The South African rand has nose-dived past the R11/$ mark at a time when newswires are suggesting that a sell off in emerging market assets has only just begun. The rand earned the crown of being the worst-performing amongst emerging market and major currencies during 2013, with a key factor weighing on the currency during the period being South Africa’s large current account deficit. Other negative issues still raising concern amongst traders are the real threat of electricity blackouts, rising labour tension pressuring the outlook for mining production and, by implication, export receipts, and generally weak economic growth associated with low consumer and business confidence, amongst other factors.
As a result, the rand is currently more than 7% weaker against the US dollar and 25% weaker compared to 12 months ago – the latter is the third-largest depreciation amongst African currencies. Technical indicators show that the currency is currently in its largest oversold position in more than a decade. South African trade and industry minister, Rob Davies, said last week that he is concerned that currency markets will not find a fair value for the South African currency due to its tendency to over- and undershoot changes in its valuation. Analysts are also not sure where exactly the rand is going. A Reuters poll, released on January 9, found that 30 currency analysts and strategists surveyed provided year-end predictions ranging from R9.60/$ to R12/$. A Reuters survey of 20 local economists released just a week later pointed to a range of R9.70/$ to R11/$.
Reuters warned on January 24 that the flight of investors from once-booming emerging markets that they previously favoured may have only just begun. It is mainly retail investors who have so far packed their bags and moved on, with a warning that if and when big institutional firms join in, there is a risk of wholesale capital flight. Signs of slowing growth in the Chinese economy and the potential global impact of a wind-down in US monetary stimulus have been particularly punishing in emerging economies dependent on external financing – with South Africa high on this list. Fund tracker EPFR estimates emerging equity and bond funds have seen outflows of almost $5bn so far this year, on top of $58bn of losses seen in 2013.
Relating to currencies, Bloomberg has commented that the worst selloff in emerging market currencies in five years is beginning to reveal the extent of the fallout from the US Federal Reserve’s tapering of monetary stimulus, compounded by political and financial instability in some countries. There has been concern for some time that African currencies would take a blow from a rolling back of easy money supplies by the US central bank. In the case of the rand, South Africa’s fundamentals – widespread strikes, weak economic growth, a large current account deficit, and a challenging political environment, as well as offshore factors like the US monetary issue – will weigh on the currency during 2014.
The currencies of Botswana, Lesotho, Namibia and Swaziland are pegged to the rand, the latter three being on parity. The rand also plays an important (albeit recently diminishing) role in Zimbabwe’s multi-currency system. All five of these Southern African countries register South Africa as their primary supplies of food and consumer goods imports, and this suggests that the smaller economies will see indirect negative effects on their economies from the rand’s weakness. The price of goods supplied by the continent’s largest economy will be negatively affected by South Africa’s imported inflation, while the smaller states will also have to trade with the rest of the world with weaker sovereign currencies.
Why do we care? The outlook for the rand is far from rosy. The currency will towards mid-2014 have to contend with labour strikes, electioneering, and weak economic fundamentals in South Africa, as well as the US Fed’s move to set into motion an unwinding of monetary stimulus. These factors are, of course, beyond the control of South Africa’s neighbours, and rand weakness is not good news, apart from the benefit that exporting companies might see to their incomes. The rand will remain oversold over the next few months and suffer from bouts of volatility – it is, after all, one of the world’s most liquid currencies. However, we do not foresee any of the smaller countries in the region adjusting their links to the rand. The benefits of their respective exchange rate arrangements still outweigh the disadvantages.
Analyst: Christie Viljoen