Publication Details

1. Exchange control: History

South Africa originally introduced exchange controls in 1939, together with the United Kingdom and other members of the Sterling Area, as part of the Emergency Finance Regulations applied by this selected group of countries, mostly members of the British Commonwealth, during and after the Second World War. The original objective was to retain a free movement of funds between these countries, but to prevent "hard currency" funds from flowing out of the area to non-sterling area countries.


The Sterling Area exchange controls were gradually removed after the War. In 1961, however, South Africa's exchange controls received its own identity when restrictions were placed on the outflow of funds from South Africa to the rest of the world. This decision followed upon the Sharpeville tragedy which led to a large outflow of funds from South Africa, and which drained liquidity and savings needed for economic development from the domestic economy.

The South African exchange controls were extended from time to time in reaction to further political incidents that led to capital outflows not based on underlying economic fundamentals. The controls were intended to protect the domestic economy from the adverse effects of non-economically motivated capital outflows -- movements that could not be arrested or reversed by conventional macroeconomic policies such as interest rate or exchange rate changes.


The South African exchange controls were applied relatively widely after 1985 when international sanctions, trade boycotts, disinvestment campaigns and the withdrawal of loan funds from South Africa exerted severe pressure on the balance of payments, and on the domestic economy. At that stage, certain restrictive measures applied to a few current account transactions, while the discounted financial rand system for non-residents was reintroduced, and the outward movement of funds of residents were subject to prior approval by the Exchange Control Authorities.

It should be noted that throughout this period, the responsibility for exchange control policy remained vested with the Minister of Finance, who appointed the Reserve Bank as his agent to implement and administer the policy on behalf of Government. The Reserve Bank has therefore always been, and still is, but an adviser to Government when it comes to decisions on Exchange Control policy.


2. The phasing out of exchange controls

The initial non-economic factors that led to the outflows of capital from South Africa during more than thirty years, from 1961 until early in the 1990's, rapidly disappeared after the announcement of the election of the Government of National Unity towards the end of 1993. Although a large amount of funds still flowed out of the country during the first half of 1994, the situation changed dramatically thereafter. In the second half of 1994, there was a net inflow of more than R9 billion into the country, and during the calendar year 1995 a further net inflow of R21,7 billion, to bring the total net inflow of capital for the 18 months from July 1994 to December 1995 to more than R30 billion.

In the beginning, most of the capital inflows consisted of short-term funds, but gradually more medium and long-term loan funds flowed into the country and, towards the end of 1995, large portfolio investments entered the country through investments in South African securities (equities and bonds) listed on the Johannesburg Stock Exchange.

The renewed capital inflows paved the way for the removal of the exchange controls. There was general agreement that the exchange controls were not in the interest of optimal economic growth and development. Over time these direct control measures, applied in a market-oriented economy, distorted important price structures, such as interest and exchange rates, financial asset prices, and even wages and salaries. Distorted prices lead to the mal-allocation of resources, and to economic growth below the potential of the country. In the longer run, it results in higher unemployment and spreads more poverty in the total community.

There were, however, many differences of opinion on how fast the exchange controls should be removed. There were, and still are, many supporters of a "big-bang" approach, that is of a total removal of all the remaining exchange controls in one bold step. There is some merit in this approach, particularly if the total community would be prepared to absorb the cost of an immediate elimination of the economic distortions of the past in a relatively short period of time. This may require a sharp depreciation of the exchange rate, extremely high interest rates for a while, some decline in financial asset prices, a downward adjustment in real wages and salaries, and a very restrictive monetary and fiscal policy to gain the confidence of local and foreign investors. Without these adjustments, the premature abolition of exchange controls could create an untenable balance of payments situation that could easily lead to the reintroduction of exchange controls, which will, of course, signal mismanagement and permanent defeat.

In view of the extremely low level of the country's official foreign reserves, it would not have been possible for the Reserve Bank to provide support of any significance to the foreign exchange market in case of a large outflow of capital. In April 1994, when the Government of National Unity took office, the Reserve Bank held about R7 billion in foreign reserves, but also had about R6 billion outstanding in short-term foreign borrowings. The subsequent inflows of capital enabled the Reserve Bank to increase its foreign reserves to more than R15 billion at the end of 1995, with no foreign liabilities outstanding.

