Look forward to rand that remains weak in foreign exchange markets this year.
I know from experience that predictions about exchange rates are futile, but my intuition is that South Africa should learn to live with a rand-dollar exchange rate of R14 to R15.
As I write this, the dollar is around R16, a bit too weak perhaps, giving some room to recover. The trend of the rand has been downwards for the last 10 years, but it appears to have overshot the mark in its depreciation recently and could rebound. See Graph 1.
Also, we tend to move in line with the Australian dollar, and the $/rand and the $/Aussie rates have diverged markedly, also recently. See graph 2.
But if the rand recovers, will it go back to R6 or R7 to the US dollar? I hope not.
Why I think the rand-dollar exchange rate should be at least $1 = R11 or so is simple: South African inflation is higher than that of our trading partners, including the US.
What is forgotten is that in the West for some time now inflation has been well under control. It is so low that it is not a matter for discussion. In fact it has dropped so low that the new fear is deflation, which is when a currency becomes stronger not weaker day by day. It’s buying power increases, so that buyers defer their purchases, leading to company closures, further buying power increases and so on in a deadly spiral.
South Africa on the other hand has struggled to contain inflation, which at times moved well out of the 3% to 6% target set by the SA Reserve Bank. We have no reason to fear deflation.
You can see how this would affect the exchange rate. If we have higher inflation than the US, our currency is worth relatively less and has to depreciate.
Take the following example. An American tourist visits South Africa in the year 2001 and pays R500 for a one-night stay at a bed and breakfast establishment. He returns towards the end of 2015 and wants once more to stay at the same establishment. Over the course of the 15 years South African prices have more than doubled. The have risen by 126%. US prices have risen too, but by a more modest 36% or so.
When our hypothetical tourist arrived in 2001 he got R7,57 for every dollar he exchanged (also hypothetically, since this is the rate recorded by the Reserve Bank, not the lower amount the bureaux de change offer). So he paid around $66 for his room.
If the dollar rand exchange rate had not fallen over the 15 years, the returning US tourist would exchange his dollars at the same rate of R7,57 and pay for the same room more than double the amount of dollars, $136 instead of $66, because SA inflation has boosted the cost of the room to R1 130.
Of course, his dollars are worth less than they used to be 15 years ago. US inflation means that $66 bought in 2001 needs around $91 to buy today, so perhaps our tourist would take that into account. He would still be paying for the room, in nominal dollars, more than double what he paid in 2001, and whatever way you look at this, it is not a bargain.
Remember that many other countries in the world are desperate for tourism dollars, including financially troubled Greece, and if their currencies don’t come to the rescue they have to take the pain of absorbing inflated costs and cut their prices.
What the B&B the tourist returns to should be doing is charging the equivalent of $66, which is what the room cost the first time round and a deep discount, adjusted for inflation. And that is almost exactly the amount the tourist will spend at the current weak rand.
By my calculations the exchange rate implied by the inflation differential between the US and South Africa should be R14,50 to the dollar. That’s quite a bit more uncomfortable for our iPad-toting lovers of imported food than R6 or R7 to the dollar. It is also the point: as all things Apple once more become unaffordable, we have to learn to live with hardware and software that isn’t the latest, try to buy cars that are not completely reliant on imported spares – some are supposedly assembled here with local content – and generally buy local.
It should spur import-substitution, where that is possible. A lot of the taste for foreign goods is probably snobbery. If South Africans can make Mercedes Benz cars and BMWs for export, I don’t see why we can’t make goods of a quality that we want to consume. I wouldn’t dream of buying foreign wine on a regular basis when good South African wines are available. And why we can’t farm enough chicken in a way that competes with US chicken imports, especially with a devalued rand making those chicken imports expensive, is beyond me and others.
The rather panicky coverage of the fall of the rand should not surprise us. It doesn’t help that there is panic in the air globally, with overseas analysts warning of a replay of the global financial crisis. If this is so, the floating exchange rate is playing the role intended, which is to act as a shock absorber for economic crisis.
A weaker rand does mean that higher inflation is certain, at last in part because our oligopolistic economy ensures that imported inflation is passed on the consumer, and in part because we have not psychologically accepted that inflation is an evil and that informal indexing makes it impossible to drive inflation down to the level of two or three percent.
Higher inflation means higher interest rates, but not as high as they would have to be to decisively protect the foreign exchange value of the rand, as in the Asian crisis of the late 1990s. Truly high rates would kill off inflation too, along with the economy, so the South African Reserve Bank will not be too ambitious.
The South African economy has been through worse, although its travails were self-inflicted in previous decades under apartheid. This time round the country is not having to live with the immediate aftermath of having pursued war on its borders and having expensively Balkanised the country into corrupt homelands.
*An important caveat: none of this is financial advice, nor should it be understood as such. I am an economics journalist, not a financial adviser and these are simply ideas.