Lifting output is vital as rand slumps

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New York - The Wall Street Journal (WSJ) Online edition led on January 23 with the following: “Investors flee developing countries: currencies in many emerging markets take a pounding, hit by growth fears”.

Investors dumped currencies in emerging markets, underscoring growing anxiety about the ability of developing nations to prop up their economies as they face uneven growth.

The Argentinian peso tumbled more than 15 percent against the dollar in early trading on Friday as the nation’s central bank stepped back from its efforts to protect the currency, forcing the bank to reverse course to stem the slide. The Turkish lira sank to a record low against the dollar for a ninth consecutive day. The Russian rouble and the rand hit multi-year lows.

US stocks tumbled too, reflecting a global pullback from riskier assets and continuing a weeks-long struggle to regain the upward momentum seen late last year. The Dow Jones industrial average slid 1.1 percent to 16 197.35, the lowest close since December 19.

The WSJ indicated that the Turkish lira had been the worst affected by the move out of emerging markets since January 1, followed by the rand and the Russian rouble, both down 3.54 percent. Clearly, emerging market economies (with a few exceptions, perhaps Mexico) are out of favour and may stay out if the current investor mood is sustained.

It was not only a bad day for emerging markets and currencies, it was a risk-off day in the US with, accordingly, equity prices down and bond prices up. The risk-on threat to emerging markets and their currencies including the rand can be easily identified. That is, more confidence in the US growth outlook (less risk attached to the prospects for the economy and the companies dependent on it) leads to higher interest rates. These higher interest or discount rates have been mostly tolerated by the valuations attached to US equities, but unwelcome to emerging market equities as rising interest rates in emerging economies, led inevitably by the US rates, threaten the already unpromising growth outlook for emerging economies.

There is also a risk-off threat to emerging markets even as US rates move lower. Raising interest rates has done little to help support exchange rates. Intervening by selling dollars has also not helped stem the currency weakness. The global tide is flowing too strongly to be diverted and higher interest rates weaken domestic demand further.

One hopes that the South African authorities have taken notice of the unhappy experience of those emerging market central banks that, unwisely and unlike the Reserve Bank, have reacted in an activist way to the pressures in the currency and bond markets emanating from global investors and capital flows out of emerging economies and back to developed ones.

Surely the best approach for an economy under stress is to allow a floating exchange rate to help absorb the pressures imposed by less sympathetic global investors; and for the authorities to do what they can with monetary policy to relieve some of the unwelcome pressure on domestic spending. While lowering short-term interest rates amid a sharp currency depreciation may be regarded as too sanguine an approach, leaving them on hold would seem to be the best that can be done in circumstances beyond the control of the monetary authorities.

For South Africa this means the mines, factories, hotels, restaurants and tour operators should stay open for business – or, better still, work overtime and double shifts where extra demand is encouraged by the weaker rand. The task for economic policy is to make sure growth led by exports and import replacement is encouraged. Only the prospect of faster growth will attract more capital to the businesses that drive the economy, and would support the rand and also improve the outlook for inflation.

There is an important economic opportunity for the local economy provided by the weaker real rand exchange rate. This is for domestic producers, enjoying wider operating profit margins, to take a larger share of the domestic market from importers and to increase their share of export markets through keener pricing, increased output and employment. Such responses raise growth rates and are the only known method likely to impress foreign investors.

* Brian Kantor is the chief economist and investment strategist at Investec Securities.


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