The South African authorities favour a gradual approach to the elimination of the exchange controls. Many structural adjustments are now in progress in the South African economy, such as the reduction of trade tariffs, the implementation of the economic reconstruction and development programme, the gradual reduction in the deficit on the public sector budget, and the modernisation of the financial markets. The abolition of the exchange controls is part of this major economic restructuring programme, and it is only with high risk that such an important element of the overall programme could be stepped up and implemented ahead of the rest.


3. Progress made with the phasing-out programme

The South African authorities made use of the opportunities offered over the past 2 years to reduce exchange controls gradually. So far, the following major steps were taken:


(i) The debt standstill arrangements which placed a restriction on the repayment of a part of South Africa's foreign debt were terminated at the end of 1993. A final debt rescheduling arrangement was entered into with South Africa's foreign creditors for a rescheduling of the "affected" indebtedness, and for the full repayment of the "blocked" debt in instalments up to the year 2002.

(ii) South African companies were allowed to make foreign direct investments in cases where the South African balance of payments stands to benefit directly from such foreign investment.

(iii) The financial rand system, in terms of which non-resident investments in listed South African securities and in other equities, were blocked within the country, was terminated in March 1995. This effectively ended the two-tier exchange rate system of the rand.

(iv) In June 1995, permission was granted to South African institutional investors to exchange through approved asset swap transactions, part of their South African portfolio for foreign securities. Over the past year, approval was given by the Exchange Control Authorities for about R14 billion of such asset swaps, enabling South African institutional investors to diversify up to 2 per cent of their total portfolio into foreign currency denominated assets.

(v) Substantial progress was made over the past two years in the development of a forward foreign exchange market outside of the Reserve Bank. The rand remains on a floating exchange rate basis, and it is important that both the spot and the forward exchange rates of the rand should reflect underlying market conditions, including expectations about future exchange rate movements.

The present status of exchange control as still applied by South Africa is therefore as follows:


South Africa now complies fully with the requirements of Article VIII of the International Monetary Fund as far as exchange controls on current account transactions are concerned. Such restrictions as do exist on current transactions are recognised as necessary for the effective implementation of the controls on the outward investment of resident-owned capital.

There are no exchange controls on non-residents, neither for capital, nor for current transactions.

Resident corporate organisations are allowed, under certain circumstances, to make direct investments outside of the country.

Resident institutional investors (pension funds, insurers and mutual funds), may diversify their asset portfolios partly into foreign assets through approved asset swap transactions.

Private individuals are not allowed to make any investments outside of the country.

Funds belonging to former residents of South Africa (emigrants) remain blocked within the country.


4. The further phasing out of exchange controls

South Africa therefore is one of more than 100 countries that still apply some form of exchange controls. The South African Government is, however, fully committed to further phase out exchange controls, and eventually to eliminate all exchange controls. At this stage, the Government is also committed to do it on a systematic and responsible basis that will not unduly disrupt short-term financial stability in the country.

Developments in the foreign exchange market in South Africa over the past four months cautioned the authorities to even greater conservatism in the abolition of the exchange controls. After the large capital inflows of the past two years had come to an abrupt standstill in the middle of February 1996, the exchange rate of the rand came under severe pressure and the Reserve Bank lost more than R4 billion in foreign reserves. The South African rand depreciated by more than 15 per cent in a relatively short period of time.

Despite these adverse developments, it is regarded as essential for South Africa to continue with a programme of gradually phasing out the remaining exchange controls. Rules for outward investments by South African corporates should be eased further, institutional investors should be allowed to invest a prudent part of the total assets managed by them in foreign currency denominated assets, private individuals should also be given some latitude to invest part of their savings in foreign currencies, and the blocked funds of emigrants should be released gradually.

In the final analysis, South Africa cannot be a full participant in an integrated global financial market and retain its exchange controls. South Africa cannot benefit fully from the much needed capital inflows into the country, and at the same time maintain restrictions on the outflow of capital. South Africa cannot sustain optimal economic growth and development to the advantage of all of its people for as long as important prices such as interest and exchange rates are not allowed to reflect the real fundamentals of the underlying situation.

The gradual phasing-out of the remaining exchange controls must therefore continue as an important element of the macroeconomic restructuring of the country. The timing of the next step, and the implementation of the programme will, to an important extent, be determined by the overall balance of payments situation. Premature action in a position of weakness can easily become counter-productive.

Good progress has been made over the past 2 years. We remain optimistic that further progress will be possible during the next few years.