currency to experience negative real rates at the front end of the curve for a slightly longer period.

Today, however, South Africa enjoys elevated real interest rates and inflation appears largely under control, bolstered by a central bank that remains steadfast in its fight against inflation. However, are rand remains starkly undervalued and most of our asset classes are trading at a discount globally.

To unlock SA’s exchange rate and foreign investment potential and return SA to favour with foreign investors, its paramount that government moves ahead with its structural reforms, facilitates robust infrastructure development and secures political stability. Addressing these crucial factors could set the stage for the rand to strengthen against the dollar to a point where it is fairly valued again, regaining its rightful place alongside other emerging markets, like Mexico.

In early November, the rand benefited from the US Fed’s decision to keep interest rates at current level and the subsequent weakening in the dollar. It also managed to withstand the disappointing news in the mid-year Budget that the budget deficit is going to be much higher than targeted, undermining National Treasury’s fiscal consolidation efforts. Disappointment on the fiscal front will need to be counterbalanced by progress on the other fronts if SA has any hope of regaining its lost ground against the dollar and recoupling with Mexico’s peso anytime soon.

In October this year, a group of one hundred economists and nongovernmental organisations led by the Institute for Economic Justice (IEJ) wrote a letter to the President urging him to consider using gold and foreign exchange contingency reserves to avoid fiscal austerity measures. The idea is reminiscent of the concluding pages of the seminal book – General Theory of Employment, Interest and Money – in which John Maynard Keynes wrote that ideas “are more powerful than is commonly understood. Indeed, the world is ruled by little else. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. … But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.” Recently, the Financial Times reported that Amia Capital, a London-based hedge fund has joined the fray in calling for President Cyril Ramaphosa to consider using the reserves to ease fiscal pressure. Indeed, the idea of using gold and foreign exchange contingency reserves is gaining currency as National Treasury and the SARB are in discussion to explore the possibility in the face of the fiscal crisis. As at the end of March 2023 these contingency reserves held by the SARB amounted to R459 billion, about the size of Eskom total debt.

Gold and foreign exchange contingency reserves are assets held by the South African Reserve Bank (SARB) to ensure stability in financial markets and meet any unexpected economic challenges. They consist of gold reserves (a form of insurance against currency fluctuations and economic uncertainties) and foreign exchange reserves which can be used to intervene in currency markets to influence the exchange rate or to pay off international debts. In essence, these reserves act as a buffer so that the state can respond to economic challenges such as currency crises, and sudden capital outflows.

On the positives, the SARB gold and foreign exchange contingency reserves can be used to alleviate fiscal imbalances in various ways. First, if a country experiences persistent trade deficits, the reserves can be used to address the imbalance either to stabilize the currency or to directly fund imports. South Africa does not face this problem although there is some noticeable worsening of the balance of payments, albeit not outside acceptable limits. Second, when country experiences problems in honouring its external debts, it can use its foreign exchange reserves to prevent default on foreign loans. Again, South Africa is not in a situation where it is about to default on its foreign debt. Its problem is significant share of domestic debt denominated in rand, which theoretically it can solve by printing money. Third, when a country is experiencing volatile currency fluctuations, the central bank can intervene using reserves to stabilize the currency. This usually happens when a country has a managed exchange rate regime. However, South Africa operates a flexible exchange rate regime which self-corrects. Fourth, the reserves could be utilized for short-term fiscal relief, that is providing a quick injection of funds to cover budget shortfalls, and thus assisting the government meet its immediate financial obligations. To a large extent South Africa has been having budget deficits since 2013 which are getting worse. In the current fiscal year the budget deficit is expected to be 4.9% of GDP which is well above the allowable 3%. The question is whether using foreign exchange reserves can provide short-term relief to a problem that has become structural. That brings us to cons of using foreign exchange reserves.

The first negative is that using foreign exchange reserves to inject funds in the economy can cause inflationary pressures. This arises because foreign currency needs to be sold for domestic currency which acts to increase money supply which in turn causes a rise in inflation. This is why the SARB is concerned with the liquidity management cost if reserves are utilized in this manner.

