- The rand hit its best level since Thursday in February.
- This is in large part thanks to a weak dollar crisis, as traders digest the impact of a Biden administration on the US currency.
- In addition, new confidence that the pandemic may soon be under control has increased appetite for emerging market currencies.
- For more articles, visit www.BusinessInsider.co.za.
On Thursday morning, the rand traded at around R15.11 – its best level since February 26, exactly nine months ago. It was also stronger against the euro (R18.02) and the pound (R20.23).
The currency has come under massive pressure in recent months, hitting R19.26 in the first week of April – shortly after South Africa entered a hard lockdown, and rating agency Moody’s demoted the country to “junk”.
Dollar / rand exchange rate. Source: XE
Last week, Moody’s and Fitch shredded SA again, voicing concern over soaring public debt, with little confidence that the state will not keep its promises to cut civil service wage spending. .
So why is the rand rallying?
Markets believe that the government of US President-elect Joe Biden will be less reluctant than Republicans to inject billions of dollars in stimulus into the US economy. This means more US government debt, which is negative for the dollar in the long run.
Biden is also expected to stop the US trade war with China and others. This will mean more imports into the United States, which could also weigh on the dollar. US importers will have to sell dollars to pay for the goods in another currency.
The dollar – a safe haven investment in times of turmoil – could also weaken if the United States gets a less erratic leader. US President Donald Trump has introduced a significant element of uncertainty to the markets over the past four years with his shock statements, particularly on trade and international relations.
High interest rates in South Africa
Traders are drawn to currencies that generate higher interest rates, and even though rates have been brought down to their lowest level in half a century in South Africa, the benchmark rate of 3.5% is still much better than what is offered by most of the other major currencies. . Many countries now have negative interest rates below zero percent.
And interest rates are not expected to drop anytime soon in South Africa – this week, news consumer inflation figures hit a seven-month high, which may deter the Reserve Bank from easing its monetary policy.
A greater appetite for emerging market currencies
For many months, investors have been concerned about the coronavirus pandemic and its impact on the global economy. They have been very risk averse – choosing to buy “safe” investments like gold, US bonds and the dollar. But recent good news regarding Covid-19 vaccines has boosted confidence that the worst of the crisis may be over. Their appetite for risk has increased and emerging market currencies are back on the menu.
South Africa’s current account is better than in years
If more money goes out of a country than inward, it is bad for its currency.
Flows out of a country are measured by the current account, and as South Africa imports most of its oil and pays huge amounts of interest and dividends to foreigners outside the country, the country has maintained a large current account deficit (as much as 6% of GDP) for many years.
But this year the current account deficit will be closer to 0%, Mike Keenan, head of fixed income and currency research at Absa, said in a recent podcast. “It’s very positive.”
The price of oil has fallen during the pandemic, and foreign investment in South Africa’s bonds and stocks has declined in recent years – meaning fewer interest rate and dividend payments abroad.
In addition, South Africa has experienced record harvests and its agricultural exports have been strong. And due to the depressed local economy, imports of machinery and other expensive goods have been low. So where we typically import more than we export – this changed in 2020:
Exports in gray, imports in blue and trade balance in yellow. Source: SARS
There is virtually no current account deficit in emerging countries at present. The recession wiped them out. Under the hood, positive sales reflect an increase in net savings in the private sector offset by large budget deficits (the public sector thus closing the domestic demand gap). pic.twitter.com/MgnwNMJuYj
– Sergi Lanau (@SergiLanauIIF) November 25, 2020
The rand is one of the most undervalued currencies in the world
The most recent The Economist’s Big Mac Index, released in July, showed that the rand is 67% cheaper than it theoretically should be against the dollar – the worst undervaluation of any measured currency.
The Big Mac Index is based on the theory of purchasing power parity. In the long run, in theory, exchange rates should adjust so that an identical product – the McDonald’s burger – must cost the same in all countries.
READ | The rand is now the most undervalued currency in the world – here’s where it should be
While the vast majority of currencies were also undervalued against the dollar – Brazil by 32%, Argentina (-39%), India (-56%) and Turkey (-64%) – none did beat the rand. The rand was even weaker than the Russian ruble (-66.5%)
Just ten years ago, the rand was “only” 39% undervalued against the dollar, according to the Big Mac Index.
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