Ye Xie and Robert Brand
After losing about a third of their value in three years, South Africa’s rand and Turkey’s lira still need to fall further to reach levels that make their economies competitive.
The lira is 12 percent overvalued and the rand is 10 percent too expensive, the most in a UBS gauge that assesses 22 exchange rates according to their trade balances. While the currencies have risen over the past six weeks, that is a result of interest rate increases rather than economic improvements, according to French bank Société Générale.
“The rand and lira are still expensive,” Shweta Singh, an emerging-market economist at Lombard Street Research, said in an interview last week. “The currencies are not appealing relative to the risks.”
While Turkey and South Africa’s current account deficits have started shrinking from their record highs, they are still about twice the size of their developing nation peers, signalling further foreign exchange losses. After Argentina’s peso, options traders are the most bearish on the lira out of 31 major currencies, while foreign investors are pulling money from South Africa’s bond market for a second quarter.
Emerging market units have been rocked in recent months, with a Bloomberg custom index of the 20 most-traded currencies falling to a five-year low on February 3 amid concern that China’s economy is slowing just as the US Federal Reserve pares its stimulus and tensions between Russia and the US rise over Ukraine. At the same time, Argentina unexpectedly devalued its peso and Turkish Prime Minister Recep Tayyip Erdogan’s cabinet became embroiled in a corruption scandal.
Economists have cut growth forecast for Asia, Latin America and eastern Europe this year to an average 3.73 percent from 3.98 percent. While rate increases from Russia to Brazil have helped bolster emerging market currencies, strategists at Morgan Stanley, Citigroup and Goldman Sachs are not convinced the worst is over.
After Argentina’s peso, the rand is the worst performer against the dollar among 24 emerging market currencies over three years, losing 36 percent. The lira has weakened 29 percent.
The rand touched an almost five-and-a-half-year low of R11.3909 to the dollar on January 30, before recovering to R10.6711 on Friday. It was bid at R10.7305 at 5pm in Johannesburg yesterday. The lira is about 3 percent weaker since the start of this year, dropping to a record 2.39 lira to the dollar on January 27 and ending last week at 2.2128.
In August last year Morgan Stanley dubbed the rand and lira, along with Brazil’s real, India’s rupee and the Indonesian rupiah, the “fragile five” emerging market currencies because of their reliance on foreign capital to finance deficits in their current accounts, the broadest measure of trade.
Turkey’s deficit will narrow to 6 percent of gross domestic product (GDP) this year, from 7.4 percent last year, according to economist estimates. That would still be the highest in the Group of 20 (G20), followed by South Africa. Its shortfall is forecast to expand to 5.5 percent of GDP.
Benefits from currency depreciation are proving hard to come by as sluggish growth in Europe and China curtails demand.
“Some of these countries need a weaker currency to make sure they stay competitive,” Jim O’Neill, the former chairman of Goldman Sachs Asset Management, said last week. O’Neill, a London-based Bloomberg View columnist, coined the Bric acronym in 2001 to describe Brazil, Russia, India and China, the largest emerging markets.
Other measures of relative value indicate that the declines in the rand and lira have already left them cheap.
The Big Mac index, which ranks exchange rates according to a purchasing-parity model based on the cost of the standard MacDonald’s hamburger, estimates the rand is 60 percent undervalued, compared with 25 percent for the lira.
UBS says that valuation models based on purchasing power may be misleading in the current economic climate because they overestimate the impact of a weaker currency on trade.
“The global trade link is broken,” Bhanu Baweja, the head of emerging market cross-asset strategy at UBS in London, who correctly predicted the developing nation sell-off, said in a March 7 interview. For the lira and rand, “you need the currencies to decline further to rebalance their economies”, he said.
Goldman Sachs estimates that to cut South Africa’s deficit to a “sustainable” level of 3.5 percent of GDP would require the rand to weaken 27 percent to R13.50 a dollar, a level last seen in December 2001, when the currency slumped to a record low of R13.8401. The lira would need to drop 13 percent to a low of 2.5 per dollar, according to the Wall Street bank.
The lira has rallied 1.8 percent since the Turkish central bank raised the benchmark one-week repo rate to 10 percent from 4.5 percent at an emergency night-time meeting on January 28. The following day, SA Reserve Bank governor Gill Marcus unexpectedly lifted the rate rate by 0.5 percentage point to 5.5 percent, prompting a 6.1 percent gain in the rand.
Those rate increases make it more expensive for speculators to bet against the currencies, which may delay the rebalancing of the economies, according to Phoenix Kalen, an emerging market strategist at Société Générale in London.
“We’re starting to see an improvement in the current account but progress is going to be slow with the rand at these levels,” Kalen said in an interview last week. “At the moment, though, it’s very difficult to push the rand weaker”, because of higher rates, she said.
Kalen expects the rand to rally to R10.30 a dollar by year-end, making her more bullish than the median estimate of 31 strategists in a survey, which sees it at R10.96. A separate poll of 27 analysts shows the lira is expected to weaken to 2.25 to the dollar by December 31. – Bloomberg