In this my first financial article of many to come I would like to just touch on the subject of the rand and its apparent volatility as seen by many especially in recent times. I will try not delving into too much detail in terms of statistics and numbers; I am sure all that is readily available even on this website for our more numbers-orientated readers.

The first thing that springs into mind is the most obvious factor that is impacting on everyone at the moment whether personally or those close to you. That is the credit crisis. If you had not heard about that as yet, you should remove those blinkers, as it has hit home recently here in South African when the official statistics showed that SA is in its first recession in 17 years.

The credit crisis has stemmed in it a crucial ingredient called fear! People all over the world have been pulling their money from economies and institutions that they perceive to be risky following the spate of bank failures in the US linked to the subprime crisis in that country that spread like a wild fire to other European nations. Unfortunately for us, this means being in the third world country this has indirectly impacted on us also. Investors, in such trying times will move their money from risky assets and economies, and put them into perceived safe ones. What are the safe options these investors would consider?

Well treasury instruments especially the US bills and cash would be the first point of shelter in terms of protecting your capital. Therefore SA loses out on the foreign direct investments as money is taken out of the economy by investors dumping Rand shares and instruments for US treasury bills and US Dollar denominated cash deposits. With such a massive outflow one can only imagine the depreciating impact it has on the Rand.

The Rand can be seen to be a somewhat floating currency dependant to a certain degree on the free market forces making the currency even more susceptible to fluctuations especially when significant global events occur. The other risk here is the exposure to currency speculators who have many ways of gaining from a volatile currency in the same manner equity investors gain from volatile stocks. Although there are some limitations to speculative activities due to some of the exchange controls that are in place in SA, unscrupulous dealers can always find a way to circumvent these (such as use of derivative instruments).

The potential for political unrest or uncertainty definitely is something that foreign investors keep an eye on. Lets face it, a lot of investors were sceptical of Jacob Zuma’s corruption case outcome and as well as the outcome of the elections. Fear of uncertainty or drastic changes, may cause foreign investors to pull their money out of the SA economy and with it causing the depreciation of the Rand. A good example is when someone who is influential such as Trevor Manuel resigned last year, albeit for a day or two, the markets and the Rand had a mini-crash upon hearing such news. This is not just a local event, as the same would have happened when the influential and long-term serving FED’s Alan Greenspan retirement was announced in the US.

Inflation statistics actually affect the Rand as well because of purchasing power parity theorem, which shows that higher than expected inflation would cause a devaluation of a currency. This “Triple P” occurs in order to eliminate the problem of arbitrage. SA inflation has been problematic especially due to prices of food and wages which have proven to be sticky downwards. The problem with inflation is that as prices increase in rand terms, they may not be increasing at the same rate as in US dollar terms. Therefore this is what results in one currency, the rand, depreciating faster than the other (the US dollar). If this market correction did not happen, then arbitrage opportunities would exist and would be exploited until the problem has corrected itself, i.e. the Rand has depreciated.

The rand quite recently has been strengthening and this is mainly attributable to the improving global sentiments. Investors are becoming more confident that the steps taken by the US and European countries to stem the global financial rot is working. This bodes well for us in third world countries since confident investors, means more risk appetite and these investors start to move their capital back into SA stocks and other third world economies, causing currencies such as the Rand to strengthen. The general trend seen at present is the US stocks recovering now and this feeds into the SA markets and the Rand. It also helps that the South African big four banks have survived well through these trying times without any need for bailouts. This once again sends positive signals to the foreign investors that South Africa does not have the same financial rot as the western countries, and brings in confidence for investments propping up the Rand.

However, trying to guess what the Rand does next is something that I doubt anyone can do precisely. The best approach in my view is considering the factors that mainly affect this currency and trying to forecast how these factors will play out in the future to reach a conclusion where the Rand will be in the upcoming months or years. But the only problem is that some of these factors are unpredictable, therefore your guess is as good as mine! Have a good day.

Maki

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