New policy poses rand volatility risk

A change in the way the Reserve Bank implements monetary policy may lead to greater volatility in the rand.

The transition starts on Wednesday night and will see the central bank shift to a surplus system from its current deficit set-up, allowing commercial banks to hold and earn interest on excess reserves. The Bank will also introduce measures to stop lenders hoarding liquidity and so help maintain an interbank money market similar to the “tiered floor” framework of the Reserve Bank of New Zealand and the Norges Bank.

While the change will not affect the central bank’s inflation target or interest-rate decisions, it may make it easier to speculate in the rand, resulting in wider price swings in times of stress. Covid-elevated randdollar basis-swap rates made it expensive to short the rand.

“The currency basis will contract, making it cheaper to short the rand,” said Michelle Wohlberg, a Johannesburgbased fixed-income analyst at Rand Merchant Bank. “This could result in volatility in riskoff bouts.”

The rand has been less volatile this year than a host of peers — including the Turkish lira, Polish zloty and Brazilian real — even as risk assets came under pressure amid rising global inflation and policy tightening, concern about a slowdown in China, and Russia’s war on Ukraine. The currency’s historic volatility versus the dollar has risen 63 basis points to 14.66%, the seventh highest of the 23 developing-currencies monitored by Bloomberg.

In a published paper addressing concern about volatility, the Reserve Bank said that managing the risk would require “caution and vigilance”, during the transition to the new framework and in moments of acute market pressure.

SA is the first emerging-market economy to adopt the tieredfloor framework.

“The risk is assessed as modest and does not represent a major objection to the concept of the new monetary policy implementation framework,” the Bank said. “That said, the exchange rate may prove to be one area where SA’s status as an emerging market yields a different experience to those of advanced economies which have used floor-style systems.”

The Bank has “a long track record of tolerating FX volatility”, and inflation expectations are anchored, and therefore not highly sensitive to exchange rate fluctuations, the paper said.

THE RISK IS ASSESSED AS MODEST AND DOES NOT REPRESENT A MAJOR OBJECTION TO THE CONCEPT OF THE NEW MONETARY POLICY FRAMEWORK