IT SEEMS as if there’s an eerie silence in the currency market. The silence is the sound of the rand NOT crashing. Because, if past trends were anything to go by, the rand should have tracked the euro and been much weaker by now.
The current fiscal crisis in Europe, led by Greece teetering on the edge of bankruptcy, raises the question whether the contagion will spread to SA. Why is the rand not tracking the euro, which has weakened sharply because of Europe’s financial problems? Is there a chance that the fiscal crisis in Europe will spread to the US and Britain as well, leading to a second wave of global recession? Will there be global risk aversion and a crash in the rand exchange rate?
Trying to predict the rand based on economic analysis is, to paraphrase former US Federal Reserve chairperson Alan Greenspan, as useful as tossing a coin. That said, it’s an activity we indulge in endlessly. After all, there are those who want a weaker rand to boost our exports, and those who want a stronger rand to ensure we don’t pay more for food and fuel. The rand must be one of the most emotive issues in the economy.
Remember when the subprime crisis struck in the US and the banking crisis swept the developed world? There was a flight from riskier assets by investors and speculators into the US dollar. It didn’t make sense, as the crisis had originated in the US. But, in times of trouble, the US is still seen as the least risky investment destination.
Rand on steroids
This flight away from risk into safe havens hammered the rand. At its worst point during the crisis, in October 2008, the rand was at R10.85 to the dollar. The euro was at trading below $1.25. Against the euro, the rand was at more than R14/euro.
But as the sense of Armageddon faded, riskier assets began to gain appeal again. The euro strengthened to close to $1.50 and the rand went below R8/$. It seemed the crisis was over with the dollar weak, the euro and the rand strong. The rand had tracked the euro weaker and stronger.
Then the Greek tragedy hit the markets, and the world is again at risk of a full-blown global crisis – this time, over government finances. The euro more than reversed all its gains against the dollar, trading below $1.22.
But now comes the conundrum: why has the rand not tracked the euro weaker again? True, the currency is off its best levels, but at around R7.50/$ at the time of writing it’s still very strong. By contrast, other commodities-based currencies such as the Australian and New Zealand dollars have weakened, albeit not to the extent of the euro. Why is the rand on steroids, and will it last?
There are a few reasons that come to mind. One is that SA’s interest rate differential with the rich countries – despite our 5.5 percentage points of interest rate cuts – is still wide. Bear in mind that our repo rate is 6.5% and the US comparable rate is near zero.
That means borrowing money in dollars to “invest” in SA is a cheap and easy way of making money. (I say “invest” in inverted commas, as this is actually speculative inflows – so-called hot money – that can leave as fast as it came in.) For countries in the eurozone, the interest margin is slightly narrower, but not so you’d notice. So, from that source, SA must also be getting hot money.
Precarious pillars and hot money
Another possible reason is if Standard Chartered (Stanchart) is really buying Nedbank for $10bn, some of that foreign exchange might be traded through the market. True, there’s been speculation that the structure of the deal – some kind of share swap between Old Mutual and Stanchart – could actually lead to an outflow of currency.
But it’s unlikely that SA authorities will allow the deal to be structured in a way that doesn’t lead to some kind of currency inflow into SA. Otherwise, why allow it? But, as we saw when Barclays bought Absa, those flows can prove highly elusive and we can’t count on them.
SA’s stock exchange has also received a healthy dose of foreign cash. Up to May 17, the inflow for 2010 was almost R14bn. But that’s about R7bn less than last year over the same period, so it wouldn’t be entirely fair to say that our stock exchange is booming with foreign investment. It’s ticking along nicely, but there’s no boom. Moreover, this money is also hot money.
The key point is that the rand’s strength is built on precarious pillars. It rests mainly on the fact that we are a commodity-producing emerging market. If the fiscal problems in Greece, Portugal, Ireland, Italy, Spain, the US and the UK blow up into a global sovereign debt crisis, the rand’s strength won’t last. This will be despite the fact that SA’s own fiscal ratios are much healthier than those of the rich countries that are in trouble now. So much for being on our best behaviour.
Many would see a rand crash as a blessing for our export industries. But most of our exports are more dependent on global demand conditions than price, and even cheaper SA exports might not find a market if they were manufactured amidst global recessionary conditions.
I am not predicting a global fiscal crisis or second wave of recession. But there will be a drag on global growth for a long time as governments put their fiscal house in order. Sanlam economist Jac Laubscher estimates it could take 20 years to sort out global fiscal problems if it’s to be done in a way that doesn’t send global growth reeling.
But, even under those circumstances, some dramatic spending cuts and tax hikes are required. Let’s hope the countries in fiscal trouble bite the bullet, because SA won’t be able to escape the fallout if there’s a global sovereign debt crisis.
- Fin24.com