The world is changing fast and to keep up you need local knowledge with global context.
South Africans are well aware of how Nenegate smashed the country’s financial reputation and the Rand, by our calculations costing the nation at least R500bn. But it has been a moot point exactly how much of the currency’s weakness was caused by President Jacob Zuma’s incompetence and how much was going to happen anyway because of global factors. RMB’s currency strategist John Cairns (right) quantified the impact in an excellent research paper the bank circulated to clients and kept for internal consumption (I asked really nicely and they agreed to let us republish it). A friend who pointed me towards this superb research described the Rand’s weakness thus: “It’s like SA is losing a soccer match 10-0 with the opposition scoring six and the other four being own goals by our own players.” That said, there is an upside. Everything else being equal, the Rand has the potential to rise 40% if Team South Africa simply stops putting the ball into its own net. Who knows what could happen if we managed to score a goal or two? India is an example of what can happen. A year ago, the country’s credit was rated, like SA’s is now, on the cusp of becoming junk, with a “negative” outlook. With the socialists finally dispatched after 60 years of misrule, India’s new market-driven economic reforms have not only unleashed massive human potential within the nation. They have had the concrete result of its ratings outlook improve first to “neutral” and more recently to “positive” and the spectre of junk now just a bad memory. Which shows that taking the right economic decisions can have a strongly positive impact in a short period. – Alec Hogg
By John Cairns*
We estimate that SA-specific factors account for approximately 41% – or R3.45 – of the rand weakness against the US dollar since 2011. The remaining weakness comes almost equally from dollar gains and “risk and commodity price” effects. These effects are summarised in Figure 1.
Rand weakness is illustrated in Figure 2.
Decomposing the weakness in this manner helps us ask the right questions in thinking through the rand outlook. Will the dollar keep gaining? Is the commodity bear cycle over? Will SA specifics keep worsening? Moreover, it highlights how important global factors are in the rand outlook, having accounted for 59% of the weakness in this cycle. By implication, we should be careful in forecasting that the rand will weaken just because local issues are negative.
Weakness Over Time
Figure 3 shows the components of rand weakness since USD/ZAR reached its lowest point in July 2011.
The dollar effect is simply derived from the Dollar Index. As can be seen in Figure 4, the dollar gained around 30% over the period, with most of the strength coming in 2014 and early 2015.
The “risk and commodity price” effect is derived from the performance of the currencies of Australia, New Zealand, Turkey, Hungary, Brazil and Mexico. These currencies trade with very high correlations with each other and with the rand. This is illustrated in Figure 5. The fact that all these currencies, including the rand, have all weakened together shows there is a common global driver — i.e. the commodity cycle and risk appetite for high-yielding/commodity plays. Adjustments were made for dollar and inflation effects to avoid double counting. This “risk and commodity price” effect accounts for around 30% of the rand’s weakness since 2011.
South African-specific factors are those that are not accounted for by the two effects above, i.e. it is the residual rand movement.
Figure 6 shows the SA specifics time series. We have taken this further back than 2011 for interest sake.
When shown like this, the impact of big local political and economic events of the last decade on the rand is clear. This is not as obvious as it sounds. When we look at just USD/ZAR in aggregate, local effects are generally hard to identify as global effects swamp the local news.
SA specifics, as noted, have added around 41% to USD/ZAR since July 2011 — that equates to R3.45. This is quite significant. Note, however, that this has not been a straight line: one can clearly see that SA specifics were priced as improving in 2014 and most of 2015. SA specifics started weakening before the finance minister changes began, and have continued since.
Figure 4 shows that SA specifics extracted from the rand have correlated very well with the implied credit rating in SA offshore credit pricing. If anything, the rand has actually discounted more negatives than the credit market.
Mostly Global Economy
Decomposing the rand as we have does not tell us anything about the future. But it does help us understand what to focus on. Analysing the data all the way back to 2000 suggests around 42% of rand moves are driven by local factors, with the dollar accounting for 31%, and “risk and commodity price” effects 27% (these figures are in line with the number that we highlighted above for the period from 2011 to now). Roughly then, when thinking about the rand, we should spend our time 60/40 between global and local factors.
- John Cairns is the currency market strategist at RMB
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Listen to the story of Cyril Ramaphosa's rise to presidential power, narrated by our very own Alec Hogg.