Publication Details

1. Introduction


Discussions on risk exposures in the international capital markets generally concentrate on the risks involved for cross-border investors or lenders of funds. It is true that a lender that has lost money because of default by a borrower will remember the event much longer than the borrower -- creditors have better memories than debtors. It is also true that international lenders and investors looking for investment opportunities have many alternatives and must therefore consider the available options with prudence - - hence their need for searching analyses on risk exposures.


Borrowing countries, however, also have to take account of certain risk exposures, some of which can be controlled or influenced by themselves, but others over which they have little control. It is essential that borrowing countries, and particularly Ministers of Finance and Governors of central banks from such countries, shall be aware of the many risks involved in international borrowing. The same lenders who at some stage may be queuing up to extend loans to a country can very easily afterwards turn around and pull the carpet from under it. As many a developing country experienced in the past, disrupting capital outflows at an inopportune time can do irreparable harm to an economy and create many hardships within the country.


Central banks unavoidably are intimately involved in every international financial crisis experienced by their countries. Their task of maintaining overall financial stability often becomes impossible in such situations. Central bankers therefore have a vested interest in advising their governments against entering into international financial arrangements that will make the country inordinately vulnerable to sudden foreign capital withdrawals and against the implementation of domestic macro-economic policies that could easily lead the country into an external financial crisis. This responsibility becomes proportionately greater as a country's international indebtedness increases.


2. The nature of the financial risk exposures for borrowing countries


South Africa is now gradually entering the international money and capital markets again as a borrower of foreign funds. From the macro-economic point of view, it is important for South Africa to have access to external funds. Domestic saving, which has declined to only about 17 per cent of gross domestic product last year, is not sufficient to sustain an acceptable minimum rate of economic growth that will provide in the many pent-up needs of the population. Unless domestic saving can be increased dramatically, a rate of growth in excess of three per cent per year will only be sustainable in the longer run if domestic saving can be supplemented on a continuous basis with a net inflow of foreign funds.


South Africa must also maintain a net inflow of capital to provide in the foreign exchange needs of the country. With a relatively high import penetration ratio (total imports as a percentage of total gross domestic expenditure) and also a very high marginal propensity to import (the increase in imports as a percentage of any given rise in gross domestic expenditure), total imports of goods and services will normally exceed total exports of goods and services in times of rapid economic growth. Taking account of the current relatively low level of the official gold and foreign exchange reserves, South Africa cannot with its limited own reserves, sustain a current account balance of payments deficit, and therefore economic growth at a reasonable level, for any lengthy period of time.

Now that foreign money and capital markets are becoming easier accessible again, South Africa has an opportunity of increasing its economic growth rate to a level that will not only provide jobs for the annual addition to the labour force, but also absorb on a gradual basis the huge backlog of unemployed people. The country must, however, handle the inflow of foreign capital with prudence and with caution, and must guard against the temptation of borrowing foreign funds without taking due care of the risks involved in international borrowing.


A few of these risks can be identified from the unpleasant experiences of the many countries that were forced into international debt rescheduling arrangements over the past fifteen years. South Africa had its own experience with the Debt Standstill on the redemption of part of its foreign debt forced on the country in September 1985. It will be in the country's longer-term interest not to forget the dismal experiences of the past.


There is, firstly, the risk of liquidity. In the context of international indebtedness, the risk of liquidity is measured by the availability of international reserves. The first line of defence for a country that experiences a sudden outflow of capital is its official gold and foreign exchange reserves. The total gross gold and foreign exchange reserves held by the Reserve Bank, the rest of the banking sector and the Government together is less than R15 billion, or hardly sufficient to cover six weeks' imports. At this stage, the Reserve Bank has access to a further amount, also of about R15 billion, of short-term international credit facilities, providing a total amount of about R30 billion in foreign exchange that can be used to support any temporary overall balance of payments deficit.

