Beginning of the end for South Africa’s rand as you know it

The lowering of the Reserve Bank’s inflation target to 3% has had a significant impact that is flying under the radar – it is making the rand more stable.

This is crucial for sustained economic growth in the future, as a more stable rand removes currency risk for foreign investors investing in South Africa.

As a result, the hurdle for investment is lowered, and more funds can flow into the country, boosting its economic growth and employment.

Efficient Group chief economist Dawie Roodt explained this phenomenon, saying it has largely gone unreported despite being such a significant improvement.

Roodt explained to State of the Nation that much at the attention of the media, economists, and commentators has been on the rand’s strength over the past year.

This has immense benefits for South Africa, largely through lower inflation from cheaper imports, which, in turn, can translate into lower interest rates.

However, this overlooks the fact that the rand is not only stronger but also far more stable than it has been historically.

“I think the press does not give nearly enough attention to the effect of the inflation target being lowered to 3% from 3% to 6%,” Roodt said.

“The previous target was a crucially important reason why the rand depreciated significantly on an annual basis, making it unstable at the same time.”

Roodt explained that this is one of the main reasons why foreign investors were hesitant to invest in South Africa, as a weakening currency raises the hurdle required to make a return on an investment.

“One of the major reasons why foreign investors do not want to invest in South Africa is that they take a currency risk,” Roodt explained.

“If you invest in South Africa and you convert dollars into rands to buy bonds, for example, you expose yourself to immense currency risk.”

“If you convert into rands and buy bonds, when you then sell those bonds, and you convert the rands back into dollars, while the rand has weakened, you lose some of the return on the investment.”

In effect, with a more stable currency, investing in South Africa will become more attractive, as returns will not be eroded by currency fluctuations on conversion.

“If foreigners believe that our inflation rate is going to be relatively low and stable, that means the exchange rate will be relatively stable, and they are likely to take more of a chance on South African bonds and equities,” Roodt said.

The rattling rand is no more

South Africa’s rand has historically been notoriously volatile, earning the nickname “the Rattler” from financial market participants.

The currency has tended to depreciate at a rate of about 5% per annum against the dollar over the past 30 years because of the inflation differentials between South Africa and the United States.

This depreciation was coupled with immense volatility given its exposure to commodity prices and South Africa’s relatively deep capital markets, which means the rand trades as a proxy for emerging markets more broadly.

However, this appears to be coming to an end with the implementation of a lower inflation target of 3%, with it set to result in a more stable currency.

“Currency volatility was a major reason why foreigners did not want to invest in South Africa, and this usually happens when your inflation rate is high, and somebody else’s is low,” Roodt explained.

“Now, with a lower inflation target and inflation expectations coming down, the volatility of the rand is reduced, and the currency risk is taken away.”

“As a result, more money flows into the country’s financial assets. That is why the bond market did so well recently, with foreign money coming into South African bonds.”

Roodt’s sentiments echo those of Reserve Bank Governor Lesetja Kganyago, who explained that the data shows the rand is no longer a volatile currency.

Kganyago has said that the rand is settling down into a more mature stage of its life, with it deserving more respect for its stability in recent times.

“When people tell you the rand is a weak and volatile currency, encourage them to think again,” he said.

“I would also like more people to recognise that rand volatility has declined. Option-implied volatility is now at long-term lows.”

“Yet, outside of financial markets, most people still believe the rand is a highly volatile currency. The only problem with this view is that it no longer describes the facts in front of us.”

Kganyago has explained that the rand’s recent stability stems from South Africa’s lower inflation over the past year, which is more in line with developed markets.

It is important for this to continue over the long run, as investor confidence in South Africa will not be built overnight.

https://dailyinvestor.com/finance/120487/beginning-of-the-end-for-south-africas-rand-as-you-know-it/