Painful economic readjustment may lie ahead

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‘At some point, global interest rates will return to more normal levels, reducing the attraction of our higher rates’

FOR most of the past decade, South African manufacturers have fretted about the perceived strength of the rand exchange rate. A strong exchange rate reduces the competitiveness of exports because it increases the cost in foreign currency of South African goods. Strong exchange rates also mean cheaper imports. Our consumers then find foreign goods more attractive, reducing local jobs in sectors such as clothing.

The period of excessive rand strength ended in about the middle of 2011. The rand exchange rate then was R6.75 to the dollar. It is now R8.90 and recently traded above R9.00. This substantial weakening has brought some relief to exporters and local producers who compete against imported goods, although the benefits are yet to translate into increased output or employment.

A weaker exchange rate also has negative consequences. It increases the rand price of vital imports such as oil, which immediately results in higher petrol prices. The price of imported capital equipment also rises. This will, for example, have a knock-on effect and raise the cost of government’s proposed R2 trillion infrastructure programme, which depends on many imported components.

There are other reasons we should be concerned by the fall in the value of the rand since 2011. Usually, the rand weakens or strengthens because of changes in global commodity prices, which affects the value of our exports, as gold and platinum are such major elements. Or it changes because of shifts in global sentiment towards emerging markets. Changes in the rand exchange rate usually do not occur in isolation.

Present rand weakness cannot, however, be blamed on adverse global forces. This time the rand has weakened when the currencies of most other emerging market countries have remained strong. The Economist noted recently that foreign investment in emerging markets has increased considerably since the eurozone financial crisis was at its peak in mid-2011. Yet, the article notes, the rand weakened even as investor confidence improved.

The rand, it concludes, can no longer be considered the “reliable gauge of global risk appetite” that it was in the past. It is trading at present, the Economist suggests, “as if investors were still terrified”.

Rand weakness also cannot be blamed on weaker commodity prices. The Financial Times notes that the currencies of commodity-producing countries such as Chile, Colombia and Peru have all strengthened in the past year and are now stronger in real terms than their average over the past decade. Policy makers in these countries, it says, are now increasingly worried about excessive exchange-rate strength.

SA must look to domestic factors, then, to explain rand weakness. These include a rising deficit on the current account of the balance of payments. To fund bigger deficits, SA needs growing inflows of foreign investment. But our ability to attract bigger inflows has been hampered by low domestic economic growth as well as concerns about the security of investments.

Recent talk of nationalising mines, violent strikes and the disruption in South Africa’s principal exports has alarmed investors. The downgrading of SA’s global credit ratings reflected similar concerns.

Improved global confidence has not benefited SA. Instead, we are battling to attract sufficient foreign exchange to fund our current account deficit. The rand exchange rate weakened as a consequence.

SA’s current account deficit is unlikely to improve markedly in the short term, so our need for foreign capital inflows will remain substantial. Fortunately, we will be helped in this by very low global interest rates. Subdued growth in the developed world means central banks are unlikely to raise interest rates any time soon. South African interest rates, while low by our historical standards, are therefore relatively attractive to foreigners.

But at some point, global interest rates will return to more normal levels, reducing the attraction of our higher rates. It is vital that, by that time, we are able to compensate for a decline in foreign inflows through a sustained rise in exports and domestic savings. We must also have re-established ourselves as a more attractive investment destination for foreigners, so inflows that will still be needed are forthcoming.

If we don’t, the rand will come under severe downward pressure. Inflation and interest rates will rise and the economy will experience very painful readjustment, as a rapidly weakening exchange rate reduces consumption and investment levels, with negative consequences for much needed economic growth and job creation.

In the past, we weathered boom and bust cycles driven by global changes, but the future isn’t what it used to be. Our fate will be determined by the extent to which we are able to make ourselves attractive to foreign investors and harness domestic economic forces for growth and prosperity. Our destiny rests in our own hands.

Keeton is with the economics department at Rhodes University.

Source: Business Day