The credit facilities, however, provide only a second line of defence that can be used to replace, for example, foreign liabilities of the private sector in times of sudden capital outflows. South Africa must, therefore, still regard it as a prime objective to increase the net official foreign reserves of the country to a more comfortable level. This is necessary not only to provide for fairly predictable fluctuations in the current account of the balance of payments, but also for covering the unpredictable capital outflows that may at times arise from a greater amount of foreign borrowing. Capital flows are more unpredictable than the normal cyclical and structural changes in imports and exports, and therefore require an even higher level of foreign reserves.


A second kind of risk exposure arises from maturity mismatches. Like any corporate borrower, a country must also avoid the bundling of maturities at any future date. In the rescheduling of South Africa's foreign debt in terms of the Debt Standstill arrangements, we have taken great care in spreading the redemption of that part of the foreign debt subject to the arrangements over a period of more than eight years. The final repayment in terms of the 1994 Debt rescheduling arrangements will indeed only take place in the year 2002. Care must now be taken to ensure that the redemption of new debt raised by South Africa will fit into this programme.


A third risk exposure is, of course, the danger of solvency. Countries often borrow to a limit beyond their capacity to service the debt, both in terms of interest payments and capital redemption. Here again South Africa is at this juncture very well placed. Its total foreign debt repayable in foreign currencies at the end of 1993 amounted to US $16,7 billion, equal to only 14,2 per cent of gross domestic product and 58,5 per cent of annual export earnings. Interest payments on the foreign debt absorbed less than 7 per cent of the annual exports of the country. Even if these ratios are doubled to incorporate an estimated amount of about $15 billion for rand denominated debt held by non-residents, the total foreign debt of South Africa is still relatively low compared to many other countries in a similar stage of economic development. Since the abolition of the financial rand, such rand-denominated debt held by non- residents has, of course, become fully convertible in foreign currency and freely transferable.


A fourth risk exposure is the danger of price changes, particularly changes in the domestic currency value of foreign debt resulting from exchange rate changes. This is a risk that has become very substantial in recent times, particularly because of volatile foreign exchange markets and large exchange rate changes, even amongst the major currencies of the world.

A fifth risk exposure arises from the integration and globalisation of the international capital markets. A borrower in these markets such as South Africa can easily be forced into a difficult position as a result of developments in another country over which South Africa has no influence or control. When the Mexican crisis hit the capital market for emerging economies in the second half of December 1994, the South African exchange rate (for the financial rand), the prices of South African shares on the Johannesburg Stock Exchange and interest rates in the South African money and capital markets were all affected almost immediately by the event.


A sixth risk exposure for the larger borrower in the international capital market is the subjection of its internal macro-economic policies to continuous international scrutiny. Before investing in any country, fund managers nowadays insist on comprehensive international credit ratings as assessed by recognised international credit agencies. A regular sovereign borrower in these markets is therefore subjected to continuous international surveillance, not only in respect of its macro-economic policies, but also in respect of all internal social and political developments. More than ever before changes in internal policy measures can have international implications, and often immediate repercussions for the country's balance of payments position, and therefore for the development of its total economy.


In summary, there are many advantages in it for an emerging and developing economy to be able to raise funds in the global capital markets. Through such lending/ borrowing operations, surplus savings are transferred from the mature industrial countries to those who still have investment/saving shortfalls. But the privilege of access to the global capital markets brings with it also greater accountability and responsibility. The international capital markets penalise mismanagement and errors of judgement in a very harsh way. They even sometimes penalise countries for mishaps in other countries over which they have no control.


3. The abolition of the financial rand system


A final word on the now buried financial rand system may not be out of place at this Conference. Through this step the South African Government reconfirmed its determination to liberalise the South African foreign exchange market, and to create in South Africa a friendly environment for the foreign investor.


A few months ago I said that South Africa should only abolish the financial rand system in a situation where it will prove to be a non-event. In retrospect, the abolition of the finrand on 1995-03-13 was not only a non-event -- it was an anticlimax. We avoided the shocks that could have been inflicted on the financial situation with a premature abolition of the dual currency system.


