Dawie Roodt shares good news about the South African rand

The lower inflation target for the Reserve Bank will lead to a decline in inflation expectations and a more stable currency, which will make it more attractive for foreigners to invest in South Africa.

This, in turn, will result in increased investment in South African assets by foreign investors, increasing demand for the rand and strengthening the currency. 

Over time, this can create a positive flywheel whereby a stronger and more stable currency will make it cheaper for South Africa to import goods, limiting inflation further. 

This will enable the Reserve Bank to cut interest rates more substantially as inflation will be structurally lower, boosting the economy. 

Efficient Group chief economist Dawie Roodt recently explained to BizNews how a lower inflation target can translate into a stronger rand. 

Roodt said the main benefit will be a more stable currency as the rand will no longer have to weaken to make up for South Africa’s declining competitiveness. 

“Currency volatility is a price that we pay in South Africa. Now, with inflation being lower and people believing inflation will remain low, that volatility is reduced,” Roodt said. 

“This makes it easier and cheaper to trade internationally using the rand and for foreigners to invest in local assets using the rand.” 

This is where the real benefit of a more stable currency comes from, with there no longer being a cost, in terms of inflation eroding purchasing power, associated with investing in South African assets. 

As a result, this will make investing in South Africa more attractive as the returns on any investment will not be lost to a weaker currency upon conversion. 

“Foreigners do not want to buy our bonds because they buy the rand and then the bonds, running a risk that when they sell the bonds and take the money out of the rand, it has weakened and they have lost on the deal,” Roodt said. 

“But, if foreigners believe that our inflation rate is going to be relatively low and stable, that means the exchange rate will be relatively stable, and they are likely to take more of a chance on South African bonds and equities.” 

South Africa desperately needs foreign investors as the country’s savings rate remains extremely low relative to developed economies, making it difficult to fund investment using only domestic sources. 

A more mature rand

Roodt’s comments point to the rand becoming a more mature currency in comparison to its historical moniker of “the rattler” due to its immense volatility. 

Given South Africa’s sophisticated and relatively deep capital markets, the rand is often traded as a proxy for broader emerging market sentiment. 

This results in it being highly volatile and susceptible to swings in commodity prices, which underpin its value and prevailing sentiment towards emerging markets. 

The lowering of the inflation target aims to reduce this volatility by bringing South Africa’s inflation more in line with its global peers. 

Regarding this, Roodt’s comments echo those of Reserve Bank Governor Lesetja Kganyago, who has made it clear that the rand is no longer the volatile currency it once was. 

Kganyago has explained that the rand is settling down into a “more mature stage of life”, saying the currency deserves more respect for its stability in recent times. 

“When people tell you the rand is a weak and volatile currency, encourage them to think again,” he said.

“I would also like more people to recognise that rand volatility has declined. Option-implied volatility is now at long-term lows.”

“Yet, outside of financial markets, most people still believe the rand is a highly volatile currency. The only problem with this view is that it no longer describes the facts in front of us.”

Kganyago has explained that the rand’s recent stability stems from South Africa’s lower inflation over the past year, which is more in line with developed markets. 

It is important for this to continue over the long run, as investor confidence in South Africa will not be built overnight. 

The Reserve Bank remains a highly credible central bank, but to maintain this credibility it has to achieve its new, lower inflation target consistently. 

Analysts also note that a lower inflation rate and improving government finances mean the rand’s strength is increasingly in South Africa’s hands. 

Historically, the rand’s strength has largely been attributed to factors outside of the country’s control, such as a weaker United States dollar.