The rand tanked on Monday after the Public Protector recommended changes to the Constitution that would see the removal of a clause to protect the currency.

Public Protector Busisiwe Mkhwebane announced her findings after her investigation into the South African Reserve Bank’s assistance to Bankorp between 1985 and 1995, which Absa bought in 1992. She wants Absa to repay R1.125bn, a move the bank refutes as it believes it has paid all money owed.

However, her big remedial action was a recommendation that the Portfolio Committee on Justice and Correctional Services change the Constitution.

It “must initiate a process that will result in the amendment of section 224 of the Constitution, in pursuit of improving socio-economic conditions of the citizens of the republic, by introducing a motion in terms of section 73(2) of the Constitution in the National Assembly and thereafter deal with matter in terms of section 74(5) and (6) of the Constitution”.

She wants section 224 of the Constitution to read:

“The primary object of the South African Reserve Bank is to promote balanced and sustainable economic growth in the Republic, while ensuring that the socio-economic well-being of the citizens are protected.

“The South African Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, while ensuring that there must be regular consultation between the Bank and Parliament to achieve meaningful socio-economic transformation.”

Mkhwebane’s suggestion removes reference to “protect the value of the currency”, Bloomberg told traders on Monday.

The Constitution currently states: “The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic.”

Opening Pandora’s box

Nomura economist Peter Montalto said the rand is taking a knock because it’s “not a good headline … it’s a live wire issue”.

“Even if a change here is not likely to actually occur, the risk of it is important to markets and ratings agencies,” he said in an emailed comment to investors.

“This is quite unusual that a Public Protector has been so specific on changing the Constitution or indeed be so radical on transformation.”

“This is touching the real last Pandora’s box,” he said. “Note, whilst the PP is meant to be independent she is widely viewed as a Zuma loyalist.

“I don’t think this is going to happen in the short to medium run. The ANC cannot really muster the support to change the Constitution in Parliament and would require a two-thirds majority.

“What the worry is here is that actually it’s much, much easier than that. You just need a new MPC (monetary policy committee) mandate, which is done by a letter from the FinMin to MPC and can be done technically at any time.

“I do not think (Finance Minister Malusi) Gigaba is going to do that, but this raises the risk and promotes the idea in public debate about how secure this last bastion of an institution is.

“The SARB is also one of few ratings positives for the ratings agencies,” he said. “The very fact this issue is being raised and the SARB dragged into the debate is negative.

“However, I see the SARB leadership strongly and resolutely defending their independence and existing mandate including via court action if necessary.”

By Matthew le Cordeur for News24

In a highly debated article, Investec’s Brian Kantor went knocking on the South African Reserve Bank’s door, pleading with them to focus on the things they have control over. His main concern is that of stagflation.

And while high inflation is usually cornered by higher interest rates, that’s the case when it’s demand driven. And he argues in South Africa’s case, it’s due to factors beyond the Reserve Bank’s control.

The Bank wasn’t listening and raised rates, using high inflation as the reason.

In economic theory there are two types of inflation:

Cost Push Inflation: This is price increases caused by increased costs of production (increased labour costs, increased costs of raw materials (think higher oil prices due to unrest in middle east, or increased prices for agriculture products due to droughts that are limiting supplies).

Demand Pull Inflation: Demand pull inflation is experienced when there is an increase in demand for goods and services, or when the demand for goods and services outstrips supply of goods and services. Strong growing economies will have increased demand for goods and services as more people are employed. Leading to increased inflation.

SARB’s main tool to control inflation is interest rates. The problem with interest rates is that it is a very crude tool to control inflation. The theory goes that if inflation goes up, it implies that there is too much money available to spend in the economy, and retailers and wholesalers know this, and they start pushing up prices to earn higher margins on their products, causing inflation to rise (Demand Pull inflation).

While this might be true for a fast growing economy. This is hardly ever the case for an economy with sluggish growth, as South Africa is currently experiencing. Interest rates are not as effective in controlling inflation when it is caused by Cost Push factors.

Now that South Africa’s inflation rate has breached the 3% to 6% target of SARB, they need to act (and they have been acting over the last couple of months by increasing interest rates). Problem with increasing interest rates to control inflation, when inflation is caused by external factors and shocks (Cost Push inflation), and not by increased demand (Demand Pull inflation).

Overall demand in the economy will slow down as interest rates lowers the amount of money people have to spend on buying goods and services as more of their money goes towards paying their debt,

Yet there is nothing to suggest that inflation would slow down too as it is not caused by increased demand. In essence we can end up with continued high inflation and lower economic growth (since higher interest rates is slowing down spending in the economy). High inflation and low to no growth…That’s called Stagflation. And this is the situation South Africa is in.

SARB is walking a very tight rope and needs to be careful when deciding on interest rates, as they can end up doing more harm than good by blindly increasing interest rates as inflation goes up. We suspect that the last couple of interest rate increases has been more to protect the vulnerable Rand than controlling inflation.

Higher interest rates leads to more foreign currency flowing into SA to take advantage of higher interest rates, leading to increased demand for the Rand, and it strengthening. A stronger Rand will also ensure that we import less inflation. Import inflation occurs when prices of goods being imported becomes more expensive as the Rand weakens, leading to those goods costing more in Rand terms.

SARB will never admit or acknowledge that they might be increasing interest rates to protect the Rand, as that is not their mandate, but we suspect they are more worried about that Rand than they are about inflation at this point in time, as they know current inflation trends is not due to increased demand in the economy, but due to external factors outside their, or consumers control.

By John Maynard* for www.fin24.com
* This is a nom de plume

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