Economist Dawie Roodt takes a closer look at what is driving South Africa’s currency.
Expressing a firm and convincing view on any currency is probably for the less experienced. Expressing such a view on the rand is probably for the foolhardy. I am therefore sensible enough to add provisos ad nauseam before I take the rather brave leap into a rand forecast. All views from this sentence onwards should automatically be considered to include words like “perhaps”, “maybe”, “probable” and the like.
Certain global and local economic trends of late do suggest a likely sharp deterioration in the exchange rate of the rand, but as usual the “when” part is the most difficult to predict.
Although local macroeconomic developments are probably the strongest forces to determine the likely path of the future value of any currency, the current global macroeconomic environment is of particular importance.
Global trends
Three major global economic forces can be identified, all of which can affect the local currency:
- The Greek calamity
The mainstream consensus view on Greece’s fiscal fiasco appears to have converged around the most likely default on that country’s debt, the first for a euro country. A bailout package this year from the IMF and some other (very reluctant) euro countries may postpone the inevitable for a year at most. However, a Greek default appears to be all but a fait accompli.
In itself such a default is not much more than a blip on the radar. The real danger is that Greece is but the proverbial tip and a list of potential future defaulters include Portugal, Spain, Italy, Iceland and even Britain (albeit a non-euro country). Other potential defaulters are European local authorities, while the holders of much of this debt (German and French banks for instance) may eventually force their governments to plunder their own treasuries to prevent yet a new wave of bank failures.
The European dilemma is simple: let Greece default and speculators will start looking for their next victim or, help Greece and add more weight to the moral dilemma. Why would laggards go through the pain of fiscal restructuring if big brother(s) is going to save them?
Whatever the outcome, the euro appears to be the inevitable victim and a dollar/euro exchange rate of $1,25 by year end sounds possible.
Doldrums for the dollar
The world’s most important reserve currency does, due to this fact, have an appeal not available to lesser currencies. Yet even the mighty can only push the financial markets to a point, and it appears as if the markets’ tolerance for US excesses may be tested before long. In fact, even the Chinese recently acquired a few Canadian dollars to add to their reserve arsenal. In the meantime, economic jargon is being invigorated and terms like “quantitative easing” have replaced simpler words like “we print dollars”. A dollar demise is probably a long-term and slow event, one that is nevertheless supported by super lax monetary policy and ballooning fiscal debt. In the short term, dollar strength could be a sign of global economic weakness as fickle capital finds assurance in the (apparent) safety of the greenback. Time, however, will eventually expose the clay feet of the dollar.
Enter the renminbi
The exchange rate of the Chinese currency (Yuan/renminbi) is “managed” at a relatively weak level vis-à-vis the US dollar and consequently against most other currencies. The rationale behind the Chinese authorities’ insistence on a particular (weak) level for the Yuan is primarily to lend support to their own exporters. In the process the Chinese current account remains positive while stellar economic growth and the resultant attractiveness for foreign capital provide an incessant upward market pressure on the renminbi. Meanwhile, a chorus of political whining is blaming a “weak” renmimbi for the world’s economic woes. By postponing an official declaration that China is a “currency manipulator”, the US afforded China an opportunity to “do something” about its currency. That “something” inevitably points to a re-evaluation of the renminbi, something that should be expected within months.
Globally a realignment of the (stronger) renmimbi will result in a weaker dollar (at least vis-à-vis the renmimbi), higher commodity prices (versus the dollar at least) and probably stronger emerging currencies, including the rand in the short term.
The scenario above is likely to lend support to the rand in the short term (few months). However, local economic conditions will eventually overshadow these global trends.
The SA economy in a nutshell
A number of domestic economic developments are likely to eventually impact on the exchange rate of the rand, mostly for the worse.
Monetary policy in South Africa is particularly accommodative. In real terms, short-term interest rates are close to zero and the interest differential between South Africa and the rest of the world suggests little continued support for the currency. Furthermore, although inflation expectations in the economy imply a CPI rate just below 6% for the next two years, we are much less optimistic.
Huge cost pressure emanating from electricity price increases, wage pressures (from those who still have jobs), increases in local authority levies, an increase in commodity prices and the like, will eventually add significantly to general price increases.
The only factors that are currently preventing inflation from escalating are very weak domestic demand (the major reason why the South African Reserve Bank maintains such an accommodative monetary policy stance), and the relative strength of the rand. Even when demand returns, which it eventually will, the South African Reserve Bank has made it clear from its recent actions that a significant tightening of monetary policy is unlikely to follow. Not to mention the political reaction that is bound to follow an increase in short-term interest rates.
Fiscal policy in the country is equally expansionary. A fiscal deficit relative to GDP well in excess of GDP growth simply implies that state debt to GDP will increase at an alarming rate over the next few years. Fortunately for South Africa, relative state debt levels have been falling in recent years and an expansionary fiscal stance is well within prudential limits, for now. However, the fact remains that funding pressure from the fiscus will add to an increased funding requirement from Eskom and a multiple other institutions. The available local savings pool is totally insufficient and international savings must be available to satisfy the local demand for capital.
Unfortunately South Africa is likely to run a current account deficit of between 4% and 5% of GDP during 2010 despite rather weak domestic demand. Any strong increase in demand will inevitably widen this deficit even further and add to South Africa’s dependency on capital inflows.
But all is forgiven when a huge international event is in the offing. The Fifa World Cup and the feel-good factor associated with such an event can only be supportive of the currency. Anyway, the world’s attention is currently focused on the Parthenon and utterances about nationalisation and other silly comments are mostly ignored.
So what can be expected from our currency? A possible pattern may look like this:
- Expect the rand to remain relatively strong and even to strengthen for the next few months, perhaps even until year-end.
- Thereafter a significant weakening of the currency may be expected and the more the rand strengthens now the more severe the weakening phase is likely to be.
A widow of opportunity exists to diversify portfolios offshore, a window of opportunity that may close soon.
Dawie Roodt is chief economist at the Efficient Group.
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