Abstract
Selected Issues
Rand Volatility: Does it Matter?1
A. Introduction
1. The South African rand has been relatively volatile as the currency has flexibly responded to domestic and external disturbances. Domestic shocks have been relatively large in recent years, elevating rand volatility to above the VIX (US stock price volatility, a commonly used indicator of global risk appetite). External shocks have also had important transmission channels––the rand is traded globally in large volumes, sometimes as a currency that proxies emerging market (EM) risks, and nonresident investors hold large shares of local assets.
2. The exchange rate regime, consistent with the SARB’s successful inflation targeting, has served the country well as a main mechanism to absorb shocks. There are a number of factors that mitigate the impact of rand movements on the economy. The large and sound domestic financial sector can provide a buffer. The low share of foreign currency-denominated and long maturities of public debt limits the economy’s vulnerability to exchange rate risk. Further, the share of overall external debt denominated in foreign currency is not too large by international standards. Moreover, the consequent rand volatility has worked as a signaling mechanism of economic developments.
3. Against this backdrop, this note quantitatively analyzes the impact of rand volatility on domestic corporate investment and cross-border portfolio investment. Private investment is critically needed to boost South Africa’s anemic growth. One view is that domestic corporates are accustomed to large rand volatility, which is consistent with the ostensible absence of major corporate distress events due to rand movements. However, survey results in South Africa warn that rand volatility prevents firms, particularly small and medium-sized enterprises (SMEs), from embarking in long-term investments (RMB Global Market Research and National Treasury, 2015).
4. The main findings of this analysis continue to support staff’s view that the policy tradeoffs related to a volatile rand are limited, even though SMEs suffer more. Rand volatility has some impact on investment for SMEs, and cross-border capital inflows. But these effects are generally relatively small, economically. To alleviate the potential negative impact of rand volatility on investment by SMEs, which are the most affected, greater policy certainty and bank competition would reduce rand volatility and the cost of hedging for exchange rate risk.
5. The rest of the note is structured as follows. Section B reviews the stylized facts about rand volatility. Section C discusses South Africa’ resilience to relatively large rand volatility. Section D econometrically analyzes the potential impact of rand volatility on private investment. Section E concludes.
B. Stylized Facts about Rand Volatility
6. The rand has been relatively volatile. In nominal effective terms and in terms of the absolute size of monthly movements, the rand is one of the most volatile currencies within the group of advanced economies (AE) and EMs (Figure 1, left panel). Its performance is comparable to that of the Brazilian real and Turkish lira. The Russian ruble and Argentine peso have registered even larger degrees of movement, but most other currencies have been less volatile. Central banks in some of the countries mentioned intervene in foreign exchange (FX) markets, in the absence of which volatility of their currencies would have been higher. Historically, the rand weakened more than 70 percent year on year against the dollar in the mid-1980s when a debt standstill took place.2 In the 2000s, the currency pair weakened around 40–50 percent year on year in 2001, 2008 and 2015 (right panel).3
South Africa: Indicators of Rand Performance
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Haver and IMF staff calculations.South Africa: Indicators of Rand Performance
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Haver and IMF staff calculations.South Africa: Indicators of Rand Performance
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Haver and IMF staff calculations.7. Rand volatility has been determined by market forces since 2003. The left panel of Figure 2 illustrates the evolution of the SARB’s foreign exchange policy. The blue line represents the SARB’s forward position as a share of GDP, inverted, and plotted on the left scale. The forward position was short until 2003, indicating that the SARB sold dollars and swapped the short dollar positions into forwards. The stock of short positions was sizable, up to 20 percent of GDP through the late-1990s. After the adoption of inflation targeting, much of the short forward positions declined. Gross official reserves (red line) increased gradually, likely as the SARB bought foreign inflows opportunistically. The right panel illustrates that South Africa has used the rand, rather than official reserves, to absorb shocks––the volatility of the rand is relatively high, while that of official reserves relative to M1 is one of the lowest among EMs.
