Reputation risk making for weaker rand

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By Cees Bruggemans

The Rand at just over of 8:$ has lost 45% of its value since its secular best of 5.60:$ this decade. In contrast the Aussie Dollar has firmed by a further 20% since then.

Yet both countries are commodity producers with sizeable current account deficits. Something seems to be weighing on the Rand that doesn’t seem to be bothering the Aussie, at least not at present.

It isn’t our relative growth performance, for our growth remains stronger than Aussie, also in per capita terms.

But reputation-wise something isn’t quite right.

The great difference between us and Aussie, of course, is that we are designated as emerging market (EM), and they are OECD. One doesn’t confuse these designations, just as one knows to distinguish between North and South Korea or Switzerland and the Balkans.

Apparently, the EM designation still comes with a certain risky odour attached, as reflected in our credit ratings. We may be investment grade by now, but that doesn’t make us gilt-edged just as yet. We still have a preponderance of poor people populating our society, potentially complicating our structure and long-term prospects, and making us potentially unstable politically and therefore financially and economically.

Not the same stigma attaches to OECD membership and a triple A credit ranking to prove it.

So our incompleteness as a country counts against us, besides which our expected current account deficit is half as big as Aussie, and second-largest in the EM rankings after Turkey. That’s the wrong size and the wrong company to keep, like originating and residing on the wrong side of the railway track.

So for starters we are considered relatively doubtful, especially at risky global moments.

When the world is in forgiving mode, as it was for years this decade, with global risk aversion receding into background white noise, we tend to go scot-free, with minimal penalties for our remaining shortcomings.

But the moment global anxiety returns, for reasons possibly entirely unconnected with us, global financial markets tend to remember who we really are, knocking us down a few perches as returning risk aversion opens up the differentials with the better propositions in our EM neighbourhood.

Especially commodity producers running large trade surpluses, such as Brazil (until very recently) and Russia or EMs enjoying enormous capital inflows, such as India, or EMs doing both, such as China, have apparently succeeded in overcoming their traditional origins. No such luck for us so far.

But no smoke comes without fire. It isn’t only the many poor in our midst yet to be uplifted that can be blamed for our risky reputation.

The current account deficit, north of 7% of GDP, with an upward bias, has come into being and is being sustained for entirely the wrong reasons, and entirely by the privileged middle class in our midst, old as much as new.

The good news may be that our fixed investment ratio to GDP is rising as we finally have saddled up for stronger infrastructure and productive capacity expansions.

But this doesn’t necessarily weigh up against the bad news marking us.

We are notorious poor savers, with households preferring to consume most of their income, and government only belatedly turning into a minor saver.

Worse, our export record is unconvincing. Our traditional mainstay, mining, has underinvested in recent years, mainly due to regulatory issues, only minimally lifting output, at a time of maximum global opportunity. What did we think we were doing all these years?

Also, we are not traditional exporters of manufacturers. Our industrial base is too small, and our cost structure as a post-industrial economy too high, to compete easily with the main exporters of manufactures.

We tend to import technology. We can’t compete with foreign low-cost industralising countries densely congregating at the low end of the undifferentiated mass good markets. We also don’t have the means to compete with the technological high-value leaders at the top end.

So we are mostly a niche player, though with huge pretensions that it could be different, if only.

That kind of reality tends to shine through, on the ground and in data, and fools few people globally. With our savings inflexibly low, and our exports struggling to maintain output speed, we tend to rely on terms of trade gains (commodity price windfalls) to spice things up.

This may have carried us for 150 years so far, but it is an inherently risky profile. That’s the rub at times of global risk aversion, when everyone gets cautious and goes over the numbers more carefully once more, suddenly remembering characteristics about us that aren’t appreciated in the least.

So much for the good news.

When bad risks have bad hair days, it has a way of turning out really disastrously. Where good risks may still be granted the benefit of the doubt, bad risks tend to get the chop, no matter how much they claim to be aspiring to be good risks, too, at least intentionally.

Now for the really bad news.