The second negative is that holding foreign exchange reserves involves an opportunity cost since the funds could be invested for potential good returns. This opportunity cost needs to be calculated and weighed by National Treasury and SARB before using reserves to fund government expenditure. If the reserves are invested in interest-bearing assets, using them means foregoing potential earnings. This could result in additional costs for the government if it needs to borrow more or if it loses out on income from the investment of those reserves.

The third negative is that depleting reserves means reduced cushion for future shocks because they act as a safety net and using them to plug fiscal gaps leaves the country more vulnerable to future economic challenges. In this case, it is better to address underlying fiscal issues.

The fourth negative is use of foreign exchange reserves can affect market and investor confidence. Investors often view robust reserves as a sign of a country’s economic strength and ability to weather uncertainties. Prudent management is crucial to maintain trust in the stability of a country’s financial system. A significant reduction of reserves may raise concerns about the country’s macroeconomic stability.

The fifth negative is that using reserves to address fiscal imbalances might postpone the need for necessary long overdue structural reforms in public finances. This will in turn exacerbate long-term fiscal sustainability challenges which South Africa is facing.

In conclusion, fiscal and monetary authorities should be aware that whilst using reserves can provide short-term fiscal relief, it is imperative to carefully weigh the short-term benefits against the potential long-term fiscal risks that could erode investors’ confidence, and ultimately lead to significant increases in borrowing costs and potentially to debt distress. To ensure sustained macroeconomic health of the country it is advisable to take a balanced approach, considering alternative fiscal measures and reforms.

^{Disclaimer: This article expresses the personal views of the author and not specifically those of SAIFM.  SAIFM encourages members with alternate views to please submit the same.  SAIFM encourages discussion and debate in the financial markets.}

Market economies are underpinned by the free-market theory popularized by Adam Smith, an 18th-century Scottish economist who is best known for his seminal work, “The Wealth of Nations,” published in 1776. In the book he outlined the principles of a free-market economy, emphasizing the importance of self-interest, competition, and the invisible hand – the idea that individuals pursuing their own interests can unintentionally contribute to the well-being of society via the market mechanism. In essence, free market theory is an economic philosophy that advocates limited or minimal government intervention in economic activities, meaning that markets should operate with little to no regulation or government interference.

Notwithstanding the advantages of the free market theory, some critics argue that it can lead to market failures, income inequality and other social and economic issues. As a result, real-world economies are mixed economies that incorporate elements of both free markets and government regulation to advance economic growth and development.

The case for government intervention

Government intervention in the economy is often justified by various arguments. These include, among others, the need to address market failure, to provide public goods and services, to address income inequality, to protect consumers, to protect the environment, and to provide public health and education. These arguments highlight the role of government in addressing market failures, promoting public welfare, and maintaining social and economic stability and stimulating economic growth and development. In recent times, no one has done a better job of combining government intervention and market forces than the “developmental” states of East Asia. Japan, South Korea, Taiwan, and, most spectacularly, China. They have all relied on a mix of policies that both encourage market forces and government intervention in selectively key sectors. Each shaped its own economic future through a wide range of industrial policies – directed credit, subsidies, tariff and non-tariff barriers, and local-content and other requirements for foreign investors – that helped it develop new areas of economic competence. These polices resulted in economic growth that lifted hundreds of millions of people from abject poverty, and elevated some of them to the status of advanced economies in less than two generations.

Privatization versus public-private partnerships

At some point, governments that take on activities beyond those required to address market failures and externalities, become riddled with corruption and widespread inefficiencies. In desperation to save the situation, they consider involving the private sector, either through privatization of inefficient state-owned enterprises (SOEs) or through public-private partnerships (PPPs). Privatization involves the transfer of ownership and control to the private sector, while PPPs maintain public ownership and seek a collaborative approach with the private sector in some activities, including infrastructure development and service delivery. The choice between these approaches depends on the specific objectives of the government.

