Rand volatile as South Africa changes policy

A shift in how South Africa’s central bank administers monetary policy may cause the rand to become more volatile.

• The switch will begin Wednesday night, with the central bank transitioning from its present deficit system to a surplus one, allowing commercial banks to store and earn interest on excess reserves.
• While the adjustment will have no effect on the central bank’s inflation target or interest-rate choices, it may make it simpler to speculate in the rand, leading to larger price swings during times of stress.
• Since the outbreak, elevated ZAR-USD basis-swap rates have made shorting the South African currency expensive.
• The currency’s historical volatility versus the US dollar has jumped 63 basis points to 14.66 percent, making it the ninth most volatile of the 23 developing-currency currencies tracked by Bloomberg.

The switch will begin Wednesday night, with the central bank transitioning from its present deficit system to a surplus one, allowing commercial banks to store and earn interest on excess reserves. The South African Reserve Bank will also implement mechanisms to prevent banks from hoarding liquidity, thereby assisting in the maintenance of an interbank money market, similar to the “layered floor” system employed by the Reserve Bank of New Zealand and the Norges Bank.

While the adjustment will have no effect on the central bank’s inflation target or interest-rate choices, it may make it simpler to speculate in the rand, leading to larger price swings during times of stress. Since the outbreak, elevated ZAR-USD basis-swap rates have made shorting the South African currency expensive.

“The currency basis will drop, making it cheaper to short the rand,” said Michelle Wohlberg, a fixed-income analyst at Rand Merchant Bank in Johannesburg. “This could lead to volatility during risk-off periods.”

The rand has been less volatile this year than a number of peers, including the lira, zloty, and real, despite rising global inflation and policy tightening, fears of a Chinese slowdown, and Russia’s war with Ukraine. The currency’s historical volatility versus the US dollar has jumped 63 basis points to 14.66 percent, making it the ninth most volatile of the 23 developing-currency currencies tracked by Bloomberg.

In a report addressing volatility concerns, the Reserve Bank stated that mitigating the risk would necessitate “caution and monitoring,” both throughout the transition to the new framework and in times of extreme market pressure. The tiered-floor framework was adopted by South Africa as the first emerging-market economy.

“The risk is evaluated as moderate and does not constitute a significant obstacle to the concept of the new monetary policy implementation framework,” it stated. “However, the currency rate may be one area in which South Africa’s status as an emerging market delivers a different experience than that of advanced economies that have adopted floor-style systems.”

According to the study, the central bank has “a lengthy track record of tolerating FX volatility,” and inflation expectations are anchored and so not extremely susceptible to exchange rate swings.