HomeBusiness DigestDomestic risks weigh down rand

Domestic risks weigh down rand

The United States dollar is a global currency. While there are many different currency pairings, most currencies are benchmarked against the US dollar, either directly or indirectly.

Report By Jealous Chishamba

Ideally, the performance of a currency derives from both the health of the underlying economy and its global connectedness.

Therefore, factors acting upon a currency can be grouped into internal and external. The sum of these two influences is reflected in the value of the currency.

However, sometimes policy makers aim to influence market forces of demand and supply to achieve certain economic targets.

South African Reserve Bank (SARB) has to a larger extent left its currency to be determined by market fundamentals.

Currencies can be grouped further depending on their level of volatility, the economy they represent and the major factors which drive their values. Surprisingly, South Africa’s rand falls into various classifications.

Firstly, the rand falls under the emerging market currencies basket.

SA was invited to join the Bric (Brazil, Russia, India, and China) nations in 2011 which is now referred to as the Brics. This group is often termed emerging markets.

In spite of positive performance by other emerging currencies, the rand has been the worst performer. The rand opened this year at 8,06, strengthened to a session high of 7,35 in February and then weakened to a session low of 9,0067 in November.

There is also another class called commodity currencies which include the Australian dollar, rand, New Zealand dollar and Canadian dollar. This class is influenced by changes in price or demand and supply trends in the commodities markets. For example, precious metals like platinum and gold have an influence on rand performance.

While commodities have registered positive performance, the rand has not been able to sustain the gains linked to firmer commodity prices.

In addition, the rand also shares the same category as the euro under risky currencies or assets. In times of uncertainty, market players sell such currencies and seek safe haven in currencies like the US dollar. Furthermore, there are other factors which ought to have supported the rand this year.

SA is the largest economy in Africa with a GDP of about US$360 billion. In addition, the country has integrated financial markets which enable smooth financial intermediation.

The country’s investment governance is quite commendable and has helped to attract foreign direct investment (FDI).

According to the 2011 Ibrahim Index of African Governance, SA had a score of 71% (ranked 5th out of 53 African countries) while Zimbabwe had a score of 31%.

Furthermore, the country is well represented in the G20 nations and it actively participates in multilateral institutions like the World Bank and IMF. In light of very low interest rates in developed economies like the US, UK and Europe, SA enjoyed an increase in capital inflows as investors search for better returns.

While these inflows are sometimes hot, one would expect them to benefit the economy at least for that short-period. For example, foreign direct investment in the mining and retail sectors grew from US$1,2 billion in 2010 to US$4,5 billion in 2011.

During this year, SA Government Bonds were also included in Citigroup’s World Government Bond index which further increased investor participation. As for the export market, SA’s major partners are China, Europe, Asia and US. While China has been faced with faltering growth, there has been a steady demand for industrial metals which could have resulted in positive rand performance.

Even though it is acknowledged SA’s export markets, mainly in Europe, are on the brink of recession, the pendulum has swung too far for the rand. Home-grown risks have largely dented rand performance since the market had already priced in Europe’s woes and US fiscal problems.

The under-performance of the rand started in June 2012 as investors focused more on the structural problems within South Africa.

The country has a ballooning public debt which was partly triggered by the need to finance the 2010 Fifa World Cup.

Currently, SA has a current account gap of about US$23 billion, which is 6,4% of GDP. The violent strikes in the primary sector, mainly mining, which halted production at big mining houses like Anglo weighed down the already fragile growth.

The mining sector grew by a negative 0,6% during this period.
In addition, the manufacturing sector weakened thus reducing the growth forecast. Manufacturing and mining sector contributes about 15% and 4-6% respectively to SA’s GDP.

In view of imminent risks embedded in the local economy, Moody’s downgraded SA from A3 to Baa1 citing a negative outlook which added to selling pressure on local assets as investors re-balanced their portfolios.

Domestic risks coupled with an already weak global economy resulted in weaker-than-expected third quarter GDP growth of 1,2% compared to 3,4% in the second quarter. When these events unfolded from September to November, the rand experienced volatile swings losing more than 7,5% as it breached the R9,00 mark against the dollar.

SA is Zimbabwe’s major trading partner. Thus volatility in the rand has direct cash flow implications on companies’ bottom lines.

Since the US dollar is the reporting currency, a weaker rand hurts exporters while a firmer rand will benefit importers.

As such exporters can buy the rand forward when it is weak and importers can sell their expected rand inflows when the currency is strong. This yields cash flow certainty and it helps to insulate corporate balance sheets from rand volatility.

Looking ahead, while the weakness in the rand might seem to be overstated, economic sentiment indicators do not rule out with certainty the possibility of double digit rand levels.

The currency remains vulnerable to changes in global risk aversion.

Even though the strikes have ended, the fourth quarter might not produce pleasing GDP figures as the fundamentals have not changed. IMF has discounted 2013 global growth forecast from 3,6% to 3,3%.

In addition, demand for SA’s exports to major partners like Europe, Asia and China is expected to be depressed. These countries consume more than 50% of SA exports, thus rand performance in 2013 is contingent on recovery in its trading partners most importantly Europe.

In addition, there is event risk on December 31 when the US has to decide on how to deal with the “fiscal cliff”. Since there is no control over what happens in the global arena, improvement in local fundamentals might restore some lost ground in the local unit.

Without orderly recovery in domestic factors, further sovereign downgrades are unavoidable and the rand might succumb to further selling pressure.

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