Challenges of the International Monetary Challenges of the International Monetary System and Response Options:System and Response Options:

A South African Perspective A South African Perspective

10-11 December 2012

Johan van den HeeverJohan van den Heever

The views expressed are those of the author and do not The views expressed are those of the author and do not necessarily represent those of the South African Reserve Banknecessarily represent those of the South African Reserve Bank

ADB-CIGI-HKIMR Workshop: The BRICS & Asia, ADB-CIGI-HKIMR Workshop: The BRICS & Asia, Currency Internationalization, and International Currency Internationalization, and International

Monetary ReformMonetary Reform

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

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

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

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

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

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

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

South Africa’s experience…

Gold price boom

Financial sanctions and debt standstill

Stronger rand=up

Southeast Asian crisis

Severe speculation against rand

Lehman failure and “flight to

familiarity”

Financial rand

abolished

Democratic election

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

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

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

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

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

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

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

Thank you!