Bitter medicine for economy - Formby

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Bloomberg

A sharp deterioration in the rand is likely to cause a hike in interest rates, analysts fear. Photo: Bloomberg

Johannesburg - The rand broke through three key psychological thresholds last week, heightening concerns about the outlook for economic growth and the scope for government policy in an election year. On Friday, the rand dropped to lows of R18.33 to the pound and R11.11 versus the dollar.

The rand’s weakening against the dollar for a third day and to a record low against the euro of R15.3646 came after foreign investors dumped the most South African bonds in eight months on Thursday.

Although the hit was prompted by expected policy moves from the US Federal Reserve and China, rand traders were quick to find local reasons to justify selling off the currency. The most obvious were the strike in the platinum sector, the current account deficit and the budget deficit.

Economists and currency traders said the sharp deterioration in the rand’s strength in recent months had significant adverse implications for the inflation rate and was expected to lead to a hike in interest rates. This would dampen the already subdued prospects for economic growth this year.

They added that while the weaker rand should boost income from the country’s mining exports, the full benefit would require a more productive industrial relations environment in the mining sector.

For general industry, some analysts are optimistic that where productive capacity has been maintained there is scope to increase exports of manufactured goods or to replace imported goods.

Rand Merchant Bank’s James Formby, who warns of “bitter medicine” for the economy, said the negative local factors aggravated the adverse impact of last week’s increased anxiety about the “tapering story” at the Federal Reserve.

In addition, the rand was hit by the currency market’s perception that South Africa is one of the so-called fragile five.

Last year, the Fed announced that it intended to taper its purchase of US bonds, which has kept US interest rates low and encouraged money to flow out of the US and into emerging market currencies such as the rand.

Global currency traders have been jittery about the impact of this and have been selling off emerging market assets. The fragile five – Brazil, Turkey, India, Indonesia and South Africa – are deemed particularly exposed to the impact of tapering because of internal economic or political risks. South Africa is regarded as having the highest economic risk because of its deficits, and Indonesia the highest political risk.

Formby said the country could be in for a tough time in the coming months as the economy responded to the rand’s weakness by reducing imports and increasing exports. However, he noted that in the short term the outlook for exports was restrained by the unrest in the platinum sector and the time lag involved in local manufacturers increasing capacity.

He said the focus of much South African investment overseas was on Africa and he had not seen evidence of any move away from these growth plans as a result of the weakening. “Investment into Africa tends to be steady and incremental and is not as exposed to currency sentiment. The local currency weakness does confirm strategies to invest and grow outside South Africa”.

Another banker said that retailers that relied heavily on imports to sell goods into the local market were under pressure. He said while most of the large retailers tended to hedge their currency exposure, this only muted the impact. “How severely they are affected will depend on the strength of demand facing each of the retailers and their ability to negotiate with suppliers as well as absorb the increased costs.”

He added that the initial response to the slump could be a surge in imports as retailers and other businesses rushed to import goods in anticipation of continued rand weakness.

Simon Eppel of the Southern African Clothing and Textile Workers Union said there were already signs of increased local sourcing, while some companies were looking to increase exports.

However, he pointed out that the ability of local companies to respond to the weaker currency had been affected by changes to the industry during the past decade.

He said the value of clothing imports from China had flattened out in recent years but an increase in imports from Bangladesh and Mauritius was countering this. – Additional reporting by Bloomberg


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