EXPLAINER: Why you should care about the rand-dollar exchange rate

The rand has been breaking records this week. It breached the R19.00/$ mark on Friday following a further downgrade into junk status by ratings agency Fitch. Some analysts are warning that it could breach the R20/$ mark in the near term.

If you’re wondering why you should care about the local unit’s movements, with the help of the SA Reserve Bank, a few economists and trading analysts, we’ve got your questions covered.

What is an exchange rate?

The exchange rate is the rate at which one country’s currency is exchanged for another. For example, if the rand-dollar exchange rate is R18, it means that to buy one US dollar, you would have to pay R18.

It’s important to know how much the dollar, pound or euro will cost you – especially if you are going to travel to these countries. It will help you plan how much you will spend during your time abroad.

Or some people even buy other currencies so that they can make money – that is to say, you would buy the US dollar with the expectation that if you had to exchange it for rands again in future, you would receive more than what you paid for it.

It also has implications for how much we pay for oil. So, if the oil price is $30 per barrel, and if the current exchange rate is R18… essentially, it would cost South Africa a steep R540 to import one barrel of oil. This in turn impacts the domestic fuel price. 

Who or what determines the exchange rate?

The exchange rate of the rand is determined by “market forces”, according to the Reserve Bank.

The buying and selling rates for dollars, are based on the supply of and demand for dollars in the market at any given time.

Sometimes, the Reserve Bank may “intervene” in the market to purchase and sell dollars – if it is in line with monetary and exchange rate policy. The bank’s intervention would be  to “smooth out unduly large short-term fluctuations” in money-market liquidity and the exchange rate.

How has the Reserve Bank “intervened” in the market?

Back in 1996, the bank supplied the foreign-exchange market with dollars, as a large demand for foreign exchange at the time threatened to disrupt the market and would potentially cause the depreciation or the weakening of the rand.

More recently, the Reserve Bank, for example, bought government bonds in order to help manage liquidity in the financial system as the country embarked on a 21-day lockdown to slow down the spread of Covid-19.

But the purchasing of government bonds is not equivalent to a quantitative easing strategy as implemented by its US counterpart, the Federal Reserve Bank, Investec chief economist Annabel Bishop pointed out in a currency note issue earlier this week.

Citing the Reserve Bank, Bishop said that quantitative easing is applied when interest rates are zero or close to zero. SA’s interest rate s are nowhere near zero – the repo rate is 5.25{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2}. QE is also implemented when inflation is far below the target range of the central bank and threatening to turn negative. For now, current inflation levels are within the Reserve Bank’s 3{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} to 6{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} target band.

Some countries have implemented quantitative easing to raise the level of inflation, but the SA Reserve Bank is not doing this, said Bishop. “South Africa does not have interest rates at or close to zero and the SARB is therefore not using this tool as a means to stimulate demand,” she explained.

The Reserve Bank’s interventions have been purely to inject liquidity in the market and to ensure its smooth functioning. It is not an economic-stimulus intervention, said Bishop.

What else influences the exchange rate?

The country’s status of transactions with the rest of the world, or its balance-of-payments – is a “direct determinant” of the exchange rate, according to the Reserve Bank.

Demand for foreign currency arises when we need to import goods or pay for services or return capital we borrowed. Supply of foreign currency arises when we export goods and services and receive an inflow of foreign capital. If the inflow of foreign exchange is greater than the outflow, then the supply exceeds demand – the rand will appreciate or strengthen against other currencies in these instances, according to the Reserve Bank.

Apart from the balance-of-payments position, the exchange rate is also influenced by the difference in inflation between SA and that of its trading partners. If the inflation rate in SA is higher than that of its major trading partners or international competitors, domestic producers will lose their “competitive edge” and consumers might opt to import cheaper goods instead of buying local. “This will reduce South Africa’s exports while the demand for imports will rise, the demand for foreign currency will increase, foreign currency will become relatively scarce and more expensive, and the rand will depreciate against other currencies,” the Reserve Bank explained.

Political developments, “unfounded rumours” and “unfavourable perceptions” about SA may also influence the exchange value of the rand – which may not necessarily reflect the balance of payments position or the country’s comparative purchasing power.

Why has the rand been weakening lately?

In recent days, the rand and other emerging market currencies’ values have been beaten down, as safe haven currencies such as the US dollar have been favoured. Investors are viewing emerging market currencies as risky, as we are about to enter into a global recession.

“The ongoing worry about the Covid-19 pandemic and the extension of lockdowns in the US and the EU has market players very nervous,” TreasuryONE’s chief of dealing Wichard Cilliers told Fin24 earlier this week. “The growth across the world will be very negatively impacted by the virus and thus are market players very nervous to take on emerging market risk,” Cilliers explained.

While there are expectations of a global recession, there is also uncertainty on the ability to contain the spread of Covid-19 and for how long the global economy will be affected. The global economy is expected to only recover in 2021, Bishop told Fin24 on Friday. “Today [Friday] there are renewed worries over the length and severity of the pandemic, seeing some further elevation in global risk aversion,” she said. 

According to Bishop, the depreciation of the currency also reflects the negative perception foreigners have of the country’s growth outlook and corporate earnings. 

A downgrade of SA’s credit rating by Moody’s to junk status last week has also dealt a blow to the rand, highlighting the risk associated with investing in SA and its government bonds. Moody’s raised concerns of the country’s growth prospects, mainly due to the uncertainty on the extent of the economic impact caused by the Covid-19 pandemic, and other “domestic impediments” to growth.

Moody’s was the last ratings agency that had SA’s credit rating ranked at investment grade. Being junk status means that the ratings agency has doubts that we could repay our debt, which sends a signal to investors and potential lenders. The country will have to be excluded from the FTSE World Government Bond Index by the end of April, as the index does not allow junk-rated bonds. This will trigger a sell-off of government bonds.

Analysts in November 2019 predicted outflows of as much as between $8 billion and $12 billion, but this might be smaller, due to the recent market sell-off in recent months as a result of Covid-19 fears, Momentum Investments economists noted.

Most bonds that will be sold are held in rands – Business Insider reports that investors will resort to selling rands in order to take their proceeds out the country. This has already placed pressure on the rand, which had weakened more than 6{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} since the Moody’s downgrade last week Friday.

Why should we care if the rand gets weaker?

A weaker rand could increase the cost of imports, economists have warned.

“For South Africa, rand weakness means higher prices for a number of goods in the shops that are imported – including electronic equipment and some wheat products,” said Bishop. Momentum Investments warned that higher costs of imported goods could raise inflation. This can limit the Reserve Bank’s ability to cut interest rates.

The weaker rand can also impact government’s ability to address the Covid-19 crisis. Deputy Health Minister Joe Phaahla, at a briefing on Friday, warned that a depreciating currency would also impact the costs at which we can import much-needed medical equipment.

Phaahla said the country is working to procure personal protective equipment for healthcare workers as well as other medical supplies from China. The demand for medical supplies has increased as Covid-19 has spread across the world.

“The demand for the goods from other countries is also a factor that contributes to these difficulties. We have to purchase these using foreign currency. The more the rand depreciates the more it limits our ability to purchase these items,” he said.

Source Article