What’s better – a strong rand or a weak rand?

A look at the arguments around the right level for the rand.

As you might have heard, the rand has had a pretty rough couple of years (see chart below). Since November 2011, it has depreciated by 27% against the US dollar, and seems likely to remain range-bound at between R9.50 and R10.50 to the dollar for the foreseeable future.

The rand’s fall is the result of a host of factors, some that are within South Africa’s control, and some that are not. Domestically, the rand has been hit by the steady rise in the burden of government debt on the economy. As the charts below indicate, government spending has consistently outpaced government revenue over the last few years (and is projected to continue doing so), and as a result, government debt has steadily ticked up. This, combined with the confidence-shaking unrest in South African labour relations, has contributed to the weaker rand.

However, the more significant downward pressure has probably come from global factors. On the global front, emerging market (EM) currencies around the world, including the rand, the Brazilian real, the Turkish lira, the Mexican peso, and the Thai baht, have all tanked in 2013. This blanket fall in EM currencies is generally attributed to the fact that growth has slowed in EMs while at the same time it has picked up in rich countries, causing investors to pull cash from EMs and shift it to developed markets (for more on this theme, see here). This, together with the risk of impending Fed tightening, has led to a brutal sell-off of EM assets and currencies, and the rand has, as a result, fallen along with the rest.

Given these broad dynamics, then, it seems likely that rand weakness will persist for at least the next few months, although the currency does usually strengthen a bit over the December holidays. At any rate, it looks like a fairly weak rand from here on out. So the question is, is this a good thing, or a bad thing?

There are two schools of thought on the subject. On the one hand there are those that prefer a stronger rand, arguing that this helps keep down the cost-to-consumer of imports like petrol (and makes their overseas holidays and imported electronics more affordable). On the other hand, there are those that argue that the rand needs to fall even further in order to make South African exports more globally competitive.

The arguments in favour of a weak rand are persuasive. In one interesting contribution to the debate, for example, Capital Economics points out the South Africa currently has both a substantial current account deficit (indicating the country is importing more than it is exporting) and high unemployment (an indicator of low domestic demand). This is a bit of a conundrum, since low domestic demand should theoretically mean lower imports, but Capital Economics points out that this is addressed by the Swan Diagram developed by Austrian economist Trevor Swan (see image below).

As you can see, the diagram illustrates how countries must balance internal and external factors. South Africa is in zone B, with a large current account deficit and high unemployment. To move to zone A, where there is balance between internal and external pressures (and as a result a stable current account and a balance between unemployment and inflation), the country needs to move along the real exchange rate axis, in other words, let the rand weaken. In other words, South Africa is displaying the usual symptoms of a country in need of a currency devaluation.

However, things are not as simple as that (are they ever?). According to recent data, South Africa’s trade deficit was R18.9bn in September, higher than the expected R16.4bn the market was anticipating, and almost unchanged from August’s R19.1bn. According to Stanlib’s economist Kevin Lings, this suggests that things are not as simple as “Let’s lower the rand.”

Says Lings, “There is still no clear indication … that the weaker Rand is helping to improve South Africa’s trade balance. This is partly because the growth in SA exports is more a function of global growth than merely Rand weakness. Equally, the extensive labour market disruptions in the mining and manufacturing sectors have severely undermined South Africa’s exports performance in 2013. In addition, it takes time for local companies to substitute domestic products for imported products when the Rand weakens – and in many instances this type of substitution is simply not possible.”

In other words, South Africa’s export weaknesses run deeper than the level of the rand. Global demand and local labour relations also play a role, and unless these change, a weaker rand alone will probably be insufficient to make much of a dent in South Africa’s growing trade deficit.

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