WHAT IS A NET OPEN

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WHAT IS A NET OPEN FORWARD POSITION?
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The market for foreign currency

• South African firms require foreign currency to
• pay for goods imported from abroad
• settle foreign currency debt
• Find it prudent to hedge
• Made it possible for SA entities to fund
  off-shore
• Bridged failure of govt. to enter foreign markets
• Across the economy as a whole, this creates a
  demand for foreign currency
• Private markets supply the majority of the
  currency demand (March Private 116 bn, SARB
  14bn)
• The South African Reserve Bank (SARB) supplied
  the remainder
• The SARB, therefore, provided forex contracts
  with SA banks and firms to provide foreign
  currency in exchange for rand

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The Forward Book

• The total value of all contracts to provide
  foreign currency in the future
• The contracts are agreements for the SARB to
  provide a certain amount of foreign currency
  (Typically US dollars) for a certain amount of
  rand at some point in the future -- at a specific
  exchange rate
• The contracts enable firms with commitments to
  hedge against possible fluctuations in the rand
  exchange rate

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The NOFP

• The Net open forward position (NOFP) is equal to
  the value of contracts for foreign currency minus
  net reserves
• Net reserves Gross reserves - foreign loans
  received
• In other words
• NOFP Net Reserves - Forward Book
• Thus the NOFP is that part of the forward book
  not covered by net reserves
• Represents currency risk that the SARB takes on
  behalf of government

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Change in the size of the NOFP

• Since,
• NOFP Net Reserves - Forward Book
• The NOFP increases in size when
• The Forward book increases and net reserves
  remain unchanged
• The SARB sells forex to the market or government
• The NOFP declines in size when
• The Forward book declines in size and net
  reserves remain unchanged
• The SARB buys forex to the market or government

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Quantified example
NB This is a highly simplified example, only for
illustration!
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The states liability

• The liability of the state is equal to the loss
  (-100) reflected on the last column on the
  illustration
• Neither the NOFP nor the Forward Book is a
  liability of the state

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Reducing the NOFP

• The NOFP is reduced through the purchanse of
  forex from the market
• Sources of foreign currency market related
  capital flows, privatisation, borrowing foreign
  listings

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Status of the NOFP

• At the end of January, the NOFP stood at 9,5
  billion, comprised of net reserves of about 5
  billion and a forward position of 14,5 billion
• The NOFP was reduced at a rate of
  /- 900 million per month between August 1999
  and March 2000, made possible mainly by inflows
  of portfolio investment
• (mainly government borrowings)
• Since April 2000, however, the pace of forward
  book reduction has slowed
• From June onwards, the SARB has been able to
  continue the path of NOFP reduction, but at a
  significantly slower pace of around 100-200
  million per month
• (emerging market volatility)

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Change in the NOFP 1996 to 2001
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Forward contracts the rand

• Forward contracts have been used to ensure that
  SA firms have access to foreign currency for
  their international transactions
• In the past, forward contracts were also used to
  support the value of the rand
• The demand for forward cover has been
  fundamentally driven by expectations of rand
  depreciation (driven by importers)

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Inflation targeting the NOFP

• Whereas in the past the NOFP was used to support
  the rand
• In the current dispensation, the SARB targets
  inflation and not the exchange rate

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Broader impact of Forward Book

• Anticipated losses on the Forward book as a
  result of currency depreciation represent a
  contingent liability
• In other words, accrued losses are a potential
  charge on the fiscus
• Therefore, international investors view the
  Forward book as a risk to the budget and to the
  debt profile of South Africa
• And, therefore, demand a somewhat higher premium
  to hold rand-denominated assets
• In short, South African interest rates are higher
  than they otherwise would be without the Forward
  book

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Accountability

• Reserve management accountability
• Joint policy decision of National Treasury and
  the Reserve Bank to eliminate the NOFP
• A consistent improvement in the NOFP appears to
  be as important, if not more so, than the actual
  level of the NOFP itself

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Policy implications

• Important to continue lowering the size of the
  Forward Book and NOFP
• Possible through several channels...
• Increased govt borrowing in foreign currency
• Increase maturity profile of liabilities
• Increased debt service costs as against
  contingent risks
• Higher risk premium on foreign debt
• Higher cost when exchange rate depreciation is
  larger than interest rate differential
• Continued reduction on the back of capital flows
• State asset restructuring and better economic
  growth will lead to continued capital flows