The rand is one of the world’s most volatile currencies, which limits the country’s growth by preventing local firms from engaging in long-term investments and scaring away foreign investors.
This is according to a report by the International Monetary Fund (IMF) and Pieter Faber, a senior executive at the South African Institute of Chartered Accountants.
South Africa’s rand is traded in large volumes globally and is seen as a proxy for emerging market investment. It makes the currency highly exposed to external shocks and, thus, highly volatile.
According to the IMF, the rand is one of the most volatile currencies globally compared to advanced economies and emerging market peers.
Only the Russian rouble and Argentinian peso have been more volatile in the last decade.
The South African Reserve Bank (SARB) tried to absorb the external shocks to the currency and prevent them from affecting the local economy.
It does this by tightly regulating the financial sector to ensure it is sound and well-capitalised, while the National Treasury minimises the effect of these shocks by ensuring the majority of South Africa’s debt is rand-denominated.
However, the SARB and Treasury cannot counteract the effect of South Africa’s poor economic performance on the currency and the effect of policy uncertainty.
How to stabilise the rand
The SARB can only absorb short-term shocks arising from the rand’s volatility. It cannot hold enough reserves to ensure long-term stability as the rand is so heavily traded.
According to Pieter Faber, what determines a currency’s long-term stability are the underlying structural forces in an economy.
For a currency to be stable, it is vital to have a growing economy, stable macroeconomic policy, investor security, and political stability.
The IMF identified policy uncertainty and political instability as the central factors that make the rand so volatile.
Of equal concern for Faber is that, while the rand is volatile, it has also been consistently losing value. Over the last 15 years, the rand has lost over half its value – from R7.17/$ in 2007 to R18.42/$ in 2023.
This makes it incredibly difficult for foreign investors to gain a real return on their investments in South Africa.
Investors want a currency to be stable over a five to ten-year period so that their real returns on investments can be predictable.
The benefits of a stable currency
Faber said that it is not about whether a currency is strong or weak, as an economy can do well regardless. For instance, the United States performs well with a strong currency, while China performs well with an undervalued currency.
What matters is whether the currency is stable as that attracts foreign investment, increases trust in the government, and typically means the country’s economy is performing well and is politically stable.
If a currency depreciates consistently over time, as the rand has done, it makes it difficult for investors to generate a real return in foreign currencies, particularly over the long term.
This is echoed by the IMF, which noted that a volatile rand prevents firms, particularly small and medium enterprises, from engaging in long-term investments as the returns are unlikely to beat inflation and rand depreciation.
This limits foreign direct investment in South Africa, which has declined in tandem with the currency over the last 15 years. This results in stunted economic growth.
According to Faber, the only way companies can generate a real return in dollar terms in South Africa is through acquisition.
This results in consolidation from large companies, which can be seen in the precipitous decline in the number of listed companies on the Johannesburg Stock Exchange.
However, the IMF points out that South African corporates are used to operating with a volatile currency. So there are few local companies that are in distress due to currency fluctuations.