Talk of R60 per dollar depreciation is ridiculous

It is unfounded to think that SA’s current economic challenges are so unprecedented that R60 to the dollar is probable in the near future, writes Pierre Heistein.

Last week a leading South African economist was reported saying that the rand could depreciate to R60 per dollar in the next two and a half years. This is ridiculous.

To be fair, it is possible that the value of the currency could plummet to these levels. As it is possible that Trevor Manuel could be our next president or that the US election could trigger the end of the dollar as a global trade currency.

But headlines that feed off sensationalist claims to drive click-bait shares – all guarded by the word “could” – need to be backed by fundamentals of the probable, not the possible. Anything is possible.

In order to evaluate predictions of what would be a 300 percent depreciation of the rand before 2019, we need to look at both economic principle and precedent.

The values of currencies change based on actual money flows, while political events or public sentiment have no effect unless they impact the amount of currency moving across our borders. To create a rand depreciation of this magnitude, the purchases of rand would have to plummet. Will they? No.

As much as our current political leadership is fraught with drama, governance is weakening and growth is slow, the South African economy is still very active.

Our financial markets remain among the best in the world and foreigners continue to flock in to enjoy our advanced tourist industry. Our monthly trade balance oscillates between deficit and surplus meaning that, as yet, there is no exodus of foreign currency due to trade.

Attractive

All of these factors may weaken in the next few years, but there is no reason for them to suddenly collapse.

The economy is also equipped with in-built braking mechanisms that make it hard for currencies to fall off the cliff. As the rand weakens against the dollar, South African goods and assets become more attractive to foreign buyers. Property in the Cape Winelands, for example, becomes cheaper in dollar terms and foreign investors bring money into the country, buy more rand and slow its depreciation.

The largest impact on the rand’s value will be South Africa’s expected credit downgrade, but it is important to understand that a credit downgrade is not apocalyptic. It simply means that South Africa’s financial assets are riskier to invest in and are less attractive to fund managers. Prices will adjust and the market will continue to trade at lower demand for South African bonds and other debt denominated assets.

A downgrade to junk status is significant in the sense that certain international funds will be forced to withdraw from South Africa. But while certain funds will pull out their money if the downgrade is announced, many have built a downgrade into their portfolios and the value of the rand already captures this. The scope for further depreciation is limited.

Inflation

There are many examples of economies around the world that operate healthy and active financial markets despite not having investment grade ratings.

Trade and investment flows can therefore be ruled out as instigators of a collapse in the value of the rand.

The only other factor that could cause such a rapid loss of value relative to the dollar is inflation. If prices escalate then the value of the rand relative to what it can buy decreases, and currency exchange rates need to adapt to reflect this.

But holding all else constant, for the rand to depreciate by 300 percent in two and half years, annual inflation would have to exceed 60 percent. This extreme inflation is only possible if the Reserve Bank decides to print money. Despite Zuma’s meddling, the SA Reserve Bank still retains enough independence to not dabble in such madness.

In its 55-year history – through all the turmoil that it has stood by – the most the South African rand has depreciated in a 36 month period is 108 percent and when it did, this was driven by an international market crisis.

It is unfounded to think that our current economic challenges are so unprecedented and our economy so fragile that R60 to the dollar is probable in the near future.

* Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on LinkedIn /in/pierreheistein.

** The views expressed here do not necessarily reflect those of Independent Media.

BUSINESS REPORT