Q&A: What's behind the rand's severe wobbles?

The rand in recent weeks weakened to above R15/$, which analysts have attributed to international developments such as trade war talks between the US and China, coupled with local risks which have scared off investors, such as bailout announcements for Eskom.

Speaking to Fin24 by phone on Thursday, Alwyn Van Der Merwe – director of investments at Sanlam Private Wealth – said the local unit is a risk barometer within SA, and that its movements have been largely dominated by market perceptions of those risks.

Up until mid-July, the rand had been trading "broadly sideways" to developed market currencies such as the US dollar, euro and pound, he noted. 

Van der Merwe shared his views on what sparked the turnaround in the rand's performance, causing it to trade around average levels of R15.20/$.

Fin24: To what extent is the rand more influenced by international events than local events?

Van der Merwe: There are many factors that have an impact on the currency, not only local events but also international events. If you look at what has happened over the last few months, it is quite clear that the global economic cycle is starting to roll over. On top of that, there were probably two low risks that started to play out. These are the trade wars and Brexit.

As a result of these risks, the international investors take a lower risk option and therefore will try to avoid destinations for money they regard to be high risk, normally emerging markets. South Africa is part of the emerging markets and was also affected when money flew out of emerging markets. As a result, the rand behaved in a similar fashion to other emerging market currencies.

Unfortunately, there were also a number of risks that came to the fore locally, which scared international investors from investing in South Africa. The biggest one was the bailout to Eskom that President Cyril Ramaphosa announced at the State of the Nation address (in June). This bailout was quantified after Finance Minister Tito Mboweni told Parliament Eskom would need R59bn in the short term. That brought fiscal risk to the fore and the rand came under severe pressure.

How do developments in trade talks between the US and China impact the rand and other emerging market currencies?

If foreign investors feel risk is building up, they would then prefer to introduce less risk in portfolios. Emerging markets are generally regarded as high risk, which is why there would be an outflow from emerging markets to less risky destinations.

The dollar should strengthen as the US is regarded as a safe destination for investors. In turn, emerging market currencies will come under more pressure.

Secondly, if the trade war has an impact on global economic activity, China to some extent would be a victim. The Chinese economic growth rate will be impacted and this will also negatively affect China's demand for commodities. Many emerging markets are commodity producers which export to China. If demand for commodities declines then the terms of trade for emerging market countries will come under pressure and that will be negative for their currencies.

What are some reasons for the rand's volatile trade from mid-July?

Since the beginning of the year most emerging market currencies strengthened somewhat against the dollar. But given the negative news coming from trade negotiations between the US and China, emerging market currencies came under pressure.

Most emerging market currencies had depreciated against the dollar, but the rand's depreciation was worse given local developments - particularly the extra R59bn financing for Eskom in the short term had a negative effect on the rand.

Is the rand the worst-performing emerging market currency?

Over the last two weeks the rand was certainly one of the weaker performing currencies, with the exception of Argentina.

We are certainly not the worst performing currency, but our performance was worse than the average performance of the emerging market complex of currencies over the very short term.

Is the rand trading at fair value? Why or why not?

When valuing a currency, we say the currency should reflect the difference in the inflation rate between South Africa and its most important trading partners. If the inflation rate is higher than most important trading partners – then the only way to stay competitive in terms of exports is to make sure the currency trades at a lower level.

Theoretically the rand should be trading at R13/$, but in reality it is trading around R15.20/$. That tells you the rand is cheaper relative to its theoretical value.

A lot of deviation between the actual value and the theoretical value of the rand depends on the investor sentiment of the day, which also depends on the Reserve Bank being able to maintain its independence in policy implementation.

The Reserve Bank must be able to continue to act on its mandate – which says they have got to protect the value of the currency. If the monetary policy is aligned to keep inflation under control, then the rand shouldn't go into freefall.

Has a credit downgrade by Moody's been priced in by markets – and how would that affect the currency?

It is probably a consensus view that Moody's will downgrade by the end of the year. If it is a consensus view, then we must understand that markets are forward looking and if markets are forward looking, it would be a fair assumption a downgrade should be priced in already.

Having said that, there is normally a knee-jerk reaction on news of a downgrade.

What would contribute to the rand strengthening?

It is probably true to say that over the last few months there were a number of disappointments, increased fiscal risks and government shared intentions to introduce to law policies which are not market friendly – this is NHI and the president's ascension of the debt relief bill.

Those are things which scare foreign investors who don’t normally understand the complexities of South Africa.

Over time, if there is market-friendly legislation in SA, if there are signs that the economy is likely to recover, if the fiscal situation improves and if it is clear to foreign investors that the Reserve Bank will maintain its independence, then I think the sentiment will change. If more money comes into the country then it will support the currency.

What are your expectations for the value the rand will reach by year-end?

It will be a guess. I would think we had so much bad news, late in July and August and a lot of that is priced into the currency. Depending on the outcome of the Moody's review at the end of the year, I guess the rand would trade around these levels – around R15/$.

*This interview was edited for clarity and brevity.

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