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CAPE TOWN — While emerging markets take a short-term hiding against the mighty dollar, the rand may well continue struggling as the Ramaphoria rainbow reminds the world of darker clouds amid the sunshine. Those darker clouds, according to Dr Azar Jammine, Chief Economist of Econometrix, are formed by the realisation that supporters of former President Zuma are preventing him from taking the corrective action needed to improve the growth rate of the SA economy. They’re still there in significant numbers at the heart of government. On the upside, Jammine says, the rand’s continued depreciation should not be enormous. Perhaps our upcoming elections will prove a blessing in disguise, waking people up to the grim reality of our dismal Gini-Coefficient and what’s needed to break its stranglehold on the economy. – Chris Bateman
By Azar Jammine*
Substantial sell-off in Emerging Market currencies over the past month
For a long while now we have been warning against the likelihood that the Rand would retrace some of the enormous gains that it made late last year and early this year following the improvement in business confidence in the wake of the election of Cyril Ramaphosa as president of the ANC and of the country. We have been arguing in a manner which has since been supported by statements by Reserve Bank Governor Lesetja Kganyago, to the effect that the appreciation seen in the Rand, which had taken it to levels between R11.50 and R11.70 to the Dollar, had been overdone and the currency was somewhere between 5% and 10% above its average value over the past three decades on a trade weighted basis.
We have been wary of the maintenance of high levels of risk appetite for emerging markets which had helped to drive the Rand upwards and we have also been aware of major constraints on the ability of the government under Ramaphosa’s leadership to increase the country’s growth rate materially on a sustained basis. In the event, the currency has lost around 4% to 6% of its value on a trade weighted basis over the past month. One might be tempted to suggest that this has been attributable to growing political unrest and signs of factionalism within the ANC.
However, closer analysis suggests that the Rand has not been alone amongst emerging markets in losing ground to the Dollar. Although the currency has depreciated by just over 5% since the beginning of April vis-a-vis the Dollar, similar losses have been made by the Brazilian Real and Mexican Peso, whilst the Turkish Lira has lost 6%, and the Argentinian Peso and Russian Ruble around 8%. In other words, the main driver of the Rand’s losses has been the strengthening of the Dollar. The latter has risen to its best levels this year on expectations that US interest rates would rise faster than had been expected because of the relative strength of the US economy in relation to economies such as those of Europe and Japan which are starting to falter.
This is bringing about the expectation of a substantial interest rate differential between the US and those countries in the future, which makes it more attractive to hold Dollars than other currencies.
However, slow wage growth and low unemployment caused short-term hiccup in Dollar on Friday
However, it was also noticeable that the Rand recovered slightly, by around 1% to 1.5% on trade weighted terms on Friday, following publication of US employment data. Superficially, the figures suggested that US growth remains strong and this could have been interpreted as implying that the upward path of interest rates which has been predicted in recent times, will indeed come to pass. The unemployment rate in fact fell to its lowest level in two decades, at 3.9% in April, down from 4.1% in March.
In addition, employment outside of agriculture grew by 164,000 jobs in April. However, this was slightly less than the 190,000 to 200,000 increase expected and was below the 200,000 per month average recorded over the past year. This could have been interpreted to imply that the pace of growth in the US economy might reach have also started slackening. Even so, this was not the main reason why the Dollar fell and the Rand rose. Instead, it was the fact that wage growth for April remained tepid despite the falling rate of unemployment.
Wage growth for April came in at 2.6%, which was the same level as the wage growth recorded in the previous month, which figure was itself downgraded from 2.7%. The big fear of inflation to be caused by falling unemployment and upward pressure on wages, which is the reason why markets have been expecting an acceleration in the pace of interest rate increases in the US, did not materialise. As a consequence, the Dollar fell and financial markets and emerging market currencies improved on the back of this new information.
Emerging market currencies were also buoyed by the news that the Argentinian central bank had increased interest rates for the third time in just over a week to no less than 40% in order to prevent the Peso from depreciating further. A decision by the Argentinian government to reduce its primary budget deficit (i.e. the deficit between expenditure excluding interest payments and tax revenue) from -3.2% to -2.7% of GDP, also exuded a message of improving fiscal discipline in an important emerging market, helping all emerging market currencies in the process.
