Strong rand poses risks amid weak economy
The current strengthening trend of the rand, and the possibility that it could gain further ground over the coming months, poses risks to the South African economy, according to Rian le Roux, chief economist at Old Mutual Investment Group (SA) (OMIGSA).
Le Roux believes the South African Reserve Bank (SARB) should avoid a repeat of the 2003 cycle in which the Bank, by not buying up more foreign exchange (selling rands) as the local currency appreciated, allowed the rand to get too strong, and subsequently reacted by aggressively lowering interest rates.
“With such low interest rates prevailing in 2004-2006, consumers went on a spending spree, partly financed by debt. The strong rand negatively affected exports and contributed to an import boom, causing a rapid deterioration in the current account of the balance of payments.
“This time we would prefer to see a more rapid build-up of foreign exchange reserves, rather than a significant further strengthening of the rand (from its current level of around R9/US dollar). While it may limit the extent of the expected decline in inflation and interest rates, it may also help to bring about a smoother cycle over the medium term.”
Another risk, he points out, is that the strong rand could aggravate the current weakness in the economy. The stronger rand is probably putting additional stress on the already-suffering mining and manufacturing sectors. “Our exports have been hard-hit by the sharp fall in global demand, and the strong rand is not doing the miners or manufacturers any favours at the moment. Any recovery in these sectors, which together account for approximately 23% of SA’s GDP, risks being delayed as a result.”
The rand has received support in recent weeks from South Africa’s avoidance of a serious financial crisis or need for emergency aid, and from relatively high interest rates, firm precious metal prices, the expected narrowing in the current account deficit and a reduction in global risk aversion.
2009 growth prospects worsen
As a result of the worse-than-expected slump in economic activity experienced around the world in the first quarter of 2009, South Africa’s own growth prospects for the year have deteriorated more than most economists had initially projected.
Le Roux has recently revised his GDP growth forecast for 2009 to around -0.5%. Based on available data, he estimates that GDP for the first quarter of the year could have contracted at an even faster pace than the -1.8% decline recorded in the fourth quarter of 2008.
“While data for the first quarter is still fairly limited, what is available paints a rather ugly picture, with big contractions in mining, manufacturing and electricity production, building plans passed and vehicle sales. At OMIGSA we are expecting first quarter GDP growth to have declined by around 3.5%,” (q/q annualized basis).
Some recovery seen 2H 2009
On the positive side, however, le Roux believes lower interest rates, a general slowdown in inflation and recent tax cuts will lend some support to real incomes and consumption in the second half of the year.
Globally, there are some tentative signs that the pace of the global downturn may be moderating. However, he stresses, there are still no clear signs that a global recovery is underway, so our exporters will continue to experience very tough conditions for some time still.
“Still, some of the recently released data has raised hopes that a global recovery will unfold in due course, even though the strength and durability of it is still uncertain. These hopes have benefited the rand as financial inflows appear to have improved moderately.”
The short-term downside risks to the local economy, le Roux believes, are a further deepening of the export slump, more widespread retrenchments and cutbacks in corporate investment. This could in turn impact more severely on consumer spending and fixed investment than currently expected.
There is also a risk consumer inflation could remain stubbornly high, with manufactured food inflation remaining sticky (at 11% in March), significant price hikes in electricity tariffs on the way and high wage settlements.
“Although these inflationary pressures remain, we don’t think this will prevent the Monetary Policy Committee from lowering the repo rate by another 100 basis points (bps) at its meeting this week,” says le Roux. “On top of this, we expect a further cumulative 100bp cut thereafter, before the SARB pauses to assess the impact of the previous rate cuts on the economy in the second half of the year. This is when sticky inflation (particularly administered prices) could help prevent further easing, particularly if there are signs the economy is starting to recover.”
