Rand on tenterhooks as Fed decision looms

China slump threatens emerging market currencies

THE chances of a US interest rate hike this week have diminished considerably following the severe bout of volatility in global financial markets triggered by the crash in China’s stock market at the end of last month.

But the jury is still out on the outcome of the Federal Reserve’s decision on Thursday, and even if US monetary policy stays on hold, emerging market currencies such as the rand are not off the hook, which, in turn, poses a threat to South Africa’s faltering economy.

The rand hit record lows against the dollar, pound and euro this week as concerns mounted over the extent of an anticipated economic slowdown in China, South Africa’s biggest trade partner and the main global consumer of commodities.

China’s government has unveiled a package of measures to ensure the country achieves its growth target of 7% this year, but

If the Fed raises rates, it would risk panic in emerging markets

market jitters are unlikely to dissipate. Uncertainty over the timing and extent of increases in US interest rates — which are hovering just above zero — will only add to the volatility.

“The rand is very sensitive to expectations about when the Fed will hike. If it does hike [this] week, there is likely to be a large negative reaction,” said Rand Merchant Bank currency strategist John Cairns.

The rand hit record lows of 14.02 to the dollar, 15.70 to the euro, and 21.45 to the pound this week — a trend mirrored in other emerging market currencies. It has since clawed back ground, but its rapid depreciation will fan inflation, hitting consumers in the pocket and piling pressure on the Reserve Bank to raise interest rates despite the economy contracting in the second quarter of this year.

Lower consumption and higher interest rates will erode prospects of a recovery in growth, which analysts have revised down to an expected 1.5% this year, compared with forecasts of 2% from the Reserve Bank and the National Treasury.

Weaker growth means lower tax revenue, which could jeopardise budget deficit and debt targets, with inevitable knock-on effects for South Africa’s sovereign credit rating.

Konrad Reuss, the MD of Standard & Poor’s in Southern Africa, hinted on Wednesday that the ratings agency may have to put a negative outlook on its BBB- rating for South Africa — the lowest investment grade.

“In some ways, the story has gone from bad to worse,” he told Business Times. “From our perspective, the key issue for focus in the months ahead is growth. If it comes in significantly lower than expected, what does it do to the fiscal side — revenue performance and expenditure management?”

The outlook on S&P’s rating is stable; changing it to negative would raise the spectre of a downgrade to “junk” status — which would reduce the appeal of South African assets to international investors and raise the cost of foreign debt.

Fitch Ratings director Carmen Altenkirch warned from London there was a rising risk of a downgrade to its BBB assessment of South Africa, which would put it where the S&P rating is now. That would not be wholly unexpected, and probably not as damaging.

The Reserve Bank is expected to keep interest rates steady when it concludes its next mon- etary policy meeting, on September 24, after unexpectedly raising its key repo rate by 25 basis points to 6% in July. Nonetheless, some analysts believe a hike is still possible, if the Federal Reserve decides to take that step.

They argue that this might even be good news for financial markets as it could remove uncertainty about the decision and send a signal of confidence in the US economy, following news of an upward revision to its growth in the second quarter, lower unemployment, better than expected retail sales and a pick-up in consumer confidence.

But to reassure global markets, a US rate hike would have to be accompanied by a statement suggesting there would not be a rapid sequence of further increases, said Barclays Africa economist Peter Worthington. Opinion is mixed as to how much financial markets have already “priced in” an initial interest rate increase. Nonetheless, World Bank chief economist Kaushik Basu has warned that if the Fed raised interest rates, it would risk igniting “panic and turmoil” in emerging markets, and has urged the US central bank to hold fire until markets are more stable. The IMF has made similar comments.

News on Wednesday that business confidence in South Africa fell more than expected in the third quarter will help convince the Reserve Bank’s monetary policy committee not to raise interest rates this month.

An index released by RMB and the Bureau for Economic Research fell by five points to 38 — which means more than six out of 10 respondents are unhappy about business conditions. The drop was spurred mainly by sharp drops in retail confidence, which plunged by 18 points to 34, and in wholesale confidence, which dived by 14 points to 50.

The figures reinforce the view that domestic consumption — South Africa’s main driver of economic growth — is waning as consumers and business respond to rising taxes, inflation and power cuts.

“The Bank has pre-empted a Fed rise . . . so it could take a back seat at the moment and not rush into another interest rate increase,” Reuss said.

If growth comes in significantly lower, what does it do to the fiscal side?

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