In essence, privatization and public-private partnerships (PPPs) are distinct approaches to involving the private sector. However, there are key differences between the two. Firstly, in privatization the government transfers ownership and control of a public asset or service to the private sector. The private entity becomes the sole owner and operator. Whereas, in a PPP the public sector retains ownership of the asset or service, while partnering with the private sector for its operation. Secondly, the primary objective of privatization is often to reduce government expenditure and improve efficiency. On the other hand, PPPs aim to leverage private sector expertise and resources while maintaining public sector influence to achieve specific public policy objectives. Thirdly, in privatization most risks are transferred to the private entity, which now would bear the responsibility for performance, financial, and operational risks whereas in PPPs risks are shared between the public and private sectors. This sharing of risk encourages collaboration and helps manage uncertainty. Fourthly, in privatization services are delivered solely by the private sector, with the goal of maximizing profit whereas in PPPs, services can be delivered by both public and private entities working together. And emphasis is achieving a balance between public and private interests.

South Africa’s weird circumstances

The economy of South Africa is mixed, and the government sector includes state-owned enterprises (SOEs) that are a large component of the economy. SOEs are a product of the ideological orientation of the governing party which is guided by the Freedom Charter adopted in 1955 by the Congress of the People which sought to nationalize what it considered to be strategic sectors -the mining industry, the banks, and the leading monopolies. Over the years the Freedom Charter became the guiding tool for the National Democratic Revolution (NDR) spearheaded by the Tripartite Alliance comprising the ANC, the SACP and COSATU whose aim is to control the strategic sectors of the economy via policies of cadre development, preferential procurement, among others.

Unfortunately, the policies adopted for spearheading the NDR were not entirely based on merit. As a result, they produced unintended results such as mismanagement, inefficiencies, and corruption in state entities. An American management consultant, Ed Ryan, provides some useful insights into why organizations, both public and private, fail to build a team of capable management. He says: “The reason why so few companies [or organizations] succeed in building a true ‘Dream Team’ is this: it’s been said that talent goes downhill. By that I mean, if you are a ten, you will hire a nine. The nine who is working for you will hire an eight. The eight hires a seven and down it goes. Inferior people work for superior people. But, for any company [or organization] to grow, it must be full of tens — people who are best at what they do in their area of expertise.”

Apparently, Ed Ryan’s observation aptly summarizes how the SOEs are staffed. First, the government itself that appoints chief executives of these enterprises is nowhere near being a ten. Because its decisions are crowded by political considerations, it is on the lower end of the talent hill. Suppose that by chance the government picks the right and ideal chief executive, something it occasionally does. The second problem is that the appointed chief executive is not given a chance to hire a nine to work under him/her either. All staff positions are filled up for him/her with people selected through a process riddled with political patronage, chicanery, nepotism, kickbacks and so forth. The criterion of picking those that are best at what they do in their area of expertise is rarely applied, save by accident.

Hence, problems at SOEs have been attributed to corruption and mismanagement by senior management in cahoots with political elites and gullible private actors. The government’s response had been to suspend senior management pending investigations and prosecution. In fact, there is a discernible pattern of events in state enterprises. The government, amidst pomp and fanfare, appoints chief executives with generally good credentials to run these enterprises. However, after a short period in office, on average two to three years, allegations of corruption and mismanagement emerge. The government responds by suspending senior management pending investigations and prosecution. Senior management contests the allegations in the courts. The investigations and the legal process drag on for several months or even years. Eventually, the suspended senior management are given golden handshakes as retrenchment packages. New senior management is appointed, and the process starts all over again. The result is that you never get a dream team to run an SOE or even just a semblance of it, but only something akin to a pyramid scheme. Hence there is generally management paralysis in most SOEs because the pyramid scheme has now reached unsustainable levels.

South Africa is experiencing state failure rather than market failure

Because of ill-conceived policies not grounded on merit, the state is now experiencing state failure to the extent that the private sector is intervening to save the state. This is a weird situation. The orthodox approach is for the state to intervene in private markets to prevent market failure as what happened during the Global Financial Crisis (2008 -2009) and the COVID-19 pandemic (2020 -2022).