South Africa: Indicators of SARB’s Foreign Exchange Policy
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Haver and IMF staff calculations.South Africa: Indicators of SARB’s Foreign Exchange Policy
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Haver and IMF staff calculations.South Africa: Indicators of SARB’s Foreign Exchange Policy
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Haver and IMF staff calculations.8. Rand volatility is relatively high reflecting domestic and external disturbances given its major role as a shock absorber:
Domestically, policy and political uncertainty have tended to increase rand volatility at least in the past several years. In Figure 3, the red and gray lines show the volatility of the rand against the US dollar implied by the pricing of option contracts, and the VIX, a similar index for US stock prices, often used as an indicator of global investors’ risk appetite. Rand volatility lied below the VIX until the early-2015. Following an increase in policy and political uncertainty since the late-2015, rand volatility rose and stayed above the VIX much of 2016 and 2017. Since then, the two lines have been changing positions relative to each other.
The rand is also subject to external shocks, at least through two important channels. Rand volatility generally co-moves with the VIX, confirming the importance of external drivers (Maveé et al, 2016). First, the rand trades in large volumes globally. Compared to major EMs, South Africa’s daily currency turnover in global markets scaled by official reserves is by far the highest as the rand is traded as EM proxy (Figure 4, left panel). Second, nonresident holdings of local assets are large in South Africa (right panel). This could increase the impact of a given external shock—discussions with market participants suggested that some nonresident investors tend to trade South Africa’s local bonds based mainly on changes in global conditions.
South Africa: Implied Volatility of Rand-US Dollar Currency Pair and US Stocks
(Percent)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and CBOE.South Africa: Implied Volatility of Rand-US Dollar Currency Pair and US Stocks
(Percent)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and CBOE.South Africa: Implied Volatility of Rand-US Dollar Currency Pair and US Stocks
(Percent)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and CBOE.
South Africa: Key Transmission Channels of External Shocks
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Key Transmission Channels of External Shocks
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Key Transmission Channels of External Shocks
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.9. Historically, high rand volatility has been accompanied by rand depreciation. Generally, asset prices tend to fall abruptly and increase uncertainty and risk premium. This linkage is particularly shown in the rand exchange rate against the US dollar (Figure 5). The x-axis represents rand performance––from large rand depreciation on the extreme left to mild depreciation as one moves to the right, and large appreciation on the extreme right. The y-axis represents the percent share of total observations. The blue line, which shows the distribution of rand performance without conditioning on rand volatility, is broadly bell-shaped, that is, moderate appreciation and depreciation take place more often than more extreme appreciation and depreciation. The red line plots the distribution of rand performance by sampling the data only when rand volatility is relatively high (one standard deviation or more away from the historical average). The red line is upward slowing to the left, suggesting that, relatively high rand volatility tends to be accompanied by relatively large rand depreciation.
South Africa: Distribution of Rand Performance
(Percent, daily rand-US dollar data, January 2000–February 2019)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and IMF staff calculations.Note: High rand volatility refers to three-month rand-dollar volatility implied by option pricing being one standard deviation (std) or more above the mean. Daily rand performance relative to HP trend.South Africa: Distribution of Rand Performance
(Percent, daily rand-US dollar data, January 2000–February 2019)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and IMF staff calculations.Note: High rand volatility refers to three-month rand-dollar volatility implied by option pricing being one standard deviation (std) or more above the mean. Daily rand performance relative to HP trend.South Africa: Distribution of Rand Performance
(Percent, daily rand-US dollar data, January 2000–February 2019)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and IMF staff calculations.Note: High rand volatility refers to three-month rand-dollar volatility implied by option pricing being one standard deviation (std) or more above the mean. Daily rand performance relative to HP trend.C. South Africa’s Resilience to Rand Volatility and Depreciation
10. The economy’s favorable balance sheet composition makes South Africa less susceptible to rand volatility. Figure 6 shows that FX debt as a share of GDP in South Africa is intermediate compared to other EMs. This could limit concerns about FX mismatches in the domestic economy. The effective extent of FX mismatches depends on natural and financial hedges. While the extent of hedging is difficult to measure, it is a fact that SOEs are mandated to hedge and large corporates that borrow in FX tend to have natural hedges, or FX revenues. Moreover, survey results indicate corporates, including some SMEs, tend to hedge exchange rate risk (Rand Global Markets Research and National Treasury, 2015).
