It is easy lose respect for people (economists and the like) who go on radio or go on record in magazines to say that the rand is definitely going to get weaker or definitely going to get stronger. So many variables, emotions and black swans could influence the value of the rand.
Whenever people make a forecast (as opposed to offering a set of scenarios) they are making a zero-sum all or nothing prediction. Despite their claims, they don’t take uncertainties into account, since it is impossible to foresee what unforeseeable events (black swans) will take place, and what their magnitude and impact will be. A set of scenarios must be weighed against each other. The best we can do is identify scenarios that play a role in determining whether the rand strengthens or weakens, and try and imagine what the consequence of either scenario could be.
The unavoidable impact of the current weak rand will be felt through inflation. South Africa runs a trade deficit, and as such will have to pay more for imports. This is exacerbated by the worst drought we have experienced in decades. There are some who estimate that we will have to import around 5 million tons of maize to cover the local shortfall. This will mostly have to be paid in US$. Unlike what some will have you believe, the weak rand will affect the poor in an even more fundamental way than the rich, as their basic living expenses will go up, while the value of whatever assets they own won’t necessarily.
By economist Dawie Roodt:
“Our R/$ forecast a year ago was the most bearish of all economists’ (that I am aware off), yet even our negative view turned out to be far too optimistic; the rand’s collapse by year-end was nothing less than theatrical. And that’s where we are now. Many factors remain rand negative with the only real difference from a year ago being that the rand is now significantly weaker. Can our currency go even lower? I don’t know. What I do know is that investors often get sucked into the hysteria of a sliding asset only to regret their disinvestment decision when this asset rallies. It has happened in the past to the rand as well when many investors took their money ‘’out’’ when the rand was at its weakest only to bring it ‘’back’’ when the rand rebounded, making huge losses. Could this be another bear trap? Will the rand make a U-turn and surprise us all again? Maybe history can assist.
So there we have it. The rand is at roughly R16 and very weak compared to the US$, but not as weak as during its all-time low. I am convinced the rand’s undervaluation will correct but I am unsure how it will correct. Will the exchange rate improve or will inflation eventually render the current nominal exchange rate “more” correct? My suspicion is that inflation will take most of the pressure. I am also not sure if we have seen the end of this flick. The rand may continue its nominal fall over the next few months especially if we get a downgrade, enter a recession or if our weak political leadership remain at the helm.”
Some factors to consider include:
- Whether the Chinese economy is growing at all. I’ve heard various prominent economists say publicly and in private that the Chinese economy is most likely growing at less than half the officially quoted rate (6,9% in Q3 2015). This is not hard to believe considering the enormous decline in raw material and commodity sales to China. It is a well known fact that the Chinese economy is over reliant on investment, and with dozens and dozens of ghost cities already built and standing empty, they seem to have run out of appetite to build more (therefore they are importing less steel and other resources). The Chinese government has made an effort to enlarge the role that consumption plays in the economy, but this has been largely unsuccessful, with marked declines in luxury good sales to China over the past year. The impact a slowing Chinese economy will have on our exports, particularly mining, will be felt. This will impact the mining companies and their employees, but also by the economy as a whole, since there is no longer as much foreign currency coming into the economy. The social impact of retrenched mine workers and the shrinking of mining communities will also have a detrimental impact on a ‘stagflating’ South African economy, and therefore won’t be able to provide new opportunities for those who have been retrenched. Social unrest may be on the cards.
- Whether the South African government can maintain fiscal and policy discipline. The value of a currency relative to other currencies is mainly an indicator of confidence in a particular economy. Unfortunately, government plays a very large role in the South African economy, through government spending, taxation and regulations. Government has for almost the past decade run a sizable fiscal deficit, meaning the government has to borrow money in order to fund its expenses (which includes a growing wage bill to a civil service bureaucracy, and a sizable portion to an ever growing number of people on social grants). At some point, investors and rating agencies will lose confidence in our government to pay back the debt. It is at this point crucial for the government to review the nuclear deal, the national health insurance scheme and the state of SAA, or risk a credit rating downgrade, making it even more expensive to borrow.
- Whether there will be more certainty surrounding the leadership of the country in the future. There is so much uncertainty about our future. Will the EFF have a greater influence on government policy as its support base grows? Will the ANC stand up for property rights and quash the rumours of land expropriation? Will a leader such as Cyril Ramaphosa with (perceived) business acumen be our next president? Or will it follow ANC tradition and be a Xhosa/Zulu male (as RW Johnson suggests)?
- Whether the US maintains the interest rate rising cycle they have entered. It is important to remember that the US$/ZAR rate depends as much on the perceived strength of the US$ as it does on the weakness of the rand. What is interesting though, is that the Federal Reserve has missed an entire cycle of a (relative) strengthening of the US economy. This means that where they should have started raising interest rates in 2011, they have kept them at close to zero since 2009, meaning that when the next decline in the economy comes, they can’t lower interest rates. Setting a negative interest rate is theoretically possible, but would cause a dent in confidence in the efficacy of the Fed’s tools and forcasts. What makes a cut more unlikely is that it is an election year, and if the interest rate is cut close to the November election, it will be seen as a political move to favour the democrats (Janet Yellen is a democrat). In case any sort of easing might be necessary, forward guidance will be the most likely tool to be used (whereby the Fed gives a clear message to markets about what interest rate policy will hold in in the coming short term period). They will most likely give markets an indication that interest rates won’t go up in the manner and period originally intended (if there is a downturn in the economy). Any sort of easing or a cut in interest rates by the Fed (not as unlikely as it may appear now) should in theory weaken the US$.
“The market can stay irrational longer than you can stay solvent.” – John Maynard Keynes
Although we will very rarely quote Keynes, this is a fundamental truth of markets. The market is what it is. It doesn’t care whether you or I think we know better than the market. We might think the rand is too weak, but so what? If the market doesn’t at that time, then we can’t do anything about it. The most disheartening thing about this whole situation is that there doesn’t seem to be any good news on the horizon for South Africa, a country which has so much potential if we can just sort our governance out.
It is difficult for many South Africans to decide whether they should take their money offshore, or hedge it against the rand by buying stocks in companies which operate offshore. Because it is fundamentally impossible for anyone to know if the value of the rand will go up or down relative to other currencies in the short and medium term, each individual must decide for themselves what level of risk they are willing to tolerate. In uncertain times, it is advised that people diversify their assets.
When you are between a rock and a hard place, it is perhaps best to not have all your eggs in one basket, and temporarily lower your expectations to the extent where you are as satisfied if you didn’t suffer any losses, as you would have been if you made a good gain under normal conditions.
Although every effort has been made to ensure the accuracy of the content of this article, South African Libertarian accepts no liability in respect of any errors or omissions contained herein. The contents of this article cannot be construed as financial or investment advice.