The changing face of exchange control and its impact on cross-border investment opportunities in South Africa  (Central Bank Articles and Speeches, 23 Jul 98)
Central bank: sarb | Type: speech | Date: 1998-07-23

The changing face of exchange control and its impact on cross-border investment opportunities in South Africa Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Annual Australia/Southern Africa Business Council Meeting Sydney on 23/7/98.

## 1.

The history of exchange control in South AfricaThe beginning of exchange control dates back to 1939 when South Africa, a member of the now defunct British Sterling Area, was asked, together with other members Sterling Area, to introduce restrictions on the outflow of funds to non-Sterling Area cou ensured the free movement of funds, emanating mainly from the United Kingdom, within Sterling Area.After World War II, the Sterling Area exchange controls were gradually phased but in South Africa in 1961 the controls were extended and given a specific South African This followed upon disrupting internal political clashes (the Sharpeville incident), Africa's withdrawal from the British Commonwealth.

Exchange control in South Africa was intended to provide some protection to the domestic economy from the adverse effects of la outflows of capital.

For the first time, exchange control also restricted the rep non-resident investment funds from the country.During the period 1961 to 1993, exchange control was extended from time to t mostly in reaction to a worsening of South Africa's internal political situation, and external pressures in general.

For example, in 1976, after the uprising of school children proceeds of the sale of non-resident owned securities in South Africa were blocked and e converted into securities rand, tradable only at a substantial discount at a second tier exchange rate.

After the United Nations introduced world-wide economic and financial san against South Africa in 1986, a standstill on the repayment of a major part of South Afric indebtedness was introduced, providing for an extended negotiated redemption of the outs amount.By the time that the major social and political reforms were introduced in Africa in the early nineties, there existed a very comprehensive system of exchange con covered certain current account transactions and the inflows and outflows of both resi non-resident investment funds.

## 2.

The phasing out of exchange controlThere was general consensus that exchange controls created many distortions i South African economy.

Interest rates, the exchange rate, financial asset and property p even production costs in the domestic economy were affected by the comprehensive exch controls.

The system prevented the important price mechanism of the market economy functioning properly.

This led to the maldistribution of scarce resources and the functio economy at levels below its optimum capacity.After the democratic election for a new Government of National Unity took pla April 1994, and international punitive actions against the South African economy were r there was general consensus within the new Government that exchange controls should al removed.

There was, however, major disagreement on how fast the controls should disappear. one extreme were supporters, mostly in the private financial sector, of a 'big bang' appr pleaded for the immediate removal of all the controls.

On the other hand, there was ssupport for a more gradualist approach and for the dismantling of the exchange controls extended period of time.The Reserve Bank supported the latter approach, mainly for the following reason- Years of economic sanctions, boycotts, disinvestment campaigns and t withdrawal of foreign loan funds from South Africa depleted the countr foreign reserves.

At the time of the elections of April 1994, the Reserv owned, on a net basis, zero foreign reserves.- During the long extended period of exchange controls, backlogs developed, a huge pent-up demand for an outflow of capital emerged.

Overdue loans had to repaid to non-residents, and no South African residents were allowed accumulate foreign assets of any significance over a period of more than years.- Distortions were by that time so much embedded in the South African finan structure that the sudden removal of exchange control would not only h exerted pressure on the country's low level of official foreign exchange re but could also have forced painful immediate structural changes that would unduly disrupted the domestic economy in the short term.The South African authorities therefore decided on a gradual phasing-out o existing exchange controls.

Beginning already in 1993, the following relaxations were acc introduced over the past five years:- As a first priority, all exchange controls applicable to current account tr were removed.

South Africa now fully complies with the requirements of Arti VIII of the International Monetary Fund.- Secondly, controls on non-residents were removed.

