ADVICE: Avoid the rand-exchange rat race

By Michael Kruger Time of article published Aug 14, 2019

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Many South Africans use the exchange rate against major developed markets (such as the US and the UK) as an indicator of the state of the country. 

When the rand does well, South Africans tend to reflect this sentiment as they feel more secure and positive about the country's outlook. The opposite is also true, in that when the rand struggles, we often become pessimistic about the country

Negative sentiment has grabbed hold and sentiment is possibly at its lowest, however, it's not all doom and gloom, and South Africans can find some reprieve in knowing that the value of our currency is only partially affected by South African specific factors.

As a small, open, emerging market that makes up less than 1 percent of the world economy, we are more likely to be affected by what is happening globally rather than domestically. This is worsened by the fact that the rand is one of the most liquid and tradeable currencies when compared to other emerging market currencies. Often, when there is global risk aversion and investors flock to safe-haven assets, the rand acts as a proxy for all assets perceived to be risky by global investors. This can often lead to the rand depreciating in value.

A sharp depreciation in value can be painful. Imported goods and services become more expensive, making it more expensive for South Africans to purchase everyday items such as fuel, machinery, electronics and vehicles.

However, the rand depreciation also benefits some parties. Local exporters benefit from the rand weakness as it makes goods and services produced here cheaper for foreigners and more attractive when compared to other markets.

One of South Africa's largest sources of income is its tourism industry. When the rand is weak, South Africa becomes more appealing to tourists as a holiday destination as they can get more bang for their buck.

For every eight tourists that visit the country, it is estimated that one permanent job is created in South Africa.

So how should we go about working out a fair value for the rand? Currencies can deviate significantly from fair value over time.

Due to the relatively higher inflation environment in South Africa (particularly compared to most developed markets), we would expect the rand to depreciate against most developed currencies in the long-term.

The US Federal Reserve, which is responsible for setting monetary policy in America, targets an inflation level of 2 percent. The SA Reserve Bank, which is responsible for setting monetary policy in South Africa, targets an inflation level of 4.5 percent.

As a simple example, if the US manages to maintain inflation at 2 percent a year and South Africa maintains inflation at 5 percent a year, we can expect the rand to depreciate against the dollar by 3 percent a year over the long term.

These factors emphasise the need for investors to remain patient, stay the course and avoid making investment decisions in a panic.

As Nobel Prize winner Harry Markowitz said: “Diversification is the only free lunch in investing.”

Michael Kruger is an investment analyst at Morningstar Investment Management South Africa.


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