Weak­ness long over­due

Even the SA Re­serve Bank wants de­pre­ci­a­tion

Finweek English Edition - - Economic Trends & Analysis - GRETA STEYN gre­tas@fin­week.co.za

A LIT­TLE BIT OF RAND weak­ness will do us good. Of course, no­body wants to hear that, given the ex­change rate’s ef­fect on in­fla­tion. But rather a mild and man­age­able weak­en­ing in the rand now than false strength that’s smashed af­ter a while by a spec­tac­u­lar crash.

At the time of writ­ing the rand was trad­ing at more than US$1/R7,80 – a far cry from the lev­els be­low US$1/R7,20 seen a few weeks ago when the rand hit its best lev­els in a rally that baf­fled most an­a­lysts and traders. The rally may have seemed like good news to those wor­ried about the petrol price, but it’s in­ter­est­ing to note that not even the SA Re­serve Bank wants to see a rand be­low US$1/R7,20. Put dif­fer­ently, the Bank re­alises that ex­change rate isn’t sus­tain­able for a coun­try with one of the world’s largest cur­rent ac­count deficits. When the rand was at its strong­est lev­els, SA’s cen­tral bank took ac­tion to nudge the cur­rency weaker.

Rand Mer­chant Bank strate­gist John Cairns draws some in­ter­est­ing con­clu­sions from the Bank’s monthly data on its for­eign ex­change re­serves. The lat­ter is the stock of for­eign cur­rency the Bank holds and that it can in­crease by buy­ing US dol­lars or euros in the mar­ket. It goes with­out say­ing that by en­ter­ing the mar­ket, the Bank puts it­self into a po­si­tion of be­ing able to in­flu­ence the cur­rency’s value.

Cairns cal­cu­lates from the July re­serve fig­ures the Bank bought around US$500m from the mar­ket. “That’s an ac­cel­er­a­tion in their pur­chases from re­cent months and in­di­cates they’ve acted against rand strength. Nev­er­the­less, the size of its ac­tiv­ity isn’t of the mag­ni­tude seen in 2006 and 2007, when it ag­gres­sively at­tempted to halt rand ap­pre­ci­a­tion,” says Cairns.

Net gold and for­eign ex­change re­serves rose $409m in July to $34,17bn. Ad­just­ing for val­u­a­tion ef­fects – the gold price was val­ued at a lower level – Cairns es­ti­mates this im­plies $520m buy­ing forex from the mar­ket. That rep­re­sents a clear ac­cel­er­a­tion in its buy­ing from the av­er­age of around $200m over the past few months.

Says Cairns: “Even though a stronger rand would help re­lieve some in­fla­tion­ary pres­sures, we be­lieve the Bank is wor­ried enough about the large cur­rent ac­count deficit to want to keep the rand at a stable but weak level. But it’s in­ter­est­ing that the ex­tent of their buy­ing in a month when the rand ap­pre­ci­ated strongly and broke key tech­ni­cal sup­port lev­els is still a lot smaller than their ac­tiv­ity in 2006 and 2007.”

Cairns doesn’t say so, but it seems clear the Bank is tread­ing care­fully, be­cause if it be­came too ob­vi­ous that it’s try­ing to steer the rand weaker, it might pre­cip­i­tate a crash. The Bank is tread­ing a fine line be­tween nudg­ing the rand weaker and not caus­ing panic in the mar­ket.

Why does the Bank want the rand to be weaker? The an­swer is sim­ply that SA has a huge cur­rent ac­count deficit and that a stronger rand would make im­ports cheaper, thus widen­ing the cur­rent ac­count deficit even fur­ther. The trou­ble with a large cur­rent ac­count deficit is that it re­quires for­eign cap­i­tal from off­shore to flow in to fi­nance the short­fall be­tween im­ports and ex­ports and that a per­cep­tion that the cap­i­tal isn’t go­ing to come into the coun­try could trig­ger a crash in the rand and a rush for the ex­its by those in­vestors al­ready in­vested in SA.

SA’s cur­rent ac­count deficit was 9% of gross do­mes­tic prod­uct in the first quar­ter of this year – the high­est since first quar­ter 1982 and one of the high­est in the world. The cur­rent ac­count doesn’t just con­sist of the bal­ance of im­ports and ex­ports of goods but also in­cludes “in­vis­i­ble” trade, such as in­ter­est, div­i­dends, freight, in­sur­ance and other ser­vices. The trade deficit for goods has im­proved in re­cent months, record­ing a sur­pris­ingly small deficit of R200m in June af­ter a mod­er­ate deficit in May. Data for May and June show less than R2bn in deficit. The lagged ef­fects of past rand weak­ness may be con­tribut­ing to a shrink­ing trade deficit, but the re­cent sharp de­clines in com­modi­ties prices might stop that trend.

It seems as if two cru­cial trends that have held up for about seven years have been bro­ken. For years, the US dol­lar has been weak and com­modi­ties prices strong. There’s an in­verse re­la­tion­ship be­tween the dol­lar and com­modi­ties prices and it comes as no sur­prise that the oil price has plum­meted while the dol­lar has strength­ened. The turn­around in th­ese past trends sug­gests rand weak­ness, with Cairns putting the ex­change rate at US$1/R8,50 by year-end.

Rand at R8,50 by year-end. John Cairns

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