A few things have happened that didn’t enhance our reputation in the least. Indeed, they apparently took us down a few more notches in global estimation.

An initial minor hitch was the gradually shaping growth disappointment. After having averaged 5% GDP growth for four years, giving the impression of having broken out on the upside from a long-term growth straitjacket, with talk of aiming for 6% ere long, it was necessary to get realistic.

Non-sustainability of trade account trends, reflecting imbalanced consumption growth and anemic saving, as well as regulatory burdens and poor public service delivery (education, health care, personal security), indicated a simple truth. Our GDP growth potential wasn’t even as yet 5%. It was closer to 4%. And though we were talking up a storm about 6%, if the spending and credit behaviour wasn’t moderated the import spillovers and underlying inflation tendencies would eventually fry us.

Thus the macro disciplines of maintaining real interest rates on the back of rising inflation and allowing a fiscal budget surplus to come into being, gradually pulling the growth outlook back towards 4%.

That wasn’t helpful for our reputation in global eyes, but it wasn’t fatal.

But the Eskom failure to adequately plan its electricity demand and supply strategy, resulting from January in unplanned massive brownouts, certainly rattled foreign perceptions. Hey, what’s going on down there? Can’t manage your affairs, further downgrading the outlook? You aren’t even a 4% growth economy, but closer to 3% (in any case the long-term average)? You are not quite the EM jewel we thought you were?

Quite a few foreigners climbed on planes to come and kick tyres here for a few days, looking us over suspiciously, trying to understand what they might have missed before.

On that score we also had to live down our politics of the past three years, with President Mbeki firing his Deputy-President Zuma in mid-2005 apparently for all kinds of reasons, only to have the tables turned on him in December 2007 at Polokwane.

Here was a new political generation in the making, with implications for policy and stability. Understanding its likely reach started to take on new urgency in light of the other events already mentioned.

Bottom line was simple. Were more or less school fees going to be paid in coming years? Either way would sway the risk assessment.

Adding up all these factors tended to weigh on our reputation risk, and by implication on the Rand, as the world these last twelve months had to grapple with increasing anxiety regarding US financial events and macro performance.

The saving grace, probably preventing an even greater sell-off in the Rand than seen so far, was our traditional strength in precious metals. The global unease and US policy responses favoured gold and platinum prices, and our electricity problems and consequent mining cutbacks perversely also assisted.

This reality more than paid for the debilitating rise in oil import costs, as our terms of trade continued to outperform, reflecting the traditional strength of our mining endowment as an enormous hedge at times of global troubles and anxiety.

Indeed, if things were to get any more hairier globally than what they are, and there is some considerable chance of that, given the depth of US troubles and the aggressive manner in which US policymakers are approaching their problems, South African mining luck could yet multiply to Aussie proportions in coming quarters, as it has indeed done on occasion in the past.

If it were to do so, it would temporarily have the potential to greatly reduce our current account deficit, further inflate our fiscal surplus, robustly increase the external reserves, and boost our growth prospects anew through the income injections it would imply.

And although temporary, such bridging to a better functioning global economy benefiting our economy in a more traditional sense would still create a sense of greater continuity than perhaps experienced at present.

We would still carry within us the uncertainty of the new political dispensation which will only formally unfold from next year. But here, too, an even greater precious metal windfall over the next two years would cover many uncertainties, allowing us to proceed with fewer penalties than encountered in recent months.

So, yes, the Rand has weakened since 2005, is in weakening mode, and could weaken more beyond 8:$ even as the Dollar itself is weakening, too, beyond 1.60:Euro.

But don’t entirely lose track of any compensating forces working globally in our favour, gaining entry through our precious metal fortunes, supporting capital inflows which we otherwise might not expect to be favouring us.

It makes the potential range of the Rand these next two years increasingly wide, as much as 6-9:$.

If that isn’t considered a useful forecast, welcome to the world of extreme risk. Can’t get away from these innate features, except possibly in the very long term.

Source: Cees Bruggemans, Chief Economist, FNB, March 11, 2008.

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