/ 11 June 2015

Why has the rand weakened so much?

Why Has The Rand Weakened So Much?

The rand is at its lowest level to date against major world currencies. This week we heard reports that the rand had breached the psychological level of R12.50 to the dollar and R19.22 to the pound. In May 2013, we were told of the psychological breach of R10 to the dollar, when the currency broke through the double-digit mental barrier for the first time in four years. 

Why has the rand weakened so much?
All emerging market currencies are suffering as investors move their money from emerging countries’ financial markets back into developed countries such as the United States. During the 2008 financial crisis, most emerging countries experienced high levels of foreign direct inflows (FDIs) as investors realised emerging countries were still growing at significant rates. As investors placed their monies in emerging countries, those countries’ currencies became stronger. International travel was affordable, petrol prices were low and food was cheap.

But 2014 saw some improvement in the economies of developed countries. The US – the biggest economy in the world – had taken the stance to stimulate its economy  though the Fed’s purchase of government and other securities to pump money into the system. This is known as quantitative easing. This kept US interest rates at an all-time low. Low interest rates mean a low return on investment and investors looked to developing countries for higher returns. But that was then.

What happened next?
The US economy has since improved. Employment figures are on the rise and the country’s macroeconomic fundamentals are back on track: a stronger US dollar, good employment numbers and the possibility that the US central bank – the Fed – will increase interest rates again. With a big, stable and trusted economy, the possibility of a rate hike is all that is needed to see FDI redirected from emerging economies back to the US.

Why should we care about all this?
You will be poorer for it. FDI has a direct impact on the rand. When investment leaves the country it means the demand for local currency has declined. When there is a lower need for the rand, it depreciates in value and weakens. South Africa is not a goods-producing country so we do not necessarily benefit from the less-valued rand and because we do not produce goods, there is no demand for the rand to buy the goods the country does not produce. The rand is extremely liquid and is influenced by FDI and currency trades. At the moment, it is not an attractive currency.

What does it all mean?
This means higher food prices, which will lead to a higher inflation and eventual higher interest rates. As the dollar strengthens, all dollar-denominated goods and dollar-denominated commodities we import from abroad become expensive. We will pay more for food. We will pay more for petrol. An increase in the food and petrol price has a direct impact on inflation. And as Reserve Bank governor Lesetja Kganyago says, a volatile rand and increasing inflation will lead to the Reserve Bank increasing interest rates.

South Africa imports almost more than half of its domestic wheat and maize. We consume about 3.1-million tonnes on average and imports are usually around 1.7-million tonnes of wheat. GrainSA adjusted its maize import to 727 000 tonnes owing to drought. With a weaker rand, maize and wheat imports become expensive and the already poor become worse off. Most staple foods: mealie meal, eggs, milk, meat and poultry become expensive.

We import crude oil, which is denominated in US dollars. When the rand weakens against the dollar, petrol becomes more expensive.

South Africa’s inflation rate should be between 3% and 6% and we are currently at a safe 4.5%. But the pressure on the rand caused by global factors will have a negative effect on inflation, bringing it closer to the 6%. This will force the Reserve Bank to increase interest rates. Interest rates determine the cost of borrowing and affects everyone who has debt, be it a credit card, car instalments or a mortgage. Everything becomes expensive and this is on top of the already more expensive food and petrol.

And the solution is?
Government, the business sector and academics aren’t able to decide on whether the National Development Plan, the Industrial Policy Action Plan or the National Growth Path is the best policy for the country. They also can’t decide about whether there should be minimal government intervention or major government intervention. Do we nationalise the country’s strategic assets or do we allow the market to dictate the best way to run the country? At any rate, there’s no solution to ease the burden of the normal South African. You make have to look for a better-paying job, send your children to cheaper schools, feed them less and make them walk everywhere.