Rand debate misplaced

The violent swings in the rand have done more damage to the economy than its absolute level, argues Malcolm Charles, fixed income portfolio manager at Investec Asset Management. For the sake of businesses in SA, Government should focus their efforts more on ways in which to stabilise it than debate the virtues of weakening or strengthening it to a perceived ‘appropriate’ level.

Masses of column inches have been devoted to the impassioned debate about the level of the rand. On one side of the fence, calls for a more "competitive" exchange rate are intensifying to address joblessness and boost exports; on the other, those comfortable with a firm currency argue that the strong rand keeps inflation and interest rates low, which is (also) good for economic growth.

We would argue that the whole debate has been misplaced. While everyone is getting carried away by the absolute level of the rand, we believe it is the extreme volatility of our currency that is doing far more damage to our economy. Government should focus their efforts more on ways in which to stabilise it from one of the most volatile in the world relative to our emerging market peers than debate the virtues of weakening or strengthening it to a perceived ‘appropriate’ level.

With a level of stability, businesses can plan for the future and make long-term decisions, as it allows them to price in costs with some degree of certainty. Whether the rand – once it is stable – is weak or strong is immaterial: business will adapt. It is when the rand spikes from R7.50 to R10.00/US$ and back again in a matter of months that business runs scared and short-term thinking dominates.

Just look at what happened in the past when the rand blew out. Miners and exporters may have made record profits, but dividends were paid out to largely offshore shareholders, with very little benefit flowing through to the real economy. Because these corrections tend to be so violent, South African businesses cannot plan effectively or adapt fast enough. They end up passing higher prices on to the consumer, which results in higher inflation and interest rates and a slowdown in the economy. Wages are adjusted upwards to the full extent and any real competitive gains that the weaker rand could have wrought, are lost.

With a less volatile currency, the real economy is set to benefit from companies having more confidence to reinvest their profits in capex projects, thereby increasing the capacity of the overall economy.

So what can be done to dampen the rand’s volatility?

We recommend that the South African Reserve Bank (SARB) manages the currency around a fluctuating fair value range, which they determine based on the inflation and interest rate differential combined with a macro overview, which would for example include the stage of the commodity cycle.

What this means in practice is that the SARB actively buys and sells reserves around this fair value range, thereby ensuring a steady source of liquidity in the currency market, which over time will lead to tighter ranges and a more stable currency. Should the rand strengthen, the SARB would implement a transparent and steady buying programme of foreign currency based on the extent to which it deviates materially from the fair value range, a level which is understood by and communicated to the market. Similarly, they should be as committed to releasing reserves back into the system at an equally methodical pace when the rand weakens. However, given that our reserve base is so low and our economy is lagging other emerging markets, it would be prudent for the Reserve Bank to buy reserves more aggressively than they sell them.

There is no ‘quick fix’ solution. Just as it took years to bring inflation and interest rates structurally lower, it will take years to achieve a more stable rand. We are certainly not advocating that the Reserve Bank ‘take on the market’, as we learnt to our detriment when the forward book blew out.

In the same way that the inflation-targeting regime has anchored monetary policy in a transparent, predictable and credible manner, the Reserve Bank can ‘manage’ the currency according to a measured programme, a move which would bring more certainty to financial markets, take out some of the guesswork where the rand is concerned and ultimately reduce its volatility.