Apparently, South African business justifies its intervention based on evidence and argues that they  have a responsibility to the country’s citizens to help. It refers to recent data from the Edelman Trust Barometer that found that 62% of South Africans trusted business more than the government. Furthermore, a recent Stats SA report, the 2022/23 Governance, Public Safety And Justice Survey, showed that citizens are using fewer government services now than they did in 2019/20. It found that, due to corruption, maladministration, and a lack of trust, they are requesting the private sector to perform services previously offered by the government.

The folly of delaying privatization

Despite privatization of inefficient SOEs in South Africa being ideologically considered taboo, eventually, it will be driven by push factors. The delay in embracing it will only serve to exacerbate SOEs being a very big fiscal burden, an albatross around the government’s neck. The burden manifests itself in poor, obsolete, and inefficient infrastructure. Eskom and Transnet are evident cases. Because they have borrowed heavily on the back of government guarantees, their creditworthiness is very low and so they cannot access cheap finance anymore and now survive on government bailouts. Because the government itself is struggling to meet its own obligations, it cannot help. At the same time, it does not want privatize the inefficient SOEs because of ideological reasons.

The folly of delaying privatization of inefficient SOEs is best exemplified by the experience of Zambia. The delayed privatization of Zambian copper mines provides a painful lesson that South Africa should learn from. By the time the Zambian government allowed the privatization to fully go through, the copper mines were in such a dilapidated state and insolvent that they fetched very little for the fiscus.

Recommendations for the way forward

The Government should come up with a coherent reform strategy for SOEs and the envisaged private sector involvement. The reform strategy should identify those SOEs that the state can retain control, those that should be privatized, and those which it can partner with the private sector in a public-private partnership arrangement. The present muddling along whereby the private sector is intervening to avert state failure is unsustainable.  In its dealing with the private sector, the government should take its cue from the late American economist Milton Friedman who aptly stated: “There is one and only social responsibility of business – to use its resources and to engage in activities designed to increase its profits as long as it stays within the rules of the game.” The rules of the game meant here are the external constraints imposed on managers by governments and society. The Government won’t go wrong if it embraces this cardinal principle.

Given that the Government is generally averse to privatization but amenable to PPPs, it is advised to note that the private sector would not want to share the burden of debts accumulated by SOEs. The private sector can only participate in PPPs not burdened by debt. Even one of the SOEs, the DBSA is indicating that it can only lend to Transnet when revenue streams are ring-fenced so that it can have its loans repaid.

Presently, PPPs are not working as desired. The largely insolvent Transnet’s experience is testimony to this as it is struggling to attract private sector participation. For PPPs to be successful, there are several conditions that must be satisfied. Firstly, well-defined goals and objectives are crucial for a successful PPP and not the ad hoc approach currently in place. Secondly, there should be a strong legal and regulatory framework to ensure accountability and dispute resolution. Thirdly, there should be an effective risk-sharing mechanism and allocation system between public and private entities. Presently, there is none and hence the failure of the few that has been tried, especially with Transnet. Fourthly, the government should recognize that the private sector will only be interested in projects that are financially viable. Fifthly, a competent governance structure and oversight mechanisms should be put in place for every PPP.

In conclusion South Africa is advised to come up with a comprehensive home-grown reform strategy of its SOEs. East Asian developmentalism offers an important lesson for South Africa. If dirigisme in South Africa focuses on creating a strong, inclusive domestic economy, it will do much good to address the country’s development challenges of high inequality, poverty and unemployment. Otherwise, it will do much harm to the rest of the economy and worsen the country’s development challenges.  

Lesetja Kganyago, Governor of the SA Reserve Bank (SARB), was exceptionally dovish at today’s (23 November 2023) Monetary Policy Committee (MPC) meeting, especially relative to his usual stance and relative to October’s CPI which came in at 5.9% year-on-year (y/y) relative to expectations of 5.6%.

While this could have provided a platform for the MPC to centre the discussion on the fight against inflation, the speech focused instead on the fact that while risks to inflation were substantial, monetary policy is restrictive, wage inflation is lower and the MPC will look through temporary price shocks and focus on second round effects – or core inflation. This is important given that the surprise to inflation is very much about first round effects and very product-specific price pressures, for example potato prices rose 64% y/y and eggs 24% y/y. These do not warrant a hike in interest rates. The meeting concluded that, barring any big shocks to core inflation, the SARB is comfortable with rates at 8.25%.

