Since 1994, the South African rand has experienced a significant decline against the US dollar, falling from R3.58/US$ to over R18/US$. This steady weakening is largely attributed to the rand’s volatility, as it often reflects investor sentiment towards emerging markets and commodities.
The value of the rand fluctuates widely based on the global economic outlook and investors’ risk tolerance. Despite these fluctuations, the long-term trend shows a consistent decline against the US dollar.
The Bureau for Economic Research (BER) highlighted the rand’s depreciation over the past 30 years in its macroeconomic review of South Africa. The BER pointed out that the primary driver behind the rand’s decline is South Africa’s high inflation rate compared to other countries. To keep the country’s exports competitive globally, the currency needs to depreciate. As inflation increases production costs, South African exports become less attractive compared to cheaper alternatives. A deliberate weakening of the currency makes these exports relatively cheaper on the international market.
Additionally, the BER identified South Africa’s current account deficit – where the country imports more than it exports – as a significant factor contributing to the rand’s weakness. This deficit leads to money flowing out of the country, reducing demand for the local currency and thus weakening it. A key factor in this scenario is the declining output from South Africa’s mining sector, historically the nation’s largest exporter.
The weakened rand exacerbates the issue by increasing the cost of imports, fueling inflation, and further eroding the competitiveness of South African exports.
The South African Reserve Bank employs monetary policy to manage inflation and prevent it from spiraling out of control. Higher interest rates are a key tool in this effort, as they help reduce inflation in several ways. By raising borrowing costs and making saving more attractive, higher interest rates curb economic demand.
Additionally, higher interest rates can strengthen the rand, making imports cheaper and thus reducing inflation. A higher interest rate improves the return on rand-based investments, particularly fixed-income investments, making them more attractive compared to investments in other currencies. This leads investors to allocate more capital towards South African assets, boosting demand for the rand and increasing its value.
However, the Reserve Bank’s ability to counter the rand’s weakness is limited by the government’s poor financial health. Since the 2007/08 financial year, South Africa’s government has consistently run budget deficits, spending more than it collects through taxes. While budget deficits are not inherently problematic, persistent deficits lead to a growing debt burden and soaring debt-servicing costs.
In 2008/09, South Africa’s gross loan debt was R627 billion, or 26% of GDP, with net loan debt at R526 billion, or 21.8% of GDP. By the most recent Budget Speech, gross loan debt had surged to R5.21 trillion, or 73.9% of GDP. The government now spends over R1 billion a day on interest payments for its loans.
This escalating debt diminishes the government’s creditworthiness, making investors reluctant to lend money unless higher interest payments are offered. Consequently, rating agencies have downgraded South Africa to below investment grade, prompting capital outflows that further weaken the rand.
Source: DailyInvestor
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