Mr Market goes all pessimistic on the Rand – but that’s no reason to justify his erratic behaviour

Vigorous, respectful debate is stimulating. And that's what we got in this interview with Investec Asset Management's Peter Kent who follows the party line on currencies – which is why desk jockeys in London and New York are apparently targeting Emerging Nations, including SA. It's not fair, I countered, but then again neither is life. The question any sane person needs ask, though, is why the double standards? Why is SA's faster growing economy and a lower Budget deficit insufficient to arrest the Rand's plunge against Sterling? Maybe we all need to realise that Mr Market is as imperfect in the currency field as he is in equities – and stop trying to justify erratic mood swings with mumbo jumbo. – AH  

GUGULETHU MFUPHI: Well, less than 24 hours away from the first MPC meeting this year, and according to Investec a rate hike, however unpleasant, might just be the saving grace for an economy in distress.  Joining us now for more is Peter Kent, portfolio manager at Investec Asset Management.  Peter, I understand that your view is that an interest rate hike is something that makes sense.  Perhaps you can tell us why.

PETER KENT:  Sure Gugu – thanks.  Ultimately, what we're presented with is a paradoxical economy at the moment.  On the one hand we have the very noticeable consumer struggling, the man on the street struggling – I think it's fair to say that we're all struggling a touch, which suggests that the economy is acting well below its potential.  However, if you look at the other side of the ledger, things like our fiscal account, if you look at what our government is spending versus what it's earning, if you look at our external account and our current account, as a country, we are importing more than we are exporting.  When you look at those two factors, it suggests that we are a country that's living beyond our means.  We're sort of spending more than we are earning.  As a result of that backdrop, our currency is being earmarked by the global markets as a fundamentally weak currency.  We've seen the currency depreciate solidly for the last couple of years, but I think the game changer is the last month or two as the rand has moved even further, and eventually  – now – has gotten above 11 to the dollar.  We just feel that it's time to act.  It's time to start dealing with this disequilibrium that we have in the economy.  The paradox of it all is that none of us feel that we're living beyond our means, but ultimately, because the country is acting well below its productive capacity…that's what reconciles the paradox.  We believe that it's time to take an active step.  It's time for the Reserve Bank to make an incredibly tough decision.  It's not a nice decision to be honest, but ultimately we need to address the fact that we are living beyond our means, and we think that the Central Bank should be pre-emptive.  The currency depreciation, more specifically in relation to the Central Bank's mandate…we all know that they try target inflation between three and six percent.  With the rand at current levels, inflation is forecast to breach the upper end of that target for an extended period, so that sort of brings their credibility under threat.  We are certainly of the belief that their credibility shouldn't be threatened, and as a result, a rate movement is required sooner rather than later.

ALEC HOGG:   The rand at eleven, as you say, to the dollar, 18 to the pound, and 15 against the euro.  Peter,  I think you're being very theoretical, and I think that often people are theoretical.  There are a bunch of desk jockeys in New York and London – as you and I both know – and they're just picking off emerging market currencies. They're having a look at who is the next one hit.  Unfortunately, it was first Argentina and then Turkey.  Any emerging market currency is fair game.

PETER KENT:  The last thing you want as a policy maker is to be held hostage by the markets.  I think five years of European crisis has shown exactly that.  For five years, European policy makers did half measures; the market questioned them, and then dictated terms to policy makers.  As a policy maker, the last thing you want is that scenario.  You therefore sit with a situation and you say 'do I potentially risk the market questioning me – the market prompting a bigger response down the line – or do I take that proactive step?'  I think a classical case in point is the Turkish Central Bank.  Last week Turkey was reluctant to raise rates.  They have a situation similar to ours – but different and perhaps more extreme – but it's not a bad example.  They raised rates in a theoretical manner, in a politically correct manner, and it was deemed a half measure by the market.  Turkish lira then depreciated significantly.  The Turkish Central Bank then spent a large portion of its reserves trying to defend the currency, and we sat with a situation yesterday where they announced an emergency meeting this evening at midnight.  They're doing it at midnight for maximum effect, to shock those desk jockeys into believing that they're getting ahead of their policy.  I agree with you.  I think becoming hostage to the market is the worst-case scenario and it's suboptimal.  However, I think a decisive move beforehand eliminates that risk.  There's no doubt that if the Central Bank doesn't hike tomorrow, there's no doubt that with a little bit of luck – if the rand comes back – in three months' time we could be avoiding this situation.  I don't want to be in a situation where I'm relying on luck to get policy back under control, if indeed the markets do question it – if they do not hike.

