South Africa's central bank lacks ammunition to defend rand - CNBC Africa

South Africa's central bank lacks ammunition to defend rand

Southern Africa

by Reuters 0

South Africa's central bank has little muscle to defend the rand through the upheaval in global markets. PHOTO: REUTERS/Siphiwe Sibeko

South Africa's central bank has little muscle to defend the rand through the upheaval in global markets, with foreign reserves stuck at low levels that could easily be wiped out if it attempted to influence the exchange rate.

South Africa brought its long-standing negative net gold and foreign exchange reserves into balance more than a decade ago, but its position has steadily declined since peaking at nearly $50 billion in February 2012.

This has rendered the Reserve Bank powerless to halt the rand's 21 percent slide against the dollar this year -- hitting a record low on Monday -- as investors expecting higher U.S. rates dump emerging market assets.

The local unit weakened on Monday after central bank data showed net gold and foreign exchange reserves barely ticked up to $41.244 billion in August.

This provides fairly adequate import cover of 5 to 7 months, but leaves the rand vulnerable to speculative attack, especially given a wide current account deficit of nearly 5 percent of GDP.

"South Africa's low level of reserves relative to its emerging market peers means we don't have the firepower or the ammunition to really influence the value of the currency," BNP Paribas Cadiz Securities economist Jeffrey Schultz told Reuters.

The central bank has long admitted it does not have enough reserves to try to defend the rand, a message Governor Lesetja Kganyago reiterated over the weekend.

In any case, it has little scope to build its arsenal as the dollar looks likely to remain strong to year end while the price of gold, a major component of South Africa's reserves, dives alongside other commodities.

"The short-term outlook for both the gold price and greenback is ‘more of the same’, which will put further pressure on the value of local central bank holdings," said Bart Stemmet, an analyst at NKC African Economics.

"This will somewhat undermine the value of the rand – already oversold, in our opinion – in the months ahead when the Federal Reserve is set to raise its interest rates for the first time in almost a decade."

The bank's limited reserves could leave it little choice but to raise interest rates further after a 25 basis point hike in July, even as economic growth languishes below 2 percent.

The monetary policy committee will hold its fifth of six rate setting meetings for 2015 later this month.

"The MPC is expected to focus more on the upside risk to inflation emanating from the rand's sharp slide in recent weeks and the threat of even further weakness in the months ahead," Nedbank analysts Johannes Khosa and Dennis Dykes said in a note.

"We still believe that there is a strong danger of another 25 basis points hike in September."