According to Businesstech amid the market jitters over trade wars and the selling pressure on emerging market assets, the rand took a further beating last week – almost touching R14 to the US dollar.
However, the fact that it has now weakened 15% against the dollar since president Cyril Ramaphosa was sworn in is clearly not because his attempts at stabilising government and the economy are failing, said Dave Mohr, chief investment strategist at Old Mutual.
Instead, Mohr believes that it is simply too early to tell how Ramaphosa has impacted the economy, and the rand’s drop can rather be seen as a reflection of global conditions.
So why are the rand and South African markets in general so exposed to global market developments?
Mohr explained the three biggest reasons below:
1. Integration in global markets
The first major factor is that emerging markets are increasingly integrated into global markets, said Mohr.
“As Financial Times commentator John Authers put it last week, emerging markets have developed and consolidated in many important ways since the wave of crises in the 1990s, and the disaster of 2008, but one fact remains. A large proportion of their shares and bonds, and particularly of the free float of shares, remains in the hands of foreign investors.
“That makes them geared to changing emotions within the developed world,” he said.
Mohr added that when these investors are nervous, they tend to reduce exposure to relatively risky emerging markets.
“South Africa with its resource dependence has always been sensitive to the global cycle, but our broader economy has increasingly integrated with the world economy since the end of isolation in the early 1990s,” he said.
2. South Africa’s bond and equity markets
The second reason for the drop is due to the fact that South Africa’s bond and equity markets specifically have integrated into global markets, said Mohr.
“They are deep and liquid and foreigners face no restrictions buying and selling (unlike locals, who are restricted by capital controls and prudential regulation),” he said.
“Relative to the size of the economy, our bond and equity markets are larger than our peers.
“The rand is also one of the most freely traded currencies in the world. According to the Bank for International Settlements’ Triennial Survey, the rand was number 20 in terms of world forex market turnover, ahead of larger economies such as Poland, Taiwan and Indonesia.
“Being one of the more liquid currencies, the rand tends to be in the front of the queue when global investors sell out of emerging markets,” he said.
3. Current account deficit surprisingly large
The third major reason is that South Africa needs foreign capital flows as it runs a large current account deficit, said Mohr.
“Again relative to the size our economy, our current account deficit is large compared to other emerging markets,” he said.
“New data from the SA Reserve Bank showed that the current account deficit had widened by more than expected in the first quarter, increasing from 2.9% to 4.8% of GDP.”
He added that this was largely due to the trade balance switching from surplus to deficit as the value of exports fell more than that of imports.
“The former was due both to lower export volumes and the stronger rand in the first quarter,” he said.
“The deficit on the services, income and transfer account remains the largest driver of the current account, with the trade balance being quite volatile from quarter to quarter. It was slightly smaller than in the first quarter, as dividend inflows from abroad exceeded dividend outflows during the quarter, but remains very sticky around 4.3% of GDP.”
According to Mohr, the current account balance is still the broadest measures of a country’s economic engagement with the rest of the world.
It tracks the net flows of imports and exports (the trade balance), the net flows of services payments, (such as cross border insurance) and tourism spending. It also tracks the net income flows (dividend and interest payments) of bonds and equities owned by foreigners in South Africa and by locals abroad.
“The other way to think about the current account deficit is that it reflects the shortfall of savings relative to investments,” he said.
“South Africans don’t generate enough savings across the household, business and government sectors to fund investment in the economy, so we need to ‘import’ savings. This happens mostly in the form of foreigners buying our bonds and equities, which as we’ve seen, they can sell in a hurry.”
Source: Business Tech
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