Rand shock hor­ror

Even if fully an­tic­i­pated, the trend line would be com­pletely smooth – and it never is

Finweek English Edition - - In The Spotlight - HOWARD PREECE howardp@fin­week.co.za

THERE ARE ONLY TWO CER­TAIN­TIES about the out­look for the rand ex­change rate: Over the short/medium term there can be no guar­an­teed fore­casts at all; but there is, on all ex­pe­ri­ence to date, one ab­so­lutely sure fac­tor that will oc­cur over the long term – a repet­i­tive, though fleet­ing, re­turn to norm of the “real ef­fec­tive ex­change rate” of the rand, ac­com­pa­nied by wild fluc­tu­a­tions ei­ther side of that po­si­tion.

Start with the short/medium sit­u­a­tion. The rand is, we know only too well, highly volatile. It re­peat­edly rises or falls in value – mov­ing over the past three decades vastly more of­ten down than up – by quite sig­nif­i­cant amounts in only a few weeks, maybe even days.

Such move­ments are by def­i­ni­tion “a shock”. If they had been fully an­tic­i­pated, the trend line would be com­pletely smooth – and it never is. Of course, some an­a­lysts will al­ways be able cor­rectly to claim on most (though def­i­nitely not all) oc­ca­sions that they called the latest cur­rency move­ments broadly cor­rectly ahead of events.

That must be so. If there are enough pre­dic­tions made, some­one must nec­es­sar­ily come pretty close to get­ting it right what­ever hap­pens – ex­cept when all con­ven­tional as­sump­tions are blown out of the wa­ter. Take, in that con­text, what SA’s Bureau of Eco­nomic Re­search (BER) said in March 2007. BER econ­o­mist Hugo Pien­aar ad­vised: “SA is in a bit of a Goldilocks sce­nario. The cur­rent ac­count of the bal­ance of pay­ments, the rand ex­change rate and in­fla­tion seem to be less of a con­cern while in­ter­est rates are likely to be un­changed for the time be­ing.” He added: “Those trends en­sure that eco­nomic growth re­mains ro­bust.”

Alas, things turned out very dif­fer­ently. A lot of the im­pe­tus has gone out of growth. In­fla­tion has soared, even al­low­ing for the lower re­vi­sion of the con­sumer price in­dex (CPI) that Sta­tis­tics SA has car­ried out. The deficit on cur­rent ac­count bounded up to 9% of GDP, an­nu­alised, in the first quar­ter of this year, against 6,5% be­tween April and June 2007. And within the past 12 months the rand has briefly strength­ened to firmer than US$0,15 (US$1/R6,50) and weak­ened as low a US$12,5c (US$1/R8).

I’m not re­motely sin­gling out the BER for spe­cial at­ten­tion: it rightly en­joys an ex­cel­lent rep­u­ta­tion. But the BER is as sub­ject to any other fore­cast­ing unit to ex­plo­sive but un­ex­pected eco­nomic change.

In March 2007 oil was back just above $50/bar­rel. The BER no more fore­saw than

The rand is also sub­ject to SA’s pol­i­tics, com­mod­ity prices

and the world econ­omy.

the In­ter­na­tional Mone­tary Fund (or any other ma­jor global eco­nomics group) that the price would be nudg­ing $150/bar­rel barely 12 months later.

The rand is also sub­ject to such mas­sive but col­lec­tively un­quan­tifi­able fac­tors as SA’s do­mes­tic pol­i­tics, com­mod­ity prices and the world econ­omy and world trade. There’s also the ef­fect of the “carry trade”.

But what about re­cur­ring sta­bil­ity of the real ef­fec­tive ex­change rate of the rand? What is that? And why does it mat­ter? It’s an in­dex fig­ure cal­cu­lated by the SA Re­serve Bank. It’s based, first, on the trade-weighted value of the rand against a bas­ket of all ma­jor cur­ren­cies. In other words, it’s a much truer in­di­ca­tor of what’s hap­pen­ing to the cur­rency than the US dol­lar/rand fig­ure, which doesn’t di­rectly al­low for enor­mous shifts in the worth of the dol­lar world­wide.

But fur­ther es­sen­tial re­fine­ment of the ba­sic in­dex arith­metic then takes place. Cru­cial al­lowance is made for the dif­fer­ence be­tween SA’s in­fla­tion rate and the av­er­age level – trade-weighted again – of the rate of price in­creases in the other na­tions.

That’s vi­tal. Sup­pose, as has been the case for more than 30 years, that the nom­i­nal ex­change rate of the rand – the value in­di­cated daily in the me­dia – is on an ob­vi­ous long-term down­trend, in­ter­rupted at times by up­ward bursts. That seems to in­di­cate per­ma­nent hap­pi­ness for ex­porters.

How­ever, if a de­clin­ing nom­i­nal ex­change rate is boost­ing rand re­ceipts by, say, 5%/year and SA’s in­fla­tion rate, and thus costs, is run­ning five per­cent­age points above the av­er­age of its trad­ing part­ners – roughly the cur­rent case – the net re­sult is no change.

That leads on to the peren­nial de­bate about whether the rand is over- or un­der­val­ued. At times it’s one, at times it’s the other. San­lam chief econ­o­mist Jac Laub­scher points to re­search by lead­ing US econ­o­mist William Cline that looks at the hefty pro­por­tion­ate size of SA’s cur­rent ac­count deficit. Cline says the real ef­fec­tive rate of the rand needs to fall by be­tween 9% and 14% to get that deficit back to sus­tain­able lev­els. That means there has to be an even greater de­cline in the nom­i­nal value of the rand to com­pen­sate for SA’s ex­ces­sive in­fla­tion. Alas, a cheaper rand also fu­els in­fla­tion.

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