Challenges of the International Monetary System and Response Options: A South African Perspective

1. 10-11 December 2012 Challenges of the International Monetary System and Response Options: A South African Perspective ADB-CIGI-HKIMR Workshop: The BRICS & Asia, Currency Internationalization, and International Monetary Reform Johan van den Heever The views expressed are those of the author and do not necessarily represent those of the South African Reserve Bank

2. Outline • Introduction • Key shortcomings of the current international monetary system or IMS • Broader weaknesses of the international financial system • Challenges that result from extraordinary economic policy settings in major developed economies • South Africa’s experience with exchange rate reform and currency internationalisation • Challenges posed by membership of regional integration arrangements and blocks • Views regarding the adjustment measures related to the IMS that countries are already implementing • Preferences on options for orderly adjustment of the IMS • Conclusion

3. Key shortcomings of the current international monetary system • Dominance of a handful of currencies • A major currency in the system is issued by a constituent monetary union that has not yet stabilised • Currency volatility

4. Broader weaknesses of the international financial system • Along the lines of the G-20 Action Plan to Implement Principles for Reform – the need to • strengthen transparency and accountability • enhance sound regulation • promote integrity in financial markets • reinforce international co-operation • reform international financial institutions • Significant progress is being made • Sound frameworks and principles can moderate risk but should not be expected to eliminate all errors of judgement and policy • Cost-benefit approach is important; taken too far compliance may have unintended – stifling - consequences

5. Challenges that result from extraordinary economic policy settings in major developed economies • From 2008 fiscal deficits have widened and government indebtedness has risen strongly • Now strong need for fiscal consolidation: painful, and the timing seems most unfortunate • Ultra-easy monetary policy (White, 2012): • The policy may not give that much short-run support to economic activity: • Normal monetary policy transmission channels may be partly blocked • Expenditure may not react so much to lower interest rates • Undesirable longer-run effects: • Undermining health of financial institutions, markets • Undermining “independence” of central banks • Encouraging imprudent behaviour by governments • Significant nominal interest rate differentials in favour of developing economies • Capital inflows to developing economies are boosted • Fears of currency overvaluation, unsustainability • Low returns on foreign-exchange reserve holdings • Search for higher-yielding, safe, liquid international assets

6. South Africa’s experience with exchange rate reform and currency internationalisation • From isolated apartheid state to normal participation in international bodies, trade and finance • 1970s: extensive reliance on direct controls in the economy • Exchange control and a parallel exchange rate where non-residents traded in rand assets between themselves • Import controls and high import duties • Various exchange rate regimes, mostly pegged • 1979+: Managed floating exchange rate, movement away from direct controls • Exchange control over non-residents abolished in 1983 • 1985+: Direct controls reintroduced • Financial sanctions, foreign currency crisis leading to debt standstill in 1985 • Exchange control over non-residents reintroduced following the debt standstill • Imperative to repay debt, run current-account surplus • Economic growth impaired

7. South Africa’s experience with exchange rate reform and currency internationalisation (continued) • 1994+: Liberalisation resumed • Standstill debt no longer a big issue – gradually repaid, good yield for patient investors • Access to offshore credit markets restored • 1995: Exchange controls over non-residents again abolished – and that is still the case • Gradual liberalisation of exchange controls over residents • Authorities stated clearly that it would be a gradual process • In practice it has involved the raising of the limits that restrain how much foreign currency a South African person or entity can acquire for current expenditure abroad or to acquire offshore assets • Limits are no longer binding for most individuals • For institutional investors (such as pension funds) the limits are fairly liberal and are of a prudential nature • The emphasis has moved from “control” to “monitoring” – an extensive reporting system has been developed to track foreign currency transactions, assets and liabilities, almost in real time

8. South Africa’s experience with exchange rate reform and currency internationalisation (continued) • Official intervention in the market for foreign currency: • Fairly extensive intervention, “leaning against the wind” through both spot and forward currency transactions up to 1998 • 1997-98: Southeast Asian crisis induced outflows of foreign currency from emerging-market economies • Large-scale intervention by the South African authorities did not help, and the rand depreciated considerably • Subsequently the authorities have refrained from intervention (but have from time to time entered the market to purchase foreign exchange, given the need to strengthen the official reserves) • Currently therefore a clean float and a deep and liquid foreign exchange market

