Why the rand punches above the weight of SA’s econ­omy

The lo­cal cur­rency is one of the most traded in the world. What does this mean for the coun­try?

Finweek English Edition - - THE WEEK - By Matthew Kofi Ocran

thie s size of the South African econ­omy out of sync with the rank­ing of the rand as the 18th most-traded cur­rency in the world?

The South African econ­omy is the 33rd big­gest in the world, with a GDP of $350bn in 2014. But its cur­rency is ranked 18th when the per­cent­age shares of the av­er­age daily turnover of the global for­eign ex­change mar­ket are con­sid­ered.

The rand has re­cently ex­pe­ri­enced an un­prece­dented level of volatil­ity – more so than most, if not all, emerg­ing-mar­ket cur­ren­cies. But a greater part of the pain has been self-in­flicted.

The low eco­nomic growth out­comes in the re­cent past, as well as the poor growth out­look and do­mes­tic po­lit­i­cal risk is­sues have all con­trib­uted to putting the lo­cal cur­rency on the back foot. An ex­am­ple of this played out in South Africa in De­cem­ber 2015, when the coun­try’s fi­nance min­is­ter was abruptly fired and re­placed with an un­known back­bencher. In­vestors lost con­fi­dence in the run­ning of the econ­omy, with ter­ri­ble con­se­quences for the rand, which reached a new low of more than R16/$.

Size of econ­omy ver­sus cur­rency trades

But this re­cent volatil­ity can’t be blamed on the fact that the rand punches above its weight in the for­eign ex­change mar­ket. Other rea­sons ac­count for this.

SA is not alone. There are many other small economies in the world whose cur­ren­cies have big­ger shares in the global for­eign ex­change mar­ket.

For ex­am­ple, the Swiss franc is the sixth most im­por­tant for­eign ex­change mar­ket in the world, but the coun­try is ranked as the 20th big­gest econ­omy. New Zealand is ranked as the 53rd big­gest econ­omy, but the New Zealand dol­lar is the tenth big­gest for­eign ex­change mar­ket.

On the re­verse side, there are a num­ber of coun­tries with big economies whose cur­ren­cies are traded very lit­tle. This is be­cause they don’t have a well-de­vel­oped fi­nan­cial mar­ket. SA’s Brics part­ners Brazil and In­dia have much big­ger economies than SA, but their for­eign ex­change mar­kets are smaller.

The US and Ja­pan, the first- and third­biggest economies in the world, also have well-de­vel­oped fi­nan­cial mar­kets. It is there­fore no won­der that the US dol­lar and the Ja­panese yen are the first and third most-traded cur­ren­cies in the world.

The Chi­nese yuan oc­cu­pies ninth po­si­tion in the rank­ing of traded cur­ren­cies, even though it is the sec­ond-big­gest econ­omy in the world. This is due to the fact that its fi­nan­cial mar­kets are rel­a­tively un­der­de­vel­oped.

This shows that the size of an econ­omy has no role in the trade­abil­ity of its cur­rency.

Rand for­eign ex­change mar­ket size

The rand for­eign ex­change mar­ket, like that of any other trade­able as­set, is un­der­pinned by de­mand and sup­ply. These de­ter­mine its mar­ket size. There are a num­ber of crit­i­cal play­ers on both sides. They in­clude: In­di­vid­u­als and in­sti­tu­tions that plan to buy

Be­cause the rand is traded in all ma­jor for­eign ex­change mar­kets such as the UK, US, Ja­pan, Sin­ga­pore and Hong Kong, spec­u­la­tors can present a dan­ger to its pric­ing.

South African as­sets – real and fi­nan­cial. Real as­sets in­clude res­i­den­tial and non­res­i­den­tial prop­er­ties. Fi­nan­cial as­sets are made up of bonds, stocks, de­riv­a­tives and other fi­nan­cial in­stru­ments. On the sup­ply side are those who plan to sell these as­sets. The ex­port de­mand of South African goods and ser­vices is also a ma­jor source of de­mand for the cur­rency. In the same way, the sup­ply side is driven by ex­porters of South African goods and ser­vices. Cur­rency spec­u­la­tors. Spec­u­la­tors of the cur­rency buy and sell and some­times hold the cur­rency for a while to make a re­turn from favourable fluc­tu­a­tions in its value. Spec­u­la­tors are also a source of sup­ply.

