Who’s afraid of a weaker rand? Not the South African Reserve Bank, according to a new study examining the pass-through of currency fluctuations to inflation.
The authors set out to find out why the correlation between the exchange rate and price growth has weakened in the past two decades, which coincided with South Africa adopting an inflation-targeting policy. They conclude that the central bank’s credibility is the main determinant.
“Improving monetary-policy credibility has helped reduce the exchange rate pass-through to inflation,” wrote Alain Kabundi, an economist at the World Bank, and Montfort Mlachila, the International Monetary Fund’s senior representative in the country, wrote in the paper published on the Reserve Bank’s website. “This is quite a remarkable achievement given the numerous shocks — including large food and fuel-price shocks, the global financial crisis, sharp fluctuations in the rand — that the economy has gone through.”
The study has implications for countries like Turkey, where political interference in monetary policy has undermined the independence of the central bank, sending the lira to a record low and inflation to the highest level in 15 years. In South Africa, by contrast, annual inflation has been within the target band for more than a year even as the rand depreciated.
“This finding is important because monetary-policy authorities do not have to worry to a great degree about exchange-rate fluctuations — over which they have made a policy choice not to influence — when deciding on monetary-policy actions,” the authors wrote. “The authorities can therefore mainly focus on domestic factors over which they have greater control.”
South Africa’s central bank doesn’t target a level for the rand, and has repeatedly said it won’t take policy action in support of the currency unless weakness feeds through to wider inflation. It cut its policy rate twice in the past 13 months, without pushing inflation above the 6 percent upper limit of its target range.
In Turkey, authorities have had to raise interest rates and take other measures to prop up the currency, with limited success. Investors are pushing for further action, including significant rate increases and even capital controls, as the lira’s meltdown hurts consumers’ sentiment and wallets and increases the debt burden of companies that borrowed heavily in dollars.