Some people now use the smooth transition from the dual to the single currency system as an argument for the early abolition of all the remaining exchange controls. What applied to the programme leading up to the final plunge on 1995-03-13 must, however, surely also apply now to the termination of the remaining exchange controls. We must first prepare the way and lead South Africa into a situation where the abolition of exchange controls on residents will also be a non- event. At this stage, we are still far away from that situation. The backlogs built up over many years in the need for some international diversification in the asset structure of South African investors are just too large. Just as we had to prepare the way for the abolition of the financial rand with patience and had to resist the unreasonable pressure for a premature relaxation of that system, we shall also now have to work gradually towards a situation of better equilibrium in the market for outward investment by South African residents.


We are particularly concerned about the huge pent- up demand with institutional investors and managers of portfolio funds for some diversification into foreign assets of part of the huge amount of funds under their control. Concessions to these investors in future will have to be made in the light of the available foreign reserves of the country, which in turn will be largely dependent on the inflow of non-resident funds into South Africa.


In the meantime, we must give serious attention to the way in which exchange rates are being made or determined in the South African foreign exchange market. Now that we have a unitary rate of exchange for the rand, it has become of even greater importance that the one and only exchange rate for the rand shall be realistic. Statements are made too easily and too loosely that the rand is over- or undervalued. These statements often emanate from groups or sectors with a vested interest in either a devaluation or a revaluation of the rand.


In a world of floating exchange rates introduced after the demise of the Bretton Woods system of fixed parities in the late nineteen seventies, exchange rates are in most cases being determined by forces of demand and supply in the foreign exchange markets. Changes in overall demand and supply in these markets are, however, now dominated by volatile capital movements, and not by current account imbalances. The conventional concept of an over- or undervalued currency, based on the principle of purchasing power parity, has little meaning, particularly in the shorter term, in this new environment. The exchange rate of a currency can easily appreciate because of persistent capital inflows, despite the simultaneous presence of a growing deficit on the current account of the balance of payments.


Exchange controls have in the past distorted exchange rates in South Africa -- we still have a floating exchange rate system operating within the constraints of the remaining exchange controls. In this situation it is extremely difficult to assess the current level of the exchange rate -- is the rand overvalued or undervalued, taking account of overall demand for and supply of foreign exchange? The situation is further complicated by the existing pent-up demand for foreign investment by South African residents already referred to above. And what will the situation be once the pent-up demand has been satisfied? Will the rand, after the final abolition of exchange controls, appreciate or depreciate? We can all but speculate on this question. South Africa could easily then become a candidate for an appreciating currency, as many other countries with successful external liberalisation and internal stabilisation programmes experienced.


As a next step towards improving the quality of the market-determined exchange rate in South Africa, the Reserve Bank is now looking into ways and means of reducing its role in the forward foreign exchange market. Discussions have been initiated with the authorised dealers in foreign exchange in this regard with a view to creating opportunities for the banks to assume a greater role in the development of the forward foreign exchange market. The spot exchange rate of the rand is often held at an artificial level -- be it too high or too low -- because of the present system in terms of which the Reserve Bank provides forward cover for established commitments and claims in foreign currencies. We are looking for a greater role for market forces to play, also in determining the exchange rate of the rate for forward cover transactions.


4. Concluding remarks


The deregulation of international financial and trade relations brings interesting new challenges for South Africa. Capital inflows into and out of the country, and greater sensitivity of the unitary floating exchange rate of the rand to changes in underlying conditions, introduce new disciplines on our macro- economic policies. In the final situation, the net capital inflows that we so desperately need for economic growth, and a stable exchange rate for the rand to support economic development, cannot be achieved or maintained through superficial Reserve Bank intervention or Governmental controls. There is no alternative for sound monetary, fiscal and other macro-economic policies.


In the future, the international money and capital markets will become an important adjudicator of the soundness of our policies. South Africa can no longer afford to ignore the norms and the standards for financial disciplines dictated by this impersonal adjudicator.