Overpriced rand hampers competitiveness

“The extreme valuation of the rand, especially against other commodity-related currencies, poses a serious threat to South Africa’s competitiveness in global markets.” So says Dr Prieur du Plessis, chairman of Plexus Asset Management.

“After weakening significantly in line with other commodity currencies up to January/February 2009, the rand has strengthened and is now trading slightly stronger against the dollar than in May 2008,” says Du Plessis. “However, the basket of commodity currencies is still significantly weaker against the dollar than 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 metal prices in US dollars, the local economy lags significantly due to the rand’s strength. Metal prices in other commodity currencies are down by only 12,4% from the May 2008 highs, while the Economist Metal Price Index is down a massive 31,5% in rand terms and has hardly shown any growth since June 2009. It is 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 local manufacturing industry. “With the rand trading below purchasing power parity (PPP) against the US dollar and euro respectively, there is little incentive to buy locally manufactured exports or relocate production facilities to South Africa.”

According to Du Plessis, whenever the rand reached 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 likely to be:

· 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 as a result of the FIFA World Cup.

· Significant long-term capital inflows due to 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,” he says. “In fact, this is the time to move money abroad if your portfolio is not yet at your preferred foreign allocation level.”