Why exchange controls aren't going anywhere

So there is the on-going saga that is exchange controls.

Every year there is also the usual pontificating, at national budget time, on the future of exchange controls. The financial pundits will all agree that exchange controls need to go and that maybe this is finally the year that the minister of finance will pluck up the courage to drop exchange controls completely and finally give South Africans (read into that wealthy and middle-class South Africans) the financial freedom to send their money wherever they want and have bank accounts (locally or offshore) denominated in a foreign currency (preferably US dollars or British pounds).

Once the national budget speech is over, pundits sulk in their respective corners and bemoan the fact that, yet again, exchange controls have not been dropped. And so the cycle goes.

But why won’t the government drop exchange controls? Because they need you to pay your tax bill in rands. In essence, it’s by dropping exchange controls that the government signals to the market that it’s okay to hold financial instruments in foreign currencies. The problem for the South African government is, that once exchange controls are dropped in their entirety, they will no longer wield significant clout (read into that the ability to tax) over your financial wealth.

As a result, the government resorts to drip-feeding taxpayers and slowly increasing the allowance that South African payers are allowed to move offshore every year. In essence it’s like a sugar addiction, just feed people enough sugar every now and again to keep your addicts happy and the system (hopefully) won’t fall apart.

The problem is exacerbated, as I noted in a previous blog posting, that in order to increase tax receipts, a government needs to either:

Improve its ability to collect tax receipts; and/or
Formalise greater portions of the informal economy in order to increase the tax base.

One of the structural issues of the South African economy is that while the South African Revenue Service is pretty good at collecting the money due to them, the major problem that the South African government faces is its inability to formalise greater portions of the informal economy, thus drawing people into the tax base.

The net effect of this is that the tax base in South Africa is highly skewed with only 3.3 million taxpayers (depending on which stats you use) but 14 million people drawing state benefits (again, depending which stats you use). In the long-run, the state cannot afford to make these benefit payments and they know it. However, by keeping exchange controls around, the government is, in essence, kicking the can down the road and hoping that other government policies may kick in that could either increase tax collections and/or increase the tax base.

So by maintaining exchange controls and keeping wealth denominated in South African rands, the government is ensuring that it has a large enough pool that it can tax in order to fund (in part) government spending each year. It’s important to bear in mind that tax receipts are only one way for governments to raise capital for its spending and tax receipts do not have to match government spending. Another primary source of government revenue is bonds (either dominated in rands, which is the most preferable option or in foreign currencies, like the South African Samurai bonds denominated in Japanese yen).

So by making and keeping the rand relevant, the government is ensuring its tax base for years to come. To drop exchange controls in their entirety (as I noted above) would be tantamount to the government committing financial suicide as it would mean they would have a decrease pool of taxable income.

Until such time as the two structural issues I noted above are resolved, it means that exchange controls will be kept in place. Yes, there may be some tinkering at the edges every year, but exchange controls, as a concept and reality of life in South Africa, are going nowhere.

You probably wouldn’t find government policy explained like this in any public (or private) policy document, but I’m willing to take a bet (denominated in rands so the government gets its fair share) that this is one possible sub-conscious policy trajectory of the ministry of finance.

And so, a delicate policy dance that started many moons ago will probably continue for a long time to come.