Africa Weekly Review: The hammering of the rand, its origins and its prospects.

The rand as a commodity currency

The rand has declined rapidly this year, passing the thresholds of 7 per US dollar in January, 8 in March and 9 in October. The currency depreciated by 16 per cent and below 10 per dollar on 15 October. This spectacular weakness has driven analysts to dust down their files in search of telling comparisons. The search will be unrewarding.

As South Africa’s credit profile strengthened under the continuing supervision of Trevor Manuel at the Finance Ministry, so its assets (including the currency) suffered decreasing contagion from crises elsewhere in the emerging markets universe. The pain from the Asia crisis (1997) was felt though the impact of subsequent turbulence (Russia in 1998, and Turkey and Argentina in 2001) progressively diminished.

Different story in late 2001

The rand had a very rough time in the closing weeks of 2001 (see chart), passing the threshold of 13 per dollar for one day just before Christmas. This coincided with the debacle for holders of Argentine government bonds (will they, won’t they default?). The trigger was a circular from the South African Reserve Bank (SARB) pledging to enforce existing foreign-exchange regulations. This led to the unwinding of some large transactions, which brought pressure on the rand.

Amid talk of manipulation, the state presidency set up a commission of enquiry, as a result of which a household name in European investment banking was sanctioned (without being named). The response of the authorities to the sell-off of late 2001/early 2002 was to hike the policy (repo) rate. It did not intervene in the foreign exchange market, because it had tried this tack and failed with disastrous consequences (in June 1998).

Spot exchange rates (monthly averages)

The current sell-off, by contrast, is in response to global market turbulence. The particular fear is the impact of the slowdown on demand for South Africa’s wide range of mineral exports. 15 October brought grief for the rand because one of the global miners commented on softening of Chinese demand. The Australian and Kiwi dollars, and the Brazilian real suffered similarly on the day.

The weakness on the current account and its financing

The deficit on the current account was equivalent to 7.3 per cent of GDP in the second quarter of 2008 (annualised). Any suggestion that the deficit could widen causes alarm in the market because South Africa’s record of net foreign direct investment is poor and because many of the all-important portfolio investors are exiting the market. Net sales of equities on the bourse by non-resident investors have totalled ZAR33 billion (US$3.3 billion) this year. In 2007 there was a net inflow of ZAR63 billion.

This year the All-share Index has shed 29 per cent and 52 per cent this year in rand and dollar terms respectively. Resource stocks dominate the bourse, which suggests that the current index level is vulnerable. It is also significant that the Johannesburg Stock Exchange is among the most liquid and transparent bourses in the EM universe. It had a market capitalisation last week of ZAR4.03 trillion (US$403 billion) or 180 per cent of GDP.

The authorities’ wariness of market intervention

The global turbulence has thrown light on South Africa’s Achilles heel, which investors tended to overlook when commodity prices were to be found in the stratosphere and liquidity was abundant. We think the rand sell-off could have another leg to run. The authorities did not try to defend the currency in late 2001 and are most unlikely to do so today. They know that it can quickly develop into a losers’ game: they also know that their armoury for self-defence (net official reserves of US$34 billion) is modest.

Nor is monetary tightening likely. GDP and credit extension growth are slowing. Inflationary pressures from food and energy prices are fast receding. The monetary policy committee (MPC) suggested in the statement following the meeting of 09 October that rand weakness could be a reason to defer the start of easing. In these conditions, the authorities will pledge continuity of Manuel’s policy. Their nightmare would be an interruption to what they hope will be a smooth transition in the presidency from Thabo Mbeki to (presumably) Jacob Zuma via Kgalema Motlanthe.

Exemplary indebtedness ratios

We stress that the rand is being punished for its status a commodity currency. At the same time, levels of indebtedness, both sovereign and total, are comfortable and compare very favourably with those in Hungary and Ukraine, for example. Total foreign exchange denominated debt at the end of March 2008 totalled US$45 billion, of which US$16 billion had an original maturity of less than one year. Total foreign debt obligations to non-residents (including those rand-denominated) totalled US$74 billion, of which less than US$30 billion were owed by the central government, public bodies and state-owned companies.

Total foreign debt was equivalent to 27 per cent of GDP at the end of 2007, and total interest and dividend payments combined to 15 per cent of export earnings. These ratios have been achieved thanks to the cautious fiscal stance of a decade, and give the authorities some room for manoeuvre. There is no need for a call for help to the IMF.

The central government’s domestic debt obligations at the end of June amounted to ZAR493 billion (22 per cent of GDP). Its total debt, including public enterprises, is therefore less than 35 per cent of GDP. Within (and outside) the EM universe, this is a very strong ratio. It is also worth noting that the banking sector is well regulated and that at least the Big Four are well capitalised.

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African property: Magnet for remittances.
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With best regards,
Gregory Kronsten
Director, Africa Research
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