Standard Bank’s Manager of Economics and Market Research Mally Likukela
Standard Bank Namibia
The recent weakening of the South African Rand has undoubtedly triggered the erosion of the primary benefits of the fixed exchange rate that Namibia has enjoyed from the fixed exchange rate arrangement embedded in the Common Monetary Area (CMA) agreement.
Namibia became a member of the CMA immediately after independence in order to benefit from the price stability, credibility and less volatile South African Rand that the CMA offered. The arrangement which entails that Namibia pegs its currency to the Rand has been beneficial in several ways, but since the recent downward spiral of the Rand, these benefits are gradually eroding.
This situation has brought to the fore the fundamental question of whether Namibia should explore alternative exchange rate regimes that will better serve Namibia’s developmental interests. Although this is an economic question, it has serious political implications given the fact that the CMA agreement was borne out of a political imperative.
This article discusses how the recent weakening in the Rand is eroding the main benefits of the fixed exchange rate arrangement that were accrued to Namibia. The article will also offers and suggests some alternative exchange rate regimes.
The primary benefit that Namibia has been enjoying from the arrangement is that of price stability. It is believed that when a country pegs its currency to the currency of a country that has low inflation, it tends to import low inflation from that particular country.
The measured inflation rate between Namibia and South Africa although may have diverged at times in the past because of the price of non-tradable goods, it has in most cases remained co-integrated.
The most recent past evidence seems to support this conclusion. In fact since 1993 the domestic inflation rate has closely mirrored the prevailing rate in South Africa. However, all this is set to change following the recent depreciation of the Rand against the major currencies of the world.
A further weakening in the Rand will see the cost of imported goods for consumers rise, making it more expensive for consumers to purchase items such as imported electronics or other durable and semi-durable items sourced from abroad.
As we all know, Namibia imports between 75% and 90% of its consumables from South Africa, meaning that Namibia will definitely import these from South Africa at even higher prices should the Rand continue to fall.
Even more worrisome is the fact that local consumers also won’t benefit from the slide in global oil prices that is expected to fall to record low levels closer to $30 a barrel. Simply put, this means that as the rest of the world gets lower petrol prices; we get ones that are higher.
Many governments in developing and developed countries have for a number of reasons experienced difficulties in making their policies generally credible. Namibia was fortunate enough to align its policies with that of the CMA of which South Africa was the main anchor immediately after independence.
With the aim of establishing a credible policy environment, membership of the CMA and the rule-based policies, such as the restrictions placed on government borrowing became necessary and were hence instrumental in raising the government’s credibility.
With the aftershock of the unfortunate and shocking removal of the Finance minister of South Africa – South African government’s policy credibility was brought into disrepute. The event immediately sent shock waves of panic in the financial market and caused the Rand to tumble down.
The Rand broke through R15 against the US dollar the same evening after President Jacob Zuma announced the removal of Finance Minister, Nhlanhla Nene. Namibia being the closest neighbor and highly integrated to South Africa both politically and economically, could not survive the investor’s sentiment regarding its policy credibility.
The continued weakening of the Rand has undoubtedly set in motion waves of doubt on the South African policy credibility and credibility being one of the key benefits Namibia enjoyed from the arrangement, Namibia definitely has all the reasons to be concerned.
As a developing country, Namibia’s credibility should be unquestionable and time consistent. Simply put, a time consistent policy is a policy that will be sustained as circumstances change over time. Time consistency is important for Namibia because it bears the advantage of credibility due to its predictability of the future.
It therefore reduces monetary disturbances and eliminates the doubts of the financial and real sector markets, thus creating a healthy and attractive environment for investment and economic growth for Namibia.
Another major advantage of the fixed exchange rate arrangement was that it helped to avoid exchange rate fluctuations and reduces the unfavorable effects of exchange rate uncertainty on trade and investment.
Given the fact that South Africa was and remain Namibia’s main trading partner, a major benefit for Namibia was the elimination of uncertainty associated with exchange rate variability. Since Namibia is a net importer of goods and services from South Africa, the benefits derived from the arrangement were expected to be large.
The recent developments in the Rand however remain very discouraging as it brings to the fore the ability of the Rand to be the anchor currency in the CMA. More worrying is the fact that Namibia’s trade with the rest of the world is priced in South African Rand – a currency that has become extremely volatile.
The sustained depreciation of the Rand has eroded the Rand’s ability to be the anchor currency so severely that Namibians have started to ask whether Namibia as a country should explore alternative exchange regimes.
The low volatility which the Rand enjoyed in past years has become a thing of the past and hence these calls for alternative exchange rate regimes that will better suit Namibia. The hunt for a more stable anchor currency must begin immediately.
Calls for an alternative exchange rate regime have increasingly becoming louder than ever before and it’s about time the Government of Namibia responds and acts to avoid being caught off guard should something horrible happen to the Rand.
In fact if the rand should fall just another 20% over the next year then by the beginning of 2017 a dollar would cost R20. Most financial analysts are in agreement that R20 per US dollar is on the cards so quickly.
In the absence of a documented official plan B exchange rate regime, Namibia can still explore the following three basic choices. These choices can be used in determining the appropriate exchange rate regime – a monetary linkage between the Namibian economy and the rest of the world.
Namibia can let its currency float freely in the exchange markets against all other currencies, or it can fix the price of its currency against a specific foreign currency or a basket of foreign currencies.
Furthermore, Namibia can pursue intermediate approaches, letting rates float to some extent but intervening to limit those fluctuations either ad hoc ("managed floating") or pursuant to some pre-determined parameters ("target zones," "crawling bands," etc.)
> Caution must however be taken given the increasing intellectual and policy consensus that suggests that "fixed but adjustable" pegs - the traditional means of "fixing" the exchange rate, does not work well for either industrial economies or emerging market economies.
Hence a country must either float to some extensive degree or fix permanently and thus credibly. While determining both regimes, it’s important to note that both courses have clear costs as well as benefits which must be weighted on the scale of balance.
(This article is compiled by Standard Bank Namibia’s Manager of Economics and Market Research Mally Likukela)