For the better part of last year and until recently, the rand seemed to be a one-way bet relative to just about any currency in the world.
Having broken R7 to the dollar in late 2003, the rand traded steadily to around R6 to the dollar by early last year. In May last year the strength started to evaporate and the rand quickly devalued to R7,80 to the dollar in the five months to October (a loss of about 30% relative to the dollar, the pound and the euro).
With just about all other emerging and developed market currencies strengthening against the dollar during this time, the extent of the rand’s weakness was surprising. The currency’s inherent weakness seemed to be confirmed with its simultaneous slide against the pound and the euro.
Because South Africa’s exports are still largely commodities, the rand can be expected to trade in line with other commodity currencies, such as the Australian and Canadian dollars. Instead, the rand relative to the Australian dollar reached levels of weakness not seen since the extreme 2001/02 blow-out.
The adverse move was also puzzling when comparing the rand to its emerging market peers. Emerging markets were (and still are) receiving unprecedented inflows into their equity, bond and currency markets. Even measures of South Africa’s external vulnerability did not explain the move.
While South Africa has a relatively large current account deficit, 6,5% of GDP, other emerging economies such as Turkey and Hungary have larger deficits and their currencies strengthened significantly, relative to the dollar, by about 15% last year.
In other important measures of external vulnerability — external debt to GDP and external debt to exports — Turkish and Hungarian debt levels far outstrip those of South Africa, which now has one of the lowest external debt ratios among emerging market economies.
So the rand stood out like a sore thumb from its peers, defying the fundamental drivers pushing it to strengthen. Although currencies can stay away from their theoretical fair values for extended periods, the calculated fair value for the rand is closer to R6 to the dollar than to the R8 level it got close to late last year.
This weakening bias relative to global emerging and developed currencies is hard to explain and no fundamental or theoretical reason seems to support it. Negative sentiment and several statements from the government and the Reserve Bank since early last year for the rand to weaken seem to be the only possible explanations.
The rand now seems to be back on a path to recovery, moving towards its fair value level not only against the dollar but also the pound and the euro. South Africa should continue to benefit from the favourable outlook for commodity prices and positive global sentiment towards emerging markets.
Because a strong rand is key to keeping inflation in check, particularly petrol and food prices, and because it gives foreigners the comfort that their investments won’t rapidly devalue, let’s hope it stays on its winning trajectory.
Réjane Woodroffe is chief economist and head of international portfolios at Metropolitan Asset Managers