Overpriced Rand hampers competitiveness

Dr Prieur du Plessis, chairman of Plexus Asset Management and author of the Investment Postcards blog says that the extreme valuation of the rand, especially against other commodity-related currencies, poses a serious threat to South Africa’s competitiveness in global markets.

The accompanying Graph A compares the movement of the US dollar against the rand (based to 100) from May 2008 to date, as well as the movement of the dollar against an index of commodity-related currencies. “After weakening significantly in line with other commodity currencies up to January/February 2009, the rand has strengthened to a level where it is now trading slightly stronger than its value against the dollar in May 2008,” says du Plessis.

“However, the basket of commodity currencies is still significantly weaker than it was against the dollar in May 2008, which obviously benefits these countries’ exports.”

The mining industry in particular is being hampered. “Where other commodity export economies are receiving a boon thanks to the revival of specifically metals prices in US dollars, the South African economy lags significantly as a result of the rand’s strength. Metal prices in other commodity currencies are down by only 12,4% from the highs in May 2008, while the Economist Metal Price Index is down a massive 31,5% in rand terms and has hardly shown any growth since June last year.” (See accompanying Graph B.) “No wonder the South African authorities are considering ways to weaken the currency,” says du Plessis.

The strength of the rand is also impeding the South African manufacturing industry. “With the rand trading below purchasing power parity (PPP) against the US dollar and the euro respectively there is little incentive to buy South African manufactured exports or to relocate production facilities to the country.”

According to du Plessis, whenever the rand reached purchasing power parity (PPP) against the euro it tended to stabilise around the PPP. When external shocks (global or regional crisis) developed, the rand depreciated significantly against the euro (see following table).

* The extent to which the euro/rand exchange rate moved away from the PPP.

“With the euro/rand deviation currently at -5% it is evident that the major run of the rand against the euro is about to end soon,” says du Plessis. “What is clear, however, and cannot be argued away, is that the rand at its current levels is extremely vulnerable to any global economic surprises on the downside or any global and regional crisis. The currency is therefore priced for perfection.”

But what are the reasons behind the rand’s extraordinary strength?

According to du Plessis, the main reasons are probably:

·  The South African banks’ ability to withstand the global debt crisis of 2008/2009. This has led to positive credit ratings relative to their foreign peers, while the country’s image has improved significantly. The country’s image has also received a major boost thanks to the FIFA World Cup.

·  Significant long-term capital inflows as a result of the massive Eskom loans and the possible take-out of Nedbank.

·  Significant short-term capital inflows as a result of speculation that the rand may improve further, together with relatively high positive interest carries.

“With an increasing number of emerging economies raising interest rates it is only a matter of time before funds will start to leave South Africa for better yields and lower risks,” says du Plessis.

“This is therefore definitely not the time to repatriate foreign funds. In fact, it is the time to move money abroad if your portfolio is not yet at your preferred foreign allocation level.”