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Market flows and the rand

May 17 2012 08:04 *Greta Steyn

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SOUTH Africa's trade deficit ballooned in the first quarter of this year as exports underperformed.

The trade data are crucial for the rand, and are a negative signal for the rand exchange rate. However, there are many factors other than trade that affect the rand, and these might counteract the bad trade figures.

When imports exceed exports a trade deficit exists. It's easy to see why this would be bad news for the rand's exchange rate, as it means South Africans are paying more foreign exchange for goods than they are receiving for their exports.

However, this outflow of foreign currency is just one of many flows through the market.

To understand the flows, we first have to understand the full current account deficit, of which the trade deficit is a component. The current account deficit is broader than just trade in goods, as it includes "invisible" trade such as services and payments such as interest and dividends.

In SA, trade in "invisibles" is usually in deficit, adding to the outflow of foreign currency from the country. The flows from this account, usually referred to as the services deficit, are only made known once a quarter, when the current account deficit is released.

Trade in goods, however, is updated monthly. Although the monthly trade figures are erratic, one can draw conclusions from the performance over a quarter.

Though the trade deficit narrowed to R5.5bn in March, it followed two months of exceptionally high deficits which pushed the trade deficit for the first quarter of this year to R26.4bn from R12.9bn in the last quarter of 2011.

Nedbank economist Johannes Khosa points out that this is the largest shortfall on the trade account since the third quarter of 2008. Though Khosa doesn't say this, during 2008 the current account deficit was a major headache which aggravated rand depreciation during the financial crisis that prevailed at the time.

Khosa says: "The trade account will remain volatile, but mostly under pressure during the year, with export performance hurt mainly by persistent weakness in Europe and slower global growth, while imports will be supported by stronger fixed investment (capital expenditure) activity."

The current account explains only one leg of the flows through the forex market. (Collectively, these flows are known as the balance of payments, BoP, or the external balance of the country.) The other leg of the BoP, the capital or financial account, is made up of investment flows.

These include very short-term, speculative inflows taking advantage of SA's higher interest rates, as well as long-term foreign direct investment. When capital inflows exceed the current account deficit, the rand should strengthen.

However, we have to bear in mind that the exchange values of major currencies such as the dollar and the euro also affect the rand's value. If the dollar is strengthening against major currencies, it's likely that the rand will weaken against the dollar, even if capital inflows exceed the current account deficit.

However, the rand won't depreciate by as much as other currencies in that case. 

SA has experienced a surge of foreign capital inflows this year, especially since Citigroup announced in April that SA is likely to be included in its World Government Bond Index from October. Inclusion in this kind of index means that global index tracker funds, that manage trillions of dollars in investments, have to invest in SA to meet the requirements of their mandates.

That means that SA gets a captive overseas market for its bonds, which means foreign investment in government paper will be a more stable and reliable source of foreign inflows than it has been in the past.

Bond and equity flows are known as portfolio flows. Foreign equity investment in SA has been negative for some time now, recording outflows last year and for the year to date. Bond inflows surged on the Citigroup news, reflecting both speculators and real money flows in anticipation of inclusion in the index in October.

Latest figures show that for the year to date, bond inflows have been R33bn, close to the inflows for the full year last year of R42bn. Citigroup estimated that the inclusion in the index could generate around $5bn in inflows since the announcement last month and mid-October, and possibly another $2bn thereafter.

 - Finweek

* Greta Steyn writes for Finweek magazine, South Africa's leading financial news publication. Follow Finweek on Twitter@finweek or visit www.fintalk.co.za.

 
rand  |  sa economy  |  trade deficit
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