How best to respond to rand weakness that has nothing much to do with SA
The SA economy has been subject to a new sharp burst of unwelcome rand weakness. Weakness that would appear to have little to do with events political or economic in SA itself. It has been a reaction to the shocks that have overwhelmed the Turkish lira. Weakness in other emerging market exchange rates has been part of the collateral damage.
The Turkish lira has lost 34.79% of its US dollar value since the July month end – from USD/TRY4.91 to USD/TRY6.96 by 14h00 on 13 August. The USD/ZAR was 13.27 on the morning of 1 August and was at 14.38 yesterday afternoon, a decline of 7.97%. But it should be recognised that the rand has been a marginal underperformer within the emerging market (EM) peer group. The JPMorgan EM currency benchmark, which includes the Chinese Yuan with a 11% weight, has lost 6.1 per cent of its USD value over the same period (see figures below where in the second, the relative to other EM currencies underperformance by the rand, shows up as a higher ratio).
A weaker rand leads to more inflation that depresses the spending power of households. It may also lead to higher interest rates, given the reaction function of the Reserve Bank. The Reserve Bank believes that higher inflation will lead to still more inflation expected and hence still more inflation as a self-fulfilling process. That is unless demand is suppressed even further with higher interest rates. This is described as the danger of so-called second round effects of inflation itself (for which incidentally there is little evidence, when demand is already so depressed). The typical SA business now has very limited power to raise prices, as has been revealed by little inflation at retail level. A still weaker rand is likely to further restrain operating margins and the willingness of SA business to invest in plant or people.
We have long argued that this represents a particularly baleful approach by the Reserve Bank to its responsibilities. We have recommended that the Reserve Bank not react to exchange rate shocks, over which they have little influence. Moreover, that raising interest rates can further depress demand without having any predictable influence on the exchange rate itself.
Indeed we have argued that slow growth itself weakens the case for investing in South Africa. Slow growth to which monetary policy can contribute adds investment risk without any predictable influence on inflation because the value of the rand is itself so unpredictable.
The best the Reserve Bank can do for the economy at times like this, when the rand is shocked weaker, is to say very little and do even less and wait for the shock to pass through – as it will in a year or so. The statement of the Deputy Governor, Daniel Mminele, made yesterday that “The South African Reserve Bank won’t intervene to prop up the rand unless the orderly functioning of markets is threatened” is to be welcomed.
The weaker rand, for whatever reason, discourages spending and weakens the case for investing in any company that derives much of its revenue from South African sources. Companies listed on the JSE that derive much of their sales offshore stand to benefit from higher revenues recorded in the weaker rand. These include the large global industrial plays that dominate the Industrial Index of the JSE by market value. Included in their ranks are Richemont, British American Tobacco and AB Inbev.
Even better placed to benefit from a weaker rand will be companies with revenues offshore but with costs incurred in rands. The increase in these rand costs of production may well lag behind the higher revenues being earned in rands, so adding to the operating margins enjoyed. Resource companies quoted on the JSE with SA operations fall into this category. Kumba and the platinum companies, as well as Sasol, are examples of businesses of this kind.
But the appeal of global and resource plays for investors will also depend on the prevailing state of global markets. Global strength will add to their value measured in USD and even more so when these stable or higher dollar values are translated into rands at a weaker rate of exchange. In such circumstances, when the rand weakens for SA specific reasons, rather than for adverse circumstances associated with a weaker global economy, the global and resource plays on the JSE have additional appeal.
The additional weakness of the rand, when compared to other EM currencies, may well have added to the appeal of JSE global and resource companies. The movements on the JSE on 13 August – at least up until mid-afternoon – do suggest that a degree of rand weakness for partly SA specific reasons- has been helpful for the rand values of the JSE global and resource plays. This is shown below. The global industrial plays and Naspers, another very important global play, have moved higher with JSE Resources. The SA plays have weakened as may also be seen and would have been predicted.
The lesson for South Africa is to remain fully committed to global trading and financial conventions. To reinforce its attractions as an investment destination at times like this when the rand comes under pressure. This will help support the rand and the prospects for the SA economy. 14 August 2018