South Africa: Foreign Currency Denominated Debt
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and IMF staff calculations.South Africa: Foreign Currency Denominated Debt
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and IMF staff calculations.South Africa: Foreign Currency Denominated Debt
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: Bloomberg and IMF staff calculations.11. The fiscal sector does not appear to be vulnerable to rand movement. Figure 7 shows that the level of public debt is not very sensitive to rand performance. For instance, historically a 10 percent rand movement in year-on-year terms would change the debt-to-GDP ratio by 0.4 percentage points. This is mainly because South Africa’s debt is in large part denominated in rand. Moreover, long average maturities help reduce pressures from rollovers, particularly when the rand value of FX bonds increases due to rand depreciation. Fiscal revenue and expenditure are mainly in the local currency.
South Africa: Fiscal Sector Characteristics
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Fiscal Sector Characteristics
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Fiscal Sector Characteristics
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.12. The banking system is resilient to rand movements. The left panel of Figure 8 shows South African banks borrow and lend mainly in rand, thus, they are little affected by rand movements. In addition, the impact of any adverse shock would be absorbed by strong bank balance sheet conditions-the right panel shows that domestic banks are well capitalized, profitable, and their NPLs are relatively low, thus representing strong buffers to absorb shocks.
South Africa: Financial Sector Characteristics
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Financial Sector Characteristics
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Financial Sector Characteristics
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.13. The system-wide picture masks significant diversity among banks. For instance, some small banks have relatively high FX debt as a share of total assets (Figure 9). This reflects their business models, which make their equity holdings high relative to total assets. Yet large FX movements could put those banks under pressure. In isolation these banks are small, but if negatively affected, the broader banking system could suffer through confidence effects.
South Africa: Selected Balance Sheet Items of South African Banks
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: SARB BA900 lines 38 and 63, and IMF staff.South Africa: Selected Balance Sheet Items of South African Banks
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: SARB BA900 lines 38 and 63, and IMF staff.South Africa: Selected Balance Sheet Items of South African Banks
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: SARB BA900 lines 38 and 63, and IMF staff.14. The pass-through of exchange rate depreciation and volatility to inflation is small. Kabundi and Mlachila (2019) suggest that the exchange rate pass-through to headline inflation in South Africa declined from around 50 percent in the late-1990s to 20–25 percent in more recent years owing largely to improved central bank credibility. This degree of exchange rate pass-through is comparable to other EMs, gauging from cross-country results discussed by Carstens (2019), even though the two sets of estimates are based on different approaches. Forbes et al (2017) find South Africa’s pass-through fell from 15 percent in 2004–09 to 6 percent, one of the lowest across its peers, in 2010–15. Staff analysis shows that the pass-through of rand volatility to inflation is relatively small (Miyajima, 2019).
15. The large domestic investor base represents another source of resilience. South Africa’s local investor base as a share of GDP is one of the largest in EMs and has tended to reduce asset price volatility by buying local assets when their valuation became more attractive and vice-versa (Figure 10). A large local investor base works as a shock absorber to rand volatility.
South Africa: Domestic Investor Base
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Domestic Investor Base
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Domestic Investor Base
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.D. Impact of Rand Volatility on Private Investment
16. There are at least two channels through which rand volatility and depreciation could affect private investment. First, higher volatility generally increases uncertainty and the risk premium, discouraging firms from investing—particularly those sensitive to uncertainty. Indeed, exchange rate volatility, including rand volatility specifically, is found to be a key deterrent to FDI (Hanusch et al, 2018; Rand Global Markets Research and National Treasury, 2015). Second, higher currency volatility and depreciation would have negative effects in the presence of currency mismatches in investors’ balance sheets, reducing resources available for investment. These impacts could be larger for SMEs than for large firms, to the extent that SMEs are more financially constrained and have less access to natural and financial hedging on currency risk.