Interest rates are deemed sufficiently restrictive at present to guide inflation back to 4.5%. We expect that the SARB will start to cut rates in line with the US Federal Reserve Bank (Fed), in the first half of 2024. We doubt cuts will materialise ahead of the Fed, as this may negatively impact the value of the USD/ZAR. The governor explained that SA is forced to keep rates restrictive because of sovereign risks emanating from high levels of public debt, energy supply issues, high administrative prices and public sector wage inflation which is not in line with productivity. If these factors were resolved, rates could be structurally lower relative to inflation.

The governor provided useful insights into the GFECRA (Gold and Foreign Exchange Contingency Reserve Account). Profits on gold and foreign exchange reserves can be utilised by National Treasury either by selling the reserves or by keeping the reserves and printing money. It’s not often that a central banker utters the words “printing money” as a realistic option. In the event that the SARB prints money equating to a portion of the profits of SA’s gold and foreign exchange reserves, this would need to be sterilised, or drained from circulation. This would mean the SARB would pay interest at the repo rate.

The risk highlighted by the governor was that it would need to recoup that interest from National Treasury, which is already cash strapped. Consequently, the SARB is working with Treasury and international experts to find mechanisms would that entail dealing with “the capital position of the bank.” The mechanisms were described as “complicated”. The unrealised profits are estimated at R497bn. Essentially, borrowing at the repo rate would be cheap funding for the Treasury, but it should be seen as additional debt, not a “magic pot of gold at the SARB.”

The public brouhaha that has erupted over the alleged currency manipulation by banks in South Africa can be likened to making a mountain out of molehill. Similarly, the jugular reaction of the Minister in the Presidency, Khumbudzo Ntshavheni, blanketly blaming the private sector for the currency manipulation, is a typical case of burning the whole forest to kill one rabbit. Nevertheless, such reactions are understandable given that the foreign exchange market could be one of the least understood markets in functioning economies. The billionaire Warren Buffet once remarked: “The foreign exchange market is the most irrational market in the world”. It is a remark that underscores the challenges we face when we try to predict currency movements.

Currency manipulation

In the literature, currency manipulation is defined as the intentional efforts taken by a government or its central bank to influence the value of its own currency in the foreign exchange market. This is achieved through various ways, typically through buying or selling currencies, adjusting interest rates, or implementing trade policies. The objective for engaging in currency manipulation is to gain a competitive advantage in international trade. In one respect, through deliberate devaluing its currency, a country can make its exports cheaper and more attractive to foreign buyers, potentially boosting its trade surplus. In another respect, a country could seek to strengthen its currency to reduce the cost of imported goods and fight inflation.

Currency manipulation can distort trade balances and lead to tensions among nations. It was one of the causes of the Great Depression of 1930s when nations engaged in competitive devaluations. In other words, it was believed to have amplified the depression. To guard against the practice, the IMF and WTO have provisions that prohibit their members from the using currency manipulation to gain trade advantages.

The alleged transgressions by South African banks cannot be termed currency manipulation because it is a government or its central bank that has the capacity to engage in currency manipulation. At best the transgressions could be described as collusion pricing of currency for either individual traders’ benefit or institutional benefit. Given that the value of the rand in the foreign exchange market is market-determined, the actions of the banks could be interpreted in one of the following two ways. First, the banks might have formed a parallel or black foreign exchange market outside the official market for some of their clients whereby they set or fixed the exchange rate. Conducting a parallel foreign exchange market is considered as market abuse in most jurisdictions. Some jurisdictions go to the extent of arresting such traders. The second possibility could be that the banks were simply conducting ad hoc over-the-counter foreign exchange trading for some special customers whereby the exchange rate was negotiated outside the official foreign exchange market. Such practice happens in almost all markets. A customer receiving a large foreign receipt can negotiate a better exchange rate with his/her bank than the rate in the official foreign exchange market. It is a common banking with significant transactions, such as mergers, acquisitions, large export deals, or capital transactions. In these cases, collaboration between banks can lead to manipulating bids and offers in the market at a specific time. 

