A fundamental model for the rand indicates that the South African currency, at just more than R7 to the dollar, is probably somewhat overvalued, according to Absa’s Group Economic Research Department.
Writing in the department’s latest Economic Perspective, Absa chief economist Christo Luus says that a model utilising capital flows as a percentage of GDP, the value of the dollar, and the inflation rate and interest rate differentials with the US shows that the rand would average around R7,56 per dollar in the second quarter, but that it could slip back to R8,48 by the fourth quarter.
Although purchasing power valuations of the rand generally indicate that the rand could strengthen further, technical and fundamental economic factors mitigate against this, he argues.
The pronounced depreciation of the rand late in 2001 was the main reason for the acceleration in the headline consumer price inflation rate from 3,5% in November 2001 to 14,5% a year later.
CPIX inflation (CPI excluding the effect of mortgage interest rates) is expected to decrease to around 4% by the end of 2003, which will be comfortably inside the Reserve Bank’s target range of 3% to 6%, according to Luus. CPIX inflation is forecast to average around 3% in 2003 — aided by further expected decreases in petrol prices.
The general expectation is that the dollar could experience further weakness against the euro in view of the US’s enormous current account deficit and the bleak outlook for that country’s financial markets over the next year or so.
By mid-2004, the dollar might start to strengthen again as the US economy starts to recover and the interest rate differential with the eurozone narrows somewhat, Luus adds.
“Furthermore, an expected easing in South Africa’s monetary policy as from June, could give rise to a somewhat weaker rand. However, a weaker rand would be less impeding on South Africa’s export performance and economic growth prospects, which are clearly being threatened by the stronger rand,” Luus states.
According to Absa, rand volatility decreased considerably in the early 1990s, but since 1995, volatility appears to have increased once again, with a relatively sharp increase occurring since 2000.
“Higher exchange rate volatility implies higher risks for importers, exporters and investors. It complicates the conduct of monetary policy because of more erratic price movements, possibly necessitating higher real interest rates than would have been necessary under more stable exchange rate conditions,” says Luus. – I-Net Bridge