Rand value ex­actly right

Noth­ing wrong with the cur­rency’s weighted ex­change rate

Finweek English Edition - - Openers - VIC DE KLERK

A COUN­TRY’S REAL ex­change rate is sim­ply cal­cu­lated by choos­ing one base year – in South Africa’s case it’s 2000 – and mak­ing that equal to 100. All the other im­por­tant cur­ren­cies are al­lo­cated a weight in terms of our trade with that cur­rency in the pre­ced­ing years. The 2000 weight­ing of SA’s real ef­fec­tive ex­change rate (REER), as cal­cu­lated by the SA Re­serve Bank, is as fol­lows:

SA’s REER, as cal­cu­lated by the Bank, was 102,17 at end-Novem­ber last year. Wichard Cil­liers, of Trea­sury One, a bou­tique trea­sury spe­cial­ist in Pre­to­ria, says the rate was about 100 last week – pre­cisely the same as the base of 100 in 2000 that’s used by the SA Re­serve Bank.

The graph shows that the REER fell to nearly 70 af­ter the sharp drop in the value of the rand at end-2001, when it fell to around US$1/R12. At that time, the rand was a dra­mat­i­cally un­der­val­ued cur­rency and the or­di­nary ex­change rate then had to re­cover.

How­ever, the graph shows clearly that the re­cov­ery was too ex­ces­sive. For ex­am­ple, by May 2006 – when the rand was trad­ing at less than US$1/R6 on the or­di­nary spot mar­ket – the REER shot up to more than 118. That meant the rand was def­i­nitely over­val­ued.

Pres­i­dent Thabo Mbeki pointed out in his State of the Na­tion ad­dress that the sig­nif­i­cant fluc­tu­a­tions in the value of the rand are/were bad for the de­vel­op­ment of SA’s in­dus­tries. Mbeki is quite right to be con­cerned. The fluc­tu­a­tion from a base of 100 in 2000 to 70 and then back to 118 be­fore now set­tling calmly on 100 – all within six years – may be rather dif­fi­cult for ex­porters who need an ex­change rate pro­jec­tion of five to 10 years to de­ter­mine the vi­a­bil­ity of a project.

In terms of mu­tual trade, the euro is twice as im­por­tant as the US dol­lar (see ta­ble). In fact, SA’s news ser­vices should there­fore give the euro/rand ex­change rate first and we should base our pre­dic­tions on that.

Af­ter the Bank’s ini­tial value cal­cu­la­tion of 100 for 2000, it’s ad­justed monthly for the dif­fer­ence in our in­fla­tion and that of other coun­tries (in terms of the weight­ings set out in the ta­ble).

The Bank de­cided to use the pro­ducer price in­dex (PPI) for that. Our pro­ducer prices rose by 8,4% in 2001. As­sum­ing the weighted in­fla­tion of our trad­ing part­ners in­creased by only 2,4% in 2001 in terms of the weights above, then the REER the­ory states that, on a weighted ba­sis, the rand should have de­val­ued by 6% (8,4% -2,4%) in 2001.

If it works out ex­actly like this ev­ery year, the REER will re­main at ex­actly 100 and the pur­chas­ing power par­ity – be­cause that’s what the REER is – of our cur­rency will al­ways re­main the same. Be­low 100 the pur­chas­ing power is too low and above 100 it’s too high.

That’s easy. It’s just a pity that heavy­weights such as the man­age­ment at SA Air­ways, didn’t have time to look at the graph in 2002/2003 to find out a lit­tle bit about the REER. Then they wouldn’t have taken out that ridicu­lous for­ward cover, which cost SA’s tax­pay­ers more than R10bn.

But where to now with our ex­change rate? In­vesto­pe­dia points out the fol­low­ing six im­por­tant forces that can de­ter­mine the di­rec­tion of a coun­try’s ex­change rate: • Dif­fer­en­tials in in­fla­tion. If a coun­try’s in­fla­tion rate is higher than that of its trad­ing part­ners, its cur­rency should de­value by the dif­fer­ence an­nu­ally. In the case of SA, our cur­rent PPI pre­sum­ably still re­quires the rand to fall by about 5%/year. • Dif­fer­en­tial in in­ter­est rates. A higher in­ter­est rate than that of your trad­ing part­ners, as we cur­rently have, can stim­u­late the in­flow of over­seas money and lead to the rand strength­en­ing. • Cur­rent ac­count deficits. SA cur­rently has a huge deficit of about 6% of its gross do­mes­tic prod­uct. Our im­ports are far more than our ex­ports, and this means that the de­mand for for­eign ex­change is greater than the sup­ply. That causes the rand ex­change rate to fall. Pub­lic debt and the fis­cal deficit. We don’t have a fis­cal deficit. In fact, there will be a sur­plus for the year to March 2007. Gov­ern­ment is there­fore not print­ing money. That’s good, and that could strengthen the rand. Terms of trade. This re­la­tion­ship mea­sures the trend be­tween the prices of a coun­try’s im­ports and ex­ports. Cur­rently, the terms of trade are in SA’s favour, as the prices of man­u­fac­tured goods that we im­port are ris­ing slower than (in par­tic­u­lar) our gold and plat­inum ex­ports. An­other plus for a stronger rand. Po­lit­i­cal sta­bil­ity and eco­nomic per­for­mance. SA prob­a­bly has some­what less of that than its trad­ing part­ners and it should cause a weaker rand. That list tells us that there are ex­actly an equal num­ber of fac­tors in our econ­omy that can cause the rand to strengthen or weaken. At the same time, the REER is ex­actly cor­rect on 100 at the mo­ment. All in all, that tells us that for the next year or so we’ll prob­a­bly see lit­tle fluc­tu­a­tion in our ex­change rate.

How­ever, if the REER again sharply di­verges from its 100 value, im­porters and ex­porters should be on the alert and not miss the op­por­tu­nity to hedge them­selves.

And don’t put the blame on Gov­ern­ment af­ter the event ei­ther. It’s the fault of a free mar­ket – which we all like to pam­per so much – that there are some­times large changes.

WEIGHTED EX­CHANGE RATE IS EX­ACTLY RIGHT AT PRESENT

REAL EF­FEC­TIVE EX­CHANGE RATE FROM 2000

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