Markets & economy

Making sense of the rand

Like other emerging market currencies, the rand has seen periods of prolonged fluctuation since September 2018 but has remained relatively stable over time. Linda Kallis explores the factors that impact the rand’s movements.

Often referred to as the world’s most volatile currency by market commentators, the rand is unpredictable and a continuing source of anxiety for South Africans. With growing uncertainty and anxiety about global politics and business conditions, capital flows into emerging markets are likely to be volatile, as will be the rand exchange rate.

Ratings agencies 

South African debt has been rated sub-investment grade by both S&P and Fitch, leaving Moody’s alone among leading ratings agencies in maintaining an investment grade rating. At least one investment grade rating is required if South Africa is to continue to be included in the World Global Bond Index (WGBI). Much attention is given to the possibility that Moody’s will downgrade South Africa’s rating thereby triggering a significant capital outflow as certain institutional investors adjust their portfolios to comply with their mandates which require WGBI membership. However, Moody’s has indicated publicly that an imminent downgrade is unlikely because South Africa’s institutional framework remains robust. Barring an unexpected adverse development, any change in the rating will await the outcome of Government’s present efforts to achieve fiscal stability. It will require some time before a definitive judgement can be made as to whether these will be successful.

The carry trade 

The ebb and flow of foreign capital into the South African capital market is of critical importance in determining the rand exchange rate. The pronouncements of ratings agencies are only one of many factors that determine such investment decisions. Among the most important is US monetary policy. At the beginning of this year the US Federal Reserve abandoned its well-communicated strategy to further increase interest rates. This has important consequences for currency markets. The prospect of lower dollar interest rates makes emerging markets where interest rates are high significantly more attractive to international investors. The carry trade is on again. This involves investors seeking to profit by accessing capital in the currencies of countries where interest rates are low, such as Japan or Europe, and redeploying these funds into currencies paying high interest rates, such as the rand. Such flows are a significant contributor to the relative stability of many emerging market currencies.

The impact of domestic South African issues

Driven by negative reports about Eskom and South Africa’s economic woes, investors sold-off the rand during August. However, this once-off adjustment may be behind us. With global price stability and a weak domestic economy, domestic inflationary pressures are increasingly benign, and inflation continues to surprise the market and the South African Reserve Bank (SARB) on the downside. In August CPI inflation was 4.3%. Accordingly, South Africa’s real rates are high by global standards, which should encourage further capital inflows and help stabilise the rand. 

South Africa’s current account deficit is approximately 4% of GDP or R200bn per year. Provided that there are no further shock announcements and we remain an attractive investment destination for foreigners, it should be possible to fund this deficit and the rand should then track the movements of its emerging market peers. The dollar is likely to continue to edge stronger against emerging market currencies, but not dramatically.

Currencies act as shock absorbers

One reason exchange rates are so difficult to predict is that they tend to act as shock absorbers which enable economies to adjust to unexpected events. Given the frequency of economic surprises, it is impossible to make confident predictions about exchange rates. This is particularly true of South Africa whose currency trades freely without official intervention. Therefore, while we may predict a relatively stable outlook for the rand, this can be totally undermined by an unexpected event.

Other factors that influence the rand 

There are various domestic factors that influence the rand’s behaviour over the short and long term, consideration of which contributes to the formulation of exchange rate predictions. 

Bearing all the above in mind, it is clear that it is impossible to accurately and consistently forecast the movements of the rand: there are just too many factors at play that we can’t control – from the mood and actions of local politicians, to foreign investor sentiment, and the daily noise in global markets. A better strategy than trying to predict what will happen next with the currency is to consider the outcome of various scenarios and make sure your portfolio is well diversified, so that you minimise the impact any one outcome has on your returns.

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