17. Two different sets of private investment are considered for this analysis. First, we look at domestic firm-level capital expenditure. The micro-level data would allow us to assume sector-level sensitivity shocks and identify heterogeneous response depending on firm size. For instance, the results would provide useful information with respect to SMEs. Second, we also look at non-resident portfolio investment. High-frequency data would allow us to capture important market reactions which could be lacking in low frequency data. What we do here relates to the literature on the impact of currency movements on economic growth, including Fowkes, Loewald and Marinkov (2016).
Capital Stock
18. The impact of rand volatility on capital stock accumulation is estimated using firm-level data at the 3-digit SIC level. The data include a wide spectrum of 704 listed firms in South Africa for 2000–17 from the Worldscope dataset. The left panel of Figure 11 shows the distribution of firms by size, with its long-left tail implying the inclusion of SMEs.4 The analysis focuses on the heterogenous responses of firm investment to rand volatility, depending on their intrinsic sensitivity to uncertainty. To do that, we use an index of sector-level sensitivity to uncertainty estimated from US firms, which allows us to address the endogeneity issues in measuring sensitivity to uncertainty. The right panel shows the distribution of firms in South Africa data by sensitivity to uncertainty.5 The distributions of mining and manufacturing firms are located more to the right, reflecting greater sensitivity to uncertainty, compared to those of services and finance.
South Africa: Firm Distribution by Size and Sensitivity to Uncertainty
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Firm Distribution by Size and Sensitivity to Uncertainty
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Firm Distribution by Size and Sensitivity to Uncertainty
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.19. The results suggest that higher rand volatility reduces SME investment. In Table 1, we look at how the interaction of sensitivity to uncertainty with rand volatility affects firm-level capital stock accumulation.6 We first look at the whole sample of firms (column 1), and then we further split the sample into SMEs (Column 2) and large firms (Column 3). The overall pattern, as illustrated in Figure 12, is that rand volatility significantly reduces investment of SMEs but has little impact on investment of large firms. The results are consistent with the IMF team’s finding that policy uncertainty limits private investment and growth.7 The economic impact can be considered relatively large for SMEs. For an SME with relatively large sensitivity to uncertainty (at the 90 percent threshold of sensitivity to uncertainty shocks, 0.046), a relatively large increase in rand volatility (inter-quartile increase of rand volatility, 0.6), leads to a decline in the ratio of capital stock to assets by 1 percentage point. This is relatively large compared to the variation in the data (the inter-quartile change of the capital/asset ratio is 3.4 percentage points). This could underestimate the negative impact on SMEs’ investment if smaller SMEs not captured in the database are more averse to uncertainty.
South Africa: Rand Volatility and Firm Investment
(By Firm size)
South Africa: Rand Volatility and Firm Investment
(By Firm size)
| All firms | Small/Medium firm | Large firm | |
|---|---|---|---|
| Rand volatility * sensitivity to uncertainty | -0.31** [0.15] | -0.66*** [0.26] | 0.054 [0.17] |
| Firm fixed effects | Yes | Yes | Yes |
| Year fixed effects | Yes | yes | Yes |
| Observations | 5708 | 2,948 | 2760 |
| Number of firms | 704 | 429 | 275 |
| R-squared | 0.02 | 0.02 | 0.02 |
South Africa: Rand Volatility and Firm Investment
(By Firm size)
| All firms | Small/Medium firm | Large firm | |
|---|---|---|---|
| Rand volatility * sensitivity to uncertainty | -0.31** [0.15] | -0.66*** [0.26] | 0.054 [0.17] |
| Firm fixed effects | Yes | Yes | Yes |
| Year fixed effects | Yes | yes | Yes |
| Observations | 5708 | 2,948 | 2760 |
| Number of firms | 704 | 429 | 275 |
| R-squared | 0.02 | 0.02 | 0.02 |
South Africa: Impact of Rand Volatility on Firm Investment
(Coefficient on term “rand vol >; sensitivity to uncertainty)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Impact of Rand Volatility on Firm Investment
(Coefficient on term “rand vol >; sensitivity to uncertainty)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Impact of Rand Volatility on Firm Investment
(Coefficient on term “rand vol >; sensitivity to uncertainty)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.Cross-Border Capital Flows
20. Next, we examine the impact of rand volatility on cross-border portfolio investment flows into South Africa. Portfolio inflows are important for South Africa. The left chart of Figure 13 shows that portfolio investment, the yellow bars, was historically an important source of current account financing. The role of portfolio investment declined as nonresident investor sold local bonds and equities during much of 2018. We use net nonresident purchases (weekly flow data) from January 2000 to April 2019 (in billions of rand) in the econometric analysis. The right panel gives a visual impression of such flows in cumulative terms since January 2000. The green line represents total flows, and the red and blue lines are subcomponents, equities and bonds, respectively. Total flows started to stagnate in 2013–14. Since early-2018, South Africa has lost $15 billion dollars’ worth of net portfolio flows. As for the model, flows are regressed on rand depreciation in percent change, lagged by one week, and rand volatility (the standard deviation of the percent change of US dollar-rand pair over the past four weeks).
