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The rand isn’t SA’s ‘share price’ anymore

The days when the exchange rate could be seen as a barometer of the country’s economic prospects (other than when politicians do something really stupid) are over.

An exchange rate is often seen as a country’s ‘share price’ – people see it as a reflection of the nation’s economic prospects, political stability, fiscal discipline, any changes in government policy, and inflation rate. We believe the rand will strengthen if these things improve and worsen if they don’t (often dramatically, to the point where the currency would basically cease to function as a monetary unit).

If a country’s economy implodes totally – the best-known example being just north of the Limpopo River – the currency will become totally worthless. And big events do have an impact on the exchange rate, as the disastrous replacement of Nhlanhla Nene as finance minister in December 2015 proved.

But when everything is going along more or less as expected, the big movements in the rand are largely the result of global investment sentiment towards so-called emerging markets as a whole.

Still the currency of choice on the continent …

The dominant position of the South African economy on the African continent, the strength of our financial system, and the liquidity of the rand on international markets, make the good old ZAR the currency of choice for investors seeking exposure to Africa.

Figures from the African Development Bank show that the continent is offering opportunities, with real GDP growth exceeding 3% most years in the last decade.

However, it seems the growth in fixed investment, international trade and income are not reflected in the demand for African countries’ currencies – they have all depreciated over the last few years, despite economic growth surpassing that of many developing countries.

The assumption that a currency reflects the internal economic health and prospects of any single country no longer holds true. This is especially true in the case of SA.

SA has seen its currency decline sharply over the last 10 years, from R8.47 against the dollar at the beginning of 2009 to R14.39 late Tuesday afternoon. Of other large developing countries, only Brazil, Turkey, Russia and Argentina performed worse.

… although seven African currencies have performed better

In Africa, the currencies of Nigeria, Ethiopia, Ghana, Malawi, Sudan, Angola and Mozambique have performed better than the rand.

Nicky Weimar, senior economist at Nedbank’s economic unit, says we need to consider that SA has become much more integrated into world markets since 1994, so much so that investors’ risk appetite for emerging market assets as a whole became the dominant factor influencing the exchange rate.

If global risk appetites improve, the currencies of all emerging markets tend to strengthen. Similarly, if global risk appetites fade, foreign investors tend to withdraw from emerging markets with a negative effect on equities, bonds and currencies, says Weimar.

She explains that “factors specific to SA only tend to play a major role in the value of the rand if news is either much worse or much better than [the] markets expected.”

Perceptions are what count

One would get a much better idea of the value of the rand by measuring how international investors perceive emerging markets as a whole. Unfortunately, this is difficult.

Weimar lists several factors that are likely to influence the flow of funds into an out of emerging markets. One of the major determinants is the difference between American interest rates and those of emerging economies as this affects returns made on carry trades. In short, the rand will improve whenever it is profitable to borrow money in New York to buy South African government bonds (while taking risk into consideration).

Slower economic growth in developing countries also tends to lower the demand for riskier investments in emerging markets, even if the emerging countries continue to show good growth. Fund managers tend to reduce their risk when things start to get difficult.

“This is why the trade war between the US and China has such an influence on emerging market currencies, including the rand,” says Weimar. “Rising protectionism will ultimately hurt global growth, but will undoubtedly hit small and open emerging economies more than those of larger developed countries.”

But the big issue remains the general perceptions of the risk of investing in developing economies. The currencies of Turkey, Argentina and Brazil fared badly against the dollar because of the fear that these countries might default on their debts, the large loans of which are denominated in dollar. The rand suffered too, despite our much lower exposure to dollar-denominated debt.

One way to ‘see’ what investors believe

Nedbank looks at the difference between capital flows into emerging markets and developed markets to gauge investors’ appetite for more riskier assets, and compares it to changes in the value of the rand. Weimar says the rand tracks this measurement of risk perfectly and can pinpoint any large discrepancies.

A good example was when former president Jacob Zuma fired Nene in 2015 – the rand devalued sharply compared to this risk gauge. “This was the moment the world realised how widespread and entrenched corruption had become in SA,” says Weimar.

The rand recovered quickly compared to the perceived riskiness when Cyril Ramaphosa was appointed leader of the ANC and president of SA.

Since then, says Weimar, the rand has been trading at a slight discount to the emerging markets risk line, probably reflecting a number of major uncertainties such as whether the government will proceed with property expropriation, and how it will deal with the electricity crisis, the dire situation at many of our state-owned enterprises, the large budget deficit, the country’s high debt burden, high rate of unemployment, education system, corruption and policy uncertainty.

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The article argues that the rand is not a barometer of the economic prospects but rather shifts in investment sentiment?

Those tend to go hand in hand… so we can infer that the rand is actually a barometer.

