What will the effect of the weakening Rand be?

Commodity currencies have weakened by an average of about 15 percent this year (35 percent since 2013). The Australian dollar has lost 14.2 percent of its value this year, the Rand 13.9 percent. The economies have been hit by the loss of earnings from both low commodity prices and the drop in demand for these exports. Canada has printed recession figures, with Brazil and Russia in recession, and South Africa at risk of joining. Australia, New Zealand and Norway’s latest GDP figures are gloomy, and Chile is experiencing slow GDP growth, as the commodity countries’ mining industries suffer. China’s slowdown translated into global growth and inflation fears, causing a rout in commodity prices, particularly metals and minerals. While China has engaged in significant momentary stimulus to support its economic growth, fiscal stimulus is likely needed, along with improved market channels. Many of the commodity currency countries have current account deficits. Tighter global liquidity conditions, with US interest rate ‘lift off’ still expected this year, worsens foreign conditions for these currencies. Notably the AUD, CAD, NZD and ZAR are at risk. South Africa has seen its terms of trade improve this year and its current account deficit reduce somewhat, but this has not been enough to stem the fall in the Rand alongside the other commodity currencies. A pull back is possible for the Rand in the remainder of the year, but R13.69 is a key level. The Rand’s historic low against the US dollar of R13.84 has been superseded, with the domestic currency recording R14.01/USD recently as the commodity currencies continue their rout. The purchasing power parity valuation of the rand is at R9.70/USD, well removed from the current value of close to R14.00/USD. However, in December 2001 when the rand reached R13.84/USD the purchasing power parity value of the rand was at R5.71/USD at that time. In 2001 when the rand weakened to R13.84/USD it was on a spike in very thin liquidity conditions, with the rand moving from R12.62/USD on 19 December 2001, to R13.84/USD on 21 December 2001, then slipping back to R12.45/USD on 24 December 2001 as liquidity was restored. It returned to PPP in 2004. Current trading patterns in the rand imply that the domestic currency could see a pull back later in the year. Trading patterns aside, the rand risks running into the R15.00 – R16.00/USD range in the down case, should the SARB remain hawkish in the face of SA’s recessionary conditions and SA see further loss of investor confidence on the down turn in the business cycle. Regulation-induced loss of ease of doing business as the burden of state control of, and intervention in, the economy grows, is also proving a negative factor. Indeed, the RMB/BER business confidence index dropped to 38 in Q3 2015 as 62 percent of respondents (senior executives) found business conditions unsatisfactory in South Africa. This very poor reading is concomitant with an economy still at risk of recession, Q2 2015 recorded a RMB/BER BCI of 43 with a -1.3 percent qqsaa GDP reading. Business confidence gives a good leading indication of the likelihood of expansion or contraction in the economy, and so the impact on private sector employment and fixed investment. Q3 2015’s outcome signals GDP in the third quarter will likely be weak, close to stalling. The drop in the RMB/BER BCI is attributed ‘to sharp declines in confidence among retailers and wholesalers. Retail confidence fell by 18 points to 34 and wholesale confidence dropped by 14 points to 50. Building confidence declined somewhat’. Higher interest rates and taxes have negatively impacted consumers, and hence retailers and wholesalers. The mood among manufacturers and new motor dealers remained in deep negative territory in Q3 2015. SA’s uncertain policy environment negatively impacts business confidence, particularly policy proposals that threaten private sector property rights such as land reform, the mineral rights bill and the expropriation bill. This is because there is typically a substantial financial outlay to acquire ownership of property rights, and any increased risk to the returns, or ownership of the property rights, tends to increase costs, and so decrease the confidence of business to invest, expand and employ. Ongoing proposals, changes and amendments to the labour laws add to the uncertain policy environment businesses face, negatively affecting sentiment and so economic growth. Slow, below potential, economic growth causes fixed investment growth and business confidence to falter, in turn negatively affecting potential economic growth and job creation, and so creates a negative cycle. SA urgently needs to break the negative spiral it is currently in, and foster both a lift in business confidence and in the ease of doing business, so that the private corporate sector can achieve faster growth and job creation. This requires a tripling in the size of the private business sector and changes in government policy resulting in a moderation in state control of, and state intervention in, the economy. The latest reading of the SARB’s leading indicator shows a similar level to that at the end of 2009, which was SA’s most recent recession year. August’s contraction in vehicle sales, coming after July’s, gives further evidence that the interest-rate-sensitive retail, wholesale and hospitality sector could stall in Q3 2015 as well. Despite the contraction in the economy in Q2 2015, and real risk of further contraction in Q3 2015 (recession), the Reserve Bank has yet to engage measures to support the economy. In 2009 CPI inflation rose to 8.5 percent year-on-year (double digits in 2008) but the MPC cut interest rates by 5.0 percent as the economy contracted (over Q4 2008, Q1 2009 and Q2 2009). The jump to double digit CPI inflation by the end of 2008 was influenced by the close to 50 percent depreciation in the rand against the US dollar by October 2008, this year the rand has depreciated by about 16 percent vs USD. On a nominal trade weighted basis the rand is 11.6 percent weaker year-on-year, compared to 33.0 percent year-on-year weaker in October 2008. About a 50c/litre cut in the petrol price is due in September, after similar cuts in July and August, which will assist in limiting CPI inflation in those months. However, given the looming risk of recession the SARB should focus on supporting the economy, as it did in late 2008 and 2009, and cut interest rates before a worse recession ensues. Article by: Annabel Bishop