South Africa: Impact of Rand Volatility on Net Portfolio Inflows
(Estimated coefficient)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Impact of Rand Volatility on Net Portfolio Inflows
(Estimated coefficient)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.South Africa: Impact of Rand Volatility on Net Portfolio Inflows
(Estimated coefficient)
Citation: IMF Staff Country Reports 2020, 034; 10.5089/9781513528519.002.A002
Sources: BIS, Haver, and IMF staff calculations.21. Results show that uncertainty (captured by rand volatility) negatively affects equity flows, consistent with our hypothesis. Figure 13 shows that higher rand volatility significantly (statistically) reduces total portfolio net inflows (see also Column 1 of Table 2). The reduction in portfolio inflows is mostly driven by the decline of equity inflows, and to a lesser extent by bond inflows (Columns 2 and 3 of Table 2). This is because rand volatility increases the volatility of firm profits and stock returns, and hence increases the risk premium and reduces the demand for equities. By contrast, bond holders, receiving fixed income, are less subject to volatility of firm operations, and instead worry more about defaults on their debt liabilities. In terms of economic significance, the impact of rand volatility on equity flows does not appear large, suggesting that many factors are at play in affecting equity flows. Faced with relatively large rand volatility (an interquartile increase of rand volatility of 0.5), equity flows would fall by R250 million. This is relatively small compared to several different benchmarks––one standard deviation of weekly net equity flows is 10 times larger, or R2.4 billion; over the past year, R4 billion worth of net portfolio flows left the country every week, on average; and the SARB’s international reserve holdings are at more than R700 billion.
South Africa: Rand Volatility and Portfolio Inflow
South Africa: Rand Volatility and Portfolio Inflow
| VARIABLES | (1) total inflow | (2) equity inflow | (3) bond inflow |
|---|---|---|---|
| % change of rand (lag) | -19.3*** [5.34] | -2.82 [3.24] | -16.5*** [4.06] |
| rand volatility | -0.51* [0.28] | -0.51*** [0.17] | 0.001 [0.21] |
| Constant | 0.81** [0.32] | 0.58*** [0.19] | 0.22 [0.24] |
| Observations | 1,153 | 1,153 | 1,153 |
| R-squared | 0.014 | 0.009 | 0.014 |
South Africa: Rand Volatility and Portfolio Inflow
| VARIABLES | (1) total inflow | (2) equity inflow | (3) bond inflow |
|---|---|---|---|
| % change of rand (lag) | -19.3*** [5.34] | -2.82 [3.24] | -16.5*** [4.06] |
| rand volatility | -0.51* [0.28] | -0.51*** [0.17] | 0.001 [0.21] |
| Constant | 0.81** [0.32] | 0.58*** [0.19] | 0.22 [0.24] |
| Observations | 1,153 | 1,153 | 1,153 |
| R-squared | 0.014 | 0.009 | 0.014 |
E. Conclusion
22. Findings of this study suggest that rand volatility tends to have limited policy tradeoffs, even though SMEs tend to be adversely affected. The impact of rand volatility on economic indicators such as firm investment and portfolio flows is relatively small. However, there are some subsectors that are more vulnerable to rand volatility than others, such as SMEs. To reduce rand volatility affecting investment in these sectors, greater policy certainty is needed. This could be achieved by clearer communication of the policy agenda and the decisive implementation of announced measures. In doing so, it is critical to avoid measures that could negatively affect private investment and economic growth. Lower risk premium, in terms of inflation and sovereign, would reduce interest rate differentials with trading partners and the attendant premium for hedging against expected rand depreciation. While advancing these reforms, it would be crucial to maintain the SARB’s policy of allowing the rand to freely absorb shocks while preserving its international reserve buffers—a regime that has served South Africa very well.