The debt standst arrangements of 1985 were finally rescheduled towards the end of 1993, and financial rand system (two-tier exchange rate) was terminated in March 1 Non-residents are now completely free to introduce funds for any purpose South Africa, to repatriate such funds and to transfer out of the country and capital gains earned on their investments without restriction.- Resident corporates (companies) were gradually enabled to make dire investments in foreign subsidiaries, branches or joint ventures by trans limited amounts of funds from South Africa, and by raising funds abroad thr equity and loan issues.

In the process, direct investments of about R50 (US $10.7 billion) were acquired by the South African corporate sector ove past four years.- Resident institutional investors were given permission in June 1995 to div part of their total assets into foreign currency denominated investments. stage, they may hold up to 15 per cent of their total assets outside o Africa.

In total, the financial sector has now acquired about R55 billi $11.8 billion) in the form of portfolio foreign investments.- Last year, in June 1997, private individuals were given permission to limited investments in their own names outside of South Africa.

At thisindividual taxpayers in good standing with the tax authorities may invest R400 000 per individual outside of South Africa.

A modest amount of fore exchange equal to less than R2 billion has since then been absorbed under concession- Many other smaller exchange control restrictions were either eased or remo for example on short-term trade financing, inter-bank financing arrangement the transfer of legacies, donations and emigrants' funds.

Administr procedures were simplified and banks (authorised dealers in foreign excha were mandated to approve many transactions without prior reference to Reserve Bank.There remains but one major area for relaxation, and that is in respect restrictions still applicable to the so-called 'blocked' funds of former residents of S Apart from settling-in allowances, the remainder of the assets of emigrants is blocked Africa and becomes non-transferable.

Income earned on blocked funds, however, is not sub the restrictions.South Africa has therefore now reached a stage where there are no effective exc controls any more on current account transactions and on the movement of funds of non-res Resident corporates, financial institutions and private individuals all have limited sc some investments outside of the country and have, on a combined basis, now accumulated more R100 billion of foreign assets.

Backlogs that existed in 1994 for the outflow of non-resi have been accommodated in full, and those that existed for the outward investment of resid are gradually being absorbed.

On balance, South Africa has now removed more than sevent cent of all the exchange controls of the past.

## 3.

The inflow of capital into South AfricaThe macroeconomic argument for the removal of exchange control is based on t assumption that, on balance, in a liberalised economy, over time capital inflows wil outflows.

Despite the need to accommodate large accumulated backlogs, this philosophy vindicated by developments in the capital account of the South African balance of payments past four years.Non-resident investors increased their holdings of South African equities by R63 billion (US $13.5 billion) from 1 January 1995 up to the end of June 1998, and also i net amount of about R30 billion (US $6.5 billion) in South African bonds.

The total investment capital inflow of more than R90 billion was mainly used for financing the acqui foreign assets by South African residents, as already mentioned above.Taking account of the relatively large net inflows of portfolio foreign outflows to finance foreign investment by residents, and all other capital movements, t account of the South African balance of payments still showed a net inflow of funds from a R53 billion over the period from the beginning of 1995 up to March 1998.

The inflows were than sufficient to cover modest current account deficits and to raise the total gross fore reserves of the country to a level of R45 billion (US $9.0 billion) at the end of March 1 level, the total foreign reserves were sufficient to cover about three months' imports o services.

In terms of international standards, the level of the foreign reserves is still but at least much more comfortable than at the end of March 1994, when the gross foreign of the country amounted to only R10.3 billion (US $3.0 billion).One of the disappointing aspects of the capital inflows into South Africa over four years has been the relatively small amount of direct foreign investment made in the co more than 25 per cent of the total inflows represented direct foreign investment, and the as portfolio investment in securities, loan capital and short-term financing facilities.

## 4.

Restructuring of the financial sectorThe gradual removal of exchange controls was accompanied by some major restructuring of the financial sector in South Africa.

To encourage competition in the ma foreign banks were allowed to establish themselves in the country.

More than 20 foreig opened up branches or subsidiaries in South Africa, and more than 60 foreign banks now do b in the country through representative offices.

Together with about 35 domestic banking ins the South African banking industry is now providing, on a competitive basis, excellent an financial services to the country.

