Dollar-rand exchange rate is not a mystery

A great deal of commercial, domestic and speculative energy is spent pondering the future of the rand. Yet past experience tells us the foreign exchange value of the rand will remain highly variable and unpredictable. The best prediction for tomorrow’s exchange rate is today’s rate, but with a high level of variance that increases with time.

As in the past, the rand is unlikely to be a one-way bet. It will experience periods of negative and positive turbulence. On average, persistent rand weakness is expected in the currency markets due to the higher inflation and sovereign risk of SA relative to the dollar and other hard currencies.

The rand cost of a dollar is priced to rise at an average rate of 5.5% per annum over the next five years and by about 4.5% in 2024. Yet for all its volatility, changes in the foreign exchange value of the rand can be almost fully explained by two persistent influences. These are the exchange rates of other emerging market currencies with the dollar and the dollar prices of the industrial metals that SA exports.

Since 2010 daily movements in the emerging market currency basket explain 54% of daily movements in the randdollar exchange rate. This is a highly significant association. If you had a crystal ball that foretold future emerging market basket-to-dollar rates, you could make confident and profitable bets on the trajectory of the rand’s exchange rate.

Unfortunately, exchange rates are random walk processes that are impossible to precisely predict. And commodity prices also follow a random walk process. Your best guess for tomorrow’s rand-dollar exchange rate is today’s rate plus or minus 1% (and about 2.2% if you’re looking a week ahead).

However, knowing why the rand behaves as it has is not much help to predict where it is heading. Forecasting the dollar-rand exchange rate demands an accurate forecast of the dollar value of other emerging market currencies and metal prices.

This is a formidable task. A strong dollar, as measured against its developed economy peers, will enforce weakness in emerging market currencies and the rand, and probably also weigh on metal prices when expressed in dollars, and vice versa.

The major force acting on metal prices will be the state of the Chinese economy — the major destination for industrial metals — and so it is another known unknown with relevance for the rand.

The other forces acting on the rand are SA-specific events, political shocks and own goals that move the rand irregularly and unpredictably one way that may then be reversed. These shocks account for up to 46% of the movement in the rand relative to other emerging markets.

This is where wise economic policy and effective implementation of those policies can positively influence the exchange rate. The persistently weaker bias of the rand when compared not only to the dollar but to other emerging market currencies is due to the failure of the SA economy to deliver meaningful growth and attractive returns.

The rand is riskier than the emerging market basket to a significant degree. A drop of 1% in the basket typically translates to a 1.5% drop in the rand. The government’s job is not only to shoot fewer own goals, but to convince through positive, co-ordinated action that SA is not significantly riskier than other emerging markets.

The potential gains are a less risky rand, a lower cost of capital, greater investment, job creation and more wealth for the country to share.