Rand depreciation would bring widespread misery

The suggestion of devaluing the rand, potentially to R15 or even R20 to the dollar, to gain demand for South Africa’s exports, must raise the question of whether a weakening currency would really be good for South Africa.

Does a weak currency increase competitiveness and is it positive for growth and job creation, given that the costs of labour in many areas of the production sector, and of electricity, are increasing at double-digit rates? Or is rand depreciation just a short-term, easy solution, outweighed by the longer-term damage, which includes sharply higher inflation and the resultant human suffering of the poor?

Essentially, competitiveness is a country’s share of the world market for the sale of its goods and services. In attempting to increase a country’s share, the temptation often arises to use price competitiveness through either currency devaluation or keeping wages too low.

But the unavoidable truth is that under a marked currency devaluation, the citizens of the country take a communal pay cut through dropping the cost of their goods sold in world markets and paying substantially more for imports.

The simple explanation of “halving the cost of exports by halving the value of the rand” misses this point. Continued rand devaluation runs the risk of entrenching South Africa as a country with a substantial export share but one that still remains poor, with a high unemployment rate.

By pursuing a weaker rand, workers become trapped with ever-lower wages, as their purchasing power continually diminishes (inflation rises relentlessly). There is no real escape other than attempting to stem the tide of currency devaluation, which becomes harder to do the longer it is pursued.

As should have already been learnt, rand weakness results in higher import costs. The past two years demonstrated this as the incidence of strikes has increased as workers agitated for higher wages to meet the higher cost of living.

Indeed, substantial, ongoing rand weakness would make the cost of importing goods, particularly machinery and other technology used in production, exorbitant or unaffordable. This would hurt infrastructural expansion. Electricity tariffs would need to be pushed up much more significantly than is already occurring, because the cost of importing the capital equipment needed in new power stations would rise as the rand weakened.

Workers are doomed to producing relatively cheap products and earning low salaries as a result of substantial currency depreciations, without the ability to tap into economies of scale – the cost of mechanising the production process is beyond the county’s reach because of the severe weakness of the currency. Unsurprisingly, the incidence of strikes increases.

Weakening the currency for the immediate gratification of a more competitive rand would actually result in a substantial lowering of living standards for those already employed.

A country’s standard of living is shaped by its output. The more it produces through the use of its resources, whether these are human, natural or capital, and the more efficient the production, the more there is to go around (including tax revenue) – as long as the gains are not eroded by inflation.

High levels of quality health care, education and public services become easily affordable and per capita incomes keep rising significantly in an environment of high growth and low inflation. The manufacture of high-quality, innovative products, which come with a high price tag and do not need currency deprecation to boost demand, allows a nation to support high wages, a strong currency and attractive returns to capital, resulting in a sustainable, high standard of living.

Restructuring the economy to export low-priced products will only support subsistence wages and translate into a low level of gross domestic product (GDP) per capita. And substantial wage increases cause retrenchments when companies find they cannot increase the price of their products to match the rise in labour costs.

However, temporary, mild rand weakness, and the emphasis really needs to be on the words “temporary” and “mild”, can help export demand only when there is significant demand globally for exports – unlike the current situation of the euro zone recession and weak global demand.

It should also be noted that exports from the mining sector are priced in dollars as they are determined by global resource prices, while all agricultural exports are influenced by the international dollar price of agricultural goods. If the rand is weakened substantially, producers would prefer to sell agricultural products overseas (given the higher return) and workers would find food prices escalating sharply and so demand higher wages.

The resulting sharp increase in labour costs and electricity tariffs would quickly erode any competitive benefit from the rand’s weakness. Indeed, rand depreciation to R15 or R20 to the dollar would doubtless cause a wage-price spiral.

It is also key to note that the current account is not being propped up by foreign purchases of South Africa’s assets. Foreigners own about a third of South Africa’s equities and bonds, and inflows are chiefly to take advantage of the country’s emerging consumer market and the deep liquid nature of the financial system, which makes purchases of South Africa’s investment-grade bonds attractive.

Additionally, the current account deficit is large (6.4 percent of GDP at the last reading) not because the trade deficit is as large (only 2.6 percent of GDP for the same period) but because the bulk of the current account deficit consists of dividend and coupon payments to foreigners holding South African equities and bonds.

A foreign sell-off of South African equities and bonds would automatically collapse the current account deficit because these foreigners would no longer receive dividend and coupon payments.

However, the sharp currency depreciation would cause the trade deficit to balloon as the cost of oil imports and capital equipment climbed and the demand for exports then dropped off as the input costs of labour, electricity, transport and others rose sharply, driving up the cost of exports and driving down their competitiveness.

Additionally, the transport system is at present not able to cope with a substantial rise in demand for bulk exports, as was seen by the country’s inability to meet increased demand for coal during Australia’s recent floods.

Existing foreign investments (particularly direct) would be prejudiced by a sudden sharp fall in the rand. Foreign direct investment (bricks and mortar investment) is urgently needed to transfer skills, create jobs and bring in savings given South Africa’s exceptionally low savings base.

Chasing away foreign investment through massive currency devaluation will chase away the huge inflow of funds the country receives on its capital account, which is vital in financing its infrastructural investment (given the dearth of domestic savings).

South Africa’s interest rates are historically low but are higher than those in advanced economies. However, as the global interest rate environment moves into an upward phase on higher economic growth, so will South Africa’s.

The risk to foreign investment that seeks higher interest rates is clearly not an increase in global interest rates but rather that the rating agencies will downgrade South African bonds closer to speculative grade on strikes, the reduction in GDP growth and the widening of the trade deficit. The unavoidable rapid rise in inflation and drop in living standards due to marked rand devaluation would also concern the rating agencies.

A massively depreciated rand would substantially increase the cost of servicing foreign debt and increase the cost of government borrowing, increasing the chance of further rating downgrades.

Even China shows that its workers are not happy with subsistence wages. If South Africa attempts to follow the path of massive currency depreciation, it will just result in greater social unrest and political instability.

A substantially depreciated currency would be easy to achieve, but the unintended (and clearly destructive) consequences would not be easy to reverse.

Annabel Bishop is Investec’s chief economist in South Africa.