Whither the rand?

2011-02-01 22:22

JANUARY was one of the worst months ever for the rand in terms of percentage declines in its value against a basket of currencies. The question is whether this month will be repeated - or will the rand stabilise or even strengthen again?

In trying to answer that question, it's worth bearing in mind what former Federal Reserve chairperson Alan Greenspan said about currency forecasts. He remarked one may as well flip a coin. That suggests the whole exercise is redundant; however, it's still useful tracking the factors that influence the rand and trying to draw conclusions from them.

The main factors that influence the currency are: the dollar exchange rate on international markets; the euro's exchange rate; the exchange rates of other emerging market currencies; the interest rate differential; flows on the capital account of the balance of payments (BoP); flows on the current account of the BoP and Reserve Bank intervention.

The main international currency pair to watch is the dollar/euro exchange rate. This has strengthened considerably, from less than $1.3250/euro at the end of November to close to $1.38/euro at present.

Ordinarily, the rand would strengthen in tandem and in December it did, even outperforming the euro. In thin trading, the rand went below R6.60 to the dollar in December but was last at R7.11/$ after hitting R7.17.

The fact that the rand isn't tracking the euro to the extent that it should is cause for concern. For this relationship to break, it may mean that SA-specific factors are coming into play.

One reason for the relationship partly breaking down, however, could be that euro strength is based on expectations of an interest rate increase. A eurozone interest rate hike will dampen demand for SA's exports.

The rand recovered some ground on Tuesday as it seemed to start following the euro again, but it was still underperforming.

The exchange rates of other emerging market currencies are a factor, as turmoil in Egypt has spread contagion around the world. RMB analysts say the markets will settle down as the world grows accustomed to Egyptian chaos, but last Friday saw a sell-off led by the rand.

Euro safe haven status?

Another factor is that the Egyptian crisis sent the oil price above $100 per barrel for the first time in more than two years.

This means money that would ordinarily flow to emerging markets is being diverted into speculative oil positions. Gold also benefits, but so far the oil price has outweighed that of the yellow metal. The oil price also adds to generalised global inflationary concerns, which are putting upward pressure on interest rates.

SA's interest rate differential still works in the rand's favour. With interest rates in the US and the UK close to zero and 1% in the euro area, and with SA's repo rate at 5.5%, there's still a nice margin to be made.

But this "carry trade" will only take place if speculators perceive no exchange rate risk. There's little point in earning interest if it's all going to be wiped out by a depreciation in the rand. Foreigners might perceive more exchange rate risk in SA, and may not be investing short-term on the scale they did before.

The other factor arising from the interest rate differential is the speculation that interest rates in Europe may rise. This is causing speculators to take positions in the "safe haven" of the euro. Of course, that safe haven status will fall apart if the sovereign debt crisis in the eurozone starts to become a crisis.

In that case you can bet the rand will follow the euro weaker, even though it didn't follow the euro all the way stronger.

An important factor behind recent rand depreciation has been the flows on the capital account of the BoP. Foreigners were net sellers of bonds to the tune of R10bn in December, and look to be selling the same amount in January.

They are getting out because the chances of another interest rate cut in SA are marginal. The belief that sprang up last year that the big investment at the time in SA's bond market was more permanent in nature seems to be untrue.

The other flows on the capital account would be Wal-Mart's purchase of a stake in Massmart. But the chances are good that the Reserve Bank will take the dollars directly and won't allow the forex to go through the market. That's Reserve Bank intervention to prevent the rand from strengthening.

The current account of the BoP, which used to be the economy's Achilles' heel, is no longer in bad shape and is not really relevant for the rand. Latest trade figures show a trade surplus of R5bn in 2010, compared with a deficit of R27bn the previous year.

Of course, the trade surplus will be wiped out by net payments for "invisibles" such as interest, freight, dividends and tourism. However, Nedbank thinks the current account deficit for last year will be a low 2.7% of gross domestic product. Only once it nears 5% will it become a problem again.

Of all the SA-specific factors mentioned, the bond sales are probably the most important signal that the rand should depreciate.

But this may be overshadowed by a healthy current account, wide interest rate differential and strengthening euro. My money is on the rand tracking the euro, but not to the full extent. Stabilisation around current levels seems likely.   

 - Fin24

  • Abe Ramsay - 2011-02-02 10:08

    Greta, nice article. Very courageous to predict the rand. I think the rand is going to track weaker because: 1. South Africa gets tarred with the same brush as Egypt, just as Canada get tarred with the same brush as the USA, and Switzerland gets tarred with the same brush as the Eurozone. 2. There is growing confidence, albeit premature and over optimistic, in the EUR and the US$. 3. South Africa might aspire to become one of the BRIC countries, but it isn't and has no hope of becoming one. Our growth rate is too low. 4. Our economy is slowing for a number of reasons like BEE and corruption but largely because we have stopped spending on infrastructure since the World Cup. It was the spending on infrastructure that took Germany out of the depression of the 1930's and made her a super-power. We have the potential to become the breadbasket to the world and in the process a mini super-power but we lack the vision.

  • Piet - 2011-02-02 11:57

    @Abe. Spending in the 30's had nothing to do with German recovery. As a direct descendant of Germans, I grew up listening to stories of incredible hard work of every German in every facet of life and business. You are severely misguided thinking that you can spend your way to prosperity.

  • Christiaan Hurter - 2011-02-02 13:53

    Your comment "An important factor behind recent rand depreciation has been the flows on the capital account of the BoP. Foreigners were net sellers of bonds to the tune of R10bn in December, and look to be selling the same amount in January." refers. If you plot the JP Morgan EMBI+ graph to the Euro/Rand exchange rate over the past three years, you should find a correlation. It should be a bit more difficult to plot the same correlation matching the euro / dollar exchange to the Rand, as so many journalists want to believe.

  • Bob - 2011-02-02 16:15

    Ja Piet. You can spend your way out of a recession. Rooseveldt did it (a Depression no less, not a recession), the Marshall Plan did it, Reagan did it, Clinton did it. I'm sure that working under the Nazis wasn't very pleasant for your family or anyone else but the facts speak for themselves... Hitler's programmes of public works and rapid industrialisation to make up for the lack of arms production and technology since the Versailles Treaty definitely created work, encouraged spending and saving and lifted Germany. Pity about what came afterwards. You build that many guns, you're going to wonder what you can do with them

  • Gawie Botha - 2011-02-04 08:47

    South Africa dont have a wizard while the Unions is running the ANC.

  • Abe Ramsay - 2011-02-09 15:09

    @Piet, you are partly right. With spending on infrastructure projects (which creates jobs), hard work and a dash of patriotism, (like we had in the run-up to the world cup) and you have a recipe for an economic boom.

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