The credibility of monetary policy in achieving the target inflation range and fiscal discipline are important foundations for moderating exchange rate volatility, Finance Minister Pravin Gordhan said on Wednesday.
Tabling his 2011/12 Budget in the National Assembly, Gordhan said the growth and transformation of financial markets in recent decades had seen increased volatility of exchange rates and capital flows.
Global commodity markets now accounted for significant fluctuations in prices for South Africa's energy imports, mineral exports and food supplies.
The macro-economic environment facing South Africans -- through interest rates, exchange rates, inflation, and credit conditions -- could be destabilised by those international shocks, Gordhan said.
The macro-economic policy task was to provide a stable and predictable economic environment by offsetting such shocks as far as possible.
"Our monetary policy, designed to target inflation, has been conducted successfully by the SA Reserve Bank, achieving the current low rate of inflation and interest rates.
"Fiscal and monetary policy will continue to work in partnership. Monetary policy, operated by the Reserve Bank, will continue to be focused on controlling inflation, and we will continue to ensure that fiscal policy is countercyclical within a sustainable long-term framework," he said.
Movements in the exchange rate affected different sectors of the economy in different ways, and presented difficulties in macro-economic policy for many countries.
Recognising the impact of rand strength on the manufacturing industry, in particular, measures to moderate the potential effect of capital inflows were announced in the medium-term budget policy statement in October.
These included amending foreign exchange regulations to allow greater foreign investment by South African institutions, and stepping up foreign exchange purchases by the Reserve Bank, which partially offset upward pressures on the rand.
As a result of these policy adjustments, and in line with shifts in investor sentiment globally, the rand depreciated from December 2010 to mid-February 2011 by about 10 percent against the US dollar, the Euro and sterling.
During 2010 South Africa received net inflows of R92 billion in liquid foreign capital, which contributed to upward pressure on the exchange rate.
Since the fourth quarter of last year, South Africa experienced capital outflows.
Along with uncertainties and volatility in global financial markets this contributed to the depreciation of the rand.
Furthermore the increase in oil and food prices was posing new risks to the inflation outlook, Gordhan said.
Government would continue to assist the Reserve Bank accumulate foreign exchange reserves when market conditions were favourable and engage in foreign currency swaps to moderate the effect of capital flows on the exchange rate.
"Overly rapid currency depreciation carries risks to macro-economic stability, however, and so we expect the governor of the Reserve Bank to be vigilant in monitoring inflationary pressures and ensuring that monetary policy is effective in meeting our inflation targets.
"The credibility of monetary policy in achieving our target inflation range, combined with our commitment to fiscal discipline, are important foundations for moderating exchange rate volatility."
Changes in the volume and direction of capital flows might be significant over the year ahead, and were largely beyond South Africa's control or influence.
"We will allow the actions announced in the MTBPS to have their full effect and continue to monitor capital flows," Gordhan said.
Other countries, too, experienced high capital inflows in 2010.
Several, including Brazil, South Korea, and Thailand, introduced tax or regulatory measures to deter such investment flows and currency speculation.
"We have examined these options and their impact, and will continue to monitor the adjustments made in other countries, while recognising that circumstances vary from country to country."
National Treasury was cognisant of the risk that financial instability and currency volatility could arise from large capital movements.
If necessary, appropriate steps to moderate these effects would be taken, together with the Reserve Bank, Gordhan said.