However, even in this common case, it is crucial to differentiate between short-term transaction flows and the broader economic fundamentals and global situations that influence the exchange rate over the long term. Moreover, most central banks worldwide – including South Africa – have mechanisms in place to counter such long-term actions and keep the exchange rate. Stable.

Currency speculation

Currency speculation is buying or selling currencies with the intention of making profit from misalignments in exchange rates. Currency speculators can be individual traders or institutions. There are three main types of techniques used in currency speculation. The first type is termed locational arbitrage which is possible when a bank’s buying price (bid price) is higher than another bank’s selling price (ask price) for the same currency. The second type is called triangular arbitrage which is possible when a cross exchange rate quote differs from the rate calculated from spot rates. The third type is covered interest arbitrage whichis the process of capitalizing on the interest rate differential between two countries, while covering exchange rate risk. Covered interest arbitrageis only possible when interest rate parity does not hold. When market forces cause interest rates and exchange rates to adjust such that covered interest arbitrage is no longer feasible, there is an equilibrium state called interest rate parity. Under such an equilibrium state, the forward rate will differ from the spot rate by an amount that is sufficient to offset the interest rate differential between two currencies under consideration.

When the foreign exchange market is efficient, market forces would eliminate short-term possibilities of currency arbitrage. Hence, currency speculation is not a sustainable profitable activity. In an efficient market, the possibility of making profit from currency speculation is quickly eliminated. A notable case of currency speculation happened in the UK in 1992 spearheaded by George Soros who used his hedge fund, Quantum Fund, to borrow billions of pounds from various banks and sell them for other currencies, such as U.S. dollars, German marks, and other currencies. This action by the hedge fund created a huge demand for other currencies and a huge supply of pounds, which drove down the value of the pound in the market. The gamble George Soros took was that the pound would eventually be devalued because there was a limit to how much pain the government was prepared to inflict on its own people. Indeed, the Bank of England pound devalued the pound following a US$22 billion intervention in the foreign exchange market and the UK government withdrew sterling from the European Exchange Rate Mechanism on 16 September 1992. It was a day remembered as Black Wednesday, and George Soros became reputed for “breaking the Bank of England. It was reported that he could have made a US$1 billion profit from that speculative activity.

The impact of alleged case of South African banks

There have been allegations that the actions of the banks caused depreciation of the rand and loss of jobs. Unfortunately, such allegations are not supported by evidence. When we examine the performance of the rand during the period 2007 to 2013 when the banks are reported to have undertaken these activities, we find a different story. As illustrated in Figure 1 below, the dollar/rand exchange rate was relatively stable over this period. In fact, the rand appreciated against the dollar between 2009 and 2011 and only started to depreciate after 2013. On the other hand, the rand/dollar purchasing power parity was stable from 2000 to 2016.

Figure 1: Rand/Dollar Exchange Rate

The National Treasury has also argued that the alleged actions of banks to manipulate the dollar-rand exchange from 2007 to 2013 were not the main cause of the local currency depreciation its value over the past decade, or tepid economic growth. Rather, it attributes the currency depreciation to problems such as Eskom blackouts and the Transnet logistics challenges.

Promoting foreign exchange literacy

Ironically, people living in countries with underdeveloped and inefficient foreign exchange markets have a better understanding of workings of the exchange rate than those living in countries with well developed and efficient foreign exchange markets such as South Africa and developed economies. Most countries north of South Africa do not have flexible exchange rate regimes. As a result, they all have thriving parallel foreign exchange markets operated by informal traders. In fact, informal currency trading is a significant form of employment. I am personally reminded of an encounter when I was in the Gambia in 1993. I wanted to change currency but when I arrived at the bank, I found it closed. However, at the closed door of the bank, there was a young man with bag who told me that he can serve me with even a better rate.

The point I am trying to put through is that adversity has made people in underdeveloped markets to acquire foreign exchange literacy. They did not need to study international finance at university as I did. Perhaps the ignorance of the workings of the exchange rate we see around us is simply because we have not experienced adversity.