Is it time to abandon exchange controls?

South Africa has had exchange controls since before any of us were born. Why do we still have them?

USDZAR – have exchange controls protected the value of the rand?

Source: Trading Economics

This is where it gets murky. Exchange controls are supposed to protect the rand against external shocks, but there is little evidence it has done much to protect the wealth and savings of South Africans.

The rand has depreciated 80% against the USD since 2008. That’s a brutal blow to inflation (imports become more expensive) and to savings. Conversely, the weaker rand has helped exports, particularly miners.

Would it have been worse if we had no exchange controls? We can only guess at the answer.

The fear of capital flight remains ever present in the minds of our central financial planners – a fear that has persisted since the apartheid years.

Arguments in favour of exchange controls

Controls make it more difficult to move money offshore, forcing capital to remain in the country. There is an ever-present fear at the Reserve Bank that free capital flows will result in funds draining out of the country in search of better opportunities abroad. Were capital to flow freely, the Reserve Bank would have to hike interest rates more aggressively, and that would strangle economic growth and lead to higher unemployment.

There is also a fairly valid argument that exchange controls have been relaxed in recent years, allowing South Africans to move R1 million annually abroad under the Special Discretionary Allowance (SDA) and the R10 million Foreign Investment Allowance (FIA). Those with substantial savings in SA have been able to ship funds abroad at a fairly steady pace and build offshore investment portfolios. It’s relatively easy for multinational companies to repatriate funds abroad, provided they go through the proper processes.

There is also evidence that exchange controls cushioned SA during major financial shocks – such as the 2008 financial crisis and the 2020 Covid shock. The ZAR, already one of the more volatile currencies in the world, would likely have experienced far greater depreciation than was the case during these events.

Arguments against exchange controls

Capital tends to flow to countries where it is easy to invest (and disinvest). Imposing restrictions on capital flows signals distrust to foreign investors, and this helps explain why foreign direct investment (FDI) to SA fell from $4.6 billion in 2019 to $3.1 billion in 2023, according to World Bank data.

Controls distort markets by trapping capital domestically, discouraging efficient allocation. Businesses hoard cash or invest in low-yield local assets rather than global opportunities, which stunts growth. SA’s per capita GDP has remained stagnant since 2008.

Experience elsewhere in the world shows abandoning exchange controls creates currency volatility for a period before it stabilises.

Another problem with exchange controls is it imposes a costly burden on the country, with most transactions (other than the R1 million SDA) requiring Reserve Bank permission. Even the sale or assignment of intellectual property requires permission from the Reserve Bank’s Financial Surveillance Department.

Large forex transactions can be delayed but are unlikely to be refused.

Experience elsewhere in the world

Four countries that abandoned exchange controls are Chile (2001), Mauritius (1994), South Korea (1997-2000) and Poland (1990s).

All four saw initial depreciation—Chile (23%), Mauritius (11%), Korea (in the midst of the Asian crisis when the won lost 89% against the USD), and Poland (31%).

What is perhaps more interesting from a South African perspective is what happened to growth in these controls post-exchange controls.

The initial drop in currency value in all four cases spurred export growth and inward investment. In Poland, inflation fell from 585% in 1990 to 10% by 1999, with GDP averaging 4.8% growth in the following decade.

The South Korean won was almost obliterated during and after the Asian financial crisis of 1997, but had stabilised by 2000 by which time inward investment came pouring in and a weak currency triggering an export boom.

The Chilean peso suffered an initial 23% drop in value post-exchange controls but stabilised by 2003, assisted by a copper export boom and massive inward capital flows, particularly ion the mining sector.

The Mauritian rupee devalued modestly (11%) immediately after the island national abandoned exchange controls, but this was offset by a tourism boom made possible by a weaker currency. The country subsequently diversified into textiles manufacture and financial services, turning it into a spectacular African success story.

Conclusion

Abandoning exchange controls in SA will lead to short-term volatility, but it must be flanked by a range of other measures intended to make the country more attractive to FDIs – such as tax incentives, relaxed labour laws, energy grid stability and re-establishing the rule of law.

It is way past time for South Africans to be debating whether we need exchange controls and what the country would look like thereafter. The above, we hope, gives some idea of what to expect.

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