Moves in emerging market currencies like the rand and Turkish lira show that countries that depend on foreign capital need to play by the rules governing international trade and flows of capital
Emerging market (EM) currencies have been caught up in the political and now financial crisis confronting the Turkish economy and its leader. But some EM exchange rates have suffered more than others. The rand, alas, has been one of the worst performers, especially on Wednesday (15 August). It is a trend that continued yesterday morning. The Turkish lira has re-gained some ground against the still strong US dollar and significantly more against the weaker rand.
At its worst this month, on 13 August, the lira had fallen from 4.99 to 6.88 against the US dollar – a decline of 37%. That same day the rand was about 9% weaker against the US dollar since 1 August and so 21% up on the lira. As I write at mid-morning on 16 August, the lira is now stronger than it was, at 5.81 to the dollar while the rand has weakened to R14.511 (see below).
The rand has now lost about 4.6% of its beginning of August US dollar value. This is not good news for the SA economy. It means more inflation and less spending power for hard pressed households and firms. Hopefully it will not lead to higher interest rates, which would depress domestic demand further.
The Turkish and SA economies have something in common: a continuing dependence on foreign capital to fund expenditure. But that is where the current similarities end. The Turkish economy has experienced a boom (over 7% real GDP growth in 2017) led by rapidly rising private sector capex funded increasingly with short-term borrowed dollars. This growth, accompanied by rapidly rising inflation and a widening ratio of current account deficit and so capital inflows to GDP. Interest rates lagged well behind inflation, now running about 16%.
The contrast with a depressed SA economy could not be greater. Our private sector capex cycle is even more depressed than household spending. Inflation (especially at retail level) remains well below interest rates and the current account deficit has stabilised at about 3.5% of GDP. The borrowing SA does is mostly by government and its agencies and is predominantly undertaken in rands.
Foreign lenders, rather than local borrowers, are exposed to the risk of the rand weakening, for which they collect a wide risk spread – of the order of 6% more than US dollar yields. SA business savings (cash retained) runs at about the same rate as stagnant or declining capital expenditure. Our fiscal deficits and the ratio of government debt to GDP are wider than those of Turkey – and may be getting wider, according to Moody’s. This is not an opinion helpful to the rand or the cost of borrowing dollars for five years: currently running at 2.17% above US five year yields. Turkish debt in US dollars is offering an extra 4.88% for five years – even more junky than RSA debt.
So what went wrong with Turkish economy that was so encouraged with abundant inflows of short term loans until recently and that were withdrawn so abruptly? The answer is fairly obvious – it is the result of a serious disagreement with the US about the arrest of a US pastor. He has possibly been imprisoned as a bargaining chip for President Ergodan’s public enemy number 1, Fethullah Gulen, who lives in the US, whose followers are accused of fomenting a coup. And so many thousands of whom are languishing in jail.
This indicates very clearly that countries that depend on foreign capital need to play by the rules (US inspired or enforced) that govern international trade and flows of capital and legal practice. This surely applies also to SA. By proclaiming upon the ANC’s intentions to expropriate farming land without compensation – definitely against the rules, and given the turmoil in the markets – ANC chairman Gwede Mantashe did SA and its growth prospects enormous harm. As Minister of Mineral Resources he could however immediately undo the damage. That is by signaling reforms of the mining charter that made mining in SA properly investor and owner-friendly. 17 August 2018