More correctly, the rand is merely an asset valued at the demand and supply of it. Currencies tend to be reasonably good predictors of economic health with the exception of the US$.

The truth is the rand has very little to do with South Africa.

The rand is just an indicator of global liquidity and it is telling you that for the last 10 years, due to shifts in larger central bank’s policies (eg US, ECB, BOE, BOJ).

Liquidity has been drying up in emerging markets in the last 5 years or so…. some emerging markets obviously have more flexible central banks like China, Nigeria to name a few, that can either increase liquidity or direct an official exchange rate.

It is actually hilarious when analysts try to predict rand day to day moves, because those movements are by large not influenced by South African institutions.

How about this? The independence of the reserve bank of a country is a much higher determiner of the value of a denomination than any of the other issues. In SA every time the SARB is threatened with nationalization the ZAR tanks. In the rest of the world; the less independent a country’s reserve bank is (like Brazil, Russia, Turkey) the more the currency is under threat.

Great article in my opinion.
And I agree…leave SARB alone and the Rand will survive. Nationalist it and not only will our credibility go but the temptation to just print money will be too hard to resist even though we have a 25yr learning curve behind us.

All the comments si far have merit.
I would add that the value of the Rand is a sure barometer of our economy and future prospects.
40 Years ago R 1,00 bought you
$1,1529 and today $ 0,07.
That illustrates where we are today, and, unfortunately where we will be next week next year etc.

Simplistically, what happens in SA doesn’t determine the direction of the ZAR move, rather whether the move is greater or less than the basket of other EM currencies.

Makes me question whether the Pound is Britain’s share price at the moment??

A share in a company is a claim on the equity of a company. Therefore, the shares of a company are “backed” by nett assets and the expected future cash flows.
The currency, on the other hand, is not backed by assets or cash flows. Any fiat currency is a “bounced cheque” because it can’t be exchanged for any underlying asset. So, the currency rate is determined by the relative speed at which different countries write cheques that bounce. If South Africa manages to write more cheques that bounce relative to another country, then the Rand will weaken relative to that currency.

Nobody wants this system of bouncing cheques to fail, therefore everybody seems to be oblivious to the presence of this elephant in the room. The foreign exchange market is nothing more than fraudulent cheques that are exchanged for other fraudulent cheques. The winner in this scam is the guy who borrows in terms of bouncing cheques to buy real assets, like shares in real companies with real assets as backing, that have real cash flows.

The losers are the people who save in terms of bouncing cheques, those are the investors in interest-bearing instruments.

Sensei, I always enjoy your unique take on a certain topic:-)

In this instance you describe the “global debt” phenomenon, supported by currencies (i.e. promissory notes) issued by central banks. The global economy seems to function purely on debt, at large.

”But to my mind, though I am native here and to the manner born, it is a custom, more honour’d in the breach than the observance”

Hamlet

Bollocks – stop trying to predict the ZAR moves.

The ZAR trends/trades on sentiment, which encompass a plethora of factors.

Problem with lots of ZAR forecasters and so-called analysts (especially ”fund” managers are that they think that they became ZAR analysts by merely watching and reading ”headline” news articles.

Nothing has changed on ZAR trending/ranging characteristics – it still reacts mainly to big orders (buying or selling)from big offshore banks and funds.

In my > 45 years trading the FX markets, I will always respect USD/ZAR trading and movements, as I learned that anything can happen with the ZAR, and it usually does!

The real issue is that the ZAR, being a fiat currency as they all are, is backed by only one thing “faith” – “faith” that my R20 will tomorrow buy a pint of milk. As the cadres control the printing presses, the day will come when they will try and exploit that “faith” and print just a little more. The “faith” will erode a little and so they will need to print more. This process can only go one way and will. Does anyone truly believe that the party of David Mabuza and Ace Magashule will be able to resist this? The ZAR is doomed to be an African nothing-currency in no time at all. It’s not very far off right now …

Pamplona: I don’t think the analogy of “the printing press” is still correct and just causes millions of Moneyweb readers to believe that, that is how it works.

@ Andries Bezuidenhout……your ignorance on how money is made is so obvious here

In fact, Pamplona is spot on !

What do you think happened in Zim ??

Well, exactly as Pamplona pointed out

Even the Fed Res is guilty of that – not just SA !

You honestly need to go back and study the basics of fiat

As far as I understand Andries, there is an actual printing press. It’s not in SA. Our money is made in Germany I believe but essentially its composite plastic and paper and is worth …. nothing, without “faith”. Hence my point. The cadres instruct the owners of that printing press, via the SA Reserve Bank, that is soon to be nationalised. Please see the ANC’s election manifesto. I think we all know where that all ends …

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