Traditional rand standby

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By Cees Bruggemans

With commodities broadly in retreat, driven along by global perceptions of sharply braking growth, especially in richer industrialised countries, we have a traditional escape valve.

Rand depreciation.

Will this once again come into play, and with what kinds of broader consequences?

So far the rand has been remarkably well behaved. Since 2005, the rand has moved from heavily overvalued below 6:$ to more macro-economically neutral territory of 7-8:$.

During this recent period, the rand hasn’t unduly penalised exporters (unlike 2003-2005), while its inflation contribution was ultimately limited.

The 25% rand/dollar weakening during 2006-2008 has proved to be not much more than matching inflation over this period, while removing overvaluation in real terms.

On an effective trade-weighted basis, against a basket of trading currencies adjusted for inflation differentials, the rand has weakened. But it isn’t always obvious that foreign suppliers price in their own currencies as opposed to taking into account market conditions in their export target markets, setting prices accordingly.

In the end, imported manufactured goods may have remained well priced in the main, while our exporters gained a limited advantage or were simply partially compensated for higher costs.

But this was while commodity prices were riding high, with our main commodity exports at times suffering output declines yet handsomely compensated by outsized price increases, which also covered the rising oil import bill.

Will this remarkably stable picture persist, or will the rand at some point be called upon to play shock absorber of last resort as it has in the past, once again creating new categories of winners and losers in the economy?

It probably all depends on how far the global commodity price correction will go and how fragmented it becomes.

As we export more commodities than we import, any tandem decline in oil prices and other commodity prices would prevent us from either being swamped by the oil bill or gaining an advantage.

Any net decline in overall commodity export earnings at unchanged rand exchange rates would imply reduced terms of trade against other import costs. This would tend to inflate our already high current account deficit.

But any further declines in commodity dollar prices at unchanged rand exchange rates would also translate into sharply reduced mining profitability. Many mining operations would be squeezed from two sides, as cost increases in recent times (oil, electricity, maintenance, equipment, labour) have been phenomenal.

Not that everyone will go out of business quickly, but traditionally these violent commodity swings against us tend to squeeze mining operations viability.

So far our macro-economic stability has been maintained by simply borrowing more internationally to cover our current account and capital account requirements without giving a jolt to inflation from a depreciating rand.

But clearly a couple of things are not sustainable in the longer run and traditionally have led to macro-changes.

Although a part of our current account deficit today is infrastructure investment related and attracts its own long-term funding credits, clearly not the entire current account is so funded.

It would be better if the external deficit were to shrink somewhat. This can be achieved through reduced import absorption (slower spending growth) or through trade switching (a weaker rand inhibiting imports and boosting exports).

We have already slowed our domestic growth momentum this year, and will probably slow it some more in coming quarters, assisting with our balance of payments restructuring. But it will probably not come close to being enough.

Falling dollar commodity prices, even if relatively limited, will in time put increased pressure on many of our mines experiencing strong cost increases. Traditionally this has tended to see the rand weakening to keep things viable.

Any general rand weakening will also have the benefit of inviting broader trade switching, favouring larger swaths of exporters (manufacturers, services companies) while inhibiting imports.

In this way any rand decline will also be GDP growth supportive. All these things were last vividly on display in 2001-2003.

It would also amount to a tax on consumption – directly, by way of higher import costs and indirectly through its inflation enhancement, possibly inducing the SARB to go slow on future interest rate cutting, maintaining household burdens for longer.

Thus the coming macro-space freed up by falling commodity prices as our inflation recedes and scope for interest rate cuts is created could partly be taken up by further rand weakening and producer support, especially for our hard-pressed mines.

But this could mean less of a benefit accruing to our hard-pressed households via interest rate easing.

Prospects for 2009-2010 remain for the prime interest rate possibly to fall to 13%, but the rand could probably ease into 8-9:$ territory.

Source: Cees Bruggemans, FNB, August 18, 2008.


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