Weak dollar saves us from scary politics
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.