South African Economy

From the days of Apartheid, to the times of today, South Africa has relied on foreign capital inflow for the purpose of sustaining high levels of growth through investment in the various sectors of the country. This great reliance on foreign investment has made South Africa vulnerable to fluctuations in the exchange rate and other global conditions. This essay will discuss the extent to which South Africa is reliant on foreign capital, reasons why this is so and the nature of these inflows.Exchange rate issues will also be discussed, with detail of how South Africa combated these issues in the various years that they arouse. Finally, methods on how South Africa can reduce its vulnerability to such fluctuations will be made apparent. South Africa’s reliance on foreign capital inflow After the end of The Apartheid era and the abolishment of all laws that were associated with the era, the various international sanctions and bands that were put on South Africa were lifted. This al lowed numerous countries to begin investing in South Africa.These foreign capital inflows were greatly needed by the South African economy as the new government had the following economic goals: â€Å"Attract foreign capital, reduce the large role of government as government owns half the countries fixed capital assets and facilitate gradual restructuring of industry along globally competitive lines† (Germishuis, 1999: 2). The two latter goals could only be achieved through proper financing for the government. During the 1994 era, domestically raised capital could not be used for the financing of local investment initiatives that promote economic growth.As Mohr (2003: 2) states, â€Å"Between January 1990 and June 1994, there was a steady net outflow of capital not related to reserves of almost R27 billion, partly as a result of repayments of foreign debt emanating from the 1985 debt standstill arrangement†. This effectively meant that South Africa had very little fund s available for boosting the investment industry which in turn helps with the sustainability of high levels of economic growth. Due to these foreign debt payments by domestic funds, South Africa heavily relies on foreign capital inflows for high levels of investment.Since the government was obviously aware of this situation, various policies and acts were put into action to attract foreign investment. â€Å"In 1997, South Africa managed to attract a net capital inflow of $3. 58 billion (3. 4 percent of GDP), more than seven times the $478 million invested in 1996. The inflow was predominantly long-term private capital, moving into stock and bond markets†(Germishuim, 1999: 1). Though the government was successful in attracting foreign capital inflows, a decrease in the domestic interest rate is eminent when capital inflows are high. From 1994 to 1999, net capital inflows in South Africa were on a steady rise for 3% of GDP in 1994 to a staggering 6. 5% of GDP in 1999† (Mo hamed, 2004: 28). Between 2000 and 2002, capital inflows fell to -2% of GDP. This was due to South Africa currency crisis in 2001 that led to high levels of capital flight in the country. After the new millennium, capital inflows in South Africa began to steadily rise and are now ranging between 4 and 7% of GDP. Exchange rate crisis of 1998 In 1997, East Asia experienced an exchange rate crisis. It is said that these countries were victims of their own success. Their very success led foreign investors to underestimate their underlying economic weaknesses†(IMF, 1998: 1). Because of large capital inflows that these economies enjoyed, there was increased demand for policies that protect the financial sector and institutions struggled to keep up with the demand. Since Asia is probably the largest exporter of goods in the world, a financial crisis in that region will evidently cause a ripple effect that will cause a global financial crisis. This Asia crisis added to what South Afri ca would have experienced the following year.In 1998, the South African currency dwelled into great depreciation. Causes of this crisis include: * Commodity prices * After the Asian financial crisis, the global demand for commodities had weakened, putting downward pressure on market prices of SA commodities. This meant a flight to safer havens such as United States commodities occurred. * Foreign Exchange Market intervention * In 1998 and 1996 as well, the South African Reserve Bank had heavily intervened in the foreign exchange market. These ventures resulted in net losses of $10 billion (8% GDP) and $14 billion (10% GDP) respectively.The capital for these ventures was acquired in the forward market, thus compromising SARB’s Net Open Forward position. * Mboweni Bump * 1998 saw the end term for the Governor of the Reserve Bank. The potential that Tito Mboweni might have left the position created doubt for South Africa and the Rand. (Saayman, 2007:1) To try and counter this cu rrency depreciation, the Reserve Bank believed that this depreciation was a temporary reaction to rumours of divisions within the government so they sold off massive amount of its foreign reserves (Diamond, Manning, Vasquez and Whitaker, 2003: 2).The Asia crisis, coupled by SA’s own currency issues led the exchange rate crisis. â€Å"The authorities reacted by intervention in reserves and then through raising of interest rates to stimulate growth. The policies implemented in 1998 did not solve the crisis but merely slowed down the process and created a false image. Yes the country did benefit through an increase in investment due to higher interest rates but paid the cost when the country was hit by another exchange rate crisis in 2001.The economy had to deal with the costs of increased debt, decreased capital inflows, which retards growth in the country. Exchange rate crisis of 2001 The Rand depreciated by 26% in nominal terms