##makers in south africa should be to soften the blows for the economy. at the one extreme there is the international monetary fund that believes that much more restrictive monetary and fiscal policies should have been applied in south africa in recent months to fend off the attacks of international speculators and short - term profiteers. at the other extreme we find economists in south africa with major private sector interests who believe that the reserve bank should have kept interest rates artificially low with a complete disregard of the consequences this would have had for the exchange rate of the rand and subsequent inflation. there are those who believe that the reserve bank should have done more to keep the exchange rate stable, even if it should have required the reintroduction or tightening of exchange controls. there are many naive critics in south africa who believe that the reserve bank is fully responsible for the high interest rates and that the reserve bank indeed used its mythical powers to force interest rates to these destructively high levels. in their ignorance they believe that the reserve bank can even at this stage pull the rabbit from the hat and instantaneously bring interest rates down again. unfortunately, in the real world such miracles are just not possible. 2. what caused interest rates to go up to avoid confusion in this debate, the real causes for the recent sharp rise in interest rates should be revisited. it will be recalled that in the first quarter of this year there was wide - spread optimism that interest rates in south africa could decline further during the course of 1998. the reserve bank had already reduced its bank rate from 17 to 16 per cent in october 1997, and to 15 per cent on 9 march 1998. inflation was declining, foreign portfolio investments flowed into the country, the foreign reserves were rising and the exchange rate of the rand was under pressure to appreciate. however, the situation changed dramatically in may 1998 when non - residents reviewed their investment strategy and started to withdraw some of the funds they had previously invested in south african bonds. during the four months january to april 1998, non - resident investors increased their holdings of south african bonds by approximately r16 billion. over the next four months, that is from may to august 1998, they reduced their holdings of south african bonds by about r19 billion. this dramatic change of strategy had an almost immediate negative effect on the overall demand and supply conditions in the south african financial markets. the yield on long - term government bonds rose from just below 13 per cent at the beginning of may to a peak of over 21 per cent

increase to us $ 1 billion. it is important to note that, at this stage, we had not implemented an saa yet and that a large portion of the reserves was borrowed funds. the goal was to preserve capital, including the cost of holding reserves. at the time, the benchmark was the london interbank offered rate, or libor, plus 30 basis points to cover our borrowing costs, and another 20 basis points to cover fund management fees. we soon realised that achieving this target of libor plus 50 basis points was not possible given the conservative nature of the mandates we had provided to the external fund managers. page 3 of 13 around 2002, we started a rather informal relationship with the world bank treasury. it was during this interaction that initial steps were taken to consider developing an saa, which was eventually implemented four years later, in 2006. needless to say, this required a revamp of our systems ’ capabilities and also led to our first investment policy being designed. we began separating the reserves into two tranches : the investment tranche and the liquidity tranche. with more insight and exposure gained through the interaction with external fund managers and the world bank, the sarb launched its first internally managed global government bond portfolio in 2004. at this stage, we had not yet formally joined the world bank ’ s reserves advisory and management programme ( ramp ), but we had come to the realisation that, with net reserves in positive territory and having gained knowledge from the external fund managers, we needed a much more objective and quantitative approach to our investment decisions. in view of this, the sarb, with the assistance of the world bank treasury, dedicated the most part of 2005 to capacitybuilding initiatives around reserves management. that same year, we joined ramp. the aim of our partnership was to ensure that foreign reserves were managed as efficiently as possible. ramp assisted with all aspects of reserves management, including governance structures, reporting lines, risk management and analytical capabilities, as well as the design of an saa framework. in fact, in the following year, the sarb would complete a comprehensive review of its reserves management investment policy, and implemented its first saa. at that stage, reserves showed good growth and net reserves sat at approximately us $ 25 billion. in our first saa, we had begun structuring the foreign reserves into three tranches : the liquidity, buffer and investment tranches. however, given the good growth in reserves and the fact that the liquid