Lit­tle room for ma­noeu­vre

Finweek English Edition - - Openers - GRETA STEYN

IT TOOK SEC­ONDS in the cur­rency mar­ket af­ter the res­ig­na­tion of Fi­nance Min­is­ter Trevor Manuel for the mes­sage to be rammed home that the rand is the main barom­e­ter of in­vestor sen­ti­ment in South Africa. There can be no doubt that SA’s cur­rency is highly vul­ner­a­ble and the coun­try’s new leaders have very lit­tle room to ma­noeu­vre.

Be­fore Manuel’s res­ig­na­tion bomb­shell it was well nigh im­pos­si­ble to try to pre­dict what would hap­pen to the rand. That’s mostly be­cause the rand’s for­tunes against the US dol­lar are mostly tied to the euro and the US dol­lar/euro rate has been gy­rat­ing madly.

For weeks – be­fore fi­nan­cial dis­as­ter struck in the United States – the story was of a strength­en­ing dol­lar and weak­en­ing com­mod­ity prices. The com­bi­na­tion was bad for the rand, which briefly traded at US$1/R8,35 – the rand’s weak­est level in five years. But then cri­sis struck, mud­dy­ing the wa­ters for the dol­lar.

It may seem strange but the US$700bn bail-out that was un­der dis­cus­sion in the US at the time of writ­ing didn’t have a pos­i­tive ef­fect on the green­back. There are fears the ex­ten­sion of the US bud­get deficit to cover the bail-out will have neg­a­tive con­se­quences for the US econ­omy in the long run, drag­ging the dol­lar down. In the midst of dis­cus­sions, the dol­lar had one of its big­gest one-day moves down­wards against the euro, go­ing nearly all the way to US$1,48/1 euro again – a far cry from lev­els around US$1,40/1 euro seen just weeks ago.

At the time of writ­ing the US dol­lar was off its worst lev­els and some economists pre­dicted it would re­bound. The rea­son they ex­pected a rally in the dol­lar was the fact that in­vestors were sell­ing out of emerg­ing mar­kets and other risky in­vest­ment av­enues and repa­tri­at­ing their pro­ceeds into US dol­lar as­sets. That phe­nom­e­non – known as risk aver­sion – has a neg­a­tive ef­fect on the rand.

From a global per­spec­tive the rand has been sub­ject to two op­pos­ing forces: US dol­lar weak­ness and risk aver­sion. Dif­fi­cul­ties in pre­dict­ing those two fac­tors and how the $700bn res­cue pack­age will pan out make fore­cast­ing the rand a haz­ardous af­fair – even without SA’s po­lit­i­cal and eco­nomic fac­tors over­shad­ow­ing the in­ter­na­tional back­drop. SA’s new leaders need to take a long, hard look at eco­nomic con­di­tions at home be­fore tak­ing any pol­icy de­ci­sions.

Cur­rently, the most im­por­tant con­straint on eco­nomic pol­i­cy­mak­ing is this coun­try’s cur­rent ac­count deficit. That’s the short­fall be­tween all im­ports, in­clud­ing in­vis­i­ble pay­ments, such as div­i­dends and in­ter­est, and ex­ports. At 7,3% of gross do­mes­tic prod­uct in sec­ond quar­ter 2008, SA’s cur­rent ac­count short­fall is one of the worst in the world. It’s highly un­likely the deficit will im­prove sub­stan­tially from cur­rent lev­els.

That was ev­i­dent from the lat­est trade fig­ures, which showed there was a shock deficit of R14,33bn in July. True, the fig­ure came af­ter an ab­nor­mally low June but it still served as a re­minder that SA’s trade sit­u­a­tion leaves this coun­try vul­ner­a­ble.

The key point about the cur­rent ac­count deficit is that it has to be fi­nanced by for­eign cap­i­tal in­flows. And that’s why the new leaders in Gov­ern­ment have to be very care­ful not to im­ple­ment any poli­cies that will scare off for­eign cap­i­tal. If cap­i­tal takes flight from SA, the rand will crash, inflation will soar, in­ter­est rates will have to rise and the Left’s hopes of al­le­vi­at­ing poverty dra­mat­i­cally will be dashed.

Rand Mer­chant Bank cur­rency strate­gist John Cairns makes a sig­nif­i­cant point about this year’s trends in cur­rency flows. He says over the past five months SA has run a R75bn cur­rent ac­count deficit. Over that pe­riod this coun­try has seen net port­fo­lio out­flows from for­eign­ers worth R17bn. Add on some buy­ing of for­eign ex­change by the SA Re­serve Bank and Cairns cal­cu­lates a cur­rency out­flow of around R100bn. For the rand to have re­mained rel­a­tively sta­ble there has to be a cor­re­spond­ing R100bn in­flow. “But where ex­actly that’s com­ing from we don’t know. Pre­sum­ably, spec­u­la­tive in­flows. But if so then we re­ally are re­ly­ing on hot money to fund our cur­rent ac­count deficit – hardly a sus­tain­able sit­u­a­tion.”

The point Cairns makes – that SA is re­ly­ing on short-term in­flows re­lated to SA’s high in­ter­est rates – rams home the fact that SA can’t count on for­eign cap­i­tal con­tin­u­ing to pour into the coun­try. Against that back­ground it would be sheer mad­ness to im­ple­ment poli­cies that have the po­ten­tial to scare off for­eign cap­i­tal. Hope­fully, SA’s new leaders re­alise that.

Hot money. John Cairns

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