/ 1 October 2010

Rand not all bad news

The rand, which was trading this week at below R7 to the dollar, finds itself in a perfect storm, say economists. And they say there is little the authorities can do to weaken the currency except to batten down the hatches and wait it out.

The rand, along with many other emerging market currencies and some developed market currencies, has strengthened markedly against the United States dollar in recent months. This has been in large part thanks to capital infl ows to the country as international investors search for better returns on investment in emerging markets.

But, combined with other elements including increased spending during the Fifa World Cup, elevated mergers and acquisition activity, such as mooted bids by Walmart and HSBC for Massmart and Nedbank respectively, the rand has flexed its muscles. Its strength has fuelled calls for the authorities to curb the currency and protect South African exports and jobs.

But a powerhouse rand is not only bad news. Its continued strength prompted speculation that consumer price inflation, which came in at 3.5% for August on Wednesday, may well fall below the bottom end of the inflation target of 3% and may lead to another cut in interest rates.

“If the rand remains at current levels of about R7 to the dollar until year-end, it is almost certain that inflation will fall below 3%. That raises the debate about further interest- rate relief and will tilt the balance in favour of another cut,” said Andrew Roux, the head of fixed income at Investec Asset Management.

South Africa is not the only country experiencing a stronger currency. Developed countries such as Japan are also feeling the effects. It intervened earlier this month in a bid to reduce the yen’s strength against the dollar.

Meanwhile, the Wall Street Journal reported on Wednesday that the central banks of South Korea, Singapore, Thailand and Indonesia were suspected of intervening in foreign currency markets to curb their currencies’ excesses.

Dawie Roodt, the chief economist at the Efficient Group, said that globally “everyone is trying to devalue their currency looking for short-term gains” in what is amounting to “a race to the bottom”. Over time, he said, this was unlikely to work as all currencies were valued relative to others and ultimately ‘there always has to be a loser”.

“The actual problem at the moment is high input costs, such as labour costs, but the short-term solution is to weaken the currency,” said Roodt. “It overlooks structural inefficiencies within economies.”

Kevin Lings of Stanlib said the desperate rush to bail out the US financial system after the collapse of investment bank, Lehman Brothers had come with some unintended consequences, one of which was “asset inflation” . The assets attracting interest included gold, which investors were buying as a hedge against inflation.

High-yielding emerging-market government bonds, such as those of South Africa, were also attractive. According to Stanlib research, a record R100-billion of foreign inflows had gone into South African bonds and equities this year, though the bond market had seen the lion’s share of these , at a record of about R70-billion since the beginning of the year.

Lings said that many countries, much like ours, were now “searching for answers” to the problem of soaring currencies. The Reserve Bank is under pressure from Cosatu to curb the strength of the rand but intervention is not without risks and costs.

The bank posted a R1-billion loss last year from losses incurred in buying foreign currency while building up its reserve position. “The past year has also seen a significant flow of capital to emerging market economies in the face of persistently low policy interest rates in advanced economies,” it said in its annual report.

“South Africa was also a beneficiary of these flows, which has resulted in a marked appreciation of the trade-weighted rand exchange rate. The bank took advantage of these infl ows to add to its foreign-exchange reserves, which, though at historically high levels, are still relatively low compared with other emerging market countries.

“However, the need to sterilise the impact of these purchases of foreign exchange on domestic liquidity resulted in the bank reporting an after-tax loss of R1.05-billion during the past financial year.” In its recent country report on South Africa, the International Monetary Fund noted that the cost of building up reserves was expensive.

In addition, it said that given the vast size of South Africa’s forex market, which traded between R7-billion and R10-billion daily, the impact of government intervention would be questionable. The IMF said a tax on capital inflows could work to slow the inflows.

“However, the international experience is that these tools might easily be circumvented, with their effectiveness eroding over time. Further, given South Africa’s reliance on foreign savings to finance investment, the adoption of such an instrument would not be straightforward.”

The IMF suggested that targeted interventions, such as assistance for companies hurting from the exchange rate, might work.

“For instance, increases in the investment tax allowance for small and medium-sized companies engaged in labour-intensive, non-traditional activities could be considered,” it said. “By tying the benefit to investment, it could help elicit more investment in plant and machinery, as well as create more jobs.”