Even so, dangerous to suggest that the worst is over for Emerging Markets
Despite the US employment news being greeted by a dip in the Dollar and a rally in emerging market currencies, one should not however necessarily believe that all the bad news for emerging markets, is necessarily out of the way. Continuing tensions regarding the potential for retaliatory import tariffs to be imposed on the US by countries such as China in response to the Trump administration’s imposition of import tariffs on imports into the US from such countries, pose a threat to the sustenance of the global economic upswing.
Secondly, one should not underestimate the extent to which a reversal of the flood of liquidity poured into the global financial markets by the US over the past decade, might deprive emerging markets from the risk appetite which has been assisting them over the past six months. Many of these emerging markets are still beset with significant debt problems.
Is Ramaphoria about to fade?
In South Africa’s case, the issues which stand to continue weighing down on the Rand are different. Whilst international financial developments have dominated the movements in the South African currency over the past month, one is increasingly concerned at the possible reversal of favourable political sentiment towards the country. It is becoming ever more apparent that the supporters of former President Zuma, who were associated with large-scale state capture and corruption which the business community perceived to be at the core of the country’s economic decline over the past decade, are still resisting the attempts by President Ramaphosa to rectify the structural impediments to economic growth.
Protests in the North West and KwaZulu Natal regarding the provincial leadership in those provinces is highlighting the persistence of a high level of factionalism within the ANC. In this regard it should not be forgotten that Ramaphosa won the presidential election within the ANC by a very narrow margin of less than 5%. One had been hoping that, following the outcome of the presidential election, the losing faction might turn to supporting Ramaphosa in order not to lose certain benefits derived from being close to presidential acquiescence. Unfortunately, this perception is increasingly being called into question.
In addition, where there had been hopes of rapid changes to the governance and management of state-owned enterprises to ensure an improvement in performance by such organisations, it is becoming increasingly apparent that the tentacles of corruption that penetrated such organisations are so deep that it is going to take several years to root them out. In turn, should the so-called “Ramaphoria” which has engulfed the business community since the beginning of the year begin to fade, some of the support for the Rand is likewise set to dissipate. For some time now, we have been arguing that this is an important reason why we believe the South African currency would lose some of its lustre and in the year closer to R13 than below R12 to the Dollar as many pundits had been forecasting. Indeed, one of the reasons why we did not anticipate the Rand appreciating quite to the extent that it did in the wake of Ramaphosa’s election as president, was precisely because we foresaw many of the constraints on his ability to rectify the country’s economic weaknesses, including the persistence of factionalism within the ruling party.
At the same time, the Dollar need not keep appreciating
In the event that risk aversion towards emerging markets continues deteriorating and Ramaphoria does start fading, the question arises how far the Rand might depreciate. One must bear in mind that the currency’s recent depreciation has already succeeded in taking the Rand back down to “fair value” as opposed to overvaluation. In other words, some of the adjustment that one might have called for in expectation of a diminution in business confidence has already taken place. Secondly, one needs to bear in mind that the US is currently running a massive trade and current account deficit. Its current account deficit is – $466bn, or -2.7% of GDP.
Indeed, the existence of such a deficit is what is encouraging the US authorities to embark upon protectionist moves against the likes of China. One should also not overlook the surge in the US budget deficit and public debt in the wake of the $1.5 trillion worth of tax cuts planned by the Trump administration. These factors render it questionable as to whether the Dollar will itself retain its recent strength. Whilst some commentators are looking for the greenback to return to about $1.15 to the Euro, this is far from guaranteed given the economic headwinds which might be facing the US. In conclusion, whilst we believe the Rand will depreciate over the rest of the year, one should be careful not to exaggerate the extent to which the South African currency might lose further ground. A year end figure around R13 still seems reasonable.
- Dr Azar Jammine is the chief economist at Econometrix.
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