The industry is healthy, well-managed and subject to regulation and supervision based on the principles of the Basle Committee guidelines a principles.While the gradual phasing-out of exchange control continued, the financial ma were also restructured, liberalised and made more flexible to accommodate almost exp increases in volumes.

In the capital market, three separate specialised institutions wer provide, respectively, for equity trading on the Johannesburg Stock Exchange (JSE), bond tr the Bond Exchange of South Africa, and trading in derivatives on the South African F Exchange.Two years ago, the JSE introduced major reforms to provide for corporate owners foreign ownership (of stock brokers), dual capacity trading, negotiated commissions and e screen trading.

The JSE is continuing to improve its facilities by providing for the imm and dematerialisation of stock, and for improved clearing and settlement arrangements. listing of about 700 different securities, a total market capitalisation of about US $275 turnover of about US $45 billion last year, the JSE is now classified as one of the m exchanges of the world.The most spectacular increase in the total volume of transactions over the p years took place in the Bond Exchange of South Africa.

Total turnover in this market incre the equivalent of US $553 billion in 1995, to US $927 billion in 1997, that is an increase cent over just two years.

The relaxation of the exchange controls made an important contr the development of the Bond Exchange.

Total gross transactions by non-residents in this ma year exceeded the equivalent of US $257 billion, or almost 30 per cent of total turnover.Interest is also growing in the South African Futures Exchange.

The total num contracts traded in this market increased from 3½ billion in 1995 to more than 5 billion inA further important development that flowed from the globalisation process i emergence of a Euro-rand market where the outstanding amount of rand-denominated loans ra by non-South African borrowers from non-South African investors now amounts to abo R36 billion.

A substantial part of the proceeds obtained from these loan issues was rei South African bonds.The market in foreign exchange in South Africa is also growing rapidly.

The av daily turnover in this market now exceeds US $10 billion.

Of particular importance is the in forward cover operations in this market, where South African banks now carry a fully forward sales (or purchases) book of about US $180 billion.The Reserve Bank recently introduced steps to encourage a more active developm of the domestic inter-bank market for funds.

It is the objective to ensure that short-term should be flexible, and should fluctuate to reflect changes in underlying market condit effective rate at which central bank funds are made available to banking institution determined on a daily basis through a tender system for repurchase transactions, ente between the Reserve Bank and banking institutions.

This greater flexibility in short-te rates is of particular importance in light of the growing volume of, and greater vo short-term international capital movements.As a further step in the development of the financial system, the Reserve Bank beginning of this year also upgraded the national payment, clearing and settlement system. system provides for an electronic on-line real-time link between participating banks, and fund transfers between these banks.

It enables the banks to monitor and manage their positions continuously, and provides for electronically managed end-of-day settlement of transactions.

As from the beginning of October, it will become possible to settle transac intra-day basis as and when instructions are received within the system.The gradual phasing-out of the exchange controls was therefore accompanied b simultaneous process of liberalising, modernising and upgrading of the domestic financial s the process, the removal of the exchange controls did not create any major disruption in th markets, and the health and soundness of the South African financial institutions were protBoth processes, however, should be seen as part of the wider movement international financial globalisation.

Without introducing these changes, it would not possible for South Africa to participate in the process of world-wide integration of financ The removal of exchange controls and the simultaneous upgrading of the domestic financial opened up the way for South Africa's participation in this process.

## 5.

The Southern African Development CommunityA further consequence of the socio/political/economic reforms in South Africa the past few years was a natural greater involvement for the country in the economic dev process of the African continent.

Apart from a more active participation in continental working through the Organisation of African Unity, the United Nations Economic Commission Africa, and the African Development Bank, South Africa is taking an active part in the ac the Southern African Development Community (SADC).Fourteen countries of the Southern African region now belong to this fo agreement for economic co-operation, with the long-term goal of eventual economic integ South Africa plays a leading role in the development of financial and investment co-o amongst the participants in SADC.Within the structured institutional framework of SADC, a Committee of Governo of all the central banks of the region was established.

