While most emerging market currencies have come under pressure recently (see chart attached), the Rand is once again the worst performing emerging market currency year-to-date. Since the end of 2010 the Rand has weakened by more than 20% against the Dollar. Almost all of this weakness has occurred since the beginning of August 2011.
The second worst performing currency has been the Turkish Lira, which is down around 18% year-to-date, with all of the decline occurring in the second half of the year.
The main reason for the recent and fairly rapid weakening of emerging market currencies is the increase in global risk aversion, associated with the financial turmoil in the Euro-area. This ‘risk-off’ trade has been very pronounced in the past two months, and appears to be worsening.
Unfortunately, there is still very little South Africa can do about the situation. The recently released National Development Plan points-out that “South Africa’s present economic capabilities do not allow greater control over the exchange rate, although reducing the volatility is a critical challenge that requires attention”.
Fundamentally, South Africa has been unable to attract foreign direct investment on a consistent basis, and therefore remains extremely reliant on foreign portfolio inflows to offset the perpetual deficit on the current account. This is a recipe for currency volatility.
In addition, the Rand has become a highly traded emerging market currency and is therefore more vulnerable than most to changes in global economic sentiment. Ironically and unfortunately, the substantial swings in the value of the Rand (both the appreciation and depreciation of the currency) do not reflect the underlying economic fundamentals of the country, and are therefore extremely frustrating for policy officials. They are also extremely distributive for businesses and households.
The economic debate regarding the merits or demerits of a weak exchange rate continues, despite the reality that the Reserve Bank and National Treasury can do very little to significantly influence the value of the Rand on a sustained basis (intervention is very expensive with no guarantees). What is of little doubt is that the current value of the Rand (if sustained) is likely to quickly feed into higher domestic inflation, creating a significant ‘stagflation’ policy dilemma for the Reserve Bank. Rates are still expected to remain on hold, but inflation is going noticeably higher.
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