Writer : Jessica Foreman | In January, South Africa’s rand collapsed to a record low against the US dollar, emphasising new threats to weak currencies across the continent, which are buffeted by Chinese volatility. This, in turn, forced investors that trade forex to sell rand for US dollars and other global currencies.
Since China’s summer slowdown, the rand has lost 30 per cent of its value and forced investors to flee from the assets of developing nations that trade with the world’s second biggest economy. But what can South Africa do to arrest this slump and boost the value of its declining currency?
Threats to the rand
Along with Chinese market turmoil, the threats facing the rand are extensive and include sluggish growth, the commodities rout, a rate-raising Fed and rallying dollar, limited FX reserves, and a lack of confidence in the president from investors.
Matters weren’t helped when President Zuma decided to get rid of his well-respected finance ministerNhlanhla Nene with relatively unknown politician David van Rooyen in December. Although another replacement in the form of Pravin Gordhan, who held the job between 2009 and 2014, came a few days later due to market pressure on Mr Zuma, the debacle wiped nearly $11bn (£7bn) off the value of shares amid a selling frenzy in South Africa’s markets.
The rand did end up recovering a large part of these losses, but Win Thin at Brown Brothers Harriman said: “The rand has now completely given up its post-Gordhan relief rally, and is set to continue weakening further…The carnage continues. The medium-term bear market is clearly back on track as 2016 begins.”
In response to the economy’s slump, which has caused the rand to become one of the most volatile EM currencies, the South African Reserve Bank has been hiking up interest rates. But according to Gabor Ambrus at RBS, more needs to be done.
Two choices for rand recovery
“The rand’s rate cushions are far too low compared with its peers, especially given the recent spike in dollar/rand volatility,” noted Ambrus. In his opinion, the SARB has two choices if it wants to stir an economic recovery and boost the rand’s value.
“Either it accepts that the pace of currency depreciation picks up and spares the economy from excessive tightening, or it starts increasing the cushion on the currency more dynamically, responding to what has become a sizeable, and likely lasting, shock to risk premia.”
Ambrus also believes that with no structural reforms, currency weakness is inevitable for the South African rand. The pace of currency depreciation must be addressed by the SARB too, as a rate of 15 per cent in a month’s time carries far-reaching macroeconomic risks.
“We think that the 75-100bp rate hike range we have pencilled in for 2016 may not be enough to meaningfully limit the rand’s pace of depreciation against the pick-up in volatility,” added Ambrus. “150bp worth of tightening now looks more likely for 2016, especially if elevated volatility persists.”