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Rand peg still beneficial

Thu, 14 January 2016 23:41
by Suta Kavari
News Flash

By Suta Kavari, Capricorn Asset Management

The South African rand’s depreciation of late has largely been due to a combination of a strengthening dollar, weak commodity prices, and expectations of rising interest rates in the United States and South Africa’s poor economic fundamentals.

The rand has had many weakening cycles but has usually tended to return to some reasonable level. The main negative for the rand remains the current account deficit.

The renewed recovery in the US economy has driven the dollar stronger, thus pushing the rand weaker. South Africa’s commodity export prices have also declined considerably in US dollar terms, leading to significant rand weakening. Domestic issues in South Africa have also not helped the currency.

While there’s been talk of ‘de-pegging’ from the rand due, in large part, to the rand’s recent and sharp depreciation, I hold the view that the benefits derived from our continued peg arrangement far outweigh the disadvantages.

The rand, like many global currencies, undergo periods of strengthening and weakening. It is also important to note that the rand is a commodity currency, which means that when prices and demand for commodities fall the currency tends to weaken.

The decision to peg the Namibia dollar to the South African rand was taken in light of the two countries long and close economic relationship, and was the most effective currency regime under the prevailing conditions at the time.

For a small open economy like Namibia, a free floating currency regime offers limited protection against speculative attacks on the currency and subsequent financial instability.

One of the biggest benefits of the peg arrangement is that it provides the domestic economy with price stability and predictability.

By pegging to a relatively low-inflation country like South Africa, Namibia imports low inflation and the ability to maintain price stability is enhanced. The inflation targeting monetary policy of the South African Reserve Bank enjoys high credibility intentionally. Together with price stability the peg arrangement also enhances fiscal prudency to a degree, reduces monetary disturbances and promotes credibility which increase investor confidence in the local economy, which bodes well for economic growth.

Another benefit is the free flow of capital between Namibia and South Africa, provides wider access to financial markets for local savers and investors.

Furthermore, the peg provides a mechanism for automatic stabilization of money supply, which enhances financial stability to a great extent.

Importantly, the peg to the rand reduces the unfavorable effects of currency fluctuations, because Namibia is a net importer of goods and services from South Africa and South Africa is Namibia’s biggest trading partner. Therefore any alternative currency regime will be dominated by the rand in any case.

The reality is that Namibia is quite small in the global context. Stocks of foreign exchange reserves are too low to protect a free floating currency.

It is difficult to say whether an independent Namibia dollar would be weaker or stronger than the rand. An independent Namibia dollar will be very volatile and unpredictable, especially now, given the global market movements and the openness of the local economy and dependence on commodities.

The economic situation in South Africa is ‘bad’, but not so bad that Namibia should seriously consider de-pegging from the rand. Even if the Namibian dollar was to de-peg, the currency would still undergo periods of depreciation and shocks like any currency.