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The rand’s hefty gains over the past few months have confounded many and proved once again that the South African currency is one of the world’s most volatile – and unpredictable.
It appreciated by 12.5% against the dollar in 2016, making it the best-performing emerging-market currency after the Brazilian real and Russian rouble, according to a basket of 24 currencies monitored by Bloomberg.
The gains were impressive given the sharp swings in the unit triggered by domestic politics, and because it began 2016 not far off a record low of R17.91 to the dollar, hit in the turmoil that followed President Jacob Zuma’s shock dismissal of finance minister Nhlanhla Nene in December 2015.
The rand ended last year at about R13.60 – and according to some analysts could extend its gains to R12.50 this year, and possibly even further. This must be galling for those who predicted the currency would close 2016 at R19 or R20, and demonstrates why so many analysts try to steer clear of forecasting the unit.
“Things look favourable at the moment – the likelihood is that we will see the rand strengthen over the next weeks and months,” says Econometrix Treasury Management market analyst Ricardo da Camara. “We think it is possible the rand will finish the year at R12.50/$ – that would be closer to its fair value.”
Da Camara is not alone. RMB currency analyst John Cairns also sees the rand appreciating this year and points out that if its history of “blowouts” is anything to go by, the currency could strengthen below R10/$ – though he believes that this outcome is unlikely.
Technical analysts say the key level to watch is R13.50 to the dollar, which is where the currency is hovering around right now. If that is broken decisively, it would signal a decisive breach of a five-year trendline that has been in place since the currency began a steady descent in 2011.
Rand forecasts widely scattered
However, rand forecasts have not been so scattered for at least a decade. Bloomberg’s latest compilation of estimates from financial institutions show year-end forecasts for 2017 ranging between R12.80/$ and R15.75/$.
So far, the bears have it, as the median of those forecasts sit at R14.60.
There are several reasons for the currency’s recovery last year. Commodity prices have begun to improve, boosting the value of South Africa’s export earnings, and a pickup in global growth makes it likely that the trend will be sustained in 2017.
The slowdown in China’s economy appears to have stabilised, and global financial markets are taking the gradual US interest rate hiking cycle in their stride. Normally higher US interest rates prompt an outflow of capital from emerging-market assets because the higher yield they offer is no longer as attractive to foreign investors, in the context of the greater risk involved.
When business mogul Donald Trump was elected president in November, emerging markets were knocked by perceptions that his promised tax cuts and ambitious infrastructure spending programme would spur US growth more than anticipated, boosting the extent and pace of interest rate increases.
But Trump’s first news conference this year helped to dispel those concerns, as few details of his plans were revealed. And a slow pace of US interest rate increases will curb gains in the dollar, which normally puts emerging-market currencies and assets on the back foot.
“We believe a continuation of dollar strength, provided it occurs gradually, poses a lesser risk to emerging-market currencies than it did between 2013 and 2015, as the macroeconomic fundamentals of most emerging-market countries are in much better shape today,” Lazard Asset Management said in a recent research report.
Support from the current account
In SA, the rand is also being supported by the narrowing deficit on its current account, the country’s broadest measure of trade in goods and services. The shortfall is seen as the Achilles heel of the rand as it has to be covered by foreign purchases of domestic bonds and equities – which are often volatile and short term.
In its mid-term budget update in October, the Treasury predicted that the country’s current account deficit would narrow to 3.8% of GDP in both 2018 and 2019, after shrinking to 3.9% from 4.3% in 2015. That was already its lowest level since 2011.
In the first 12 days of this year, emerging markets have attracted net equity and debt inflows to the tune of $1.2bn. Although it underperformed the trend, SA’s assets look very attractive – the equity market rose by 5.2% in dollar and 4% in rand terms, while the bond market rose 2.6% in dollar and 1.4% in rand terms, according to research by Standard Bank.
The Reserve Bank’s commitment to keeping inflation at bay through higher interest rates – despite the weakening economy – has also helped to support the rand. The Reserve Bank’s monetary policy committee has raised the key repo rate by two percentage points to 7% since the start of 2014, despite criticism from some quarters.
Da Camara maintains that, ironically, the rand often performs well during periods of weak domestic economic growth, as imports subside, thus helping to curb the current account deficit.
Global data more important than domestic
In a research paper published last October, the International Monetary Fund (IMF) pointed out that perceptions that surprises in domestic data significantly affect the rand are misplaced.
Rand volatility was mainly driven by global factors, including commodity price volatility, particularly in SA’s four main exported commodities – gold, coal, platinum and iron ore, it said. Macroeconomic surprises originating from the US mattered, but not domestic surprises nor those in other emerging markets, it added.
An important caveat, however, is that the IMF found that local political uncertainty was associated with rand volatility – as was seen last year, when the rand plunged 4.4% on news that finance minister Pravin Gordhan would be charged with fraud and rallied by 2.8% on news three weeks later that the charges were withdrawn.
This supports evidence after the US election that the rand has taken over from the Mexican peso as the world’s most volatile currency, according to Bloomberg research. This makes the rand a challenging currency to trade – investors have to make quick decisions, and change course abruptly.
But the influence of political events is climbing globally as well – Société Générale global strategist Kit Juckes maintained in a research note early in the year that politics would be at least as important as economics in 2017. In this context, the rand looks very vulnerable – the ANC is holding a policy conference in July and an elective conference in December, when a successor to Zuma will be chosen. Both have the potential to deliver nasty – or positive – surprises.
Credit rating updates due from Standard & Poor’s and Fitch this year could also affect the rand, as both agencies have put SA on the lowest rung of the investment grade ladder.
Rand undervalued on Big Mac index
On a more light-hearted level, The Economist’s “Big Mac” index also suggests that the rand is significantly “undervalued” – which means it should strengthen.
The index was invented in 1986 based on the theory of purchasing power parity, which holds that in the long run, exchange rates should move towards the levels which would equalise the prices of an identical basket of goods and services – in this case a hamburger – in any two different countries.
Based on 11 January exchange rates, a Big Mac costs $1.89 in SA compared with an average of $5.06 in the US – making the rand a whopping 62.7% undervalued, the worst in the world after Egypt, Ukraine and Malaysia.
According to the index, in both 2015 and 2016 the rand has not been as undervalued since 2002.
Although the index has become a global standard, The Economist points out that it does not take labour costs into account, and a more fair measure of currency valuation would be the difference between prices and GDP per person. Based on that, the rand would still be more than 35% undervalued against the dollar.
Mariam Isa is a freelance journalist who came to SA in 2000 as chief financial correspondent for Reuters news agency after working in the Middle East, the UK and Sweden, covering topics ranging from war to oil, as well as politics and economics. She joined Business Day as economics editor in 2007 and left in 2014 to write on a wider range of subjects for several publications in SA and in the UK.
This article originally appeared in the 26 January edition of finweek. Buy and download the magazine here.
