Rand reflects global turmoil

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By Cees Bruggemans

At 8.55:$ and weakening, it would be pushing the envelope to describe the Rand as resilient and not ‘weak’.

Still, most of such perceived Rand weakness reflects the Dollar gaining strongly on the back of global financial funding problems.

Against Sterling and the Euro, together accounting for half of our trade-weighted basket, the Rand has of late maintained it self better near 15 and 11.65 territory.

During 2007, the Rand averaged 7.05:$, 9.65:Euro and 14.11:Sterling. Today’s exchange rates suggest Rand weakening so far this year of some 22% against the Dollar, 21% against the Euro and 7% against Sterling compared to 2007’s average.

With Rand trade weights of 36.5% (Euro), 15.5% (Dollar), 15.5% (Sterling), 10.5% (Yen) and 22% (emerging markets), the trade-weighted Rand today is about 19% down compared to 2007.

But given our much steeper inflation bulge this year as compared to the experiences of most of our main trading partners, the real or inflation-adjusted Rand today is probably only just over 10% down on 2007.

This is substantial, but not overly much, considering the size of our current account deficit at 7%-8% of GDP, weaker commodity prices and the current global tumult.

With an annualized deficit of R180bn, our external funding requirement looks daunting, given so many headwinds this year.

Yet during 1H2008 annualized capital inflows amounted to some R190bn, partly contributed by portfolio inflows, corporate inward investment, public sector infrastructure credits and short-term bank borrowing.

Despite our growth slowdown, our current account deficit is not expected to ease much, primarily because savings and exports will likely disappoint and fixed investment and import performances will remain relatively robust.

This suggests annual external funding needs of R200bn for some while.

How stable is our foreign capital access so that we may continue to fund our external needs without putting undue downward pressure on the Rand?

South Africa is not an exceptional growth story longer term, probably in the 3.5%-4.5% range. But we do have attractive corporate assets, which aren’t currently overvalued, offering good yields over time.

In a normally functioning world, with our credit-rating unimpaired and asset values attractively priced, we should have little difficulty of attracting portfolio inflows and direct corporate investments. Also, global hunger for a slice of our infrastructure funding provides access to long-term capital. Additional trade funding requirements should be easily bank-funded.

That is in normal times.

Anyone prepared to suggest these aren’t normal times?

The tailwinds are over, with the current account deficit no longer three times over-funded as it was in 2003. But the Rand hasn’t fallen out of bed either.

Foreign capital inflows are still more than matching the current account shortfall of 7%-8% of GDP, given that the SARB’s reserves aren’t draining away.

But is this only an accident waiting to happen? Other emerging countries, such as India and especially Russia, and some highly developed ones such as Iceland, have seen increasing headwinds over their capital accounts in recent weeks and months, putting downward pressure on their currencies and stock markets.

But no runaway condition has really come into being (yet) unless it is Russia’s special set of circumstances. And now Iceland’s.

Yet that is exactly where the shoe now pinches most. Surely this could happen any time, also to us (again)?

Infrastructure investment credits may be safe, but portfolio flows have been draining out (again), foreign appetite for our corporate assets could cool as growth (globally and locally) tails off more, and banks may find their borrowing windows closing, given the global mayhem. And then what?

Our foreign capital needs remained well provided during the past 14 months of enormous global aggravation. The strain was not so much experienced within emerging countries, as within and between rich developed ones.

Equity and fixed income markets did sell off, with our JSE now 35% down and foreign appetite weakening, inducing portfolio outflows.

But our economic performance and our robust democracy these past twelve months, even when laid low by electricity outages (common worldwide) and whiffs of xenophobia (also apparently not exceptional), simply did not succeed in upending our applecart.

Importantly, last week saw another turning point in global affairs, as America decisively decided to address financial sector repair.

Overheated commodity prices already broke last July. Global growth is receding, with the main industrial regions already in recession. This will kill off inflation for the time being, freeing policy space for growth support.

Between these cyclical and structural turnings, global strains should ease rather than intensify into 2009. Risk aversion should subside once again.

This suggests improving portfolio inflows, reviving corporate investment appetite and ongoing banking access.

The Rand will remain the ultimate reflection of these many forces. On balance, the risks of a runaway condition should now be cyclically weakening. The global fevers look like having been broken. What remains is cleanup rather than deepening despair at collapsing performances.

The moment of maximum exposure for us was probably the six trying months between Bear Sterns (March) and Lehman folding (September), oil hitting $147 (July).

We should now be entering a less risk-prone quadrant globally, with the Americans and Europeans in full cleanup mode. This should assist in keeping the Rand resilient in current trading ranges rather than still belatedly sinking it.

But vigilance remains advised. This may convince the SARB to hold off cutting rates until key central banks have done so and global financial markets have signaled more clearly of starting to calm down, now that the US Treasury will be turning proactive shortly, with central banks meanwhile providing whatever liquidity is required to keep the global banking system afloat.

The Rand will remain an active barometer of all these many cross-currents.

Source: Cees Bruggemans, FNB, October 6, 2008.


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