Weakness long overdue
Even the SA Reserve Bank wants depreciation
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