This Committee introduced a n co-operation projects intended to develop the financial systems and markets of the reg approach of the Governors Committee at this stage is first to develop the financial infras each of the countries, before venturing into the more challenging task of macroec co-ordination or integration.One of the important projects in the work of the SADC Governors Committee is remove remaining exchange controls within the region.

Where practicable, countries are encto do this even faster than what has been programmed for the overall phasing out of the con envisaged that there will eventually be a relatively free movement of goods, services and this vast area with a total population of more than 180 million people.

## 6.

The financial globalisation processThe phasing out of exchange control and the restructuring of the financial sys important preconditions for South Africa's greater participation in the financial gl process.

As can be deducted from some of the statistics quoted in this address, South Afr firmly on the road of greater participation in the expanding international financial marketRecent events in the wake of the East Asian financial crisis proved once however, that the globalisation process is not without risk.

The easy movement of large a funds into and out of countries with relatively small economies can at times be very d During the four months January to April 1998, non-residents increased their holdings o African bonds, acquired through the Bond Exchange, by more than R16 billion.

Over the ne weeks, that is during May, June and the first half of July 1998, they reduced their holdin R12 billion.Both the inflows and the outflows of capital on this occasion disrupted the African financial markets and complicated the implementation of monetary policy centred medium-term objective of maintaining financial stability in the interest of optimum e growth.

In the situation and against the background of a rather depressed domestic econ yield on long-term government bonds increased from 12.7 per cent on 30 April 1998, to 1 cent on 6 July, before it declined again to 15.5 per cent last week.The Reserve Bank's fluctuating repo rate similarly showed wide fluctuations increased from 14.8 per cent in early May to a peak of 24.0 per cent on 22 June, before set at a level of about 21 per cent.

All banking institutions in the country were forced t deposit and lending rates by about 6 percentage points since the end of April.

The prime rate of the major commercial banks now stands at 24 per cent.

With the latest measure of i only 5 per cent per annum, real interest rates are at an extremely high level.The exchange rate of the rand also came under a lot of pressure.

After relatively stable for a period of about 18 months from October 1996 up to the end of April rand depreciated from R5.05 against the US dollar in the middle of May to R6.62 = $1 on 1998.

Since then, the exchange rate appreciated again to fluctuate around the R6.00 = $1 the last few days.

At this level, the rand, measured against a basket of currencies, is sti cent down from where it was at the beginning of this year.Some critics do believe that the removal of the exchange controls is partl blamed for this greater volatility in financial conditions.

They advise South Africa, t reintroduce some of the controls, for example, the two-tier exchange rate system.

This vi shared by the monetary authorities in South Africa.

Despite the gyrations of recent weeks believe that the advantages of participation in the financial globalisation process wil bring more advantages to the South African economy than disadvantages.

## 7.

Concluding remarksThe policies of the phasing out of exchange control, the restructurin liberalisation of the financial system and the promotion of active participation in the financial globalisation, have created many opportunities for cross-border investment in SouForeign banks, fund managers, institutional investors and manufacturing concerns are ex their financial business with South Africa in the form of:- conventional short-term trade financing;- short-term inter-bank financing facilities;- loans extended for medium and longer-term periods to South African borrowe in both the private and public sectors;- portfolio investment in equities, bonds and financial derivatives, acquired the various capital market exchanges; and- direct investment in the form of subsidiaries, branches, or joint ventur South African undertakings.Developments in recent years also led to the creation of an active Euro-rand outside of South Africa, and to a greater involvement of South Africa in the economic deve process of the Southern African region.These exciting developments have already created opportunities, also for expansion of financial relations between South Africa and Australia.

I believe man opportunities exist and are waiting for the financial and other economic entrepreneurs Africa and in Australia to be exploited.Our two countries should not always be regarded as major export competitors i world markets for base minerals and other commodities.

There are also many areas wher economies are complementary and where our policies can be supportive in the global enviro This applies particularly when it comes to our efforts of integrating our financial mark world environment.