References
Carstens, Agustín. 2019. “Exchange rates and monetary policy frameworks in emerging market economies.” Bank for International Settlements General Manager’s Lecture at London School of Economics, 2 May 2019.
Forbes, Kristin, Ida Hjortsoe, and Tsvetelina Nenova. 2017. “Shocks versus structure: explaining differences in exchange rate pass-through across countries and time.” Bank of England Discussion Paper No. 50.
Fowkes, David, Chris Loewald, and Marina Marinkov. 2016. “Inflating our troubles: South Africa’s economic performance and the exchange rate”, Economic Research Southern Africa (ERSA) Policy Paper 22.
Hanusch, Marek, Ha Nguyen, and Yashvir Algu. 2018. “Exchange rate volatility and FDI inflows: Evidence from cross-country panel data,” World Bank Macroeconomics, Trade, and Investment (MTI) Discussion Paper 2.
Kabundi, Alain, and Montfort Mlachila. 2019. “The role of monetary policy credibility in explaining the decline in exchange rate pass-through in South Africa.” Economic Modelling. 79, 173–85.
Maveé, Nasha, Roberto Perrelli, and Axel Schimmelpfennig. 2016. “Surprise, surprise: What drives the rand / U.S. dollar exchange rate volatility?” IMF Working Paper 16/205.
Miyajima, K. 2019. “Exchange Rate Volatility and Pass-Through to Inflation,” IMF Working Paper No. 19/277.
RMB Global Markets Research and National Treasury. 2015. Currency risk and risk management in South Africa.
Tong, Hui and Shang-Jin Wei. 2019. “Endogenous Corporate Leverage Response to a Safer Macro Environment: The Case of Foreign Exchange Reserve Accumulation”, NBER Working Paper No. 26545.
Prepared by Ken Miyajima and Hui Tong; reviewed by Ana Lucía Coronel.
Debt standstill is a mechanism by which a country agrees to cease payments on its debts until a restructuring agreement has been negotiated with its creditors.
South Africa witnessed several bouts of large currency depreciation and capital outflows in the past: the mid-1980s (a debt standstill; Harris, 1986), 1998, 2001 (Bhundia and Ricci, 2005), the global financial crisis (GFC) in 2008, and the removal of the finance minister in 2015. Capital flight is estimated to have been worth 15–20 percent of GDP in the early-1980s and up to 15 percent of GDP in the late-1990s (Mohamed and Finnoff, 2004).
We use the median value of firm size in the sample to separate SMEs from large firms.
To construct the index, we follow Tong and Wei (2019) and take three steps as below. First, we regress each US stock’s daily returns onto the daily VIX index for 2000–06. Second, the firm-level sensitivity to uncertainty is defined as the negative value of the coefficient for the uncertainty index. Finally, for each 3-digit SIC sector, we define the sector-level intrinsic sensitivity to uncertainty by the median value of the firm-level sensitivity within the sector. This uncertainty-index is assumed to vary mostly due to technological reasons, such as the sector’s intrinsic sensitivity to the volatility of the economy through the input-output linkages.
Rand volatility is measured as the volatility of the daily percent change in dollar-rand currency pair for each year. Capital stock is expressed relative to total assets.
This pattern also confirms the earlier findings by Fowkes, Loewald and Marinkov (2016) that rand volatility has limited impact on the growth of large firms.