against the dollar in 2001 between September an d December. It is suggested that, â€Å"there was an acceleration in money growth in the summer of 2001, suggesting that the depreciation may have been a case of exchange rate overshooting† (Bhundia and Ricci, 2004: 1). Though this was the case, the South African Reserve Bank did not intervene or raise interest rates this time around (as was the case in 1998).Bhundia and Ricci (2004: 7-11) identify the following as probable cause of the 2001 financial crisis: * Delays in privatising Telkom * The SA government had announced that the privatisation of Telkom will happen in 2001 but this did not happen due to weakening global stock markets. This had a negative effect as it created doubt within the financial market of SA’s commitment to economic reform. * South African Reserve Bank’s Net open forward book * â€Å"The SARB’s forward book contained large short term liabilities.These low reserve adequacies have been found to increase the probability of exchange rate pressure (Bhundia and Ricci ,2004: 7). The forward book received from the Apartheid government was rather large and despite repayments made, the book remained huge. * Tightening of existing capital controls * The South African Reserve Bank announced on the 14th October 2001 that there would be a tightening of exchange rate controls. It was argued that, â€Å"this announcement reduced market liquidity and thereby contributed to the sharp rand depreciation† (Bhundia and Ricci, 2004: 8).Though market data cannot confirm this for sure, these actions and the time they were taken have an effect on the crisis of the time In 2001, the SA government and SARB decided to act differently than it did in 1998. The increase in interest rates of 1998 had limited effects on reducing depreciation and was seen to be costly for growth and investment. South Africa was less likely to be affected by fluctuations in the exchange rate as it did not hold large foreign currency.The South African g overnment decided not to intervene in interest rate percentages and reserve ratios. â€Å"The South African government have admitted that the 1998 intervention policy was inappropriate. When 2001 arrived, the intervention policy of 1998 was not used and that showed to be a very successful strategy as the macroeconomic reactions of the crisis were very few and over the next few years, the rand strengthened†(Bhundia and Ricci , 2004: 17). There was a large improvement in macroeconomic framework (policy), which made policy credibility stronger.The forward book that was utilised in 1998 was also abolished. â€Å"Also, the adoption of an inflation- targeting framework successfully provided a more credible nominal anchor for exchange rate expectations† (Bhundia and Ricci, 2004: 18). So effectively, the policy reactions of 2001 were more successful. Reduction of SA’s vulnerability to external shock SA is the economic powerhouse in Africa and hence needs measures that h elp reduce the effects of external shocks such as global financial crises.For this reduction to occur, certain conditions such as, â€Å"peace and security, quality institutions, infrastructure and support for the private sector must be in place† (UNECA, 2010: 11). With the above in place, South Africa should try and implement the following: * Provide sufficient policy space, so that policymakers can handle the shocks that are externally generated. * Improve the mobilization of domestic resources and encourage regional integration * Strengthen neighbouring country relations and cooperation * Increase private capital inflows Open new and improve existing markets * Heighten social safety nets that will minimise shocks effect on the poor * Investment in labour-intensive employment-focused public investment programmes that promote private sector growth. * Decrease the amount of debt owed The above mentioned points need to be encoded into policies that can be properly implemented by the government of South Africa and the South African Reserve Bank so as to reduce the vulnerability that SA has when it comes to external shocks. This objective has been achieved by South African economic policies.Monetary policies have been used to contain inflationary pressures and financial policies for the strengthening of public finance that will allow exchange rates that are competitive. In the February of 2000, an inflation targeting strategy was adopted that helped to regulate monetary growth within the economy. These policies have encouraged international competitiveness and assisted in the reduction of the current account deficit of 1999 (0. 4% of GDP), to 0. 3% of GDP in 2000 (IMF, 2001: 1). In 2006, real Gross domestic product grew by 5% and continued to grow into early 2007.During the start of the new millennium, the SARB publically announced that it would have a foreign market intervention policy that was used solely for boosting reserves. This new approach was succ essful because by 2007 May, gross reserves had reached $27,9 billion (IMF, 2007: 1). This shows that South Africa has been successful economic policies in place: policies that will combat external shock. A United Nations report places South Africa as one of the six oil importing nations that withstood the effects of the global financial crisis of 2008-2009.This was done through implementation of stimulus packages and affective countercyclical fiscal and monetary policies that encouraged expenditure on services and infrastructure (UNECA, 2010, 8). Conclusion The new South African government had to take the mess of the past and turn it into the message of the future. A message that says that anything is possible; all that is needed are the correct tools, used in the correct scenarios. With the various monetary and fiscal policies put into play in South Africa, I have no doubt that we are ready for the next global financial crisis.