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Can the rand hold steady at below R12 to the dollar?

Feb 05 2018 06:00
Joel Oluwajodu

MANY South Africans view the recent strengthening of the rand as a positive signal for things to come, and with good reason.

A stronger rand will probably lead to a fuel price drop (assuming international oil prices stay constant/decrease), potential interest rate cuts, reduced import prices and a potential for a decrease in unemployment. All of this means more money in your pocket.

The cause of the current rand/dollar exchange rate has been discussed at great length in several articles. This article however focuses on the sustainability of the current exchange rate - what factors would contribute to maintaining the exchange rate at below R12/$, and is the rand capable of maintaining this relatively strong position in the medium term?

My aim is not to conclude whether you should long or short at the current rand level.

Let's start off with a quick economics ('quick maths' in Big Shaq's voice) lesson on the factors that influence a country's currency.

On a high level, the value of the rand in the short term, just like any other commodity (you could include cryptocurrencies here, though at your own risk!), is determined by market forces of demand and supply. The higher the demand for the rand (as South Africa could be seen as being more business friendly) relative to the supply, the greater its value in relation to another currency (in this case the dollar).

A practical example of demand for the rand: someone wanting to buy vuvuzelas manufactured in South Africa would have to first convert their currency into rand, so that they can pay the merchant at the stall at the Johannesburg market. The more people wanting to do business in SA (or put differently, the more attractive SA Inc. is to the world), the greater the demand for the rand. Anyway, enough economics 101 for now...

The rand has gained significant ground against the dollar in the last month, growing by c. 42% from a record low of R16.86 in December 2015 to its current (February 2 2018) levels of R11.87. This strengthening of the rand has been influenced by a number of factors. They include the 'Cyril 19' effect, increases in commodity prices, the 'Trump' effect (as well as remarks made by his administration in the last weeks) which contributed to the weakening of the dollar, speculation around President Jacob Zuma's possible dethroning (priced into the current exchange rate somewhat, but how much exactly we don't know), among many other variables.

Ultimately, the stronger rand is largely driven by the renewed confidence of investors and the international community in the South Africa environment.

Interestingly, the rand is known as one of the most volatile currencies in the world, and has in recent times been particularly sensitive to political events. Like many other countries in the world, where political decisions, speculation over political parties, elections, wars, etc. have had a significant impact on their respective currencies, the same holds for the rand. This was discussed in detail by the March 2017 foreign-exchange survey by UK-based Consensus, which concluded that political uncertainty is the most influential factor on the rand.

Consequently, in determining whether the rand will remain steady below R12/$ in the short to medium term, we need to determine whether the political environment will stabilise in the same period.

From a medium-term perspective, and as captured in the history books, we know that political uncertainties could persist up until immediately after the 2019 elections.

Political uncertainties will stem from the overthrowing of Jacob Zuma before the 2019 elections; continued growth of the EFF; and uncertainties regarding Cyril Ramaphosa's leadership capabilities, which remain untested.

In the short term, Zuma is scheduled to give his State of the Nation Address at Parliament. Many have forecast that he would tender his resignation after his speech, but obviously this is again just speculation. As to how much of this speculation has been factored into the rand, nobody will know.

Historically, non-political factors for rand weakness coincided largely with sovereign debt rating downgrades, low productivity and decreases in export commodity prices. Non-political factors creating an appreciation of the rand coincided with an improvement in export commodity prices, better productivity trends and the avoidance of additional sovereign debt rating downgrades.

My view: Inasmuch as these political uncertainties linger, we can rest assured that the rand will continue to remain volatile - which could mean rising above the R12/$ mark. However, in the medium to long term (post the 2019 elections), we can expect the unit to be influenced less by political uncertainties and more by commodity price  fluctuations and purchasing power parity. You should accordingly decide whether you will short or long the rand at R12.

Joel Oluwajodu
Analyst, CA (SA)

*The views expressed above are mine only and no not represent those of the firm I am employed at.

* SUBSCRIBE FOR FREE UPDATE: Get Fin24's top morning business news and opinions in your inbox.

rand  |  sa economy  |  markets  |  currencies
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