Who is do­ing the buy­ing and sell­ing? A host of play­ers are ac­tive in the for­eign ex­change mar­ket of the rand. These in­clude: com­mer­cial and in­vest­ment banks, cen­tral banks, se­cu­ri­ties houses, as­set and fund man­agers, com­pa­nies and in­sti­tu­tional in­vestors such as pen­sion funds.

Ben­e­fits and risks

The in­ter­est in SA’s cur­rency in the global for­eign ex­change mar­ket is a re­flec­tion of how the do­mes­tic econ­omy is plugged into the world econ­omy, par­tic­u­larly the de­vel­oped world. This needs to be cher­ished.

This con­nec­tiv­ity is fa­cil­i­tated by a fi­nan­cial sys­tem that is well reg­u­lated. In fact, it out­per­forms a great many other de­vel­oped coun­tries. For ex­am­ple, for four con­sec­u­tive years the coun­try was ranked num­ber one in the world when it comes to the reg­u­la­tion of se­cu­ri­ties ex­changes.

The ben­e­fit of be­ing con­nected to the in­ter­na­tional fi­nan­cial mar­ket is that SA’s mar­ket is ex­posed to a larger num­ber of par­tic­i­pants. This con­trib­utes im­mensely to the liq­uid­ity of do­mes­tic real as­set and fi­nan­cial as­set mar­kets.

Clas­si­cal eco­nomic the­ory sug­gests that high liq­uid­ity re­sults in trades be­ing priced cor­rectly. This doesn’t hap­pen in an illiq­uid mar­ket with a small num­ber of buy­ers and sell­ers.

The dan­ger posed by spec­u­la­tors

Spec­u­la­tors pose the big­gest risk to a cur­rency. Be­cause the rand is traded in all ma­jor for­eign ex­change mar­kets such as the UK, US, Ja­pan, Sin­ga­pore and Hong Kong, spec­u­la­tors can present a dan­ger to its pric­ing.

But the risk of an at­tack by spec­u­la­tors is min­i­mal if the South African Re­serve Bank is seen to be pur­su­ing a sen­si­ble ex­change rate pol­icy. For in­stance, if the South African Re­serve Bank de­cides to in­ter­vene in the rand for­eign ex­change mar­ket with the in­ten­tion of man­ag­ing the cur­rency’s ex­change rate, it may open up the cur­rency for spec­u­la­tive at­tacks.

A clas­sic ex­am­ple is the fa­mous “Black Wed­nes­day” episode, when spec­u­la­tors broke the Bri­tish pound on 16 Septem­ber 1992. The Bri­tish gov­ern­ment got its fin­gers badly burnt in an at­tempt to sup­port the pound. One spec­u­la­tor, Ge­orge Soros, is re­ported to have walked away with $1bn in a sin­gle day from bet­ting against the Bank of Eng­land. Its les­son shouldn’t be lost on any­one. In fact, the hands of the South African Re­serve Bank are tied as far as the rand’s for­eign ex­change rate is con­cerned. Even if it wanted to, it couldn’t in­ter­vene in any mean­ing­ful way to in­flu­ence the di­rec­tion of the cur­rency’s for­eign ex­change rate. This is be­cause it doesn’t have the re­sources: the for­eign ex­change mar­ket is mas­sive rel­a­tive to the for­eign ex­change re­serves of the coun­try.

Just look at the num­bers. The bank’s gross of­fi­cial gold and for­eign ex­change re­serves are es­ti­mated at $47bn. Given that the value of trade in the rand alone is more than $60bn in a typ­i­cal day, it would be fool­hardy to imag­ine that the coun­try’s for­eign ex­change re­serves can be used to prop up the cur­rency’s ex­change rate.

That’s not to say that noth­ing can be done. Un­due volatil­ity can be man­aged. The gov­ern­ment and its Na­tional Trea­sury, which over­sees the coun­try’s econ­omy, have a role to play. They can make sure that eco­nomic poli­cies are sound and sta­ble, and that in­vestor con­fi­dence in the coun­try is main­tained. The gov­ern­ment can also make sure that the rule of law is up­held.

Rand ban­knotes and coins sit in a cash till in­side a store in the Rose­bank dis­trict of Jo­han­nes­burg.

Ge­orge Soros Bil­lion­aire and founder of Soros Fund Man­age­ment LLC

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