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This paper aims at identifying the determinants of South African currency premia, which usually form an important element of debt cost in developing countries, in order to assess the scope of South African economic policies for narrowing the spread on local-currency denominated debt.

The paper argues that South Africa is one among very few emerging economies able to borrow long-term domestically and abroad in its own currency, the rand, and one of the few to have developed its domestic bond market fairly well. However, the rand nominal exchange rate has proved increasingly unstable and volatile over the last years. As a result, local-currency denominated bond finance in South Africa has remained substantially more expensive than foreign currency denominated debt. This must be an issue since the bulk of bond issuances from South African governmental entities and corporations is made in local currency.

Lessons that can be drawn from the South African experience in recent years (1996-2002) include:

• the downsizing of the “net oversold forward position” has contributed to dampening the perception of external vulnerability, i.e. to diminish the expectations of further depreciations of the rand
• a strong commitment to inflation targeting has been key to stabilising the currency premium and keeping debt costs low
• capital account liberalisation must be handled carefully and in a timely fashion in order to avoid sharp depreciations and subsequent increases in the currency premium

[adapted from author]

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