South Africa was featured in this weekend’s edition of the Wall Street Journal - because the Rand has suddenly become the worst performing emerging market currency this year. This is after exhibiting a relatively high degree of stability during the first eight months of the year. What has happened?
Year-to-date (Friday, 23 September 2011) the Rand has weakened by 18.5% against the Dollar, and on Thursday (22 September) was down 21.3% year-to-date. Most of this depreciation has occurred during the current month, with the Rand plunging 13.7% against the Dollar month-to-date, and declining 7.8% in the past week (see chart attached that shows the weekly movement of the Rand this year).
This has shocked the local financial markets as well as many businesses and consumers. If sustained, it will have significant implications for domestic prices over the coming months – already the daily (22 September) under-recovery on the domestic petrol price is a massive 61c/l.
Part of the explanation for the weaker Rand against the US Dollar can clearly be attributed to the strength of the Dollar. During September (month-to-date) the Dollar has gained over 6% against the Euro, driven largely by the ongoing uncertainty surrounding the sovereign risk crisis in the Euro-area.
A further explanation for the Rand weakness can loosely be ascribed to a general increase in global risk aversion, heightened by Ben Bernanke’s negative comments last week about the poor state of the US economy and the increased risk that economic conditions will weaken. The increased global risk aversion has also been aggravated by the lack of resolve on the part of the Euro-area member states to adequately address the sovereign risk crisis, especially in Greece. This increase in risk aversion is reflected in the fact that foreign investors have become net sellers of SA equities and bonds in the past couple of weeks.
However, a more precise explanation for the Rand weakness has been provided by various presentations/discussions at the IMF and IIF Annual Meetings in Washington this weekend. The various discussants made the following key points:
- It is not just the Rand that has weakened. Many emerging market currencies have declined against the stronger Dollar during the past couple of weeks, especially the Brazilian Real, the Hungarian Forint, the Polish Zloty and the Chilean Peso (see charts attached). Even the Singapore Dollar has weakened noticeably this month.
- Foreign investors are not selling out of emerging markets because they think emerging markets are suddenly far more risky, many are selling because they need the liquidity. The debt crisis in Europe (and now the extreme uncertainty about the risk of default in Greece and the unease over Italy and Spain) has created an increase demand for liquidity (including by Banks), forcing many investors to liquidate positions in emerging markets.
- The sell-off in emerging market currencies has included countries that have very strong economic fundamentals (eg Singapore: AAA rated with extremely strong fiscal position).
- The sell-off has also been concentrated in countries that are more easily able to provide liquidity quickly. In other words, the sell-off has partly focused on emerging market countries that have more sophisticated and deep financial market systems, which allow investors to withdraw funds quickly and effectively (eg South Africa).
So now what?
We have maintained that the fair-value of the Rand is currently around R8.00 to R8.20 against the Dollar. So, in a sense, the current value of the Rand is simply more reflective of fair-value; with the weakness over-done in the short-term.
However, the disorderly nature of the currency depreciation in the past couple of weeks will further damage SA consumer and business confidence. One of the presenters at the IIF conference this weekend made the point that South Africa tends to be regularly plagued by a disorderly weakening of the currency, given the heavily reliance on foreign portfolio investment, which is extremely disruptive for business. In other words, while it can be argued that a somewhat weaker Rand is helpful for the South African economy, the analysts that have historically clamoured for a weaker Rand have conveniently ignored the fact that the Rand has a tendency to weaken in a disorderly and disruptive fashion that can be substantially damaging to the economy. (Businesses and consumers can more easily adjust and cope with a gradual depreciation of the Rand).
The short-term outlook for the Rand will be heavily determined by the current economic and political developments in Europe and the USA; and hence the degree of risk aversion in the global financial markets. The situation in Europe appears extremely uncertain and set to remain volatile over the coming weeks. This is compounded by the fact that domestic importers are likely to increase their demand for forward-cover on their foreign currency exposure, which could exacerbate the short-term volatility.
Looking a little further-out, South Africa’s economic fundamentals remain relatively sound by global standards, especially the fiscal position. Interest rates remain attractive to foreign investors, which implies that should the fiscal uncertainty in Europe and the US improve, the Rand is likely to gain some ground. The key reference point for the Rand, as useless and inadequate as it is, remains the fair value estimate.
Download the presentation slides