ALEC HOGG:   You have to ask 'where does the rand have to go to before people start believing that its properly valued?'  I was in Switzerland this week as we were discussing earlier and bottled water at Zurich station – not in a fancy restaurant – costs R65.00, so it cost me five times as much for bottled water as it does in South Africa etcetera.  The rand is already 12 against the Swiss, and 18 against the pound.  Does it have to go to 20 or is an interest rate of one percent going to help?

PETER KENT:  Well Alec that is Alpine water, so perhaps it should be a little bit more expensive, so to approach the question more seriously…market sell-offs, rallies etcetera; they don't halt because they are cheap or expensive markets.  As you've said, there are many desk jockeys pushing markets, so markets don't necessarily stop themselves because they're cheap.  The rand therefore, isn't necessarily going to stop selling off because it's cheap.  Valuation is never a means to stop a selloff.  It's a means to assess the investment case and indeed, the rand is excessively cheap and we've been reducing some of our exposure and our portfolios as a result.  What you need in a market like this, in a market that's questioning policy makers…you need an exogenous variable.  You need something that shocks the market that slaps it in the face, and says 'hey, you're actually ridiculously cheap.  You need to start investing in us right now'.  We think that a rate hike could be one of those exogenous variables.  It doesn't necessarily mean that if they do hike tomorrow, that the rand is going to rally strongly from that point.  We suspect that ultimately, what the market needs to see is it needs to elicit a behavioural response from not only the Central Bank, but from South Africa.  The market wants to see South Africa addressing its current account balance, and addressing its fiscal benefits.  One of the things that we mentioned in our piece:  perhaps a better policy is for the National Treasury to start cutting into their deficit.  They're running a deficit of four percent.  They've been dealt a very tough deck of cards over the last few years and they've been delaying their deficit reduction because growth hasn't been rising.  We therefore think that a better response is to eat into that deficit and then, that allows the Central Bank to be slightly more lenient on the monetary side.  If you think of the UK as an example, the UK did exactly that a few years ago.  They had a choice.  They could either keep on running the deficit, in which case the Central Bank – the Bank of England – would have to tighten monetary conditions, but they chose to tighten fiscal conditions.  People then stopped questioning their bond markets, they stopped questioning the value of guilds, and the Central Bank kept the taps flowing and they're doing quite well at the moment, so they took that little bit of medicine and as a result they're bearing fruits on that.

ALEC HOGG:   There seems to be one set of rules for emerging markets and another one for developing countries.  I see the British grew at 1.9 percent last year.  We should grow at around two percent.  That will make it, I think, 13 or 14 years in a row that South Africa has grown faster than the UK, yet the pound is stronger because the UK is now growing.  You talk about deficits.  Four percent is one of the lowest deficits in the world.  We're much lower than the United States, and much lower than the UK.  Why should we still cut that further?  Double standards, Peter, but I guess it doesn't help us to rail against it.  The reality is that these are the guys who make the rule because they have the deepest pockets.

PETER KENT:  I would question your 'double standards'.  I would ask Italy.  I would ask Spain.  I would ask Portugal.  I would ask all of those countries if they feel that there were double standards at the height of their crises.  They were all being lumped in developed markets.  There was a period where developed markets were seen as the ugly duckling of the investment world.  It's swings and roundabouts. Markets have the tendency to over-extrapolate those points and over simplify those points.  That's a personal bugbear of mine.  Ultimately, I think if you think about South Africa as a cricket match.  Ultimately, this country needs six runs and an over to achieve the target/chase down the target, so we need growth of six percent per year.  We're currently running at two percent, so if we try to reconcile that gap we say two percent of that gap is probably because we're being very unproductive.  The National Development Plan is drawn up to address that unproductivity.  Ultimately, there's two percent of growth out there on the back of an envelope, which we could attain if we managed to sort out some of our longer term structural problems.  That leaves us with a two percent gap.  That other two percent gap is definitely cyclical, so if the global economy recovers…if we get animal spirits back in this country, you could see growth go to four percent.  However, that still doesn't address the two percent underperformance this country will achieve because it's not behaving productively.  Hopefully the National Development Plan will address this, but that's a long tale solution, and when the rand is under pressure as it is, a long tale solution just doesn't seem to be enough.