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Understanding rand depreciation

As the rand stumbles around the R9 to the US dollar mark, South Africa could do well if it slipped to R15 or even R20 to the dollar.

In practical terms, if the value of the rand halved to R18 a dollar, the price of South African exports would be half as expensive for its trading partners, making them very attractive to foreign importers. Likewise, the price of imports to South Africa would cost twice as much.

There are always winners and losers in exchange rate movements, but with a restructuring of the South African economy we may be able to have our cake and eat it.

South African trade sits in a precarious situation. South Africans have a high propensity to import and import penetration (a measure of the degree to which domestic demand is satisfied by imports) is currently around 24.7 percent.

Last year closed with an average current account deficit of about 6 percent of gross domestic product. What makes this dangerous is that this deficit is being funded by temporary capital investment inflows on the financial account spurred on by South Africa’s high interest rates relative to the developed world. When economic stability and higher interest rates return to the European economies, the South African current account will be left vulnerable to fend for itself.

A reversal of this balance of payments situation is necessary and a weaker rand could be the catalyst that sparks it. But increasing import costs and the inflation that follows are not a feasible option for the current state of the economy.

In order to reap the benefits of rand depreciation, a fundamental restructuring of South Africa’s trade is necessary. The country’s largest imports by percentage of total value are fuel (24 percent), motor vehicles (10 percent), electronics (3 percent), and pharmaceuticals (2 percent).

The elephant in the room here is fuel, because the other sectors could, in part, be replaced by local manufacturing if it were more competitive to do so. To sustain further depreciation of the rand, South Africa needs to address its energy mix and look to alternatives for imported fuel. The most effective and possibly easiest option would be to put systems in place to reduce the need for fuel consumption.

If the economy could detach itself from such a large dependence on imports, then a significant depreciation of the rand would become beneficial.

To start the process interest rates must be lowered. Borrowing costs would be lowered, foreign capital inflows would decrease and the rand would depreciate. The manufacturing sector must be ready to take advantage of lower investment costs and increased demand and to use the window period to re-establish itself as a competitive player on the world stage.

In the long run, the reversing trade balance will increase the demand for the rand and decrease inflows, thereby appreciating the rand once more. Eventually, the real exchange rate may re-establish itself at current levels, but in that case its strength will be based on real value-added production and a reduced reliance on imports – not on temporary financial inflows.

It is not a change that can happen overnight, nor is it a systematic interventionist policy that can be completely controlled. But a depreciating rand under the right conditions could be exactly what South Africa needs to reset it to a more stable growth path.

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