Weak dol­lar saves us from scary pol­i­tics

Business Day - - OPINION - Kan­tor is chief econ­o­mist and strate­gist at In­vestec Wealth & In­vest­ment. He writes in his per­sonal ca­pac­ity.

The most im­por­tant sin­gle in­di­ca­tor of the fu­ture di­rec­tion of the South African econ­omy is the value of the dol­lar com­pared to the euro and the other de­vel­oped mar­ket cur­ren­cies.

Most help­fully for SA and the emerg­ing mar­ket world, mea­sured this way, the dol­lar has lost nearly 4% of its ex­change value this quar­ter.

Dol­lar weak­ness has brought a small de­gree of strength to emerg­ing mar­ket (EM) cur­ren­cies in­clud­ing the rand and metal prices, which make up the bulk of SA’s ex­ports. For much of the pe­riod be­tween 2011 and mid-2016, dol­lar strength put pres­sure on EM ex­change rates. Over this pe­riod, the dol­lar had gained as much as 30% ver­sus its peers, the EM cur­rency index lost about the same ver­sus the dol­lar, while in­dus­trial metal prices and the trade-weighted rand had fallen to about half their val­ues.

The dol­lar has weak­ened and in­dus­trial metal prices have im­proved since 2016 be­cause the rest of the in­dus­trial and emerg­ing mar­ket world has be­gun to play catch-up with the re­vival of the US econ­omy.

A stronger Europe and Ja­pan im­ply more com­pet­i­tive in­ter­est rates and re­turns out­side the US. Hence less de­mand for dol­lars and more for the com­pet­ing cur­ren­cies and met­als.

The rand and RSA dol­lar-de­nom­i­nated bonds have ben­e­fited from these trends de­spite, it should be em­pha­sised, less rather than more cer­tainty about the fu­ture di­rec­tion of SA’s pol­i­tics and eco­nomic pol­icy and a weaker rat­ing ac­corded by the credit rat­ings agen­cies. The rand ex­change rate lost more than 50% of its av­er­age tradeweighted ex­change value in 2011-16. The cost of in­sur­ing five-year dol­lar-de­nom­i­nated RSA debt had soared to nearly 4% more than the re­turn of­fered by a five-year US Trea­sury bond by early 2016.

To­day, this risk spread has de­clined to less than 1.8%, while the rand has gained about 15% on a trade-weighted ba­sis and 17% ver­sus the dol­lar since early 2016. This im­prove­ment has as in­di­cated come with gen­eral dol­lar weak­ness and EM ex­change rate strength and de­spite the con­tin­ued un­cer­tainty about the di­rec­tion of SA’s pol­i­tics.

Re­gard­less of pol­i­tics and poli­cies that caused the sack­ing of for­mer fi­nance min­is­ter Nh­lanhla Nene in late 2015 and Pravin Gord­han in March, the mar­kets — if not the rat­ings agen­cies — ap­pear to be bet­ting on a bet­ter set of poli­cies to come.

It is to be hoped that the mar­kets are right about this. The re­cent strength of the rand and metal prices of­fers mon­e­tary pol­icy an op­por­tu­nity to do what it can to help the econ­omy by re­duc­ing rates. In­fla­tion has come down and will stay down if the rand main­tains its im­proved value, har­vests are nor­mal and the dol­lar re­mains where it is. Lower in­ter­est rates will lift spend­ing and boost de­pressed growth rates and gov­ern­ment rev­enues.

In­ter­est rates were raised af­ter 2014 as the rand weak­ened and in­fla­tion picked up, in­flu­enced also by a drought that drove food prices higher. These higher in­ter­est rates and higher prices fur­ther de­pressed spend­ing by South African house­holds and firms, and con­se­quently GDP growth. To be con­sis­tent, rates could and should now be low­ered be­cause the rand has strength­ened and the out­look for in­fla­tion has im­proved.

Does it make good sense for in­ter­est rates in SA to take their cue from the ex­change rate and other sup­ply-side shocks that drive in­fla­tion higher or lower but over which nei­ther in­ter­est rates nor the Re­serve Bank have much pre­dictable in­flu­ence?

Their only pre­dictable in­flu­ence is to fur­ther de­press spend­ing and growth rates.


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