Little room for manoeuvre
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