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The Dollar/Rand exchange rate spiked up to a historical high of 19.9 in May. This is after already declining 15% in the previous 12 months from 15.9 to 18.4 at the beginning of May 2023.
The pros and cons of a weak currency for South Africa are debatable, but over time, currency weakness raises inflation, advances volatility, and volatility is disruptive to businesses. The bottom line is that we all feel poorer when the Rand weakens, and the poor are most affected as inflation soars, leading to higher interest rates.
Over time, the Rand is largely driven by international trade flows and broad-based emerging market investment movements. But market shocks have spiked the currency in the past, with a subsequent quick recovery as rationality returns. The question is, will the Rand recover after this current spike?
Rand/Dollar Exchange Rate
Looking back on key events
When we consider only the past 23 years, we can identify several key unsettling events that have been negative for the Rand.
2001-2002: 9/11 World Trade Center attacks
The 11 Sep 2001 terrorist attacks are considered one of the most devastating black swan events over the last 100 years. The fear of further terrorist acts and political instability had a negative impact on the Rand. This resulted in the worst Rand spike up in the last 23 years from 8 to 12 (50%) in 6 months. In today’s terms that would mean a Rand at 28, using a 4% inflation differential factor.
2008-2009: Global Financial Crisis (“GFC”)
In the years leading up to 2008, irresponsible low-interest-rate lending caused a housing bubble in the US. Many lenders, unable to settle their bonds and selling properties at losses, created serious economic strife for many US households.
Several large credit instruments collapsed, with some banks closing and markets expecting greater losses, forcing the US Federal Reserve to intervene by decreasing interest rates and bailing out big banks.
2015-2016: Nenegate
In 2015, Nhlanhla Nene was unexpectedly removed as SA minister of finance and replaced by an unqualified Des van Rooyen. The change was seen as a blatant act by then-president Jacob Zuma of grabbing control for personal gain and state capture. After four days, Des van Rooyen was replaced by Pravin Gordhan, but with the concern of state capture still looming.
The Rand made a further recovery after Jacob Zuma was replaced by Cyril Ramaphosa, but not for long.
2020: Covid
In Dec 2019, Covid-19 started spreading throughout China, reaching the rest of the world in 2020. In response to managing hospital capacity, global lockdowns were imposed, with SA imposing among the strictest. This created significant strain on the fiscus with unemployment in SA soaring to 33%.
2023: Loadshedding, slow economic growth, SA’s stance on Russia / Ukraine war
Many negativities have been stacking up against SA: the economic outlook appears dismal with increased loadshedding, rising interest rates and failing infrastructure. To add fuel to the fire, South Africa’s impartial stance on the Ukraine / Russia war and its invitation to Putin to visit SA, has been threatening our relations with our biggest trading partners: Europe and the USA.
Despite all these negativities, we believe it’s not warranted for the Rand to have depreciated 25% over the last 12 months, spiking out to R19.9/US$ in May.
How has the Rand fared against its peers?
As an emerging market currency, it is important to view how the Rand has performed alongside its peers, given that global investment flows are often a big driver of currencies. Comparing the relative performance of the Rand to an average Emerging Market basket of currencies, the Rand has often outperformed, but over the last 12 months, the Rand has underperformed the average by nearly 15%.
The chart below depicts the Rand, the Indian Rupee, the Chinese Renminbi, the Brazilian Real and Russian Ruble against the USD over the past 10 years. The Brazilian Real and Russian Ruble have underperformed the Rand.
The Rand’s fundamental value
The Rand’s purchasing power parity (PPP) to the US Dollar is currently 14.5, which is denoted by the blue line in the graph below. We believe the Rand should trade at a 25% risk premium to PPP, due to SA’s weak economic outlook, rising debt, and a dysfunctional ANC government, which values the R/$ at 18.12.
A large driver of the Rand is international trade flows, which have swung very negative as commodity prices have weakened. These very negative flows should tapper-off and should reduce the level of outflows weakening the Rand.
SA Current Account (Trade of goods and services)
So where to for the Rand?
In the short term (1 year) the Rand has always been very difficult to forecast, due to the mix of global flows and local sentiment. But over the long term (5 years +) we believe that the Rand will continue to weaken due to SA’s weak economic outlook, its rising debt and unstable political environment.
Therefore, barring any other unforeseen event, we believe the Rand is likely to strengthen over the shorter term. But in 5 years, we expect the Rand to be materially weaker than current levels.