History in the new South Africa: an introduction - Det danske ...

to support job creation. The income tax burden – the share of aggregate personal income paid
in tax – fell from almost 15 percent to below 12 percent.
(ii) Monetary and exchange rate policy
In any economy, the monetary authorities would choose, if they could, to have an open capital
market to enable access to external finance, and a stable nominal exchange rate to support
international trade and the freedom to adjust interest rates to meet domestic objectives such as
output growth and price stability. But these three goals constitute a ‘trilemma’: only two can
be pursued simultaneously, at least in the medium-term, so policy authorities must decide
which one to abandon.
Until 1994, South Africa’s capital account was closed, with exchange controls and a dual
exchange rate (commercial and financial rand rates) to discourage capital outflows and
disinvestment. Domestic business strongly favoured liberalisation to allow capital outflows,
and the Reserve Bank was committed to this by 1994. The two-tier currency was abolished in
March 1995 removing restrictions on foreign owners of capital, and three-quarters of the
foreign exchange control regulations on domestic investors were eliminated by 1998. In 1995,
branches of foreign banks were allowed to operate and the Johannesburg Stock Exchange
admitted foreign brokers. By 2000, there were 12 foreign bank branches and 61 representative
offices in South Africa. Inflows of direct foreign investment have also been encouraged by the
establishment of promotion agencies to woo foreign multinationals and more liberal
regulatory regimes in most infrastructural services.
After opening the capital markets, the Reserve Bank initially tried to avoid the trilemma and
pursue all three objectives. The Bank was anxious about excessive inflows, which can cause
price inflation and exchange rate appreciation damaging international competitiveness.
Between July 1994 and June 1995, there was a net inflow of R18.6 billion (about 3.8 percent
of GDP), compared with the accumulated net outflow of R50 billion between the debt
standstill in 1985 and 1993. Capital account liberalisation in March 1995 was also intended to
reduce net short-term inflows by offsetting large gross inflows with capital outflows. Capital
inflows were used to increase foreign exchange reserves, enabling the Reserve Bank to reduce
its large ‘contingent liabilities’ of US$25.8 billion in the forward foreign currency market,
which were a source of financial weakness.
Up till August 1998, the Reserve Bank raised real interest rates to hold back inflation, and
‘sterilised’ net capital inflows, keeping them offshore to limit money supply growth, also to
restrict inflation. the nominal exchange rate was slowly depreciated to enhance
competitiveness while avoiding inflation. Trying to avoid the trilemma was an optimistic
strategy, and possible only if net capital inflows were large and had long-term maturities. This
was the case between March 1995 and January 1996, and again between September 1996 and
April 1998. But an open capital market meant that net inflows were susceptible to abrupt
reversal, which occurred in both February 1996 and May 1998, the first triggered by domestic
political uncertainty and the second in the wake of the Asian crisis. Expecting a rand
depreciation, foreign portfolio investors’ herd-like behaviour – rushing to sell randdenominated
assets to avoid losses in their own currency – produced a self-fulfilling
prophecy. In both episodes, the Reserve Bank tried to stem the outflow by selling dollars into
the market and increasing its future commitments to buy dollars, a costly and ultimately
wasteful exercise. In September 1998, these commitments were roughly the same as in March
1995, but billions had been wasted in the interim. At the same time, real interest rates were
hiked – about 2.5 percent in 1996 and a full 7 percent in 1998 – in a vain effort to attract
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