Of exchange rates and running down of the Rand value

2015-03-11 09:45

I recently posted an article imploring people to not be dismissive about the goings on in another place as not affecting them. The South African Rand is currently undergoing a rout along with other emerging markets. Expectations that the US interest rates could rise by midyear has been the primary instigator of the selloff of emerging currencies. According to Thomson Reuters data the rand hit a session trough of R12.31/$, the weakest it has been since January 2002 and was at R12.23 by 16:28 on 10 March 2015.

In simplified terms, an exchange rate is the cost of acquiring another currency expressed in a base currency i.e. when you hear that the exchange rate is at R12.31/$ it means it costs R12.31 to buy $1. An appreciation of a currency is whereby the value (strength) of a currency increases i.e. you now need less of the currency (Rands) to buy the same amount of the other currency (Dollars). So an appreciation would be seen in rate moving from R12.31:$1 to R12.00:$1. However, currently our currency is experiencing depreciation- we need more Rands to buy the same amount of dollars.

The value of an exchange rate is determined by the forces of supply and demand which interplay to determine price and quantity of a commodity (good or service) in the market. The more people want a particular currency (increase in quantity demanded) with no increase in its supply, the higher the price (value) of that currency. In the prevailing environment there is a global increase in demand for US dollars which has seen demand for emerging market currencies declining- Rand being one of these. In fact according to Fin24, “It (the Rand) was among the five weakest performers in a basket of 25 emerging market (EM) currencies monitored by Reuters; the others being the Russian rouble, Turkish lira, Polish zloty and Hungarian forint.”

Global (Read: Western world) sentiment towards emerging markets tends to follow a similar pattern. When investor risk appetite for these currencies falls, demand for the currencies declines. Emerging markets by and large offer higher rates of return (i.e. interest rates) but with risk considered to being higher than developed markets. Anticipation of an increase in interest rates in the US where the risk is lower results in investors shifting their funds from the emerging markets. This is apart from the other factors which are country specific which might cause currency to not be as attractive. In South Africa’s case current “nagging deficits on its budget and current account, and structural impediments to economic growth including chronic electricity shortages result in the local unit being hit hard in the face of souring global risk appetite” (Fin24).

A weakened Rand stands to benefit exporters as South African products become relatively cheaper as those importing our produce now need less US dollars to import the same quantity of produce. On the other hand firms importing are negatively impacted as they now need to part with more Rands to get the same volume of produce they were importing. What happens in another place does affect us as we might end up seeing changes in some product prices which require imported inputs. There is a systemic impact on us as the general populace due to the interlinkages brought about by being in a globalised world economy.

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