Could Exchange Control Regulations tighten?

Nov 10, 2018

The issue of increased controls placed on foreign exchange transactions by the SA Reserve Bank is not only of concern to investors and business in general, but also a cause of great anxiety amongst Expat South Africans who still have investments back in the country. It has been conventional wisdom that exchange control will continue to be relaxed until finally done away with completely. Really?

Exchange Control is typically instituted to act as a shock absorber in order to protect a country’s currency against volatility. It acts like a faucet: by controlling the flow of capital the Reserve Bank essentially attempts to manage sudden currency appreciation or devaluation, especially due to political or economic shocks from either internal or external sources.

But Exchange Control comes at a cost – not only the very real cost of regulation and compliance in all its forms, but also in deterring investment and making it more difficult for local businesses to compete, invest and grow internationally. It also makes it difficult for local companies to access capital (raise funding) from abroad, and for local citizens to diversify their portfolios. 

During the apartheid-sanction years the Exchange Control regime – as unpopular then as it has been since – served the authorities in their quest to shield the Rand and the sanction-affected economy against inflation and other dangers. These controls on capital movement were relaxed after 1994.

Today institutional funds can invest up to 25% of their value abroad. Individual residents were at first allowed to invest up to R1m overseas per annum, then this value was upped to R4m, and currently it is effectively set at R11m per person per annum, or R22m per household family unit. Individuals can even apply to take larger amounts abroad, and as long as all is in order (including taxes) the SARB typically grants permission. Importantly, there are no longer penalties levied on transfers – remember Mark Shuttleworth’s legal battle with the authorities to get his R150m “levy” back? These levies were essentially an indirect tax.

This relaxation of Exchange Control Rules and Regulations led most commentators to expect a continuation towards eventual full abolishment. Indeed, successive ANC governments seemed to understand business and foreign investor’s concerns about the system, and successive Finance Ministers made encouraging noises in this regard.

But then the financial crises of 2008 hit, and a number of Emerging Market Economies (including SA’s BRICS partners) subsequently fell on hard times. Growth in China slowed and the commodity cycle tanked in the following years, hurting SA. The resulting turmoil not only brought a fresh appreciation of the few advantages of exchange controls, it even led some economies to introduce new controls on capital flows – including China and Russia.

Other factors have contributed indirectly to entrench Exchange Controls: today the intense administration inherent in managing the Exchange Control regime acts as a secondary bulwark against tax evasion, money laundering and funding of terrorist activities.

But the risk is not one of simply maintaining the status quo, it is one of returning to a much more restrictive regime. South Africa is currently facing a well-publicized political and economic crisis. Recent downgrades to junk bond status by international ratings agencies suddenly raises the unwelcome specter of large investor outflows and a downward debt spiral. It may be alarmist at this point, but there is even talk in the air that, as government debt increases as a percentage of GDP and as borrowing costs escalate, South Africa may be heading for an eventual IMF bailout – with all the austerity that such en event would entail.

How will the ANC government respond? Tightening Exchange Control may provide an easy and politically expedient strategy, in conjunction with higher taxation (the implementation of which has already started). First steps could be the drastic lowering of capital allowances, the implementation of taxes or levies on any funds destined for investment abroad, and the restriction of investment freedom for institutional funds.

As always, the poor will suffer the most when the predictable economic costs of such an action becomes evident, but any populist measures to restrict the “fleeing” of “rich, white, monopoly capital” will go down well with the average voter.

Is such a scenario plausible? It is difficult to say at this point in time, but the actions of the ruling political party have repeatedly confirmed that short-term political gains trump longer-term fiscal prudence. The prospect of restricted capital freedom is therefore definitely a concern in the medium to long term for anyone with investments in SA. It will come without warning (which will be counter-productive as it will simply cause a stampede for the gate).

A defensive strategy could be prudent in this regard. Whilst the going is still relatively good…