The roiling rand and its consequences
The rand has not been doing well of late. According to Nedbank Capital, looking back over the month ended mid-October, ?The rand depreciated 4.9% against the trade-weighted (currency) basket, dropping 5.6% against the US dollar, 4.5% against the euro, 4.6% against the British pound and 5% against the Japanese yen. Against peer commodity and emerging market currencies the rand also depreciated.?
In other words, the rand has recently experienced a steady decline against virtually every other currency out there.
The reasons for this are pretty obvious ? the country?s debt has been downgraded by both Moody?s and Standard and Poor?s, strike action has savaged several industries leading to losses in production and potentially major increases in labour unit costs, and South Africa?s current account deficit has expanded faster than a balloon at a children?s party.
There?s also reason to believe that the rand may resume its weakening, or at the very least stay at its current relatively weak levels. The unrest in the mining industry has hurt production, which means that South Africa?s exports are likely to be lower in the months ahead, since minerals and metals account for a giant chunk of exports. This suggests that the current account deficit will continue to expand, keeping up the pressure on the currency.
In addition, it?s possible that the country will face further debt downgrades. As RMB?s Global Markets division notes, ?Standard and Poor?s (S&P) downgraded South Africa?s sovereign rating from BBB+ to BBB. S&P?s rating is now one notch lower than the other major rating agen- cies (Fitch and Moody?s) and we shouldn?t be surprised to see either of them move with actions that bring their ratings in line with S&P over the next few months.
?(What?s more), given that S&P?s growth forecasts of 2.5% for 2012 and 3.0% for 2013 are more optimistic than (RMB?s) projections and that consensus is shifting towards our bearish view, we think another downgrade by S&P will follow during the next 18 months. Our ratings model suggests that South Africa should be on BBB rather than BBB+ and based on our expectations for growth, exports and the current account deficit, a further downgrade is very likely.?
Downgrade fallout
Another downgrade would make foreign investors more reluctant to put money into South Africa, which would further unbalance the current account, which is highly reliant on foreign investment flows. The only escape valve, in that scenario, would be more rand weakening. Politically, the country is also facing grave difficulties, as The Economist discussed in its mostrecent cover story.
Balancing out these negative risks are several factors, including the fact that the global picture has improved a little, with Europe heading in a more stable direction, the Federal Reserve opening the taps on almost- perpetual stimulus, and job growth resuming in the United States, and that there is hope that South Africa can resolve its labour troubles and return to business as usual. However, even under the rosiest scenario, it?s unlikely that the rand is going to strengthen much beyond the 8.50 to the dollar level, and almost all the risk is on the downside.
So what does this mean for investors? Well, basically, it puts them in a pickle. Economic growth in South Africa is already pretty tepid, and most projections anticipate it remaining weak for the foreseeable future. Again, things like labour unrest create downside risks to growth, and so it?s likely that domestic assets are not going to provide stellar returns in the medium- term.
Under these circumstances, one might be inclined to look offshore for opportunities. But because South Africa has elected to have a free floating currency (which enables the country to set its own monetary policy and allow almost-free capital movement), investing offshore is a risky proposition due to the danger of rand devaluation, as anyone who had money off-shore in late 2002 will recall. And, to make matters worse, the usual rand hedges that an investor could turn to ? notably resources stocks ? are the very companies being affected by labour unrest and production disruption.
Where does that leave you? Well, when uncertainty beckons around every corner, the best strategy is generally diversification and conservation: hedge against inflation by holding equities, hedge against domestic weakness by investing a proportion of your assets off-shore, and hedge against capital loss by keeping some money in instruments like inflation- linked retail bonds.
Consult with a financial advisor you trust to make sure your portfolio is balanced, and try to take some consolation in the fact that investors around the world are facing the same uncertainties and anxieties as you are.
Felicity Duncan for moneyweb.co.za
In other words, the rand has recently experienced a steady decline against virtually every other currency out there.
The reasons for this are pretty obvious ? the country?s debt has been downgraded by both Moody?s and Standard and Poor?s, strike action has savaged several industries leading to losses in production and potentially major increases in labour unit costs, and South Africa?s current account deficit has expanded faster than a balloon at a children?s party.
There?s also reason to believe that the rand may resume its weakening, or at the very least stay at its current relatively weak levels. The unrest in the mining industry has hurt production, which means that South Africa?s exports are likely to be lower in the months ahead, since minerals and metals account for a giant chunk of exports. This suggests that the current account deficit will continue to expand, keeping up the pressure on the currency.
In addition, it?s possible that the country will face further debt downgrades. As RMB?s Global Markets division notes, ?Standard and Poor?s (S&P) downgraded South Africa?s sovereign rating from BBB+ to BBB. S&P?s rating is now one notch lower than the other major rating agen- cies (Fitch and Moody?s) and we shouldn?t be surprised to see either of them move with actions that bring their ratings in line with S&P over the next few months.
?(What?s more), given that S&P?s growth forecasts of 2.5% for 2012 and 3.0% for 2013 are more optimistic than (RMB?s) projections and that consensus is shifting towards our bearish view, we think another downgrade by S&P will follow during the next 18 months. Our ratings model suggests that South Africa should be on BBB rather than BBB+ and based on our expectations for growth, exports and the current account deficit, a further downgrade is very likely.?
Downgrade fallout
Another downgrade would make foreign investors more reluctant to put money into South Africa, which would further unbalance the current account, which is highly reliant on foreign investment flows. The only escape valve, in that scenario, would be more rand weakening. Politically, the country is also facing grave difficulties, as The Economist discussed in its mostrecent cover story.
Balancing out these negative risks are several factors, including the fact that the global picture has improved a little, with Europe heading in a more stable direction, the Federal Reserve opening the taps on almost- perpetual stimulus, and job growth resuming in the United States, and that there is hope that South Africa can resolve its labour troubles and return to business as usual. However, even under the rosiest scenario, it?s unlikely that the rand is going to strengthen much beyond the 8.50 to the dollar level, and almost all the risk is on the downside.
So what does this mean for investors? Well, basically, it puts them in a pickle. Economic growth in South Africa is already pretty tepid, and most projections anticipate it remaining weak for the foreseeable future. Again, things like labour unrest create downside risks to growth, and so it?s likely that domestic assets are not going to provide stellar returns in the medium- term.
Under these circumstances, one might be inclined to look offshore for opportunities. But because South Africa has elected to have a free floating currency (which enables the country to set its own monetary policy and allow almost-free capital movement), investing offshore is a risky proposition due to the danger of rand devaluation, as anyone who had money off-shore in late 2002 will recall. And, to make matters worse, the usual rand hedges that an investor could turn to ? notably resources stocks ? are the very companies being affected by labour unrest and production disruption.
Where does that leave you? Well, when uncertainty beckons around every corner, the best strategy is generally diversification and conservation: hedge against inflation by holding equities, hedge against domestic weakness by investing a proportion of your assets off-shore, and hedge against capital loss by keeping some money in instruments like inflation- linked retail bonds.
Consult with a financial advisor you trust to make sure your portfolio is balanced, and try to take some consolation in the fact that investors around the world are facing the same uncertainties and anxieties as you are.
Felicity Duncan for moneyweb.co.za
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