9. South Africa’s experience… Stronger rand=up Gold price boom Financial rand abolished Lehman failure and “flight to familiarity” Southeast Asian crisis Democratic election Financial sanctions and debt standstill Severe speculation against rand

10. South Africa’s experience with exchange rate reform and currency internationalisation (concluded) • Currency internationalisation is facilitated by • A strong banking system and well-integrated financial markets • A solid legal system • Transparency and good governance in the corporate sphere • Accounting standards in harmony with international best practice • Solid financial regulation • A sound payment system with features such as real-time gross settlement and access to Continuous Linked Settlement • Sound, transparent and consistent monetary and financial policies and economic policy in general • However, developing strong and reputable institutions along the above lines • comes at a price • may involve sacrificing elements of national sovereignty or local flavour

11. Challenges posed by membership of regional integration arrangements • South Africa is a member of, inter alia, • the Common Monetary Area (CMA), a monetary union/currency board arrangement with Lesotho, Namibia and Swaziland • the Southern African Development Community (SADC) involving 14 countries in Southern Africa • In the case of the CMA the participating economies all had the same currency before gaining independence • CMA shows strains in difficult times to maintain the currency peg • Illustrates need for fiscal conservatism, cooperation, smoothing mechanisms

12. Challenges posed by membership of regional integration arrangements (concluded) • In the case of SADC the countries have independent monetary policies • Inspired by the initial success of the euro area, in the early 2000s a programme was developed to drive to a single central bank by 2016 and a single SADC currency by 2018 • Euro-like convergence criteria • Some reservations have crept in: • The problems in the euro area… • …pointing at the need for fiscal integration alongside monetary integration • The considerable differences in economic structure between SADC countries… • …and with it large differences in the terms of trade • Accordingly the programme for monetary integration is being reviewed

13. Views regarding the adjustment measures related to the IMS that countries are already implementing • Rebalancing of the leading currencies in the IMS in favour of the developing economies • Sensible • In the case of renminbi, underlying size considerations are favourable • Also more attractive trend growth than the economies of the traditional reserve currencies, and at times a different cyclical position • Greater international use comes at a price • International pressure to give global externalities a more significant weight in conducting economic policy • Transaction flows more difficult to explain, predict • Sometimes counterintuitive and disruptive flows • Large pool of own foreign reserves is helpful for stabilising confidence and calming sentiment

14. Preferences on options for orderly adjustment of the IMS • Allow for variable geometry and diversity in the IMS, not one-size-fits-all dispensation for all countries • IMF: • Strengthened role • Expanding the pool of SDR and lending facilities • Multilateral surveillance in addition to individual country surveillance • Strengthening support mechanisms – bilateral, in regional economic communities and in other multi-country formations • Swap lines • Pooling of reserves

15. Preferences on options for orderly adjustment of the IMS (concluded) • Augmenting the existing set of reserve currencies in three ways • More reserve currencies – currencies achieving the economies of scale and solidity of reputation that is required • Expanding the range and role of quasi-reserve assets – currencies that are close substitutes for reserve currencies • Sovereign wealth fund assets as additional source of international liquidity beyond what central banks have available • As a result, further opportunities for diversification and risk/return enhancement for reserve managers • Structural, business-cycle, monetary policy and fiscal positions differ between countries • Wider choice of currencies and assets • A continued voluntary role for precious metals such as gold and platinum in the IMS • Precious metals: Liquid international reserve assets which are the holder’s asset but nobody’s liability • Holding them bolsters confidence in difficult times • Inappropriate to move back to setting fixed parities for precious metals – shifts in underlying supply or demand for the metal could be damaging

16. Conclusion • Adding to the number of reserve currencies in the world is desirable, but not easy, requiring the building of institutions that support confidence in the currency and facilitate its use in international transactions • The dominance of a handful of currencies may further be softened through a number of further currencies coming to the fore as quasi-reserve currencies • Gradualism has worked well for the South African authorities in liberalising the market for foreign currency • Grand schemes towards monetary union should be treated cautiously, mindful of – • the usefulness of a national monetary policy and exchange rate as adjustment mechanisms • the fiscal dimension which has to accompany monetary integration

17. Thank you!