Good news about the rand

The rand has weakened significantly against major global currencies over the past two decades, with its value declining steadily by around 5% per annum. 

This was expected to boost the competitiveness of local exports, but has failed to result in meaningful improvements due to South Africa’s relatively high inflation rate. 

The rand’s weakness and the impact of elevated inflation were outlined by Reserve Bank researchers Christoper Loewald, Rudi Steinbach, and Jeffrey Rakgalakane. 

In a white paper outlining the benefits of a lower inflation target, the researchers explained how South Africa’s relatively high inflation has contributed to weakening the rand. 

The paper has been released amid advanced discussions between the Reserve Bank and the National Treasury about the lowering of the inflation target. 

There are expected to be wide-ranging benefits, including better price stability, increased inflows into local assets, improved economic growth, and eventually lower interest rates. 

However, these are expected to come with some short-term pain in the form of elevated interest rates for longer to keep inflation at a lower target. 

This may limit economic growth in the short term, the researchers said, but only to a small degree as interest rates begin to decline to lower levels in the long run. 

One of the significant benefits of a lower inflation target is expected to be a stronger rand as it will attract more investment into the country by making local assets more attractive. 

It will also move South Africa in line with its peers and more developed economies, creating a more level playing field. 

The current inflation target range of 3% to 6% is too broad and high for the rand’s weakness to boost local export competitiveness, the researchers said. 

“Maintaining or improving competitiveness requires preventing continuous real currency appreciation, caused by domestic prices rising faster than those in trading partners,” they said. 

“In South Africa’s case, relatively higher inflation has meant that nominal exchange rate depreciation has failed to translate into meaningful competitiveness gains.”

However, if the Reserve Bank can achieve a lower inflation target and maintain it, then a weakening of the nominal exchange rate will result in a depreciation of the real exchange rate and a better export performance. 

Currently, the rand is weakening at a similar rate to the country’s headline inflation, limiting any benefit of a weaker currency for exports. This can be seen in the graph below. 

The rand’s collapse

The lower inflation target should be able to undo some of the rand’s steady weakening over the past two and a half decades. 

This is because one of the primary reasons why the currency has weakened is the country’s relatively elevated inflation rate compared to its peers and developed economies. 

While the rand’s value can swing wildly in either direction, its long-term decline has been quite steady and predictable over the past decades. 

This is because a currency’s value is largely determined by the performance of the local economy, the country’s trade balance, and inflation. 

The rand’s constant depreciation since 2000 thus reflects a gradual decline in confidence in the South African economy and its elevated inflation rate. 

Over the past few decades, South Africa’s headline inflation rate has been higher than that of its developed counterparts, requiring a degree of currency depreciation to ensure the country’s exports remain competitive. 

While many of South Africa’s peers target a 3% rate of inflation, it has maintained a range of 3% to 6% since 2000 despite plans to lower it gradually over time. 

As inflation raises the cost of producing exports, they become less attractive than cheap alternatives. To counteract this, a currency is deliberately weakened to make the country’s exports relatively cheaper on the global marketplace.

These longer-term factors have been coupled with short-term hits for the rand, with rising global and political uncertainty accelerating its steady weakening. 

Investors tend to sell out of riskier emerging market assets amid periods of global uncertainty, preferring ‘safe havens’ such as the United States, Europe, and Japan. 

This results in the weakening of emerging market currencies, such as the rand, as investors dump local equities and bonds.