Monetary Reset

At its launch in 1961, the South African Rand was worth US$1.40. Its value remained above the U.S. dollar for 21 years, and was only overtaken in 1982, when it took around R1.20 to purchase $1. Generally, the currency has taken only a downward trend (lost value), over the years, with periods of slight recovery in between. At independence, in 1994, it was trading at R3.50 to the dollar. Almost 30 years later, the exchange rate is now R18.80 for each dollar. Concurrently, the average annual inflation rate since 1994, to date, is 5.54%. This produces a cumulative inflation value of 377%, through the past 29 years. This means that, prices are currently, almost five times (4.77) higher, than in 1994. By inference, what costs R20 today, could be purchased for R4 in 1994. Understanding that inflation figures mainly target basic commodities, further insinuates that, prices of luxury and non-basic goods have surged even sharper, than the 377%, over the years. If this exact trend were to continue for the next 30 years, assuming that all things remain constant, then the Rand will be trading at almost R100 to the dollar, with prices following in the same direction. To be realistic, things may actually be worse or better, depending on how the economy is managed, going forward. If there are issues with domestic political stability and other unfavourable economic phenomena, then downside risks will prevail. A major problem with persistent inflation is that, it causes an expectation of further price hikes in the future. As a result, trade unions and businesses will exert more upward pressures on wages and profits, based on inflationary expectations, thereby, fuelling more virulent price hikes. 

In order to curb this, a monetary reset may be necessary. In this regard, the SARB needs to be informed and ready to use redenomination as a viable contingency tool for the reset. Redenomination is the process of removing zeros on bank account balances and the face value of bank notes, so as to create a system where society and businesses can work with figures that are easier to calculate and manage. Excessive inflation results in the need to memorize, record, manage, distribute and interpret enormous monetary figures. It becomes difficult to keep up, as the human mind is not trained to deal with them. When monetary authorities remove zeros from the currency, new bank notes, with lower values, will be issued and the older ones are phased out. The new, redenominated notes, will provide a chance for creating positive sentiment in the domestic economy, thereby, becoming a mechanism towards retaining depreciation and inflation. In other regions, the process has been historically characterised by renaming the national currency, so that the psychological impact on society is maximized. For example in China, in 1949, the Silver Yuan was introduced to replace the Gold Yuan, which had undergone excessive depreciation. One Silver Yuan was worth fifty million Gold Yuan notes.
Using South African examples, if the SARB does a redenomination by removing one zero to Rand balances, a R10 note will be replaced by a new coin or note of R1. Consequently, R20, R50, R100 and R200 will be replaced by R2, R5, R10 and R20 notes, respectively. All Rand denominated bank balances will also lose a zero. For instance, R32 800 will be redenominated to R3280, Whilst R72 will become R7.20. Retailers and all merchants in the supply chain will follow suit, according to the procedure. This should not be confused for a revaluation of the currency. After a systemic elimination of zeros across the board, the purchasing power of R100, will be the same as the buying power of the new R10 note. Old currency notes will be redeemed by the banking system, whilst new ones are issued. The new currency might be given a new name, for greatest impact. For instance, it might be launched as the “Pretoria dollar”, whilst Rand balances are redenominated to the new currency, at a rate of SAP$1: R10. In this case SAP$ is a theoretical “South African Pretoria Dollar”. 

These discussions may seem far-fetched, whilst  general exchange rate and price stability are currently prevailing. However, a contingency plan for an eventuality where redenomination may be a necessary option, is vital for the SARB to keep. There is a saying which states that- “The best way to predict the future, is to create it”. In the same manner, through comprehensively adjusting for any possible changes to the domestic currency and exchange rates, the SARB will be found prepared and ably respond to any outcome, instead of falling victim to events.  

Now that the technical side of redenomination has been explained, it is paramount to look at the type of environment required before, during and after the process. If certain economic principles are observed, then the country will not find itself coming back to another round of redenomination, in the future. It is important to note that, the more that an economy embarks on such exercises, the higher  the risk of losing monetary credibility, with citizens, business, investors and international financiers. Doing things right, once-and-for-all, will be key, as failure would be a wasted opportunity that may come with adverse costs for the nation. 

In this regard, there is a need to revisit and correct issues which give rise to an adverse Rand exchange rate and inflation. These conditions must be met, well-before the launch of the exercise. When there is stability prior to the exercise, the public will embrace and support it. Issues around designing and launching of the new currency will also be discussed, later. 

Amongst causes of a weakening exchange rate and inflation, are; gaping budget deficits, political instability and policy uncertainty, volatile commodity prices, stunted economic growth and expansionary monetary policies. 

To address deficits, the government has to consider a stake in new businesses operating in strategic industries. Appropriation of current firms should be avoided as opposite results (crashing of the Rand), may be obtained. With growth in population and increase in AI and technology replacing human jobs, it will remain difficult for the government to keep up with revenue needs, unless it participates in strategic sectors of the economy. To avoid issues of poor management and governance in business, public ownership in strategic industries may be limited to,  no more than 30%. This means that the government will not appoint the management of such companies or determine their strategic and operational direction. All there will be, is to reap financial dividends, which can be channelled towards infrastructure, welfare programs and other avenues for economic growth. 

Political stability and policy certainty are low hanging fruits which should be picked and utilized for the benefit of the nation. Improving on the containment of crime and safety, is set to produce positive results as well. 

With regards to fluctuating commodity prices, more investments in value addition of primary products should be sought. The higher value of beneficiated materials and growth in employment due to development of industries in the value chain, will result in abounding benefits for the exchange rate, employment, and the economy. 

Since 1994, the SARB has been making great effort towards managing exchange rate stability and inflation. Currently, the official statements from the SARB indicate that over-tightening may continue in order to tame prices, as inflation is a perceived bigger risk than liquidity problems. This should be commended and if the apex bank continues with such an approach, inflation will eventually be put under control. 

A currency board may be proposed by some but it is most difficult to sustain, when there are limited foreign exchange reserves. In such a set-up, all domestic currency is to be backed by forex. For instance, R1 will be backed by and exchangeable for US$1. Alternatively, in an example closer to reality, R10, will be exchangeable for a dollar. This means that the government will need enough forex reserves and money supply will not increase unless there is a higher stock of dollars in the country. Local interest rates will naturally be tied to or closely follow rates in the U.S. domestic market. Such an institution ensures that money supply and inflation are kept tightly controlled. However, its ability to grow the economy through periods of a downward economic cycle, is almost non-existent. Nevertheless, there will be high integrity of the banking system, which may attract more foreign investment into the country.

The design and launching strategy for the new currency, are equally important aspects to carefully consider. Good design of new bills will assist in creating favourable public perception. Knowing public preferences and having their buy-in, goes a long way towards creating an atmosphere where the currency is embraced. The face value of the different bank notes and total quantity of bills in circulation, will also need to be determined. Thereafter, publicity and educational campaigns may be rolled out to educate and inform the public. 

Resetting the system through redenomination, will give the economy a chance to revive the sovereign currency. If the current inflationary levels persist, it will just be a matter of time until the process becomes necessary. In the worst case scenario, redenomination will avert a situation where people might end up having to carry bags of domestic currency, in order to settle basic transactions. With gradual devaluation of the currency, there will be pressure on cashiers and bank services such as ATMs. A properly planned and managed redenomination process will inevitably be an indispensable contingency plan for the SARB. 

Kevin Tutani is a political economy analyst- tutanikevin@gmail.com

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