Businesses are bracing themselves for a rand at R8 or even R8,50 to the United States dollar after the shock 20% weakening in the local currency since early May.
The Reserve Bank is likely to tighten interest rates aggressively from here to stem the slide in the rand. Some economists are forecasting a further 1,5% to 2% increase in rates over the next year. This would rein in the consumer spending spree, which registered a 7,1% increase in the first quarter of 2006 over the same period last year, and put a crimp on household borrowing.
The proximate cause of the recent softening in the rand is the current-account deficit of 6,4%, the result of weaker exports and strong demand for imported goods.
The rand was of the world’s best-performing currencies between 2002 and 2005, but this year finds itself in league with the world’s weakest currencies, including the Icelandic krona, Turkish lira and New Zealand dollar, all of which have lost between 12% and 17% against the US dollar so far this year. Each of these currencies suffers from abnormally high current-account deficits, fuelled in part by previous currency strength that stimulated imports.
Brait economist Colen Garrow says the Reserve Bank is likely to hike interest rates by a further 0,5% each time in August, October and December, when the bank’s monetary policy committee meets. Beyond this, further interest rate increases are unlikely, according to Garrow.
A cause for concern for the Reserve Bank is the rise in consumer debt as a percentage of disposable income, now at a record 68% and up from 62,4% last year. Consumers have made increasing use of home equity to fund the recent spending spree, but will find it more difficult to sustain this level of borrowing as interest rates increase. This is also likely to suck some of the oxygen out of house prices, particularly at the higher end of the market. Properties valued below R500 000 are still likely to see appreciation this year, mainly owing to buying pressure from the emerging market.
A further 1,5% increase in interest rates would push the prime lending rate to 12,5%, which many economists believe will be the high water-mark of the current interest rate cycle. Each one percentage point increase in lending rates means homeowners will have to fork out an additional R84 a month on a R100 000 bond repayment, or R588 on a more typical bond size of R700 000.
Assuming oil prices remain around $70 a barrel, South African motorists can expect to pay 20% more for petrol over the coming months. Fuel accounts for about 12% of the consumer price index, but the knock-on effects of higher energy prices on other sectors will likely start to show up in inflation figures over the next six months.
Rising interest rates will hurt consumers, but the weaker rand is good for export sectors such as mining, currently in the midst of a recession after three consecutive quarters of contraction.
“You cannot compare this current cycle with 1998. The domestic economy is still strong and we expect to see the benefits of massive infrastructure spending coming through as we lead up to the Soccer World Cup in 2010,” says Garrow. “One worry, however, is that the promised infrastructure spending has been slow in coming through.”
Alaister Lea, Coronation Small Companies Fund manager, says the local economy can stomach another two percentage point increase in interest rates without disturbing the growth cycle.
Ken Humphries, CE of VFP Exchange, a currency treasury house, says international currency speculators leapt on the rand once it broke the R7-to-the-dollar barrier, pushing it briefly to R7,57. “The rand is a favourite among currency speculators because of its volatility. Once it broke the R7 technical barrier, the speculators jumped on board and pushed it to current levels. We think there must be a pull-back, perhaps to R7, but many businesses are now planning for a rand at R8 or even R8,50.”
Louis Stassen, chief investment officer at Coronation Asset Managers, says the recent drop in the prices of consumer stocks such as Massmart and Ellerine — both of which are down about 30% since May — has been overdone. “The market is discounting interest-rate increases of 200 basis point [two percentage points] and we think the sell-off has been an over-reaction.”