- The rand is currently trading at levels against the dollar last seen in January 2020.
- While the SA economy is in a world of trouble, local interest rates are attractive to foreign investors.
- SA has seen more money flowing into its borders than out over the past year.
The rand is currently trading around R14.60/dollar – after strengthening to below R14.52 over the past couple of days.
These are levels last seen in January 2020 – long before South Africa confirmed its first Covid-19 case on March 5th, and the country was downgraded to “junk” in the same month.
By April, the rand blew out to R19.26 amid fears about the impact of South Africa’s hard lockdown - as well as continued concern about the expected exodus of foreign capital after South Africa was stripped of its investment grade rating. A “junk” rating means many large international investment funds aren’t allowed to buy South African government bonds, making it harder and more expensive for the country to borrow money.
In recent months, ratings agencies cut South Africa even further into junk, voicing concern about the ballooning government debt, with little confidence that the state will make good on its promises to cut spending on civil servant wages.
The economy is still on track to shrink by about 8% this year, unemployment is spiking amid mass retrenchments and South Africa is facing a surge in coronavirus cases – with a record number of almost 15,000 cases in the past day alone.
So why is the rand strengthening against the dollar?
Dollar weakness
The dollar is under pressure as the country looks set to adopt a $2.3 trillion coronavirus aid and government spending package. While US president Donald Trump is demanding changes to the legislation, it is expected to pass this week – and it will mean the US government will have to take on much more debt, which is negative for the dollar in the longer run.
The markets are also betting that the incoming US president, Joe Biden, will stop the American trade war with China and others. This will mean more imports to the US, which could also weigh on the dollar. US importers will have to sell dollars to pay for goods in another currency.
Also, it’s expected that Biden won’t cause as much volatility in global markets as Trump – reducing the demand for the dollar as a safe-haven investment. Trump introduced a large element of uncertainty in markets over the past four years with his shock pronouncements, specifically on trade and international relations. This often unnerved global investors, who then bought dollars, because it is seen as a safe investment – much like gold - in volatile times. But if Biden proves to be a less erratic leader, there should be less shocks – and hence less demand for dollar.
High interest rates in South Africa
Traders are attracted to currencies which earn higher interest rates, and even though rates have been cut to the lowest levels in half a century in South Africa, a recent Bloomberg survey shows that its real interest rate (3%) is the highest on offer across the seventeen biggest emerging markets.
Many countries now have negative interest rates of below zero percent.
Interest rates are not expected to go lower in SA any time soon – recent inflation has inched higher, which may dissuade the Reserve Bank from relaxing its monetary policy.
Bigger appetite for emerging market currencies
For many months, investors have been fretting about the coronavirus pandemic and its impact on the world economy. They have been very risk averse – choosing to buy “safe” investments like gold, US bonds and the dollar.
But as Covid-19 vaccine programmes are launched in some countries, this has boosted confidence that the worst of the crisis might be over – despite a strong second wave of infections forcing lockdowns across the world. Investors’ risk appetite increased and emerging market currencies are back on the menu.
South Africa's current account is in fantastic shape
If more money flows out of, than into, a country – it’s bad for its currency.
The flows out of a country is measured by the current account, and because South Africa imports most of its oil, and pays huge amounts in interest and dividends to foreigners outside the country, the country has maintained a large current account deficit (of as much as 6% of GDP) for many years.
But in the third quarter, South Africa posted a record current account surplus of R297.5 billion. This is more than four times the size of the previous largest surplus, recorded in the first quarter of 2020, says the Reserve Bank.
This is partly because of strong exports – South Africa’s trade surplus (exports minus imports) hit R454 billion in the third quarter.
South Africa is enjoying a brilliant export year. A record high gold price has helped, as well as bumper agricultural exports. For example, maize exports are exceptionally strong, while South Africa may export almost 10 billion pieces of citrus fruit this year, one of the best seasons on record. This helped to counteract lower vehicle exports.
The trade surplus was also helped by the much lower oil price, which meant less money had to flow out to pay for the fuel. (In recent weeks, however, oil prices headed higher, and South Africans can expect big fuel price hikes in the first week of January, with diesel currently on track to climb by 53c a litre, and petrol by between 30c and 40c.)
In addition, because of the depressed state of the SA economy, imports have been weak – companies are hesitant to import machinery and other expensive goods.
What also contributed to the current account surplus was a drop in the dividend and interest payments to foreigner investors who hold South African shares and bonds. Because foreigners have been selling off SA shares and bonds for many months, dividend and interest transfers have declined.
Still, the junk rating has - so far - not been as damaging as was expected. While some forecasts predicted large outflows of between R110 billion to R250 billion in response to the downgrade, foreigners were net sellers of R53 billion in South African bonds this year.
The rand is one of the world’s most undervalued currencies
The most recent The Economist’s Big Mac Index, released in July, showed that the rand is a whopping 67% cheaper than it theoretically should be against the dollar – the worst undervaluation of all the currencies measured.
The Big Mac Index is based on the theory of purchasing-power parity. In the long run, theoretically, exchange rates ought to adjust so that an identical product – the McDonald’s hamburger - must cost the same across countries.
While the vast majority of currencies were also undervalued to the dollar – Brazil by 32%, Argentina (-39%), India (-56%) and Turkey (-64%) – none beat the rand. The rand was even weaker than the Russian rouble (-66.5%)
As recently as a decade ago, the rand was “only” undervalued by 39% against the dollar, according to the Big Mac index.